CONMED Corporation (CNMD) Earnings Call Transcript & Summary

Thank you, everyone, for joining us today for the 2021 Morgan Stanley Healthcare Conference. I'm Drew Ranieri, one of the medical device analyst here. It's my pleasure today to have Curt Hartman, President and CEO; and Todd Garner, EVP and CFO of CONMED with us today. Just before we jump into our fireside chat, for important disclosures, please see morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. So Curt and Todd, thank you so much for being here today. Really appreciate the time.

I don't think you'd be surprised with the topic to start. But just given that multiple companies have been talking about at this conference in the past week, the elective surgery impact from Delta, some have pointed to pressure adjusted numbers, but maybe at a high level, what are you seeing in terms of Delta across your orthopedics business and general surgery business to start with?

Yes. Thank you, Drew. Why don't I start and I'll hand part of this over to Todd here. If you go back to our second quarter call, we definitely noted the prevalence of Delta and how we thought that would influence the third quarter. And I think everybody who looks at the headline would probably say at this point, it's been a harsher impact than what we even spoke to on that call. With that said, we don't give quarterly guidance. We give annual guidance. And if we felt we were in a position where we needed to adjust annual guidance, we would do so. And so sitting here today, we think our perspectives on the full year are reflected in that annual guidance. Now obviously, that could change in a go-forward period at some point in the future, and if it did, then we would discuss that at that point. So certainly, it's worse than maybe we would have anticipated. But I think, Todd, and I would both look back going to first quarter of 2020, January 2020 and so we've taken the COVID-19 virus very seriously and tried to factor into -- that into all of our conversations from a quarterly standpoint, quarterly discussion and other investor interactions.

And with that said, maybe looking at past experience through the past over 1.5 years. And maybe how has pandemic unfolded in your Sports Medicine business and general surgery business. I mean, if you were seeing potential impacts in those 2 categories, how quickly did you see the impact? And maybe on the other side, how quick were either of those 2 to rebound?

Todd, do you want to grab that one?

Sure. The first thing I'd highlight, Drew, is that the business, once we got past Q2 and the arbitrary lockdowns across the globe, the business has actually performed pretty well through these different surges and peaks and valleys of the virus. Obviously, the general surgery side has been more resilient than sports medicine. Sports medicine is affected by the reduction in the recreational sports activity, right? And so we've said multiple times that until the field and courts are full again for a period of time, across the globe, not just in the U.S., but remember that we have a global business. Until you get activity back to normal, you're probably not going to get procedural growth back to normal on the sports medicine side. The general surgery side has been even more resilient and we think rebounds faster. So the good news and bad news is that this isn't new. We've now been through a lot of these surges, and we've navigated them well. We stay close to our customer. We -- as Curt said, we've taken this very seriously from the start. When everybody else was talking about a V recovery back in the spring of 2020, Curt was talking about W and potentially success of W and it turns out that, that's more the reality that we live in today. So we're in a new surge that's more elevated than all of us wish it were, but we'll get through this one, too. And our -- we're focused on managing the business and winning customers and strengthening CONMED for the long term. And we're pretty happy with how we've done that through this storm.

Just a couple of other topics here before we move on. But I'm forgetting the percentage of your portfolio that might be tied to capital. But kind of what are you seeing in the capital environment today? And if there were delays in terms of capital placements, should we only be -- should we be thinking that the order book is only getting larger versus any type of cancellations for orders?

It's a great question. And at CONMED total, the ratio is about 80% consumables, 20% capital. It's a little more capital in orthopedics, probably a 70%-30% capital in orthopedics, a little less so on the general surgery side of the business. If you think about the CONMED capital portfolio, it's really tied to procedure volumes. You have lower ticket items. And if procedures are trending upward or trending where there's a surge in procedures, then they need more capital, either to replace older capital or to expand their ability to handle those procedures. Going back to last year, Todd and I thought capital was really going to take a hit. It didn't get impacted as much as we would have assumed. And I think that's because the financial health of the institutions remains strong. Customer behavior didn't change financially. They continue to pay their bills on time, but they were reallocating that capital of things that supported the surge in COVID cases. So as COVID volumes have ebbed and flowed, from our perspective, our capital has somewhat ebbed and flowed with those. And again, lower ticket price items and capital tied directly to procedures being performed. So a little bit different capital mix maybe than some of the other companies that have presented.

And just last question here. Maybe to Todd, just looking at the second quarter transcript, you mentioned freight increasing. Several companies have kind of pointed to that, too. I mean, as you're looking at the supply chain -- sorry, there's some background noise. But as you're looking at the supply chain, I'm sure inflationary pressures are potentially impacting the business. But anything to call out? Are there semiconductor shortages that are affecting anything in your business? Just like to hear a little update there.

