CONMED Corporation (CNMD) Earnings Call Transcript & Summary

All right, thanks, everyone, for joining us today. I'm Drew Ranieri, a member of the medtech team here. It's my pleasure to have Curt Hartman and Todd Garner, the CEO and CFO of CONMED. Before we kind of jump into Q&A, just our quick disclaimer, but for important disclosures, please see Morgan Stanley Research disclosure's website. And if you have any questions, just reach out to your Morgan Stanley sales rep.

But again, pleasure Curt and Todd to have you with us today. And we kind of started some of these conversations really kind of on the macro standpoint. And just as we've kind of heard through the past couple of days and even last week, it sounds like from a procedure volume perspective that things have slowed down in June, July and then improved in August and even into September. But we would kind of love to hear your views on that from a sports medicines perspective and even just general surgery, if you can kind of help us with your view.

Sure and thanks for having us, Drew. And hopefully everybody can hear me. I think as we look first at our first 6 months of the year, we're very pleased with our first half results. Inclusive in that was the acquisition of In2Bones. And the combination of the underlying performance of General Surgery and the Advanced Surgical business and the addition of In2Bones, we're really happy with our first half. Obviously, we're not into the habit of commenting intra-quarter on what's going on. But I think it's safe to say that things that have been very uncharacteristically up and down, have at least reached some level of stability. And you've got to have stability before you can have improvement. So I think that's probably where I'd leave it on the macro environment. On the surgical volume side, I don't think there's a lack of patience I think and we've talked about this really all year. Surgical staff is still an issue. That's just not an efficient process right now because a lot of surgical staff is new to the procedure. They haven't been in those procedures, which means the doctor has to move at a slower rate of performance. And then you still have variability in surgical staff attendance driven by COVID, which is not the headline today, but it's certainly still impacting participation and attendance in surgery. So again, plenty of patients, just not enough staff yet at this point in time. I don't think it's getting worse, can't say that's a light switch that I think is going to recover overnight. Todd, I don't know if there's other comments you'd add on to that.

No. I think that captures it well.

And maybe just on the staffing side, the capacity side, how much of a drag do you think that still is maybe on your procedure specifically?

Like, it's a really interesting question, and I hate to guesstimate, but I'll give an anecdotal story. I had dinner with an orthopedic sports medicine surgeon. I first started out asking is there a patient challenge. Absolutely not, not a patient challenge. He goes, "Every day that I come in do surgery, the first question I asked my staff is how many of you have done this procedure before? And inevitably, the only person in the room that raises their hand is your sales rep." So I don't know how to handicap what that means in terms of reducing his productivity on a daily basis or as those staff get more familiar, how they improve or how hospitals and surgery centers are improvising to say we've got to do it differently and get our efficiency back. But it's definitely having an impact on surgery. I just don't know how big that number is.

Got it. Maybe just sticking to macro still, but the inflation data came out today. And Todd, Curt, you both have kind of talked about freight still being a significant headwind for the company in freight and materials. So as you kind of think about that 300 basis points of impact for this year, is that -- is today's inflation data kind of reflected in that view?

Yes, I think I would characterize that kind of like Curt said, it's kind of stable, right, not a big improvement. We're still dealing with very high cost. I'll remind everybody that we have a 6-month deferral because you have to recognize your expenses with the revenue that those expenses are associated with. And so, the accounting rules have us defer our manufacturing variances for 6 months until that inventory sells. And so as long as these -- as long as the costs remain elevated, that means for the next 6 months, we'll have continued cost pressures. So we talked about the back half of 2022 being at about a 55% gross margin level. My hope -- with the stability that we're kind of seeing right now, I hope that that has captured kind of the worst case and that hopefully there's -- I do think it's more likely that things get better than worse going forward. But I think it's a little too early, obviously, based on today's report to get too excited about things getting better too fast.

To your point, got it choppy. Got it. Okay. So maybe just a couple of other questions here is I know you're not necessarily capital exposed or capital heavy, but just some of the areas where you do touch bigger picture or bigger ticket capital or purchases. Are you still seeing strong demand from a hospital perspective or has there been any kind of elongated cycle. And even in the way maybe clinicians' staff really evaluate technology to bring on board?

