CONMED Corporation (CNMD) Earnings Call Transcript & Summary

Good morning, everybody, and thanks for joining us virtually for the Barclays Healthcare Conference. It is my pleasure to host. This is Kristen Stewart, Medical Supplies and Devices analyst. With me today, I have CONMED Corporation's President and CEO, Curt Hartman; and the Executive Vice President and CFO, Todd Garner. Since this is now virtual, if you do have any questions for Curt or Todd, I would ask you to e-mail me at [email protected], or if you are available on Bloomberg Chat, just chat me. My handle is kstew@barcap. So let's just dive right in.

So Curt and Todd, you guys issued a press release this morning updating your expectations for the first quarter to reflect the impact of COVID-19. I was wondering if you could just kind of walk through that. It looks like you took down your expectations for sales growth in the quarter. You did comment that you do expect there to be an offset, I guess, from a lower expected tax rate. Maybe just kind of talk through kind of the puts and takes as you're currently kind of seeing them at this point in time.

Sure, Kristen. Thank you, and thanks, everybody, for joining us this morning. I'll do a little bit of history. Back on January 29, CONMED held its fourth quarter earnings call, during which we issued our full year 2020 guidance. We also were a little more instructive relative to the first quarter on that call, and that was partially informed by the fact that we had started to see the outbreak of COVID-19 in China, and we had been made aware of the fact that China had instructed people to not come back to work until February 10 versus what would have typically been February 1 in that time frame. And we also have pretty good leadership team on the ground there that was able to help decipher that information and give us some estimates relative to the impact that they anticipated in China. So here we are, a little bit later, March 10, and we thought it was appropriate to update what we've seen and how things have unfolded in what is clearly a very dynamic situation. So obviously, back on January 29, we were only looking at a region of China and today we're obviously looking at all of China. We're looking at Italy, Korea, broader Asian markets, inclusive of Japan and more recently in the U.S. And we thought it was appropriate that we update our guidance today before we get on the call with investors really today. And as a result, we've moved our first quarter guidance range down to 2% to 4%. Now that's a pretty wide range with 3 weeks left. But I think it encompasses what is a dynamic situation, and it's really hard to understand or predict how this is going to impact the U.S. markets. We're still early in understanding that. But we do think, on the other side, China is pretty well understood at this point in time. And so we're trying to spread a little bit of that range. I'm going to hand it over to Todd to talk about the tax item and provide a little more details on the rest of the guidance included in this press release. Todd?

Yes. Thank you, Curt. Yes, as we saw last year in Q1, as some year-end audit issues get resolved and finalized, we've ended up with a credit that will help us with a lower tax rate in Q1, similar to Q1 of last year. So that will help somewhat offset the impact from the lower revenue because of this issue. And then the only other thing that I would add to what Curt said is that this guidance is specific to Q1. We have not made an attempt to quantify this for the full year yet, and we will do that. We'll give you our latest and best estimates as we get to our Q1 call in late April.

Perfect. All right. Thanks for all that. And with that out of the way, I guess, let us move on to kind of the more regular course of business and let's just talk through, I guess, the rest of the year. I know that you had talked a little bit about just kind of, in general, just seeing a little bit of other kind of weaknesses within the course of the fourth quarter within the Orthopedic business, and you talked about kind of splitting up some of the sales force because of some of the success you had been seeing within Buffalo Filter and AirSeal. Can you maybe just give us an update on kind of how all that is going?

