CONMED Corporation

Good day, and thank you for standing by. Welcome to ConMed's second quarter fiscal 2024 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. Before the conference call begins, let me remind you that during the call, management will be making comments and statements regarding its financial outlook, its plans and objectives. These statements represent the forward-looking statements that involve risks and uncertainties as those terms are defined under the federal securities laws. Investors are cautioned that any such forward-looking statements are not guarantees of future events, performance or results. The company's actual results may differ materially from its current expectations. please refer to the risk and other uncertainties disclosed under the forward-looking information in today's press release, as well as the company's SEC filings for more details on the risks and uncertainties that may cause actual results to differ materially. The company disclaims any obligation to update any forward-looking statements that may be discussed during this call, except as may be required by applicable law. You also hear management refer to non-GAAP or adjusted measurements during this discussion. While these figures are not the substitute for gap measurements, management uses these figures to aid in monitoring the company's ongoing financial performance from quarter to quarter and year to year on a regular basis, and for benchmarking against other medical technology companies. Adjusted net income and adjusted earnings per share measures the income of a company, excluding credits or charges that are considered by the company to be special or outside of its normal ongoing operations. These adjusted items are specified in a reconciliation supporting the company's earnings releases posted in the company's website. With these required announcements completed, I will turn the call over to Kurt Hartman, ConMed's Chair of the Board, President and Chief Executive Officer, for opening remarks. Mr. Hartman?

Thank you, Amy. Good afternoon, and thank you for joining us for ConMed's second quarter 2024 earnings call. With me on the call is Todd Garner, Executive Vice President and Chief Financial Officer, and Pat Beyer, our Chief Operating Officer. Today, we will share with you our second quarter results and the overall outlook for our business. We will then open the call to your questions. I'll start by reviewing our second quarter results. Total sales for the quarter were $332 million, representing a year-over-year increase of 4.5% as reported and 5.2% in constant currency. This performance delivered a record high quarterly sales result and was within our range of expectations. From an earnings perspective during the second quarter, our GAAP net income totaled $30 million. This compares to net income of $13.7 million in the second quarter of 2023. Excluding special items that affected comparability, our adjusted net income of $30.6 million increased 17.2% year over year, and our adjusted diluted net earnings per share of 98 cents increased 18.1% year over year. Overall, we had several areas of strong financial performance in the quarter to include gross margin, adjusted EPS, and our leverage ratio, which Todd will cover. Jumping into the key product categories, on the orthopedic side of the business, we did not clear the supply constraints to the level we had expected. While the absolute dollar level of back order is back to normal, The current mix is far more weighted to our core single-use disposables and implant categories, and this by nature creates inefficiencies for our sales teams. Those missed opportunities result in lost sales as customers have alternatives in many of these categories. Further, this slows our team's ability to be fully on offense going after new customers. This leaves us behind our initial plan entering Q3 and requires us to lower guidance for the remainder of the year. We understand this performance is frustrating for both our customers and our investors. On the general surgery side of the business, demand remained healthy across the portfolio. Regarding AirSeal, while it is still very early in the rollout of the new surgical robot, I wanted to provide you with some insight into what we are seeing after its first full quarter in the market. First, in the quarter, our U.S. AirSeal Capital Unit sales grew faster than they did in the prior year quarter. we are seeing no sales slowdown on AirSeal Capital. Second, we understand that the first locations to receive the new robot were likely a targeted list of key customers. We also understand these locations are expected to commit to a certain number of procedures using the full feature set of the robot before they make any adjustments based on their preference. Against that backdrop, in this very early window, our initial surveillance shows that the percentage of surgeons that returned to AirSeal after their initial committed number of procedures on the new robot appears to be consistent with the percentage of surgeons that chose AirSeal on the previous generation. This shows that clinical precision in sufflation at low pressure remains a user preference. Third, AirSeal is used in roughly a third of robotic surgical procedures today, and those surgeries are concentrated in the longer, more complex procedures such as prostatectomy, nephrectomy, hysterectomy, and bariatric surgery. These procedures typically stress standard insufflation due to leaks, smoke evacuation, suction requirements, and large cavity volume demand. We believe, and our early surveillance confirms, that based on patient outcomes and numerous published clinical studies, that the procedures are most likely to use AirSeal today will be the same procedures that use AirSeal with the new robot. I will now turn the call over to Todd, who will provide a more detailed analysis of our Q2 financial performance and take you through our updated full-year guidance. Todd?

