CONMED Corporation (CNMD) Q1 2022 Earnings Report, Transcript and Summary

Good day, and thank you for standing by. Welcome to the First Quarter Fiscal Year '22 CONMED Earnings Conference Call. [Operator Instructions]. With us today are Curt Hartman, President and CEO; and Todd Garner, Executive Vice President and Chief Financial Officer. I would like to now turn the conference over to CONMED. Please note this conference is being recorded.

Good afternoon, everyone. Before the conference call begins, let me remind you that during this call, management will be making comments and statements regarding its financial outlook and its plans and objectives, which represent forward-looking statements that involve risks and uncertainties as those terms are defined under the federal securities laws. Investors are cautioned that any such forward-looking statements are not guarantees of future events, performance or results, and the company's actual results may differ materially from its current expectations. Please refer to the risks and other uncertainties disclosed under forward-looking information in today's press release as well as the company's SEC filings for more details on the risks and uncertainties that may cause actual results to differ materially. The company disclaims any obligation to update any forward-looking statements that may be discussed during this call, except as may be required by applicable law. You will also hear management refer to certain non-GAAP adjusted measurements during this discussion. While these figures are not a substitute for GAAP measurements, management uses these figures to aid 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. Adjusted net income and adjusted earnings per share measure the income of the company, excluding credits or charges that are considered by the company to be special or outside of its normal ongoing operations. These adjusting items are specified in the reconciliations supporting the company's earnings releases posted to the company's website. With these required announcements completed, I will turn the call over to Curt Hartman, CONMED's Chair of the Board, President and Chief Executive Officer, for opening remarks. Mr. Hartman?

Thank you, Debbie and Julie. Good afternoon, and thank you for joining us for CONMED's First Quarter 2022 Earnings Call. With me on the call is Todd Garner, Executive Vice President and Chief Financial Officer. Today, we'll share with you our first quarter results, a more detailed review of the In2Bones acquisition and the overall outlook for our business. We'll then open the call to your questions. I'll start by reviewing our first quarter results. Total sales for the quarter were $242.3 million, representing a year-over-year increase of 4.1% as reported and an increase of 4.3% in constant currency. From an earnings perspective, during the first quarter, our GAAP net income totaled $15 million. This compares to net income of $9.9 million in the first quarter of 2021, excluding special items that affected comparability, our adjusted net income of $23.5 million increased 22.9% year-over-year, and our adjusted diluted net earnings per share of $0.70 increased 11.1% year-over-year. March was our best month in the quarter as the impact of Omicron was strongest in January and dissipated throughout the quarter. In our international markets, I would note that Asia, Japan and Canada all started slow, while Europe and Latin America delivered very solid performances. The U.S. market showed improvement late in the quarter. Overall, I'm pleased with the quarter and the commercial performance as we continue to navigate the impact of COVID. We introduced new products across the business and delivered solid results in both the top and bottom line. During the quarter, we saw additional smoke legislation passed in Arizona, Georgia and Washington, which now places about 18% of the U.S. hospital network under some form of legislation. While this is favorable, it clearly indicates more room ahead on this important topic. We are encouraged by our revenue outlook after 1 quarter, both with and without the acquisition. Given the inflationary pressures and the impact expected from the acquisition, I'm comfortable that we have landed on a responsible earnings outlook, which Todd will cover in more detail. I'll now switch my comments to the acquisition of privately held In2Bones. Today, we announced that we signed a definitive agreement to acquire Memphis, Tennessee based In2Bones for $145 million upfront payment with the potential for an additional $110 million in revenue growth-based earn-outs over a 4-year period. We think In2Bones is an excellent platform for CONMED. The company brings to CONMED a very experienced leadership team, an innovative and comprehensive foot and ankle portfolio, a well-established and growing sales channel and existing international presence and an exciting platform for future innovation. We're excited to enter the lower extremity foot and ankle market, which is an estimated $4.5 billion market growing in the high single-digit range. We expect the transaction, which is subject to Hart-Scott-Rodino clearance and approval to close late in the second quarter or early in Q3. We expect the transaction to be accretive to our top line and gross margin, while being marginally dilutive to earnings in 2022 and 2023. From an organizational standpoint, the business will run as a full platform stand-alone in the U.S. market and will retain the current organizational structure, including the existing sales channel. Outside of the U.S., the products will be picked up commercially by our international team in areas where there is no existing coverage or where the existing coverage is not as comprehensive as we believe is needed. As with our current global orthopedics effort, this business will report directly to Pat Beyer, our President of International and Global Orthopedics. We believe the CONMED platform will allow us to expand areas such as medical education and engineering, human resources and accounting services as well as the previously mentioned international market expansion, to name a few. Overall, CONMED has been evaluating strategic options in this space for the last several years, and we think our patience and diligence has allowed us to find a great platform addition, led by a talented management team. We look forward to welcoming Alan Taylor and the In2Bones employees and sales agents and assure you that we're committed to continued growth in this business. In closing, I'm pleased with our start to the year, excited with the addition of the In2Bones business, which gives us a solid entry into the high-growth lower extremity market, and I'm looking forward to the continued efforts to grow and expand our business in all the markets we serve. I'll now turn the call over to Todd, who will provide a more detailed analysis of our Q1 financial performance, discuss the impact of the In2Bones deal and take you through our full year guidance. Todd?