Yes. Not anything specific that I think is worth calling out, Drew. I would point out, and this might be needs and different than how other people did it. We were one of the few companies to talk about COVID on our January 2020 call. If everybody -- I'll bring everybody's mind back to what was happening. China had announced that instead of taking one week for the Chinese New Year, they were going to take 2, and then they were going to get back to work after that. When they didn't come back to work, when they extended it another week, that's when the alarms went off at CONMED. And we -- and our operations team back then to late January, early February of 2020, it was all have on deck, daily meetings, reaching out to our supply chain and our vendors to make sure we had the right contact information, we knew who the person who could give us the answer and panic is true strong a word, but focus is probably too soft of a word to say what was happening in that -- at that time, so we could make sure that we could deliver to our customers. At the time, we thought we're probably going to have to do this for a couple of months like this, until we get through this period of uncertainty. Well, now that's what we do every day. That's part of our daily muscle is that we focus hard daily on the supply chain and making sure that we can minimize disruption to the biggest tree possible. We've had some disruption, nothing overly significant. The required external disclosure, but it's a battle, and it's been a challenge, and we've navigated it well now for whatever that is, 19 months or something, and we're going to have to probably keep doing it for longer. And we will continue to keep doing it. Freight has been elevated really since that time. So it's now in the cost. We look forward to the day when it comes down, and we get back to pre-COVID distribution costs. But we've been living with that now for a long time. And so we continue -- our mix profile is very strong. Our gross margin profile has been improving despite all the noise. And so I look forward to the day when we truly are post pandemic, and I think it will be more obvious on all the improvements that have happened here along the way. But it's been an intense period of focus that lasted a long time now, and we're going to keep doing it.

Okay. And maybe, Curt or Todd, I think one of the -- just reviewing last quarter, there was a lot of questions around your announced commercial sales force expansion. I mean, just looking back over the last few years, I think you've traditionally hired sales reps, maybe at a later point in the year. So why do it now midyear in 2021, kind of what's giving you the confidence and layering on those additional reps? And should we be thinking that's like specific product categories or end markets? Just any detail there would be great.

Sure. For context, every year in January, since I arrived at CONMED, we'll do sales force expansions. That's an industry typical event. And sales force expansions are typically predicated on a couple of very important factors. Number one, how is the product portfolio. And if you go back to my first public comments on this company, I said it's about people and products. So from day one, we've been working on products, whether it's organic or inorganic product acquisition and introduction to the company. So in January this year, we did our normal sales force expansion. As the year was unfolding, and we're looking at our product portfolio. And just as a reminder, we continue to innovate through 2020, even when we had fully remote R&D workforces, we kept them very focused on the items that the commercial leaders said we're going to be the most important to our future success, not only in the next year, but in the long-term. So as we got to the midyear point, kind of working our way through Q1, early parts of Q2, it's a bottoms-up exercise. It's the sales management team, the marketing team, the general managers of the business, country managers saying, boy, we could really benefit from more feet on the street. And our profitability through COVID, after we got through Q2 of last year, has been pretty strong because we turned a lot of spending off that was not relevant to the COVID trade shows down substantially, things of that nature. So as we looked at our profitability, as we looked at the product portfolio, as we looked at what the commercial teams were advocating for, this was our #1 priority. So we -- Todd and I sat down, we went through each of the plans, and we said, yes, this makes sense. And what you have now in front of you is a sales force expansion that's very surgically done. I have a very med device seasoned management team. They know how to do these things. The sales leaders have done them before. We're not a new company for the first time doing a sales force or channel change. We've done this every year now and the management team had done it many years before they ever got to CONMED. So we're expanding our general surgery sales force. We're expanding our orthopedic sales force. We're expanding in the U.S. We're expanding in international markets. And we're actually also doing a very focused expansion with smoke associates, meaning they cover a broader area of geography and help the full line rep to ensure we are not missing smoke evacuation opportunities. So that's on top of the normal sales force expansion. It just made sense. It's a strategic investment. Todd and I don't run this thing quarter-to-quarter. We run it for the long haul. That's what our strategic plan calls for running this for the long haul. And we're a growth-focused med tech company, and a big part of that growth is new products and more feet on the street, and that's why we did it.

And maybe going back a couple of years, maybe it was 2019, there was kind of maybe some confusion over the rep hiring that you're doing at that point and maybe concerned that there would be disruption. So if you kind of look at today's mid-year rep build-out, is this a similar magnitude to that? Or is this multiples above that level?

