NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands except per share amounts)
Note 1 - Operations and Significant Accounting Policies
Organization and operations
CONMED Corporation (“CONMED”, the “Company”, “we” or “us”) is a medical technology company that provides devices and equipment for surgical procedures. The Company’s products are used by surgeons and other healthcare professionals in a variety of specialties including orthopedics, general surgery, gynecology, thoracic surgery and gastroenterology.
Principles of consolidation
The consolidated financial statements include the accounts of CONMED Corporation and its controlled subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments which affect the reported amounts of assets, liabilities, related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. The Company considered COVID-19 related impacts on its estimates, as appropriate, within its consolidated financial statements and there may be changes to those estimates in future periods. The Company believes that the accounting estimates are appropriate after giving consideration to the increased uncertainties surrounding the severity and duration of the COVID-19 pandemic. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may differ from those estimates.
Cash and cash equivalents
We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Inventories
Inventories are valued at the lower of cost and net realizable value determined on the FIFO (first-in, first-out) cost method.
We write-off excess and obsolete inventory resulting from the inability to sell our products at prices in excess of current carrying costs. 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 and expected future trends.
Property, plant and equipment
Property, plant and equipment are stated at cost and depreciated using the straight-line method over the following estimated useful lives:
| | | | | | | | |
| Building and improvements | 12 to 40 years |
| Leasehold improvements | Shorter of life of asset or life of lease |
| Machinery and equipment | 2 to 15 years |
Leases
The Company leases various manufacturing facilities, office facilities and equipment under operating and finance leases. We determine if an arrangement is a lease at inception. Right-of-use ("ROU") assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. We use the implicit rate when readily determinable. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. Certain of our leases include variable lease payments, mainly when a lease is tied to an index rate. These variable lease payments are recorded as expense in the period incurred and are not material.
The Company has lease agreements with lease and non-lease components, which we account for separately. For certain equipment leases, we apply a portfolio approach to efficiently account for the operating lease ROU assets and lease liabilities. We also elected the short-term lease exemption and do not recognize leases with terms less than one year on the balance sheet. The related short-term lease expense is not material.
Our leases have remaining lease terms of one year to 14 years, some of which include options to extend the leases for up to five years, and some of which include options to terminate the leases within one year. We only account for such extensions or early terminations when it is reasonably certain we will exercise such options. Refer to Note 6 for further detail on leases.
The Company places certain of our capital equipment with customers on a loaned basis and at no charge in exchange for commitments to purchase related single-use products over time periods generally ranging from one to three years. Placed equipment is loaned and subject to return if minimum single-use purchases are not met. The Company accounts for these placements as operating leases but applies a practical expedient and does not separate the non-lease and lease components from the combined component. Accordingly, the Company accounts for the combined component as a single performance obligation with revenue recognized upon shipment of the related single use-products. The cost of the equipment is amortized over its estimated useful life which is generally five years.
Goodwill and other 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. Factors that contribute to the recognition of goodwill include synergies expected to increase net sales and profits; acquisition of a talented workforce; cost savings opportunities; the strategic benefit of expanding our presence in core and adjacent markets; and diversifying our product portfolio. Customer and distributor relationships, trademarks, tradenames, developed technology, patents and other intangible assets primarily represent allocations of purchase price to identifiable intangible assets of acquired businesses. Sales representation, marketing and promotional rights represent intangible assets created under our agreement with Musculoskeletal Transplant Foundation (“MTF”).
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. We completed our goodwill impairment testing of our single reporting unit during the fourth quarter of 2022. We performed our impairment test utilizing the market capitalization approach to determine whether the fair value of a reporting unit is less than its carrying amount. Based upon our assessment, the fair value of our reporting unit continues to exceed carrying value.
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.
For all other indefinite-lived intangible assets, we perform a qualitative impairment test. Based upon this assessment, we have determined that our indefinite-lived intangible assets are not impaired.
Other long-lived assets
We review other long-lived assets consisting of property, plant and equipment and field inventory for impairment whenever events or circumstances indicate that such carrying amounts may not be recoverable. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the asset, an impairment loss is recognized by reducing the recorded value to its current fair value.
The Company maintains field inventory consisting of capital equipment for customer demonstration and evaluation purposes. Field inventory is generally not sold to customers but rather continues to be used over its useful life for demonstration, evaluation and loaner purposes. An annual wear and tear provision has been recorded on field inventory. The net book value of such equipment at December 31, 2022 and 2021 is $41.3 million and $42.5 million, respectively.
Contingent consideration
Certain acquisitions involve potential payments of future consideration that is contingent upon the acquired businesses reaching certain performance milestones. The Company records contingent consideration at fair value at the date of acquisition based on the consideration expected to be transferred, estimated as the probability-weighted future cash flows, discounted back to present value. The fair value of contingent consideration is measured using projected payment dates, discount rates, revenue volatilities and projected revenues. Projected revenues are based on the Company’s most recent internal operational budgets and long-range strategic plans. The discount rate used is determined at the time of measurement in accordance with accepted valuation methodologies. Changes in projected revenues, revenue volatilities, discount rates, and projected payment dates may result in adjustments to the fair value measurements. Contingent consideration is remeasured each reporting period using Level 3 inputs, and the change in fair value, including accretion for the passage of time, is recognized as income or expense within operating expense in the consolidated statements of comprehensive income (loss). Contingent consideration payments made soon after the acquisition date are classified as investing activities in the consolidated statements of cash flows. Contingent consideration payments not made soon after the acquisition date that are related to the acquisition date fair value are reported as financing activities in the consolidated statements of cash flows, and amounts paid in excess of the original acquisition date fair value are reported as operating activities in the consolidated statements of cash flows.
Translation of foreign currency financial statements
Assets and liabilities of foreign subsidiaries have been translated into United States dollars at the applicable rates of exchange in effect at the end of the period reported. Revenues and expenses have been translated at the applicable weighted average rates of exchange in effect during the period reported. Translation adjustments are reflected in accumulated other comprehensive loss. Transaction gains and losses are included in net income (loss).
Foreign exchange and hedging activity
We manage our foreign currency transaction risks through the use of forward contracts to hedge forecasted cash flows associated with foreign currency transaction exposures. We account for these forward contracts as cash flow hedges. To the extent these forward contracts meet hedge accounting criteria, changes in their fair value are not included in current earnings but are included in accumulated other comprehensive loss. These changes in fair value will be reclassified into earnings as a component of sales or cost of sales when the forecasted transaction occurs.
We also enter into forward contracts to exchange foreign currencies for United States dollars in order to hedge our currency transaction exposures on intercompany receivables denominated in foreign currencies. These forward contracts settle each month at month-end, at which time we enter into new forward contracts. We have not designated these forward contracts as hedges and have not applied hedge accounting to them. We record these forward contracts at fair value with resulting gains and losses included in selling and administrative expense in the consolidated statements of comprehensive income (loss).
Income taxes
Deferred income tax assets and liabilities are based on the difference between the financial statement and tax basis of assets and liabilities and operating loss and tax credit carryforwards as measured by the enacted tax rates that are anticipated to be in effect in the respective jurisdictions when these differences reverse. The deferred income tax provision generally represents the net change in the assets and liabilities for deferred income taxes. A valuation allowance is established when it is necessary to reduce deferred income tax assets to amounts for which realization is likely. In assessing the need for a valuation
allowance, we estimate future taxable income, considering the feasibility of ongoing tax planning strategies and the realizability of tax loss carryforwards following tax law ordering rules. Valuation allowances related to deferred tax assets may be impacted by changes to tax laws, changes to statutory tax rates, reversal of temporary differences and ongoing and future taxable income levels.
Deferred income taxes are not provided on the unremitted earnings of certain subsidiaries outside of the United States earned after December 31, 2017 as it is expected that these earnings are permanently reinvested. Such earnings may become taxable upon a repatriation of assets from a subsidiary or the sale or liquidation of a subsidiary. Deferred income taxes are provided when the Company no longer considers subsidiary earnings to be permanently invested, such as in situations where the Company’s subsidiaries plan to make future dividend distributions.
Revenue recognition
The Company recognizes revenue when we have satisfied a performance obligation by transferring a promised good or service (that is an asset) to a customer. An asset is transferred when the customer obtains control of that asset. The following policies apply to our major categories of revenue transactions:
•Revenue is recognized when product is shipped at which point the performance obligation is satisfied and the customer obtains control of the product.
•We place certain of our capital equipment with customers on a loaned basis and at no charge in exchange 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 which is generally five years.
•We recognize revenues in accordance with the terms of our agreement with MTF on a net basis as our role is that of an agent earning a commission or fee. MTF is responsible for the sourcing, processing and distribution of allograft tissue for sports medicine procedures while the Company represents, markets and promotes MTF’s sports medicine allograft tissues to customers. The Company is paid a fee by MTF which is calculated as a percentage of the net amounts invoiced by MTF to customers for sports medicine allograft tissues. The Company accounts for the services provided to MTF as a series of distinct performance obligations and each service is recognized over time as MTF simultaneously receives and consumes the benefit.
•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 $21.7 million, $17.0 million and $14.6 million for 2022, 2021 and 2020, 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. We do so by applying historical loss rates to our accounts receivable aging schedule to estimate expected credit losses. We further adjusted expected credit losses for specifically identified and forecasted credit losses. Historically, losses on accounts receivable have not been material. Management believes that the allowance for doubtful accounts is adequate to provide for probable losses resulting from accounts receivable.
•We sell extended warranties to customers that are typically for a period of one to three years. The related revenue is recorded as a contract liability and recognized over the life of the contract on a straight-line basis, which is reflective of our obligation to stand ready to provide repair services.
Please refer to Note 11 for further detail on revenue.
Earnings (loss) per share
Basic earnings (loss) per share (“basic EPS”) is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the reporting period. Diluted earnings (loss) per share (“diluted EPS”) gives effect to all dilutive potential shares. As the Company was in a net loss position for the year ended December 31, 2022, there were no dilutive potential shares included in the computation of diluted shares outstanding. The following table sets forth the computation of basic and diluted earnings (loss) per share at December 31, 2022, 2021 and 2020, respectively:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2022 |
| Basic EPS | | Adjustments | | Diluted EPS |
Net loss | $ | (80,582) | | | — | | | $ | (80,582) | |
| | | | | |
Weighted average shares outstanding | 30,040 | | | — | | | 30,040 | |
| | | | | |
Stock compensation | — | | | — | | | — | |
| | | | | |
Warrants | — | | | — | | | — | |
| | | | | |
Convertible notes | — | | | — | | | — | |
| | | | | |
| 30,040 | | | — | | | 30,040 | |
| | | | | |
EPS | $ | (2.68) | | | | | $ | (2.68) | |
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2021 |
| Basic EPS | | Adjustments | | Diluted EPS |
Net income | $ | 62,542 | | | — | | | $ | 62,542 | |
| | | | | |
Weighted average shares outstanding | 29,162 | | | — | | | 29,162 | |
| | | | | |
Stock compensation | — | | | 1,275 | | | 1,275 | |
| | | | | |
Warrants | — | | | 506 | | | 506 | |
| | | | | |
Convertible notes | — | | | 1,273 | | | 1,273 | |
| | | | | |
| 29,162 | | | 3,054 | | | 32,216 | |
| | | | | |
EPS | $ | 2.14 | | | | | $ | 1.94 | |
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2020 |
| Basic EPS | | Adjustments | | Diluted EPS |
Net income | $ | 9,517 | | | — | | | $ | 9,517 | |
| | | | | |
Weighted average shares outstanding | 28,581 | | | — | | | 28,581 | |
| | | | | |
Stock compensation | — | | | 883 | | | 883 | |
| | | | | |
Warrants | — | | | — | | | — | |
| | | | | |
Convertible notes | — | | | — | | | — | |
| | | | | |
| 28,581 | | | 883 | | | 29,464 | |
| | | | | |
EPS | $ | 0.33 | | | | | $ | 0.32 | |
The shares used in the calculation of diluted EPS exclude stock options to purchase shares and stock appreciation rights where the exercise price was greater than the average market price of common shares for the year and the effect of the inclusion would be anti-dilutive. Such shares aggregated approximately 0.6 million and 1.4 million at December 31, 2021 and 2020, respectively. As the Company was in a net loss position for the year ended December 31, 2022, there were no anti-dilutive shares.
