The following discussion should be read in conjunction with Selected Financial
Data (Item 6), and our Consolidated Financial Statements and related notes
contained elsewhere in this report.
As part of this reporting structure change, we also restructured our product lines. Orthopedic surgery consists of 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. Surgical visualization consists of 2D and 3D video systems for use in minimally invasive orthopedic and general surgery. These product lines as a percentage of consolidated net sales are as follows:
2011 2012 2013 Orthopedic surgery 51 % 54 % 54 % General surgery 40 37 37 Surgical visualization 9 9 9 Consolidated net sales 100 % 100 % 100 %
A significant amount of our products are used in surgical procedures with approximately 80% of our revenues derived from the sale of disposable products. Our capital equipment offerings also facilitate the ongoing sale of related disposable products and accessories, thus providing us with a recurring revenue stream. We manufacture substantially all of our products in facilities located in
Business Environment and Opportunities
The aging of the worldwide population along with lifestyle changes, continued cost containment pressures on healthcare systems and the desire of clinicians and administrators to use less invasive (or noninvasive) procedures are important trends which are driving the long-term growth in our industry. We believe that with our broad product offering of high quality surgical and patient care products, we can capitalize on this growth for the benefit of the Company and our shareholders.
In order to further our growth prospects, we have historically used strategic business acquisitions and exclusive distribution relationships to continue to diversify our product offerings, increase our market share and realize economies of scale.
We have a variety of research and development initiatives focused in each of our principal product lines as continued innovation and commercialization of new proprietary products and processes are essential elements of our long-term growth strategy. Our reputation as an innovator is exemplified by recent new product introductions such as the Y-Knot® Flex System for instability repairs featuring the smallest double-loaded (1.8mm) anchors available and curved, flexible instrumentation to help
surgeons achieve ideal anchor placement and the Y-Knot® RC anchors for rotator cuffs are the world's only self-punching all-suture anchors which helps simplify techniques while its small size is designed to improve placement options; the new D4000 Resection System featuring an intuitive touchscreen display and direct pump integration for a seamless clinical experience; the IM8000 2DHD Camera System can be used in multi-specialty procedures and includes a new autoclavable camera head featuring proprietary CMOS technology for clear, crisp imagery and a new LS8000 LED light source providing improved light sensitivity for clearer visualization; the new Hall 50™ Powered Instrument System can be used in total joint replacements featuring lighter, ergonomically-designed handpieces to provide a comfortable, high-performance clinical experience while the new Hall UL-approved autoclavable lithium batteries deliver dependable, long-lasting power and the unique, multi-tray system also provides hospitals with new levels of sterilization convenience; the new GS2000 50L Insufflator features the market's fastest flow rate and a dual-tank shuttle valve system to help provide clear and consistent laparoscopic visualization; the EntriPort line of trocars help deliver effective sealing and clear visualization in a wide range of sizes optimal for nearly every minimally invasive abdominal surgical application; our new D-Flex probes were designed for use with the da Vinci® Surgical System and enable non-contact hemostasis with argon gas and our DetachaTip® III Multi-Use Endosurgery Instruments offer the optimal blend of performance and cost efficiency - combining precise, reliable, and comfortable performance with dramatically reduced procedural costs.
Significant volatility in the financial markets and foreign currency exchange rates as well as depressed economic conditions in both domestic and international markets, have presented significant business challenges since the second half of 2008. While we returned to revenue growth in 2010, 2011 and 2012, we experienced a sales decline during 2013. We are cautiously optimistic that the domestic economic environment is improving, however conditions in
Over the past few years we successfully completed certain of our operational restructuring plans whereby we consolidated manufacturing and distribution centers as well as restructured certain of our administrative functions. We continue to restructure both operations and administrative functions as necessary throughout the organization. However, we cannot be certain such activities will be completed in the estimated time period or that planned cost savings will be achieved.
