-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DthQL86WQKBaLDJM9LABKD9rVmWQjnRYxKLnyWmwVmPL3FdlHdbjfts0q4xg8vYf Whu2NoqvsRME9x8e6TWZgg== 0000914317-05-000930.txt : 20050316 0000914317-05-000930.hdr.sgml : 20050316 20050316130228 ACCESSION NUMBER: 0000914317-05-000930 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050316 DATE AS OF CHANGE: 20050316 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONMED CORP CENTRAL INDEX KEY: 0000816956 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 160977505 STATE OF INCORPORATION: NY FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-16093 FILM NUMBER: 05684354 BUSINESS ADDRESS: STREET 1: 525 FRENCH ROAD CITY: UTICA STATE: NY ZIP: 13502 BUSINESS PHONE: 3157978375 MAIL ADDRESS: STREET 1: 310 BROAD STREET STREET 2: 525 FRENCH ROAD CITY: UTICA STATE: NY ZIP: 13502 10-K 1 form10k-65888_conmed.txt ================================================================================ United States Securities and Exchange Commission Washington, D.C. 20549 Form 10-K Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 For the fiscal year ended December 31, 2004 Commission file number 0-16093 CONMED CORPORATION (Exact name of registrant as specified in its charter) New York 16-0977505 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 525 French Road, Utica, New York 13502 (Address of principal executive offices) (Zip Code) (315) 797-8375 Registrant's telephone number, including area code Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value per share (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_| The aggregate market value of the shares of the voting stock held by non-affiliates of the Registrant was approximately $815,443,701 based upon the closing price of the Company's common stock on the NASDAQ Stock Market, which was $27.40 on June 30, 2004. The number of shares of the Registrant's $0.01 par value common stock outstanding as of March 9, 2005 was 29,307,032. DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Definitive Proxy Statement or other informational filing for the 2005 Annual Meeting of Shareholders are incorporated by reference into Part III of this report. CONMED CORPORATION ANNUAL REPORT ON FORM 10-K FOR YEAR ENDED DECEMBER 31, 2004 TABLE OF CONTENTS Part I Page ---- Item 1. Business 2 Item 2. Properties 26 Item 3. Legal Proceedings 27 Item 4. Submission of Matters to a Vote of Security Holders 27 Part II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 28 Item 6. Selected Financial Data 29 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 31 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 45 Item 8. Financial Statements and Supplementary Data 46 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure 46 Item 9A. Controls and Procedures 46 Item 9B Other Information 46 Part III Item 10. Directors and Executive Officers of the Registrant 47 Item 11. Executive Compensation 47 Item 12. Security Ownership of Certain Beneficial Owners and Management 47 Item 13. Certain Relationships and Related Transactions 47 Item 14. Principal Accounting Fees and Services 47 Part IV Item 15. Exhibits and Financial Statement Schedules 48 -1- CONMED CORPORATION Item 1. Business Forward Looking Statements This Annual Report on Form 10-K for the Fiscal Year Ended December 31, 2004 ("Form 10-K") contains certain forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) and information relating to CONMED Corporation ("CONMED", the "Company", "we" or "us" -- references to "CONMED", the "Company", "we" or "us" shall be deemed to include our direct and indirect subsidiaries unless the context otherwise requires) which are based on the beliefs of our management, as well as assumptions made by and information currently available to our management. When used in this Form 10-K, the words "estimate," "project," "believe," "anticipate," "intend," "expect" and similar expressions are intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, including those identified under the caption "Item 1: Business -- Risk Factors" and elsewhere in this Form 10-K which may cause our actual results, performance or achievements, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: o general economic and business conditions; o cyclical customer purchasing patterns due to budgetary and other constraints; o changes in customer preferences; o competition; o changes in technology; o the introduction and acceptance of new products; o the ability to evaluate, finance and integrate acquired businesses, products and companies; o changes in business strategy; o the possibility that United States or foreign regulatory and/or administrative agencies may initiate enforcement actions against us or our distributors; o future levels of indebtedness and capital spending; o quality of our management and business abilities and the judgment of our personnel; o the availability, terms and deployment of capital; o the risk of litigation, especially patent litigation as well as the cost associated with patent and other litigation; o changes in regulatory requirements; and o various other factors referenced in this Form 10-K. See "Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 1-Business" for a further discussion of these factors. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We do not undertake any obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events. -2- General CONMED Corporation was incorporated under the laws of the State of New York in 1970 by Eugene R. Corasanti, the Company's founder, Chairman of the Board and Chief Executive Officer. CONMED is a medical technology company specializing in instruments, implants and video equipment for arthroscopic sports medicine and powered surgical instruments, such as drills and saws, for orthopedic, otolaryngologic ("ENT"), neurosurgery and other surgical specialties. We are a leading developer, manufacturer and supplier of radio frequency ("RF") electrosurgery systems used routinely to cut and cauterize tissue in nearly all types of surgical procedures worldwide, endosurgery products such as trocars, clip appliers, scissors and surgical staplers and a full line of electrocardiogram ("ECG") electrodes for heart monitoring and other patient care products. We also offer integrated operating room systems and equipment. Our newest product line, CONMED Endoscopic Technologies offers a portfolio of innovative disposable products used by gastroenterologists to diagnose and treat diseases of the digestive tract. Our products are used in a variety of clinical settings, such as operating rooms, surgery centers, physicians' offices and hospitals. See Note 9 to the Consolidated Financial Statements for further discussion of our principal operating units. We have historically used strategic business acquisitions and exclusive distribution relationships to diversify our product offerings, increase our market share in certain product lines, realize economies of scale and take advantage of growth opportunities in the healthcare field. During the last five years, we have completed eleven strategic business acquisitions. These acquisitions, complemented by internal growth, have resulted in a compound annual growth rate in net sales during that period of approximately 7%. We are committed to offering products with the highest standards of quality, technological excellence and customer service. Substantially all of our facilities have attained certification under the ISO international quality standards and other domestic and international quality accreditations. