Curt R. Hartman - CONMED Corp. Todd W. Garner - CONMED Corp..

Mike Matson - Needham & Co. LLC Kristen Stewart - Deutsche Bank Securities, Inc. Dylan J. Gantley - Leerink Partners LLC J.P. McKim - Piper Jaffray & Co. Matthew Mishan - KeyBanc Capital Markets, Inc..

Good afternoon, everyone. Before we begin, let me remind you that during this call management will be making comments and statements regarding its financial outlook, which represent forward-looking statements that involve risks and uncertainties as those terms are defined under the federal securities laws.

The company's actual results may differ materially from its current expectations. Please refer to the risk factors and other cautionary factors in today's press release as well as the company's SEC filings for more details on factors that may cause actual results to differ materially.

You will also hear management refer to certain non-GAAP adjusted measurements during this discussion.

While these figures are not a substitute for GAAP measurements, management will use 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 measure the income of the company, excluding credits for 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 in the press release issued this afternoon.

With these required announcements completed, I will turn the call over to Curt Hartmann, CONMED's President and Chief Executive Officer, for opening remarks. Mr.

Hartman?.

Thank you, Jonathan. Good afternoon and thank you for joining us for CONMED's First Quarter 2018 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 highlights for the quarter.

Todd will then provide a more detailed analysis of our financial performance and discuss our 2018 financial guidance. After that, we'll open the call to your questions. As we outlined in our press release, we had a very strong start to the year. Our people and new products continue to make a difference for CONMED in the markets we serve.

And our adjusted EBITDA growth in the quarter confirms our commitment and ability to drive profitable growth going forward. All of this gives us the confidence to increase our top and bottom line outlook for 2018, which Todd will discuss in more detail later in the call.

Our total sales for the first quarter were $202.1 million, representing an increase of 8.3% as reported and 6.8% in constant currency and as adjusted for the new revenue accounting standard when compared to the first quarter of 2017. This growth was driven by broad-based strength across both of our categories on a global basis.

From an earnings perspective during the first quarter, our adjusted net earnings of $15.1 million increased 42.7% year-over-year, and adjusted diluted net earnings per share of $0.53 increased 39.5% year-over-year. Now, let me update you on a few non-financial highlights from the quarter.

First, we were very pleased to receive the de novo FDA approval of thoracic indication for AirSeal. This is the first ever approval of an access management platform for MIS procedures in the thoracic cavity, and it required substantial data in order to receive approval given the anatomy in this space.

This approval expands our indications and procedural base, and validates the strategy we developed at the time of the SurgiQuest acquisition to advance both the technology and clinical application of the platform.

Second, during the quarter, we participated in the AAOS, ACFAS, AORN, and SAGES trade shows, where we had the opportunity to showcase several new products.

Overall, we were very pleased with the market reception and customer enthusiasm at these industry shows and we are encouraged by the early feedback on the MicroFree power system and the Anchor retrieval system.

New products are a critical part of our future and we look forward to introducing even more innovative products as we progress through the year.

Finally, I want to note that we successfully completed our CFO transition and I'd like to personally thank both Todd and Luke for the effort they put in to ensuring it was a smooth, productive and successful transition. Overall, we're very pleased with our financial and operating accomplishments during the quarter.

Going forward, we remain focused on building upon our first quarter performance and continue to bring innovative new products to market. While we'll have a sharp focus on profitability, we will also prioritize reinvestment of any earnings growth in excess of our mid-teens target back into the business in order to drive long-term top line growth.

I'll now turn the call over to Todd, who will provide a more detailed analysis of our financial performance and discuss our 2018 financial guidance.

Todd?.

Thanks, Curt. As mentioned, we reported a solid first quarter with total sales of $202.1 million. This is an increase of 8.3% on a reported basis over the first quarter a year ago. In constant currency and as adjusted for the new revenue accounting standard, ASU 2014-09, our first quarter revenue increased 6.8%.

I'll remind you that starting January 1, 2018, we adopted this new standard. The impact of this change is that roughly $8 million in annual fees that we've paid to GPOs and distributors will be recorded as a reduction of revenue on the income statement in 2018 instead of expense and SG&A where it was last year.

