CONMED Corp: Form 10-Q for the period ended Mar 31, 2024

Forward-Looking Statements

In this Report on Form 10-Q, we make forward-looking statements about our financial condition, results of operations and business. Forward-looking statements are statements made by us concerning events that may or may not occur in the future. These statements may be made directly in this document or may be “incorporated by reference” from other documents. Such statements may be identified by the use of words such as “anticipates”, “expects”, “estimates”, “intends” and “believes” and variations thereof and other terms of similar meaning.

Forward-Looking Statements are not Guarantees of Future Performance

Forward-looking statements involve known and unknown risks, uncertainties and other factors, including those that may cause our actual results, performance or achievements or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include those identified under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2023 and the following, among others:

• general economic and business conditions, including, without limitation, a potential economic downturn, supply chain challenges and constraints, including the availability and cost of materials, the effects of inflation, and increased interest rates;
• compliance with and changes in regulatory requirements;
• the failure of any enterprise-wide software programs or information technology systems, or potential disruption associated with updating or implementing new software programs or information technology systems;
• the risk of an information security breach, including a cybersecurity breach;
• pandemics and health crises, and the responses thereto by governments and hospitals, which poses risks to our business, financial condition and results of operations;
• the possibility that United States or foreign regulatory and/or administrative agencies may initiate enforcement actions against us or our distributors;
• the introduction and acceptance of new products;
• the ability to advance our product lines, including challenges and uncertainties inherent in product research and development, and the uncertain impact, outcome and cost of ongoing and future clinical trials and market studies;
• competition;
• laws and government regulations;
• changes in customer preferences;
• changes in technology;
• cyclical customer purchasing patterns due to budgetary, staffing and other constraints;
• environmental compliance risks, including lack of availability of sterilization with Ethylene Oxide (“EtO”) or other compliance costs associated with the use of EtO;
• the quality of our management and business abilities and the judgment of our personnel, as well as our ability to attract, motivate and retain employees at all levels of the Company;
• the availability, terms and deployment of capital;
• current and future levels of indebtedness and capital spending;
• changes in foreign exchange and interest rates;
• the ability to evaluate, finance and integrate acquired businesses, products and companies;
• changes in business strategy;
• the risk of a lack of allograft tissues due to reduced donations of such tissues or due to tissues not meeting the appropriate high standards for screening and/or processing of such tissues;
• the ability to defend and enforce intellectual property, including the risks related to theft or compromise of intellectual property in connection with our international operations;
• the risk of patent, product and other litigation, as well as the cost associated with such litigation;
• trade protection measures, tariffs and other border taxes, and import or export licensing requirements; and
• weather related events which may disrupt our operations.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below and “Risk Factors” and “Business” in our Annual Report on Form 10-K for the year ended December 31, 2023 for a further discussion of these factors. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We do not undertake any obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect the occurrence of unanticipated events.

Overview

CONMED Corporation (“CONMED”, the “Company”, “we” or “us”) is a medical technology company that provides devices and equipment for surgical procedures. The Company’s products are used by surgeons and other healthcare professionals in a variety of specialties including orthopedics, general surgery, gynecology, thoracic surgery and gastroenterology.

Our product lines consist of orthopedic surgery and general surgery. Orthopedic surgery consists of sports medicine and lower extremities instrumentation and implants, small bone, large bone and specialty powered surgical instruments as well as imaging systems for use in minimally invasive surgery procedures and service fees related to the promotion and marketing of sports medicine allograft tissue. General surgery consists of a complete line of endo-mechanical instrumentation for minimally invasive laparoscopic and gastrointestinal procedures, smoke evacuation devices, a line of cardiac monitoring products as well as electrosurgical generators and related instruments. These product lines as a percentage of consolidated net sales are as follows:

A significant amount of our products are used in surgical procedures with approximately 85% of our revenues derived from the sale of single-use products. Our capital equipment offerings also facilitate the ongoing sale of related single-use products and accessories, thus providing us with a recurring revenue stream. We manufacture substantially all of our products in facilities located in the United States and Mexico. We market our products both domestically and internationally directly to customers and through distributors. International sales approximated 44% of our consolidated net sales during both the three months ended March 31, 2024 and 2023.