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports are accessible free of charge through the Investor Relations section of our website (http://www.conmed.com) as soon as practicable after such material has been electronically filed with, or furnished to, the United States Securities and Exchange Commission. Industry Market growth for our products is primarily driven by: o Favorable Demographics. The number of surgical procedures performed is increasing. This growth in surgical procedures reflects demographic trends, such as the aging of the population, and technological advancements, which result in safer and less invasive surgical procedures. Additionally, as people are living longer, more active lives, they are engaging in contact sports and activities such as running, skiing, rollerblading, golf and tennis which result in injuries with greater frequency and at an earlier age than ever before. Sales of surgical products aggregated approximately 90% of our total net revenues in 2004. See "Products." o Continued Pressure to Reduce Health Care Costs. In response to rising health care costs, managed care companies and other third-party payers -3- have placed pressures on health care providers to reduce costs. As a result, health care providers have focused on the high cost areas such as surgery. To reduce costs, health care providers use minimally invasive techniques, which generally reduce patient trauma, recovery time and ultimately the length of hospitalization. Approximately 50% of our products are designed for use in minimally invasive surgical procedures. See "Products." Health care providers are also increasingly purchasing single-use, disposable products, which reduce the costs associated with sterilizing surgical instruments and products following surgery. The single-use nature of disposable products lowers the risk of incorrectly sterilized instruments spreading infection into the patient and increasing the cost of post-operative care. Approximately 75% of our sales are derived from single-use disposable products. In the United States, the pressure on health care providers to contain costs has caused many health care providers to enter into comprehensive purchasing contracts with fewer suppliers, which offer a broader array of products at lower prices. In addition, many health care providers have aligned themselves with Group Purchasing Organizations ("GPOs") or Integrated Health Networks ("IHNs"), whose stated purpose is to aggregate the purchasing volume of their members in order to negotiate competitive pricing with suppliers, including manufacturers of surgical products. We believe that these trends will favor entities which offer a diverse product portfolio. See "--Business Strategy". o Increased Global Medical Spending. We believe that foreign markets offer significant growth opportunities for our products. We currently distribute our products through our own sales subsidiaries or through local dealers in over 100 foreign countries. Competitive Strengths Management believes that we hold a significant market share position in each of our key product areas including, Arthroscopy, Powered Surgical Instruments, Electrosurgery, Patient Care, Endosurgery and Endoscopic Technologies. We have established a leadership position in the marketplace by capitalizing on the following competitive strengths: o Brand Recognition. Our products are marketed under leading brand names, including CONMED(R), Linvatec(R) and Hall Surgical(R). These brand names are recognized by physicians and healthcare professionals for quality and service. It is our belief that brand recognition facilitates increased demand for our products in the marketplace, enables us to build upon the brand's associated reputation for quality and service, and realize increased market acceptance of new branded products. o Breadth of Product Offering. The breadth of our product lines in our key product areas enables us to meet a wide range of customer requirements and preferences. This has enhanced our ability to market our products to surgeons, hospitals, surgery centers, GPOs, IHNs and other customers, particularly as institutions seek to reduce costs and minimize the number of suppliers. o Successful Integration of Acquisitions. We seek to build growth platforms around our core markets through focused acquisitions of complementary businesses and product lines. During the last five years we have -4- completed eleven such acquisitions. These acquisitions have enabled us to diversify our product portfolio, expand our sales and marketing capabilities and strengthen our presence in key geographical markets. Our management team has historically demonstrated their ability to identify complementary acquisitions and successfully integrate acquired businesses and product lines into our operations. o Strategic Marketing and Distribution Channels. We market our products domestically through five focused sales force groups consisting of approximately 170 employee sales representatives and 230 sales professionals employed by independent sales agent groups. Each of our dedicated sales professionals are highly knowledgeable in the applications and procedures for the products they sell. Our sales representatives foster close professional relationships with physicians, surgeons, hospitals, outpatient surgery centers and physicians' offices. Additionally, we maintain a global presence through sales subsidiaries and branches located in key international markets. We directly service hospital customers located in these markets through an employee-based international sales force of approximately 60 sales representatives. We also maintain distributor relationships domestically and in numerous countries worldwide. See "--Marketing." o Operational Improvements and Manufacturing. We are focused on continuously improving our supply chain effectiveness, strengthening our manufacturing processes and optimizing our plant network to increase operational efficiencies within the organization. Substantially all of our products are manufactured and assembled from components we produce. Our strategy has historically been to vertically integrate our manufacturing facilities in order to develop competitive advantage. This integration provides us with cost efficient and flexible manufacturing operations which permit us to allocate capital more efficiently. Additionally, we attempt to exploit commercial synergies between operations, such as the procurement of common raw materials and components used in production. o Technological Leadership. Research and development efforts are closely aligned with our key business objectives, namely developing and improving products and processes, applying innovative technology to the manufacture of products for new global markets and reducing the cost of producing core products. These efforts are evidenced by recent product introductions, including the following: Advantage(R) Turbo Arthroscopic Shaver System; PINN-ACL(R) cross pin device; Lightwave(TM) suction ablator; PowerProMax(TM) powered instrument handpieces, batteries and attachments; ThRevo(TM) triple-loaded suture anchor; and SuperRevo(R)/Bio-Anchor(R)/Duet(TM)/Impact(TM) suture anchors pre-threaded with Herculine(TM). Business Strategy Our principal objectives are to improve the quality of surgical outcomes and patient care through the development of innovative medical devices, refinement of existing products and development of new technologies which reduce risk, trauma, cost and procedure time. We believe that by meeting these objectives we will enhance our ability to anticipate and adapt to customer needs and market opportunities, and provide shareholders with superior investment -5- returns. We intend to achieve future growth and earnings development through the following initiatives: o Introduction of New Products and Product Enhancements. We continually pursue organic growth through the development of new products and enhancements to existing products. We seek to develop new technologies which improve the durability, performance and usability of existing products. In addition to our internal research and development efforts, we receive new ideas for products and technologies, particularly in procedure-specific areas, from surgeons, inventors and other healthcare professionals. o Pursue Strategic Acquisitions. We pursue strategic acquisitions in existing and new growth markets to achieve increased operating efficiencies, geographic diversification and market penetration. Targeted companies have historically included those with proven technologies and established brand names which provide potential sales, marketing and manufacturing synergies. o Realize Manufacturing and Operating Efficiencies. We continually review our production systems for opportunities to reduce operating costs, consolidate product lines or identical process flows, reduce inventory requirements