CONMED Corporation (NASDAQ:CNMD) Q4 2015 Results Earnings Conference Call January 27, 2016 4:30 PM ET
Curt Hartman - President and CEO
Luke Pomilio - EVP and CFO
Kristen Stewart - Deutsche Bank
Ravi Misra - Leerink Partners
Matthew O'Brien - Piper Jaffray
Mike Matson - Needham & Company
Jeffery Cohen - Ladenburg Thalmann
Matthew Mishan - KeyBanc
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 or charges that are considered by the company to be special or outside of its normal ongoing operations. These adjusting items are specified in the reconciliation in the press release issued this afternoon.
With these required announcements completed, I will turn the call over to Curt Hartman, CONMED's President and Chief Executive Officer, for opening remarks. Mr. Hartman?
Thank you, Karen. Good afternoon and thank you for joining us for CONMED's fourth quarter and fiscal year 2015 earnings call. With me on today's call is Luke Pomilio, CONMED's Executive Vice President and Chief Financial Officer. Today I'll provide a brief overview of the financial and operating highlights for the quarter and fiscal year, then Luke will provide a more detailed analysis of our financial performance. I will then provide an overview of our fiscal 2016 outlook and financial guidance, before opening the call to your questions.
2015 was about change in effecting a turnaround at CONMED and I'm proud of the progress we've made in our transformation efforts. By the end of the year, we reversed the trend of top line deterioration experienced in 2014 and we exited 2015 with two consecutive quarters of constant currency revenue growth. Total company sales for the fourth quarter of 2015 were $191 million a decrease of 2% as reported and an increase of 50 basis points in constant currency over the prior year period.
GAAP diluted earnings per share were $0.28, a decrease of 31.7% versus $0.41 in the fourth quarter of 2014. Adjusted diluted earnings per share for the fourth quarter of 2015 were $0.52 versus $0.53 for the fourth quarter of 2014. With these results, full year 2015 sales of $719.2 million declined 2.8% as reported but increased 30 basis points in constant currency. Full year 2015 GAAP diluted earnings per share were $1.09 compared to $1.16 in 2014, a decline of 6%. On an adjusted basis EPS for 2015 was a $1.68, a decrease of 12.5% versus a $1.92 adjusted earnings per share for the full year of 2014.
Looking at some positives within the quarter and year, our worldwide Orthopedics business, which represented 55% of total sales grew 2.4% as reported and 5.9% on a constant currency basis in the fourth quarter. This marked the second consecutive quarter of constant currency growth. As you may recall prior to third quarter of 2015, this business experienced declines for four quarters in a row. Domestically, our Orthopedic business posted its second consecutive quarter of year-over-year growth after declining in nine of the previous 10 quarters.
Looking at our total international business, the direct markets again performed well in the quarter and in fact recorded growth every quarter on a constant currency basis in 2015 with growth accelerating in the second half of the year. Additionally in the fourth quarter we took an important step to further revitalize our Advanced Surgical business by announcing the acquisition of SurgiQuest and closing the transaction at the beginning of February. We believe the proprietary AirSeal system will become a center piece in our Advanced Surgical product portfolio. We view this as a transformative acquisition for CONMED and for our Advanced Surgical business from a customer, operating, and financial perspective.
Finally, I would note that our domestic advanced surgical business delivered 3.2% growth in 2015, while completing the combination of our Advanced Energy and Endomechanical businesses and securing the SurgiQuest transaction.
Now let me discuss the main challenges we faced during the quarter and the fiscal year. In the international markets we saw continued softness in our export business as a result of continuing macroeconomic headwinds. Overall results here remain consistent with prior quarters with softness continuing in Brazil and the expected pressure in China, which is a smaller market for us. This was offset somewhat by improvements in the Middle East, Africa and Asian export businesses. Clearly international export was a headwind throughout 2015 but we feel our actions to stabilize this business have been appropriate.
Our General Surgery category was down 6% as reported and 4.5% year-over-year on a constant currency basis in the fourth quarter. This decline was largely due to weakness in worldwide endoscopic technologies and critical care and the export market slowdown I previously noted. Finally the worldwide visualization business declined 10.8% as reported and 8.5% on a constant currency basis during the fourth quarter. Overall visualization was negatively impacted by the anniversary of the IM8000 launch in October of last year, reduced export video sales as well as the continued impact from the discontinuation of an OEM video product line during 2015.
However, it's worth noting that visualization did show sequential growth in dollars every quarter in the domestic market and in international market the fourth quarter was our largest dollar quarter of the year. Overall in spite of these challenges we remain confident that we are implementing the right strategies to enable us to show continued progress in 2016 and position CONMED for long term success.
