January 29, 2015 CONMED Corporation Current Recommendation NEUTRAL Prior Recommendation Underperform Date of Last Change 11/21/2012 Current Price (01/28/15) $47.14 Target Price $49.00 Earnings Update- Q4 fiscal 2014 SUMMARY (CNMD-NASDAQ) CONMED s fourth-quarter results have failed to impress us. Revenues fell short of the Zacks Consensus Estimate and management trimmed down revenue projection for 2015. CONMED s plans to combine its domestic Advanced Energy and Endomechanical organizations should enable the company to provide enhanced customer focus and achieve better top-line performance. Though the company announced a series of changes to its commercial structure in order to reposition itself for growth, we feel that some of these changes will likely cause sales disruption in the short term. Moreover, volatile foreign exchange is expected to remain a major headwind. Given the mixed signals, we maintain our Neutral recommendation and set a price target of $49.00. SUMMARY DATA 52-Week High $49.65 52-Week Low $36.53 One-Year Return (%) 14.66 Beta 1.43 Average Daily Volume (sh) 168,289 Shares Outstanding (mil) 28 Market Capitalization ($mil) $1,298 Short Interest Ratio (days) 8.42 Institutional Ownership (%) 87 Insider Ownership (%) 4 Annual Cash Dividend $0.80 Dividend Yield (%) 1.70 5-Yr. Historical Growth Rates Sales (%) 1.8 Earnings Per Share (%) 13.2 Dividend (%) 15.1 using TTM EPS 24.4 using 2015 Estimate 25.2 using 2016 Estimate Zacks Rank *: Short Term 1 3 months outlook * Definition / Disclosure on last page N/A 3 - Hold Risk Level * Type of Stock Low, Mid-Blend Industry Med/Dental-Supp Zacks Industry Rank * 117 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 187 A 193 A 179 A 203 A 763 A 2014 182 A 188 A 175 A 195 A 740 A 2015 N/A N/A N/A N/A N/A 2016 N/A N/A N/A N/A N/A Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.45 A $0.43 A $0.40 A $0.53 A $1.81 A 2014 $0.49 A $0.47 A $0.44 A $0.53 A $1.93 A 2015 N/A N/A N/A N/A $1.87 E 2016 N/A N/A N/A N/A N/A Projected EPS Growth - Next 5 Years % N/A 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
RECENT NEWS Fourth Quarter Fiscal 2014 Highlights CONMED Corp reported adjusted earnings of $0.53 per share in the fourth quarter of 2014, which remained flat on a year-over-year basis. While earnings improved on the back of lower operating costs, a lower tax rate and reduced shares outstanding, it was offset by lower sales and gross margin. Net sales in the quarter dipped 4.1% (2.7% on a constant currency basis) to stand at $195 million. Domestic sales, which accounted for 50.7% of total sales, declined 1.8% to $98.9 million. The decline in the U.S. was caused by reduced single-use product revenues, partly offset by higher capital equipment sales. Meanwhile, international sales fell 6.5% (3.8% on a constant currency basis) to $96.1 million, accounting for 49.3% of total sales. The downside can be primarily attributed to foreign exchange headwinds and reduced capital equipment sales. In terms of product category, CONMED generated revenues of $154.7 million and $40.3 million from single-use and capital products, respectively. Both single-use and capital products revenues declined 4.2% and 3.8% from the prior-year quarter, respectively. Revenues from the company s three major product lines also reveal year-over-year declines. Orthopedic Surgery revenues declined 5.6% (or 3.9% in constant currency) to $101.7 million. Meanwhile, revenues from General Surgery were down 1.8% (or 0.9% in constant currency) to $75.4 million. Also, revenues from Surgical Visualization slipped 5.3% (or 3.7% in constant currency) to $17.9 million. However, domestic visualization sales increased 15.8% in the fourth quarter due to the launch of IM-8000 in October last year. Adjusted gross margin contracted 150 basis points (bps) to 54.3%, primarily owing to foreign exchange headwinds, unfavorable product mix and production variances due to inventory reduction. Selling and administrative expenses fell 9.1% to $74.9 million, or 38.4% of net sales, thanks to considerable expense control. On the other hand, research and development expenses climbed 10.4% to $7.1 million, or 3.6% of sales, owing to several product development programs. Adjusted operating margin improved 10 bps to 11.5% driven by lower operating expenses. CONMED exited the year with cash and cash equivalents of $66.3 million, higher than $54.4 million as of Dec 31, 2013. Long-term debt (inclusive of current portion) increased to $241.4 million from $215.6 million as of Dec 31, 2013. Consequently, the long-term-debt-to-capitalization ratio rose 310 bps to 29.3% from 26.2% as of Dec 31, 2013. In 2014, cash flow generated from operating activities was $65.2 million, lower than $80.9 million in 2013. The reduction can be attributed to significant special charges incurred in 2014 and minor increases in working capital. 