Thank you, Kurt. All sales growth numbers I referenced today will be given in constant currency. The reconciliation to gap numbers is included in our press release. As usual, we have included an investor deck on our website that summarizes the results of the quarter and our updated guidance. For the second quarter of 2024, our total sales increased 5.2%. For Q2, our sales in the U.S. increased 6.1% versus the prior year quarter, and our international sales grew 4.0%. Worldwide orthopedics declined 0.1% in the second quarter. In the U.S., orthopedic sales declined 0.4%, and internationally, orthopedic sales grew 0.1%. We've talked about our supply chain issues in our sports medicine and foot and ankle businesses, and we expected Q2 to be a transition back to offense. As Kurt said, that transition is taking longer than we expected. Total worldwide general surgery revenue increased 9.4% in the quarter. U.S. general surgery revenue grew 8.9%, while internationally general surgery revenue increased 10.5%. So the general surgery side of the business continues to be healthy and perform in line with historical trends. Consistent with the data that Kurt provided on AirSeal, we continue to see very good global growth in that product line. Now let's move to the expense side of the income statement. We will discuss expenses and profitability in the second quarter, excluding special items, which include charges for acquisitions and contingent consideration, termination of distributor agreements, legal matters, software implementation costs, amortization of intangible assets, and amortization of deferred financing fees net of tax. Adjusted gross margin for the second quarter was 55.3%, an increase of 90 basis points compared to the prior year quarter. Research and development expense for the second quarter was 4.2% of sales, 10 basis points lower than the prior year quarter. Second quarter adjusted SG&A expenses were 36.9% of sales, 50 basis points lower than the prior year quarter. On an adjusted basis, interest expense was $8.2 million in the second quarter. The adjusted effective tax rate in Q2 was 24.0%. Second quarter GAAP net income was $30.0 million. This compares to GAAP net income of $13.7 million in Q2 of 2023. GAAP earnings per diluted share were 96 cents this quarter compared to 43 cents a year ago. Excluding the impact of special items discussed earlier in the second quarter, we reported adjusted net income of $30.6 million, an increase of 17.2% compared to the second quarter of 2023. Our Q2 adjusted diluted net earnings per share were 98 cents, an increase of 18.1% compared to the prior year quarter. Turning to the balance sheet, our cash balance at the end of the quarter was $28.9 million compared to $33.9 million as of March 31. Accounts receivable days as of June 30th were 65 compared to 70 at the end of March and 65 a year ago. Inventory days at quarter end were 196 compared to 207 in March and 200 a year ago. Long-term debt at the end of the quarter was $965.2 million versus $990.1 million as of March 31st. Our leverage ratio on June 30th was 3.8 times which was better than we expected. So all balance sheet metrics moved in the right direction in the quarter and were improving in our working capital controls. Cash flow provided from operations in the quarter was $43.3 million compared to $26.7 million in the second quarter of 2023. Capital expenditures in the second quarter were $3.6 million compared to $4.5 million a year ago. Now let's turn to financial guidance. The revenue in the first half of the year is very close to what we expected at the beginning of the year. However, we expected to have better improvement in our global orthopedics business at this point. We knew we had supply challenges to work through early in the year, and we expected our teams to be fully back on offense by July 1st. While we have made significant improvements with the supply chain and our back order is back to pre-pandemic levels, we remain hand-to-mouth on too many items, which is impeding our ability to be fully back on offense. Of course, this is a central focus for us, and we believe that we should be in a much stronger position by the end of the year. In Q1, we grew 5.9%, and in Q2, we grew 5.2%, both against the strong growth rates we saw throughout 2023. So we've grown between 5% and 6% constant currency in the first half of the year. We think it's prudent to expect that same level of growth in the second half of the year, with Q3 on the lower part of that range. We project about 50 basis points of currency headwind in the third quarter and immaterial FX in Q4. That would put our full year reported revenue guidance between $1.305 billion and $1.315 billion. Our focus will be to strengthen our operational foundation over the next six months, increase the confidence of our sales forces, particularly in orthopedics, and be back to full offense by the start of 2025. With orthopedics being slower in the back half of the year than we expected, that has an impact on gross margins. For the first six months of 2024, we improved gross margins by 130 basis points compared to 2023, consistent with our initial guidance for the year of improvement between 100 and 150 basis points. And we continue to project improving margins sequentially. We expect Q3 to be in the mid-56% range and Q4 to be around 57%. That would put us around 100 basis point improvement on the year, with the mixed engine still very positive and driving us northward. Again, our focus over the next six months will be to improve our internal operations, and we believe that will allow us to continue to improve margins at a higher pace than the vast majority of MedTech. We've included in our IR deck how this revised guidance impacts our original 2024 guidance for SG&A, interest expense, and the tax rate. We will continue to invest in the business to improve our revenue growth, but grow expenses slower than revenue. We project EPS growth to be between 9 and 11 percent in Q3, and between 13 percent and 18 percent in Q4. That would put our new full-year guidance for adjusted EPS between $3.95 and $4.02, representing growth between 14.5 percent and 16.5 percent still much better than the vast majority of medtech. While we're disappointed by the need to reset our guidance lower than our initial expectations on the year, we believe these numbers are responsible and demonstrate a healthy growth company on the top and bottom lines with upside in the future. We are focused on executing and winning in the marketplace with our improving engine. And with that, we'd like to open the call to your questions and turn it back to Amy.

