CONMED Corporation (CNMD) Earnings Call Transcript & Summary

My name is Mason Austen, associate on the medical device research team here at Morgan Stanley. I'm pleased to welcome CONMED here with us today as part of our virtual Healthcare Conference. From the company, we have Curt Hartman, President and CEO; Todd Garner, Executive Vice President and CFO. Before we get started, just a quick disclaimer. Please note this webcast is for Morgan Stanley clients and employees only. This webcast is not for members of the press. If you're a member of the press, please disconnect and reach out separately. For additional details on disclosures, please visit morganstanley.com/researchdisclosures. So with that, Curt, Todd, thank you both for being here today. And we can go ahead and jump right in, if you want to skip the preamble here. So…

[ Yes ].

Excellent. So Curt, Todd, you saw sequential improvement every month in the business through July from April trough of down 50% to 55%. Anything you can tell us in terms of monthly sequential trends in August and September? How has recovery played out relative to your expectations? And kind of where do you sit today?

Mason, we said on the call, the improvement with April being the low point, that we saw May better than April, June better than May and that, that had continued into July. We're not going to get into an intra-quarter update here today. But we certainly liked the cadence of things from the low point in the April downturn. And certainly, as more and more geographies have opened up with surgery getting -- if you can say the word back to normal, the cadence of surgery improving, certainly, the business is going to continue to improve with that trend.

But if we were to frame expectations, Curt, from how you were feeling in July to say how you were feeling to today, would you say that's kind of on par with your expectations? It's played out better than expected? Worse than expected? How would you characterize that?

I think on the earnings call, one of our concerns was the reemergence of COVID, particularly in the southeast portion of the United States. And I think sitting here today, that didn't take quite the extreme measure that some people had predicted. With that said, on the other side, outside the U.S., there were some markets that did see slowdowns. In Australia, Australia was looking really to be in great shape, and then the area around Melbourne effectively shut down and all surgery stopped. So you're seeing more of these limited geographic slowdowns. So it's a bit of a W for me. They might be small Ws, but it's a bit of a W. You'll see things improving, and then you'll get a geographic slowdown that -- and that particular region, will pull things back and then you got to go through the restart again. So it didn't -- big drop in the southeast, but are seeing smaller drops in more distinct geographies.

Got it. And you've obviously had significant tailwinds with Buffalo Filter and AirSeal, which we'll talk about a little bit later. Have you seen any signs of growth within the business outside of those 2 key products?

Number one, I am going to touch on Buffalo Seal -- Buffalo Filter and AirSeal. They were high-growth platforms before COVID-19, and they certainly have continued that momentum and then some for reasons that we can discuss later. As the rest of the portfolio -- and again, it's a portfolio of 4 distinct portions. There's Sports Medicine business. There's the legacy portfolio, patient care, which is ECG electrodes and multifunctional electrodes. There's a GI business, upper and lower GI tract, really focused on the interventional therapeutics side and then Advanced Surgical, where AirSeal and Buffalo Filter have resided since the acquisitions. All of the businesses have improved as surgery has come back. Patient care is probably the one that has the slowest recovery. And the other businesses, as they're directly tied to surgery and directly tied to interventions, have a faster rate of recovery as the markets have improved.

Got it. That's very clear. So geographically, you said at gen surg, EU grew in the second quarter, which is admittedly a little bit surprising given the European businesses, for some of your competitors, actually declined. Why do you think your performance looks a little bit different? And then as a quick follow-up to that, do you expect this level of growth to continue into the third quarter?

We've got a very good International business at CONMED. We're a little bit disproportionate relative to the rest of med tech and that over 45% of our revenue comes from outside the U.S. And we have great leadership teams across our international markets. And in Europe, we have a very sound leadership structure right down to the country level. And it's been a couple of years now, but we took that -- we took our portfolio and really integrated it. Gave each country manager total ownership of the entire portfolio. So as they've gotten more and more acclimated and associated with General Surgery, we're seeing faster growth on the General Surgery side. And then you put on top of that, the Buffalo Filter and AirSeal platforms, and it really was an accelerant in the quarter. So we're very, very proud of what our teams in Europe and, candidly, across the globe have been doing. But that General Surgery growth really benefited from, number one, kind of that alignment of the General Surgery brands underneath the org structure. 5 years ago, they were sold very separate, very distinctly different, really, kind of a, "come one, come all," distributor model. We've now gone direct in the majority of those markets; and number two, the benefit from AirSeal and Buffalo Filter on top of that. So we just got the right combination moving right now across Europe, which I think led to the General Surgery growth. Do we see it continuing? I think we feel pretty optimistic about what's going on in the General Surgery franchise in general. And we feel good certainly about what's going on with AirSeal and Buffalo Filter as catalysts for that franchise.