Thank you, Curt. All sales growth numbers I reference today will be given in constant currency. The reconciliation to GAAP numbers is included in our press release. As usual, we have included an investor deck on our website that summarizes the results of the quarter and our updated guidance, including a few slides on the acquisition announced today. For the first quarter of 2022, our total sales increased 4.3%. The month of January was below the prior year January due to the impact of Omicron on hospital procedures and staffing and each month of the quarter saw improving hospital volumes. For Q1, our sales in the U.S. increased 5.9% versus the prior year quarter. Our international sales grew 2.6% for the quarter compared to the prior year. Worldwide Orthopedics revenue grew 0.4% in the first quarter. In the U.S., Orthopedic sales grew 2.2% and internationally, Orthopedic sales decreased 0.5%. Total worldwide General Surgery revenue increased 7.7% in the quarter. U.S. General Surgery revenue grew 7.5%. Internationally, General Surgery revenue increased 8.2%. AirSeal and our direct Buffalo Filter product lines had a very strong quarter despite the slow start. The OEM side of the Buffalo Filter products continues to lag our direct products. Now let's move to the expense side of the income statement. We will discuss expenses and profitability in the first quarter, excluding special items, which include charges for restructuring, amortization of intangible assets and amortization of deferred financing fees and debt discount net of tax. Adjusted gross margin for the first quarter was 56.1%, an increase of 90 basis points over the prior year quarter. Our improving mix continues to drive margins up. We are seeing increased costs that will affect future quarters, and we will talk about that more when we discuss guidance. Research and development expense for the first quarter was 4.4% of sales, 10 basis points higher than the prior year quarter. First quarter SG&A expenses on an adjusted basis were 39.7% of sales, an increase of 60 basis points from Q1 2021 due to the expansion of the sales force last summer. On an adjusted basis, interest expense was $4.1 million in the first quarter. The adjusted effective tax rate was 17.5% in Q1. Once again, we benefited from the excess tax benefit from stock plans. We do not expect that same level of benefit going forward. First quarter GAAP net income totaled $15.0 million, an increase of 51.9% over Q1 of 2021. The $0.47 of earnings per diluted share this quarter was up 51.6% over the prior year quarter. Excluding the impact of special items discussed earlier, we reported adjusted net income of $23.5 million, an increase of 22.9% compared to the first quarter of 2021. Our Q1 adjusted diluted net earnings per share was $0.70, an increase of 11.1% compared to the prior year quarter. Turning to the balance sheet. Our cash balance at the end of the quarter was $24.9 million compared to $20.8 million as of December 31. Accounts receivable days as of March 31 were 68 days compared to 60 days at the end of 2021. This is a function of the timing of revenue in the quarter, with March being much stronger than January, a higher mix of receivables came in the last month of the quarter than our normal cadence. Inventory days at quarter end were 215 and our effort to serve our customers, we continue to build inventory to mitigate supply challenges. About half of the increase since December has been in raw materials and WIP. Long-term debt at the end of the quarter was $704 million versus $672 million as of December 31. About $23 million of the increase is due to the new accounting standard for convertible notes. The other side of the reclass is essentially a debit to equity. Our leverage ratio on March 31, 2022, was 3.5x, which is consistent with December 31. Cash flow provided from operations for the quarter was $0.3 million compared to $22.3 million in the first quarter of 2021. The difference is due to the increase in accounts receivable and inventory discussed earlier. Capital expenditures in the first quarter were $3.7 million compared to $3.1 million a year ago. Now let's turn to financial guidance. We are very pleased with what we're seeing on the revenue momentum. While the effects of COVID still linger, we are seeing good volumes in most of our geographies. Our confidence in our revenue projection has strengthened since January. Therefore, on an organic basis, we are raising our revenue guidance today to the range of $1.085 billion to $1.130 billion. That represents organic growth between 7% and 12% over 2021. Compared to our previous guidance, the new range is $10 million higher on the bottom and $5 million higher on the top. There is still a lot of year left, but