CONMED Corporation
Q4 2007 Earnings Call Transcript

Published: 10 Feb 2008

[Operator:]

Good day, ladies and gentlemen, and welcome to the fourth quarter 2007 CONMED earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. Joseph Corasanti, President and CEO. Please proceed, sir.

[Joseph Corasanti:]

Thank you very much. Good morning, everyone. Welcome to CONMED Corporation's fourth quarter 2007 earnings conference call. With me today is Rob Shallish, our Chief Financial Officer. After formal remarks, the call will be opened for questions. Before we begin, let me remind you that during this call, we will be making comments and statements regarding our financial outlook, which represent forward-looking statements that involve risks and uncertainties as those terms are defined under federal security laws. Our actual results could differ materially from our current expectations. Please refer to the risk factors and other cautionary factors in today's press release as well as our SEC filings for more details on factors that could cause actual results to differ materially. CONMED had a very strong quarterly performance. We exceeded our previously disclosed financial performance metrics that we had set for the company at the beginning of the year and again at the end of Q3. Here are the highlights. Sales increased 11.6% over the 2006 fourth quarter. The non-GAAP operating margin percentage grew 270 basis points to 12.3% in the fourth quarter of 2007 compared to the non-GAAP operating margin of 9.6% in the fourth quarter last year. Non-GAAP diluted earnings per share grew 33% to $0.44 per share from $0.33 per share non-GAAP comparative figure in the 2006 fourth quarter. After-tax income increased 36% when comparing this year's fourth quarter non-GAAP income to last year's fourth quarter non-GAAP amount. Cash from operations for the quarter was equal to $31.8 million or $1.09 per share. For the full year, cash from operations was $67.2 million or $2.32 per share. We've previously stated our expectation for the foreseeable future that company's revenue growth should outpace operating expense growth, thus creating margin and bottomline expansion in excess of topline growth. In our just completed fourth quarter, the company's revenues increased 11.6%, while selling, administrative and research expenditures increased 3.1%. Given our recent results, we've clearly demonstrated our ability to improve our profitability and thus expect to see additional margin expansion. Now, I will review each of our product lines in more detail. CONMED's arthroscopy product line consists of minimally invasive medical devices designed to repair soft tissue injuries in the joints such as ACL repair in the knee and rotator cuff repair in the shoulder. This business is also referred to as sports medicine, because many of the injuries giving rise to the surgical repair are caused by sports activity. In the fourth quarter of 2007, this product line grew 31% overall and 26% in constant currency compared to the same period last year. For all of 2007, this product line grew 15.9% reported and 12.7% in constant currency. This was an exceptional quarter for our arthroscopy products and was driven by 9% growth in our core arthroscopy products, 45% growth in the imaging portion of the lines and an additional $9 million in sales of our integrated operating room systems. We believe this line's core business, consisting of new numerous surgical devices, screws and anchors for repair of soft tissue injuries, grew at a greater pace than the overall market for these items. Our surgical video systems led by our high-definition cameras and related equipment continued the rapid growth that we have seen all year. We believe our autoclavable high-definition camera systems provide the highest resolution and clarify available on the market today. The system operates at 1080p, the highest resolution possible, and provides an increased horizontal field of view with a 16-to-9 aspect ratio. This enables a surgeon to visualize a much wider portion of the surgical field than is possible with standard definition systems. We have received excellent feedback from surgeons to date and expect that demand for these superior products will continue at strong levels. Lastly, as I mentioned in our previous conference call in October, installations of our integrated operating room systems were finally completed after previous delays caused by customer requests. You'll recall that the integrated operating room systems are capital projects that upgrade standard operating rooms to state-of-the-art surgical suites. The systems include ceiling-mounted booms that hold the video monitors and other equipment, which is all controlled by a central touch screen computer console. In the third quarter of 2007, some of these installations were delayed and rolled into the fourth quarter. The other piece of our orthopedic business, the power surgical instruments line, which consists of electric battery and pneumatic powered surgical instruments used to perform orthopedic and other surgical procedures, continued producing strong sales with 7.9% increase in revenue for the fourth quarter and 8.8% increase for the year. We continue to see the benefits of the new products we introduced in 2006, including the MPower System, one of the most versatile battery-powered surgical instrument systems on the market today, and the MicroPower System for small bone surgery. Although our domestic sales in this category were somewhat softer than we anticipated in the fourth quarter, we experienced good growth from our international sales organization. Our endo surgery line had a great year in 2007, growing 11.6%. This line consists of products enabling minimally invasive surgery of the abdominal region without making a major incision. Endo surgery experienced a slight decline in fourth quarter sales compared to the fourth quarter of '06 due to reduced orders from international distributors. We do not believe this to be an indication of the any trend and has more to do with ordering patterns from distributors, which, as you know, can be lumpy from time-to-time. I would add that our domestic sales growth in this product group was in line with our internal projections and that international direct business in the UK, Canada and Australia had better than expected growth. The electrosurgery line consists of products used by surgeons to cut tissue and to cause hemostasis using RF electrical energy while performing surgery. As a technique, electrosurgery is used in 80% to 90% of all surgical procedures. Approximately 25% of our electrosurgery sales are capital equipment items, specifically