Yes. Good question. So in the third quarter of 2019, we announced a very specific sales force expansion. We were going to expand the advanced surgical sales force. And why did we do that? Well, we had acquired Buffalo Filter in February of '19. So 7, 8 months later, it made sense to put more feet on the street. And we also did some international general surgery channel changes and/or channel enhancements increases. And we had a general surgery channel internationally because of the AirSeal acquisition in 2016, it gave us the capability to really expand our general surgery presence outside the U.S., which prior to 2015, was really underdeveloped channel. But the international team had done a great job starting in 2016, building that channel. So those were 2 very targeted expansions. And when you look at what happened in Advanced Surgical, which carries Buffalo Filter and AirSeal in 2020, everybody is pretty happy we did that, because it gave us a lot more feet on the street a lot sooner. This expansion is much bigger. It's bigger than that sales force expansion. It's multi-level and that we have direct territory expansion, and we have associate expansion, but all very well-managed locally by the teams or the countries that are doing it, and it crosses both ortho and general surgery U.S.

Got it. And so maybe let's go into the smoke evacuation opportunity. And maybe just first to start on the smoke evacuation associate hires. Just what -- you touched on this a bit, but maybe go into more detail about why now, kind of what's the opportunity that you are seeing that you weren't able to really capture previously?

So the smoke evacuation category is a high-growth category. We said that when we acquired the business in 2019 that this is a category that had been growing north of 20% for a number of years prior to CONMED acquiring Buffalo Filter. All that has done is accelerate. It accelerated because, number one, we're a much larger company than Buffalo Filter was. We had a very large direct presence in the U.S. where they had a very small direct presence. And then secondarily to that, the ongoing push for awareness around the hazardous surgical smoke, coupled with the question around operating in a COVID environment and is it say, how do you pull those virions, those molecules out of the air and the filtration device and smoke evacuation as well as the AirSeal platform have been demonstrated to capture those virions. So when you look at the smoke category and why go to associates, we have a best-in-class product in Buffalo Filter. It is clearly the branded product that we sell directly is clearly the best-in-class product. And more often than not, when we are in a head-to-head evaluation with a competitor, we win. Where we don't win is where we don't know about it. And we are outnumbered by feet on the street by a lot of the large multinationals, as you would expect, size is relative there. So how do we increase our win rate in those situations? We have to be aware of the trials going on. We have to be aware of the opportunity. The smoke associate, 100% focused on covering a larger geography, they have one thing to think about all day, every day. Go hospital to hospital, under the direction of the full line rep and duty manager and uncover those opportunities to create them through education or uncover them because we're now in that hospital where before our full line rep couldn't get there. So we're just trying to get more presence, more feet on the street, more awareness of the ongoing opportunities that are out there. Todd, did I miss anything?

Yes. It's a big category, obviously. That said correctly, I think you have it.

And just when you've identified one of these accounts, whether it's through one of the new associates or just being near that account? And kind of what's the process of onboarding a hospital to your smoke evacuation system? I mean, is it led by a champion in the administrative -- in the administration? Or is it more being pushed increasingly from nurses?

So the loudest advocates are the nurses, the operative room nurse, who is in that environment, 5 days a week, maybe more in every surgical case, dealing with surgical smoke, 95% of procedures. They are the -- they have been pushing this topic going back to the early 2000s, and now they're supported by clinical studies. More often than not, in today's environment, it starts locally. It starts with an operative staff, maybe a Chief Nursing Officer, an OR director and a surgeon champion because remember, it's about the staff and the patient and surgeon, but you're interrupting the surgeon workflow. And by that, I mean, you're taking the device they have on their hand, and you're modifying it so that it has evacuation methodology associated with it. So you've got to win over that surgeon. So it has to start locally and then expand from there. Now that's not to say that in today's environment, there aren't top-down decisions, where there's a hospital CEO and a hospital Head of HR and the Chief Nursing Officer saying, we really need to create a better work environment, and they might say, we are moving to a smoke-free environment. But when you go to implementation, you still have to win that room specialty [indiscernible]. And that's just a reality of how the market unfolds.

Got it. And then just if I'm remembering this correctly, maybe back when you bought Buffalo Filter, I think you might have talked about the market being somewhere around $100 million at that point, and maybe it's $200 million now. So kind of what's underpinned that market growth? I mean, has a lot of that been driven by one, Buffalo Filter? And 2, has there kind of been an acceleration through the whole COVID pandemic of just recognizing that this is a solution, not only for the OR today, but going forward to solve smoke evacuation problems?