Finally as we look at the year there are several important changes that we believe are critical in the CONMED transformation. None of these are more important than people and during the year we filled the remaining roles in what is now a revamped leadership team. This team brings an intense focused commercial improvement, operational enhancement and quality which is starting to pay dividends. We also aligned our marketing product strategy roadmap to reinvigorate our organic product pipeline, while leveraging our restored business development function to actively pursue acquisitions as evidenced by the four transactions completed in 2015.
In addition gross margin improvement in the second half of the year and lower operating expenses as a result of cost savings initiatives are positive trends we intend to build on. Overall I'm pleased with our momentum as we enter 2016.
I'll now turn the call over to Luke.
Thank you, Curt. As Curt mentioned our total sales for the fourth quarter of 2015 were $191 million, a decrease of 2% on a reported basis and an increase of 0.5% on a constant currency basis, versus the fourth quarter of 2014. For fiscal 2015 our total sales were $719.2 million a decrease of 2.8% on a reported basis and an increase of 0.3% on a constant currency basis over the prior year period. Our top line performance throughout the fourth quarter and fiscal year on a constant currency basis was primarily attributable to improvements in our domestic orthopedic business as well as due to strength in our international direct business.
For the quarter ended December 31, 2015 domestic sales which represented 51.1% of our total reported revenue decreased 0.9% as growth in Orthopedics was offset by declines in General Surgery and visualization. International sales which represented 48.9% of total reported revenue declined 3.2% compared to the fourth quarter of 2014 on a reported basis. Foreign currency exchange rates including the effects of the FX hedging program had a negative impact of $3.9 million on fourth quarter sales. In constant currency international sales increased 2.1% versus the prior year period.
For the fiscal year ended December 31, 2015 domestic sales which represented 50.3% of our total reported revenue increased 0.5% and were driven by increases in capital equipment sales across all three businesses. International sales which represented 49.7% of total reported revenue declined 6% compared to the same period a year ago on a reported basis. Foreign currency exchange rates including the effects of the FX hedging program had a negative impact of $22.9 million on fiscal year sales. In constant currency international sales increased 0.1% versus the prior year period as a result of growth in sales of capital equipment, particularly within Orthopedics, which was offset by weakness within visualization and General Surgery.
I will now review our three product categories with all growth rates stated in constant currency. Worldwide Orthopedic revenue increased $5.9 million in the fourth quarter which was the second consecutive quarter of growth following four quarters of decline. For fiscal year 2015 our worldwide Orthopedic revenue grew 0.7% compared to a 1.3% decline for the previous fiscal year. We are encouraged by these growth trends which validate the changes we continue to implement throughout our commercial organization.
Domestically fourth quarter Orthopedic revenue increased 3.1 year-over-year due to capital equipment sales growth. This marks the second consecutive quarter of year-over-year growth following six quarters of negative growth. Internationally fourth quarter Orthopedic revenue increased 8% year-over-year primarily driven by growth in capital equipment. For fiscal year 2015 international Orthopedics revenue increased 2.6%.
Worldwide General Surgery revenue was down 4.5% for the fourth quarter and down 0.1% from the fiscal year. In the United States, fourth quarter General Surgery sales declined 3%, largely driven by weaker sales in Endoscopic Technologies and critical care. For the fiscal year domestic General Surgery sales were up 1% as Advanced Surgical growth was offset by weakness in Endoscopic Technologies and critical care. We're encouraged by the General Surgery business returning to positive growth on an annual basis particularly the 3.2% growth in Advanced Surgical. Internationally, General Surgery sales were down 7.2% for the fourth quarter and decreased 2.2% for the fiscal year, as we experienced continued weakness especially in our export markets.
Worldwide visualization sales were down 8.5% during the fourth quarter and down 0.1% during the fiscal year. Domestically, fourth quarter visualization sales decreased 8.6% year-over-year primarily due to the impact of the anniversary of the IM8000 launch last year. For the year, domestic visualization sales increased 13.5% over 2014. International visualization sales were down 8.4% compared to fourth quarter of last year and decreased 11.2% compared to fiscal year 2014. The business in direct countries was up 15.6% in the quarter versus the fourth quarter of 2014.
The export visualization business was weak in the fourth quarter declining $1.5 million versus 2014, $700,000 of this decline was related to the discontinuation of an OEM video product line during 2015 which will be behind us in 2016. The total impact in 2015 of this OEM discontinuation was $2.8 million. The remaining weakness in export visualization was due to the IM8000 launch anniversary and a challenging export market.