Our facilities are subject to periodic inspection by the
Critical Accounting Policies
Preparation of our financial statements requires us to make estimates and assumptions which affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Consolidated Financial Statements describes the significant accounting policies used in preparation of the Consolidated Financial Statements. The most significant areas involving management judgments and estimates are described below and are considered by management to be critical to understanding the financial condition and results of operations of
Revenue is recognized when title has been transferred to the customer which is at the time of shipment. The following policies apply to our major categories of revenue transactions:
• Sales to customers are evidenced by firm purchase orders. Title and the risks and rewards of ownership are transferred to the customer when product is shipped under our stated shipping terms. Payment by the customer is due under fixed payment terms and collectability is reasonably assured. • We place certain of our capital equipment with customers on a loaned basis in return for commitments to purchase related single-use products over time periods generally ranging from one to three years. In these circumstances, no revenue is recognized upon capital equipment shipment as the equipment is loaned and subject to return if certain minimum single-use purchases are not met. Revenue is recognized upon the sale and shipment of the related single-use products. The cost of the equipment is amortized over its estimated useful life. • We recognize revenues related to the promotion and marketing of sports medicine allograft tissue in accordance with the contractual terms of our agreement with
Musculoskeletal Transplant Foundation("MTF") on a net basis as our role is limited to that of an agent earning a commission or fee. MTF records revenue when the tissue is shipped to the customer. Our services are completed at this time and net revenues for the "Service Fee" for our promotional and marketing efforts are then recognized based on a percentage of the net amounts billed by MTF to its customers. The timing of revenue recognition is determined through review of the net billings made by MTF each month. Our net commission Service Fee is based on the contractual terms of our agreement and is currently 50%. This percentage can vary over the term of the agreement but is contractually determinable. Our Service Fee revenues are recorded net of amortization of the acquired assets, which are being expensed over the expected useful life of 25 years. • Product returns are only accepted at the discretion of the Company and in accordance with our "Returned Goods Policy". Historically the level of product returns has not been significant. We accrue for sales returns, rebates and allowances based upon an analysis of historical customer returns and credits, rebates, discounts and current market conditions. • Our terms of sale to customers generally do not include any obligations to perform future services. Limited warranties are provided for capital equipment sales and provisions for warranty are provided at the time of product sale based upon an analysis of historical data. • Amounts billed to customers related to shipping and handling have been included in net sales. Shipping and handling costs included in selling and administrative expense were $13.0 million, $12.8 millionand $12.6 millionfor 2011, 2012 and 2013, respectively. • We sell to a diversified base of customers around the world and, therefore, believe there is no material concentration of credit risk. • We assess the risk of loss on accounts receivable and adjust the allowance for doubtful accounts based on this risk assessment. Historically, losses on accounts receivable have not been material. Management believes that the allowance for doubtful accounts of $1.4 millionat December 31, 2013is adequate to provide for probable losses resulting from accounts receivable.
We write-off excess and obsolete inventory resulting from the inability to sell our products at prices in excess of current carrying costs. The markets in which we operate are highly competitive, with new products and surgical procedures introduced on an on-going basis. Such marketplace changes may result in our products becoming obsolete. We make estimates regarding the future recoverability of the costs of our products and record a provision for excess and obsolete inventories based on historical experience, expiration of sterilization dates and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write-downs may be required.
Goodwill and Intangible Assets
We have a history of growth through acquisitions. Assets and liabilities of acquired businesses are recorded at their estimated fair values as of the date of acquisition. Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired businesses. Effective
assets created under our
In accordance with FASB guidance, goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to at least annual impairment testing. It is our policy to perform our annual impairment testing in the fourth quarter. The identification and measurement of goodwill impairment involves the estimation of the fair value of our business. Estimates of fair value are based on the best information available as of the date of the assessment, which primarily incorporate management assumptions about expected future cash flows and other valuation techniques. Future cash flows may be affected by changes in industry or market conditions or the rate and extent to which anticipated synergies or cost savings are realized with newly acquired entities. During 2013, we completed our goodwill impairment testing with data as of
During 2011, we estimated the fair value of the legacy CONMED Patient Care reporting unit (refer to Note 8 for discussion regarding the change in operating segments) utilizing both a market-based approach and an income approach. Under the income approach, we utilized a discounted cash flow valuation methodology and measured the goodwill impairment in accordance with ASC 350. The first step of the impairment test determined the carrying value exceeded fair value and therefore we proceeded to Step 2. Under Step 2, we calculated the amount of impairment loss by measuring the amount the carrying value of goodwill exceeded the implied fair value of the goodwill. We determined the goodwill of our legacy CONMED Patient Care reporting unit was impaired as a result of lower future earnings due to pricing pressures in a number of our product lines and consequently we recorded a goodwill impairment charge of
Intangible assets with a finite life are amortized over the estimated useful life of the asset and are evaluated each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization. Intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The carrying amount of an intangible asset subject to amortization is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the asset. An impairment loss is recognized by reducing the carrying amount of the intangible asset to its current fair value.
