Okay, good afternoon, everyone. My name is Vik Chopra. I'm one of the Medical Device Analysts at Wells Fargo. I am pleased to introduce management from CONMED for this session. Joining us for the company is Todd Garner; EVP and CFO. Todd, thanks very much for being here.
Thanks, Vik. Thanks for having us.
Todd, let's just kick off with a few big-picture questions. You reported Q2 Earnings in July, where you talked about healthy underlying market trends and improving staffing levels, but you also called out inflationary pressures on the material side and supply chains not yet back to normal. Just remind us what's gotten better and what's gotten worse since those comments in Q2?
Yeah. So we're not gonna update Q3 activity, but consistent with what we said in Q2, and we've been saying this all year, you know, 2023 feels like the first normal year since 2019. You know, the market seems to be healthy, which I would define underlying market in kind of the mid-single-digit growth rate. I think we might be even benefiting a little more than that. I do think it's true that there's this tailwind from pent-up procedures during the pandemic, that we're seeing activity, you know, back to doctor's offices, working their way through physical therapy and then surgeons and, you know. So I think we're starting to see a little tailwind from that. But, you know, thankfully, the market seems healthy. It seems stable.
And so that's how we guided the rest of the year, and that's kind of how we see the current environment.
Got it. And then just on your comments on the backlog, you know, is that specific just to your ortho business, I'm assuming? And then how much benefit did you have from backlog in Q2 and expectations for the rest of the year?
Yeah. It definitely is more so in the ortho business, and we know that because when things shut down in Q2 of 2020, our general surgery business reduced by about 30% when you took away, you know, the... what people call elective, but I would say kind of discretionary or, or, delayable procedures. We saw about a 30% reduction on the general surgery side, and we saw about a 50% reduction on the ortho side. So that would tell you that behavior was more impacted on the ortho side of the business, and the general surgery side was more resilient, and people continued to get more of those procedures done. So that logic would say, yes, if there's that pent-up kind of tailwind, would be more pronounced on the ortho side than on the general surgery side.
The second part of your question, Vik, sorry?
Just, can you quantify or do you know-
Oh
What the benefit was from the backlog?
Yeah. I think it's impossible to quantify. You can, you know, everybody's talking about it. I think it's logical that there's this tailwind. I've seen other companies try and, you know, put a number to it. I, I don't know - I don't think you can actually put a precise number on it. You know, when they go through that math, I think what they're doing is taking the incident rate that happened before the pandemic and then look at the procedures that happened during the pandemic and saying: Well, if all those incidents continued to happen... I, I just don't think we know that the incident rate was constant during that period. So for me, the question would be, what is - you know, how much backlog is there? How long does it last?
I think that's impossible to answer, but I do think it's probably fair that we're getting a little help from that tailwind right now.
Got it. You know, we're two months into Q3 now. I'm just wondering, what are some of the potential tailwinds and headwinds that you'd highlight to keep an eye out for the rest of the year?
Yeah, we gave our guidance assuming a continued kind of healthy, stable environment. And, you know, so far, I haven't seen anything that would, that would alter that assumption. There's always the - you know, we've learned over the last few years that geopolitical macro issues can change quickly, and so that would always - that obviously is something to watch out for. But, you know, I think we feel good about 2023, and hopefully, we can keep saying it's the first normal year since 2019. But so far, so good.
Got it. So just on that point, you know, you had pretty impressive 12.6% organic growth in Q2, on the back of 18% organic growth in Q1. You know, you and you also raised guidance in Q2. So how do you view the sustainability of this strength on your top line?
Yeah, I think, you know, Q1 had a lot of noise in it as we came back from our warehouse issue in Q4. I think Q2 is more representative. You know, I think the comps were kind of normal, and we were past the warehouse issue at the end of Q1. So I think Q2 is more representative of what the business is doing. We've talked about we should be a double-digit organic revenue growth company going forward now that we've anniversary, our two acquisitions from 2022. We think that kind of puts us over the, over the top of being consistently and reliably, that double-digit organic growth company, and I think our guidance captures that in the range we gave.