Now turning to other components of the income statement. GAAP gross margin in the fourth quarter expanded 30 basis points to 53.6% compared to 53.3% a year ago. Adjusted gross margin for the fourth quarter, excluding restructuring costs, expanded 80 basis points to 55.1% compared to 54.3% in the fourth quarter of 2014. The improvement in adjusted gross margin during the fourth quarter was driven by now positive impact from production variances of approximately 200 basis points. This upside was offset by the negative impact of foreign exchange of 120 basis points.
For fiscal year 2015, GAAP gross margin was 53.1% compared to 54.6% a year ago. Adjusted gross margin, excluding restructuring and business acquisition costs was 54.2% compared to 55.4% a year ago. The decrease in gross margin was due to the negative impact in foreign exchange of 140 basis points. Despite starting the year with $5 million of unfavorable deferred variances, production favorability for the year contributed 30 basis points and second half results -- and as favorable second half results offset first half unfavorability. Mix contributed roughly 10 basis points of unfavorability for the year.
On an adjusted basis, selling and administrative expenses for the fourth quarter slightly decreased to $76.3 million or 39.9% of sales, compared to $76.4 million or 39.2% of total sales in the fourth quarter of 2014. For fiscal year 2015, selling and administrative expenses on an adjusted basis were 39.9% of total sales versus 40.5% for the same period in 2014. Research and development expense for the fourth quarter totaled $6.7 million or 3.5% of total sales compared to $7.1 million or 3.6% of total sales a year ago. For fiscal year 2015, our research and development was consistent with the prior year at approximately $27 million or 3.8% of total sales.
Adjusted EBITDA margin in the fourth quarter of 2015 expanded 40 basis points to 18.5% compared to 18.1% a year ago. For fiscal year 2015, adjusted EBITDA margin was 17.4% compared to 18% a year ago. Please see the schedule in today's press release for details on the margin calculations.
Now turning to a discussion of our income tax rate. Our non-GAAP quarterly tax rate increased to 29.9% compared to 29.3% in the fourth quarter of 2014. The tax rate was impacted during the quarter by domestic taxes, net of foreign tax credits associated with the repatriation of foreign earnings to United States which increased tax expense by $1.1 million. The increase of tax rate was offset by tax benefits recorded in the quarter as a result of the expansion of the Federal Research Credit.
For the full year our tax rate was 32.7% compared to 30% a year ago. The tax rate was primarily higher in 2015 as a result of the tax impact associated with the repatriation of foreign earnings to United States. For the fourth quarter of 2015, our diluted earnings per share on a GAAP basis were $0.28, and our adjusted diluted earnings per share were $0.52. For fiscal year 2015, our diluted earnings per share on a GAAP basis were $1.09 and our adjusted diluted earnings per share were $1.68.
Looking at the balance sheet, our cash balance as of the end of the fourth quarter of 2015 was $72.5 million compared to $66.3 million as of December 31, 2014. Accounts receivable days were at 65 days as of December 2015 compared to 64 days a year ago. The inventory balance was at $166.9 million compared to $148.1 million as of December 31, 2014. Inventory days were a 170 versus a 169 as of December 31, 2014. In conjunction with the SurgiQuest acquisition we expanded our credit facility by an additional $250 million. As a reminder our private credit facility consists of a $450 million revolving line of credit, our new credit facility consists of a $175 million term loan and $525 million revolving line for a $700 million commitment in aggregate.
As of December 31, 2015 prior to the closing the SurgiQuest acquisition we had $256 million outstanding on the credit facility. Interest under the new facility is on a pricing grid subject to our leverage ratio. Until November 2016 pricing is fixed at LIBOR plus 200 basis points. As we proceed through 2016 we will have over $200 million of availability under the new credit facility which is sufficient for CONMED's needs.
Turning to cash flow, cash from operating activities totaled $9.3 million for the fourth quarter of 2015 compared to $25.6 million a year ago. The reduction in operating cash flow was due to inventory billed during the quarter. For fiscal 2015 cash from operating activities totaled $48.1 million compared to $65.2 million a year ago.
Before handing the call back over to Curt we'll discuss our fiscal 2016 outlook. I will briefly discuss our change cash EPS reporting and the details of our hedging program. As we have previously stated, beginning in 2016 we will exclude amortization of intangible assets from our adjusted net earnings per share. If amortization of intangible assets were excluded, adjusted diluted cash earnings per share for 2015 would have been a $1.98. For modeling purposes the impact of amortization of intangible assets is spread evenly across the four quarters.