Great question and I'll start with the end in mind here. We've not yet felt any slowdown in acquisition of CONMED's capital. And keep in mind for CONMED, it's only about 20% of our business and we're on the lower ticket price end of the capital spectrum. I think our individual -- single largest purchase price item would be about $40,000. So we're not the high 6s or 7-figure capital items, and our items are really needed to do surgery. Whether you're doing general surgery or orthopedic surgery, you've got to have that equipment in the room. It's not imaging systems or anything like that. So right now, the customer still appears to be healthy in that price range. I can't comment on the bigger extended price ranges. But so far, our teams report the appetite remains.

And just kind of given the staffing shortages and capacity constraints though, there's not a -- it's not an inhibiting factor for an evaluation perspective, are they?

No, if a system is looking to upgrade, they've made that commitment. So they're signing up for that. And I haven't seen that. I think generally speaking, everybody now got some form of value analysis committee that they're putting all purchases through, whether it's a new disposable or a new capital acquisition. So they're a pretty well vetted process. Companies know how to navigate and participate in that. So I don't think staff plays into the decision for more capital at this point in time.

Maybe just a follow-up from the earlier inflationary comment. But just in terms of pricing, and I know Medtech, you're kind of capped into what you can do -- for what you can do in terms of pricing. But have you been able to use that as a potential inflation hedge or mitigant this year?

Well, pricing in this industry has always been kind of a flat to down 1% to 2%. I think we're in an environment where our customers understand the inflationary pressures and are more receptive to the discussion. And I think the other point would be that the majority of products are sold in the U.S. market to the IDN or GPO contract outside the U.S. It typically falls under a tender. And so those contracts typically are 3 years. So on any annual cycle, you might have 1/3 of your business come up for contract renewal. And that's where we're starting to have price discussions. We also -- as Todd says this much better than I can that price is always about innovation and competition. So where we have a highly innovative product, think an AirSeal or something, we're more likely to be able to garner a price advantage in a future negotiation than where we have a me-too product. So innovation matters. We think we've done well there in terms of innovation we brought into the company, both through M&A and through the organic pipeline. And then the market, the customer is a little more receptive to the price discussion, but it will take time. It's not -- again, it's not go to your market and say we're going to change price and get too aggressive because price opens up competition. So you walk a fine line there, but far more receptive than I think Todd and I have ever felt in our careers in the industry.

Yes, I think this is my last macro question before we move on. But as we're kind of looking at some of the headwinds, FX has become incremental headwind for many companies. So as you're kind of thinking about the back half of FX rate, does that kind of hold -- at current rates, should we look for a similar impact for all of 2023 or can you maybe give us a framework for how to think about early like next year's numbers?

Sure and normally we wouldn't talk about '23 numbers yet, but I think the academic nature of this question, and it's certainly a fair question and especially in our case, because we have a very active hedging program. And so earlier in 2022, we saw less impact from currency than some of our peers did because of our hedging program. On our Q2 call, we did say that because of the move of the dollar, it was going to cost us $0.10 of EPS headwind in 2022. And we now have the -- we've gotten our preliminary look at kind of the mix of geographies for next year in 2023. And I have to put a whole bunch of caveats on this, obviously, because it's -- we're way early. But the academic exercise is if rates stayed exactly where they are and didn't move, and we carried that through 2023, we currently estimate that that would be about $0.10 of headwind in 2023 on the bottom line. So that kind of gives you the magnitude of what FX would do next year if everything stayed exactly flat where it is now.

This might be a silly question, but just can you remind me maybe what the major currencies are that you are looking at in terms of kind of making that calculus?

Yes, our biggest presence is in the pound, the euro, the Canadian, the Australian and Japan, I would say are kind of the biggest, that kind of the rank order. I don't know that I got them in the perfect order, but those are the top 5.

Okay, okay. Let's kind of shift gears and talk about the latest acquisition. You hosted a call, you kind of walked through the strategic rationale, but just remind us why this was kind of the right asset for CONMED. How it fits into the portfolio and just listening to the call, it kind of sounded like there was maybe a pushback on valuation, but really kind of what gives you the confidence in the technology and the growth and maybe the margin profile of this asset?