and optimize existing processes. Our vertically integrated manufacturing facilities allow for further opportunities to reduce overhead, increase operating efficiencies and capacity utilization. o Geographic Diversification. We believe that significant growth opportunities exist for our surgical products outside the United States. Principal foreign markets for our products include Europe, Latin America and Asia/Pacific Rim. Critical elements of our future sales growth in these markets include leveraging our existing relationships with foreign surgeons, hospitals, third-party payers and foreign distributors, maintaining an appropriate presence in emerging market countries and continually evaluating our routes-to-market. o Active Participation In The Medical Community. We believe that excellent working relationships with physicians and others in the medical industry enable us to gain an understanding of new therapeutic and diagnostic alternatives, trends and emerging opportunities. Active participation allows us to quickly respond to the changing needs of physicians and patients. -6- Products The following table sets forth the percentage of net sales for each of our product lines during each of the three years ended December 31: Year Ended December 31, ----------------------- 2002 2003 2004 ---- ---- ---- Arthroscopy ....................... 36% 37% 37% Powered Surgical Instruments ...... 25 25 23 Electrosurgery .................... 15 15 15 Patient Care ...................... 16 14 14 Endosurgery ....................... 8 9 8 Endoscopic Technologies ........... -- -- 3 -------- -------- -------- Total ........................... 100% 100% 100% ======== ======== ======== Net Sales (in thousands) .......... $453,062 $497,130 $558,388 ======== ======== ======== Arthroscopy We offer a comprehensive range of devices and products for use in arthroscopic surgery. Arthroscopy refers to diagnostic and therapeutic surgical procedures performed on joints with the use of minimally invasive arthroscopes and related instruments. Minimally invasive arthroscopic procedures enable surgical repairs to be completed with less trauma to the patient, resulting in shorter recovery times and cost savings. Arthroscopic procedures are performed on the knee and shoulder, and smaller joints, such as the wrist and ankle. Our arthroscopy products include powered resection instruments, arthroscopes, reconstructive systems, tissue repair sets, metal and bioabsorbable implants and related disposable products, fluid management systems, imaging products and integrated operating room systems and equipment. It is our standard practice to transfer some of these products, such as shaver consoles and pumps, to certain customers at no charge. These capital "placements" allow for and accommodate the use of a variety of disposable products, such as shaver blades, burs and pump tubing. We have benefited from the introduction of new arthroscopic products and technologies, such as bioabsorbable screws, ablators, "push-in" and "screw-in" suture anchors, resection shavers and cartilage repair implants. A significant portion of arthroscopic procedures are performed to repair injuries which have occurred in the joint areas of the body. Many of these injuries are the result of sports related events or similar traumas. For this reason, arthroscopy is often referred to as "sports medicine."
- --------------------------------------------------------------------------------------------------------------- Arthroscopy - --------------------------------------------------------------------------------------------------------------- Product Description Brand Name - --------------------------------------------------------------------------------------------------------------- Ablators and Shaver Ablators Electrosurgical ablators and resection ablators to Advantage(R) resect and remove soft tissue and bone; used in knee, ESA(TM) shoulder and small joint surgery. Sterling(R) UltrAblator(R) Lightwave(TM) Trident(R)
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- --------------------------------------------------------------------------------------------------------------- Arthroscopy - --------------------------------------------------------------------------------------------------------------- Product Description Brand Name - --------------------------------------------------------------------------------------------------------------- Knee Reconstructive Systems Products used in cruciate reconstructive surgery; Paramax(R) includes instrumentation, screws, pins and ligament Pinn-ACL(R) harvesting and preparation devices. Grafix(R) Soft Tissue Repair Systems Instrument systems designed to attach specific torn Spectrum(R) or damaged soft tissue to bone or other soft tissue Inteq(R) in the knee, shoulder and wrist; includes Shuttle Relay(TM) instrumentation, guides, hooks and suture devices. Blitz(R) Fluid Management Systems Disposable tubing sets, disposable and reusable Apex(R) inflow devices, pumps and suction/waste management Quick-Flow(R) systems for use in arthroscopic and general surgeries. Quick-Connect(R) Imaging Surgical video systems for endoscopic procedures; Apex(R) includes autoclavable single and three-chip camera 8180 Series heads and consoles, endoscopes, light sources, Envision(TM) monitors, VCRs and printers. Autoclavable Three Chip Camera Head Implants Products including bioabsorbable and metal screws, BioScrew(TM) pins and suture anchors for attaching soft tissue to Bio-Anchor(R) bone in the knee, shoulder and wrist as well as BioTwist(R) miniscal repair. UltraFix(R) Revo(R) Super Revo(R) Bionx(TM) Meniscus Arrow(TM) Integrated operating room Centralized operating room management and control CONMED(R) systems and equipment systems, service arms and service managers. Nurse's Assistant(R) Other Instruments and Forceps, graspers, punches, probes, sterilization Shutt(R) Accessories cases and other general instruments for arthroscopic Concept(R) procedures. TractionTower(R) - ---------------------------------------------------------------------------------------------------------------
Powered Surgical Instruments Electric, battery or pneumatic powered surgical instruments are used to perform orthopedic, arthroscopic and other surgical procedures, such as cutting, drilling or reaming. Each instrument consists of one or more handpieces and related accessories as well as disposable and limited reusable items (e.g., burs, saw blades, drills and reamers). Powered instruments are categorized as either -8- small bone, large bone or specialty powered instruments. Specialty powered instruments are utilized in procedures such as spinal surgery, neurosurgery, ENT, oral/maxillofacial surgery, and cardiothoracic surgery. Our line of powered instruments is sold principally under the Hall(R) Surgical brand name, for use in large and small bone orthopedic, arthroscopic, oral/maxillofacial, podiatric, plastic, ENT, neurological, spinal and cardiothoracic surgeries. Large bone, neurosurgical, spinal and cardiothoracic powered instruments are sold primarily to hospitals while small bone arthroscopic, otolaryngological and oral/maxillofacial powered instruments are sold to hospitals, outpatient facilities and physicians' offices. Our CONMED Linvatec subsidiary has devoted significant resources in the development of new technologies for large bone, small bone, arthroscopic, neurosurgical, spine and otolaryngological instruments which may be easily adapted and modified for new procedures. Our powered instruments product line also includes the PowerPro(R) Battery System. This full function orthopedic power system is specifically designed to meet the requirements of most orthopedic applications. The PowerPro(R) Battery System has a SureCharge(TM) option which allows the user to sterilize the battery before charging. This ensures that the battery will be fully charged when delivered to the operating room, unlike competitive battery systems currently available on the market. The PowerPro(R) uses a proprietary process for maintaining sterility during charging, thus avoiding the loss of battery charge during sterilization, which frequently results in competing battery systems.