Our currency rates have had a significant impact on our financial results, so I'd like to provide an overview in this area. Approximately half of our sales are outside the U.S. and of these international sales 65% are denominated in local currencies. Accordingly 33% of our sales are subject to foreign currency exposure. The remaining international sales are sold to international distributors with these sales denominated in U.S. dollars. These are the export sales that we have referred to today. For the direct markets 80% of our foreign currency exposure is represented by four currencies; the euro, British pound, Canadian dollar and Australian dollar.
We have a hedging program in place in which we're able to hedge the cash flows from our foreign operations. Under hedge accounting rules we approximate cash flows as our local sales plus local expense. In general we can hedge approximately 35% of our sales exposure and 75% of our earnings exposure to our four primary currencies. Our ability to hedge beyond these levels is limited under hedge accounting rules. As a result of our hedging activities we realized a revenue gain of approximately $3.6 million during the fourth quarter and $12.2 million during the fiscal year.
As you may recall, foreign currency rates changed significantly in January 2015. The top line impact net of hedging gains in 2015 was $23 million. If rates had stayed the same after the January 2015 moves the primary headwind in 2016 would have been the $12 million of hedge gains reported in 2015. Rates have continued to move unfavorable in 2015 especially in Q4. Based on January 25, 2016 exchange rates we are forecasting an additional $9 million to $11 million foreign exchange impact. As of today we have hedged our 2016 exposure. These contracts were entered into in the second and third quarter of fiscal year 2015 and the above $9 million to $11 million impact is net of these hedges.
To be clear our guidance for revenue and earnings per share on a recorded basis already contemplates the impact of foreign exchange, including the gains and future losses associated with our hedging program. Constant currency revenue guidance as always excludes the impact of any hedging activity.
And now I'd like to turn the call back to Curt.
Thank you, Luke. I'll now discuss our 2016 outlook. Before I start I'd like to remind you and point you to our website that in conjunction with today's earning press release we posted a detailed supplemental disclosure on the homepage of the Investors section of our website, at www.conmed.com. We believe this will be helpful in modeling 2016, particularly the impact of the SurgiQuest acquisition.
For 2016 we forecast our reported 2016 sales to be in the range of $760 million to $770 million which represents growth of 6% to 7% over reported 2015 revenue of $719 million. Based on the 2016 revenue of $760 million to $770 million we forecast our 2016 adjusted diluted cash earnings per share to be in the range of a $1.85 to a $1.95, which excludes the cost of special items including acquisition costs and restructuring costs which are estimated to be $18 million to $20 million net of tax.
Our 2016 financial projections factor in a number of headwinds and tailwinds. Beginning with revenue the headwinds are an estimated $21 million to $23 million of currency related impact made up of the previously disclosed $12 million hedge gains recorded in 2015 revenue and an additional $9 million to $11 million of further currency impact, which is based on January 25, 2016 exchange rates and existing hedges. On the revenue side tailwinds include the following, we've modeled the AirSeal system to contribute $55 million to $60 million of initial revenue. We've modeled underlying organic constant currency sales growth of 1% to 3%.
On the earnings side, we've noted that we're moving to adjust with cash EPS and to that end from a modeling standpoint we see the following headwinds as it relates to 2016. The unfavorable currency based on January 25, 2016 spot rates have an impact of $0.41 to $0.43 per diluted share. In terms of earnings tailwinds, we see the following. The favorable impact of not starting the year with $5 million of deferred unfavorable manufacturing variances contribute to $0.11 per diluted share. We pick up $0.30 from moving to adjusted cash EPS on the existing CONMED business. The impact from the organic growth and the SurgiQuest acquisition which we have previously discussed contributing double-digit accretion to earnings on an adjusted cash basis.
These estimates does not include any benefit from the rescindment of the medical device excise tax. We have showed valuating best alternatives with reinvestment the priority. Our anticipated medical device tax for 2016 had been approximately $4.5 million.
We would now like to open the call to your questions.
Thank you. [Operator Instructions] Our first question comes from the line of Kristen Stewart from Deutsche Bank.
Hi, thanks for taking the questions. I was just wondering, I know SurgiQuest here hasn't been closed for that long, I think maybe like moreover 20 days now but any initial observations and maybe you can give us a little bit more background on that and just see the confidence that you will be able to achieve the sales level that you've outlined?