So, you know, that's kind of how we feel about as long as the markets stay stable and healthy, you know, we should be a double-digit organic revenue company going forward.
Okay. Does the strong 1-1 first half comp, the performance in 2023 in the first half, does that create a tough comp for next year?
You know, that's a really good question. For Q2, I don't think so. Q1, like I said, had a lot of noise in it, really strong growth. But yeah, we were catching up on shipping some items that didn't ship in Q4, but we also started the quarter without our full complement of being able to service our customers on our, you know, on our front foot. We were a little bit on our back foot, playing defense a lot, too, and so I think that's an interesting question. So Q1 was noisy. That might turn into a comp issue, but Q2, I don't. I'm not worried about comps overall for 2024.
Okay. So, you know, like I said, we're in September now. I'm sure you're thinking about planning for 2024. I know better than to ask you guidance for 2024, but just how are you thinking about the macro environment in 2024, and how is that impacting your planning process?
You know, for right now, there's no reason to believe that it won't stay healthy and stable. Like I said, you always have your eye on, you know, watching out for macro events that can happen quickly, and they can be negative. But right now, there's no reason to, you know, be overly concerned about that. Right now, I would expect 2024 is a continued healthy macro environment, and med tech continues to do well, and we should do better than our markets. And so, you know, that double-digit organic revenue growth would be our expectation for 2024 at this point.
Two of the large ortho companies at this conference have said that they expect the backlog to last well into 2024. Any reason you think that will change from your perspective?
Yeah, and this is back to where I see them make those comments, and I've heard some more granular comments with, you know, the math behind it. I just don't know that I can subscribe to the math. That would be great. I hope they're right. You know, I just don't know what the magnitude of the pent-up demand is and how long it takes to burn through it, and so I would probably come a little short of talking about that in a, from a magnitude perspective. But there's no reason that... If that's true, and if they're right, we should enjoy that same environment.
Got it. And then just lastly, on 2024, any items that you're aware of running through the PL that you can potentially share with us?
Yeah, I mean, as you said, and you're doing a great job of trying, but we'll talk about 2024 in January. I would say it's interesting right now, the big banks, when they talk about interest expense, and we do have some debts, and some of it is variable. And so, you know, some banks say the rate's gonna come down meaningfully next year. Some say it's gonna go up, so they're kind of all over the place. So that's the thing that I'm kind of interested in, and hopefully, we can get a little better consensus as we move as we're giving guidance for the year.
Got it. I want to switch gears to Buffalo Filter and AirSeal. I'm sure you haven't gotten any questions on this today. So these two products combined grew over 20% in Q2. Do you see these products continuing to growing at that rate over the near term?
Yes. So we've been talking about this for a number of years, that those together. You know, they're different products, of course, but we talk about them together just to kind of map. We don't want to tell the competition exactly how much we're selling in each. But yeah, they've been growing at that level for a long time. We see that continuing for a long time still.
Got it. So listen, potential competition from Intuitive Surgical, it's been a large overhang on your stock recently. You know, I get questions from investors on a weekly basis about this, as I'm sure you do as well. So just tell us why you don't think AirSeal revenues will go to zero if Intuitive Surgical launches their own, insufflation product.
Yeah. So we have enormous respect for Intuitive Surgical. Obviously, the Street does, too, because any inference that they might do anything is having a big impact. What we know, they have actually filed filings that show the device that they're talking about in insufflation. And it's a standard insufflation device, defined as: it has valves that's gonna try and keep the gas in, and it operates, it appears to operate like every other standard insufflation device, which performs its functions sequentially. So it's either insufflating CO2, or it's measuring, or it's removing, and it does things sequentially like every other insufflation device on the market other than AirSeal. AirSeal is very differentiated in that we don't have valves. We use an aerodynamic principle to control the gas.