- ------------------------------------------------------------------------------------------------------------ Powered Surgical Instruments - ------------------------------------------------------------------------------------------------------------ Product Description Brand Name - ------------------------------------------------------------------------------------------------------------ Hall(R) Surgical Large Bone Powered saws, drills and related disposable MaxiDriver(TM) accessories for use primarily in total knee and hip VersiPower(R) Plus joint replacements and trauma surgical procedures. Series 4(R) PowerPro(R) Advantage(R) SureCharge(R) Small Bone Powered saws, drills and related disposable Hall(R) Surgical accessories for small bone and joint related surgical E9000(R) procedures. MiniDriver(TM) MicroChoice(R) Micro 100(TM) Advantage(R) Otolaryngology Specialty powered saws, drills and related disposable Hall(R) Surgical Neurosurgery accessories for use in neurosurgery, spine, and E9000(R) Spine otolaryngologic procedures. UltraPower(R) Hall Osteon(R) Hall Ototome(R) Cardiothoracic Powered sternum saws, drills, and related disposable Hall(R) Surgical Oral/maxillofacial accessories for use by cardiothoracic and E9000(R) oral/maxillofacial surgeons. UltraPower(R) Micro 100TM VersiPower(R) Plus - ------------------------------------------------------------------------------------------------------------
-9- Electrosurgery Electrosurgery is a technique of using high-frequency electrical energy which, when applied to tissues through special instruments, may be used to cut or coagulate tissues. Radio frequency ("RF") is the form of high-frequency electrical energy used in electrosurgery. An electrosurgical system consists of a generator, an active electrode in the form of an electrosurgical pencil used to apply concentrated energy from the generator to the target tissues and a ground pad which returns the energy safely to the generator. Electrosurgery is routinely used in most forms of surgery, including general, dermatologic, thoracic, orthopedic, urologic, neurosurgical, gynecological, laparoscopic, arthroscopic and endoscopic procedures. Our electrosurgical products include electrosurgical pencils and active electrodes, ground pads, generators, the Argon-Beam Coagulation system (ABC(R)), and related disposable products. ABC(R) technology is a special method of electrosurgery, which produces a faster and more superficial coagulation of tissues as compared to conventional electrosurgery. Unlike conventional electrosurgery, the electrical energy travels through an ionized column of argon gas, allowing the energy to be applied to the bleeding tissues in a completely non-contact mode. Clinicians have reported notable benefits of ABC(R) over traditional electrosurgical coagulation in certain clinical situations, including open-heart, liver, oncology and trauma surgery.
- --------------------------------------------------------------------------------------------------------------- Electrosurgery - --------------------------------------------------------------------------------------------------------------- Product Description Brand Name - --------------------------------------------------------------------------------------------------------------- Pencils Disposable and reusable surgical instruments designed Hand-Trol(R) to deliver high-frequency electrical energy to cut GoldLine(TM) and/or coagulate tissue. ClearVac(R) Ground Pads Disposable ground pads which disperse electrosurgical MacroLyte(R) energy and safely return it to the generator; ThermoGard(R) available in adult, pediatric and infant sizes. SureFit(TM) DiaTemp(TM) Active Electrodes Surgical accessory electrodes with UltraClean(R) and without the proprietory UltraClean(TM) Stealth(R) coating which provides an easy to clean electrode surface during surgery. Generators Monopolar and bipolar clinical energy sources for EXCALIBUR Plus PC(R) surgical procedures performed in a hospital, SABRE(R) physicians' office or clinical setting. System 5000(TM) System 2500(TM) Hyfrecator(R) 2000 Argon Beam Specialized electrosurgical generators, disposable ABC(R) Coagulation Systems hand pieces and ground pads for Argon Enhanced Beamer Plus(R) non-contact coagulation of tissues. System 7500(R) ABC Flex(R) Bend-A-Beam(R) - ---------------------------------------------------------------------------------------------------------------
-10- Patient Care We manufacture a variety of patient care products for use in monitoring cardiac rhythms, wound care management and intravenous ("IV") therapy. These products include ECG electrodes and cables, wound dressings and catheter stabilization dressings. Our patient care product line also includes disposable surgical suction instruments and connecting tubing. Sales are primarily derived from the distribution of ECG electrodes, surgical suction instruments and tubing. Although wound management and IV therapy product sales are comparatively small, the application of these products in the operating room complements our surgical product offerings. In January 2004, we announced an agreement with Dolphin Medical, Inc., a subsidiary of OSI Systems, Inc., under which we became the exclusive North American distributor for a full line of Dolphin(R) pulse oximetry products.