Yes. There's -- it's a multifactor answer here, Drew. The underlying smoke evacuation market really driven pre -- call it, CONMED acquisition of Buffalo Filter, was really driven by efficacy by the OR staff and advocacy by Buffalo Filter creating awareness. They did a phenomenal job in building studies that the Nurse associations could use on behalf of advocacy. And that's a global event. And then you had select markets start to legislate. Canada was one of the earliest markets. You've got some of the Nordic countries that have mandated smoke evacuation. That preceded comments direct investment in Buffalo Filter. You've had a little bit more legislation, but on day of close, Todd and I both said, legislation is not the driver here. This is a general health care worker safety event, and it makes no sense to have that type of exposure. So you've got the operating nurse is pushing this. You now have surgeon champions starting to push it. And then on top of this, you put in 2020 COVID and everybody in the room is saying, we have to go back to surgery, but how do we filter the air that's coming out of the surgical site, and the filters within the smoke evacuation devices trap the [indiscernible] released by the virus. And then you couple that with CONMED's other key platform, the AirSeal platform that also does MIS, smoke evacuation, smoke evacuation mode, we're really the only company that can advocate a total solution across the hospital by just working with one vendor. So it puts us in a really strong position with best-in-class technology.

And just let's talk about evacuation on the Buffalo Filter side and AirSeal prior transaction. Just how are you thinking about the U.S. opportunity versus international? I mean, are you focused more mainly on U.S. today and international can come? But just any perspective there would be great.

No, we're equally as excited about the international opportunity as we are the U.S. opportunity. And our international team, as I mentioned earlier, has done a great job building out a very underdeveloped general surgery channel since the acquisition of AirSeal. Prior to 2015, the general surgery approach internationally was managed by 2 individuals located in the U.S. who signed up international distributors, come one, come off. As soon as we put in a President internationally, so this is a massive opportunity. And we've gone country by country, saying how do we build a dedicated or more controlled distribution channel in these selective markets. And we've done that year in, year out as investments would allow. And AirSeal was a big motivation behind that. And then when you put Buffalo Filter through that channel, it allows you to go even deeper, either with distributors or with direct reps. And that's been the approach. The markets are a little bit different. There's not as many robots as an example, in the international markets as they are in the U.S. So the AirSeal platform has to go up to general laparoscopic procedures, far more often than the U.S. market does at this point in time. It's almost an easier sale in the U.S. to attach to a $1 million robot. You don't have to go to a laparoscopic pure play. But we have people doing that, and it's another reason to have more feet on the street if you want to get into those cases. But that's the long play for this portfolio of AirSeal and then Buffalo Filter to just try to capture a very large procedure base on a global basis.

All right. And just with Buffalo Filter, with AirSeal, and I think it's safe to say that they've been 2 very solid acquisitions that you've made over the past 5 to 6 years. So maybe just talk to us about the opportunity for additional M&A? Are you focused mainly on the general surgery area or sports medicine? Are you an equal opportunity acquirer? And just should we maybe expect more to come as you're deleveraging or delevering from, I think, about 4x or 4 turns as of June.

Todd, do you want to go ahead and take that one?

Yes. It's a huge priority for us. It's the first priority for our capital, Drew, that we add further growth platforms to the portfolio. To your point, we've had 2 home runs. Our filters have not changed. Our energy and desire has not changed. It's very simple. It's got to be accretive to growth. It's got to be -- have a clear line of sight to be accretive to the margin profile. And then that growth has to be sustainable, either protected by IP or trade secrets or know-how or something that doesn't make it be a big splash and then an anchor, right? You don't want that. And then the fourth thing is it has to be at a value that provides value to CONMED shareholders, you can't give all the value to the seller. And so we haven't moved off of those filters. We continue to look. We've been looking actively throughout the pandemic. We've got a great banking partnership, great consortium that we know will be supportive. If we find something that meets those criteria, and we continue to look, and we'll continue to do so.

We only have a couple of minutes left, but Curt or Todd, I want to turn the floor over to you to see if you have any last minute comments or things that we missed that we should highlight.

I'm very proud of our team and the way we've navigated from January of '20 through current. And Todd mentioned some of the excellent work that our global teams have done operationally and logistically. And our commercial teams, as we touched on last year, were very patient trying to respect what customers had going on, and they've become more engaged this year as markets have opened up. And I think that's the offense. We're continuing to focus on innovation as clearly where we're headed and where we've been at, and we'll continue to accelerate. And I'll hand it over to Todd to talk more about the story in terms of gross margin and operating margins, because that's the other big look when people say what's CONMED about. They look at those numbers and they have questions. So Todd should probably wrap up with those type of commentary.

Sure. Yes. We've been working hard on. It starts with the top line, right? We've got to keep that top line strong, above market. We've been very clear about that. And as we invest to do that, it's a dual effort to get the margin profile up. And we've been doing that as well. The pandemic has actually mapped a lot of improvement that we have made. And so as I said earlier, I make sure for the day when that becomes a little bit clearer. But we continue to drive both gross margin expansion and operating margin expansion. And we've done it throughout the pandemic. And when the storm does eventually clear, I think that will be more obvious for people to see. But we're excited about the future. We continue to run the same playbook, and it's been effective even through this very uncertain time.

I think we'll have to close it there. But Curt and Todd, really appreciate the time today. Thanks so much for being able to attend.

Our pleasure, Drew.