You can, you can look right down into the trocar and see into the abdomen, so we don't have gas escaping the same way that standard insufflators struggle with. We do all of the functions simultaneously and constantly. We don't turn them on and off and do things sequentially. So the impact of that is every other insufflator on the device in the market has to operate at higher pressures because they're constantly battling the ups and downs of insufflation, and in order to keep that minimum working space acceptable, they have to operate at higher pressures on the high end. Because we have a stable environment with lower pressure, and we don't have to worry about all the things they do, we operate at lower pressures, which is safer for the patient.
We have millions of procedures under our belt and numerous studies that cover 6,000 patients that show half length of stay, 33% less PACU time, less pain management post-surgery. So very differentiated, clinically, superior device. I think what investors are missing is a fairly simple concept. It's been frustrating that I haven't been able to help them better. It's a pretty simple concept that exists in a lot of markets, where the market is segmented into the basic insufflation, and then we are a significantly premium device on the market that is very different than everything else. And case in point, the doctors, when they see those benefits, and they believe in them so much, they pay about three times more for our device than they do for basic insufflation.
From everything we can see that has been filed, and a lot has been filed, the potential device you're talking about is a standard insufflation device. So it would be relevant to compare that to other standard insufflation devices. It is not going to. Doctors that have chosen and value the benefits of AirSeal are not gonna go that far backwards in technology because it comes from a certain vendor. That's not how medical device works in any way, in any place. It's just, it's just faulty. It's a faulty narrative that's been pressed by the shorts in our stock, and right now they're winning the debate, it seems. But we will keep, we'll keep executing, and you will see that AirSeal continues to grow throughout, you know, whatever the competition does and with basic insufflation.
Basic insufflation, standard insufflation, is not a threat to AirSeal.
Got it. That's helpful. So, you know, we've also seen more legislation come online regarding smoke evacuation in the U.S. I think we're up to, like, 14 states now, I believe. So are you seeing more companies entering the market as legislation becomes live?
Not yet, not currently, but we certainly expect that, and we have expected that from the beginning. We bought Buffalo Filter in February 2019. At the time, it was about a $100 million market, and Buffalo Filter, this little company that nobody had ever heard of until we bought them, had half the market. The market has more than doubled in size since we bought them. We continue to have about half the market. It is a. We have significant advantages because of that first-mover advantage. Product leadership 101 in med tech is, as the competition tries to catch up to your product, you continue to move the bar forward so that they're catching up to your old product, and you've got the new, better product. So we will continue to follow that playbook. But we have always known that as...
We expect this to become a multibillion-dollar market when the world protects all nurses from this toxic smoke, which we do expect will eventually happen. It will be. You know, we'll measure the market in billions, not millions, and certainly as that opportunity becomes more attractive and larger, it's going to attract more players, and a lot of the bigger players will want to control their own destiny. So we're well aware of those dynamics and expect to see them eventually. We haven't really seen much change yet. But, you know, given the size of the opportunity here, I'll say two things: There's room for a lot of people to win, and we expect to be one of those winners. And like I said, we expect to maintain about half the market as we grow.
If we come short of that, and we end up with a little less than half the market, it will still be, you know. We could see revenue at CONMED measured in the $ billions in this product line, and then we think that's where we're headed.
Right. And just one more on AirSeal. I know you have a number of patents that are issued and a number that are pending. You know, how important are these patents in limiting competitors' participation in the market?
They're very important because I talked about, like, the valve device, and how every other insufflator on the market kind of does similar function. To really get to the benefits of AirSeal and to perform like AirSeal, you would really need to be valveless. You would really need to figure out the aerodynamic side of things. SurgiQuest, the company we bought in 2016, went through several iterations of how to solve this, patented every single one of them along the way. And so I think it would be very difficult to do anything to solve this problem with an aerodynamic principle that would not infringe on our patents. The patents on the current device go out into the mid- to late 2030s.