The 2.625% convertible notes due in 2024 (the "2.625% Notes") and 2.250% convertible notes due in 2027 (the "2.250% Notes"), more fully described in Note 8, are convertible under certain circumstances, as defined in the respective indentures for each series of notes, into a combination of cash and CONMED common stock. The following is intended to describe the impact of the 2.625% Notes and 2.250% Notes and related hedge transactions on the calculation of diluted EPS. Additional shares to be issued pursuant to the terms of the Notes and related hedge transactions, if any, would occur at settlement.
Effective with our adoption of ASU 2020-06 on January 1, 2022 (see Note 2), the Company began using the if-converted method to compute diluted EPS. Under the if-converted method, in the calculation of diluted EPS, the numerator is adjusted for interest expense applicable to the convertible notes (net of tax) and the denominator is adjusted to include additional common shares assuming the principal portion of the notes and the conversion premium are settled in common shares, when permitted or required. Under the if-converted method, when convertible notes require the principal to be paid in cash, then only the conversion premium affects the calculation of diluted EPS.
On June 6, 2022, the Company repurchased and extinguished $275.0 million principal value of 2.625% Notes as further discussed in Note 8. Concurrently, the Company entered into a Supplemental Indenture related to the remaining $70.0 million in 2.625% Notes, pursuant to which the Company irrevocably elected to settle the principal value of the 2.625% Notes in cash. Similarly, the 2.250% Notes, issued on June 6, 2022, require the principal to be paid in cash. As a result, in periods in which the Company has net income, only the conversion premium will affect dilutive share count. Accordingly, for periods prior to adoption of ASU 2020-06 on January 1, 2022 and after June 6, 2022, in periods in which the Company has net income, the calculation of diluted EPS includes potential diluted shares upon conversion of the 2.625% Notes and the 2.250% Notes, only when the average market price per share of our common stock for the period is greater than the conversion price and only for the conversion premium, with the principal portion required to be settled in cash.
We have entered into convertible note hedge transactions to increase the effective conversion price of the 2.625% Notes from $88.80 to $114.92. However, our convertible notes hedges are not included when calculating potential dilutive shares since their effect is always anti-dilutive. Concurrent with entering into the hedge transactions, we entered into warrant transactions under which we agreed to sell shares of our common stock at $114.92. In periods in which the company has net income, the calculation of diluted EPS includes potential diluted shares to be issued under the warrants when the average market price per share of our common stock for the period is greater than $114.92, calculated under the treasury stock method.
On June 6, 2022, we entered into convertible notes hedge transactions to increase the effective conversion price of the 2.250% Notes from $145.33 to $251.53. However, our convertible notes hedges are not included when calculating potential
dilutive shares since their effect is always anti-dilutive. Concurrent with entering into the hedge transactions, we entered into warrant transactions under which we agreed to sell shares of our common stock at $251.53. In periods in which the Company has net income, the calculation of diluted EPS includes potential diluted shares to be issued under the warrants when the average market price per share of our common stock for the period is greater than $251.53, calculated under the treasury stock method.
Stock-based compensation
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 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.
We issue shares under our stock based compensation plans out of treasury stock whereby treasury stock is reduced by the weighted average cost of such treasury stock. To the extent there is a difference between the cost of the treasury stock and the exercise price of shares issued under stock based compensation plans, we record gains to paid in capital; losses are recorded to paid in capital to the extent any gain was previously recorded, otherwise the loss is recorded to retained earnings.
Accumulated other comprehensive loss
Accumulated other comprehensive loss consists of the following:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Cash Flow Hedging Gain (Loss) | | Pension Liability | | Foreign Currency Translation Adjustments | | Accumulated Other Comprehensive Loss | |
| | | | | | | | |
Balance, December 31, 2019 | $ | 493 | | | $ | (31,691) | | | $ | (28,079) | | | $ | (59,277) | | |
| | | | | | | | |
Other comprehensive income (loss) before reclassifications, net of tax | (5,393) | | | (7,068) | | | 6,963 | | | (5,498) | | |
Amounts reclassified from accumulated other comprehensive income (loss) before tax(a) | (1,378) | | | 2,821 | | | — | | | 1,443 | | |
Income tax | 333 | | | (682) | | | — | | | (349) | | |
| | | | | | | | |
Net current-period other comprehensive income (loss) | (6,438) | | | (4,929) | | | 6,963 | | | (4,404) | | |
| | | | | | | | |
Balance, December 31, 2020 | $ | (5,945) | | | $ | (36,620) | | | $ | (21,116) | | | $ | (63,681) | | |
| | | | | | | | |
Other comprehensive income (loss) before reclassifications, net of tax | 6,560 | | | 4,426 | | | (7,072) | | | 3,914 | | |
Amounts reclassified from accumulated other comprehensive income (loss) before tax(a) | 4,010 | | | 3,327 | | | — | | | 7,337 | | |
Income tax | (969) | | | (804) | | | — | | | (1,773) | | |
| | | | | | | | |
Net current-period other comprehensive income (loss) | 9,601 | | | 6,949 | | | (7,072) | | | 9,478 | | |
| | | | | | | | |
Balance, December 31, 2021 | $ | 3,656 | | | $ | (29,671) | | | $ | (28,188) | | | $ | (54,203) | | |
| | | | | | | | |
Other comprehensive income (loss) before reclassifications, net of tax | 10,981 | | | 3,961 | | | (8,418) | | | 6,524 | | |
Amounts reclassified from accumulated other comprehensive income (loss) before tax(a) | (16,024) | | | 2,589 | | | — | | | (13,435) | | |
Income tax | 3,884 | | | (628) | | | — | | | 3,256 | | |
| | | | | | | | |
Net current-period other comprehensive income (loss) | (1,159) | | | 5,922 | | | (8,418) | | | (3,655) | | |
| | | | | | | | |
Balance, December 31, 2022 | $ | 2,497 | | | $ | (23,749) | | | $ | (36,606) | | | $ | (57,858) | | |
(a) The cash flow hedging gain (loss) and pension liability accumulated other comprehensive income (loss) components are included in sales or cost of sales and as a component of net periodic pension cost, respectively. Refer to Note 16 and Note 13, respectively, for further details.
Note 2 - New Accounting Pronouncements
Recently Adopted Accounting Standards
In August 2020, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity ("ASU 2020-06"), which simplifies the accounting for convertible instruments by removing certain separation models requiring separate accounting for embedded conversion features which will result in more convertible debt instruments accounted for as a single liability. The ASU eliminates certain settlement conditions that are required for equity classification to qualify for the derivative scope exception. The ASU addresses how convertible instruments are accounted for in the calculation of diluted earnings per share by using the if-converted method. The ASU is effective for fiscal years beginning after December 15, 2021,
with early adoption permitted no earlier than fiscal years beginning after December 15, 2020. The Company adopted this standard on January 1, 2022 using the modified retrospective method. The adoption of this new guidance resulted in:
•an increase of approximately $22.6 million to long-term debt in the consolidated balance sheets, to reflect the full principal amount of the convertible notes then outstanding net of issuance costs (the "2.625% Notes" described more fully in Note 8);
•a reduction of approximately $37.9 million to additional paid-in capital, net of income tax effects, to remove the equity component separately recorded for the conversion features associated with the 2.625% Notes;
•a decrease to deferred income tax liabilities of approximately $5.5 million; and
•a cumulative-effect adjustment of approximately $20.8 million, net of income tax effects, to the beginning balance of retained earnings as of January 1, 2022.
The adoption of this new guidance reduced interest expense related to amortization of debt discount on the 2.625% Notes by approximately $2.6 million during the three months ended March 31, 2022. Additionally, the dilutive share count increased by approximately 2.5 million shares as a result of calculating the impact of dilution from the 2.625% Notes using the if-converted method. During the year ended December 31, 2022, the Company repurchased and extinguished $275.0 million principal value of the 2.625% Notes as further discussed in Note 8. Concurrently, the Company entered into a Supplemental Indenture related to the remaining $70.0 million in 2.625% Notes, pursuant to which the Company irrevocably elected to settle the principal value of those 2.625% Notes in cash. As a result, in periods in which the Company has net income, only the conversion premium will affect the dilutive share count. As the Company was in a net loss position for the year ended December 31, 2022, there were no dilutive potential shares included in the computation of diluted shares outstanding for the year ended December 31, 2022.
Recently Issued Accounting Standards, Not Yet Adopted
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides optional guidance if certain criteria are met for entities that have contracts, hedging relationships, and other transactions that reference LIBOR or other reference rates expected to be discontinued as a result of reference rate reform. This ASU was effective as of March 12, 2020 through December 31, 2022 and was extended through December 31, 2024 by ASU 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848. The Company has not adopted these ASUs as of December 31, 2022. Our seventh amended and restated senior credit agreement includes language to address the change from LIBOR to SOFR, an alternative base rate, therefore we do not believe reference rate reform will have a significant impact on our consolidated financial statements.
Note 3 – Business Acquisitions
On June 13, 2022, we acquired In2Bones Global, Inc. ("In2Bones") and all of its stock (the "In2Bones Acquisition") for an aggregate upfront payment of $145.2 million in cash. In addition, there are potential earn-out payments to In2Bones’ equity holders in an amount up to $110.0 million based on the achievement of certain revenue targets for In2Bones products during the sixteen (16) successive quarters commencing on July 1, 2022. In2Bones is a global developer, manufacturer and distributor of medical devices for the treatment of disorders and injuries of the upper (hand, wrist and elbow) and lower (foot and ankle) extremities. The In2Bones Acquisition was funded through a combination of cash on hand and long-term borrowings as further described in Note 8.