So we've done 2 acquisitions since June. In June, we announced and closed on the In2Bones acquisition, which is a foot and ankle space. And then in August, we announced and closed on Biorez, which is a collagen product for healing. Both of these acquisitions we're super excited about. I'll start with In2Bones. When we went into the market looking at foot and ankle, increasingly the extremities surgeon are doing more soft tissue repair. We were seeing that through our own portfolio of mechanical fixation and had developed some products to call on that customer. But it was an unfocused area for our existing sales force. We also liked the extremities market. But for CONMED to get into the extremities market, we had to do it by buying a business and a business that had a management team that understood the space and had great clinical connectivity to thought leaders. We had to do it with somebody that had a comprehensive portfolio for the foot, the entire foot and inclusive of an ankle. In2Bones had that. We had to do it with somebody who had a dedicated sales force. In2Bones did that. And honestly, from my chair, one of the most important things we had to do with the management team that was motivated to stick around and help us see this through. And In2Bones did that by the nature of the acquisition structure, which was an upfront payment, but an opportunity for revenue growth earn-outs over the next 4 years. So we think it's a great adjacency. It's complementary to what we're doing in sports. It actually helps draw more focus to the remaining U.S. orthopedics team in sports medicine. They can go back to calling on shoulder, knee and hip sports medicine docs, and get out of the extremities market, and let the extremities team under In2Bones now do that work. And then we were able, and it was just serendipity, to close a couple of months later on Biorez. And if you go talk to a sports medicine surgeon and understand the fundamental underlying issue in sports medicine cases, its soft tissue defect. And if you Google rotator cuff repair revision rates or ACL revision rates, you get a wide range of revisions. But either way, even the bottom end of the range is a really big number. And so, we talk to sports med docs what do you need from us? We think mechanical fixation has kind of reached its limits. We need something that helps heal the underlying tissue. Tendon and ligament repair is done today through mechanical fixation, reattaching that to the bone in a part of the anatomy that has low vascularization and therefore, the repair and healing rate is very slow. What Biorez does is augments that procedure. It's not a disruption or an additional procedure. It augments that through a collagen PLLA matrix that helps tissue re-growth, reattach. And we have a product both for the shoulder and one for the knee. And that fits right over home plate for the orthopedic sports medicine rep, helps them spend more time with the shoulder doc, the knee doc, and we'll see where the technology takes us long term, but right now it's just a very exciting acquisition. Commonality, both acquisitions bring growth margins over 80%. Both acquisitions, we believe, are in high-growth opportunities. Everybody knows the foot and ankle space is a multibillion-dollar total addressable market growing in the high single-digits. The BioBrace product is in a market development category, but the Gen 1 device that's out there, we believe, is in the hundreds of millions of dollars of revenue. And that's only being used in the shoulder, and we have an opportunity already in the knee with the mix of products that Biorez brought to CONMED. So 2 super exciting acquisitions happen to close in a very short period. We kept the team very busy over the summer, but love the outlook for both of them.

And maybe from a sales force perspective, did you bring in kind of the existing sales force or is this just really about layering it on with the existing CONMED ortho sales team?

So the In2Bones acquisition is completely stand-alone. We kept their entire sales force, and we will work to create that sales force outside the U.S. as regulatory approvals under CONMED's existing international infrastructure get put in place. Biorez and the BioBrace product drops right into our existing orthopedic sales force. So it's a channel already in place, already talking to shoulder, knee and hip sports medicine docs, got a really new innovative, exciting healing product.

Got it. And maybe on the Biorez revenue opportunity that you're kind of seeing over the next couple of years, I think single-digit millions for 2023, double-digit millions for 2024, that is just specifically for that product. It doesn't sound like that's any halo cross-selling effect to the broader portfolio.

That's exactly right and we're being cautious here, new technology. We have to train our sales force, have to ensure the customer understands the procedure and proper patient selection. We think it's a home run technology. There's -- on the date of close, there was over 350 implantations that went out up to a year, 0 revision rates. So that was a very exciting set of data. We just want to build on that and do it cautiously while we work on getting those 2-year clinical studies to demonstrate everything that we believe to be true with this technology and then we'll really ramp it up. And that's the revenue ramp you described. Do we think there'll be sales synergies and pull-through of existing portfolio? Yes, we do. We haven't quantified that. It's a little too early for us to do that. But it just -- it makes sense if they're buying something as innovative as the BioBrace product, they might want to use our sutures, our anchors, our shavers, our cameras, all that other good stuff.

Right. Maybe sticking to orthopedics broadly or your sports medicine portfolio, just kind of the recent quarter, international orthopedics, I think, really kind of drove growth. I think, Curt, you said on the call that more work still has to be done in the U.S. With these 2 acquisitions, I mean, with the 2 recent deals, does this solve your U.S. ortho growth challenges or just maybe how are you kind of thinking about the playbook evolving?