- ------------------------------------------------------------------------------------------------------------ Patient Care - ------------------------------------------------------------------------------------------------------------ Product Description Brand Name - ------------------------------------------------------------------------------------------------------------ ECG Monitoring Line of disposable electrodes, CONMED(R) monitoring cables, lead wire products and Ultratrace(R) accessories designed to transmit ECG signals Cleartrace(R) from the heart to an ECG monitor or recorder. Wound Care Disposable transparent wound dressings ClearSite(R) comprising proprietary hydrogel; able to absorb Hydrogauze(TM) 2 1/2 times its weight in wound exudate. Patient Positioners Products which properly and safely Airsoft(R) position patients while in surgery. Surgical Suction Disposable surgical suction instruments and CONMED(R) Instruments and connecting tubing, including Yankauer, Poole, Tubing Frazier and Sigmoidoscopic instrumentation, for use by physicians in the majority of open surgical procedures. Intravenous Therapy Disposable IV drip rate gravity VENI-GARD(R) controller and disposable catheter MasterFlow(R) stabilization dressing designed to hold and Stat 2(R) secure an IV needle or catheter for use in IV therapy. Defibrillator Pads Stimulation electrodes for use in emergency cardiac PadPro(R) and Accessories response and conduction studies of the heart. Pulse Oximetry Used in critical care to continuously Dolphin(R) monitor a patient's arterial blood oxygen (a registered saturation and pulse rate. trademark of Dolphin Medical, Inc.) - ------------------------------------------------------------------------------------------------------------
-11- Endosurgery Endoscopic surgery (also referred to as Endosurgery or Laparoscopic surgery) is surgery performed without a major incision. This surgical specialty results in less trauma for the patient and produces important cost savings as a result of shorter recovery times and reduced hospitalization. Endoscopic surgery is performed on organs in the abdominal cavity such as the gallbladder, appendix and female reproductive organs. During such procedures, devices called "trocars" are used to puncture the abdominal wall and are then removed, leaving in place a trocar cannula. The trocar cannula provides access into the abdomen for camera systems and surgical instruments. Some of our endosurgical instruments are "reposable", meaning that the instrument has a disposable and a reusable component. Our Endosurgical products include the Reflex(R) clip applier for vessel and duct ligation, Universal S/ITM (suction/irrigation) and Universal Plus(TM) laparoscopic instruments, specialized suction/irrigation electrosurgical instrument systems for use in laparoscopic surgery and the TroGard Finesse(R) which incorporates a blunt-tipped version of a trocar. The TroGard Finesse(R) dilates access through the body wall rather than cutting with the sharp, pointed tips of conventional trocars thus resulting in smaller wounds, and less bleeding. We also offer cutting trocars, suction/irrigation accessories, laparoscopic scissors, active electrodes, insufflation needles, linear cutters and staplers, and ABC(R) handpieces for use in laparoscopic surgery. Our disposable skin staplers are used to close large skin incisions with surgical staples, thus eliminating the time consuming suturing process.
- ------------------------------------------------------------------------------------------------------------- Endosurgery - ------------------------------------------------------------------------------------------------------------- Product Description Brand Name - ------------------------------------------------------------------------------------------------------------- Trocars Disposable and reposable devices used to TroGard Finesse(R) puncture the abdominal wall providing access Reflex(R) to the abdominal cavity for camera systems and Detach a Port(R) instruments. OnePort(R) Multi-functional Instruments for cutting and coagulating tissue Universal(TM) Electrosurgery and by delivering high-frequency current. Universal Plus(TM) Suction/Irrigation Instruments which deliver irrigating fluid to FloVac(R) instruments the tissue and remove blood and fluids from the internal operating field. Clip Appliers Disposable and reposable devices for Reflex(R) ligating blood vessels and ducts by placing a PermaClip(TM) titanium clip on the vessel. Laparoscopic Scissors, graspers DetachaTip(R) Instruments Skin Staplers Disposable devices which place Reflex(R) surgical staples for closing a surgical incision.
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- ------------------------------------------------------------------------------------------------------------- Endosurgery - ------------------------------------------------------------------------------------------------------------- Product Description Brand Name - ------------------------------------------------------------------------------------------------------------- Microlaparoscopy Small laparoscopes and instruments for MicroLap(R) scopes and performing surgery through very small instruments incisions. - -------------------------------------------------------------------------------------------------------------
Endoscopic Technologies Gastrointestinal (GI) endoscopy is the examination of the digestive tract with a flexible, lighted instrument referred to as an "endoscope". This instrument enables the physician to directly visualize the esophagus, stomach, portions of the small intestine, and colon. This technology allows the physician to more accurately diagnose and treat diseases of the digestive system. Through these scopes a physician may take biopsies, dilate narrowed areas referred to as strictures, and remove polyps which are growths in the digestive tract. Some of the more common conditions which may be diagnosed and treated using this procedure include gastro-esophageal reflux disease (GERD), ulcers, Crohn's disease, ulcerative colitis and gallbladder disease. We offer a comprehensive line of minimally invasive diagnostic and therapeutic products used in conjunction with procedures which require flexible endoscopy. Our principal customers include GI endoscopists, pulmonologists, surgeons, and nurses which perform both diagnostic and therapeutic endoscopic procedures in hospitals and outpatient clinics. Our primary focus is to identify, develop, acquire, manufacture and market differentiated medical devices, which improve outcomes in the diagnosis and treatment of gastrointestinal and pulmonary disorders. Our diagnostic and therapeutic product offerings for GI and pulmonology include forceps, accessories, bronchoscopy devices, dilatation, hemostasis, biliary devices, and polypectomy.
