CONMED Corporation
Q1 2010 Earnings Call Transcript

Published: 2 May 2010

[Operator:]

Good day ladies and gentlemen. Welcome to the First Quarter Earnings Conference Call. My name is Lumeda and I will be your operator for today. (Operator Instructions). I would now like to turn this conference over to your host for today’s call, Mr. Joseph Corasanti, President and CEO. Please proceed, sir.

[Joseph Corasanti:]

Thank you very much. Good morning, everyone, welcome to CONMED Corporation’s First Quarter 2010 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 represents forward-looking statements that involve risks and uncertainties as those terms are defined under the Federal Securities laws. Our actual results may 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 may cause actual results to differ materially. You will also hear Rob and me refer to certain non-GAAP measurements during this discussion. While these figures are not a substitute for GAAP measurements, company management uses them to aid us in monitoring the company’s ongoing financial performance from quarter-to-quarter and year-to-year on a regular basis and for benchmarking against other medical technology companies. Non-GAAP net income and non-GAAP earnings per share measure the income of the company excluding credits or charges that are considered by management to be unusual or outside of the normal ongoing operations of the company. These unusual items are specified in the reconciliation in the press release issued this morning. With these required announcements completed, I can now turn to my comments. 2010 has started off well for CONMED both operationally and financially. Specifically CONMED net income rose 63% over the first quarter of 2009 on a sales increase of 7.5%, adjusting for unusual items in both quarters, non-GAAP net income increased 53%, additionally year-over-year the GAAP gross margin improved to 52% compared to 46.5% and the non-GAAP gross margin improved to 52.4% compared to 48.3%. Also we experienced double digit sales growth in the majority of our single-use product lines and although capital equipment sales were essentially flat compared to a year ago given the three or five year replacement cycle have been historically same. We believe that the performance of this area of our business should improve as the year progresses. Importantly this is the third quarter in a row that we have achieved a year-over-year gains in financials performance, reaffirming our belief that the worst of the global economic crisis is behind us. With that said let’s take closer look at the first quarter results as you know single-use medical devices primarily used in surgery are the mainstay of our business accounting for approximately 75% of CONMED’s revenues. These products are used everyday in medical centers around the world. Let me quickly review what occurred last year, in the first six months of 2009 our sales of this single-use devices declined 2.2% in constant currency. This reflected as we believe economic concerns on the part of patients who may have delayed surgery and on the part of certain distributors of our products who may have reduced inventory levels. In the second half of 2009, the negative trend was reversed with positive constant currency growth of 2.1% resulting in flat single-use sales to the full year taking the affects of currency into consideration. Now here in the first quarter of 2010, the constant currency growth of our entire line of single-use products improved 4% over that of the first quarter of 2009. Two of our product lines are Arthroscopy and EndoSurgery, accounted for over 1.5 of our single-use product sales for the quarter and had double digit revenue growth in constant currency for their disposable surgical products. Within Arthroscopy, the sales improvement was due to new product introductions such as the Shoulder restoration System which we have previously discussed. In our EndoSurgery division the increase was due to continued market penetration. While our relatively weak 2009 first quarter in this segment did create a favorable comparison, we are quite pleased with our results in this segment. The weakest single-use sales performance came from the Patient Care line of products. The 8.1% constant currency decline is primarily results of our decision to eliminate certain unprofitable products from the portfolio. Although this has an affect on the