Great question, Kristen. We closed the SurgiQuest transaction on January 4th, and there's really two priorities when you close a transaction, its number one, people and number two, product supply. And on the day of close, we communicated to every individual within SurgiQuest, their status within CONMED. We also brought both selling organizations together, including management of sales, all sales reps and all marketing individuals from both organizations and conducted extensive product training across the entirety of the offering, inclusive of the SurgiQuest bag, inclusive of the CONMED bag. When sales reps went home, they went home into a new defined territory and I'd say over the last couple of weeks the effort has been focused on learning the new geography for the reps that were picking up new customers. It's a lot of meeting and reading and seamless handoff from the CONMED rep or the SurgiQuest rep who may have covered them. So I feel like we've got out of the gates on the right foot, great communication. Really likely every employee at CONMED and SurgiQuest know where they should and I think overall we would say our customer reception has been favorable and it's really about picking up both sides of the offering and making sure we're doing our best to advance that. The guidance we put out there, $55 million to $60 million we think is a responsible number. You look at some of the supplemental information, we show a pretty detailed schedule of what SurgiQuest did last year. We call out that there was some onetime items in their second quarter related to their revenue for international. We also know that they had a really strong fourth quarter, some of that clearly motivated by the announcement of the acquisition. And so we have tried to handicap all of that and give ourselves a solid chance to get to the revenue that we put for guidance. So, how do we get it early, feels very good about where things stand, the leadership that Bill Peters and the sales and marketing team are bringing to that business.
And do you feel that there was any softness in the General Surgery line because that --the announcement of SurgiQuest and maybe pushing that forward to an earlier close?
It would be very hard for me to quantify but we're not a large organization. So all the people that are driving business are the same people that we're working on acquisition and integration plans and I think it's reasonable to assume there were some impact on the focus on the underlying Advanced Surgical business during the run up to the close of that. We got pretty quick Hart-Scott Rodino close or other contractual items that we had detailed that had to be closed and when we got the quick news on Hart-Scott Rodino it just made sense to go really fast to close it as quickly as possible. Though as Luke called out, I think I mentioned, in the quarter the CET business and the cardiology critical care business were both pretty soft and I think that had more to do with the fourth quarter than any big distraction in Advanced Surgical, though there certainly was some.
Thank you. And our next question comes from the line of Richard Newitter from Leerink Partners.
This is actually Ravi in for Rich, can you hear me okay?
We can Ravi.
And maybe if I can start off right there with the question on the Advanced Surgical business, it sounded like the commentary that you gave the business delivered low single-digit growth. Talk a little bit about the puts and takes going on there and I have a follow-up. Thanks.
The Advanced Surgical business in 2015 for the year delivered 3.2% growth and as you recall at the beginning of the year, we made an announcement that we're taking two smaller businesses Endomechanical and Advanced Energy and going to combine those to create smaller geographies and sales professionals who had a bigger offering that would allow them to be more efficient with their accounts and their coverage. And we think that that played out very well. Obviously, during that time we were cross-training people on the half of the bag that they were picking up. We think that the SurgiQuest acquisition is a natural drop-in center of the fairway whatever you want to call it product for that portfolio and as an only-in-class technology, highly innovative offering, we think it'll shine even a brighter light on the broad CONMED Advanced Surgical bag. So I call those kind of all the positive things that we saw in 2015. Obviously, things that potentially were adverse to the effort this year as I mentioned in the previous question, it's still a pretty small management team and at the same time they’re trying to run the business. They are working diligently around the clock on the SurgiQuest transaction, on the SurgiQuest integration planning and really trying to put their arms around that organization and the people within CONMED that were impacted by that change. And so there's only so much bandwidth, but I feel like we really ended the year in good shape and I'm optimistic about how our chances work for Advanced Surgical as we enter 2016.
And maybe a follow up, so switching to guidance. You're continuing calling out softness in Brazil, China. Wondering, how -- when do you see that turning around or what have you factored into that for guidance? Does guidance factor in any upside from this area?
When you look at our 2016 guidance specifically as it relates to export, we did not factor in any material upswing in those markets, specifically in Brazil or in China. Now I would say that as we look at the trend from a dollar standpoint, from a performance year-over-year over a number of year period, we'd like to believe that we kind of hit the bottom of the trough. When I look at our fourth quarter versus our third quarter versus the second quarter and first quarter, we don’t see anything right now that indicates a worsening. Certainly, I think China got a little bit worse for everybody in the fourth quarter. I think I mentioned at the conference earlier this month that China was a pretty small percentage of our overall revenue under 2.5%. And we're exporting portions of China, we're directing other portions, our direct business seems to be doing okay, hanging in there, export business a little bit more up and down. So no material change in guidance and part of this is just macroeconomic and I'm not smart enough to call a change on that.