I don't believe anybody's going to be able to do anything with that kind of functionality for a very long time against AirSeal. So we're. The moat is wide and filled with crocodiles.
Got it. Let's switch gears to the P&L. You have a target of 60% gross margins by 2025. Just talk about the opportunities to improve gross margin towards that target and what some of these drivers are.
Yeah, the good news is you don't really have to believe me. Between 2019 and 2022, the whole world has seen significant inflationary pressure, right? For us, that calculates to 400 basis points. So between freight and labor and increased material cost, that negatively impacted our gross margin by 400 basis points in that three-year period. If you look at my margins in 2019 or gross margins in 2019 and 2022, you'll see that they're flat. So what that means is we've offset all that inflation with the mix tailwind in the business, and so all we need is the cost to stabilize and settle down. If they were just flat, you would see that tailwind come through, and that's what we expect to start seeing now as we move into the back of 2023.
The other point I would make is that mix benefit is not waning at CONMED. It's actually increasing because our We bought In2Bones in June 2022. We bought Biorez in August 2022. So that, that tailwind in those numbers in that period, that I just gave, those two product lines, which are over 80% gross margin, both of them, they only contributed to the last six months-
Right
Of that math, and they will obviously grow and become a bigger part of the portfolio as we move forward. So we just need cost to settle down, and you'll see dramatic, margin improvement here at CONMED.
Besides the two acquisitions you just highlighted, what are some of the other higher-margin products that would drive mix?
Well, so we talked about AirSeal and Buffalo before. AirSeal's in the low 70s, Buffalo's in the low 60s. So all of those four kind of primary higher growth product lines are all growing above company average and are margins above the company average, and so that's, that's probably the biggest. That probably captures the lion's share of, of the mix benefit.
Got it. And beyond 60% in 2025, I'm assuming - that's, that's, that's not a ceiling for you guys, right?
No, it's certainly not a ceiling. We'll talk about where... You know, we're on our way to 60% gross margin and 20% operating margin. We'll get there, and then we'll talk about, you know, where it goes from there.
Got it. Your capital business was up mid-teens in the first half of the year. Just talk about what trends you're seeing on the capital side.
Yeah, I wouldn't call it anything abnormal. It seems healthy. Our customers are rational. If anything, I think at CONMED, because of our issues with our shipping issues with the warehouse software implementation in the Q4, I think we started the year, like I said, kind of on our back foot, playing a little defense. And so we were -- Our sales force was spending a lot of time trying to just make sure the procedures were covered. So if anything, I think we, because of that self-inflicted wound, we're not able to spend our normal offense time with capital. So I would think, you know, we've probably underperformed on the capital side of the world, you know, so far this year because of that start.
I think as the markets are healthy and as, you know, obviously, the warehouse issue is now behind us, we should move back to offense, and I think, hopefully we see even better capital performance going forward.
It sounds like you're not seeing anything that would sort of give you cause for concern and-
We're not seeing anything in the market that causes concern over capital.
Okay.
Remember, our capital is lower dollar, right?
Right.
I mean, I think our most expensive capital device is probably $40,000.
Right.
We don't have any six-figure or seven-figure capital device.
Got it. Todd, let's talk about leverage. Your leverage at the end of Q2 was 5.1x. What gives you confidence in being able to achieve your targets of below 4.25x by the end of the year?
Yeah, well, our financial forecasting. We're, we do pretty well at, understanding what the business is doing and how that translates to ca- We have a good cash engine, where our cash approximates our earnings. Pretty- we have a pretty good correlation there. Yeah, the- as soon as we, you know, the issue is that that metric is current debt divided by the last 12 months' EBITDA. We still have Q4 of 2022 in that EBITDA part of the formula, which was dramatically lower than normal due to our warehouse issues. When we get to Q4... What we said was, we'll get below 5 turns at the, or 5 times, sorry, at the end of Q3.
Mm-hmm.