top line in the long-term the profitability of this division will be improved by eliminating lower margin products. Turning now to the 25% portion of our business that falls into capital budget cycles of our hospital customers, sales were slightly lower in constant currency than the sales in the first quarter a year ago. Surgical video within the Arthroscopy group was down 2.9% constant currency, powered surgical instruments and Handpieces were down 4.1% while electrosurgical generators offset the decline by growing 7.4%. Purchases of these capital products are susceptible to variability due to the nature of the longer sales cycles compared to single use products which are generally dependent on the demand created by surgical procedures. As we have discussed in the past these capital products are used routinely in surgical setting each day and are susceptible to wear and tear and must be replaced on fairly regular basis. Generally we believe that the capital product replacement cycle ranges between three and five years. Well there can be some delay in purchasing replacements; these products will most certainly need to be replaced eventually. Though while this quarters capital equipment sales did not quite meet our expectations, the key take away for us is that nothing in our market intelligence indicates that we are losing market share, thus we continue to believe that this years capital equipment business will produce growth over 2009. Moving on to our newer products as mentioned previously the Shoulder restoration System continues to be a strong performer that enhances our portfolio of Arthroscopy procedures specific devices. The ECOM device for monitoring cardiac output on a minimally invasive basis during surgery continues to gain traction. During the first quarter, we continue to roll out to select markets in Europe. Our tissue sealing device from our Electrosurgery group continues to be on track to be release on a limited basis this summer. On the cost side of our business as expected, we now beginning to realize the benefit of the various cost improvement programs that we have been working on over the last several quarters. This is best evident by the improving gross margin percentage which grew to a 52.4% compared to 48.3% in the first quarter of the last year after adjusting for non-GAAP items. Little over one half of this margin improvement was due to improved foreign currency translation rates while the remainder approximately $3 million was the result of the impact of cost improvements and to some degree a product mix. We continue to be pleased with the progress being achieved by our new manufacturing plant in Chihuahua, Mexico. As we look out to the remainder of 2010, we are encouraged by the various positive economic trends both in the overall market and those we ourselves are experiencing. However, unemployment remains in certain countries in Europe seems to be taking a longer time than the U.S. to recover from the economic downturn. That remains possible that these factors couldn’t have an affect on the number of surgical procedures performed and the capital equipment appetite of our hospital customers. Notwithstanding these uncertainties, we anticipate that 2010 should be a much improved year for CONMED relative to ‘09. Capital spending on the part of hospitals should improve as the year progresses, single use products sales are growing on a constant currency basis and foreign currency rates have returned to a more favorable position. Over the company’s the performance in the first quarter of 2010 meet our expectations. Taking the previously detailed uncertainties that remain in the market and into account, we are reiterating the 2010 guidance previously provided. Specifically, we estimate that CONMED’s sales in 2010 should approximate $715 million to $725 million in that non-GAAP diluted earnings per share should range between $1.20 and a $1.30. We continue to believe that our financials results for the full year will be more backend loaded than usual as the improving trends of the global economy gain momentum. Accordingly, we estimate that second quarter 2010 should approximate $175 million to $180 million representing 7% to 10% growth over the second quarter of 2009 and that non-GAAP diluted earnings per share should approximate $0.25 to $0.30. I will now turn the call over to Robert Shallish for a further review of our financials. Rob?