2015 Outlook CONMED anticipates constant currency sales growth of 1% to 3% for 2015, banking on new product launches and reorganization of certain aspects of the commercial sales organization in early 2015. However, the company has updated its 2015 guidance in order to incorporate the significant volatility in the currency markets witnessed in Jan 2015. Based on currency spot rates as of Jan 23, 2015, Equity Research CNMD Page 2
management expects a negative foreign exchange impact of $19 million to revenues and $0.14 to EPS versus the prior estimates of $6 million and $0.04, respectively. Accordingly, the company now anticipates full-year revenues in the range of $727 $742 million as against the prior range of $740 $755 million. Adjusted earnings are projected in the band of $1.82 $1.92 per share, lower than the earlier guidance of $1.92 $2.02. The current Zacks Consensus Estimate of $1.95 lies above the company s updated guidance range. VALUATION CONMED shares are currently trading at 24.4X TTM earnings, a premium to the peer group average of 24.3X and S&P 500 average of 18.6X. The stock is trading near the high-end of the historical range of 14.8X to 25.8X TTM earnings. Thus, a chance of upside from the current level is limited. The company s price-to-book value ratio in the last quarter was 2.1x, compared to 4.1x for the industry and 5.1x for the S&P 500. Over the last five years, the company s shares have traded in a range of 0.9x to 2.1x of its book value. Currently CONMED s valuations are trading inline with the high-end of its historical range. We maintain our Neutral recommendation and set a target price of $49.00 (26.2X 2015 EPS). Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low CONMED Corporation (CNMD) 25.2 N/A N/A 13.3 24.4 25.8 14.8 Industry Average 23.0 19.6 13.1 51.0 24.3 52.2 18.3 S&P 500 16.2 15.1 10.7 16.1 18.6 19.4 12.0 Align Technology Inc. (ALGN) 27.9 23.4 18.7 32.7 32.6 46.9 18.5 Nobel Biocare Holding AG (NBHGF) 13.0 26.0 35.5 96.1 15.1 Merit Medical Systems, Inc. (MMSI) 20.1 17.0 14.5 10.7 21.5 27.0 14.7 Tornier N.V. (TRNX) N/A N/A 15.0 127.4 N/A N/A N/A TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow CONMED Corporation (CNMD) P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA 2.1 2.1 0.9 9.0 0.4 1.8 14.3 Industry Average 4.1 4.1 4.1-3.3 0.3 0.4 11.0 S&P 500 5.1 9.8 3.2 24.8 N/A 2.0 N/A Equity Research CNMD Page 3
Earnings Surprise and Estimate Revision History NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET Equity Research CNMD Page 4
OVERVIEW Headquartered in Utica, N.Y., CONMED Corp (CNMD) is a major medical products manufacturer specializing in surgical instruments and devices for minimally invasive procedures and monitoring. CONMED has roughly 3,600 employees and several manufacturing facilities. The company reported total revenues of $762.7 million in 2013. Revenues in the nine-month period ended Sep 30, 2014 declined 2.5% year over year to $545.1 million. U.S. revenues accounted for 48.1% of revenues while international revenues approximated 51.9%. A significant portion of the company s revenues are derived from products designed for the orthopedic surgery markets of arthroscopy and powered surgical instruments. The company also sells products for general and other surgical specialties such as electrosurgery systems for all types of surgery, and endosurgery instruments for minimally invasive laparoscopic surgery. Patient Care products, including ECG electrodes for heart monitoring and pulse oximetry for blood oxygenation monitoring, are provided for various clinical settings. CONMED has three product lines, namely, orthopedic surgery (55.2% of revenues in the nine months of 2014), general surgery (37.4%) and surgical visualization (7.4%). The orthopedic surgery product line includes CONMED s sports medicine instrumentation and small bone, large bone and specialty powered surgical instruments and service fees related to the promotion and marketing of sports medicine allograft tissue. General surgery consists of a complete line of endo-mechanical instrumentation for minimally invasive laparoscopic and gastrointestinal procedures, a line of cardiac monitoring products as well as electrosurgical generators and related instruments. The