generators, which convert wall current to radiofrequency electrical energy that is used to safely cut and cauterize tissue during surgery. The other 75% of our products in this electrosurgery line are single-use instruments used by the surgeon to achieve the desired surgical effect. We hold the number two market share position in this market. Electrosurgery experienced a sales decline of 14.2% in the fourth quarter and a decline of 5.8% for the year compared to the similar periods in 2006. As you may recall, this line experienced unusually strong growth of 10.6% in 2006 compared to the prior year. The difference in rates of growth, which mean this year and last year principally lies in sales of the generators in large-packets transactions. For example, in one quarter last year, we had $1 million sale of generators to a regional healthcare group in Western Canada. In 2007, we did not have nearly as many of these types of major transactions as we did in 2006, primarily because prospective customers appear to be taking longer in their decision-making process. More importantly, we've not seen any signs that we're losing larger transaction to the competition. Further, the performance in this line was hampered in the fourth quarter by inventory adjustments for one of the company's domestic distributors of single-use electrosurgery items. We believe this is only a temporary matter, because information from the distributor regarding end-user sales to hospitals demonstrate the sales consistency and hospital demand. As we look to 2008, we're expecting that our electrosurgery business will return to a positive growth pattern in part due to more traditional comparisons, but also because of the introduction of an innovative new line of surgical energy products expected to be launched in the fourth quarter of 2008. Our patient care line of products consists of heart monitoring electrodes, pulse oximetry monitoring, surgical suctions, tubing and various other devices used in clinical settings. Although sales in this line have been relatively flat for most of 2007, we experienced an increase of 9% in the fourth quarter, partially due to the addition of a recently acquired line of specialty heart monitoring disposables that carry gross margins higher than the average for this line. Over the last two years, this line has been affected by increased material costs, especially with regard to plastics, which have high petroleum content. In 2006 and continuing in 2007, we have increased prices in some case aggressively on these products when our contracts with hospitals have expired. We generally enter into three-year pricing contracts with our hospital customers. Additionally, we have increased prices on a variety of our products that are sold on an OEM basis. As a result of these prices increases, we have seen a decline in volume. However, because of pricing increases, manufacturing efficiency strategies that we initiated 12 months ago, we are seeing higher levels of profitability. So, we have seen gross profit dollars improve 20% in the fourth quarter and 15% for the year. As we look to the future of our patient care products, we will emphasize obtaining higher gross margins on the current line of products by continuing to be diligent with passing on our increased material costs, but at the same time, continuing to see seek out efficiencies in the manufacturing process. In 2008 and beyond, we also expect profitability improvements to be driven by new products for pulse oximetry and cardiac output measurement. The next product line I would like to discuss is endoscopic technologies. You may recall that this is CONMED's full line of GI endoscopy products. After several quarters of declining sales, due to manufacturing issues at a contract manufacturer, endoscopic technologies had sales increase of 6.3% in the fourth quarter when compared with fourth quarter of 2006. As indicated in my last conference call with you, we believe we have rectified the manufacturing difficulties experienced at the Mexican assembly operation. Consequently, the back orders for product have been eliminated, and we now have a ready supply of products. We expect that in 2008, we will experience growth over 2007 amounts with these products. Now, turning to our expense structure, the second part of our overall profit strategy involves keeping costs under control and finding ways to operate more efficiently. In the fourth quarter, while our sales grew 11.6%, SG&A and R&D expense grew only 3.1%, and that was due to sales commissions on higher year-over-year quarterly sales. This leveraging of our infrastructure resulted in expansion of our operating margin. Although the company's gross margin percentage declined slightly 50 basis points compared to the non-GAAP gross margin in the fourth quarter of 2006, this is solely attributable to product mix rather than any delay in the company's plans for gross margin improvement. Typically the company's capital product sales are approximately 25% of our total sales. The capital products generally carry gross margins less than the company's overall margin. This past quarter with the excellent sales of video systems and integrated operating room systems, capital products revenue was 32% of our total, causing downward pressure on gross margins. Absent this product mix shift, we would have seen improving gross margins due to the various cost improvement actions we have undertaken. We are continuing to identify opportunities for efficiency enhancement as we implement these enhancements in an orderly fashion. We believe we will continue to produce meaningful margin expansion. As we look out to 2008, we expect that the company will achieve additional sales and profitability growth. In the 2008 first quarter, we anticipate that sales will approximate $180 million to $184 million with diluted earnings per share of $0.33 to $0.37. For the total year 2008, we forecast sales growth of 5% to 6%, which would equate to total year 2008 sales of $728 million to $735 million. Our previously provided full year 2008 diluted EPS forecast was $1.47 to $1.52. We now expect that with the momentum built in the last part of 2007, we can increase our 2008 full year estimated EPS to $1.48 to $1.56. All of us here at CONMED are looking forward to 2008 with excitement. Our results for 2007 were better than we anticipated. Thanks to the efforts of our entire organization. In 2008, we will further build on last year's achievements, yielding excellence and service to our customers and an improved profitability for our shareholders. I'll now turn the call over to Rob Shallish for a further review of the financials. Rob?