[Robert Shallish:]

Thanks very much. As Joe mentioned 2010 is off to an excellent start. Sales grew 7.5% year-over-year to $176.4 million, while net income grew 63% on a GAAP basis and 53% on a non-GAAP basis. Importantly we return to year-over-year quarterly profitability growth when measured on GAAP basis for the first time in several quarters. Although the global economic crisis is still having some lingering effects on the company’s performance. We believe the positive results of the last three quarters indicate that the worst is behind us and we can proceed with our goal for increased profitability. Further, the upfront cost associated with the restructuring activities of 2008 and 2009 are beginning to pay dividends. As evidenced by the increased gross margin in the first quarter compared to that of a year ago. Specifically, the GAAP gross margin in the first quarter this year grew to a 52% from 46.5% in the first quarter last year. On a non-GAAP basis excluding the restructuring matters, this year’s first quarter gross margin was 52.4% compared to 48.3% in the March 2009 quarter. While currency was favorable this year compared to last year first quarter and resulted in a little over one half of the improved gross non-GAAP gross margin percentage. The rest of the improvement was due to the more efficient manufacturing operating structure CONMED has been implementing me over the last year as well as product mix to some degree. Our Mexican manufacturing plant is fully operational and as we have discussed on our last conference call, beyond the product lines we have already transferred to that site, we will be moving additional lines there over the next few months. Selling, general and administrative expense for the first quarter of this year was 40% of sales as compared to 37.7% in the prior year period. The increase was due to the effect of foreign currency translation rates and our OUS selling costs in the amount of $3.3 million which accounts for 1.9 percentage points of the increase in this ratio. Now on a sequential basis compared to SG&A costs in the fourth quarter of 2009. The first quarter’s cost declined to $2.3 million due to lower variable selling costs. As we look out to the remainder of 2010 we expect that the company’s SG&A costs were moderate as a percentage of sales as we see increases in sales. We will of course be monitoring these cost to be sure that spending is appropriate for the level of business activity. If adjustments need to be made we will make them. Research and development cost of $7.7 million declined $800,000 compared to the March 2009 quarter as a result of certain R&D activities nearing completion. On a quarterly basis we expect similar R&D costs for the remainder of this year. With the respect of the company’s overall non-GAAP operating margin derived by adding back the reconciling items between GAAP and non-GAAP amounts described in this press announcement this morning. The first quarter’s margin grew to 8% compared to 5.4% in the first quarter of 2009. This is inline with our goal for expanding CONMED’s operating margin as we leverage the anticipated top line increase in sales in comparison to the relatively fixed cost structure and manufacturing and administrative expense. The company’s income tax rate in the first quarter on a non-GAAP basis was 32.6%. This is lower than our previously disclosed expected effective tax rate of 37.5%. Due to the completion of the 2008 IRS exam which allowed us to reverse certain tax reserves. We anticipate that the tax rate for the remaining quarters of 2010 will be approximately 37.5% although of Congress does not reinstate the research and development tax credit; we could see effective rates slightly higher than this amount. I will remind you that payment of nearly all of this tax provision is deferred to future periods because of difference and reporting expense for financials accounting compared to tax accounting plus increasing the company’s current cash flow. With record to the reconciling items between GAAP and non-GAAP amounts that are described in this mornings press announcement. We now anticipate that the restructuring costs associated with the movement of additional product lines to the Chihuahua manufacturing site will approximate $3 million for the full year of 2010, a much lower amount than we incurred in 2009 when we work in a start-up mode. This cost estimate for 2010 is a slight increase from the $2.5 million we had forecasted on our last conference call. Now turning to the balance sheet, the most significant change results from the company’s receivable financing facility with the bank and a required change in accounting for such facilities. Previously receivables sold to the bank through the facility were eliminated from our balance sheet as we have disclosed in all of our SEC filings. As we have discussed in the passed beginning in 2010, the Financial Accounting Standards Board requires such off balance sheet receivable financing to be placed on the company’s balance sheet. As of March 2010, we used $33 million of this facility to finance receivables. So, on this quarters balance sheet receivables are higher by $33 million than they would have been without the changing our accounting. Further the company’s debt is $33 million higher than what have been the case using the previous methodology. Let me emphasize that all of the company’s financing sources are exactly the same as they were in December of 2009. The change in receivables and the current portion of long-term debt on March 2010 balance sheet is simply the result of the required change in accounting for the receivables facility. Further, this change in accounting only affects the balance sheet and the cash flow statement; there is no effect on our P&L. Including the securitization facility in the financing, including the securitization financing in the debt to booked capitalization calculation. In the March 2010 ratio declined to 26.4% compared to the December 2009 ratio of 27.1%. Cash flow of the business was very good in the first quarter of 2010. I draw your attention to the cash flow statement and the additional reconciliation of cash flow from operations included in this mornings press release. Excluding the effect of the change in accounting which we view as a non-cash matter, cash flow from operating activities grew to $16.1 million compared to $6.7 million in the first quarter a year ago. This adjusted cash flow from operations is more than double the net income of the quarter and demonstrates CONMED’s cash flow generation ability. Now let’s spend a few moments updating the foreign currency hedging program we started some months ago. Our plan involves entering into foreign currency exchange contracts whereby we agree to deliver foreign currency at a set time and an agreed up on exchange rate. We entered into several of these foreign contracts such that approximately 80% of the first quarter 2010 risk was hedged, 60% of the second and third quarter exposure is hedged and approximately 40% of the fourth quarter of 2010 exposure is hedged. As time passes and rate seem appropriate we plan on adding additional contracts to balance the FX exposure. Recently the euro on pound have weakened while there has been an offset to some degree by the strengthening of the Canadian and Australian dollars. Further, foreign currency contracts we put in place last year kind of dampen the recent currency in movement’s effect on the financials statements. In summary, the first quarter results demonstrate that we are on target for meeting our planned financial results for the full year of 2010 and we should continue to make progress on improving the profitability of the company as the year moves along. With that operator we would like to now open the session to questions.

[Operator:]

(Operator Instructions). And your first question comes from the line of Dalton Chandler from Needham & Company. Please proceed, sir.