Customer relationship assets arose principally as a result of the 1997 acquisition of
We evaluate the remaining useful life of our customer relationship intangible assets each reporting period in order to determine whether events and circumstances warrant a revision to the remaining period of amortization. In order to further evaluate the remaining useful life of our customer relationship intangible assets, we perform an analysis and assessment of actual customer attrition and activity as events and circumstances warrant. This assessment includes a comparison of customer activity since the acquisition date and review of customer attrition rates. In the event that our analysis of actual customer attrition rates indicates a level of attrition that is in excess of that which was originally contemplated, we would change the estimated useful life of the related customer relationship asset with the remaining carrying amount amortized prospectively over the revised remaining useful life.
We test our customer relationship assets for recoverability whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Factors specific to our customer relationship assets which might lead to an impairment charge include a significant increase in the annual customer attrition rate or otherwise significant loss of customers, significant decreases in sales or current-period operating or cash flow losses or a projection or forecast of losses. We do not believe that there have been events or changes in circumstances which would indicate the carrying amount of our customer relationship assets might not be recoverable.
For all other indefinite lived intangible assets, we perform a qualitative impairment test in accordance with ASC 350. Based upon this assessment, we have determined that it is unlikely that our indefinite lived intangible assets are impaired.
See Note 4 to the Consolidated Financial Statements for further discussion of goodwill and other intangible assets.
We sponsor a defined benefit pension plan (the "pension plan") that was frozen in 2009. It covered substantially all our
The weighted-average discount rate used to measure pension liabilities and costs is set by reference to the Citigroup Pension Liability Index. However, this index gives only an indication of the appropriate discount rate because the cash flows of the bonds comprising the index do not match precisely the projected benefit payment stream of the plan. For this reason, we also consider the individual characteristics of the plan, such as projected cash flow patterns and payment durations, when setting the discount rate. The rates used in determining 2013 and 2014 pension expense are 3.90% and 4.75%, respectively.
We have used an expected rate of return on pension plan assets of 8.0% for purposes of determining the net periodic pension benefit cost. In determining the expected return on pension plan assets, we consider the relative weighting of plan assets, the historical performance of total plan assets and individual asset classes and economic and other indicators of future performance. In addition, we consult with financial and investment management professionals in developing appropriate targeted rates of return.
Pension expense in 2014 is not expected to be material. Pension expense was
In performing a sensitivity analysis on our pension plan expense, we do not believe a 0.25% increase or decrease in discount rate or investment return would have a material impact on our pension expense.
See Note 9 to the Consolidated Financial Statements for further discussion.
All share-based payments to employees, including grants of employee stock options, restricted stock units, performance share units and stock appreciation rights are recognized in the financial statements based at their fair values. Compensation expense is generally recognized using a straight-line method over the vesting period. Compensation expense for performance share units is recognized using the graded vesting method.
