CONMED Corporation 10-Q Summary
Reporting period: Three and six months ended June 30, 2011; filed July 29, 2011. CONMED is a medical technology company focused on minimally invasive surgical devices, equipment and monitoring products. Approximately 51% of second-quarter sales and 50% of first-half sales were to customers outside the United States.
Financial Performance and Position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $183.2 million | $181.1 million | $366.7 million | $357.5 million |
| Gross profit | $91.5 million | $93.7 million | $187.2 million | $185.5 million |
| Gross margin | 49.9% | 51.7% | 51.0% | 51.9% |
| Income from operations | $16.7 million | $14.8 million | $34.0 million | $28.3 million |
| Operating margin | 9.1% | 8.1% | 9.2% | 7.9% |
| Net income | $8.7 million | $7.3 million | $17.7 million | $14.6 million |
| Diluted EPS | $0.30 | $0.25 | $0.61 | $0.50 |
- Second-quarter sales increased 1.2%; first-half sales increased 2.6%. On a local-currency basis excluding hedging effects, sales decreased 0.3% in the quarter and increased 1.9% year to date.
- Single-use product sales grew 3.5% in the quarter and 3.0% for the first half. Capital equipment sales declined 6.5% in the quarter but increased 1.2% for the first half, reflecting hospital capital-spending constraints.
- Cost of sales increased faster than quarterly revenue, reducing gross margin by 1.8 percentage points. Management attributed the decline principally to unfavorable manufacturing variances from lower production levels in the fourth quarter of 2010.
- Selling and administrative expense declined 5.1% in the quarter and 2.9% year to date, reflecting restructuring and cost controls that more than offset adverse foreign-exchange effects. Research and development expense increased modestly to $6.8 million in the quarter and $14.5 million year to date.
- Net cash provided by operating activities was $40.2 million for the first six months, compared with $5.5 million in 2010. Capital expenditures were $8.6 million, and management expected approximately $20.0 million of capital expenditures for full-year 2011.
- Cash and cash equivalents were $24.3 million at June 30, 2011, compared with $12.4 million at December 31, 2010. Net working capital was $157.8 million.
- Total debt recorded on the balance sheet was $174.7 million, including $144.1 million classified as current and $30.6 million classified as long term. The company had $54.3 million outstanding under its term loan and no revolving-credit borrowings; approximately $240.2 million of revolving capacity was available, net of letters of credit.
- Shareholders’ equity increased to $616.7 million from $586.6 million at year-end 2010. Weighted-average diluted shares declined to 28.9 million in the quarter and 28.8 million year to date.
Material Changes Versus Prior Period
- The principal operating segment, comprising Linvatec, Electrosurgery and Endosurgery, reported second-quarter sales of $154.1 million, up 1.6%, and first-half sales of $309.0 million, up 3.3%. First-half operating margin improved to 14.5% from 12.9%.
- Arthroscopy sales declined 5.7% in the quarter and 0.7% year to date, driven primarily by lower video-imaging and capital-equipment sales. Powered Surgical Instruments, Electrosurgery and Endosurgery sales increased.
- Patient Care sales declined 5.1% in the quarter and 4.3% year to date. The segment recorded an operating loss of $1.0 million in the quarter and $1.7 million year to date, compared with operating income in the prior-year periods.
- Endoscopic Technologies improved to operating income of $0.4 million in the quarter and $0.2 million year to date, versus losses in the comparable periods.
- Restructuring costs charged to cost of sales were $1.0 million in the quarter and $1.7 million year to date. Administrative consolidation costs were $0.1 million and $0.8 million, respectively. Management estimated total 2011 restructuring costs of approximately $4.0 million to $5.0 million.
- The effective tax rate was 37.5% in the quarter versus 38.5% in the prior-year quarter, but 37.4% for the first half versus 35.4% in the prior-year period. The year-to-date comparison was affected by a 2010 IRS examination settlement.
- Foreign-currency translation increased accumulated other comprehensive income, while cash-flow hedging produced a $0.8 million year-to-date loss in other comprehensive income. Hedging contracts had aggregate notional amounts of $99.6 million at June 30, 2011.
Outlook, Risks and Unusual Items
- Management was cautiously optimistic about improving economic conditions and the return to revenue growth, but stated that the recovery might not be sustained.
- Restructuring and manufacturing transfers to Mexico were continuing. Expected benefits and completion timing were uncertain, and additional employee termination and exit costs were possible.
- The $112.1 million principal amount of 2.50% convertible senior subordinated notes is subject to holder put rights on November 15, 2011, 2014 and 2019. The company planned to use its revolving credit facility if the notes were put in November 2011. The notes mature in 2024 and had an initial conversion price of $38.19 per share.
- The company was in compliance with its senior credit agreement covenants at June 30, 2011. Scheduled term-loan principal payments include $31.7 million due June 30, 2012 and $21.5 million due September 30, 2012.
- Key risks include hospital capital-budget constraints, foreign-exchange and interest-rate volatility, competition, product acceptance, material costs, regulatory actions or recalls, patent and product-liability litigation, environmental obligations, acquisition integration and potential goodwill or intangible-asset impairment.
- Pending legal matters were described as ordinary-course claims and investigations. Management did not expect them to have a material adverse effect, but noted that future uninsured claims or investigations could be material. Product-liability insurance was $25 million per incident and $25 million in annual aggregate coverage.
- The company expected to contribute approximately $2.1 million to its pension plan in 2011, of which $0.5 million had been contributed during the second quarter.
Investor Verification Points
- Verify the timing and financing of the November 2011 convertible-note put opportunity and the company’s subsequent debt maturities.
- Assess whether gross-margin pressure from prior production variances is temporary and whether restructuring achieves the projected savings.
- Monitor Patient Care’s operating losses and the recovery of Arthroscopy capital-equipment demand.
- Reconcile operating cash flow with working-capital movements and confirm that the expected $20.0 million of 2011 capital expenditures remains appropriate.
- Review foreign-exchange exposure, hedging losses and the sensitivity of reported sales and earnings to currency movements.
- Evaluate potential impairment risk for $294.9 million of goodwill and $186.9 million of other intangible assets, particularly in lower-margin businesses.
- Confirm developments in regulatory, product-liability, patent, environmental and tax matters, including the adequacy of insurance and reserves.