This will have a negative impact on the top line this year relative to 2017, which will be offset by the lower SG&A expense, meaning EBIT is unaffected. I'd also like to remind you that we provided a full quarterly reconciliation of this change on our fourth quarter call and that presentation can still be viewed on our website.

All remaining sales growth numbers I reference today will be given in constant currency and as adjusted for this change. Our domestic sales increased 8.7% driven by solid performances in both General Surgery and Orthopedics. International sales increased 4.7% versus the prior year period.

Worldwide Orthopedics revenue increased 2.3% in the first quarter and was driven by robust growth in capital sales. Domestically, first quarter Orthopedics revenues saw growth in back-to-back quarters for the first time in a long time with revenues up 3.3% versus the prior year period.

Internationally, Orthopedics revenue increased 1.6% year-over-year and an eighth consecutive quarter of growth. Worldwide General Surgery revenue grew 12.5% in the first quarter driven by strong performances across the product portfolio.

Domestically, first quarter General Surgery sales increased to 12.8%, and internationally, General Surgery sales increased 12.1%. Now turning to other components of the income statement. Gross margin for the first quarter was 54.2%, up 50 basis points compared to adjusted gross margin a year ago.

While this was at the low end of the guidance range we provided for the full year, we expect stronger performance in the coming quarters and we continue to expect our full year 2018 adjusted gross margin to improve by 50 to 100 basis points driven principally by cost savings initiatives.

On an adjusted basis, which excludes the impact of amortization, selling and administrative expenses for the first quarter were $80.5 million or 39.9% of total sales compared to 39.7% in the first quarter of 2017. As I mentioned on our last call, we expected SG&A as a percentage of total sales to be higher than prior year ratios early in the year.

And given our outperformance on the bottom line already, we will be increasing investments in this area globally in order to get closer to our customers and provide the necessary infrastructure to drive strong, consistent top line growth longer-term. Research and development expenses for the first quarter were $7.7 million or 3.8% of total sales.

This compares to $7.6 million or 4.1% of total sales reported in the first quarter of 2017. While the start of the year was below our full year guidance range, we anticipate increasing this investment moving forward, and we continue to expect full year 2018 R&D expense in the range of 4.5% to 5% as a percentage of total sales.

Adjusted EBITDA margins in the first quarter of 2018 was 17.1% compared to 16.4% a year ago. Our adjusted EBITDA grew 13.9% over the prior year period, delivering on our commitment of increased profitability. Excluding the impact of tax reform, our non-GAAP effective quarterly tax rate decreased to 15.9% from 32.7% in the prior-year quarter.

In the first quarter, we recognized the benefit of Belgian tax reform, which resulted in a reduction in taxes of $1.8 million and equated to $0.06 of EPS benefit. Without this discreet benefit, our first quarter effective tax rate would have been 25.9%.

So, going forward, we continue to expect our adjusted effective tax rate to be between 25% and 27% each quarter. But for the full year, we now expect it to be between 23% and 25% due to the sizable credit in the first quarter.

First quarter GAAP net income totaled $10.7 million or $0.37 per diluted share compared to a reported net loss of $4.5 million or $0.16 per diluted share a year ago. 2018 first quarter GAAP net income includes $300,000 or $0.01 per share of expense primarily related to the impact of U.S. tax reform on our 2017 inventory balances.

As we previously discussed and as outlined in today's press release, we also excluded cost of other special items including acquisitions, restructurings, legal matters, gains on sales of assets, debt refinancing and amortization of intangible assets net of tax from our calculation of adjusted diluted net earnings per share.

Excluding the impact of these items, our first quarter adjusted diluted net earnings per share were $0.53 versus $0.38 in the prior year period, representing growth of 39.5%. Even excluding the impact of Belgian tax reform, our cash EPS growth would have been 23.7% in the first quarter.

So obviously, this is well above the guidance range that we provided for the full year and it puts us in a strong position of being able to continue to invest in the business where needed.