On August 9, 2022, we acquired Biorez, Inc. ("Biorez") and all of its stock (the "Biorez Acquisition") for an aggregate upfront payment of $85.5 million in cash. We paid $83.7 million as of December 31, 2022, with a $1.8 million holdback, pursuant to the merger agreement for the Biorez Acquisition. In addition, there are potential earn-out payments to Biorez’ equity holders in an amount up to $165.0 million based on the achievement of certain revenue targets for Biorez products during the sixteen (16) successive quarters commencing on October 1, 2022. Biorez is a medical device start-up focused on advancing the healing of soft tissue using its proprietary BioBrace® implant technology. The Biorez Acquisition was funded through a combination of cash on hand and long-term borrowings.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as a result of the In2Bones and Biorez Acquisitions that were accounted for as business combinations. The assessment of fair value is based on preliminary valuations and estimates that were available to management at the time the consolidated financial statements were prepared. Accordingly, the allocation of purchase price is preliminary and therefore subject to adjustment during the measurement adjustment period.
| | | | | | | | | | | |
| In2Bones | | Biorez |
| | | |
Cash | $ | 445 | | | $ | 754 | |
Accounts receivable, net | 5,036 | | | 318 | |
Inventories | 24,247 | | | 61 | |
Prepaid expenses and other current assets | 1,490 | | | 118 | |
Current assets | 31,218 | | | 1,251 | |
Goodwill | 139,128 | | | 60,034 | |
Developed technology | 37,300 | | | 176,300 | |
Distributor relationships | 27,600 | | | — | |
Trademarks and tradenames | — | | | 1,600 | |
Other long-term assets | 2,875 | | | 112 | |
Total assets acquired | $ | 238,121 | | | $ | 239,297 | |
| | | |
Current liabilities assumed | 6,332 | | | 1,441 | |
Deferred income taxes | 16,738 | | | 37,801 | |
Other long-term liabilities | 466 | | | — | |
Total liabilities assumed | $ | 23,536 | | | $ | 39,242 | |
Net assets acquired | $ | 214,585 | | | $ | 200,055 | |
The goodwill recorded as part of the In2Bones Acquisition primarily represents revenue synergies, the related cost to enter into this new product offering and the In2Bones assembled workforce. Goodwill is not deductible for tax purposes. In2Bones distributor relationships and developed technology are each being amortized over a weighted average life of 15 years. The fair value of the intangible assets was estimated using an income approach, specifically the multi-period excess earnings method for distributor relationships and the relief-from-royalty method for the developed technology intangible asset.
The goodwill recorded as part of the Biorez Acquisition primarily represents revenue synergies, the related cost to enter into this new product offering and the Biorez assembled workforce. Goodwill is not deductible for tax purposes. Biorez developed technology and trademarks and tradenames are each being amortized over a weighted average life of 20 years. The fair value of the intangible assets was estimated using an income approach, specifically the multi-period excess earnings method for the developed technology intangible asset.
Significant judgment was applied in estimating the fair value of the developed technology and distributor relationships intangible assets acquired, which involved the use of significant estimates and assumptions with respect to the timing and amounts of cash flow projections, including revenue growth rates, obsolescence rate, EBITDA margin, the customer attrition rate, royalty rate and discount rates. EBITDA is defined as earnings before income tax, interest expense, depreciation and amortization.
The contingent consideration of $69.4 million and $114.5 million for In2Bones and Biorez, respectively, was recorded at fair value at the date of acquisition based on the consideration expected to be transferred, estimated as the probability-weighted future cash flows, discounted back to present value. The fair value of contingent consideration is measured using projected payment dates, discount rates, revenue volatilities, and projected revenues. The recurring Level 3 fair value measurements of contingent consideration for which the liability was recorded at the acquisition date include the following significant unobservable inputs:
| | | | | | | | | | | |
| | Assumptions |
Unobservable Input | | In2Bones | Biorez |
| | | |
Discount rate | | 5.67% | 10.34% |
Revenue volatility | | 12.75% | 18.87% |
Projected year of payment | | 2023-2026 | 2023-2026 |
We recorded $23.7 million in net sales for In2Bones since the date of acquisition, June 13, 2022. The net sales were recorded in the consolidated statements of comprehensive income (loss) for the year ended December 31, 2022. Earnings
recorded in the consolidated statements of comprehensive income (loss) for the year ended December 31, 2022 were not material. We also believe the proforma information is immaterial for the years ended December 31, 2022 and 2021.
Net sales and earnings for Biorez were immaterial to the year ended December 31, 2022. We also believe the proforma information is immaterial for the years ended December 31, 2022 and 2021.
During 2022, we recognized $4.5 million in costs for inventory step-up adjustments associated with the In2Bones Acquisition, which are included in cost of sales. During 2022, we recognized $10.1 million in consulting fees, legal fees and other integration related costs associated with the acquisitions of In2Bones and Biorez, which are included in selling and administrative expense.
Note 4 - Inventories
Inventories consist of the following at December 31:
| | | | | | | | | | | |
| 2022 | | 2021 |
Raw materials | $ | 110,677 | | | $ | 83,386 | |
Work in process | 26,166 | | | 17,449 | |
Finished goods | 195,477 | | | 130,809 | |
| $ | 332,320 | | | $ | 231,644 | |
Note 5 - Property, Plant and Equipment
Property, plant and equipment consist of the following at December 31:
| | | | | | | | | | | |
| 2022 | | 2021 |
Land | $ | 4,027 | | | $ | 4,027 | |
Building and improvements | 97,214 | | | 95,518 | |
Machinery and equipment | 269,745 | | | 256,478 | |
Construction in progress | 22,161 | | | 16,601 | |
| 393,147 | | | 372,624 | |
Less: Accumulated depreciation | (277,536) | | | (263,761) | |
| $ | 115,611 | | | $ | 108,863 | |
Internal-use software, included in gross machinery and equipment at December 31, 2022 and 2021 was $49.4 million and $49.1 million, respectively, with related accumulated depreciation of $45.7 million and $45.3 million, respectively. Internal use software depreciation expense was $2.1 million, $3.3 million and $4.7 million for the years ended December 31, 2022, 2021 and 2020, respectively. Also, during 2020, we sold a vacant facility for $3.2 million.
Note 6 - Leases
Lease costs for the years ended December 31, consist of the following:
| | | | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 | | |
Operating lease cost: | | | | | | | |
Straight-line lease cost | $ | 7,685 | | | $ | 7,720 | | | $ | 7,255 | | | |
| | | | | | | |
Total operating lease cost | 7,685 | | | 7,720 | | | 7,255 | | | |
Finance lease cost: | | | | | | | |
Depreciation | 396 | | | 389 | | | 355 | | | |
Interest on lease liabilities | 17 | | | 30 | | | 33 | | | |
Total finance lease cost | 413 | | | 419 | | | 388 | | | |
Total lease cost | $ | 8,098 | | | $ | 8,139 | | | $ | 7,643 | | | |
Supplemental balance sheet information related to leases as of December 31, is as follows:
| | | | | | | | | | | |
| 2022 | | 2021 |
Operating leases | | | |
Other assets | $ | 17,710 | | | $ | 19,425 | |
| | | |
Other current liabilities | $ | 6,919 | | | $ | 7,162 | |
Other long-term liabilities | 11,759 | | | 12,726 | |
Total operating lease liabilities | $ | 18,678 | | | $ | 19,888 | |
| | | |
Finance leases | | | |
Property, plant and equipment, gross | $ | 1,924 | | | $ | 1,984 | |
Accumulated depreciation | (1,510) | | | (1,145) | |
Property, plant and equipment, net | $ | 414 | | | $ | 839 | |
| | | |
Current portion of long-term debt | $ | 178 | | | $ | 324 | |
Long-term debt | 52 | | | 240 | |
Total finance lease liabilities | $ | 230 | | | $ | 564 | |
| | | |
| | | |
Weighted average remaining lease term (in years) | | | |
Operating leases | 5.17 years | | 3.90 years |
Finance leases | 1.92 years | | 3.05 years |
| | | |
Weighted average discount rate | | | |
Operating leases | 5.39 | % | | 5.02 | % |
Finance leases | 4.54 | % | | 4.47 | % |
Supplemental cash flow information related to leases for the years ended December 31, was as follows:
| | | | | | | | | | | | | | | | | | | |
| | | 2022 | | 2021 | | 2020 |
| | | | | | | |
Cash paid for amounts included in the measurement of lease liabilities: | | | | | | | |
Operating cash flows from operating leases | | | $ | 7,383 | | | $ | 7,791 | | | $ | 7,535 | |
Financing cash flows from finance leases | | | 313 | | | 287 | | | 373 |
| | | | | | | |
Right-of-use assets obtained in exchange for lease obligations: | | | | | | | |
Operating leases | | | 5,167 | | | 4,704 | | | 4,242 | |
Finance leases | | | — | | | 305 | | | 76 | |
Maturities of lease liabilities as of December 31, 2022 are as follows:
| | | | | | | | | | | |
| Finance Lease | | Operating Lease |
| | | |
2023 | $ | 178 | | | $ | 6,919 | |
2024 | 34 | | | 5,417 | |
2025 | 14 | | | 2,408 | |
2026 | 12 | | | 1,394 | |
2027 | 2 | | | 1,138 | |
Thereafter | — | | | 4,272 | |
Total lease payments | 240 | | | 21,548 | |
| | | |
Less imputed interest | (10) | | | (2,870) | |
| | | |
Total lease liabilities | $ | 230 | | | $ | 18,678 | |
As of December 31, 2022, we have not entered into any operating or finance leases that have not yet commenced.
Note 7 – Goodwill and Other Intangible Assets
The changes in the net carrying amount of goodwill for the years ended December 31, are as follows:
| | | | | | | | | | | |
| 2022 | | 2021 |
Balance as of January 1, | $ | 617,528 | | | $ | 618,440 | |
| | | |
| | | |
| | | |
Goodwill resulting from business combinations | 199,162 | | | — | |
| | | |
Foreign currency translation | (1,261) | | | (912) | |
| | | |
Balance as of December 31, | $ | 815,429 | | | $ | 617,528 | |
During 2022, the Company acquired In2Bones Global, Inc. and Biorez, Inc. as further described in Note 3. Goodwill resulting from the In2Bones Acquisition amounted to $139.1 million and acquired intangible assets including distributor relationships and developed technology amounted to $64.9 million. Goodwill resulting from the Biorez Acquisition amounted to $60.0 million and acquired intangible assets including developed technology and trademarks and tradenames amounted to $177.9 million.
Total accumulated goodwill impairment losses aggregated $107.0 million at December 31, 2022 and 2021, respectively.
Other intangible assets consist of the following:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 | | December 31, 2021 |
| Weighted Average Amortization Period (Years) | Gross Carrying Amount | | Accumulated Amortization | | Gross Carrying Amount | | Accumulated Amortization |
Intangible assets with definite lives: | 22 | | | | | | | |
| | | | | | | | |
Customer and distributor relationships | 24 | $ | 369,854 | | | $ | (170,870) | | | $ | 342,452 | | | $ | (152,934) | |
| | | | | | | | |
Sales representation, marketing and promotional rights | 25 | 149,376 | | | (66,000) | | | 149,376 | | | (60,000) | |
| | | | | | | | |
Patents and other intangible assets | 16 | 79,838 | | | (52,472) | | | 76,392 | | | (50,890) | |
| | | | | | | | |
Developed technology | 18 | 320,204 | | | (34,675) | | | 106,604 | | | (26,495) | |
| | | | | | | | |
Intangible assets with indefinite lives: | | | | | | | | |
| | | | | | | | |
Trademarks and tradenames | | 86,544 | | | — | | | 86,544 | | | — | |
| | | | | | | | |
| | $ | 1,005,816 | | | $ | (324,017) | | | $ | 761,368 | | | $ | (290,319) | |
Amortization expense related to intangible assets which are subject to amortization totaled $33.7 million, $33.3 million and $34.2 million for the years ending December 31, 2022, 2021 and 2020, respectively, and is included as a reduction of revenue (for amortization related to our sales representation, marketing and promotional rights) and in selling and administrative expense (for all other intangible assets) in the consolidated statements of comprehensive income (loss).