- ------------------------------------------------------------------------------------------------------------ Endoscopic Technologies - ------------------------------------------------------------------------------------------------------------ Product Description Brand Name - ------------------------------------------------------------------------------------------------------------ Pulmonary Transbronchial Cytology and Histology Aspiration WANG(TM) Needles, Disposable Biopsy Forceps, Cytology Brushes, Blue Bullet(R) and Bronchoscope Cleaning Brushes Precisor BRONCHO(R) GARG(TM) Biopsy Disposable biopsy forceps, Percutaneous Liver Biopsy Precisor(R) instrument, Disposable Cytology Brushes HepaCore(TM) Polypectomy Disposable Polypectomy Snares Singular(R) Optimizer(R)
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- ------------------------------------------------------------------------------------------------------------ Endoscopic Technologies - ------------------------------------------------------------------------------------------------------------ Product Description Brand Name - ------------------------------------------------------------------------------------------------------------ Biliary Triple Lumen Stone Removal Balloons, Advanced Apollo(TM) Cannulation Triple Lumen Papillotomes, High Apollo3(TM) Performance Biliary Guidewires, Cannulas, Biliary Apollo3AC(TM) Balloon Dilators, Plastic and Metal Endoscopic XWire(TM) Biliary Stents DirecXion(TM) Director(TM) Duraglide(TM) Duraglide 3(TM) ProForma(R) HYDRODUCT(R) Dilation Multi-Stage Balloon Dilators, American Dilation System Eliminator(R) Hemostasis Endoscopic Injection Needles, Endoscope Ligator, SureShot(R) Multiple Band Ligator, Sclerotherapy Needle, Bipolar Stiegmann-Goff(TM) Hemostasis Probes Bandito(TM) RapidFire(R) Flexitip(TM) BICAP(R) Accessories Disposable Bite Blocks, Cleaning Brushes Scope Saver(TM) Channel Master(TM) Blue Bullet(R) - ------------------------------------------------------------------------------------------------------------
Marketing A significant portion of our products are distributed domestically directly to more than 6,000 hospitals and other healthcare institutions as well as through medical specialty distributors and surgeons. We are not dependent on any single customer and no single customer accounted for more than 10% of our net sales in 2002, 2003 and 2004. A significant portion of our U.S. sales are to customers affiliated with GPOs, IHNs and other large national or regional accounts, as well as to the Veterans Administration and other hospitals operated by the Federal government. For hospital inventory management purposes, some of our customers prefer to purchase our products through independent third-party medical product distributors. In order to provide a high level of expertise to the medical specialties we serve, our domestic sales force consists of the following: o 230 sales representatives selling arthroscopy and powered surgical instrument products employed by independent sales agent groups; o 60 employee sales representatives selling electrosurgery products; o 30 employee sales representatives selling endosurgery products; o 30 employee sales representatives selling patient care products; o 50 employee sales representatives selling endoscopic technologies products. Each employee sales representative is assigned a defined geographic area and compensated on a commission basis or through a combination of salary and -14- commission. The sales force is supervised and supported by either area directors or district managers. Sales agent groups are used in the United States to sell our arthroscopy, multi-specialty medical video systems and powered surgical instrument products. These sales agent groups are paid a commission for sales made to customers while home office sales and marketing management provide the overall direction for sales of our products. Our Corporate sales organization is responsible for interacting with large regional and national accounts (eg. GPOs, IHNs, IDNs, etc.). We have contracts with many such organizations and believe that, with certain exceptions, the lack of any individual group purchasing contract will not adversely impact our competitiveness in the marketplace. In addition, all of our sales professionals are required to work closely with distributors where applicable and maintain close relationships with end-users. The sale of our products is accompanied by initial and ongoing in-service end-user training. Each of our dedicated sales professionals are highly knowledgeable in the applications and procedures for the products they sell. Our sales professionals, in turn, provide surgeons and medical personnel with information relating to the technical features and benefits of our products. Maintaining and expanding our international presence is an important component of our long-term growth plan. Our products are sold in over 100 foreign countries. International sales efforts are coordinated through local country dealers or through direct in country sales. We distribute our products through sales subsidiaries and branches with offices located in Australia, Austria, Belgium, Canada, France, Germany, Korea, the Netherlands, Spain, and the United Kingdom. In these countries, our sales are denominated in the local currency. In the remaining countries where our products are sold through independent distributors, sales are denominated in United States dollars. We sell to a diversified base of customers around the world and, therefore, believe there is no material concentration of credit risk. Manufacturing We manufacture substantially all of our products and assemble them from components we produce. Our strategy has historically been to vertically integrate our manufacturing facilities in order to develop competitive advantage. This integration provides us with cost efficient and flexible manufacturing operations which permit us to allocate capital more efficiently. Additionally, we attempt to exploit commercial synergies between operations, such as the procurement of common raw materials and components used in production. Raw material costs constitute a substantial portion of our cash cost of production. We use numerous raw materials and components in the design, development and manufacturing of our products. Substantially all of our raw materials and select components used in the manufacturing process are procured from external suppliers. We work closely with multiple suppliers to ensure continuity of supply while maintaining high quality and reliability. None of our critical raw materials and components are procured from single sources for reasons of quality assurance, sole source availability, cost effectiveness or constraints resulting from regulatory requirements. The loss of any existing supplier or supplier contract would not have a material adverse effect on our financial and operational performance. To date, we have not experienced any protracted interruption in the -15- availability of raw materials and components necessary to fulfill production schedules or substantial increases in their costs. All of our products are classified as medical devices subject to regulation by numerous agencies and legislative bodies, including the United States Food and Drug Administration ("FDA") and comparable foreign counter parts. The FDA's Quality System Regulations set forth standards for our product design and manufacturing processes, require the maintenance of certain records and provide for on-site inspections of our facilities by the FDA. In many of the foreign countries in which we manufacture and distribute our products we are subject to regulatory requirements affecting, among other things, product standards, packaging requirements, labeling requirements and import laws. Regulatory requirements affecting the Company vary from country to country. The timeframes for regulatory submission and approval from foreign agencies or legislative bodies may vary from those required by the FDA. Certain requirements for approval from foreign agencies or legislative bodies may also differ from those of the FDA . We believe that our production and inventory management practices are characteristic of those in the medical device industry. Substantially all of our products are stocked in inventory and are not manufactured to order or individual customer specifications. We schedule production and maintain adequate levels of safety stock based on a number of factors including, experience, knowledge of customer ordering patterns, demand, manufacturing lead times and optimal quantities required to maintain the highest possible service levels. Customer orders are generally processed for immediate shipment and backlog of firm orders is therefore not considered material to an understanding of our business. Research and Development New and improved products play a critical role in our continued sales growth. Internal research and development efforts focus on the development of new products and product technological and design improvements aimed at complementing and expanding existing product lines. We continually seek to leverage new