Looking at the balance sheet, our cash balance as of the end of the first quarter 2018 was $21.1 million compared to $32.6 million as of December 31, 2017 as we paid down debt during the quarter. Accounts receivable days as of March 31, 2018 were 70 days compared to 67 days in the same quarter a year ago.

Inventory days at quarter end were 142, the same as a year ago. Long-term debt at the end of the quarter was $442.4 million versus $471.7 million three months ago. Our leverage ratio at March 31, 2018 was 3.2 times. Cash flow from operations was $25 million in the first quarter of 2018 compared to $15.3 million in the prior year period.

And free cash flow was $21.2 million in Q1 of 2018 compared to $12.7 million in the prior year period. Now moving to our financial guidance. Based on the current business trends, we are increasing our previously issued financial guidance.

We now expect full year 2018 constant currency sales growth in the range of 4.5% to 5.5% compared to our previous guidance range of 4% to 5%. Based on recent exchange rates, we continue to project the positive impact to 2018 sales from foreign exchange to be between 100 and 150 basis points.

We now forecast full year 2018 adjusted diluted net earnings per share in the range of $2.15 to $2.20, compared to our previous guidance range of $2.11 to $2.17. This represents growth over 2017 of approximately 14% to 16%.

The adjusted diluted net earnings per share estimates for 2018 exclude the cost of special items, including acquisition costs and restructuring costs, which are estimated in the range of $3 million to $5 million net of tax, and amortization of intangible assets, which is estimated in the range of $16 million to $18 million net of tax.

So, obviously, the strong start to the year provided us with choices around what to do with the overachievement on sales and the benefit of the Belgian tax reform.

As we discussed on our fourth quarter call, we believe the actions we can take that are most valuable to our shareholders are to provide the increased 14% to 16% cash EPS growth to our shareholders in 2018 and invest the remaining outperformance back into the business to drive strong sustainable top line and profitability growth for future years.

The goal is not to maximize EPS in 2018, but to strengthen the longer-term engine of sustainable, above market revenue and profitability growth. We will continue to focus on improving our R&D pipeline. We will also accelerate efforts to get closer to our customers and strengthen our C-suite sales and contracts group in the U.S.

We are also improving our systems and infrastructure to more efficiently manage and support a growing global business.

Because we expect the quarterly cadence of 2018 to play out differently than prior years, given the discrete tax item in the first quarter and our increased investment later this year, we'd like to provide guidance for the second quarter. We expect second quarter revenue to be between $205.5 million and $208.5 million.

For adjusted cash EPS in the second quarter, we expect approximately 10% growth over the prior year second quarter, and we'll be looking to invest any earnings higher than that amount back into the business. With that, we'd like to open the call to your questions, and I'll turn it back to Jonathan..

Certainly. Our first question comes from the line of Mike Matson from Needham & Company. Your question, please..

Yeah, thanks for taking my questions. I guess I just wanted to start with the commentary around reinvesting upside. Obviously, it's a good position to be in to have some upside to guidance to potentially reinvest.

But this is the first I've really heard you guys kind of talk about that approach and why do you feel – I mean the business has really accelerated. It seems to be performing pretty well.

But I guess why do you feel like you still need additional investment in certain areas?.

Sure. Mike, I'll remind you that when we talked about it last quarter, we thought the company had reached this inflection point where we can now deliver on a sustainable basis mid-single-digit growth in constant currency revenue and double-digit earnings growth, right. So that's the model we're starting with.

We're actually now at this point, on the earnings growth side, in the mid-teens, right, 14% to 16% growth.

And our view is simply that rather than make that a few pennies higher in 2018, it's better to invest those pennies so that 2019 and 2020 are in a stronger position to deliver on the top line, and so that we can continue to deliver the higher profitability numbers on a longer-term basis..

Okay. Thanks. And that kind of leads into my second question. So the EPS guidance is going up by less than the upside in the quarter.

So I mean is that essentially why because you're going to choose to reinvest some of the upside you might have otherwise had?.

That's exactly right..

All right. Thanks a lot..

Thanks, Mike..

Thank you. Our next question comes from the line of Kristen Stewart from Deutsche Bank. Your question, please..