Got it. That's helpful. So appreciating you're not going to guide to the third quarter on this call, obviously, and you didn't quantify exactly the June exit rates, but most of devices are quantified June exit rates or June trends of down low double digits. Any reason to think -- as we think about your third quarter consensus estimates for down 12%, it seems a little bit conservative given that most other device companies have exited June roughly down low double digits. I guess the way I'll ask this question is any reason we should think about your business recovery trajectory looking different than peers?

I think the one thing I would point to would be that business mix, the International component of our franchise, 46%. International markets, just on a historical basis, don't grow as fast, and they typically don't fall as far in a market contraction. And I think that, that weighting could change the relative exit rates, if you will. That said, we spent the last 5 years really working hard on innovation, sales design, sales model, go-to-market strategies, so those things all work in our favor. And to your point, we're not going to give intra-quarter updates. We'll just have to see how the quarter shakes out. But I think we're doing the right things as an organization to continue to move forward as a business. Todd, I don't know if there's other things you'd add to that.

I think that's well said, Curt.

Got it. Okay. And with slightly greater visibility now, given the past 2 months that have transpired since earnings, I mean, how do you think about -- or how would you characterize to investors how you think about a return to normal? So obviously, a lot of companies have called out the fourth quarter potentially looking like a more normal quarter. Would you characterize this as in line with your expectations? Or is this more likely to be early next year?

Todd, do you want to grab that one?

Sure. Yes. As Curt said earlier, Mason, I think when we did our call at the end of July, there was a lot of uncertainty around this resurgence of cases in the southern part of the United States. That has subsided somewhat, right? So I think it's fair to say our angst is a little lower than it probably was when we did the call. The problem is trying to translate that into the future. I think there's still lots of question marks on what's flu season going to be, what's COVID going to do through the winter, how are hospitals going to react. So I would just definitely stop short from trying to provide any -- even qualitative guidance on when we get "normal." I just think it's too soon. I think there's too many question marks about what's ahead of us to go there.

That's helpful, Todd. That's exactly where I was going to go next. So what are your current hospital conversations, either Curt or Todd? What are your current customer conversations implying? A lot of survey work we've done has resulted in hospitals telling us they've reduced elective procedure capacity in anticipation of the flu season, and some of them are doing this now. So I guess what are you hearing from your hospital conversations? What they're doing now, what they're planning to do in the next couple of months and how that plays into a 4Q dynamics.

I think the answer is a little bit driven by the region of the market or the region of the country or the geography if you go outside the U.S. In the Northeast, I think they're still working back up to the cadence, the pace depending on the type of procedures. Again, we have 4 very different businesses. You go to some of the Midwest and Western states, they're back to normal. They're moving pretty well. And patient receptivity to coming in for surgery seems to be pretty high right now. As they look at the fall, I think there's a couple of things that are different than what we experienced in April. Number one, there's not a PPE shortage. Number two, health systems understand how to treat these patients with much more clarity and much more productive fashion. They also know how to manage their unique institution to have capacity for patient surge and continue to keep surgery moving forward. I think there was a lot learned relative to the negative consequences of deferral at surgery. That created a different type of health crisis. And I don't think anybody wants to go back there anytime soon. And as we talk to customers, they talk about their experience with some of these patients who are -- who were on that deferred list and they're coming back in and they're having other related issues. People don't show up early with pain. People don't say, "I might have a problem, let's do surgery now." They typically wait until the very end. They typically wait until the pain is really dynamic and not something they want to live with anymore. And then you take that person and say, "We're going to defer the surgery for 6, 8 weeks." There's a lot of negative consequences and things like that. So I just think the overall network is in a lot better shape to deal with recurrence, if it happens. And if you get on top of that at a really bad flu season, fall flu season. So I don't see us going back to an April scenario. I do think the markets are in better shape, and I think our customers are well aware of how to deal with it. And I candidly think our customers are the people that are best -- in the best position to decide when and how much surgery to do or not do. And that should kind of be left with them, candidly.

That's helpful, Curt. And that's the access side of the equation. So I guess the larger structural debate we're dealing within devices broadly is patient willingness, and you kind of referenced this earlier. Said simplistically, how do we get patients more comfortable coming back to the hospitals for procedures? And what are your conversations telling you on that side of the equation? Are you seeing a healthy channel of new patient procedures coming back to the hospital? Or is there kind of that hesitancy still?

