CONMED Corporation — Q3 2017 Form 10-Q Summary
Business Context and Reporting Period
CONMED is a medical technology company providing surgical devices and equipment for minimally invasive procedures across orthopedic, general surgery, gynecology, neurosurgery and gastroenterology specialties. The filing covers the three and nine months ended September 30, 2017, with comparative periods ended September 30, 2016. Approximately 80% of revenue is derived from single-use products, and international sales represented 48% of sales in both the quarter and year-to-date period.
Financial Performance and Position
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $190.1 million | $184.8 million | $573.8 million | $559.4 million |
| Gross profit | $102.5 million | $101.2 million | $307.1 million | $301.4 million |
| Gross margin | 53.9% | 54.8% | 53.5% | 53.9% |
| Operating income | $13.5 million | $13.8 million | $23.8 million | $25.1 million |
| Operating margin | 7.1% | 7.5% | 4.1% | 4.5% |
| Net income | $7.2 million | $7.3 million | $8.8 million | $8.0 million |
| Diluted EPS | $0.26 | $0.26 | $0.31 | $0.28 |
General surgery sales increased 7.1% in the quarter and 6.8% year to date, driven primarily by AirSeal, smoke management and endoscopic technologies. Orthopedic surgery sales declined 0.8% in both periods as growth in sports medicine single-use products was offset by lower capital equipment sales. Single-use sales grew 4.5% in the quarter and 3.7% year to date, while capital product sales declined 3.3% and 2.0%, respectively.
Cash and cash equivalents were $44.0 million at September 30, 2017, compared with $27.4 million at December 31, 2016. Net cash provided by operating activities was $44.8 million for the first nine months, versus $26.2 million in the prior-year period. Capital expenditures were $9.2 million, and investing cash outflows totaled $24.4 million, including $15.2 million for business and asset acquisitions. The company paid $16.7 million in dividends during the period.
Total debt was approximately $508.3 million, consisting primarily of $159.7 million outstanding under the term loan and $346.0 million under the revolving credit facility, plus a $3.2 million mortgage. Revolver availability was $175.6 million, with approximately $3.4 million reserved for letters of credit. The company was in compliance with its debt covenants. Net working capital was $217.4 million.
Material Changes Versus the Prior Comparable Period
- Sales increased 2.9% in Q3 and 2.6% for the first nine months; constant-currency growth was 2.4% and 3.0%, respectively.
- Gross margin declined 90 basis points in Q3 and 40 basis points year to date, primarily due to restructuring costs, product mix, manufacturing variances and foreign exchange effects.
- Operating income declined 2.7% in Q3 and 5.2% year to date, despite higher sales.
- Interest expense increased to $4.8 million in Q3 and $13.3 million year to date, reflecting higher borrowing rates. Weighted-average borrowing rates increased to 3.68% and 3.44%, respectively.
- The effective tax rate decreased to 16.9% in Q3 and 15.8% year to date, compared with 26.5% and 25.5%, respectively, primarily due to tax benefits related to SurgiQuest acquisition matters, state tax benefits and stock-based compensation accounting.
- Operating cash flow improved substantially, while 2016 investing cash flow included $256.5 million of payments for the SurgiQuest acquisition.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide explicit revenue or earnings guidance. Management expects 2017 capital expenditures to approximate $15.0 million and states that operating cash flow, cash on hand and available revolver capacity should be adequate for working capital, debt service, capital expenditures and potential share repurchases in the foreseeable future.
CONMED continued its operational restructuring program, recording $1.3 million of inventory write-offs in Q3 and $2.8 million of restructuring costs year to date. Additional restructuring, employee termination and exit costs may be incurred. The company also accrued $12.2 million related to a jury verdict in the SurgiQuest-Lexion litigation, comprising $2.2 million of compensatory damages and $10.0 million of punitive damages. CONMED was evaluating an appeal.
EndoDynamix sellers filed a Delaware Chancery Court action seeking approximately $12.7 million in accelerated contingent and royalty payments. CONMED disputes the claim and expects to defend it. The company also identifies risks related to product liability, patent and other litigation, regulatory and FCPA compliance, foreign exchange and interest rates, competition, product acceptance, acquisitions, materials availability and allograft tissue supply.
CONMED adopted several accounting updates in 2017. It plans to adopt the new revenue recognition standard on January 1, 2018 using the modified retrospective method and does not expect a material impact on net income or EPS, although certain group purchasing organization fees will move from selling and administrative expense to a reduction of revenue. Management was evaluating the impact of the new lease and other standards.
Important Facts for Investors to Verify
- Whether general surgery growth, particularly AirSeal, can offset continued weakness in orthopedic capital equipment.
- The sustainability of reported profitability after excluding litigation, restructuring, acquisition-related and other unusual items.
- The outcome and cash payment timing of the Lexion litigation appeal and the EndoDynamix contingent-payment dispute.
- Debt reduction, revolver utilization, covenant headroom and exposure to rising interest rates.
- Whether restructuring initiatives deliver planned cost savings without further material charges.
- The effect of the 2018 revenue recognition adoption on reported sales presentation and comparability.
- Future foreign exchange effects, given the company’s substantial international sales and outstanding currency hedges.