Hi, thanks for taking my question and congratulations on a good quarter..

Thanks, Kristen..

You're welcome. I was wondering if you could just maybe talk to the performance of SurgiQuest in the quarter and just how that's been going. And I know you mentioned that you have the new indication, so maybe just give a little bit more color on what you think that could mean in terms of the growth trajectory of that business..

Sure. We continue to be very pleased with the SurgiQuest acquisition and the AirSeal platform. I would point out General Surgery for us in the quarter and in some previous quarters has continued to strengthen.

And that is inclusive of AirSeal, but it's also inclusive of our legacy portfolio, the ECG electrode business and the endoscopic technologies platform and then the – where the AirSeal platform sits (00:19:24) advanced surgical. All three of those businesses have been strengthening through 2017.

And really everything came together the first quarter here in 2018. So we had really strong General Surgery performance, of which, the AirSeal platform has remained a very important part on a global basis. So we're really encouraged about it, continue to be optimistic about what we can do there.

And I think everybody is aware there's a certain relationship that we have with Intuitive Surgical robotics placement as their volume has remained strong. We've benefited from that. But playing into your second question, the thoracic indication is us continuing to branch this technology out.

We think there's about 100,000 annual thoracic procedures a year that this technology is applicable to. We will not ramp that up rapidly. It'll be a little bit slower walk because it is a newer market for us. But it's just expanding the procedural count.

It's expanding the opportunity to place not only the iFS box but driving the disposables that go with it. So we think it just continues to do what we said we'd do when we closed on the deal which was take this technology into other applications. So we're definitely excited about it, but its part of the long game..

Okay. Great. And then just anything further that you can add from a color perspective on the performance of the Orthopedic business this quarter? It's nice to see that trends are continuing to do well there..

Yeah, I think globally we're happy with the traction we're getting from the new product portfolio and new products are not a one-time event. We had a good 2017 with new products. We had a nice start to the year with the MicroFree launch and a few other products at Academy. Everything takes a little bit of time to ramp up.

But I think the results there go hand in hand with the new product cadence. And as we said earlier in the year in the January call, new products will be a little more backend loaded this year. We see that more of a second, third quarter for Orthopedics and a little bit bigger volume.

But as new products go, those businesses are getting more stability on a global basis and continuing to trend the direction we'd like..

Okay. Perfect. And thanks again..

Thank you. Our next question comes from the line of Richard Newitter from Leerink Partners. Your question please..

Hey, this is Dylan Gantley on for Richard Newitter. Hey, I wanted to follow up again on what Kristen was saying. Can you walk us through the cadence of contribution for those new products and U.S.

ortho this year?.

I think you got to – if I understand your question here, Dylan, the cadence of contribution is strongest from the items that we introduced last year candidly. Because new product contribution takes many quarters to build up. It's a competitive marketplace.

You got to almost wait your turn in line and demonstrate to the clinician first that you've got something that's going to help them with their patients. You then go through the value analysis committee, and it's just a longer process.

So products that we introduced last year are as important as the products we're introducing now are for future periods. Obviously, they all kind of build on each other.

So there's not one or two that I would point to as going to take us to the promised land, it's a continuation of rounding out the portfolio and the offering, and we're excited about what we put out in the market last year. But if you walked the Academy floor this year, we had pretty good attention to the MicroFree platform.

We had very good attention on the Edge portfolio which is our RF ablation technology, it's been up for a couple years. We introduced a new probe specifically for hip applications. We've continued to expand our resection shaver line and see that broadening our offering and the customers' reception to that.

So all these things kind of add up to make the overall business better. Hopefully, that addresses your question..

Yeah, thanks.

So should we think about an acceleration as we model that contribution going through the rest of the year here?.

I'm not sure I'd go to acceleration. I think it's kind of steady state performance with new product cadence on a global basis continuing to influence the results. And remember, some of these are cannibalization of existing products. So it's not just a new dollar for every dollar we sell. There's a bit of a tradeoff of net contribution if you will.