Mason, a lot of our products deal with what I would call a younger patient. The Sports Medicine business is typically a younger patient. The General Surgery category can have a broader age. But again, a lot of those are private pay, younger patients. So I don't think we've heard a lot of folks discussing or lamenting the lack of patient receptivity. There have been a lot of telehealth done, so I think that's kept the patient population engaged. And I think as the clinical community has told the patient it's okay to come in to go through that check and authorization presurgical, I think they've accepted that as a matter of good outcomes, that the health systems are able to protect them. So I don't think we're hearing from customers a watch out about lack of patient receptivity. Again, I'm making a broad brush statement here. There are some regional differences outside the U.S. There's a little more single-payer system that's got a little tighter funnel on some of that. But generally speaking, our customers are saying it's not a patient-access scenario playing out in front of them.

Got it. Okay. So let's move on to more of the fundamental side of the business, so Buffalo Filter and AirSeal. You've been pretty vocal about the success of these businesses, even throughout COVID. I guess at a high level, Curt, why do you think these products have been so durable out-performers? And has COVID changed the value proposition of these products and how you position them to hospitals moving forward?

Yes. I would just remind everybody, AirSeal, we acquired January of 2016, Buffalo Filter February of '19. They were both high-growth platform technologies before we bought them in the CONMED network. They've continued to be high-growth platform technologies. And we've got a broader distribution organization on a global scale. And we've continued to build up the clinical study basis underneath these technologies. So 2 great, highly innovative technologies, 2 great growth markets, very early in their development, the underlying markets are very large and still have a lot to get after. We're candidly still in the very early innings of both platforms. What really changed in the COVID environment, as the society started writing about return to surgery and how to do that safely, societies like SAGES and American College of Surgeons, they started writing documentation. Those societies will never specifically call out a company's product. But what they do is put specifications in their literature. And if you look at those specifications and match it up with the AirSeal and the Buffalo Filter technology, you candidly had a pretty strong read on our technology. And as soon as those documents went out, we started hearing from customers about, "We need this technology to return to surgery safely." Granted, we thought Buffalo Filter was already part of that equation from a health care worker removal of carcinogenic smoke, but now you're also trying to remove the virulence associated with COVID-19, and that gets into the filtration technology. So both of -- both those platforms read right into those return to surgery safety. And I mentioned this on our first quarter earnings call that we thought COVID and these write-ups could help us on the second quarter earnings call. I said, "Starting to see the financial benefits." That trend has continued. And we're very excited about the technology on a global basis. It is not a geographic, market-limited technology application. It's a global application. And again, great platforms, great technology and innovation and now getting the endorsement really coming from the community of customers versus the company trying to instruct and educate. So we really got a boost from those clinical community publications.

That's helpful, Curt. And so these businesses obviously grew significantly in the first half. Are you worried about these tailwinds kind of reversing in the second half or 2021 at all? Or do you feel like the underlying market growth rate that you've talked about, north of 20%, can continue for the foreseeable future here?

We had commented -- our last comments on Buffalo Filter coming into this year -- last year, in Buffalo Filter because we had to publicly report the numbers, the growth rate was around 40%. I think Todd did his best to walk people up. Don't set 40% growth as an expectation. But certainly, the market, we believe, is growing 20-ish plus percent. And on AirSeal, we said it's a double-digit grower, and it has been really since the day we acquired it. As we sit here today, Buffalo Filter is growing faster than that. And AirSeal remains a steady-state, double-digit grower. And again, I go back to where we are in the market development sets -- cadence, we're still early innings on these technologies. So we feel very good about the future for both of these platforms, whether that's for the second half of this year or out into 2021 and beyond.

Got it. And do you feel this can be -- I think the asset did roughly $50 million, $60 million in 2019, up slightly north of 40%, like you said, growth tampering that off a little bit in 2020 and probably out in the next couple of years. Can this be a $100 million asset in 2021, Curt? Or is this more likely 2022?

Yes. I wouldn't pick a date or a calendar year for the cresting of the $100 million mark. What I would remind people of is the relative size of these markets. Today, we think the smoke evacuation filtration market, it's probably, call it, $150 million, give or take. CONMED's got a very good market share of that total market. Yet when you look at the total addressable market, 395 million surgical procedures on an annualized basis, 95% of them use an energy platform, therefore, creates smoke and the average consumable in a procedure is $20. The math on that alone is gigantic. It's -- we don't really talk about it because it's so large. And then you put on top of that the capital component and you put on top of that the replacement filter component. So we've got a long runway, whether we get to $100 million, $150 million, $200 million, we're going to be at this for a long time. And what I would convey to people is just a nice, steady, straight growth platform and a market leadership position for CONMED Corporation.