[Dalton Chandler:]

Just with regard to the move of products to the Mexican facility, do you expect this to be somewhat of an ongoing thing? Do you think you’ll be moving additional products there next year as well? And do you have any capacity issues with that facility?

[Joseph Corasanti:]

We don’t have plans today for product moves to occur on 2011. There is the possibility that could happen from any number of our factories here in the U.S. but currently we don’t have plans beyond what we are doing today.

[Dalton Chandler:]

I think you touched a little bit on the new tissue sealing device. Just a couple of questions on that. Have you filed for the 510(k) yet? And secondly, you mentioned you expect a limited launch, is there a reason that you’re not going with a broader launch on that product?

[Joseph Corasanti:]

Yeah Dalton with the tissue sealing device we have filed for the 510(k), we did that about 30 days ago and when we say limited launches generally what we have been doing at CONMED Corporation with large significant product launches involving new technology which tissue sealing is new technology for us in the market. We did the same thing with our Shoulder restoration System where for the first month it was realized simply to our top sales reps who demonstrated for efficiency at selling number one new technology and had trained extensively on the new technology. So, we will be doing something along those lines with tissue sealing.

[Dalton Chandler:]

How long does it typically take, then, to get to a broad launch on those types of products?

[Joseph Corasanti:]

Well with the Shoulder System I think we are out two or three months on a limited basis and then haven’t had an official launch to every sales rep after that.

[Operator:]

And your next question comes from the line of James Sidoti from Sidoti & Company. Please proceed, sir.

[James Sidoti:]

I’m sorry, but can you repeat what you said about the hedging, what percent of the revenue for the back-end of the year was hedged at this point?

[Rob Shallish:]

Sure, Jim, it’s approximately 60% for the second quarter, 60% for the third and approximately 40% for the fourth.

[James Sidoti:]

Okay and then on the cost savings. It seems like you’re starting to see some of the benefits now. Is this something that should improve throughout the year or is it kind of a steady state situation?

[Rob Shallish:]

Well I would hope we would see some slightly improvement but I would say that its probably steady state, I think that where we might see some improvement in gross margin this year would result from volume. Assuming relatively stable currency rates, I would say if we are successful in increasing volume of sales and that should have an impact on the gross margin.

[James Sidoti:]

You should be able to leverage that?

[Rob Shallish:]

Right.

[James Sidoti:]

Okay. And then, just in terms of volume, some companies have already started to see capital equipment sales pick up. You guys, it seems like it’s taking a little longer. Do you have any thoughts behind that?

[Joseph Corasanti:]

It’s interesting with capital Jim, we saw a mixed result. So electrosurgical generators did extremely well growing 7% and 7.5% in the quarter. We have growth in the U.S. and even better growth outside the U.S. and in both our direct markets and export markets for generators and its interesting we really can’t explain why that occurred other than to speculate that there is something perhaps pent up demand for generators because they were so soft in ‘09. With video and with powered instruments we had declines in both those areas of capital. In the UK and in Spain we think there is still capital freeze especially in the UK with government spending which is a bit of a turnaround from the early part of last year when in the UK the government wasn’t spending money on capital. So, they have tightened their belts there this year. So, it’s mixed for us, we are continuing to analyze it but again I think we really need to standby our statements which are about the nature of our capital. The replacement cycle we think is three to five years, at some point these purchase delays they just simply can’t go on forever.

[James Sidoti:]

All right. Thank you.

[Operator:]

(Operator Instructions). And our next question comes from the line of Matt Miksic from PJC. Please proceed, sir.

[Matt Miksic:]

Hi. Thanks for taking our questions. One follow-up on margins. You had talked a little bit about the contribution of mix and the contribution of sort of restructuring and of currency. Wondering if you could talk a little bit about how much of the non-currency impact in your gross margin, how much is this sort of like ongoing, I would imagine it’s like a step down in your manufacturing costs related to moving products between facilities and how much has to do with this single-use versus capital mix that we saw in the quarter? And then I have one follow-up here on international.