Yes, 2 sides there. On the third quarter call back in October, we talked about pulling forward, what I would refer to as typical sales force expansions on the General Surgery side in the domestic markets. And we talked about accelerating some channel changes in the international markets, and that was both on the General Surgery and the Orthopedics side. So as we went into the call in January, a lot of that work on those 2 items had already occurred and we were moving into what I would refer as the execution stage, meaning a lot of the hiring was done, a lot of the geographic assignments had been made, some of the sales force training on products had started to occur. And that was, what I would call, an atypical move in that we pulled that forward. Typically, organizations in our space, they wait till the first quarter of the new year to do that because you don't want to disrupt your selling teams. But we felt good about where the business was and thought it was appropriate that we pull that forward. And we did that because we have a very strong portfolio really across the company, and we wanted to benefit the company for the long-term by getting those changes in place sooner rather than later. On the January call, we said we were now going to initiate that similar type of work in our U.S. Orthopedics business. The caveat being in the U.S. Orthopedics business they're a little further behind in the product portfolio. We've really spent a lot of time and effort enhancing that product portfolio and 2020 was -- 2019 was a breakout year. And we thought the sales force performance should be stronger. And as a result, when we came into 2020, we said it's time to enhance our performance management, make some transitions and changes in certain geographies. And we announced that we would be doing that work in the first quarter. We're well into the first quarter at this point in time. The execution of that plan is well underway. Sales reps have been hired, converted, whatever the category may be and feel good that, that execution is well underway and moving appropriately. Obviously, we also said at that point in time that we thought the U.S. Orthopedics business would be more back-half performance-driven because we want those reps to have a chance to get familiar with the products, learn their geographies, get familiar with their customers and work that sales process. And I think we remain on track with all of that.

Okay, sounds good. And then, I guess, the other kind of angle, all this, I would say, is just with a bunch of different conferences now being scheduled and thinking about kind of new product launches and typically, these are going to be the venues that you're promoting new products and whatnot. Do you think this is going to have a disruption for just how you approach the business going forward and kind of detail new products? And I'm sure this is kind of a bigger picture question for all companies, I guess, this year within the medical device space. As we were just chatting before this began, AAOS just got canceled. AORN is now canceled. Outside of your purview, I guess, cardiology conferences are now being canceled. How do you just kind of think about now with bringing new products to market and just kind of detailing to your physician groups, just kind of rolling out products this year? Could this be just disruptive, I guess, overall?

It's a great question. And I think the way CONMED thinks about it, I won't say industry, I'll say CONMED, we look at trade shows as an opportunity to enhance awareness about what we're doing on the innovation front across all of our businesses. Nothing has ever been sold to a customer at a trade show is the other side of that. The sales process always happens from the sales force and the marketing teams, what I would call the push side, where they are talking to their customers locally, trying to understand what's going on in their product cadence, their innovation, their interest and their schedules because a big part of getting a new product in front of the customer is working with the schedule locally and then the budgeting process. So we think that the push side, the CONMED side of being in front of customers one-on-one really remains the key driver of new product success and then the other part that's coupled with that is the medical education, and that could be cadaveric workshops, and this is more relevant on the Orthopedic side. Cadaveric workshops here in our Largo, Florida facility, where we have a world-class cadaveric work center or in our international cadaveric work centers or in other lease facilities that we'll occasionally use when we do regional customer visits and training on new technology. So the trade shows create awareness. So we will miss that awareness. But at the end of the day, our sales reps out in the street and the number of feet on the street are the ones that really drive that awareness, that hands-on -- that cadence of new product acceptance, and the medical education is a phenomenal supplement to help enhance that. So I think, yes, awareness may be more on the shoulders of CONMED because the trade shows are being diminished or deferred, in some cases. ASCA is a big trade show, was supposed to happen in Milan in May. They've moved that to September now. So it's deferred versus canceled. So our teams are going to have to work a little bit harder, our marketing teams, to create the awareness. But there will be no change to the push by the sales reps, the marketing teams and the medical education teams, which is really where the sales process is made. Hopefully, that makes sense as people think about how the process works.

Yes, that's fair. All right. And then just turning over to AirSeal and Buffalo Filter. Is it fair to say that combined, those 2 products on an annualized basis, are approaching kind of that $200 million level of sales? And if we think about it, those are growing in kind of that strong double-digit, those end markets should be growing kind of in the teens, I guess? Is that kind of a reasonable ballpark, I guess?

Yes, Kristen, you know we don't break out product line sales. We do have an investor presentation that has a pie chart on it and you can use your best estimates based on those pie charts. At the end of the day, we're excited about both platforms. They're highly innovative technologies. They are clearly best-in-class. They are unique and differentiated. And the customer enthusiasm is just fantastic. And the best thing that we have done to support those is expanding the sales force around the globe candidly that carries those so that we can get more time with customers and meet the growing demand. They are both important parts of the General Surgery side of the business, and we don't see that diminishing anytime soon. Todd, I don't know if there's other comments you throw on top of what I just said there, given the priority we placed on those 2 products?