So that's a good point you bring up, Curt. This has become a very attractive market for yourself and others. It's a significant market opportunity that's growing north of 20%. Have you seen anything on the competitive front? And do you feel like any of the larger players will start to take more of an interest in this space?

The large strategics are already in the space. The benefit of the acquisition of Buffalo Filter is that company has been in the space for 30 years, and they started out by being a manufacturer to industry. If you dig through the Buffalo Filter files, you'll see their first medical device distributor agreement was signed in 1993, and the signature on the bottom of that is CONMED Corporation. So we've been their distributor for the longest, but they have other names, names you would recognize, names that have been at your Morgan Stanley conference. We continue to service them with a product. We continue to service them and meet what they -- what we would refer to as their R&D input, how they want to evolve the product. And then we reserve, and we have a branded product that goes through our sales channel. And because of the time period that the company has been in this space, there's really 2 levels of performance. There's the branded version, which we save kind of the best features and benefits for, and then there's a common platform we provide for the rest of the industry. Certainly, as the market grows and gets bigger, could one of these strategics do something else? Pick a path to do it on their own? Yes, absolutely. And we're very mindful of that. But right now, we're happy that all these participants are out there creating market awareness and helping to build the market that's still in very early stage.

Got it. Okay. So moving on to the ortho and gen surg part of the businesses. Across the business, you've optimized the way you evaluate the commercial organization over the past 6 to 12 months. Can you talk to us about some of these initiatives? Why you chose to enact them? And any way to quantify or talk about the results that you've seen from some of these actions?

Todd, do you want to grab that one?

Sure. I'll take it in 3 pieces, actually, Mason. So first, back in Q3, we talked about increasing the sales force in our in what we call our Advanced Surgical business, which is the sales force who sell -- they sell both Buffalo Filter and AirSeal. We've been talking about the benefits and the growth rates of those products and so that was really just more feet on the street and shrinking the territories and letting more sales reps sell those 2 growth platforms for us. That's been really successful. We're super happy we did it. I don't think that'll be the last time we talk about increasing sales force there. The other thing we announced back in Q3 was international, some international changes in some key markets where we had distributors who just weren't running to the speed that we felt like we could go in those markets, and we thought it was an issue of focus. And so we went direct in a couple of those key markets. We're certainly very happy we did that. And that went well, and that was implemented in the first quarter before COVID hit us. The third one that we talked about in January was really actually somewhat related in our domestic Orthopedics business. Now that we have a new product pipeline that's coming out, now you can assess the performance of the sales team on a different metric than you had before. And again, for those areas where they weren't embracing the new products at the speed we expected and we're more comfortable going to existing CONMED accounts and less comfortable going into competitive accounts, we made some changes to make sure that we could get our products into the market and take share at a faster rate. That was implemented kind of as COVID was hitting us, so I think we have yet to really see the results of that. But we're pleased with those moves. During the downtime of COVID, we spent a lot of time training sales force. So the sales force probably is as up to speed technically or better than they've ever been. And as we've returned to face-to-face with the customer, we believe we're seeing those benefits. But it's still a little too early to say definitively or with any sort of magnitude on the success of that. But we're pleased with all 3 of those changes. The focus, again, trying to make sure that the innovation that we are developing here at CONMED gets into the hands of our customers.

Got it. Okay. So let's move on to the P&L here, Curt and Todd. So you obviously took your foot off hiring throughout COVID amongst a few other initiatives. Can you just parse out for us or for the investors on the line, which of these cost-savings initiatives are more structural versus temporary? And how to think about the margin profile progression over the next 3 to 6 months?