The estimated amortization expense related to intangible assets at December 31, 2022 and for each of the five succeeding years is as follows:
| | | | | | | | | | | | | | | | | |
| Amortization included in expense | | Amortization recorded as a reduction of revenue | | Total |
2023 | $ | 29,351 | | | $ | 6,000 | | | $ | 35,351 | |
2024 | 29,059 | | | 6,000 | | | 35,059 | |
2025 | 29,551 | | | 6,000 | | | 35,551 | |
2026 | 29,308 | | | 6,000 | | | 35,308 | |
2027 | 30,347 | | | 6,000 | | | 36,347 | |
Note 8 - Long Term Debt
Long-term debt consists of the following at December 31:
| | | | | | | | | | | |
| 2022 | | 2021 |
Revolving line of credit | $ | 70,000 | | | $ | 140,000 | |
Term loan, net of deferred debt issuance costs of $729 and $1,373 in 2022 and 2021, respectively | 133,858 | | | 226,196 | |
2.625% convertible notes, net of deferred debt issuance costs of $432 and $3,700 in 2022 and 2021, respectively, and unamortized discount of $23,404 in 2021 | 69,568 | | | 317,896 | |
2.250% convertible notes, net of deferred debt issuance costs of $18,834 in 2022 | 781,166 | | | — | |
Financing leases | 230 | | | 564 | |
Total debt | 1,054,822 | | | 684,656 | |
Less: Current portion | 69,746 | | | 12,249 | |
Total long-term debt | $ | 985,076 | | | $ | 672,407 | |
Seventh Amended and Restated Senior Credit Agreement
On July 16, 2021, we entered into a seventh amended and restated senior credit agreement consisting of: (a) a $233.5 million term loan facility and (b) a $585.0 million revolving credit facility. The revolving credit facility will terminate and the loans outstanding under the term loan facility will expire on July 16, 2026. The term loan was payable in quarterly installments increasing over the term of the facility. During 2022, we made a $90.0 million prepayment on the term loan facility resulting in the elimination of such quarterly payments with the remaining balance due upon the expiration of the term loan facility. The $90.0 million prepayment was accounted for as an extinguishment and resulted in a write-off to other expense of unamortized debt issuance costs of $0.5 million. Proceeds from the term loan facility and borrowings under the revolving credit facility were used to repay the then existing senior credit agreement. During 2021, we recorded $1.1 million to other expense related to the loss on the early extinguishment and third-party fees associated with the seventh amended and restated credit agreement. Interest rates are at SOFR (4.323% at December 31, 2022) plus an interest rate margin of 1.125% (5.448% at December 31, 2022). For borrowings where we elect to use the alternate base rate, the initial base rate is the greatest of (i) the Prime Rate, (ii) the Federal Funds Rate plus 0.500% or (iii) the one-month Adjusted SOFR rate plus 1.000%, plus, in each case, an interest rate margin.
There were $134.6 million in borrowings outstanding on the term loan facility as of December 31, 2022. There were $70.0 million in borrowings outstanding under the revolving credit facility as of December 31, 2022. Our available borrowings on the revolving credit facility at December 31, 2022 were $513.2 million with approximately $1.8 million of the facility set aside for outstanding letters of credit. The carrying amounts of the term loan and revolving credit facility approximate fair value.
The seventh amended and restated senior credit agreement is collateralized by substantially all of our personal property and assets. The seventh amended and restated 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 December 31, 2022. We are also required, under certain circumstances, to make mandatory prepayments from net cash proceeds from any issuance of equity and asset sales.
2.625% Convertible Notes
On January 29, 2019, we issued $345.0 million aggregate principal amount of 2.625% convertible notes due in 2024. Interest is payable semi-annually in arrears on February 1 and August 1 of each year, commencing August 1, 2019. The 2.625% Notes will mature on February 1, 2024, unless earlier repurchased or converted. The 2.625% Notes represent subordinated unsecured obligations and are convertible under certain circumstances, as defined in the indenture, into a combination of cash and CONMED common stock. The 2.625% Notes may be converted at an initial conversion rate of 11.2608 shares of our common stock per $1,000 principal amount of 2.625% Notes (equivalent to an initial conversion price of approximately $88.80 per share of common stock). Holders of the 2.625% Notes may convert the 2.625% Notes at their option at any time on or after November 1, 2023 through the second scheduled trading day preceding the maturity date. Holders of the 2.625% Notes will also have the right to convert the 2.625% Notes prior to November 1, 2023, but only upon the occurrence of specified events. The conversion rate is subject to anti-dilution adjustments if certain events occur. A portion of the net proceeds from the offering of the 2.625% Notes were used as part of the financing for the Buffalo Filter acquisition and $21.0 million were used to pay the cost of certain convertible notes hedge transactions as further described below.
On June 6, 2022, the Company repurchased and extinguished $275.0 million principal amount of the 2.625% Notes for aggregate consideration consisting of $275.0 million in cash and approximately 0.9 million shares of the Company's common stock. During the year ended December 31, 2022, the Company recorded a loss on extinguishment of $103.1 million to other expense based on the fair value of the shares of the Company’s common stock issued in connection with the extinguishment. This loss was not deductible for tax purposes. We also recorded a write-off to other expense of unamortized debt issuance costs related to the 2.625% Notes of $2.9 million. Concurrently, the Company entered into a Supplemental Indenture related to the remaining $70.0 million in 2.625% Notes, in which the Company irrevocably elected to settle the principal value of those 2.625% Notes in cash. The $70.0 million in 2.625% Notes are reflected in the current portion of long-term debt at December 31, 2022.
Our effective borrowing rate for nonconvertible debt at the time of issuance of the 2.625% Notes was estimated to be 6.14%, which resulted in $51.6 million of the $345.0 million aggregate principal amount of 2.625% Notes issued, or $39.1 million after taxes, being attributable to equity. For the years ended December 31, 2021 and 2020, we have recorded interest expense related to the amortization of debt discount on the 2.625% Notes of $10.2 million and $9.7 million respectively, at the effective interest rate of 6.14%. On January 1, 2022, we adopted ASU 2020-06 using the modified retrospective approach as further described in Note 2. This ASU eliminated the equity component separately recorded for the conversion features associated with the convertible notes and related debt discount. For the years ended December 31, 2022, 2021 and 2020, we have recorded interest expense on the 2.625% Notes of $4.8 million, $9.1 million and $9.1 million, respectively, at the contractual coupon rate of 2.625%.
The estimated fair value of the 2.625% Notes was approximately $79.0 million as of December 31, 2022 based on a market approach which represents a Level 2 valuation in the fair value hierarchy. The estimated fair value was determined based on the estimated or actual bids and offers of the 2.625% Notes in an over-the-counter market transaction on the last business day of the period.
2.250% Convertible Notes
On June 6, 2022, we issued $800.0 million aggregate principal amount of 2.250% Notes. Interest is payable semi-annually in arrears on June 15 and December 15 of each year, commencing December 15, 2022. The 2.250% Notes will mature on June 15, 2027, unless earlier repurchased or converted. The 2.250% Notes represent subordinated unsecured obligations and are convertible under certain circumstances, as defined in the indenture, into a combination of cash and CONMED common stock, with the principal required to be paid in cash. The 2.250% Notes may be converted at an initial conversion rate of 6.8810 shares of our common stock per $1,000 principal amount of the 2.250% Notes (equivalent to an initial conversion price of approximately $145.33 per share of common stock). Holders of the 2.250% Notes may convert the 2.250% Notes at their option at any time on or after March 15, 2027 through the second scheduled trading day preceding the maturity date. Holders of the 2.250% Notes will also have the right to convert the 2.250% Notes prior to March 15, 2027, but only upon the occurrence of specified events. The conversion rate is subject to anti-dilution adjustments if certain events occur. A portion of these proceeds were used to repurchase and extinguish a portion of the 2.625% Notes, pay off our then outstanding balance on our revolving line of credit, pay down $90.0 million of our term loan and partially pay for the In2Bones Acquisition. In addition, approximately $115.6 million of the proceeds were used to pay the cost of certain convertible notes hedge transactions related to the 2.250% Notes.
For the year ended December 31, 2022, we have recorded interest expense on the 2.250% Notes of $10.3 million at the contractual coupon rate of 2.250%.
The estimated fair value of the 2.250% Notes was approximately $731.0 million as of December 31, 2022 based on a market approach which represents a Level 2 valuation in the fair value hierarchy. The estimated fair value was determined based on the estimated or actual bids and offers of the 2.250% Notes in an over-the-counter market transaction on the last business day of the year.
Convertible Notes Hedge Transactions
In connection with the offering of the 2.625% and 2.250% Notes, we entered into convertible note hedge transactions with a number of financial institutions (each, an “option counterparty”). The convertible note hedge transactions cover, subject to anti-dilution adjustments substantially similar to those applicable to the respective Notes, the number of shares of our common stock underlying the 2.625% and 2.250% Notes. Concurrent with entering into the convertible note hedge transactions, we also entered into separate warrant transactions with each option counterparty whereby we sold to such option counterparty warrants to purchase, subject to customary anti-dilution adjustments, the same number of shares of our common stock.
In connection with the repurchase and extinguishment of $275.0 million principal amount of the 2.625% Notes, the Company entered into agreements with the option counterparties to terminate a corresponding portion of the hedges on the 2.625% Notes. The transactions had a net fair value due the Company on execution date of $22.2 million which was recorded as an adjustment to Paid-in Capital. The Company recorded a $5.5 million charge to other expense as a result of a subsequent decline in fair value between execution date and settlement date with the Company receiving net cash of $16.7 million. The
termination of the convertible notes hedge resulted in the release of the related deferred tax asset. In connection with the issuance of 2.250% Notes, the Company purchased hedges for $187.6 million ($142.1 million net of tax) and received proceeds from the issuance of warrants totaling $72.0 million, recorded to paid-in capital.
The convertible note hedge transactions are expected generally to reduce the potential dilution upon conversion of the Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted Notes, as the case may be, in the event that the market price per share of our common stock, as measured under the terms of the convertible note hedge transactions, is greater than the strike price of the convertible note hedge transactions, which initially corresponds to the conversion price of the Notes and is subject to anti-dilution adjustments substantially similar to those applicable to the conversion rate of the Notes. If, however, the market price per share of our common stock, as measured under the terms of the warrant transactions, exceeds the strike price ($114.92 for the 2.625% Notes and $251.53 for the 2.250% Notes) of the warrants, there would nevertheless be dilution to the extent that such market price exceeds the strike price of the warrants as noted in Note 1, unless we elect to settle the warrants in cash.