No, I think that's well said, Curt. I would say that the Buffalo Filter demand, we expect that market to grow north of 20%, I would say, Kristen, for the foreseeable future. And AirSeal, again, strong double-digit growth on the AirSeal side for the foreseeable future. So we feel very good about the momentum in those businesses and what those products can become over time.

Yes. And some of that Buffalo Filter, you, guys do sell through to other players as well as just individually selling as your own Buffalo Filter branded product too, correct?

We do. We OEM...

That's -- go ahead, Todd.

Yes, we do OEM at product level. Doesn't have all the key features and benefits of our branded product, but we do OEM for other strategics.

Okay, great. Perfect. And then just in terms of, I guess, AirSeal, that product, we should think about that as also growing in line with more robotic surgery procedures. Is that the way to think about that underlying demand as well?

Go ahead, Todd.

Okay. Sorry about that, Curt. Curt and I are not in the same place. So I apologize for the delay. Yes. Well, I'd say, at least at that level. We've been growing a little faster than the robotic procedure growth in the U.S. And the other interesting part of this, of course, AirSeal is relevant to all laparoscopic surgery, not just robotic. And we're seeing very strong growth OUS where there are not a lot of robots. And so in those markets, our sales reps are selling into just general laparoscopic procedures. And of course, there's a 10:1 -- the volume is 10:1 in favor of nonrobotic procedures. And so that's what gives us the confidence that AirSeal can grow not just in the wake of the robots, but beyond that wake for a very long time. We think we're in the very early penetration levels of what this product could be. And as Curt said earlier, there's really nothing like it. It's extremely differentiated and provides meaningful benefits that justify the economics for robotics, certainly, but also for nonrobotic cases.

And so these 2 products, obviously, from a mix perspective, definitely accretive from a top line growth. How do they also filter through the P&L? Are they accretive both from a gross margin perspective, and how does that pull through from an operating margin perspective as well?

Yes. So AirSeal is now in the high 60s or even low 70s on a gross margin basis. Buffalo came in the door on the date of acquisition, just a little over a year ago, was in the mid-50s. So right at the corporate average from a gross margin perspective, but accretive on an operating margin perspective on day 1. We are in the process of integrating the manufacturing for Buffalo Filter into our existing facilities. And so as that completes, as we work through -- as we get through 2020, the Buffalo Filter gross margin will be in the 60s. And then as volume improves, that will go north from there. So you've got these 2 product lines, which are strong growth drivers for us also being margin -- gross margin accretive and certainly operating margin accretive for the portfolio.

Great. Then just kind of sticking on that topic of margins. Todd, I know that you've kind of talked about, in general, seeing some opportunities for, I think, it's 50 to 100, correct me if I'm wrong, margin -- operating margin improvement -- or sorry, gross margin improvement each and every year and then we should think about at least that from operating margin expansion as well as you think through what you want to kind of invest, I guess, from an SG&A basis. Is that correct, I guess, the right way to think about it? Putting this year aside, I guess, that's more of just kind of a general framework for margin expansion?

That is correct. Yes. And on an organic basis, kind of the trends that we're seeing, we would expect, as you said, at least 50 to 100 on the gross margin side and then as it drops through operating expenses a little better than that on operating margin. And that would kind of be the status quo of how you should think about a longer-term kind of profitability improvement here at CONMED. And I think where you're going, 2020 is actually set up to be a little better than average on the gross margin side. We are making some of these significant investments that Curt talked about on the sales force that will add SG&A early in the year. And then those resources will become more productive as the year unfolds. And so there'll be a little bit of a noise on the SG&A line in 2020. But we still see operating margin improving meaningfully this year and setting us up for a strong 2021 and beyond from profitability improvement standpoint.

Okay. And I think I have 1 question coming in from the webcast. Just kind of going back, I guess, looping back to kind of corona and knowing that you will be updating kind of the full year as part of the first quarter, but the question kind of goes back to how to think about kind of the puts and takes for the full year? Your original guidance had incorporated a fairly significant ramp-up in the sales growth through the balance of the year and implied you exiting the year at about, I guess, an 8% run rate. How should we just think about kind of the puts and takes and the level of confidence that you still would have in that sort of second half acceleration?