Thank you. And our next question comes from the line of Matthew O'Brien from Piper Jaffray.
Luke, there's a ton of moving parts here on the EPS line, but as I'm doing some adjustments here from the numbers that you gave us, I'm getting something like $1.78 for  on the bottom line, if we back out FX and then add back the benefit on the manufacturing variances and then SurgiQuest. I mean again I'm using a lot of assumptions, but I am getting to something around 7% organic EPS growth for '16 when I do that. Are my numbers way off and if they are, can you help me and others understand what that organic EPS growth rate looks like here?
Sure can. So the way I look at it is as follows, so we're ending 2015 at $1.60 on an adjusted basis. And we really have two things going on that's going to reset the bar for 2015. So the first is moving the cash EPS and the impact of that on the legacy CONMED business is $0.30. The other item that we have to factor in to reset the bar is FX and that number is $0.41 to $0.43, but if we assume $0.43, the -- now that those two brings us from $1.68 to sort of a new baseline of $1.55. And then I think of sort of the next category is areas where we need to execute in 2016 and that's an aggregate of $0.30 to $0.40 and that gets us to the $1.85 to $1.95. Within the $0.30 to $0.40 is our organic business as well as SurgiQuest and what we are trying to give today is really lay out the components of SurgiQuest in the supplemental, our financial disclosures that let people fill models. But what I will say is that within that $0.30 to $0.40 depending on where you are in the range SurgiQuest provides a substantial amount.
Okay. So again just backing up to follow up there a little bit just if you can help us that 1% to 2% organic growth that you talked about ex-SurgiQuest on the bottom line what does that look like? What number is that roughly with the guidance range that you've given us?
What I would say is it's including the $0.30 to $0.40 and the difficulty that I have is we are expecting something from a major contribution from SurgiQuest. However we have taken the SurgiQuest business and we merged it within to our Advanced Surgical business. So it's really one business now. So we are actually cutting in some places our business, reinvesting on the SurgiQuest side. We are also doing the opposite, getting synergies on SurgiQuest. So I guess what I would do with your modeling is use the guidance that we've provided to come up with your estimate on SurgiQuest and then the differences is really the organic growth.
Thank you. And our next question comes from the line of Mike Matson from Needham & Company.
Hi. Thanks for taking my questions. I guess I was just wondering, if you could maybe give us some additional details around the expectations for our gross margins, SG&A and R&D for 2016? It's a little bit more complicated this year because you got the SurgiQuest in the mix. And then additionally I was wondering, if you could maybe give us some guidance around the amortization and the expense that you expect now that's SurgiQuest is in there?
So let me start with SG&A. So we ended up the year below 40% and that would certainly be the target we would be looking for under normal circumstances in 2016. Unfortunately currency is going to be impacting FX and the FX impacting currency is going to be 80 basis points unfavorable. Going the other way is that we are going to get leverage from SurgiQuest and a leverage we are going to get from SurgiQuest on the SG&A line will push us back below the 40% level. And last, while it's a reporting change from a reporting standpoint going forward with the adjusted cash EPS will get an additional 170 basis points reduction on an adjusted basis. So that's really the puts and takes on SG&A. From gross margin we ended the year on adjusted basis of 54.2% compared to 2014, adjusted up 55.4%. While there is a 120 basis points decline towards 2015 actually a 140 basis points of currency impact, we also had 70 basis points of un-favorability due to the beginning of year differed variances. So excluding those items our gross profit improvement in 2015 was 90 basis points. As we look at 2016 we are going to get back to 70 basis points from the differed variances as we are starting to see certainly they are much more variable. As we have discussed, FX continues to be a problem and the FX impact on 2016 gross profit based on the current FX rate is an additional 140 basis points. And just to be clear this is in addition to the impact realized in 2015 of a 140 basis points. So we are having an aggregate 280 basis points unfavorable FX impact since the beginning of 2015. The last factor that's going to impact our 2016 gross margin is SurgiQuest which will have a slight variable impact on an adjusted basis as the SurgiQuest margins are higher than our corporate averages. From an R&D perspective, R&D amounted to 27.8% in 2015, as we mentioned representing 3.8% of sales, with the SurgiQuest acquisition will be adding $2.8 million to $3.2 million of additional spend. From a percentage standpoint we should be closer to historic levels based on our current R&D budgets. And as Curt mentioned we are considering various alternatives to redeploy the funds freed up from the medical device excise tax expansion and slightly that additional research and development projects will be one of those alternatives. So I'm going to pause there and see if you have any additional questions.