The scheduled maturities of long-term debt outstanding at December 31, 2022 are as follows:
| | | | | |
2023 | $ | 70,000 | |
2024 | — | |
2025 | — | |
2026 | 204,587 | |
2027 | 800,000 | |
The above amounts exclude debt discount, deferred debt issuance costs and financing leases.
Note 9 - Income Taxes
The provision (benefit) for income taxes for the years ended December 31, 2022, 2021 and 2020 consists of the following:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Current tax expense (benefit): | | | | | |
Federal | $ | 98 | | | $ | (97) | | | $ | (729) | |
State | 1,582 | | | 609 | | | 86 | |
Foreign | 14,082 | | | 7,046 | | | 6,963 | |
| 15,762 | | | 7,558 | | | 6,320 | |
Deferred income tax expense (benefit): | | | | | |
Federal | (4,096) | | | 3,466 | | | (12,253) | |
State | (1,636) | | | 1,449 | | | (1,173) | |
Foreign | (310) | | | (1,910) | | | (808) | |
| (6,042) | | | 3,005 | | | (14,234) | |
| | | | | |
Provision (benefit) for income taxes | $ | 9,720 | | | $ | 10,563 | | | $ | (7,914) | |
A reconciliation between income taxes computed at the statutory federal rate and the provision (benefit) for income taxes for the years ended December 31, 2022, 2021 and 2020 follows:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Tax provision at statutory rate based on income before income taxes | 21.0 | % | | 21.0 | % | | 21.0 | % |
| | | | | |
Stock-based compensation | 1.5 | | | (9.4) | | | (267.7) | |
| | | | | |
Federal research credit | 2.4 | | | (2.3) | | | (124.2) | |
| | | | | |
Valuation allowance | 2.5 | | | (2.2) | | | 49.7 | |
| | | | | |
Settlement of taxing authority examinations | — | | | — | | | (122.9) | |
| | | | | |
Non-deductible premium on extinguishment and change in fair value of convertible notes | (32.2) | | | — | | | — | |
| | | | | |
Non-deductible/non-taxable items | (2.9) | | | 0.8 | | | 28.6 | |
| | | | | |
US tax on worldwide earnings at different rates | (1.8) | | | (0.4) | | | (123.7) | |
| | | | | |
Foreign income taxes | (1.8) | | | 3.1 | | | 79.9 | |
| | | | | |
State income taxes, net of federal tax benefit | (1.4) | | | 3.7 | | | (24.5) | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
Other, net | (1.0) | | | 0.1 | | | (10.1) | |
| | | | | |
| (13.7) | % | | 14.4 | % | | (493.9) | % |
The Company has elected to account for Global Intangible Low Tax Income ("GILTI") using the period cost method. The net impact of GILTI including the allowable GILTI deduction is presented in the rate reconciliation as a component of “US tax on worldwide earnings at different rates”.
The tax effects of the significant temporary differences which comprise the deferred income tax assets and liabilities at December 31, 2022 and 2021 are as follows:
| | | | | | | | | | | |
| 2022 | | 2021 |
Assets: | | | |
Inventory | $ | 2,939 | | | $ | 4,694 | |
Net operating losses | 12,721 | | | 18,383 | |
Capitalized research and development | 11,402 | | | 4,173 | |
Deferred compensation | 3,012 | | | 2,563 | |
Accounts receivable | 3,580 | | | 3,147 | |
Compensation and benefits | 8,723 | | | 6,583 | |
Accrued pension | 2,530 | | | 3,930 | |
Research and development credit | 16,785 | | | 15,542 | |
Interest limitation | 9,116 | | | — | |
Convertible notes hedge | 36,204 | | | 4,869 | |
Lease liabilities | 2,735 | | | 3,573 | |
Other | 4,134 | | | 5,741 | |
Less: valuation allowances | (543) | | | (786) | |
| 113,338 | | | 72,412 | |
| | | |
Liabilities: | | | |
Goodwill and intangible assets | 152,155 | | | 106,065 | |
Depreciation | 2,373 | | | 2,546 | |
State taxes | 11,733 | | | 11,833 | |
Unremitted foreign earnings | 1,573 | | | 2,449 | |
Convertible notes debt discount | — | | | 4,915 | |
Lease right-of-use assets | 2,579 | | | 3,484 | |
| | | |
| 170,413 | | | 131,292 | |
| | | |
Net liability | $ | (57,075) | | | $ | (58,880) | |
Income (loss) before income taxes consists of the following U.S. and foreign income (loss):
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
U.S. income (loss) | $ | (96,114) | | | $ | 45,260 | | | $ | (16,026) | |
Foreign income | 25,252 | | | 27,845 | | | 17,629 | |
Total income (loss) | $ | (70,862) | | | $ | 73,105 | | | $ | 1,603 | |
As of December 31, 2022, the amount of federal net operating loss carryforward was $11.0 million and begins to expire in 2027. As of December 31, 2022, the amount of federal research credit carryforward available was $16.8 million. These credits begin to expire in 2027.
We have accrued tax liabilities related to the amount of unremitted earnings at December 31, 2017 and certain subsequent unremitted earnings as these are not considered permanently reinvested. Deferred taxes have not been accrued on unremitted earnings subsequent to December 31, 2017 that are considered permanently reinvested. The amount of such untaxed foreign earnings for the periods occurring after December 2017 totaled $28.7 million. If we were to repatriate these funds, we would be required to accrue and pay taxes on such amounts. The Company has estimated foreign withholding taxes of $1.4 million would be due if these earnings were repatriated.
The Company is subject to taxation in the United States and various states and foreign jurisdictions. Taxing authority examinations can involve complex issues and may require an extended period of time to resolve. Our federal income tax returns have been examined by the Internal Revenue Service (“IRS”) for calendar years ending through 2019.
We recognize tax liabilities in accordance with the provisions for accounting for uncertainty in income taxes. Such guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.
The following table summarizes the activity related to our unrecognized tax benefits for the years ending December 31,:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Balance as of January 1, | $ | 200 | | | $ | 200 | | | $ | 2,170 | |
| | | | | |
| | | | | |
| | | | | |
Increases for positions taken in current periods | — | | | — | | | — | |
| | | | | |
Decreases in unrecorded tax positions related to settlement with the taxing authorities | — | | | — | | | (1,970) | |
| | | | | |
Decreases in unrecorded tax positions related to lapse of statute of limitations | — | | | — | | | — | |
| | | | | |
Balance as of December 31, | $ | 200 | | | $ | 200 | | | $ | 200 | |
If the total unrecognized tax benefits of $0.2 million at December 31, 2022 were recognized, it would reduce our annual effective tax rate. The amount of interest accrued in 2020, 2021 and 2022 related to these unrecognized tax benefits was not material and is included in the provision (benefit) for income taxes in the consolidated statements of comprehensive income (loss).
Note 10 - Shareholders’ Equity
On February 29, 2012, the Board of Directors adopted a cash dividend policy and declared an initial quarterly dividend of $0.15 per share. On October 28, 2013, the Board of Directors increased the quarterly dividend to $0.20 per share. The total dividend per share was $0.80 for each of 2022, 2021 and 2020. The fourth quarter dividend for 2022 was paid on January 5, 2023 to shareholders of record as of December 16, 2022. The total dividend payable was $6.1 million and $5.9 million at December 31, 2022 and 2021, respectively, and is included in other current liabilities in the consolidated balance sheet.
Our shareholders have authorized 500,000 shares of preferred stock, par value $.01 per share, which may be issued in one or more series by the Board of Directors without further action by the shareholders. As of December 31, 2022 and 2021, no preferred stock had been issued.
Our Board of Directors has authorized a $200.0 million share repurchase program. Through December 31, 2022, we have repurchased a total of 6.1 million shares of common stock aggregating $162.6 million under this authorization and have $37.4 million remaining available for share repurchases. The repurchase program calls for shares to be purchased in the open market or in private transactions from time to time. We may suspend or discontinue the share repurchase program at any time. During 2022, 2021, and 2020 we did not repurchase any shares.
We have reserved 6.5 million shares of common stock for issuance to employees and directors under two shareholder approved share-based compensation plans (the "Plans") of which approximately 2.8 million shares remain available for grant at December 31, 2022. The exercise price on all outstanding stock options and stock appreciation rights (“SARs”) is equal to the quoted fair market value of the stock at the date of grant. Restricted stock units (“RSUs”) and performance stock units (“PSUs”) are valued at the market value of the underlying stock on the date of grant. Stock options, SARs, RSUs and PSUs are generally non-transferable other than on death and generally become exercisable over a 4 to 5 year period from date of grant. Stock options and SARs expire 10 years from date of grant. SARs are only settled in shares of the Company’s stock. The issuance of shares pursuant to the exercise of stock options and SARs and vesting of RSUs and PSUs are from the Company’s treasury stock.
Total pre-tax stock-based compensation expense recognized in the consolidated statements of comprehensive income (loss) was $21.7 million, $16.3 million and $13.1 million for the years ended December 31, 2022, 2021 and 2020, respectively. These amounts are included in selling and administrative expense. Tax related benefits of $3.8 million, $3.9 million and $3.2 million were also recognized for the years ended December 31, 2022, 2021 and 2020, respectively. Cash received from the exercise of stock options was $8.9 million, $19.6 million and $13.7 million for the years ended December 31, 2022, 2021 and 2020, respectively, and is reflected in cash flows from financing activities in the consolidated statements of cash flows.
The Company uses the Black-Scholes option pricing model to estimate the fair value of stock options and SARs at the date of grant. Use of a valuation model requires management to make certain assumptions with respect to select model inputs. Expected volatilities are based upon historical volatility of the Company’s stock over a period equal to the expected life of each stock option and SAR grant. The risk free interest rate is based on the stock option and SAR grant date for a traded U.S. Treasury bond with a maturity date closest to the expected life. The expected annual dividend yield is based on the Company's anticipated cash dividend payouts. The expected life represents the period of time that the stock options and SARs are expected to be outstanding based on a study of historical data of option holder exercise and termination behavior. Forfeitures are recognized as incurred.
The following table illustrates the assumptions used in estimating fair value in the years ended December 31, 2022, 2021 and 2020:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Grant date fair value of stock options and SARs | $ | 49.88 | | | $ | 42.47 | | | $ | 22.62 | |
Expected stock price volatility | 38.45 | % | | 39.27 | % | | 26.89 | % |
Risk-free interest rate | 1.68 | % | | 0.81 | % | | 0.89 | % |
Expected annual dividend yield | 0.56 | % | | 0.64 | % | | 0.82 | % |
Expected life of options & SARs (years) | 5.4 | | 5.5 | | 5.5 |
The following table illustrates the stock option and SAR activity for the year ended December 31, 2022:
| | | | | | | | | | | |
| Number of Shares (in 000’s) | | Weighted- Average Exercise Price |
Outstanding at December 31, 2021 | 3,264 | | | $ | 80.79 | |
| | | |
Granted | 730 | | | $ | 141.84 | |
Forfeited | (113) | | | $ | 114.72 | |
Exercised | (180) | | | $ | 60.80 | |
| | | |
Outstanding at December 31, 2022 | 3,701 | | | $ | 92.98 | |
Exercisable at December 31, 2022 | 1,725 | | | $ | 67.66 | |
Stock options & SARs expected to vest | 1,976 | | | $ | 115.09 | |
The weighted average remaining contractual term for SARs and stock options outstanding and exercisable at December 31, 2022 was 6.6 years and 5.1 years, respectively. The aggregate intrinsic value of SARs and stock options outstanding and exercisable at December 31, 2022 was $49.3 million and $43.0 million, respectively. The aggregate intrinsic value of stock options and SARs exercised during the years ended December 31, 2022, 2021 and 2020 was $13.6 million, $49.2 million and $26.6 million, respectively.