Business Environment

The Company has been and continues to be impacted by the macro-economic environment and we are experiencing higher manufacturing and operating costs caused by inflationary pressures and ongoing supply chain challenges. We work with suppliers to mitigate these impacts; however, we expect these challenges to continue through 2024. This will likely impact our results of operations.

The Company has not been materially impacted by the conflicts in Ukraine and the Middle East. The Company has no direct operations in these regions with our business limited to selling to third party distributors. Total revenues and accounts receivable associated with sales to third party distributors in these regions are not material to the consolidated condensed financial statements. We will continue to monitor and adjust our business strategy in response to the conflicts in these regions as necessary.

Critical Accounting Policies

Preparation of our financial statements requires us to make estimates and assumptions which affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2023 describes the significant accounting policies used in preparation of the Consolidated Financial Statements. On an ongoing basis, we evaluate the critical accounting policies used to prepare our consolidated financial statements, including, but not limited to, those related to goodwill and intangible assets, contingent consideration and our pension benefit obligation.

Consolidated Results of Operations

The following table presents, as a percentage of net sales, certain categories included in our consolidated condensed statements of comprehensive income for the periods indicated:

Net Sales

The following table presents net sales by product line for the three months ended March 31, 2024 and 2023:

Net sales increased 5.7% in the three months ended March 31, 2024 compared to the same period a year ago primarily due to increases in both orthopedic surgery and general surgery product lines.

• Orthopedic surgery sales increased 2.8% in the three months ended March 31, 2024 primarily driven by growth in procedure specific and BioBrace® product offerings.
• General surgery sales increased 8.0% in the three months ended March 31, 2024 on growth in our AirSeal® and biliary product offerings.

Cost of Sales

Cost of sales increased to $140.3 million in the three months ended March 31, 2024 as compared to $140.1 million in the three months ended March 31, 2023. Gross profit margins increased 250 basis points to 55.1% in the three months ended March 31, 2024 as compared to 52.6% in the three months ended March 31, 2023.

The 250 basis point increase in gross profit margins during the three months ended March 31, 2024 was mainly due to favorable product mix during the three months ended March 31, 2024. In addition, during the three months ended March 31, 2024, we wrote off $1.4 million in inventory, tooling and equipment related to the cancellation of a planned new product line and $0.2 million in severance related to the elimination of certain positions. During the three months ended March 31, 2023, we incurred costs for the amortization of inventory step-up to fair value of $2.1 million related to the In2Bones acquisition, $1.1 million in consulting fees related to a cost improvement initiative and $1.0 million in severance related to the elimination of certain positions.

Selling and Administrative Expense

Selling and administrative expense decreased to $123.4 million in the three months ended March 31, 2024 as compared to $130.1 million in the three months ended March 31, 2023. Selling and administrative expense as a percentage of net sales decreased 450 basis points to 39.5% in the three months ended March 31, 2024 as compared to 44.0% in the three months ended March 31, 2023. The 450 basis point decrease in selling and administrative expense as a percentage of net sales for the three months ended March 31, 2024 was primarily driven by:

• A decrease of $10.9 million in costs related to fair value adjustments to contingent consideration ($6.5 million of income in 2024 compared to $4.4 million expense in 2023), see Note 6; and
• $4.3 million in costs related to the implementation of a new warehouse management system in 2023. These costs mainly consisted of incremental freight, labor and travel costs as well as professional fees.

These decreases are offset by higher selling and administrative expenses associated with higher sales volumes.

Research and Development Expense

Research and development expense increased to $13.6 million in the three months ended March 31, 2024 as compared to $12.5 million in the three months ended March 31, 2023. As a percentage of net sales, research and development expense increased 20 basis points to 4.4% in the three months ended March 31, 2024 as compared to 4.2% in the three months ended March 31, 2023. The change in spend as a percentage of sales was mainly driven by additional research projects during the three months ended March 31, 2024 as compared to the same period in the prior year.