[Rob Shallish:]

Thanks very much, Joe, and good morning, everyone. As Joe mentioned, the company finished off 2007 with a great fourth quarter. Sales for the quarter were $189.6 million, an increase of 11.6% over the fourth quarter of 2006. In constant currency, the rate of growth was 8%. For the full year of 2007, our revenues of $694.3 million represented an increase of 7.3% over 2006. All year along, we experienced the benefits of the favorable foreign currency rates. In constant currency, this year's growth was 5%, achieving the goal we set for the company at the beginning of the 2007. This constant currency internal growth of 5% compares to 4% in 2006 and 2.2% in 2005. So, we have continued to make progress at the topline by having the right products and the appropriate sales and marketing groups to sell them. By geography, sales outside the United States outpaced domestic revenue growth by increasing 24% in the fourth quarter and 16% for the full year. For the fourth quarter, international sales amounted to 43.5% of the total, an increase from the 39.2% of sales in the fourth quarter of 2006. On a constant currency basis, the weakening of the US dollar relative to a year ago produced a fourth quarter sales number $6.1 million higher than if foreign currency exchange rates had remained consistent with the fourth quarter of 2006. For the full year, the benefit to sales from FX amounted to $15.2 million compared to 2006 exchange rates. I'd add that our international organization consist of direct selling through our own local employees in eleven countries with distributors representing our products in most other countries of the world. Before turning to a discussion of profits and margins, I'd like to discuss comparisons to GAAP and non-GAAP financial amounts. Over the last several quarters, we have called out a number of adjustments to the GAAP numbers, which we thought were important for gaining and understanding of CONMED's ongoing business. I'd not go into detail on each of these past reconciling items. They are further described in today's press announcement. In the fourth quarter of 2007, there is one adjustment relating to a matter of litigation, which we have identified as unusual. While, purposes of clarifying our financial results, we believe these non-GAAP measurements aid in an understanding of our business. Now turning to a discussion of our margins, our gross margin percent of sales was 50.5% in the fourth quarter of 2007, a sequential improvement from the third quarter of 2007, when the gross margin was 50.1%. There is also an improvement compared to the fourth quarter 2006 GAAP gross margin of 48.5% due to the completion of the manufacturing transition activities of our Endoscopic Technologies product line. For the full year of 2007, the gross margin was equal to 50.3% of sales compared to the non-GAAP gross margin of 50.1% in 2006 and the GAAP gross margin of 58.3% in 2006. Beyond the elimination of the manufacturing transition cost of 2006, our managers have been focused on improving the efficiencies of our manufacturing processes. We have consolidated products, move product lines to more appropriate assembly locations, and use lean manufacturing techniques to increase efficiency. We expect to see continued improvement, as we progress into 2008. SG&A, as a percentage of sales was 34.3% in the fourth quarter. This is a 230 basis point improvement from a 36.6% of sales that we incurred in the fourth quarter of 2006. As we have previously discussed, we are holding a line on operating costs to increase operating leverage and improve the utilization of our infrastructure. For the full year of 2007, our net SG&A costs have increased only 2.4% over 2006 and we are at 34.6% of sales in 2007 compared to 36.3% of sales in 2006. Research expenditures were 3.9% of sales in the fourth quarter of 2007, a decline compared to 4.8% of sales in the fourth quarter of 2006. This decline should not be construed as a reduction in our research and development efforts, but rather the result of standard timing related to work on our various projects. For the full year of 2007, R&D expenditures were 4.4% of sales compared to the 4.7% of sales in 2006. This net changes resulted in a non-GAAP operating margin for the 2007 fourth quarter of 12.3% compared to the non-GAAP margin of 9.6% in the 2006 fourth quarter. This is a 270 basis point improvement. For the full 12 months of 2007, the non-GAAP operating margin was 11.3% compared to the 2006 non-GAAP operating margin of 9.1%. Interest expense was $3.5 million in the quarter, a 24% reduction, when compared to interest of $4.6 million in the fourth quarter of 2006. Full year, interest costs decline to $16.2 million compared to $19.1 million in 2006. The reduced interest cost results from lower debt levels as well as a slight decrease in rates effective during the quarter and year. At the end of December 2007, our debt is a mixture of fixed and floating rate instruments. The $150 million convertible bonds carrying interest rate of 2.5%. Also, the company has approximately a $15 million mortgage outstanding at 8%. As for floating rate debt, the December 2007 balance on our term loan was $59 million at LIBOR plus 1.5%. Currently, interest expense is affected by the cost of the receivable securitization balance of $45 million at LIBOR plus 1%. So, looking now to 2008 reduced LIBOR rates will affect slightly over $100 million of our financings. Non-GAAP pretax income in the December quarter grew to $19.7 million. This calculates to a 67% increase over the 2006 December quarters pretax income on a non GAAP basis. On a GAAP basis, the increase is much greater with the fourth quarter 2007 GAAP pretax income of $18,419,000 matched against the fourth quarter of 2006 pretax loss of $40.1 million. Our non-GAAP pretax margin for the year has grown to 8.9% of sales compared to $6.1% in 2006. Using GAAP amounts, the pretax margin is equivalent to 9.3% in 2007 compared to a loss of 3.8% of sales for 2006. These margins demonstrate the CONMED's profits continuing to improve substantially. We believe further progress will be made in 2008 with our current expectation of operating margin nearing 12% for the full year of 2008. The company's income tax rate in the fourth quarter was 35.8% and 36% for the full year. As mentioned in past conference calls, payment of nearly all these tax provision is deferred to future periods because of differences in reporting expense for financial accounting compared to tax accounting thus increasing the company's current cash flow. Looking now to 2008, we believe the income tax rate will increase slightly to 37.5%. But most of this rate will relate to deferred taxes with only a small percentage being required for current cash payment. Cash flow from operations continues to be positive for the company reaching $67.2 million or $2.32 per share for 2007, while this per share calculation is a non-GAAP measurement. We believe it is useful for a more complete understanding of the company's business. Capital expenditures for 2007 were $22.2 million. We expect that CapEx in 2008 will approximately be $20 million to $22 million. During 2007, the company reduced its balance sheet debt by approximately $45 million and increased its cash balances by $7.9 million. Debt to total book capitalization declined to 30.6% at December 31, 2007 compared to 37.8% at the end of December 2006. With regard to inventory, our days investment in inventory at December 2007 was equal to 160 days approximately the same amount as December 2006. Accounts receivable days in December 2007 heading back the effect of the $45 million utilization of the securitization facility were 60 days in line with our recent past performance. Now with that, Sarah, I'd like to open up the lines for questions.