The following table illustrates the RSU activity for the year ended December 31, 2022:
| | | | | | | | | | | |
| Number of Shares (in 000’s) | | Weighted- Average Grant-Date Fair Value |
Outstanding at December 31, 2021 | 51 | | | $ | 101.55 | |
| | | |
Granted | 21 | | | $ | 136.35 | |
Vested | (25) | | | $ | 100.68 | |
Forfeited | (1) | | | $ | 113.87 | |
| | | |
Outstanding at December 31, 2022 | 46 | | | $ | 117.91 | |
The weighted average fair value of RSU awards granted in the years ended December 31, 2022, 2021 and 2020 was $136.35, $129.94 and $85.45, respectively.
The total fair value of RSUs and PSUs vested was $2.6 million, $2.2 million and $6.2 million for the years ended December 31, 2022, 2021 and 2020, respectively.
As of December 31, 2022, there was $59.2 million of total unrecognized compensation cost related to nonvested stock options, SARs and RSUs granted under the Plans which is expected to be recognized over a weighted average period of 3.5 years.
We offer to our employees a shareholder-approved Employee Stock Purchase Plan (the “Employee Plan”), under which we reserved 1.0 million shares of common stock for issuance to our employees. The Employee Plan provides employees with the opportunity to invest from 1% to 10% of their annual salary to purchase shares of CONMED common stock at a purchase price equal to 95% of the fair market value of the common stock on the exercise date. During 2022, we issued approximately 17,353 shares of common stock under the Employee Plan. No stock-based compensation expense has been recognized in the accompanying consolidated financial statements as a result of common stock issuances under the Employee Plan.
Note 11 - Revenues
The following tables present revenue disaggregated by product line and timing of revenue recognition for the years ended December 31, 2022, 2021 and 2020:
| | | | | | | | | | | | | | | | | |
| 2022 |
| Orthopedic Surgery | | General Surgery | | Total |
Timing of Revenue Recognition | | | | | |
Goods transferred at a point in time | $ | 422,648 | | | $ | 577,625 | | | $ | 1,000,273 | |
Services transferred over time | 38,880 | | | 6,319 | | | 45,199 | |
Total sales from contracts with customers | $ | 461,528 | | | $ | 583,944 | | | $ | 1,045,472 | |
| | | | | | | | | | | | | | | | | |
| 2021 |
| Orthopedic Surgery | | General Surgery | | Total |
Timing of Revenue Recognition | | | | | |
Goods transferred at a point in time | $ | 398,963 | | | $ | 567,244 | | | $ | 966,207 | |
Services transferred over time | 39,461 | | | 4,967 | | | 44,428 | |
Total sales from contracts with customers | $ | 438,424 | | | $ | 572,211 | | | $ | 1,010,635 | |
| | | | | | | | | | | | | | | | | |
| 2020 |
| Orthopedic Surgery | | General Surgery | | Total |
Timing of Revenue Recognition | | | | | |
Goods transferred at a point in time | $ | 340,318 | | | $ | 484,147 | | | $ | 824,465 | |
Services transferred over time | 34,387 | | | 3,607 | | | 37,994 | |
Total sales from contracts with customers | $ | 374,705 | | | $ | 487,754 | | | $ | 862,459 | |
Revenue disaggregated by primary geographic market where the products are sold is included in Note 12.
Contract liability balances related to the sale of extended warranties to customers are as follows:
| | | | | | | | | | | |
| December 31, 2022 | | December 31, 2021 |
| | | |
Contract Liability | $ | 19,114 | | | $ | 16,760 | |
Revenue recognized during years ended December 31, 2022, 2021 and 2020 from amounts included in contract liabilities at the beginning of the period were $11.5 million, $10.3 million and $9.3 million, respectively. There were no material contract assets as of December 31, 2022 and December 31, 2021.
Note 12 - Business Segments and Geographic Areas
We are accounting and reporting for our business as a single operating segment entity engaged in the development, manufacturing and sale on a global basis of surgical devices and related equipment. Our chief operating decision maker (the CEO) evaluates the various global product portfolios on a net sales basis and evaluates profitability, investment, cash flow metrics and allocates resources on a consolidated worldwide basis due to shared infrastructure and resources. Our product lines consist of orthopedic surgery and general surgery. Orthopedic surgery consists of sports medicine instrumentation and small bone, large bone and specialty powered surgical instruments as well as imaging systems for use in minimally invasive surgical procedures and fees related to sales representation, 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, smoke evacuation devices, a line of cardiac monitoring products as well as electrosurgical generators and related instruments. These product lines' net sales and primary geographic market where the products are sold, are as follows for the years ended December 31, 2022, 2021 and 2020:
| | | | | | | | | | | | | | | | | |
| 2022 |
| Orthopedic Surgery | | General Surgery | | Total |
Primary Geographic Markets | | | | | |
United States | $ | 173,176 | | | $ | 405,777 | | | $ | 578,953 | |
Europe, Middle East & Africa | 113,649 | | | 84,288 | | | 197,937 | |
Asia Pacific | 103,353 | | | 59,124 | | | 162,477 | |
Americas (excluding the United States) | 71,350 | | | 34,755 | | | 106,105 | |
Total sales from contracts with customers | $ | 461,528 | | | $ | 583,944 | | | $ | 1,045,472 | |
| | | | | | | | | | | | | | | | | |
| 2021 |
| Orthopedic Surgery | | General Surgery | | Total |
Primary Geographic Markets | | | | | |
United States | $ | 158,553 | | | $ | 393,980 | | | $ | 552,533 | |
Europe, Middle East & Africa | 108,457 | | | 81,238 | | | 189,695 | |
Asia Pacific | 107,590 | | | 63,628 | | | 171,218 | |
Americas (excluding the United States) | 63,824 | | | 33,365 | | | 97,189 | |
Total sales from contracts with customers | $ | 438,424 | | | $ | 572,211 | | | $ | 1,010,635 | |
| | | | | | | | | | | | | | | | | |
| 2020 |
| Orthopedic Surgery | | General Surgery | | Total |
Primary Geographic Markets | | | | | |
United States | $ | 139,715 | | | $ | 342,349 | | | $ | 482,064 | |
Europe, Middle East & Africa | 90,998 | | | 70,086 | | | 161,084 | |
Asia Pacific | 93,636 | | | 46,961 | | | 140,597 | |
Americas (excluding the United States) | 50,356 | | | 28,358 | | | 78,714 | |
Total sales from contracts with customers | $ | 374,705 | | | $ | 487,754 | | | $ | 862,459 | |
Sales are attributed to countries based on the location of the customer. There were no significant investments in long-lived assets located outside the United States at December 31, 2022 and 2021. No single customer represented over 10% of our consolidated net sales for the years ended December 31, 2022, 2021 and 2020.
Note 13 - Employee Benefit Plans
We sponsor an employee savings plan (“401(k) plan”) covering substantially all of our United States based employees. We also sponsor a defined benefit pension plan (the “pension plan”) that was frozen in 2009. It covered substantially all our United States based employees at the time it was frozen.
Total employer contributions to the 401(k) plan were $9.9 million, $9.2 million and $8.9 million during the years ended December 31, 2022, 2021 and 2020, respectively.
We use a December 31, measurement date for our pension plan. Cumulative gains and losses in excess of 10% of the greater of the benefit obligation or the market-related value of assets are amortized on a straight-line basis over the lesser of the expected average remaining life expectancy of the plan's participants or 11.38 years. The limit of 11.38 years is adjusted to reflect the percentage change in the average remaining service period for the plan's active membership.
The following table provides a reconciliation of the projected benefit obligation, plan assets and funded status of the pension plan at December 31:
| | | | | | | | | | | |
| 2022 | | 2021 |
Accumulated benefit obligation | $ | 71,203 | | | $ | 95,508 | |
| | | |
Change in benefit obligation | | | |
Projected benefit obligation at beginning of year | $ | 95,508 | | | $ | 101,242 | |
Service cost | 1,077 | | | 991 | |
Interest cost | 2,148 | | | 1,803 | |
Actuarial gain | (23,607) | | | (3,427) | |
Benefits paid | (2,805) | | | (2,703) | |
Settlements | (1,118) | | | (2,398) | |
Projected benefit obligation at end of year | $ | 71,203 | | | $ | 95,508 | |
| | | |
Change in plan assets | | | |
Fair value of plan assets at beginning of year | $ | 79,404 | | | $ | 76,940 | |
Actual gain (loss) on plan assets | (13,125) | | | 7,565 | |
Benefits paid | (2,805) | | | (2,703) | |
Settlements | (1,118) | | | (2,398) | |
Fair value of plan assets at end of year | $ | 62,356 | | | $ | 79,404 | |
| | | |
Funded status | $ | (8,847) | | | $ | (16,104) | |
The projected benefit obligation decreased $24.3 million as of December 31, 2022 mainly due to the increase in the discount rate from 2.81% at December 31, 2021 to 5.41% at December 31, 2022 and changes in the lump sum conversion rates.
Amounts recognized in the consolidated balance sheets consist of the following at December 31,:
| | | | | | | | | | | |
| 2022 | | 2021 |
Other long-term liabilities | $ | (8,847) | | | $ | (16,104) | |
Accumulated other comprehensive loss | (31,346) | | | (39,122) | |
Accumulated other comprehensive loss for the years ended December 31, 2022 and 2021 consists of net actuarial losses not yet recognized in net periodic pension cost (before income taxes).
The following actuarial assumptions were used to determine our accumulated and projected benefit obligations as of December 31,:
| | | | | | | | | | | |
| 2022 | | 2021 |
Discount rate | 5.41 | % | | 2.81 | % |
Other changes in plan assets and benefit obligations recognized in other comprehensive income (loss) in 2022 and 2021 are as follows:
| | | | | | | | | | | |
| 2022 | | 2021 |
Current year actuarial loss | $ | 5,228 | | | $ | 5,836 | |
Amortization of actuarial loss | 2,589 | | | 3,327 | |
Total recognized in other comprehensive income (loss) | $ | 7,817 | | | $ | 9,163 | |
Net periodic pension cost for the years ended December 31, consists of the following:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Service cost | $ | 1,077 | | | $ | 991 | | | $ | 717 | |
Interest cost on projected benefit obligation | 2,148 | | | 1,803 | | | 2,555 | |
Expected return on plan assets | (5,295) | | | (5,155) | | | (5,021) | |
Amortization of loss | 2,589 | | | 3,327 | | | 2,821 | |
| | | | | |
Net periodic pension cost | $ | 519 | | | $ | 966 | | | $ | 1,072 | |
Non-service cost of $0.4 million is included in other expense in the consolidated statements of comprehensive income (loss) for the year ended 2020. Non-service pension cost/(benefit) was immaterial for the years ended 2022 and 2021.