Just on then amortization with the intangibles in there from SurgiQuest deal, what are you expecting on an annualized for intangible after amortization?
Our preliminary number is $8 million but I wanted to caution that's a preliminary number, and we're still completing the valuation.
Thank you. And our next question comes from the line of Jeffery Cohen from Ladenburg Thalmann.
Thanks for taking the questions. Two come to mind. Firstly, can you update us on what we should expect on the balance sheet, cash and debt, on the [Q4] numbers of the $72.5 million and $256 million?
So, as I mentioned we had $256 million as of the end of the year. We acquired SurgiQuest for $265 million and of that purchase price approximately of $42 million was related to cash that we had on our balance sheet.
Okay. And one more, if I may. Do you have any commentary about the filings today about the holdings by Scopia from Coppersmith of the 1.63 million shares?
Sure Jeff, I think the filing is reflective of Scopia. It's a simple business transaction Scopia acquired Coppersmith, Jerome Lande the Principal at Coppersmith is now a high level executive within Scopia. And the shares of Coppersmith were -- that Coppersmith owned in CONMED are now owned by Scopia and Jerome remains a member of our Board of Directors and this was a simple regulatory filing to announce that transaction.
Thank you. And our next question comes from the line of Matthew Mishan from KeyBanc.
Great. Thank you, Curt, Luke, for taking my questions. With the constant currency growth, I was hoping you could give me a sense of the cadence. I think in 2015, you initially thought it was going to be lower in the first half and stronger in the second half. And what is the cadence of the constant currency growth through the course of 2016?
Yes, I think the way to look at cadence for 2016 and I think 2015 is a respectable predicate. The second and the fourth quarter are certainly bigger quarters on an absolute dollar basis. And I think that's a byproduct of the way we structured the U.S. selling effort with commission driven sales force, with target setup on an annualized basis, but also people very motivated to show product at the halfway -- or to show progress at the half way mark. International's a little bit harder to predict because of the export versus direct business and they tend to be more stable throughout the course of the quarters. So I do think, you cannot use the fourth quarter as a predicate on the first quarter and I do think you will see us growing through Q1 into Q2. You always get a little bit of third quarter slowdown and tends to be a bigger fourth quarter and I see no reason to expect different this year. SurgiQuest we have tried to build a responsible model. We know that out of the gate, there's lot of things that have happened in the transaction; cross-training, customer, new customers, new ramps. So we think that has a little bit slower start out of the gate and then builds as the year unfolds for more of a straight line build through the year versus following the normal pattern of Q2, Q4 being bigger. Does that help?
Yes, okay. Yes, that's helpful, thank you. And just to squeeze two more in real quick. First, on the inventory build -- I think Luke mentioned there was an inventory build in the fourth quarter. I was curious what was behind that? And then I didn't quite catch this, as Luke was going through the explanation, what the actual gross margin guidance is for 2016? I just didn't hear it.
Let me take the inventory build, so biggest piece of it was building up some inventory related to the Denver shutdown. So as you may recall that facility made primarily electrosurgical generators for which we have a pretty good business outside the U.S. And as a result in order to give some lead time on registrations, we need to build up some inventory. And as far as gross margins for next year, given all the puts and takes, I think we're going to be trying to get back to 54%, but as I've mentioned there is a lot of moving pieces around.
Thank you. And our next question is a follow up from the line of Kristen Stewart from Deutsche Bank.
Thanks for taking the follow-up. I have two questions. The first was going back to SurgiQuest. Just have you seen or what are your expectations on the pull-through of the commodity laparoscopic products, just having SurgiQuest now with the portfolio?
It's a great question. It's an expectation. It's not an expectation that we built early into the model. It's something that as we look at the business, we think happens in a longer period of time because the focus out of the gate is each side of the transaction CONMED learning the SurgiQuest product portfolio, SurgiQuest learning the CONMED portfolio. There is some time to get everybody comfortable and then moving to that next level we get product pull throughs probably a little bit later in the year. Though we certainly think that something is innovative as the SurgiQuest AirSeal system, when we bring that in and talk with customers, it shines a brighter light on the rest of our portfolio. So that's an absolute expectation. I can't say that I could point anything at three weeks and say that we've seen that, but it's certainly an expectation.
Okay. And then I just wanted to make sure I fully understood. The organic growth of 1% to 3%, what kind of again gives you confidence on that? I understand the kind of stage is set with all of the sales force realignments and everything else, but finishing the year at 0.5%. You do have I guess some level of easier comps, but sounds like international exports will remain soft. And just kind of wondering, why start the year off with 1% to 3%? Why not be a little bit more conservative?