Sure. And I'm going to answer your future in a broader frame than 3 or 6 months because there's a lot of fur flying and uncertainty in the next 3 to 6 months. But if we look at what we've done from a cost basis, when everything shut down in the U.S. and pretty much globally, we made the strategic decision to keep our organization on idle, right? We spent the last 3 years building an infrastructure to support a much higher revenue base. And we didn't want to damage that engine and have to go through another restart. We didn't know how long the freezing of nonurgent surgical procedures would last. We didn't know if it would be a couple of months or a couple of quarters. But we opted to keep the team in place and to keep them at the ready. And we're really glad we did it that way. Obviously, travel turned off immediately. The conferences, the marketing, gatherings turned off immediately. We spend a significant amount of money in those areas. So all of that turned off organically. And then we went through the organization. Curt and I got very involved and very granular with each business. And we went through line-by-line of their spending to determine what we needed to keep the health of the engine ready to service our customers when we came back and what could be delayed or paused. And we went line-by-line for each business and made those decisions together. And I think we're really pleased with how that went. As we all know now, the recovery came a little faster and a little sharper than most people were predicting back in March and April, and we were there ready to service our customers. And so a lot of that will come back with revenue, right? A lot of the sales rep travel, the direct expenses with samples and those things that it takes to service the customer, that will come back with revenue. Some of the broader expenses, like the big marketing meetings and the conferences and the boots and the trade shows, I think that'll be a while. I think revenue will come back way before those expenses come back to the extent they were before. So we'll get that benefit in SG&A. We also used the time during Q2 with lower production volumes. Now our production employees' availability to tackle some cost-savings projects that, frankly, we had on our list, but they just weren't prioritized over the volume and the new products and delivering to the customer. Well, now that the volumes were much lower, those folks could focus on some of these things that we needed to focus on. And so we were able to do that. I think that's going to provide us long-term benefits. And frankly, we probably wouldn't have gotten to some of those projects until next year, and we were able to do some of those this year. So all-in, I think when revenue does return to normal levels, I think CONMED will be sitting here with a better margin profile, both in gross margin and operating margin. Now in the next 3 to 6 months, you'll get a lot of ebbs and flows with manufacturing activity and the variances and how those get released into the P&L. So that improvement could be masked depending on how that all shakes out. But I think if you take a broader view, I'm confident that we're trending towards a better margin profile than we had before.

That's very helpful, Todd. And that's exactly where I was going to go next. So it sounds like you're very confident that when revenue, whenever it returns to a normalized profile, that margins can be better. I just wanted to confirm.

Right.

Got it. Okay. So just lastly on 2021, and I appreciate you're not going to not going to give formal guidance here, but a key debate investors are grappling with, Curt, Todd, is how to think about 2021 top line relative to 2019? I think consensus is currently modeling your 2021 revenue 5% above 2019. How would you think about or help investors parse through kind of the puts and takes of your business? And how you generally feel about revenue being mid-single digits higher than 2019 in 2021?

I would point to a couple of historical events for CONMED to kind of give investors a sense of what our strategic priorities are. We've said from day 1 we want to grow faster than the markets we serve because we're a small market share player. We think in a normal environment, the markets we serve, when you aggregate them, are growing in the 3% to 5% range, maybe in a good year, 4% to 6%. So our stated goal has not changed. We want to grow faster than those markets. And I don't care if you take that and apply that to '21 or you can apply that to '22, that statement is going to remain the same. And from that, we want to deliver not less than double-digit growth in profitability. Some years, there will be more, some years, it'll be just the double digits. But those strategic priorities have not changed. And we'll look at 2021 guidance when we get to January. But those 2 priorities should be the guideposts by which the investor looks at the company and says, "Where are they going?" Todd, I don't know if you'd add to that.

That's well said, Curt.

That's very helpful and fair enough. So in the last minute or 2 here we have, Curt and Todd, so you're currently at 5.5x leverage. This is obviously pretty high relative to where you've been historically. Can you just help us think about where your near-term priorities sit in terms of debt pay down, M&A? Does this level of leverage limit your ability to do near-term M&A? And I guess have you set any quantitative targets where we want to be, I don't know, south of 4x in the next 12, 18 months? Anything to help us piece through, that would be very helpful.

Sure. So when we bought the Buffalo Filter asset back in February of 2019, it took us up above 5 turns, and we committed to be down at the 3-turn level by the end of 2021. We were ahead of that schedule prior to COVID, right? The Buffalo Filter acquisition has been terrific. Our cash flow has been strong. And so that debt was coming down faster. And EBITDA was coming up faster than that model had anticipated. When COVID hit, obviously, we have a big pause in the middle, right? So -- but once we've got COVID in our rearview mirror, we fully expect to regain that same trend line and we can't put a time frame on that yet, but investors should appreciate that our focus is not necessarily -- we're not managing the business to a leverage number, right? Our focus is adding growth platforms to the portfolio that improve the growth profile and the margin profile of the company. And then how we finance those, we'll figure out what makes the most sense at that time. But that remains our key focus is externally finding those platforms and internally developing organic innovation to service our customers.

That's very helpful. That's a great way to end it. Curt and Todd, thank you very much for your time. It was nice chatting with you. And thank you all for listening on the line.

Thank you, Mason.

Thank you. Mason.

Thanks.