And again it's a little hard to predict the timing of the uptake, some faster than others. MicroFree being a capital item, you're working through capital budget cycles. Edge probes, it's about clinician trial evaluation. So a little hard to predict the overall cadence but the more we have on the new product side, the better results tend to be..

Sure, understandable. Thank you. One last one here, you're increasing the guide only 50 basis points here.

That's a little bit of a slowdown for sales for the rest of the year as comps get easier especially in 2Q and 3Q, are there anything specific you want to call out here?.

No, Dylan, I think, look, we've got a couple of good quarters in a row here. Check back with us when we've got a couple or more..

Sure enough. Thank you very much..

Thank you. Our next question comes from the line of Matt O'Brien from Piper Jaffray.

Your question, please?.

Hi, good afternoon. This is J.P. on for Matt. Thanks for taking the question. I wanted to – to start, just when we look out at the remainder of the year starting with Orthopedic, that segment, that's another second quarter of growth here in the U.S.

At 2.3% organic growth, where should we think about where you can take that? Is that kind of 4% to 5% range? How should we see that kind of ramping throughout the year given how much of that contributes to the top line and how much that can contribute to leverage going forward?.

Look, I think just going back to what we've said really from the time we started the transition, step one is to get each of our business categories back to market growth. Step two is to figure out what rate they should grow for the long term.

And overall, we came into the year saying we were going to be mid-single-digit, 4% to 5% was the guidance, now 4.5% to 5.5%. If you think specifically about Orthopedics, we've got a couple of different categories there. Sports medicine the procedure, Anchor soft tissue pure repair is probably a 5% to 7%, 6% to 8% grower.

The power tools, the video platforms probably grow a little bit slower than that. Resection is probably a 1% to 3% grower. So, if you kind of think about the overall CONMED Orthopedics portfolio, it's probably a mid-single-digits grower on a global basis with some elements of that being higher and some being lower.

So we're just trying to walk it forward with all the new products. And we think as the new products get traction and our customers vote with their purchasing dollars, we should continue to move that growth rate forward. So I'm not going to give specific numbers, but the cadence of new products will dictate how fast that moves forward..

Okay.

But, in general, the delta we saw between 12.5% at General Surgery and then below 2.5% in Orthopedics, that should close throughout the year or is it going to be another year of SurgiQuest and General Surgery really driving the bulk of growth in 2018?.

Well, we feel really good about our General Surgery outlook here. And it is – obviously, AirSeal is an important part of that, but we feel really good about the entirety of that portfolio. So that business has a lot of things working in its favor and Orthopedics has still got a little longer cadence on new products to get out.

But we think they're going to make progress as the year unfolds..

Okay. And then one more for me onto some guidance. I know we've got the EPS and the revenue guidance you put out there, but can we just focus in on EBITDA margins and whether you expect to expand that this year.

And if you would just put out a target for what you think that can get to for the full year of 2018 given the investments and all the tax movements going on here?.

Yeah, and I'm not going to get too prescriptive on that, but we definitely do expect that to get better as we move through the year even with the increased investment. So our EBITDA margins should be, I think, at a minimum kind of high single-digit growth. Let me say that more clearly.

Our EBITDA should be high single-digit growth and you should expect to see EBITDA margins for the year better than they were last year..

Okay, very helpful. Thank you..

Thank you. Our next question comes from the line of Matthew Mishan from KeyBanc.

Your question, please?.

Great, Curt, Todd, thanks for taking the questions..

You bet..

I just wanted to go back to gross margin a little bit and I didn't catch all the moving pieces in the script and I'm sorry if I missed it.

But could you kind of walk through like year-over-year the moving pieces of gross margin and, I guess, why are you not seeing more of a lift kind of with the mix of AirSeal and the volume leverage you should be getting in your facilities from sales growth?.

Yeah, I think we will see more of that in the coming quarters, Matt. As far as the pieces of gross margin, it was really driven by cost improvements. FX and price kind of offset each other this quarter. And so, really, the 50 bps that you're seeing is really from cost improvements and we expect that to only get better as the year progresses..