Well I look at a couple of things here. Number one the biggest percentage of our revenue is Orthopedics and we put together what I think is a stronger second half of the year, which bodes well for the future and we did that both in the U.S. as well as in our direct international markets which is two-thirds of the international business. So the biggest piece of our business had a stronger second half than it did a first half and those leaders, those managers, those reps in the direct markets get better with each and every day. I also think the cadence of products is going to help them. Three or the four acquisitions that we completed in 2015, where three of those were product line drop-ins that benefit the Orthopedics business on a global basis. And then there is internal work that continues, products that were introduced last year that will continue to increase and products that we have in the plans for this year that we think should benefit. So the biggest business I think we've got a lot of things lined up correctly to help us move forward there. The next biggest business is the Advanced Surgical portfolio. Again the team has been in place now for a year, we just added -- and they grew 3.2% in the U.S. market. We just added a very exciting acquisition to that portfolio. They had some new products that they were supposed to get in 2015 that are now more geared towards the first half of 2016. So the combination of the experienced leadership team at SurgiQuest and the addition as to new products, so our second biggest business has a lot of momentum. And that leaves our two smaller businesses, Endoscopic Technology is a legacy business, Cardiology critical care, both of those businesses have had full time leaders in place since last January. Both of those leaders have been looking at strategic alternatives for their businesses in terms of product additions, sales force efforts with customers in different manners whether it's through structured programs and I think we will start to realize some of that benefit as this year unfolds. So I put all that together and on the other side I think we spend a lot of time studying the export market and where we think we are with the export market. Just for reference, data point, if export would have been flat in 2015, we would have been in our original growth range. So the volatility in export took us out of the game. Could it happen again, yes, it could happen. But again I've got to look at the facts, the data I have in front of me and right now we think export is going to be stable and so we've modeled 1% to 3% based on everything that we would -- that I've just discussed and then other things we are expecting.
Thank you. And our next question comes from the line of Matthew O'Brien from Piper Jaffray.
Thanks for taking the follow-up question. Just -- I'm trying to make sure I understand SurgiQuest a little bit more. And I haven't had a chance to look through the supplemental information, but what kind of growth rate did that business see in 2015?
The business finished the year -- and this is in the supplemental schedule, we break it out by quarter. The business finished at just over $49 million and I believe the prior year number was around mid-30s. I don’t have that number right in front of me, so don’t hold me to the T, but it was in the mid-30s. So it's a pretty sizeable growth rate but again we point that part of that growth rate in 2015 came from some one-time build up of international distributors that will not repeat. So we've got to back that out. And then we also know that in the fourth quarter they had a pretty substantial run up which we think is a inherent byproduct of highly motivated sales people not having a clear picture on what their future is going to look like until the transaction closes. So we think there is probably some revenue that may not necessarily repeat. So we try to pull those things out and build a responsible model, so we've put the $55 million to $60 million guidance there.
Okay. So if those were not to recur or not to impact you as severely as they potentially could, it feels to me like there could be some considerable upside potentially available with SurgiQuest as a standalone. And then going through your new direct integrated sales force on the pull-through side as well, potentially?
We hope we can have that conversation at some point in the future.
Thank you. And we also have a question from the line of Richard Newitter from Leerink Partners.
Thanks for taking the follow-up. It's Ravi, again. Regarding the double-digit accretion guidance of SurgiQuest, are you referring to that on a percentage basis or on a dollar basis?
It's a percentage. It's -- actually it works both ways percentage and dollar.
All right, thanks.
Thank you. And we have another follow-up from the line of Matthew Mishan from KeyBanc.
I just had a follow-up question on SurgiQuest. Is there a backlog for SurgiQuest coming into the year? And how should I be thinking about the breakdown between capital sales there and recurring sales?
So the business does have both capital and recurring and it's a little bit analogous to CONMED in that the majority of the business north of 70% is recurring. I wouldn’t say that there is a large capital backlog and I think you can look at the supplemental schedule we put out and look at their fourth quarter to support that statement. So it is the capital business. The capital is not placed, it is sold and there is an active pipeline that continues to be worked and we are looking to expand that pipeline. Does that answer your question?
Yes, it does. Thank you.
Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to management for any additional comments.
Okay, thank you Karen. And thank you everyone for your time today. We look forward to speaking with you on our next earnings call, which will be held on April 27th of 2016 and we look forward to getting the year off to a good start. So thank you everybody. Have a good evening.
Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day.
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