Interest Expense

Interest expense decreased to $9.6 million in the three months ended March 31, 2024 from $10.3 million in the three months ended March 31, 2023. The weighted average interest rates on our borrowings increased to 3.18% in the three months ended March 31, 2024 as compared to 3.14% in the three months ended March 31, 2023. The decrease in interest expense in the three months ended March 31, 2024 was driven by lower weighted average borrowings outstanding on our senior credit facility during 2024.

Provision for Income Taxes

The Company's tax provision for interim periods is determined using an estimate of its annual effective tax rate applied to its year-to-date earnings, and also adjusting for discrete items arising in that quarter. In each quarter, the Company updates its estimate of the annual effective tax rate and if the estimated annual effective tax rate changes, the Company would make a cumulative adjustment in that quarter.

Income tax expense has been recorded at an effective tax rate of 22.5% for the three months ended March 31, 2024 compared to 25.6% for the three months ended March 31, 2023. The lower effective tax rate for the three months ended March 31, 2024 was primarily the result of the higher income in 2024 incurring a lower percentage of tax expense. The three months ended March 31, 2024 included discrete income tax benefit related to acquired federal research credits which reduced the effective tax rate by 1.4% and discrete income tax expense from stock options which increased the effective tax rate by 0.4% as compared to the three months ended March 31, 2023 which included discrete income tax benefit from stock option exercises which reduced the effective tax rate by 2.4%. A reconciliation of the United States statutory income tax rate to our effective tax rate is included in our Annual Report on Form 10-K for the year ended December 31, 2023 under Note 9 to the consolidated financial statements.

Non-GAAP Financial Measures

Net sales on a "constant currency" basis is a non-GAAP measure. The Company analyzes net sales on a constant currency basis to better measure the comparability of results between periods. To measure percentage sales growth in constant currency, the Company removes the impact of changes in foreign currency exchange rates that affect the comparability and trend of net sales.

Because non-GAAP financial measures are not standardized, it may not be possible to compare this financial measure with other companies' non-GAAP financial measures having the same or similar names. This adjusted financial measure should not be considered in isolation or as a substitute for reported net sales growth, the most directly comparable GAAP financial measure. This non-GAAP financial measure is an additional way of viewing net sales that, when viewed with our GAAP results, provides a more complete understanding of our business. The Company strongly encourages investors and shareholders to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure.

Liquidity and Capital Resources

Our liquidity needs arise primarily from capital investments, working capital requirements and payments on indebtedness under the seventh amended and restated senior credit agreement. We have historically met these liquidity requirements with funds generated from operations and borrowings under our revolving credit facility. In addition, we have historically used term borrowings, including borrowings under the seventh amended and restated senior credit agreement to finance our acquisitions. We also have the ability to raise funds through the sale of stock or we may issue debt through a private placement or public offering.

Operating cash flows

Our net working capital position was $344.3 million at March 31, 2024. Net cash provided by operating activities was $29.1 million in the three months ended March 31, 2024 compared to net cash used in operating activities of $3.8 million in the three months ended March 31, 2023, generated on net income of $19.7 million and $1.8 million for the three months ended March 31, 2024 and 2023, respectively. Significant changes in assets and liabilities affecting operating cash flows in the three months ended March 31, 2024 include the following:

• An increase in cash flows from accounts receivable as we experienced higher sales in the fourth quarter of 2023 compared to the fourth quarter of 2022 as well as the timing of cash receipts;
• An increase in cash flows from accounts payable due to the timing of payments; and
• A decrease in cash flows from accrued compensation and benefits as a result of higher incentive compensation payments in the three months ended March 31, 2024 compared to the same period a year ago.