If you look at CONMED's history over the last 7 years, the majority of our business has -- set COVID and everything associated with it aside -- has performed pretty consistently. And we had a talk track get to above-market growth rate and stay there, just take market share that's the size of the company we should be. Our U.S. ortho business has been more of a cardiac kit, a little bit up and down, up and down, inconsistency over the quarters. In 2020, we had the leader of that business depart. So I folded it underneath Pat Beyer, who is running our international franchise. And Pat was my first hire when I got to CONMED in 2014, and Pat and I had worked together in a previous company. And at that time, international was 52% of our revenue. So getting that right really mattered. And I knew Pat is a trusted leader and he did wonderful things with international. Pat came in, took over U.S. ortho, and has really over the last year turned over every stone. He's rebuilt the entire management team. If you were at academy in March and came through the booth, you saw a lot of new products that came out as he was pushing on marketing and R&D. And the last couple pieces of that renovation for U.S. ortho was a General Manager of the Heads of Marketing, which came in play early this year. And I feel super good about that leadership team committed to what they're doing with that business. They'll get a check plus when we deliver a couple quarters of above market growth. So that's what I need to see to say we've fixed everything. I'm pretty confident in this team. They're -- I think Todd and I would say it's the best -- some of the best business reviews we've had, have been with this new team in terms of where they're going and the focus they're bringing. In2Bones, I would just remind you, is a completely stand-alone business, independent of the U.S. orthopedics sales force, sports medicine effort. That's got to run well. U.S. ortho has got to run well. It diversifies our orthopedics offering, and we think that's a good thing as well.

Right. As we kind of think about the long-term growth for CONMED, the growth algorithm, I think you previously kind of talked about it maybe after AirSeal and Buffalo Filters. I mean you're doing these 2 -- you've done these 2 transactions for sports medicine for foot and ankle. But just help us build to what maybe the long-term growth rate of CONMED is at this stage post these additional trends?

Sure, so really when we've talked about AirSeal and Buffalo together being at least 25% of the revenue, and we provide a pie chart in our IR materials that shows it's just a tick above that. By adding In2Bones, that's about 4% or so of the company. And then Biorez obviously is -- it's very early revenue days. But you're around that 30% now -- a company that's growing very nicely, very healthy double-digits. So then it's -- so the rest of the question, the real question would be what is the rest of the business going to do. Again, Curt reiterated our definition of success is above market growth. And I think that's been the question is where is market growth today. It should be, you would think if we get to a stable normalized place in the markets that we play in as you aggregate those that kind of mid-single digits, I think is a safe place to say where the market should be, and we believe that we should be above that. So if you take that other 70% and put a 5% growth or something, you add all that up and you get to -- we are either at or very close to being a double-digit revenue growth company in a stable macro environment. And we do believe that that -- if we could get to stability and normalcy that that's where CONMED should be.

And maybe just kind of a similar question. But when you kind of add it all up from a gross margin perspective, I think you -- or maybe operating margin, you kind of laid out previous targets, but anything that we should be thinking about longer term for the profitability profile of the company, especially as you kind of layered in some high-growth, high-margin products?

Yes, so pre-COVID, we talked about kind of 50 to 100 basis points of annual gross margin improvement. Since then, COVID has forced our operations team to get a lot more sophisticated and frankly, a lot better. We have a lot stronger team today than we did 2 years ago in that arena. So I would expect more out of that team in general. And then of course, we've added a couple of 80% plus gross margin assets that will contribute over time. So I think that 50 to 100 would be on the low side of -- in a normal environment, what the CONMED growth engine could provide as far as margin improvement.

Got it. Maybe with some of the M&A that you've recently done, leverage has kind of ticked up above 5% right now. Just help us understand maybe kind of your deleveraging targets and thinking through there -- thinking through that. And is it safe to assume that you're kind of on the M&A sidelines for at least some time or is there still some opportunity to look at tuck-ins in the next 12, 24 months?

I'll also take the tough question about deleveraging. We have not turned off our business development efforts. And the reason we take that approach is business development does not happen overnight. If I use both of these recent transactions, we have known these teams for a while. And you have to go through those processes and see how they operate and see if the culture of the organization, is the technology and the promise that they are telling you really unfolding the way they said it would, and they're building that credibility. So our business development teams, our commercial teams continue to scour the marketplace for innovative products. Obviously, our current leverage, anything they brought forward would have to be a really, really attractive target. So I've done the easy part. I'll let him talk about the leverage part.

