CONMED Corporation (NYSE:CNMD) Q4 2022 Earnings Call Transcript

CONMED Corporation (NYSE:CNMD) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: Good afternoon, everyone. Before the conference call begins, let me remind you that during this 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 will also hear management refer to non-GAAP or adjusted measurements during this discussion. While these figures are not a substitute for GAAP 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 from benchmarking against other medical technology companies. Adjusted net income and adjusted earnings per share measure the income of the company, excluding credit or charges that are considered by the company to be special or outside of its normal ongoing operations.

These adjusting items are specified in the reconciliation supporting the company’s earnings releases posted to the company’s website. With these required announcements completed, I will turn the call over to Curt Hartman, CONMEDs Chair of the Board, President and Chief Executive Officer for opening remarks, Mr. Hartman.

Curt Hartman: Thank you, Justin. Good afternoon and thank you for joining us for CONMED’s fourth quarter and full-year 2022 earnings call. With me on the call is Todd Garner, Executive Vice President and Chief Financial Officer. Today, I’ll provide a brief overview of the financial and operating performance for the fourth quarter and full-year. Todd will then provide a more detailed analysis of our financial performance and discuss our 2023 financial guidance. After that, we’ll open the call to your questions. Our Q4 results were materially impacted by our warehouse management software implementation in October as indicated by our November 14 suspension of guidance. Total sales for the fourth quarter were $250.9 million, representing a year-over-year decrease of 8.4% as reported and a decrease of 7% in constant currency.

Clearly, the lack of ability to ship customer orders in a timely fashion resulted in both delayed revenue and lost sales opportunity as customers supported surgeries with competitive products. This disruption also took our sales teams out of their normal business routines and cost us new opportunities typically associated with the fourth quarter. We know our customers perform surgery daily with minimal inventory on hand independent or reliable stream of products support their needs. In this regard, we came up short in Q4 and in many cases customers found alternative solutions. However, customers choose CONMED products over competing products for a reason and we’re working hard to regain their trust and have them return to the CONMED brand following the system implementation issues.

Given the revenue shortfall in the quarter, fourth quarter earnings also suffered with GAAP net income of $26.6 million. This compares to net income of $24.4 million in the fourth quarter of 2021. Excluding special items that affected comparability, our adjusted net income of $12.9 million decreased 61.3% year-over-year and our adjusted diluted net earnings per share of $0.42, decreased 60.7% year-over-year. For the full-year, sales reached $1.045 billion, representing a year over increase of 3.4% as reported and a 4.6 % increase in constant currency. The 2022 GAAP net loss totaled $80.6 million, compared to net income of $62.5 million in 2021. Excluding special items that affected comparability, our adjusted net income of $85 million decreased 14.5% year-over-year and our adjusted diluted net earnings per share of $2.65 decreased 17.4% year -over-year.

Looking back at 2022, we strengthened the broader business to include two fantastic acquisitions, which are both off to a great start quantitatively and qualitatively. We also locked in the majority of our debt at 2.25% interest rate for five years with the new convertible notes. We continue the development and strengthening our new product introduction process and this difficult experience in Q4 will make us even better at delivering to our customers. From a market perspective, we believe the surgical environment trended more favorably in the fourth quarter with stability in procedures and subtle increases in staffing levels across the healthcare system, all of which are encouraging signs moving forward. The overall environment has more stability than at this point a year ago, while noting there are still areas of uncertainty around recessionary pressures.

As we step into 2023, we’re laser focused on basic execution to deliver top line growth and leverage earnings growth. Further, we believe we’ve assembled a high growth portfolio through a disciplined combination of organic and inorganic development across both general surgery and orthopedic categories. And as you will hear from Todd, we have more clarity on our gross margin outlook in the years ahead. While 2022 did not end as we had planned, the strategic outlook for CONMED remains strong on both the top and the bottom line and this will benefit patients, customers, employees and shareholders in the quarters and years ahead. Overall, I remain honored to work with this executive team and beyond impressed by their commitment and persistence in pursuing what is in the best interest of CONMED.

They and all of our global employees and related partners remain committed to our growth strategies. In 2023, we will define success by staying focused on our people and ensuring the financial growth and health of the company, while remaining committed to our strategy to drive above market growth in both revenue and earnings. With that, I’ll turn the call over to Todd, who will provide a more detailed analysis of our financial performance and discuss our financial guidance. Todd?