Yes. I would say that we still see very good momentum in the core business. We've talked about couple of our growth drivers. The new products on the Sports Medicine side of the business we expect to contribute more in 2020 than they did in 2019, and we expect that to build each quarter as we move out. So I think we feel very good ex -- if we can exclude the corona impact which is very hard to project for the full year, we think the underlying strength of the business is very good. The CONMED sales team continues to become more seasoned, become more relevant to our customers. CONMED's reputation in the marketplace is improving every quarter. The new product pipeline is validating that. And so we believe that we are set up to take market share as we move forward, and that's how you grow faster than the market, obviously, and that's what we've been messaging and that's how we've built the company. And we believe that we've built an infrastructure that can support a much higher revenue base. So as those sales grow, our expenses can grow slower and our profitability profile improves. And so we remain committed and feel very good about all of those factors. I think we're just dealing with kind of a storm right now that the whole world is dealing with, and we're trying to get through that storm. But as we come out the other side, I think we feel very good about the fundamentals and the engine of the business and our ability to grow faster than the markets.

And the guidance reduction, that's China and other geographies or just China at this point? Reconfirming that.

Yes, it is China, other Asian countries. It includes Italy and some softness in other Western European countries. And then also, as Curt said, it's a little bit of a wide range actually for 3 weeks left in the quarter because it contemplates even some softness in the U.S. And so obviously, we're not exactly sure how the next 3 weeks play out, but we're trying to capture a reasonable range of possibilities given the facts on the ground as of now.

Okay. Okay. [indiscernible] that question. And then I guess the last thing in the last minute or so that we have, kind of, I guess, a broader and, I guess, a little bit different question. How do you guys just kind of think about where you are from just a leverage situation? And I guess, thinking through that, just given the volatility that we see in the market and everything else, you guys did do Buffalo last year, where do you, I guess, see the leverage going over time and are there future M&A, I guess, endeavors?

Sure. Very good question. So yes, when we closed Buffalo a little over a year ago we were at 5.2 -- well, by the end of -- at the end of Q1 of 2019, we were at 5.2 turns debt to equity -- I'm sorry, debt-to-EBITDA. The -- that is now, at the end of the year, that was 4.4. We had said that we would be at 3 turns by the end of 2021, and we're actually ahead of that schedule so far after just a few quarters. And so Buffalo has performed very well. The rest of the business has performed very well. Cash flow has been strong, growing with or better than income, and our EBITDA has been improving. And so -- our debt payments and our commitments are actually very low. We're nowhere close to in danger of not being able to meet those payments, and the leverage is coming down actually faster than we had projected. So we are comfortable with our debt leverage. We don't see any reason to be concerned about our ability to meet those commitments at all.

Okay. I guess, if there's one thing that you kind of want to make sure the audience leaves with a take-home message, what would it be?

I think from my chair, Kristen, it would be the fundamentals that got CONMED to this point, the product innovation, the focus on the customer, focusing on profitability with enhanced vigor in the last couple of years as we put those other steps, the right people and the right products in place. That has not changed. There's obviously external factors right now with COVID-19 working its way around the world that we are navigating through. And candidly, I think given the work that the company's leadership team had to do in the early years of the transformation going back to '15, '16, '17, this team is well versed in dealing with adversity and challenging, surprising situations. And we feel pretty good about the underlying fundamentals of this business and the innovation that we've got in the portfolio. So I like where we're at. Obviously, some current challenges, and I think we will get through them.

All right. Sounds good. I think you guys will get through it, too, for what that's worth.

Thank you.

All right. With that, I think we will wrap this session up and I'll allow everybody else to dial on into their next session. So I want to thank you again for your patience and understanding for converting this over to a virtual form. I appreciate that very much. And thanks, everyone, for joining us in on this virtual beachside, fireside, deskside chat. So thanks again, and we'll all be talking very soon. Stay safe, everybody.

Thanks, Kristen.

Thank you, Kristen.

Thank you. Take care, bye-bye.