Thank you. As a reminder, to ask a question, you will need to press star 11 on your telephone. To remove yourself from the queue, you may press star 11 again. You will be limited to one question and one follow-up. Please stand by while we compile the Q&A roster. And our first question comes from the line of Rick Weiss with Stiefel. Your line is open.

Good afternoon to you both. First, you know, I appreciate the good things about the quarter and the first half frustrating here about the second half. But can you help me help us better understand exactly what's happening with the supply chain? What specifically has not rammed in which specific products and help us just in as concrete terms as possible understand what you can do, what you are doing to get it back on track, and what's taking so long, frankly.

Yeah, Rick, a lot to unpackage in that question. There's a number of things. Let me start with the products. As we said in the script, key implantables in orthopedics, and that includes not only sports medicine, key markets of knee and shoulder, but also in the foot and ankle business. Now, I would say with with that comment, foot and ankle exit the midpoint of the year in much better shape than the knee and shoulder implant categories. That's where we're still struggling to catch up. Part of the challenge is variability and surprise in our supplier base. As an example, we've had seven suppliers unexpectedly close their doors on us this year, and not just us, but everybody they were serving. And this is not a business where you can just rapidly pick up things and start producing tomorrow night after they close tonight. It takes time and validation and qualification, and it only takes one component to put a product on a supply constraint. And so those are the type of things we're dealing with. We've had other individualized issues, machine downtimes that crimp supply. We've had material availability issues. So it's not one thing I would point to that is slowing everything down. It's been a host of issues. And the teams in our manufacturing sites are very dedicated and focused and working diligently to find alternate suppliers, to qualify those alternate suppliers, to get a product availability in stock, to really focus on the key items that our sales teams and customers are asking for. And everybody's frustrated. I think we understand that clearly. Right.

And just to follow up, you gave some very detailed, very clear guidance, Todd. And just thinking, just I feel like if I get the third quarter right, you know, I'm going to be able to get to the fourth quarter in the year. Just, you know, you're implying operating margins step up, I think, 70 bits or so sequentially. But my rough initial math here and maybe i'm just way off you'll you'll help me um is third quarter sales maybe in the whatever 3 19 320 kind of area and eps at 99 cents you know based on just my rough uh back of the envelope uh hearing your comments does that sound like the place that you'd hope people would be yeah i'm going to stick to my disclosure rick if you don't mind uh low low fives

percent growth, constant currency with 50 basis points of FX headwind in Q3. And then we said 9% to 11% growth in EPS.

Thank you. And our next question comes from the line of Robbie Marcus with JPMorgan. Your line is open.

Thanks for taking the questions. Appreciate it. Two for me. First, Todd, when we came in, I remember we met at the J.P. Morgan Conference in January this year, and at that point, the elevated margin expansion targets for 24 and 25 were still on the table. You've clearly had supply issues this year. Are those margin targets gone at this point? Are they still feasible to get back to at some point in the future, or have there been more permanent shifts in the business that take away that type of expansion?