Todd Garner: Curt? All sales growth numbers I referenced today will be given in constant currency. The reconciliation to GAAP 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 fourth quarter of 2022, our total sales decreased 7.0%. Our best estimate of the revenue impact from our warehouse software implementation is in the neighborhood of $65 million. Our end customer backlog at year-end, due to this disruption was approximately $30 million, which included the impact of shutting down the warehouse for the last three days of the year to perform a complete physical inventory. History has shown that when supply disruptions in our industry are resolved, the original supplier wins back the vast majority of business loss during the temporary disruption.

Photo by Atikah Akhtar on Unsplash

We know that our customers were well aware of the substitute products prior to our delivery problems and they choose CONMED to use for a specific reason. Those reasons still exist today and we are even more energized to be excellent partners to our customers. Revenue from the recent acquisitions was $12.5 million in the quarter. As Curt said, both In2Bones and Biorez are off to strong starts and exceeded our expectations in 2022. These products were unaffected by the warehouse disruption as they are not shipped from that location. For Q4, our sales in the U.S. decreased 3.9% versus the prior year quarter, those of our U.S. sales decreased 3.9% and our international sales decreased 10.6%. The U.S. is where the majority of In2Bones and Biorez are sold.

We estimate that the impact from the warehouse disruption was similar in percentage in the U.S. and OUS. The U.S. was impacted immediately while our international geographies initially benefited from inventory held in our regional distribution centers. Because of that, the remediation efforts first focused intensely on U.S. customers. As the duration of the issue extended, the international channel was depleted and the end customer there was impacted later in the quarter. We’ve made good improvement in shipping globally and we are shipping at or above normal daily volumes. As of this week, our end customer backlog from the affected warehouse is approximately $10 million. So we’re making progress, but we’re not where we want to be yet and we still have work to do to replenish our distribution channels and increase our shipping capacity for future expected growth.

We will continue to focus and improve until we have turned this weakness into a strength. Worldwide Orthopedics revenue decreased 0.3% in the fourth quarter. In the U.S. Orthopedic sales grew 15% and internationally orthopedic sales decreased 9%. Obviously, the U.S. is seeing most of the benefit from the acquisitions. Total worldwide general surgery revenue decreased 12.0% in the quarter. U.S. general surgery revenue declined 11.5%, while internationally general surgery revenue decreased 13.1%. We estimate that the sales impact from the warehouse disruption was fairly balanced across the portfolio with a little more impact felt on the general surgery side. For the full-year of 2022, our total sales increased 4.6%. Revenue from the recent acquisitions was $24.8 million in 2022.

For the full-year, our sales in the U.S. increased 4.8% versus the prior year and our international sales increased 4.3%. Worldwide Orthopedics revenue increased 6.5% for the full-year of 2022. In the U.S. Orthopedic sales grew 9.2% and internationally Orthopedics sales increased 5.0%. Total worldwide general surgery revenue increased 3.1% for the full-year 2022. U.S. general surgery revenue grew 3.0%, while internationally general surgery revenue increased 3.2%. Now let’s move to the expense side of the income statement. We will discuss expenses and profitability in the fourth quarter and the year excluding special items, which include charges for acquisitions and contingent consideration, legal matters, restructuring and software implementation costs, debt refinancing and extinguishment costs, amortization of intangible assets and amortization of deferred financing fees and debt discount net of tax.

Adjusted gross margin for the fourth quarter was 54.2%, a decrease of 270 basis points from the prior year quarter. The majority of the decline is due to the cost deflation we’re all dealing with in 2022. The gross margin was lower than we expected due to the significant revenue miss and certain period expenses recognized in Q4. For the full -year, adjusted gross margin was 55.3%, a decrease of 90 basis points from 2021. We told you back in the spring that freight and material cost increases had cost us approximately 300 basis points in gross margin, since the 2019 baseline. As we updated that analysis for the end of €˜22, it shows inflationary costs of 330 basis points in total. There has been some relief on the freight side, but the full impact of material cost inflation was higher for the full-year 2022 than what we had seen back in the spring.