surgical visualization business consists of 2D and 3D video systems for use in minimally invasive orthopedic and general surgery. REASONS TO BUY Approximately 80% of CONMED s revenues are recurring, derived from the sale of disposable singleuse products. Hospitals and clinics are expanding the use of single-use, disposable products, which reduce overheads from sterilizing surgical instruments and products following surgery. Utilizing onetime disposable products also lowers the risk of patient infection and reduces the cost of postoperative care, which is no longer covered by Medicare. The remaining 20% of revenues comes from sales of capital equipment (such as powered drills and saws for surgery, electrosurgical generators, video-imaging cameras, fluid control systems, and surgical hand-pieces), which in turn creates demand for complementary single-use items. CONMED is benefiting from the increasing trend of using minimally invasive techniques as a large percentage of the company s products are designed for these procedures. The use of minimally invasive surgery lowers costs by reducing patient trauma, recovery time and the length of hospitalization. This will act to CONMED s advantage and drive top-line in the long run. CONMED offers a broad line of surgical products. CONMED s product pipeline consists of 8 new devices including 3 new sports medicine products, 3 endomechanical offerings, a new electrosurgical council and a new 2D Arthroscopy video system. With increased product offerings, the company can Equity Research CNMD Page 5
accelerate its dwindling top-line growth. The IM 800 surgical visualization system was moved into full commercial launch in the third quarter of 2014 and is expected to make significant contribution to revenues in 2015. The Edge Ablation system, which received 510(k) clearance from the U.S. Food and Drug Administration (FDA) in third-quarter 2014, is positioned for a full launch in early 2015. We believe that this will also boost revenues going forward. In order to reduce inefficiencies and to contain costs arising out of using multiple suppliers, health care providers are reducing the number of vendors. To enter into contracts with fewer vendors, providers need manufacturers who can offer a broader array of products at lower prices. CONMED benefits from this trend as it can provide multiple products under the same roof. CONMED has the ability to leverage investor return via share repurchase and dividends. The company s board of directors authorized a $200 million share repurchase program in the 2014-first quarter. Through Sep 30, 2014, the company repurchased a total of 6.1 million shares for $162.6 million under this program. The company has $37.4 million remaining under the buyback. Aggressive share buyback will boost earnings as well as shareholders value over the long run. REASONS TO SELL CONMED is subject to reimbursement-related risks. The recently implemented medical device tax in the U.S. is an additional burden on the company s expenses. Lower healthcare spending in the global market is also adversely affecting CONMED s top line. Over 50% of CONMED s sales take place in overseas markets. Sales in major European countries have been affected by governmental spending cuts, which led to soft procedure growth and capital spending. The surgical video visualization product line, consisting primarily of capital equipment, has been affected by the budgetary constraints of the hospitals in Europe as well as other nations. CONMED operates in a highly competitive environment that includes competition from companies like Johnson & Johnson, Medtronic, Smith & Nephew, Stryker Corporation, and others. These organizations may have greater resources and larger research and development budgets compared with CONMED. Furthermore, CONMED lags the larger orthopedic companies in product bundling arrangements, which gives the companies a competitive edge. The orthopedic industry faces severe pricing pressure due to the advent of group purchasing organizations (GPOs) and CONMED is no exception. GPOs act as agents that negotiate vendor contracts on behalf of their members. The current economic scenario has bolstered the bargaining power of the GPOs, thereby putting pressure on the company s top line. Equity Research CNMD Page 6
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of CNMD. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1116 companies covered: Outperform - 15.8%, Neutral - 77.2%, Underperform 6.4%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research CNMD Page 7