We'll be below 4.25 by the end of the year, and that big step down from Q3 to Q4 is really because the Q4 2022 comes out of the math, replaced by Q4 2023, and that's, that's where you see that step function. Then we'll get below 4, obviously, in next year.
I think you said a target of low threes by the end of-
Yeah
- 2024.
Yeah. We'll update that in January, but yeah, we'll be into the threes easily in 2024.
Okay. So Todd, you said earlier that both In2Bones and Biorez have now turned organic for you guys. I know you're focused on lowering leverage, but just comment on your thoughts on potential further M&A in terms of deal size, area of interest, and financial criteria?
Yeah, this is an area that we have never shut off, even during the pandemic, you know? It takes time for deals to marinate. You've gotta be acutely aware of everything that's happening with, you know, technology and studies. And so, that team is very busy and active, as active and busy as they ever are. Having said that, obviously our leverage, you know, we need to digest the last couple of deals, and so it would take something incredibly compelling that we would have to feel strongly about, our board would have to feel strongly about. If it's that compelling, it should make sense to them. But if we're gonna do something in this environment with this leverage, it would have to be pretty compelling.
So I would say the bar is pretty high to get something done before the leverage comes down, but the leverage will be down soon, right?
Right.
We're only, we're only months away from, you know, having something in the threes. But, you know, the leverage number does not dictate activity, right?
Yep.
It dictates ability and options of how you could fund something. We don't – we're not gonna do a deal because, oh, we're at three times leverage, we need... We should go buy something. You know, we're not gonna do that. But we've done this cycle now a few times with both AirSeal and Buffalo, where we were up over five turns. We digested down into the 3s. We did another deal. And so, you know, we're not concerned about it. Hang on for a few more months, and the leverage will be a lot more palatable for folks.
Where do you see the most obvious portfolio gaps, or are you sort of open to another platform like you have with In2Bones in terms of deals?
Yeah, it's for us, it's always about platforms, right? You don't wanna buy single product lines that might have a splash and then kind of slow down. We've done a really good job with all of our acquisitions, that they really have been platforms with legs that grow and. You know, it's. You think about AirSeal, we bought that 7.5 years ago, and it continues to grow, you know, 20% or better 7.5 years later with no signs of slowing down.
Right.
We'll continue to look for things like that. We have a wide field to choose from. General surgery obviously touches a lot of things. There's a lot of adjacent products and procedures that, you know, I think we prefer things kind of close to what we do today, either a market or a call point or a technology that we feel like we're experts at. I don't think you'd see us do something where, you know, we don't have really s- we don't have strength at least two of the three of those.
Right.
There's always good ideas being formed out there in our world, and one of the... You know, there's not a lot of benefits to being small in med tech, but, we're as small as we are. One of them is, you know, if you find something that's $10 million growing to $20, growing to $30 or $40, for us, that moves the needle-
Right
And that's worth our time, whereas a lot of folks we compete against commercially, you know, it's probably not worth much. You know, it's too small for them. So we can move the needle easier than a lot of our competitors can. So, that is one place where I think we have a little bit of an advantage with some of these budding technologies.
Okay, got it. And then just lastly on M&A, just remind us of the financial metrics you evaluate, such as ROIC?
Yeah, we've been consistent, and it's pretty simple. It has to be revenue growth accretive to the business. It has to have some durability to that, right? It can't be a splash and then slows down, so that's where the platform comes in. That's where IP protection comes in. Gross margins is important to us. It has to be accretive to margins, if not on day one, a clear line of sight. You know, Buffalo was like that, right? When we bought Buffalo, it was kind of right at the corporate average gross margin, but quickly became accretive once, you know, once we brought it in-house, and there was some volume help. And so... And then the last thing is, you know, it's gotta be at a value that CONMED shareholders get.