technologies which improve the durability, performance and usability of existing products. In addition, we maintain close working relationships with surgeons, inventors and operating room personnel who often make new product and technology disclosures, principally in procedure-specific areas. For clinical and commercially promising disclosures, we seek to obtain rights to these ideas through negotiated agreements. Such agreements typically compensate the originator through royalty payments based upon a percentage of licensed product net sales. Royalty expense approximated $2.9 million, $3.5 million and $3.8 million in 2002, 2003 and 2004, respectively. Amounts expended for Company sponsored research and development was approximately $16.1 million, $17.3 million and $20.2 million during 2002, 2003, and 2004, respectively. We have rights to significant intellectual property, including United States patents and foreign equivalent patents which cover a wide range of our products. We own a majority of these patents and have exclusive and non-exclusive licensing rights to the remainder. In addition, certain of these patents have currently been licensed to third parties on a non-exclusive basis. We believe that the development of new products and technological and design improvements to existing products will continue to be of primary importance in maintaining our competitive position. -16- Competition The market for our products is highly competitive and our customers generally have numerous alternatives of supply. Many of our competitors offer a range of products in areas other than those in which we compete, which may make such competitors more attractive to surgeons, hospitals, group purchasing organizations and others. In addition, several of our competitors are large, technically-competent firms with substantial assets. The following chart identifies our principal competitors in each of our key business areas: Business Area Competitor ------------- ---------- Arthroscopy Smith & Nephew, plc Arthrex, Inc. Stryker Corporation ArthroCare Corporation Johnson & Johnson; Mitek Worldwide Powered Surgical Stryker Corporation Instruments Medtronic, Inc. Midas Rex and Xomed divisions The Anspach Effort, Inc. MicroAire Surgical Instruments, LLC Electrosurgery Tyco International Ltd.; Valleylab 3M Company ERBE Elektromedizin GmbH Patient Care Tyco International Ltd.; Kendall 3M Company Endosurgery Johnson & Johnson; Ethicon Endo-Surgery, Inc. Tyco International Ltd.; U.S.Surgical Endoscopic Technologies Boston Scientific Corporation - Endoscopy Wilson-Cook Medical, Inc. Olympus America, Inc. U.S. Endoscopy Factors which affect our competitive posture include product design, customer acceptance, service and delivery capabilities, pricing and product development/improvement. In the future, other alternatives such as new medical procedures or pharmaceuticals may become interchangeable alternatives to our products. Government Regulation and Quality Systems Substantially all of our products are classified as medical devices subject to regulation by numerous agencies and legislative bodies, including the FDA and comparable foreign counter parts. Authorization to commercially distribute our products in the U.S. is granted by the FDA under a procedure referred to as 510(k) premarket notification. This process requires us to demonstrate that our new product, line extension or modified product is substantially equivalent to a -17- legally marketed device which was on the market prior to May 28, 1976 or is currently on the U.S. market and does not require premarket approval. Substantially all of our products have been classified as either Class I or Class II devices with the FDA, indicating that they are subject to the 510(k) premarketing notification clearance as discussed above and must continually meet certain FDA standards (Our products are classified as Class I, II and III in the European Union (EU) and subject to regulation by our European Notified Body). None of our medical devices are included in a category for which the FDA requires a premarket approval whereby we would be tasked with independently demonstrating from clinical data that our new medical device is safe and effective. Our FDA clearance is subject to continual review and future discovery of previously unknown events could result in restrictions being placed on a product's marketing or notification from the FDA to halt the distribution of certain medical devices. Products marketed in the EU and other countries require preparation of technical files and dossiers which demonstrate compliance with applicable local regulations. Our operations have quality assurance/regulatory compliance groups which have been tasked with monitoring compliance with design specifications and relevant government regulations for all of our products and quality systems. We and substantially all of our products are subject to the provisions of the Federal Food, Drug and Cosmetic Act of 1938, as amended by the Medical Device Amendments of 1976, Safe Medical Device Act of 1990, Medical Device Modernization Act of 1997, Medical User Fee and Modernization Act of 2002 and similar international regulations, such as the European Union Medical Device Directives. As a manufacturer of medical devices, the FDA's Quality System Regulations as specified in Title 21, Code of Federal Regulation (CFR) part 820, set forth standards for our product design and manufacturing processes, require the maintenance of certain records, provide for on-site inspection of our facilities and continuing review by the FDA. Many of our products are also subject to industry-defined standards. Such industry-defined product standards are generally formulated by committees of the Association for the Advancement of Medical Instrumentation (AAMI), International Electrotechnical Commission (IEC) and the International Organization for Standardization (ISO). We believe that our products presently meet applicable standards in all material respects. We market our products in several foreign countries and therefore are subject to regulations affecting, among other things, product standards, packaging requirements, labeling requirements and import laws. Many of the regulations applicable to our devices and products in these countries are similar to those of the FDA. The member countries of the European Union have adopted the European Medical Device Directives, which create a single set of medical device regulations for all member countries. These regulations require companies that wish to manufacture and distribute medical devices in the European Union maintain quality system certification through European Union recognized Notified Bodies. These Notified Bodies authorize the use of the CE Mark allowing free movement of our products throughout the member countries. Requirements pertaining to our products vary widely from country to country, ranging from simple product registrations to detailed submissions such as those required by the FDA. We believe that our products currently meet applicable standards for the countries in which they are marketed. Our products may become subject to recall or market withdrawal regulations and we have made product recalls in the past. No product recall has had a material effect on our financial condition or results of operations, however there can be no -18- assurance that regulatory issues will not have a material adverse effect in the future. Any change in existing federal, state, foreign laws or regulations, or in the interpretation or enforcement thereof, or the promulgation or any additional laws or regulations may result in a material adverse effect on our financial condition or results of operations. Employees As of December 31, 2004, we had approximately 2,830 full-time employees, including more than 1,893 in operations, 136 in research and development, and the remaining in sales, marketing and related administrative support. We believe that we have good relations with our employees and have never experienced a strike or similar work stoppage. None of our employees are represented by a labor union. Risk Factors An investment in our common stock involves a high degree of risk. Investors should carefully consider the specific factors set forth below as well as the other information included or incorporated by reference in this Form 10-K. See "Forward Looking Statements". Our financial performance is subject to the risks inherent in our acquisition strategy, including the effects of increased borrowing and integration of newly acquired businesses or product lines. A key element of our business strategy has been to expand through acquisitions and we may seek to pursue additional acquisitions in the future. Our success is dependent in part upon our ability to integrate acquired companies or product lines into our existing operations. We may not have sufficient management and other resources to accomplish the integration of our past and future acquisitions and implementing our acquisition strategy may strain our relationship with customers, suppliers, distributors, manufacturing personnel or others. There can be no assurance that we will