we're seeing very good momentum on the commercial side of the business. As it relates to currency, foreign exchange has gotten worse since January, but our hedges are doing what they are intended to do so far. And at the end of the first quarter, we continue to expect a material impact to 2022 financial guidance from currency. On the cost side, we are definitely seeing elevated inflation compared to what we were seeing 3 months ago. Oil costs are significantly up, which affect freight and resins. We are currently projecting freight to be 14% higher for the full year 2022 than we were projecting in January. Material costs have also increased. So far, we estimate that materials in aggregate will cost us 5% more in 2022 than we thought 3 months ago. Because of how we recognize costs with inventory, those recent increases did not really impact our P&L in Q1, but they will begin to weigh on the margins we report going forward. Of course, we don't know how long we will live in this inflationary environment and where it goes from here. We are actively working to mitigate these pressures on the P&L. We have already implemented some price increases where it makes sense and are analyzing the opportunity to take price in other areas. We are also being extremely judicious with any new commercial spending. However, I do want to emphasize that we do not think it would be wise to make wholesale cuts to our commercial infrastructure in an effort to offset these macro and hopefully, temporary inflationary pressures. Our business momentum is strong, and we expect double-digit revenue growth in the back half of this year. We think it would be very unwise to jeopardize our revenue growth to solve what is hopefully a short-term macro issue. Due to those increased costs without the acquisition that we will talk about in a few minutes, we would have been directing investors to the low end of our prior full year adjusted EPS guidance. Specific to gross margins, 3 months ago, I told you I expected gross margins in 2022 to grow over each prior year quarter. Q1 was a good example of that forecast as it grew 90 basis points above the prior year. However, given the accelerated inflation, I now project each remaining quarter this year to be below the prior year gross margin for the comparable quarter, because we recognize manufacturing variances with inventory, we have a better forecast for Q2 than we do for the subsequent quarters. I can tell you that Q2 looks to be about 100 basis points lower in gross margin than Q2 of 2021. We will keep you updated as we move through the year. We also did an analysis of what our gross margins would be today if freight and material costs were simply static with pre-pandemic levels. Our estimate is that these 2 items alone have cost us approximately 300 basis points in gross margin since 2019. Our commercial engine is strong. Our prior investments are paying off. We are also navigating an unprecedented macro storm along with everyone else. We will continue to stay focused on the customer and serving them with an engaged workforce and innovative products, which has resulted in increased profits for our shareholders. That continues to be our approach. As we transition out of the pandemic, we believe customers will continue to reward our actions as valued partners with increased trust and market share. Now let's talk about the financial impacts of the acquisition we announced today. In2Bones had revenue of $36.8 million in 2021 at approximately 80% gross margin. We expect a late Q2 or early Q3 close, and we always want to be cautious in the first months of an acquisition due to potential disruption and channel issues. So we are estimating $20 million of revenue contribution in the back half of 2022 from the acquisition. As you see in the materials included in our deck, we expect the extremities market to grow in the high single-digits and In2Bones has been growing at least twice as fast as the market. We expect that similar growth rate to continue as we join together to address this important customer base. From an adjusted EBITDA perspective, we expect the acquisition to be slightly positive in 2022, contribute single-digit millions of EBITDA in 2023 and double-digit millions after that. From an adjusted EPS perspective, we expect the acquisition to be between $0.05 and $0.10 dilutive to both the remainder of '22 and the full year of '23 and to be accretive thereafter. That would make our full year 2022 revenue guidance, including the acquisition to be between $1.105 billion and $1.150 billion. Our full year 2022 adjusted cash EPS guidance range, including the dilution from the acquisition is $3.50 to $3.65. And with that, I'll turn you back to Debbie for the Q&A portion of the call.