The following actuarial assumptions were used to determine our net periodic pension benefit cost for the years ended December 31,:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Discount rate on benefit obligation | 2.81 | % | | 2.44 | % | | 3.33 | % |
Effective rate for interest on benefit obligation | 2.33 | % | | 1.83 | % | | 2.88 | % |
Expected return on plan assets | 7.00 | % | | 7.00 | % | | 7.00 | % |
The Company’s discount rate and mortality assumptions are the significant assumptions in determining the projected benefit obligation of the Company’s pension plan.
The discount rate represents the interest rate used in estimating the present value of projected cash flows to settle the Company’s pension obligations. The discount rate assumption is determined by management using a full yield curve approach, which involves applying the specific spot rates along the yield curve used in the determination of the benefit obligation that correlates to the relevant projected cash flows.
Mortality assumptions are based on published mortality studies developed primarily based on past experience of the broad population and modified for projected longevity trends. The mortality assumptions used for 2022 and 2021 are based on the Pri-2012 Mortality Tables using the MP-2021 mortality improvement scale.
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.
Asset management objectives include maintaining an adequate level of diversification to reduce interest rate and market risk and providing adequate liquidity to meet immediate and future benefit payment requirements.
The allocation of plan assets by category is as follows at December 31,:
| | | | | | | | | | | | | | | | | |
| Percentage of Pension Plan Assets | | Target Allocation |
| 2022 | | 2021 | | 2023 |
Equity securities | 72 | % | | 73 | % | | 75 | % |
Debt securities | 28 | % | | 27 | % | | 25 | % |
Total | 100 | % | | 100 | % | | 100 | % |
As of December 31, 2022, the pension plan held 27,562 shares of our common stock, which had a fair value of $2.4 million. We believe that our long-term asset allocation on average will approximate the targeted allocation. We regularly review our actual asset allocation and periodically rebalance the pension plan’s investments to our targeted allocation when deemed appropriate.
FASB guidance defines fair value and establishes a framework for measuring fair value and related disclosure requirements as described in Note 16. Following is a description of the valuation methodologies used for our pension assets. There have been no changes in the methodologies used at December 31, 2022 and 2021:
| | | | | |
Common Stock: | Common stock is valued at the closing price reported on the common stock’s respective stock exchange and is classified within level 1 of the valuation hierarchy. |
| |
Fixed Income Securities: | Valued at the closing price reported on the active market on which the individual securities are traded and are classified within level 1 of the valuation hierarchy. |
| |
Money Market Fund: | These investments are public investment vehicles valued using the Net Asset Value (NAV). |
| |
Mutual Funds: | These investments are public investment vehicles valued using the Net Asset Value (NAV) provided by the administrator of the fund. The NAV is based on the value of the underlying assets owned by the fund, minus its liabilities, and then divided by the number of shares outstanding. |
The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the pension plan believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.
The following table sets forth the value of the pension plan's assets as of December 31, 2022 and December 31, 2021:
| | | | | | | | | | | |
| 2022 | | 2021 |
Investments measured at fair value: | | | |
Level 1 | | | |
Common Stock | $ | 6,628 | | | $ | 9,767 | |
Fixed Income Securities | 15,963 | | | 20,272 | |
Total Investments measured at fair value | 22,591 | | | 30,039 | |
| | | |
Investments measured at NAV: | | | |
Money Market Fund | 1,477 | | | 1,098 | |
Mutual Funds | 38,288 | | | 48,267 | |
Total Investments measured at NAV | 39,765 | | | 49,365 | |
| | | |
Total Investments | $ | 62,356 | | | $ | 79,404 | |
We do not expect to make any contributions to our pension plan for 2023.
The following table summarizes the benefits and settlements expected to be paid by our pension plan in each of the next five years and in aggregate for the following five years. The expected payments are estimated based on the same assumptions used to measure the Company’s projected benefit obligation at December 31, 2022.
| | | | | |
2023 | $5,948 | |
2024 | 5,643 | |
2025 | 5,823 | |
2026 | 6,143 | |
2027 | 5,538 | |
2028-2032 | 25,737 | |
Note 14 - Legal Matters and Contingencies
From time to time, the Company may receive an information request, subpoena or warrant from a government agency such as the Securities and Exchange Commission, Department of Justice, Equal Employment Opportunity Commission, the Occupational Safety and Health Administration, the United States Food and Drug Administration, the Department of Labor, the Treasury Department or other federal and state agencies or foreign governments or government agencies. These information requests, subpoenas or warrants may or may not be routine inquiries, or may begin as routine inquiries and over time develop into enforcement actions of various types. Likewise, if we receive reports of alleged misconduct from employees and third parties, we investigate as appropriate.
Manufacturers of medical devices have been the subject of various enforcement actions relating to interactions with health care providers domestically or internationally whereby companies are claimed to have provided health care providers with inappropriate incentives to purchase their products. Similarly, the Foreign Corrupt Practices Act ("FCPA") imposes obligations on manufacturers with respect to interactions with health care providers who may be considered government officials based on their affiliation with public hospitals. The FCPA also requires publicly listed manufacturers to maintain accurate books and records, and maintain internal accounting controls sufficient to provide assurance that transactions are accurately recorded, lawful and in accordance with management's authorization. The FCPA poses unique challenges both because manufacturers operate in foreign cultures in which conduct illegal under the FCPA may not be illegal in local jurisdictions, and because, in some cases, a United States manufacturer may face risks under the FCPA based on the conduct of third parties over whom the manufacturer may not have complete control. While CONMED has not experienced any material enforcement action to date, there can be no assurance that the Company will not be subject to a material enforcement action in the future, or that the Company will not incur costs including, in the form of fees for lawyers and other consultants, that are material to the Company’s results of operations in the course of responding to a future inquiry or investigation.
Manufacturers of medical products may face exposure to significant product liability claims, as well as patent infringement and other claims incurred in the ordinary course of business. To date, we have not experienced any claims that have been material to our financial statements or financial condition, but any such claims arising in the future could have a material adverse effect on our business, results of operations or cash flows. We currently maintain commercial product liability insurance of $35 million per incident and $35 million in the aggregate annually, which we believe is adequate. This coverage is on a claims-made basis. There can be no assurance that claims will not exceed insurance coverage, that the carriers will be solvent or that such insurance will be available to us in the future at a reasonable cost.
Our operations are subject, and in the past have been subject, to a number of environmental laws and regulations governing, among other things, air emissions; wastewater discharges; the use, handling and disposal of hazardous substances and wastes; soil and groundwater remediation and employee health and safety. Likewise, the operations of our suppliers and sterilizers are subject to similar environmental laws and regulations. In some jurisdictions, environmental requirements may be expected to become more stringent in the future. In the United States, certain environmental laws can impose liability for the entire cost of site restoration upon each of the parties that may have contributed to conditions at the site regardless of fault or the lawfulness of the party’s activities. While we do not believe that the present costs of environmental compliance and remediation are material, there can be no assurance that future compliance or remedial obligations would not have a material adverse effect on our financial condition, results of operations or cash flows.
In 2014, the Company acquired EndoDynamix, Inc. The agreement governing the terms of the acquisition provides that, if various conditions are met, certain contingent payments relating to the first commercial sale of the products (the milestone payment), as well as royalties based on sales (the revenue based payments), are due to the seller. In 2016, we notified the seller that there was a need to redesign the product, and that, as a consequence, the first commercial sale had been delayed. Consequently, the payment of contingent milestone and revenue-based payments were delayed. On January 18, 2017, the seller provided notice (the "Notice") seeking $12.7 million under a liquidated damages clause, which essentially represented the seller's view as to the sum of the projected contingent milestone and revenue-based payments on an accelerated basis. CONMED responded to the Notice denying that there was any basis for acceleration of the payments due under the acquisition agreement. On February 22, 2017, the representative of the former shareholders of EndoDynamix filed a complaint in Delaware Chancery Court claiming breach of contract with respect to the duty to commercialize the product and seeking the contingent payments on an accelerated basis. In the third quarter of 2018, the Company decided to halt the development of the EndoDynamix clip applier and recorded a charge to write off assets and released a previously accrued contingent consideration liability. In court filings the Plaintiffs claim to seek liquidated damages, as well as additional damages up to $24.8 million. A non-jury trial in the Delaware Chancery Court commenced on March 18, 2021, and testimony concluded on April 7, 2021. On June 30, 2022, the Court issued a ruling that CONMED had presented overwhelming evidence that it had not breached its obligations under the acquisition agreement, and that CONMED was entitled to judgement on all claims asserted against it. The Company had not recorded any expense related to potential damages in connection with this matter and the period within which the former shareholders of EndoDynamix could have appealed expired without any appeal being filed.
CONMED is defending two Georgia State Court actions. The first action was filed in Cobb County by various employees, former employees, contract workers and others against CONMED and against a contract sterilizer (the "Cobb County Action"). The second action was filed in Douglas County against CONMED’s landlord and other allegedly related entities (the "Douglas County Action"). Plaintiffs in the lawsuits allege personal injury and related claims purportedly arising from or relating to exposure to Ethylene Oxide, a chemical used to sterilize certain products. CONMED is defending the claims asserted directly against it and is providing indemnification for certain other defendants based on contractual provisions.
Both actions are in their early stages. The Company’s motion to dismiss in the Cobb County action was heard on January 10, 2022, and the Court issued a ruling on June 15, 2022 dismissing 44 of the 51 plaintiffs' claims as precluded by the exclusive workers' compensation remedy, as well as one claim from a non-employee plaintiff. As to the remaining claims that were not the subject of the motion to dismiss, CONMED believes it has strong defenses and will vigorously defend itself and all parties it is indemnifying. As with any litigation, there are risks, including the risk that CONMED may not prevail with respect to the defense of the underlying claims, or with respect to securing adequate insurance coverage for the indemnification claims. The Company is unable to estimate a range of possible loss at this time, and has not recorded any expense related to potential damages in connection with this matter because the Company does not believe any potential loss is probable.
CONMED submitted the foregoing claims for insurance coverage. One insurer is providing coverage for certain of the claims asserted directly against the Company. CONMED has been litigating two lawsuits in the United States District Court for the Northern District of New York with Federal Insurance Company (“Chubb”): one involving CONMED’s claim for coverage for the indemnification claims arising from the Cobb County Action, and the other concerning CONMED’s claim for coverage for the indemnification claims arising from the Douglas County Action. On March 10, 2022, the Court ruled in favor of CONMED with respect to coverage for the indemnification claims arising from the Cobb County Action. Chubb's motion for
reconsideration was denied, and Chubb filed a notice of appeal. On August 9, 2022, CONMED won a similar ruling finding in its favor and against Chubb as to the coverage case concerning the Douglas County Action. Chubb appealed that decision as well. CONMED believed its position was well-grounded in the facts and the law. Chubb subsequently withdrew its appeal and agreed to pay for the underlying defense of the two claims, subject to certain reservations of rights, and in January 2023 agreed to reimburse CONMED for certain costs it had previously incurred in connection with the defense of the two lawsuits. There can be no assurance that Chubb will honor its obligations prospectively.