Investing cash flows

Net cash used in investing activities in the three months ended March 31, 2024 decreased $2.2 million from the same period a year ago due to capital expenditures being lower at $2.0 million in the three months ended March 31, 2024 compared to $4.3 million in the same period a year ago.

Financing cash flows

Net cash used in financing activities in the three months ended March 31, 2024 was $17.0 million compared to net cash provided by financing activities of $5.4 million during 2023. Below is a summary of the significant financing activities impacting the change during the three months ended March 31, 2024 compared to 2023:

• During the three months ended March 31, 2024, we repaid the remaining $70.0 million outstanding on the 2.625% Notes.
• During the three months ended March 31, 2024, we paid $26.9 million in contingent consideration related to the In2Bones and Biorez acquisitions.
• During the three months ended March 31, 2024, we had net borrowings on our revolving line of credit of $86.0 million, compared to net borrowings of $9.0 million in the same period a year ago.
• During the three months ended March 31, 2024, we had net cash proceeds of $1.1 million related to stock issued under employee plans compared to $3.4 million in the same period a year ago.

Other Liquidity Matters

Our cash balances and cash flows generated from operations may be used to fund strategic investments, business acquisitions, working capital needs, research and development, common stock repurchases and payments of dividends to our shareholders. Management believes that cash flow from operations, including cash and cash equivalents on hand and available borrowing capacity under our seventh amended and restated senior credit agreement, will be adequate to meet our anticipated operating working capital requirements, debt service, funding of capital expenditures, dividend payments and common stock repurchases in the foreseeable future. In addition, management believes we could access capital markets, as necessary, to fund future business acquisitions.

The Company is also being impacted by the macro-economic environment and we are experiencing higher manufacturing and operating costs caused by inflationary pressures and ongoing supply chain challenges. We continue to monitor our spending and expenses in light of these factors. However, we may need to take further steps to reduce our costs, or to refinance our debt. See “Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2023, for further discussion.

There were $114.6 million in borrowings outstanding on the term loan facility as of March 31, 2024. There were $88.0 million in borrowings outstanding under the revolving credit facility as of March 31, 2024. Our available borrowings on the revolving credit facility at March 31, 2024 were $495.4 million with approximately $1.6 million of the facility set aside for outstanding letters of credit.

The seventh amended and restated senior credit agreement is collateralized by substantially all of our personal property and assets. The seventh amended and restated senior credit agreement contains covenants and restrictions which, among other things, require the maintenance of certain financial ratios and restrict dividend payments and the incurrence of certain indebtedness and other activities, including acquisitions and dispositions. We were in full compliance with these covenants and restrictions as of March 31, 2024. We are also required, under certain circumstances, to make mandatory prepayments from net cash proceeds from any issuance of equity and asset sales.

In February 2024, the Company repaid the remaining $70.0 million then outstanding of the 2.625% Notes through borrowings on our revolving credit facility and issued 0.1 million shares of the Company's common stock.

See Note 10 for further information on our financing agreements and outstanding debt obligations.

Our Board of Directors has authorized a $200.0 million share repurchase program. Through March 31, 2024, we have repurchased a total of 6.1 million shares of common stock aggregating $162.6 million under this authorization and have $37.4 million remaining available for share repurchases. The repurchase program calls for shares to be purchased in the open market or in private transactions from time to time. We may suspend or discontinue the share repurchase program at any time. We have not purchased any shares of common stock under the share repurchase program during 2024. We have financed the repurchases and may finance additional repurchases through operating cash flow and from available borrowings under our revolving credit facility.

New Accounting Pronouncements

See Note 3 to the consolidated condensed financial statements for a discussion of new accounting pronouncements.

There have been no significant changes in our primary market risk exposures or in how these exposures are managed during the three months ended March 31, 2024. Reference is made to Item 7A. of our Annual Report on Form 10-K for the year ended December 31, 2023 for a description of Qualitative and Quantitative Disclosures About Market Risk.

As of the end of the period covered by this report, an evaluation was carried out by CONMED Corporation’s management, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) occurred during the quarter ended March 31, 2024 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.