[Operator Instructions]. Our first question comes from Robbie Marcus with JPMorgan.

This is Lilly on for Robbie. Maybe just to start with one on near-term trends. What are you seeing in terms of the recovery into 2Q? Has that momentum you called out continued into April? And are there any geographies or parts of the business that are still lagging?

I don't want to get too far into Q2, Lilly. But I think what we saw in the month of March, we feel good about that as an exit point and how that's continued as we started the second quarter. To the point of where there may still be challenges. I was reading some data relative to the China market. And I think everybody knows China is not a massive market for CONMED, but there was a reference that some 340 million people are under some form of lockdown. So obviously, China is still a little bit slow relative to other places around the globe. Other than that, I think things are moving forward around the globe on a positive fashion.

Okay. That's helpful. And then maybe just one on Buffalo Filter and AirSeal. How should we be thinking about how those 2 products did in the quarter? And is 25% of the business growing faster than 20% still the right way to think about those 2 products?

Yes. Thanks, Lilly. Yes, that's definitely still how we see it. Again, our direct business in Buffalo Filter is doing much better than the OEM business, which is to be expected. And so the OEM business is a little bit of a drag on that metric. But AirSeal and our direct side of the Buffalo Filter business continue to do very well.

The next question comes from Rick Wise with Stifel.

Maybe, Curt, you could just expand on your thoughts in pursuing In2Bones. I mean, obviously, big TAM, rapid growth, better gross margins, those are pretty evident. But maybe talk about how you see the synergies between In2Bones and today's CONMED and how it's likely to evolve working together as we look ahead to the next few years.

Great question, Rick. And the first 3 you nailed, those are all very important parts when we look and this is obviously a new adjacency for us. It's under the umbrella of orthopedics, but it's not a space that we have a very large presence in it all. We do have some products through our sports medicine business that address the foot and ankle, soft tissue aspects of the extremities marketplace. And so that has allowed us to spend more time in this market, get more acquainted with the market. And there's a lot to like in this market. And specific to In2Bones, they bring a very experienced and seasoned leadership team. They have a very broad portfolio, and they have a very well-established sales channel and very important from a CONMED perspective, they have a very solid international presence with direct sales channel in a couple of markets and coverage of 25 countries. So all of those things lined up very well for CONMED. When we looked at this particular asset relative to everything else that may have been in the marketplace at any given time. As I noted in my comments, we've been looking at this market for some period now. We think it's just -- it's an expansion opportunity. It's a high-growth market. And so for all those reasons and probably more, it just fit very well with where we want to go, not only today, but well into the future. And we already compete with a lot of these competitors that would be line up against. So I think we're comfortable with that. And I think we've demonstrated we can do that, and this is just another opportunity for CONMED Corporation.

And just a follow-up. And you -- at the end of going -- where I was going to go anyway. I know I'm going to get asked how is CONMED going to compete with the larger players and you and I have had this conversation about your existing business multiple times, and you've answered it eloquently. Do you -- but there are other aspects, do you have a big enough portfolio to compete? Are the decision points different, will you have to invest more aggressively to continue the kind of growth you laid out in sales force. So just maybe talk in a little more granularity about some of those points.

Sure. We believe the existing portfolio that In2Bones has is a phenomenal starting point for CONMED. And they've worked very diligently to build that portfolio. And obviously, they continue on with their R&D efforts. And that was certainly one of the things that excited us as we delved in our diligence and looked at their portfolio and where they were taking the portfolio. So innovation is a consistent part of the story in extremities, just like it's a consistent part of what we've been trying to do at CONMED over the last several years. Sales force expansion, sales force excellence, consistent part of being in the implant market, which extremities certainly is in the implant market. It's surgeon-driven preference item that's very similar to what CONMED already operates with our portfolio. And so all those things are very similar to what we already do today. And as I noted, the competitive base is very similar to the people we line up against. So the -- those things are all very similar to us. I'm not going to say there aren't nuances to this market relative to our other markets. Every specialty has its own nuances. But I think our team feels very comfortable about entering that. And I say that because of the leadership team that In2Bones brings and has from a depth of experience in this marketplace. We are, in essence, buying a platform. We're not buying a product line. We're buying a platform and it starts with people, and that's something I've said from day 1. We want to find great people, and we'll do well in the markets if we have great people. And I think we're getting all of that and then some with this acquisition.

The next question is from Mike Matson with Needham & Company.

Another question on In2Bones. The press release mentions upper and lower extremities, but it sounded like the comments on the -- in the prepared remarks, really focus more on the lower extremity portion. So can you just talk about the mix there in the portfolio? And within the foot and ankle area, I guess are there any kind of key poles or they're lacking products like maybe like [indiscernible] or something like that?