[Operator:]

(Operator instructions) First question comes from the line of Mark Mullikin from Piper Jaffray. Please proceed.

[Mark Mullikin:]

Good morning. Rob, can you just remind us how the foreign exchange impact plays out on the bottom line in '08 and what you're factoring into the top line for foreign exchange?

[Rob Shallish:]

Well, for 2008 our assumptions in all of the numbers that we've given would be that the currency rates would approximate the average rates for 2007. So, basically we don't have any currency in the numbers that we've given for guidance in 2008.

[Mark Mullikin:]

And, so there is no FX contribution to your thinking on '08 guidance at all?

[Rob Shallish:]

That’s correct. Our belief is that, at least in the guidance that the foreign currency rates would approximate the rates that we've seen in the -- on average in 2007.

[Mark Mullikin:]

Okay. And is there anything specifically driving the core Arthroscopy growth, I think you said that was 9%. That's a pretty noticeable acceleration for CONMED. Are there any particular products driving that?

[Joseph Corasanti:]

We'll, we've seen very good growth internationally all year long and so that's been very helpful. Our Procedure Specific Products, I think continue to do well. We've seen good growth in our so called shaver blade business, the powered instrument portion of Arthroscopy. So, all of these products are, I mean, we've new products that we introduce every year in this line. But I'd say that none of them have been of a blockbuster nature such as the HD Video Systems have been. So, it's just more meeting the customer requirements, servicing our customers and providing them with the best products that we have available.