When we add in the labor component to that metric, we estimate the total inflationary costs have decreased our gross margin by approximately 400 basis points in the last three years. Adjusted gross margin in 2019 were 55.4%. So that means that our improving mix and cost savings over the past three years have essentially offset the impact of inflation over that time period. Research and development expense for the fourth quarter was 4.9% of sales, 80 basis points higher than the prior year quarter. For the full-year 2022, R&D expense was 4.5% of sales, 20 basis points higher than 2021. Fourth quarter adjusted SG&A expenses were 39.7% of sales an increase of 300 basis points over the prior year quarter, because of the miss sales in Q4 2022. For the full-year, adjusted SG&A expenses were 38.8%, so 50 basis points higher than 2021.

On an adjusted basis, interest expense was $7.9 million in the fourth quarter and $24.0 million for the full-year. The adjusted effective tax rate was 26.5% in Q4. This was higher than anticipated as the lower income reduces the credits, we are able to take against the income. For the full -year, our adjusted effective tax rate was 23.5%. Fourth quarter GAAP net income was $26.6 million, this compares to GAAP net income of $24.4 million in Q4 2021. GAAP earnings per diluted share were $0.86 this quarter, compared to $0.75 a year ago. For the full-year, GAAP net loss was $80.6 million, compared to GAAP net income of $62.5 million in 2021. GAAP net loss per diluted share was $2.68 in 2022, compared to GAAP net income of $1.94 in 2021. Excluding the impact of special items discussed earlier in the fourth quarter, we reported adjusted net income of $12.9 million, a decrease of 61.3%, compared to the fourth quarter of 2021.

Our Q4 adjusted diluted net earnings per share were $0.42, a decrease of 60.7%, compared to the prior year quarter. Excluding the impact of special items discussed earlier for the full-year 2022, we reported adjusted net income of $85.0 million, a decrease of 14.5%, compared to 2021. Our full-year adjusted diluted net earnings per share were $2.65, a decrease of 17.4%, compared to the prior year. Turning to the balance sheet. Our cash balance at the end of the year was $28.9 million, compared to $33.4 million as of September 30. Accounts receivable days as of December 31 were 69 days, compared to 65 at the end of Q3. Inventory days at year-end were 251 compared to 222 at September 30. Obviously, this was meaningfully impacted by the sales shortfall in the quarter.

We expect this metric to reduce significantly as we progress through 2023. Long-term debt at the end of the year was $985.1 million versus $1.36 as of September 30. We reclassified the remaining $69.6 million of the 2019 convertible notes to short-term liabilities. Our leverage ratio on December 31, 2022 was 5.6 times, compared to 5.0 times on September 30. The increase is due to the dip in EBITDA in Q4 of 2022. This metric is debt divided by the last 12 months of EBITDA. So this lower Q4 will be in the calculation until Q4 of 2023. We expect adjusted EBITDA for the full-year 2023 in the neighborhood of $240 million. We expect our leverage to drop below 5 times in Q3 of this year and be below 4.25 times by the end of 2023, and in the low-3s by the end of 2024.

Cash used for operations in the quarter was $11.6 million, compared to cash flow from operations of $33.8 million in the fourth quarter of 2021. Cash flow provided from operations for the full-year 2022 was $33.4 million, compared to $111.8 million in 2021. The biggest driver of this difference was the significant levels of inventory built in 2022. We expect operating cash flow around $130 million in 2023. Capital expenditures in the fourth quarter were $5.7 million, compared to $3.2 million a year ago. For the full-year, capital expenditures were $21.8 million, compared to $14.9 million in 2021. Now let’s turn to financial guidance. We expect reported revenue for the full-year to be between $1.170 billion and $1.220 billion. This includes currency headwinds of 150 to 200 basis points.

We’ve included the detail of the different components of our financial guidance in the investor deck associated with this call, which can be found on our website. As a reminder, we closed on In2Bones in June of 2022 and we closed on Biorez in August. So essentially, both become organic in the second half of the year. So what you see in the reconciliation is basically the revenue from the acquisitions in the first half of the year. For adjusted gross margins, the improving mix of the portfolio is strong and will continue to drive meaningful benefits in the future. For 2023, we think mix, including the acquisitions, should drive between 110 and 140 basis points of benefit. However, 2023 has some specific challenges on the margin side. FX is a meaningful headwind of between 40 and 60 basis points and we continue to digest the inflationary costs discussed earlier and we will be temporarily slowing production in our slower moving product lines to bring our inventory balance down.