Great question, Robbie. Yeah, we're definitely on the same track, right, as far as improvements, but this is a speed bump that's going to delay us getting there. So back in the fall of 22, we put a three-year kind of long-range plan out there that would get us around 60%, we said, at the end of 25. So now what I just said was we're going to be around 57% at the end of 24. So in order to get to 60, I'd have to improve 300 basis points in that 12-month period. While that's not impossible, I don't think that's likely. So I think we're likely going to be short of what we said in the fall of 22 for the end of 25, but we still are enjoying about 100 basis points of tailwind from Mix. And so we still see that Mix tailwind. And so it's just a matter of when we get there. And it's going to take a little longer than we thought a couple years ago. But the margin improvement story I still think is one of the best in MedTech. And it does continue here.

Got it. Okay. Then maybe just to follow up on Rick's question. You know, last year was the warehouse software issue. This year has been supply issues. Before that, I believe there, a couple years ago, it was a Salesforce expansion. At what point do you need to maybe broaden the controls of the company and review and overhaul some of the you know, the quality issues and processes in place here. For a company your size, I'm surprised there are so many disruptive issues that happen. Just wondering if you think about that and how we should think about any maybe layered expenses moving forward to implement better quality controls. Thanks.

That's a good question, Robbie. And I think as you walk through those topics, in 21, we did a Salesforce expansion. because the markets were recovering from COVID. And as it turned out, there were two other iterations of COVID that kicked in after that Salesforce expansion. So it made it look as though our Salesforce expansion was mistimed. And I think nobody at that point in time could predict the variance of COVID and when they were going to or not hit. Warehouse issue was fourth quarter 2022. That was an absolute execution issue on our part. I'm proud of the team, the way we remediated it. But nonetheless, it was a disruption, disruption to customers, disruption to our financial performance. And we have been dealing since the third quarter of last year with supply chain challenges from our supply base and from our internal issues. You know, as companies scale, you do put more systems, more expense, more demand. infrastructure in place, people, both people and systems around that, and controls. I think we've been doing that appropriately as we look at areas that we believe need investment. I think we've been diligent with doing that. Certainly, we're as frustrated by these hiccups, by these missteps as anybody is. Our teams are frustrated, and we frustrated, as I said in my script, customers and investors, and that's very... very challenging to deal with. And we are all committed to solving and remediating and getting these things behind us. Is there something systemic we need to do? We challenge ourselves every day with those questions. And I think we're doing the right things.

Thank you. And our next question comes from the line of Vic Chopra with Wells Fargo. Your line is open.

Hello, this is Dino Weinstock on for Vic Chopra. One question, I guess, further on the supply chain challenges. What kind of confidence do you have that this won't bleed into 2025, and do you have any expected timeline when you expect to fully recover? Thank you.

Yeah, good question. We, you know, we're probably a little bit hesitant. We had thought at this point in the year we would have most of this behind us, and we We've had some surprises that have popped up that were not on our radar screen. We have a very detailed plan as we look at the third quarter. As I noted earlier, we feel like we're on the other side of things as it relates to our foot and ankle business back in solid supply there. It is really the implant categories in the shoulder and the knee where we're kind of hand to mouth and struggling. We just cleared a key category with our arthroscopic enabling devices, getting back into full stock, getting our sales teams back on full offense there. The implant categories are the two remaining challenges, and we think as we, you know, as Todd talked about in his commentary, we thought the guide for the second half would be a little slower in Q3 and closer to the higher end in Q4. So that implies that we think we'll be working through a lot of it in Q3. and be in better shape as we get into Q4, but we're trying to give ourselves a little extra time, given what we've gone through here in the first six months.

Got it. Thank you for the answer. Another question, I guess, on the F&A side. What trends are you seeing in the lower extremities market during Q2, and are you expecting second-half growth to get back on track?

The trend question is relative to ConMed or the market in general?

the market?

I think we still believe the foot and ankle market is a great market, a growth market, and a market we want to be in, and a market that we have a great asset to participate. Obviously, we've struggled because of our supply chain challenges, and we think now that we have the majority of that behind us that we should be getting back on offense here. Further, we've added, I think we noted on the last call that we have moved some of the sports medicine-related foot and ankle products into the foot and ankle business to further support that offering, as well as have done an initial rollout and launch of BioBrace, which BioBrace brings along more implantations of lower extremity foot and ankle products that our portfolio has. We think we've got the right offense, and it's just getting them back on, or we think we've got the right portfolio, and it's just getting them back on offense with product availability, which I think that is the one part of orthopedics that we do believe we exited the mid-year point where we thought we would.