The recorded future tax benefit arising from deductible temporary differences and tax carryforwards is approximately
The Company is subject to taxation in
Consolidated Results of Operations
The following table presents, as a percentage of net sales, certain categories included in our consolidated statements of comprehensive income for the periods indicated:
Year Ended December 31, 2011 2012 2013 Net sales 100.0 % 100.0 % 100.0 % Cost of sales 48.3 47.1 45.9 Gross margin 51.7 52.9 54.1
Selling and administrative expense 38.1 39.4 40.7 Research and development expense 4.0 3.7 3.4 Impairment of goodwill
8.3 - - Medical device excise tax - - 0.8 Other expense 0.2 1.3 1.8 Income from operations 1.1 8.5 7.4 Loss on early extinguishment of debt - - 0.0 Amortization of debt discount 0.5 - - Interest expense 0.9 0.7 0.7
Income (loss) before income taxes (0.3 ) 7.8 6.7 Provision (benefit) for income taxes (0.4 ) 2.5 1.9 Net income
0.1 % 5.3 % 4.8 % 2013 Compared to 2012
Sales for 2013 were
• Orthopedic surgery sales decreased
$413.9 millionin 2012 mainly due to lower sales in our resection product offerings and large bone burs and blades. In local currency, excluding the effects of the hedging program, sales increased 0.1%.
• General surgery sales remained relatively flat with a
increase in 2013 to
$286.7 millionfrom $286.6 millionin 2012 mainly due to increased sales in our endomechanical, gastrointestinal and pulmonary product offerings offset by decreased sales in our advanced energy and patient monitoring product offerings. In local currency, excluding the effects of the hedging program, sales increased 0.5%.
• Surgical visualization sales decreased
$65.8 millionfrom $66.6 millionin 2012 mainly due to lower video system product sales. In local currency, excluding the effects of the hedging program, sales decreased -0.9%.
Cost of sales decreased to
Selling and administrative expense increased to
Research and development expense was
In accordance with the Patient Protection and Affordable Care Act and Health Care and Education Affordability Reconciliation Act, the Company was required in 2013 to begin paying a 2.3% excise tax imposed upon sales within the U.S. of certain medical device products. The medical device excise tax expense totaled
As discussed in Note 11 to the Consolidated Financial Statements, other expense in 2013 consisted of an
As discussed in Note 5 to the Consolidated Financial Statements, we entered into an amended and restated senior credit agreement on
Interest expense was
A provision for income taxes was recorded at an effective rate of 29.0% in 2013 and 31.9% in 2012 as compared to the Federal statutory rate of 35.0%. The effective tax rate is lower than that recorded in the same period a year ago as a result of a greater proportion of earnings in foreign jurisdictions where the corporate tax rate and deduction for notional interest on equity allowed against taxable profits in
2012 Compared to 2011
Sales for 2012 were
• Orthopedic surgery sales increased
$42.7 million(11.5%) in 2012 to $413.9 millionfrom $371.2 millionin 2011 mainly due to the distribution agreement with MTF, increased sales of our procedure specific, large bone burs and blades and small bone handpiece product offerings. In local currency, excluding the effects of the hedging program sales increased 11.4%. • General surgery sales decreased $0.8 million(-0.3%) in 2012 to $286.6 millionfrom $287.4 millionin 2011 mainly due to lower sales in our patient monitoring products and advanced energy products offset by increases in our gastrointestinal and pulmonary products. In local currency, excluding the effects of the hedging program, sales decreased -0.4%. • Surgical visualization sales remained relatively flat, with a $0.1 million(0.2%) increase in 2012 to $66.6 millionfrom $66.5 millionin 2011 due to higher video systems sales. In local currency, excluding the effects of the hedging program, sales increased 0.7% .
Cost of sales increased to
Selling and administrative expense increased to
former distributor for the Nordic region of
Research and development expense was
During 2011, we recorded a
As discussed in Note 11 to the Consolidated Financial Statements, other expense in 2012 consisted of a
Amortization of debt discount was
Interest expense was
A provision for income taxes was recorded at an effective rate of 31.9% in 2012 and -132.6% in 2011 as compared to the Federal statutory rate of 35.0%. Income tax expense recorded in 2012 was higher than recorded in the same period a year ago as a result of increased pre-tax earnings, offset by higher earnings in foreign jurisdictions where the tax rates are lower than the statutory federal rate and tax benefits recorded in 2012 as a result of determinations received from multiple taxing authorities. A reconciliation of
Liquidity and Capital Resources
Our liquidity needs arise primarily from capital investments, working capital requirements and payments on indebtedness under the amended and restated senior credit agreement, described below. We have historically met these liquidity requirements with funds generated from operations and borrowings under our revolving credit facility. In addition, we have historically used term borrowings, including borrowings under the amended and restated senior credit agreement and borrowings under separate loan facilities, in the case of real property purchases, to finance our acquisitions. We also have the ability to raise funds through the sale of stock or we may issue debt through a private placement or public offering. We believe that our cash on hand, cash from operating activities and proceeds from our amended and restated senior credit agreement provide us with sufficient financial resources to meet our anticipated capital requirements and obligations as they come due.