[Rob Shallish:]

Well yes Matt, most of the improvement non-currency improvement in the gross margin is a result of the changes that we have made to the manufacturing structure. There is a slight component; I would say no more than 20% of the improvement that’s non-currency related that relates to mix because we did see our single-use sales the 78% of our business this quarter which is a little bit higher than the norm, the norm is about 75%. Our capital products well there is again no overall answer but in general and on an overall basis I guess I would say that the video products have a little bit lower margin than the other capital products and lower than the single-use products. In general the capital products tend to have a slightly lower gross margin when we saw them, than the single-use products. So, that would mean that with a little bit less capital product sales in the quarter we would have an improved gross margin because we are selling more single -use products. But I guess I go back to the 80-20 rule, the 80% of the benefit this quarter was a result of cost changes that we have made.

[Matt Miksic:]

Thanks Rob, it is a very helpful color on the margin. Overseas, I guess we ran into this frustration where market trends are heading in one direction and sometimes not everybody is seeing the same level of benefit. I am just wondering you talked about staying in the UK maybe moving in kind of different direction. Any other regions outside the U.S. where you feel like you got a disproportionate concentration in a particular geography that’s going the wrong way on you and anything that we can look at in terms of trends that will help us understand when the businesses might start to pick up again for you.

[Rob Shallish:]

Well I would say Matt that the UK is the one that we are watching perhaps more closely than any of the other individual countries and to put that in perspective, the UK is in the neighborhood of 5% or 6% of sales. We actually saw improvement in Canada, Australia, and Japan but in general I would say the UK was the laagered with the rest of Europe being somewhat flat. So, we saw improvement in some countries and flatness I would say the European region in general. So, Europe is the one that we are watching perhaps more closely and off Europe, UK would be the one to that we are focusing on.

[Joseph Corasanti:]

The interesting thing is there seems to be negative for orthopedic capital. The electrosurgery products, the generators declined in the UK and the rest of Europe, it’s for been the direct market as well as our export business.

[Matt Miksic:]

And one follow-up just on the UK. Again, one of the things we’ve seen in some of the other markets is at the beginning of a new fiscal year sometimes things start to pick up a little bit and I believe UK’s fiscal year ends in March. Any sense that we saw sort of like an end-of-year clamp-down on budgets, which may logically ease as we get into their new fiscal year?

[Joseph Corasanti:]

We have heard some of that from our sales force Matt and whether then in fact is the case and we will start seeing improvement in the UK sales then that certainly is the possibility.

[Operator:]

And your next question comes from the line of Robert Goldman from CL King. Please proceed, sir.

[Robert Goldman:]

Just looking for guidance on two elements of the income statement. Rob, on R&D, I couldn’t tell if you were saying R&D would be in dollars flat for the rest of the year versus the first quarter or as a percent of sales, and then also if you could provide some guidance on SG&A and perhaps outline any unusual SG&A items that resulted in SG&A being up more than sales in the quarter. Thank you.

[Rob Shallish:]

On your first question with R&D perhaps I didn’t say it well but the $7.7 million was just so that we did had an R&D this quarter. Roughly should be that amount each quarter as we go forward for this year. So, as a percentage it might change a little bit depending on what the sales number is but and in terms of absolute dollars in that $7.5 million to $8 million range per quarter is what we are anticipating now. With the respect to SG&A I did mention currency as a significant factor because the dollar is weaker in the first quarter of this year compared to last year that creates higher selling expense for us wherever we are direct and we are direct in 12 countries. So, in rough terms about $3.3 million of expense additional expense was incurred in this quarter of 2010 as compared to the first quarter of last year. Other things that impact this are changes in some of our marketing programs; we have added some sales people this year compared to a year ago. Some of employee benefit costs such as workers compensation and then health cost are a little bit higher. I do think that SG&A as a percentage of sales should moderate as we go through the rest of the year. First of all we are watching these lines very carefully and will adjust our spending if necessary to meet our goals and then secondly we expect that sales should improve as we go through the rest of the year and on a percentage basis that would mean that the denominator is greater and therefore the percentage will come down. So, I am hoping and believe that this would be the high point in terms of a percentage.

[Operator:]

And there are no questions at this time. I will turn the call over to Mr. Joseph Corasanti for closing remarks.

[Joseph Corasanti:]

Well thank you very much everyone for joining us today. CONMED continues to work hard to improve the company’s operations. I look forward to discussing our further progress with you on our next conference call. Thank you very much. Have a good day.

[Operator:]

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day. Copyright policy

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