In addition, one of CONMED’s contract sterilizers, which is defending toxic tort claims asserted by various residents in the areas around its processing facility, has placed CONMED on notice of a claim for indemnification relating to some of those claims. CONMED is reviewing the notice, and has not at this time taken any position on the notice.
The government of Italy passed a law in late 2015 to tax medical device companies on revenue derived from sales to public hospitals. The tax is calculated and based on provincial spending over and above certain thresholds. Since the law was enacted, the Italian government essentially made no effort to administer or collect the tax. A lack of interpretative guidance and complexity of the law resulted in uncertainty as to the actual amount of liability. In September 2022, the Italian government passed a further decree which, amongst other provisions, delegated administration and collection to the provincial level for the years 2015 – 2018. The Italy medical device tax represents variable consideration in the form of a retroactive discount potentially owed to the customer, which is ultimately the Italian government. The Company is challenging the imposition of the medical device tax in Italy, as have many other medical device companies, on the ground that the law was never implemented properly with regulations. While the Company is informed that its position is well-grounded in the law, there can be no assurance that the Company will prevail. In January 2023, the Italian government postponed the due date for payment of the tax to April 30, 2023, to allow time for Italian courts to rule on the constitutionality of the law. No amounts have been remitted to date.
From time to time, we are also subject to negligence and other claims arising out of the ordinary conduct of our business, including, for example, accidents our employees may experience within the course of their employment or otherwise. We are currently defending one such claim, which we expect to be fully covered by insurance, involving potentially significant personal injuries. The Company is unable to estimate any range of possible loss at this time, and therefore has not recorded any liability related to potential damages in connection with this matter.
We record reserves sufficient to cover probable and estimable losses associated with any such pending claims. We do not expect that the resolution of any pending claims, investigations or reports of alleged misconduct will have a material adverse effect on our financial condition, results of operations or cash flows. There can be no assurance, however, that future claims or investigations, or the costs associated with responding to such claims, investigations or reports of misconduct, especially claims and investigations not covered by insurance, will not have a material adverse effect on our financial condition, results of operations or cash flows.
Note 15 - Guarantees
We provide warranties on certain of our products at the time of sale and sell extended warranties. The standard warranty period for our capital equipment is generally one year and our extended warranties typically vary from one to three years. Liability under service and warranty policies is based upon a review of historical warranty and service claim experience. Adjustments are made to accruals as claim data and historical experience warrant.
Changes in the carrying amount of standard warranties for the years ended December 31, are as follows:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Balance as of January 1, | $ | 2,344 | | | $ | 1,826 | | | $ | 2,186 | |
| | | | | |
Provision for warranties | 224 | | | 1,458 | | | 783 | |
Claims made | (624) | | | (940) | | | (1,143) | |
| | | | | |
Balance as of December 31, | $ | 1,944 | | | $ | 2,344 | | | $ | 1,826 | |
Costs associated with extended warranty repairs are recorded as incurred and amounted to $5.9 million, $6.8 million and $6.1 million for the years ended December 31, 2022, 2021 and 2020 respectively.
Note 16 - Fair Value Measurement
We enter into derivative instruments for risk management purposes only. We operate internationally and, in the normal course of business, are exposed to fluctuations in interest rates, foreign exchange rates and commodity prices. These fluctuations can increase the costs of financing, investing and operating the business. We use forward contracts, a type of derivative instrument, to manage certain foreign currency exposures.
By nature, all financial instruments involve market and credit risks. We enter into forward contracts with major investment grade financial institutions and have policies to monitor the credit risk of those counterparties. While there can be no assurance, we do not anticipate any material non-performance by any of these counterparties.
Foreign Currency Forward Contracts. We hedge forecasted intercompany sales denominated in foreign currencies through the use of forward contracts. We account for these forward contracts as cash flow hedges. To the extent these forward contracts meet hedge accounting criteria, changes in their fair value are not included in current earnings but are included in accumulated other comprehensive loss. These changes in fair value will be recognized into earnings as a component of sales or cost of sales when the forecasted transaction occurs.
We also enter into forward contracts to exchange foreign currencies for United States dollars in order to hedge our currency transaction exposures. These forward contracts settle each month at month-end, at which time we enter into new forward contracts. We have not designated these forward contracts as hedges and have not applied hedge accounting to them.
The following table presents the notional contract amounts for forward contracts outstanding:
| | | | | | | | | | | | | | | | | |
| | | As of |
| FASB ASC Topic 815 Designation | | December 31, 2022 | | December 31, 2021 |
Forward exchange contracts | Cash flow hedge | | $ | 198,473 | | | $ | 172,894 | |
Forward exchange contracts | Non-designated | | 81,929 | | | 38,897 | |
The remaining time to maturity as of December 31, 2022 is within two years for hedge designated foreign exchange contracts and approximately one month for non-hedge designated forward exchange contracts.
Statement of comprehensive income (loss) presentation
Derivatives designated as cash flow hedges
Foreign exchange contracts designated as cash flow hedges had the following effects on accumulated other comprehensive income (loss) ("AOCI") and net earnings on our consolidated statements of comprehensive income (loss) and our consolidated balance sheets:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Amount of Gain (Loss) Recognized in AOCI | | Consolidated Statements of Comprehensive Income (Loss) | | Amount of Gain (Loss) Reclassified from AOCI |
| | Years Ended | | | | Total Amount of Line Item Presented | | Years Ended |
Derivative Instrument | | 2022 | 2021 | 2020 | | Location of amount reclassified | | 2022 | 2021 | 2020 | | 2022 | 2021 | 2020 |
| | | | | | | | | | | | | | |
Foreign exchange contracts | | $ | 14,494 | | $ | 8,650 | | $ | (7,111) | | | Net Sales | | $ | 1,045,472 | | $ | 1,010,635 | | $ | 862,459 | | | $ | 15,085 | | $ | (5,421) | | $ | 1,997 | |
| | | | | | Cost of Sales | | 474,227 | | 442,599 | | 402,159 | | | 939 | | 1,411 | | (619) | |
Pre-tax gain (loss) | | $ | 14,494 | | $ | 8,650 | | $ | (7,111) | | | | | | | | | $ | 16,024 | | $ | (4,010) | | $ | 1,378 | |
Tax expense (benefit) | | 3,513 | | 2,090 | | (1,718) | | | | | | | | | 3,884 | | (969) | | 333 | |
Net gain (loss) | | $ | 10,981 | | $ | 6,560 | | $ | (5,393) | | | | | | | | | $ | 12,140 | | $ | (3,041) | | $ | 1,045 | |
At December 31, 2022, $2.8 million of net unrealized gains on forward contracts accounted for as cash flow hedges, and included in accumulated other comprehensive loss, are expected to be recognized in earnings in the next twelve months.
Derivatives not designated as cash flow hedges
Net gains and losses from derivative instruments not accounted for as hedges offset by gains and losses on our intercompany receivables on our consolidated statements of comprehensive income (loss) were:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Years Ended |
Derivative Instrument | | Location on Consolidated Statements of Comprehensive Income (Loss) | | 2022 | | 2021 | | 2020 |
| | | | | | | | |
Net loss on currency forward contracts | | Selling and administrative expense | | $ | (240) | | | $ | (451) | | | $ | (2,269) | |
Net gain (loss) on currency transaction exposures | | Selling and administrative expense | | $ | (1,950) | | | $ | (1,832) | | | $ | 646 | |
Balance sheet presentation
We record these forward foreign exchange contracts at fair value. The following tables summarize the fair value for forward foreign exchange contracts outstanding at December 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2022 | Location on Consolidated Balance Sheet | | Asset Fair Value | | Liabilities Fair Value | | Net Fair Value |
Derivatives designated as hedging instruments: | | | | | | | |
Foreign exchange contracts | Prepaid expenses and other current assets | | $ | 6,757 | | | $ | (3,121) | | | $ | 3,636 | |
Foreign exchange contracts | Other long-term liabilities | | 60 | | | (400) | | | (340) | |
| | | $ | 6,817 | | | $ | (3,521) | | | $ | 3,296 | |
| | | | | | | |
Derivatives not designated as hedging instruments: | | | | | | | |
Foreign exchange contracts | Other current liabilities | | 48 | | | (395) | | | (347) | |
| | | | | | | |
Total derivatives | | | $ | 6,865 | | | $ | (3,916) | | | $ | 2,949 | |
| | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2021 | Location on Consolidated Balance Sheet | | Asset Fair Value | | Liabilities Fair Value | | Net Fair Value |
Derivatives designated as hedging instruments: | | | | | | | |
Foreign exchange contracts | Prepaid expenses and other current assets | | $ | 5,331 | | | $ | (430) | | | $ | 4,901 | |
Foreign exchange contracts | Other long-term liabilities | | 82 | | | (161) | | | (79) | |
| | | $ | 5,413 | | | $ | (591) | | | $ | 4,822 | |
| | | | | | | |
Derivatives not designated as hedging instruments: | | | | | | | |
Foreign exchange contracts | Other current liabilities | | 38 | | | (180) | | | (142) | |
| | | | | | | |
Total derivatives | | | $ | 5,451 | | | $ | (771) | | | $ | 4,680 | |
Our forward foreign exchange contracts are subject to a master netting agreement and qualify for netting in the consolidated balance sheets.
Fair Value Disclosure. FASB guidance defines fair value and establishes a framework for measuring fair value and related disclosure requirements. This guidance applies when fair value measurements are required or permitted. The guidance indicates, among other things, that a fair value measurement assumes that the transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. Fair value is defined based upon an exit price model.
Valuation Hierarchy. A valuation hierarchy was established for disclosure of the inputs to the valuations used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, including interest rates, yield curves and credit risks, or inputs that are derived principally from or corroborated by observable market data through correlation. Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. There have been no significant changes in the assumptions.
Valuation Techniques. Assets and liabilities carried at fair value and measured on a recurring basis as of December 31, 2022 consist of forward foreign exchange contracts. The Company values its forward foreign exchange contracts using quoted prices for similar assets. The most significant assumption is quoted currency rates. The value of the forward foreign exchange contract assets and liabilities were valued using Level 2 inputs and are listed in the table above. The Company values contingent consideration using Level 3 inputs. These include projected payment dates, discount rates, revenue volatilities, and projected revenues. The fair value of contingent consideration related to the In2Bones Acquisition increased to $70.2 million at December 31, 2022 from $69.4 million at the date of the acquisition and the fair value of contingent consideration related to the Biorez Acquisition increased to $116.2 million at December 31, 2022 from $114.5 million at the date of the acquisition. We recognized the $2.5 million fair value adjustments to contingent consideration in selling and administrative expense. These adjustments related to the passage of time and changes in market assumptions. Contingent consideration of $18.6 million and $167.8 million is included in other current liabilities and other long term liabilities, respectively, in the consolidated balance sheet at December 31, 2022.
The carrying amounts reported in our balance sheets for cash and cash equivalents, accounts receivable, accounts payable and variable long-term debt approximate fair value.