We had total cash on hand at
Operating cash flows
Our net working capital position was
The decrease in cash provided by operating activities is primarily the result of the payments related to the medical device excise tax that became effective
Investing cash flows
Net cash used in investing activities during 2013, consisted primarily of capital expenditures. Capital expenditures were
Financing cash flows
Financing activities in 2013 resulted in a use of cash of
The amended and restated senior credit agreement is collateralized by substantially all of our personal property and assets. The senior credit agreement contains covenants and restrictions which, among other things, require the maintenance of certain financial ratios, and restrict dividend payments and the incurrence of certain indebtedness and other activities, including acquisitions and dispositions. We were in full compliance with these covenants and restrictions as of
We have a mortgage note outstanding in connection with the
Our Board of Directors has authorized a
Management believes that cash flow from operations, including cash and cash equivalents on hand and available borrowing capacity under our amended and restated senior credit agreement, will be adequate to meet our anticipated operating working capital requirements, debt service, funding of capital expenditures and common stock repurchases in the foreseeable future. See "Item 1. Business - Forward Looking Statements."
During 2011, 2012 and 2013, we continued our operational restructuring plan which includes the transfer of additional production lines from manufacturing facilities located in
As part of our ongoing restructuring, the Company discontinued a patient monitoring product offering and incurred
During 2011, 2012 and 2013, we consolidated certain administrative functions throughout the Company and incurred
We have recorded an accrual in current liabilities of
We plan to continue to restructure both operations and administrative functions as necessary throughout the organization. As the restructuring plan progresses, we will incur additional charges, including employee termination and other exit costs. We estimate restructuring costs associated with the
Refer to Note 15 to the Consolidated Financial Statements for further discussions regarding restructuring.
The following table summarizes our contractual obligations for the next five years and thereafter (amounts in thousands) as of
December 31, 2013. Purchase obligations represent purchase orders for goods and services placed in the ordinary course of business. There were no capital lease obligations as of December 31, 2013. Payments Due by Period Less than 1-3 3-5 More than Total 1 Year Years Years 5 Years Long-term debt $ 215,575 $ 1,140 $ 2,573 $ 211,026 $ 836Contingent consideration 50,000 16,667 33,333 - - Purchase obligations 40,130 39,996 134 - -
Operating lease obligations 28,529 6,723 9,926 6,874 5,006 Total contractual obligations
In addition to the above contractual obligations, we are required to make periodic interest payments on our long-term debt obligations (see additional discussion under Item 7A. "Quantitative and Qualitative Disclosures About Market Risk-Interest Rate Risk" and Note 5 to the Consolidated Financial Statements). The above table also does not include unrecognized tax benefits of approximately
We have reserved shares of common stock for issuance to employees and directors under three shareholder-approved share-based compensation plans (the "Plans"). The Plans provide for grants of options, stock appreciation rights ("SARs"), dividend equivalent rights, restricted stock, restricted stock units ("RSUs"), performance share units ("PSUs") and other equity-based and equity-related awards. The exercise price on all outstanding options and SARs is equal to the quoted fair market value of the stock at the date of grant. RSUs and PSUs are valued at the market value of the underlying stock on the date of grant. Stock options, SARs, RSUs and PSUs are non-transferable other than on death and generally become exercisable over a five year period from date of grant. Stock options and SARs expire ten years from date of grant. SARs are only settled in shares of the Company's stock. (See Note 7 to the Consolidated Financial Statements).
New Accounting Pronouncements
See Note 14 to the Consolidated Financial Statements for a discussion of new accounting pronouncements.