Thank you. And our next question comes from Travis Steed from B of A. Your line is open.

Hey, I kind of wanted to follow up on Robbie's margin question, but ask it on the revenue side. I think you always kind of talked about achieving kind of double-digit growth. This year it's kind of 5% to 6%. Is this 5% to 6% and maybe a little bit better 6% to 7% kind of the right place to be longer term?

No, we still think we're capable of much better than that, Travis. We still, you know, that same 30% plus of our portfolio is that should be very healthy double digits, we think under normal circumstances should be there. So, you know, if that 30%, that ought to be able to deliver, you know, close to 6% growth just on its own. And so if the rest of the 70% was, you know, mid-single digits, then you're in those high single digits just with kind of that being normal. So we don't think this is normal, and our expectations are certainly be a faster grower than this but you know but you know five to six percent growth while disappointing to us I think is still probably above average in med tech and certainly our EPS growth is above average for med tech so even at these disappointing levels it is a you know healthy growing profitable business but not growing as fast and not as profitable as we expected at the beginning of the year, granted.

Great, thank you. And another question, just like when you think about the rest of the markets, I know you had your supply issues, but I don't know if you think about the markets, if there's been any kind of change in the markets, just because like you're not the only company that's kind of resetting kind of the second half here and having more kind of inline prints. And so I don't know if there was just like, some sort of moderation in ortho markets or kind of anything you've seen on the margin?

Travis, I don't think there's anything we would point to. I think we believe commercially our teams, and we just did a big round of international meetings, the only thing we would point to in the markets are the strikes in Korea are continuing longer than anybody had anticipated. And events in China have slowed the overall China market. But those are smaller markets for ConMed. They're growth markets for ConMed, but they're smaller. But the majority of our big markets, Canada, the US, Western Europe, we see pretty healthy underlying markets. Pat, I don't know if you want to add anything to that. You've spent a lot of time.

I would just agree with what you're saying and would again call out a Japan market also continuing to grow well from the market standpoint.

Thank you. And our next question comes from the line of Mike Mattson with Needham. Your line is open.

Yeah, thanks for taking my questions. I just want to ask a couple on general surgery. You know, the growth was obviously good, much better than orthopedics, but it's probably a little slower than I would have expected just given that, you know, that's where a couple of your bigger growth drivers are. So, you know, what are your thoughts on that business? Is there anything going on there? I understand the supply chain is more on the ortho side, but... Yeah, I mean, I think that business...

is pretty close to historical rates there, Mike. Air seal is definitely good. Smoke is a little soft. We had a transitory quality issue that we dealt with and has been remediated. It did affect us a little bit in Q2, so smoke was soft, but we think that's temporary. Other than that, I think things were pretty normal on general surgery.

Okay. And then just looking into the second half, I would assume that the kind of the growth, you know, you expect similar growth overall for the company. So the two businesses, general surgery and orthopedics, I would assume would be kind of similar to what we saw in the first half as well.

Yeah. Yeah. For our guidance kind of assumes that orthopedics stays challenged a little bit for longer than we thought originally, of course. And so, but, but, The general surgery business, we think, will continue to do what it's been doing.

Okay. Got it. Thank you.

Our final question comes from the line of Kristen Stewart with CL King. Your line is open. Hi. Thanks for taking the question.

I was just wondering if there's any risk that we could see some of these supply constraints and supply issues bubbling over into the general surgery business, or do you still have confidence in that for the balance of the year? being unaffected?

No, right now, Kristen, we feel very good about the general surgery side of the business, the product availability, the manufacturing controls. Obviously, with a product line like AirSeal, a product line like Smoke, we very early brought those under our complete manufacturing control and have a lot of redundancy for products like that. Some of the orthopedic categories have multiple generations of products, and we don't control all of those. That is part of our cleanup, is to really focus our energy efforts on the key product lines and start transitioning more customers. So we are not anticipating that. And trust us, we are watching those categories very closely.

Okay, thanks very much.

Thank you, and I would now like to turn the conference back to Kurt Hartman for closing remarks.

Thank you, Amy, and just wrap up here today and say thank you, everybody, for your time, and we look forward to speaking with you on our next earnings call.

And this concludes today's conference call. Thank you for participating. You may now disconnect.