So, you know, that's. I would say a lot of these deals, we never get to the altar because the seller, you know, wants all of the value in the model. Well, but it's CONMED that has to execute, build, you know, realize all that. So there has to be, there has to be some value for CONMED shareholders at the end of the day, and we've, we've stuck to those filters, and we've done a really good job of picking the right things and saying no to things that didn't fit, and I think we'll continue to be consistent. ROIC, clearly double digits, but, you know, it has to be above our weighted average cost of capital, obviously, which is going up currently because of interest rates.
But clearly, it needs to be, you know, double digit ROIC in the, you know, 5+ years kind of metric.
Got it. So, internationally, you guys generate close to half your revenues overseas. Anything you'd call out, specific geographies where you're seeing strength, weaknesses?
You know, not really. Our margins in both Q1 and Q2 were a little lower than we had projected, because everybody had done well, but Latin America and Asia had done a little better, even better in both Q1 and Q2, so that... And they're a little lower margin geographies for us. But, but, you know, I think every, you know, the comments I made about the market and the health and the stability, I think that applies to the globe. So nothing, nothing I'd really call out.
How much is China as a % of your sales?
Oh, it's I think 2%-3% of total revenue.
Okay. And are you seeing any impact from the recently enacted anti-corruption measures there?
No, we're not really seeing anything.
Okay. You know, so just one question for you, on GLP-1s. How big is bariatric surgery for CONMED, and any impact that you've seen from these weight loss drugs?
Yeah, we're not seeing it. So it's impossible for us to actually know because the hospital uses our instruments in lots of procedures. We don't actually get something back that says where it was used, but the sales force gives us, I think, the best information we can have, and our estimate is that maybe 2% of our rev... Something in that neighborhood is related to bariatric issues. You know, we haven't seen. There's nothing that I would call out as a big, you know, alert on that front.
Okay. Just wanted a quick question on your In2Bones acquisitions. Just talk about some of the trends you saw in lower extremities during Q2 and how you feel about your competitive positioning in the market.
Yeah, that business has been just really consistent and exactly like we hoped. You know, when we... They had competed very successfully against Paragon 28, Treace, Wright, which is now Stryker. They - we think that market grows in the high single digits, and they've been growing at least twice the market for a number of years before we got them, before we bought them. Our goal was to not slow them down and not get in their way. We've left them essentially standalone, and they've continued to operate like that, and so, we've been very, very pleased with that now that we're past the year. We have - our, our hope is to be helpful, right? And to give them a little more presence in marketing and trade shows and clinical education, and I think we're doing that. We had a couple of novel products.
We had a small bone power tool called MicroFree Cordless, which is kind of the best on the market, but we didn't really- we don't call a lot on small bone. And then we had a really novel small bone anchor system called TruShot that docs loved. But again, we don't really call on that call point so much. So both of those fit maybe even better into the In2Bones portfolio. So they now - so we still sell it in sports medicine too, but that's probably actually more relevant. And so we've given them some products. We have some biologic products in our partnership with MTF, that In2Bones also now is using. And so, you know, hopefully, we can be helpful and not harmful, and so far we've been able to walk that line, and, and they've done very, very well.
Okay. We've got about 1 minute 20 left in this session. I want to turn the floor over to you. Any sort of last closing comments that you have for the room and for investors online?
No, I mean, Look, I get the respect for Intuitive. We have we work really well with Intuitive. We, they are great at robot, at robotic surgery. They're the best. They're the best because they've been doing it for 30 years, and they've been focused on that. I think they will continue to be the best robotic company. I don't think they want to become an insufflation company. I don't think they're going to become an insufflation company. And, I know, based on what they filed on this first generation, is that it does not compete with AirSeal. The market is segmented into premium and basic. It makes all the sense in the world that they would pursue two-thirds of their procedures using basic. And, you know, they probably made an assessment that that wouldn't be too hard to compete with.
I guarantee you, AirSeal would be very, very hard to compete with. I think they know that. We certainly know that. So I think the concerns over that have been dramatically overblown in the market.
Got it. Thank you so much, Todd.
Thank you, Vik.
Thank you, everyone.