It's a great question. And if you go to the In2Bones website, you'll see that they do mention upper and lower extremities as their company descriptor. And it's a fair descriptor. And if you look at our investor deck, we've got a slide in there with the product portfolio that does show some upper extremity items. If you dissect that $38.6 million of revenue, the majority of that revenue is driven by the lower extremities, and that's really what we valued the company on. Now in saying that, we do believe that there is some value in that upper extremities portfolio. And we do believe that over time, we can look at that and see if we want to invest more and continue to develop that. We certainly have a channel that calls on that space. If you think about the shoulder and what we do in sports medicine in the shoulder, we've got some products that go into the hand and wrist. So there may be some opportunity there, but that's to be determined, Mike. We're more focused on the value that they've created in the lower extremities and where that's going to take us right out of the gate.

Okay. Got it. Yes, I didn't even flip to that slide yet. It's definitely helpful. All right. And then I guess as far as the supply chain goes, a lot of commentary about the cost pressures, but I didn't really hear anything about any kind of significant shortages of any sort of components or anything like that. So I just wanted to check in and see if you've had any kind of issues where you've not been able to fulfill orders with any of your products that you couldn't get components or raw materials or something like that?

Yes, Mike. We're dealing with that like everybody else is dealing with that. And that's part of the material cost increase, too, right, because the suppliers are in a position of scarcity. And if you want to get the product, they've kind of -- you pay the price to get it. And so that is definitely part of what's happening out there. I would -- to give you some historical perspective, we're now at about -- we -- we're now at about 2 days' worth of sales in back order. Before the pandemic, we probably lived routinely below half a day worth of sales. And so it's not -- you think about 2 days of sales, it's not that much, right, on a material basis. But compared to where we used to live, I'd rather have 2 more days of sales in Q1 or I'd always rather have 2 more days of sales. So yes, so it's something we're dealing with. I think our team has really done a noble job of mitigating through those pressures, but we are certainly not immune and are feeling the same things that everybody else is feeling around the world.

Okay. And then just a follow-up on that, Todd. I think I heard you say you expect double-digit growth in the second half -- revenue growth in the second half. Is that because you're including the inorganic component from the acquisition? Or were you speaking on an organic basis? Or did I just completely hear that wrong?

No, you heard it right. That's on an organic basis. Now part of that is the back half of 2021 was a lot worse than it was supposed to be, right, because of Delta and then Omicron. So there's some easy comps in there. But yes, we do project without the acquisition, we expect double-digit revenue growth in the back half of 2022.

The next question is from Matthew Mishan with KeyBanc.

Congratulations on the acquisition. I just wanted to go to the dilution in '22 and '23 from it. Just how are you thinking -- and I'm sorry if I missed it, how are you thinking about like the financing cost of this acquisition? And does that also include like investments you need to make to support the growth?

Yes. Great question, Matt. So yes, the financing part is basically what makes it dilutive, right? Because we told you from an EBITDA perspective, it's actually positive even in the first 6 months, which is 2022. And then it gets -- it adds single-digit millions to EBITDA in 2023. And so what turns that positive EBITDA into diluted EPS is the financing. We can fund that -- it's $145 million upfront with milestones over 4 years. We certainly have that kind of capacity in our current credit facility, but rates are rising rates. So that's what -- it is the financing that makes it dilutive. And so I would just point out that there's 2 quarters in 2022 and then 4 quarters in 2023, which is -- so it is getting more accretive as we move forward, but it's 4 quarters' worth of interest costs in 2023. So that's why it still stays dilutive in 2023. And then we should be accretive once we get through 2023.

Okay. That makes total sense, given the current environment. And then just you mentioned this was a platform that's been built. Just can you go back and give us a little bit of context of how this company has come together? Was it organic or inorganic? And just trying to understand how it's been built?

Sure. I'll do my best here from what I know of the history. I started out as a French-based company, developed a U.S. commercial presence. At some point, there was a merger of the U.S. commercial presence with the French entity. And both entities had some form of R&D established. And that's in part why they have a bigger presence internationally than a lot of companies at this scale. So today, they retain a presence split about 50-50 in terms of people in the U.S. and internationally. The U.S. sales channel is -- sales channel we're very familiar with. It's a distributor-based sales channel, which is not atypical in this particular specialty. And we obviously have a hybrid sales channel here in our U.S. Orthopedics business. So we're familiar with those. And majority of their product portfolio to the best of my knowledge, has come through organic innovation and development. So I think it's been built very financially responsible. And has a very good, solid and growing presence in the leadership team and the experience and depth of knowledge of the market is very evident when you look at the background. So a lot to like here, and that's what made it very appealing to CONMED.

This concludes our question-and-answer session. I would like to turn the conference back over to Curt Hartman for any closing remarks.

Thank you, Debbie. I want to thank everybody on today's call for your time, and we look forward to speaking with you again on our next earnings call. Thank you. Have a good evening.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.