This all results in total gross margin improvement of 20 to 50 basis points in 2023. As we look beyond 2023, we expect at least 150 basis point improvement in 2024 and around 250 basis points in 2025. We believe we’re on a path to have around 60% adjusted gross margins at the end of 2025. As a percentage of sales, we expect adjusted SG&A to be between 37.0% and 37.4% in 2023 and R&D expense to be in the mid-4s as a percentage of sales. We expect adjusted interest expense to be between $32.3 million and $32.8 million in 2023. We expect the adjusted effective tax rate to be around 25% in 2023. We expect adjusted EPS in 2023 to be between $3.20 and $3.45. That includes an FX headwind between $0.20 and $0.25. As we look at the first quarter, we expect reported revenue between $262 million and $272 million.

That includes about 300 basis points of FX headwind based on the December 31 rates. We see this headwind decreasing each quarter throughout the year. We expect adjusted EPS in Q1 to be between $0.58 and $0.63 inclusive of FX headwind. The full-year FX headwind on the bottom is almost all in the first half of the year split fairly evenly between Q1 and Q2. 2023 will have one less selling day overall than 2022. The way our calendar falls, Q1 will have one extra day and Q3 will have two fewer days. We feel very good about the exciting revenue growth and profitability potential from the portfolio we have built, including our recent acquisitions. We have a self-inflicted wound we need to recover from quickly, we’re focused on that. We’re moving back on offense and we will be a better and stronger company because of these experiences and focus.

And with that, we’d like to turn the call over back to Justin for your questions.

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Q&A Session

Operator: And thank you. And our first question comes from Travis Steed from Bank of America Securities. Your line is now open.

Travis Steed: Hi, good afternoon, everybody. Thanks for taking the question. I guess, I wanted to understand any impact from the Q4 issues going over into Q1? How to think about the Q1 impact? And what’s assumed in the guide per share recapture? It sounds like you’re assuming all this comes back pretty immediately. Are you seeing signs of that now? I’m just trying think if there were some at a risk, because there’s been some examples in that type last year where the share didn’t come back quite as fast as the company’s thoughts? So just want to make sure we understand being — what’s being assumed in the guidance?

Todd Garner: Yes. So we ended the year, our back order was $30 million and we just said that it’s about $10 million right now, so we’ve had a good January, made some good improvements. We’ve got some more to go. We’re focused on that. The way I think about it, Travis, is the impact to sales should be the biggest in Q1, right? Because we’re closer to the issue, and as we get further from the issue, there should be decreasing impact, right? And we do expect that we’ll get the vast majority of those customers in that volume back. We may not get it all, but we do expect we’ll get the vast majority of that. And that’s what’s assumed in the guidance. And I would just point out that obviously the backlog benefits the start of the year.

So where you have the biggest hole to fill and to make up for, you also have the biggest — that’s where you have the big benefit of catching up on the backlog. So we feel good about the — about our guidance today and are focused on executing and winning the size of those customer paths.

Travis Steed: Okay. And I don’t know if you do, did you give a dollar amount of how to think about the inflection in Q1? And then the other question was just wanted to understand the U.S. and OUS impact. And it sounds like things maybe got worse, but the issue is ended the quarter, I think we’re talking was more of an issue — the U.S. issue at that point, but now it’s impacting kind of both U.S. and OUS and if not, the OUS have lingered even further into 2023?

Todd Garner: Yes, that’s correct. So no, we can’t estimate the exact impact of the catch up we have to do in Q1. We think it’ll be the biggest negative impact, which is offset by the biggest positive impact, right? And then so it would be impossible to really quantify that quarter-to-quarter. Our focus is to earn that business back as quick as possible obviously. And you are correct, when we first talked about this and we expected to resolve quicker than it was, it was U.S. focus, we felt like that the buffer of inventory in our OUS distribution centers would protect us. It did protect us for a time, but because the issue took longer to resolve than we all wanted it to. Those international geographies were impacted later in the quarter.

And so as we roll into 2023, the U.S. has recovered better and faster because the remediation efforts were first on that side of the business and we’re making up good strides on international, but international is probably more impacted at the start of the year here than U. S. is.

Travis Steed: Okay. I’ll leave it there, let others jump in. Thank you.