What would a really attractive target be?

Something like a Biorez, something like an AirSeal, something like a Buffalo Filter. I mean -- we went over 5 turns with both of those transactions, AirSeal and Buffalo Filter. And I think everybody is really happy today that we did that, and we feel very good about these 2 recent transactions. So if somebody on our team identified something that we thought was of that nature, we take a really hard look at it.

Yes, and that's essentially how is going to answer the question. In 6 years, we've now done -- this is the third time that we followed this pattern. In 2016, we bought SurgiQuest, which was the AirSeal product. We went over 5 turns. We -- in absence of any new deal, we burn that down to about 3 turns. And then in 2019, we bought Buffalo Filter again, went over 5 turns said that we would be to 3 turns by the end of '21, not knowing there would be a global pandemic in the middle of that timeframe. Despite the global pandemic, we still got it down to 3.5 in that same timeframe. And then somehow we've done these deals which again puts us a little over 5. In the absence of something really compelling, that leverage will come back down again. I'll tell you -- I'll just remind everybody, $800 million of our debt we just redid in the form of convertible notes that are fixed for the next 5 years at 2.25% and don't become part of the share count until the stock is over $251. So I -- and there's no payments required for those in the next 5 years. So of all the things I worry about, our leverage is not one of them.

And there hasn't been like a firm commitment of getting back down to like that 3.5 turn?

No, it's just not how we even think about it, right? I mean it's about finding the great opportunities to help the growth engine be stronger and better. We have very stringent filters that we have never moved on. And to Curt's point, obviously the bar has even been raised. At our current leverage, the bar is raised to add anything to that. And so -- but we'll continue to focus on the strength of the revenue growth engine and profitability. And if we find a compelling asset that we think that it's compelling to us and we believe it will be compelling to our shareholders, we would act on that.

Got it. We talked through acquisition, I think we kind of ignored pipeline unfortunately. Just as you're looking at your orthopedics business and general surgery business, what's kind of in the hopper for a product launch that we should be kind of thinking about that's exciting in the portfolio? What's your favorite child coming up?

Yes, you're not going to get an answer on that from me. The market is littered with people in my chair who've talked about future products that didn't materialize, and we want our sales reps and our customers focused on what we currently offer them. And at academy this year on the orthopedic side, we introduced new products in the shoulder, the knee and the hip, and those are coming to market throughout the course of the year, and we're very excited by those. On the general surgery side, we introduced last fall a great product for AirSeal that pairs up with Intuitive and has really opened up access on their latest iteration of robot, the 3-port technique. We're very excited about that. And our GI business, our advanced endoscopic technology business is introducing an energy platform in the GI space. So that's in the early days of launch. So we've got something going on in every one of our businesses, and we'll continue that cadence. And we'll see what we show between now and the end of the year and next year, but we'll talk about them after we get them into the market. That's just the discipline that we try to have as a company.

Right. Maybe just on the smoke evacuation market kind of in our closing here. But I mean, I remember you raised kind of the market expectations or TAM for Buffalo Filters. But maybe from a legislation perspective, how is that kind of been shaping up? And I know it was never a huge part of your growth story, but hopefully post COVID just kind of how are you thinking about that?

I think today, there are 9 states that have passed some form of legislation and we believe there are 9 states that have pending legislation. And when you look at the legislation, you have to -- all legislation is not created equal. There are some legislation in the marketplace that really doesn't have a lot of substance or bite behind it. There are other markets like the state of Colorado that put legislation in place that really moved the market over a 24-month period. And that's the kind of legislation we like, obviously, as a provider to the marketplace. And we think it's a responsible legislation because stand in the operating room all day and inhale surgical smoke, it's no longer a question of is it hazardous? The question is why would you allow that to happen. Todd uses the analogy "you can't go into a hospital today, the dentist office and have an X-ray without lead being put on." We think smoke evacuation filtration has the same standard for safety of patients and staff.

Got it. Unfortunately, we're out of time. But Curt, Todd, thanks for joining us today, and thanks, everyone, for sticking with us today. Appreciate it.

Thank you, Drew.

Thank you, Drew.