Business Context and Reporting Period
CONMED Corporation is a medical technology company focused on surgical devices and equipment for minimally invasive procedures and monitoring, serving orthopedic, general surgery, gynecology and gastroenterology markets. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods.
Key Financial Metrics
| Metric | Q3 2014 | Q3 2013 | First 9 Months 2014 | First 9 Months 2013 |
|---|---|---|---|---|
| Net sales | $175.0 million | $179.3 million | $545.1 million | $559.3 million |
| Gross profit | $96.4 million | $95.4 million | $300.0 million | $301.0 million |
| Gross margin | 55.1% | 53.2% | 55.0% | 53.8% |
| Income from operations | $2.4 million | $8.8 million | $35.7 million | $40.3 million |
| Net income | $2.0 million | $5.7 million | $20.9 million | $25.7 million |
| Diluted EPS | $0.07 | $0.20 | $0.75 | $0.91 |
| Operating margin | 1.4% | 4.8% | 6.5% | 7.2% |
| Net margin | 1.1% | 3.0% | 3.8% | 4.6% |
- Operating cash flow was $39.5 million for the first nine months of 2014, down from $53.6 million in 2013. Higher inventory, partly associated with anticipated fourth-quarter product launches and lower-than-forecast sales, was a principal use of cash.
- Capital expenditures were $12.3 million; management expected approximately $16.0 million for full-year 2014.
- Cash and cash equivalents were $64.6 million at September 30, 2014, compared with $54.4 million at December 31, 2013.
- Net working capital was $263.6 million. Inventories increased to $162.1 million from $143.2 million at year-end 2013.
- Total debt was approximately $248.0 million, including $241.0 million drawn under the $350.0 million revolving credit facility and a $7.0 million mortgage note. Available revolver capacity was $103.6 million, including approximately $5.4 million reserved for letters of credit.
- The company was in compliance with its debt covenants at September 30, 2014. Weighted-average borrowing rates were 2.38% in the quarter and 2.41% year to date.
- Dividends were $0.20 per share in the third quarter and $0.60 per share year to date. The company repurchased $16.9 million of common stock during the first nine months, with $37.4 million remaining under the authorized repurchase program.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales decreased 2.4%; nine-month sales decreased 2.5%. Local-currency sales, excluding hedging effects, declined 2.6% in the quarter and 2.3% year to date.
- Quarterly sales declined across all product lines: orthopedic surgery fell 2.9%, general surgery fell 0.3% and surgical visualization fell 9.4%. Year-to-date surgical visualization sales declined 14.5%, primarily as customers awaited the IM8000 2DHD camera system.
- Capital equipment sales declined 2.4% in the quarter and 5.1% year to date; single-use product sales declined 2.4% and 1.9%, respectively.
- Gross margin improved due primarily to savings from completed operational restructuring. Selling and administrative expense also declined, while year-to-date research and development expense increased 6.6%.
- Operating income and net income declined substantially because of higher unusual expenses. Third-quarter other expense was $14.5 million, including an $11.0 million executive management restructuring charge and $2.4 million of shareholder-activism costs.
- Interest expense increased because of higher average borrowings and borrowing rates.
- The nine-month effective tax rate increased to 33.0% from 28.4%, including a $2.3 million non-cash write-off of New York State deferred tax assets following tax-law changes. The quarterly tax benefit produced a negative effective tax rate of 116.9%.
Guidance, Outlook, Risks and Unusual Items
- Management expected restructuring costs of approximately $4.0 million to $5.0 million during the remainder of 2014.
- Expected 2014 restructuring savings included approximately $3.0 million in cost of sales, $1.5 million in research and development and $1.5 million in selling and administrative expense. The Centennial consolidation was expected to generate an additional $3.5 million to $4.5 million of annual cost-of-sales savings after completion, but was not expected to be fully reflected for approximately 15 months.
- On July 30, 2014, CONMED acquired EndoDynamix for $1.3 million in cash and recorded $13.9 million of contingent consideration, including milestone payments and future royalties. The purchase-price allocation remained preliminary.
- The company accrued $33.3 million of remaining contingent obligations under its sports medicine distribution agreement with the Musculoskeletal Transplant Foundation; $16.7 million was due within the next fiscal year and the remainder in 2016.
- CONMED disclosed continuing exposure to foreign-exchange, interest-rate, regulatory, product liability, patent litigation, product development, competition, inventory obsolescence and acquisition-integration risks.
- The FDA issued a January 2014 Warning Letter related to a 2013 inspection of the Centennial, Colorado facility. CONMED stated that it had undertaken corrective actions, but noted that additional regulatory action, recalls, fines or sales restrictions could occur.
- The company settled the Bonutti Skeletal Innovations patent litigation for $0.9 million in April 2014. Other legal and settlement costs were also recorded during the year.
- Management stated that cash on hand, operating cash flow and available revolver capacity were expected to meet anticipated operating, capital expenditure and debt-service needs.
Investor Verification Items
- Verify whether sales weakness, particularly in surgical visualization and capital equipment, reverses following the IM8000 launch and other new-product introductions.
- Assess whether restructuring savings materialize as projected and whether remaining restructuring costs remain within the $4.0 million to $5.0 million estimate.
- Monitor inventory growth, operating cash conversion and working-capital requirements.
- Review leverage, revolver availability, covenant compliance and the effect of higher interest rates on debt service.
- Track the timing and amount of EndoDynamix milestone and royalty payments and the remaining MTF contingent obligations.
- Follow FDA remediation and any additional regulatory, product liability or patent matters.
- Evaluate the sustainability of reported earnings excluding the $11.0 million management restructuring charge, shareholder-activism costs, legal costs and tax-related items.