Okay, got it. And then on R&D and potentially moving some – and reinvesting some dollars in that area, I guess you have a flat 2017 versus 2016. R&D was again flat like first quarter of 2018 versus 1Q 2017.

How ready are you guys to begin to put more dollars towards R&D I guess versus like an investment in sales?.

I think part of the offense here has been to rebuild the marketing teams and the R&D teams. And as the cadence of new products has come out, as the traction in the market of those products has been proven out by the customer purchases, we're happy to make those investments. Part of the challenge of ramping up R&D is finding the right people we want.

We've put a concerted effort on finding more R&D engineers and have been successful with that recently. So we think as the year unfolds, those people get in their chairs and the projects are lined up. We'll see that spend ramp up. So we're ready to make the spend. We've been guiding to a higher spend.

We just haven't had the cadence of people and priorities lined up. And we just feel as we move forward that those things start falling in place..

All right. And then if I can just sneak one last one in, I believe Intuitive Surgical is also working on an indication for thoracic surgery.

Does AirSeal work as well with the Intuitive product as it does with sort of as it does in the abdominal and in other surgeries?.

So our goal with the AirSeal platform is to enable access and call it a form of clinical insufflation where there's benefit to use the AirSeal system for all your insufflation needs and the appendage of the word clinical to that is there for a very specific purpose. Because AirSeal enables lower pressure insufflation.

We're only in class in that regard in addition to smoke evacuation and stable pneumo. So you put all that together and it leads to clinical studies that benefit patient, benefit health care provider and health care system.

And so whether it's Intuitive robots, somebody else's robot, standard laparoscopic procedure, it's all about the system and the clinical insufflation that it brings to the procedure. So I wouldn't say we're sitting around designing with one specific thing in mind beyond clinical insufflation and access to MIS procedures..

All right. Thank you very much..

Thank you. Our next question is a follow-up from the line of Kristen Stewart from Deutsche Bank.

Your question please?.

Hi, thanks for taking the follow-up. I just had a follow-on, on to the R&D question. So you've talked about increasing R&D for a while and I was just wondering and you mentioned you plan on doing it now that you have the people in place.

But can you give us any color in terms of what your priorities are for R&D spending in terms of is it going to Orthopedics, General Surgery or just what are some of the more areas that you can share with us on a more granular basis? Thank you..

Yeah, I would say that obviously orthopedics has been a priority from day one. Given the, what I would call, lack of innovation that had been in the portfolio for a number of years. And there's a lot of work going on there and we'll see that unfold as the year unfolds in front of us.

We'll see those products starting to come into the market again a little bit later in the year. With that said, we're very encouraged by what's going on in General Surgery, and each of those business leaders, there are marketing leaders, there are R&D leaders, are working aggressively on their portfolios as well.

So I don't want to send a message that it's one piece of the business over the other because it really is each business lining up plans and driving their R&D portfolio to best serve the customers that they're calling on and overall serve the needs of the business.

So right now, if I look at the list that's in front of us, it's pretty even split in terms of number of projects. Dollars might be a little more heavily weighted toward to Orthopedics, but the pure number of projects is pretty even between General Surgery and Orthopedics..

Okay. And then just on kind of from the balance sheet perspective, you guys have mentioned, I think, a leverage of 3.2 times.

Where do you see that going? Is that a level that you're comfortable with? Should we consider also some M&A investments to the extent that you get better upside on the top line? Could that be an area of investment as well? Thank you..

Well, that was our first priority for use of cash is strategic M&A, right, Kristen. And it strengthens the portfolio and gives us platforms that we can build around. So that hasn't changed. I think at 3.2 times, I think we're comfortable there.

Obviously, it will come down to the opportunities that are available strategically and I think our second choice would probably continue to be debt pay down. As you know, we do pay a modest dividend but that's probably the priorities..

Okay. Thanks very much. Have a good night..

Thank you..

Thank you..

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Curt Hartman for any further remarks..

Thank you, Jonathan. And thank you everybody for being on the call with us tonight. And we'll look forward to catching up with you again either at upcoming conferences or on our second quarter call. The date will be announced at a point later in the future. Thank you..

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day..