[Rob Shallish:]

Yeah I'd like to add that I think we've greater focus on our domestic selling as well for the core products. And I think we've seen some pull through as we've gained penetration with video, with our HD Camera System. We are getting in front of more surgeons even some surgeons we are building new relationships with some surgeons and then having pull through business and selling deeper into our bag on the arthroscopy side of the business.

[Mark Mullikin:]

Okay. So, in '08 do you expect the domestic growth rates to improve, it looks like you get 3.7% domestically in the fourth quarter 1.8% for the year. Do you expect that growth rates to accelerate domestically above and beyond that 4% level?

[Joseph Corasanti:]

Well, our goal is to certainly improve on the -- the annual growth number of around 2%. We expect improvement there and are working towards that. And again it will come from greater focus on US sales and as well as getting better pull through with the video that's already been sold into the market and then continuing into '08 with video.

[Mark Mullikin:]

Okay. And just my final question what is your expectation for CapEx in '08?

[Rob Shallish:]

'08 CapEx will be similar to this past years CapEx, so in a $20 million to $22 million.

[Mark Mullikin:]

Very good. Thank you.

[Operator:]

Your next question comes from the line of James Sidoti with Sidoti & Company. Please proceed.

[James Sidoti:]

Good morning. Can you hear me?

[Joseph Corasanti:]

Yes, Jim.

[James Sidoti:]

Okay. I've two questions. First can you give us an update on ECOM and when you think that will be ready and what do you think the R&D will look like as a result of that this year?

[Joseph Corasanti:]

ECOM is performing very well. We are continuing to use it in clinical settings with patient setting. We are still at the VA in San Francisco on UCLA. We are completing the IRB application process within a week or two at three other sites, so start using the product on patients at three other sites and it looks like we will probably have a limited market release actual sales of the disposable tubing portion of the system beginning in April. We were hoping for a March launch I guess of a limited market launch then it's now going to be April. The system is performing very well. We're getting correlation results with correlating our product with pulmonary artery catheters, Swan-Ganz catheters and expect a full launch in the July, August timeframe.

[James Sidoti:]

Okay. And how does that affects R&D between now and then, do you see a tick up, does it actually start to step down in 2008?

[Joseph Corasanti:]

R&D is we believe will be constant or consistent certainly with what we spent in the past, it about the 4.5% of sales level.

[James Sidoti:]

Okay. And then a question for Rob, you talked about the taxes a little bit. But can you tell us what you actually hear actual cash tax rate would be in 2008?

[Rob Shallish:]

Yeah, Jim, I think it's going to be under 10% and most of that would be foreign taxes, some state taxes, very little federal tax.

[James Sidoti:]

Okay, thank you.

[Operator:]

(Operator Instruction) The next question comes from the line of [Bill Happy with Investment Counselors]. Please proceed.

[Unidentified Analyst:]

Thanks. You said that GAAP ratio is getting down kind of near the bottle if I think what your range is targeted just wondering what a prioritizing uses of cash going forward and maybe if acquisitions are part of that, what the environment looks like? Thanks.

[Rob Shallish:]

Sure. Bill, our strategy really hasn't changed. We have several uses for cash, debt payment, acquisition and in the past we've had stock buybacks. We continue to look for acquisitions. We haven't made any acquisitions of any significant in the last three years. So, absent opportunities, then we'd be thinking about debt payment. (inaudible) to add Joe.

[Joseph Corasanti:]

Well, in fact, we are already below our range of debt to total cap that was 35% to 45%, we are below that already. But without any other uses of cash, cash requirements we'd be paying down debt.

[Unidentified Analyst:]

Okay. Can I do a follow-up question?

[Joseph Corasanti:]

Of course.

[Unidentified Analyst:]

Maybe update on leadership at Linvatec and I don't know if you're doing a search or just?

[Joseph Corasanti:]

Yeah the search for a new president at the CONMED Linvatec division is underway and we expect that to continue for the next couple of months. The team here is a solid team. The business is running smoothly and as we'd expect its business as usual and this division is performing very well as you can see from the results of 2007.

[Unidentified Analyst:]

Okay, thank you.

[Joseph Corasanti:]

Sure.

[Operator:]

At this time, there are no further questions. I'd like to turn the call over to Joseph Corasanti for closing remarks.

[Joseph Corasanti:]

Thank you very much. Thanks everyone for joining us today. We continue to work hard at improving the companies operations. I look forward to discussing our further progress with you at our next conference call again thanks for joining us today. We look forward to talking to you on our next call. Thank you, bye.

[Operator:]

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.