be able to identify and make acquisitions on acceptable terms or that we will be able to obtain financing for such acquisitions on acceptable terms. In addition, while we are generally entitled to customary indemnification from sellers of businesses for any difficulties that may have arisen prior to our acquisition of each business, acquisitions may involve exposure to unknown liabilities and the amount and time for claiming under these indemnification provisions is often limited. As a result, our financial performance is now and will continue to be subject to various risks associated with the acquisition of businesses, including the financial effects associated with any increased borrowing required to fund such acquisitions or with the integration of such businesses. Failure to comply with regulatory requirements may result in recalls, fines or materially adverse implications. All of our products are classified as medical devices subject to regulation by the FDA. As a manufacturer of medical devices, our manufacturing processes and facilities are subject to on-site inspection and continuing review by the FDA for compliance with the Quality System Regulations. Manufacturing and sales of our products outside the United States are also -19- subject to foreign regulatory requirements which vary from country to country. Moreover, we are generally required to obtain regulatory clearance or approval prior to marketing a new product. The time required to obtain approvals from foreign countries may be longer or shorter than that required for FDA approval, and requirements for foreign approvals may differ from FDA requirements. Failure to comply with applicable domestic and/or foreign regulatory requirements may result in: o fines or other enforcement actions; o recall or seizure of products; o total or partial suspension of production; o withdrawal of existing product approvals or clearances; o refusal to approve or clear new applications or notices; o increased quality control costs; or o criminal prosecution. Failure to comply with Quality System Regulations and applicable foreign regulations could result in a material adverse effect on our business, financial condition or results of operations. If we are not able to manufacture products in compliance with regulatory standards, we may decide to cease manufacture of those products and may be subject to product recall. In addition to the Quality System Regulations, many of our products are also subject to industry-defined standards. We may not be able to comply with these regulations and standards due to deficiencies in component parts or our manufacturing processes. If we are not able to comply with the Quality System Regulations or industry-defined standards, we may not be able to fill customer orders and we may decide to cease production of non-compliant products. Failure to produce products could affect our profit margins and could lead to loss of customers. Our products are subject to product recall and we have made product recalls in the past. Although no recall has had a material adverse effect on our business, financial condition or results of operations, we cannot assure you that regulatory issues will not have a material adverse effect in the future or that product recalls will not harm our reputation and our customer relationships. The highly competitive market for our products may create adverse pricing pressures. The market for our products is highly competitive and our customers have numerous alternatives of supply. Many of our competitors offer a range of products in areas other than those in which we compete, which may make such competitors more attractive to surgeons, hospitals, group purchasing organizations and others. In addition, several of our competitors are large, technically-competent firms with substantial assets. Competitive pricing pressures or the introduction of new products by our competitors could have an adverse effect on our revenues. See "Competition" for a further discussion of these competitive forces. -20- Factors which may influence our customers' choice of competitor products include: o changes in surgeon preferences; o increases or decreases in health care spending related to medical devices; o our inability to supply products to them, as a result of product recall, market withdrawal or back-order; o the introduction by competitors of new products or new features to existing products; o the introduction by competitors of alternative surgical technology; and o advances in surgical procedures, discoveries or developments in the health care industry. Cost reduction efforts in the health care industry could put pressures on our prices and margins. In recent years, the health care industry has undergone significant change driven by various efforts to reduce costs. Such efforts include national health care reform, trends towards managed care, cuts in Medicare, consolidation of health care distribution companies and collective purchasing arrangements by GPOs and IHNs. Demand and prices for our products may be adversely affected by such trends. We may not be able to keep pace with technological change or to successfully develop new products with wide market acceptance, which could cause us to lose business to competitors. The market for our products is characterized by rapidly changing technology. Our future financial performance will depend in part on our ability to develop and manufacture new products on a cost-effective basis, to introduce them to the market on a timely basis, and to have them accepted by surgeons. We may not be able to keep pace with technology or to develop viable new products. Factors which may result in delays of new product introductions or cancellation of our plans to manufacture and market new products include: o capital constraints; o research and development delays; o delays in securing regulatory approvals; or o changes in the competitive landscape, including the emergence of alternative products or solutions which reduce or eliminate the markets for pending products. Our new products may fail to achieve expected levels of market acceptance. New product introductions may fail to achieve market acceptance. The degree of market acceptance for any of our products will depend upon a number of factors, including: o our ability to develop and introduce new products and product enhancements in the time frames we currently estimate; o our ability to successfully implement new technologies; o the market's readiness to accept new products; -21- o having adequate financial and technological resources for future product development and promotion; o the efficacy of our products; and o the prices of our products compared to the prices of our competitors' products. If our new products do not achieve market acceptance, we may be unable to recover our investments and may lose business to competitors. In addition, some of the companies with which we now compete or may compete in the future have or may have more extensive research, marketing and manufacturing capabilities and significantly greater technical and personnel resources than we do, and may be better positioned to continue to improve their technology in order to compete in an evolving industry. See "Competition" for a further discussion of these competitive forces. Our Senior credit agreement contains covenants which may limit our flexibility or prevent us from taking actions. Our Senior credit agreement contains, and future credit facilities are expected to contain, certain restrictive covenants which will affect, and in many respects significantly limit or prohibit, among other things, our ability to: o incur indebtedness; o make investments; o engage in transactions with affiliates; o pay dividends or make other distributions on, or redeem or repurchase, capital stock; o sell assets; and o pursue acquisitions. These covenants, unless waived, may prevent us from pursuing acquisitions, significantly limit our operating and financial flexibility and limit our ability to respond to changes in our business or competitive activities. Our ability to comply with such provisions may be affected by events beyond our control. In the event of any default under our credit agreement, the credit agreement lenders may elect to declare all amounts borrowed under our credit agreement, together with accrued interest, to be due and payable. If we were unable to repay such borrowings, the credit agreement lenders could proceed against collateral securing the credit agreement, which consists of substantially all of our property and assets, except for our accounts receivable and related rights which are sold in connection with the accounts receivable sales agreement. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" for a discussion of the accounts receivable sales agreement. Our credit agreement also contains a material adverse effect clause which may limit our ability to access additional funding under our credit agreement should a material adverse change in our business occur. Our substantial leverage and debt service requirements may require us to adopt alternative business strategies. We have indebtedness that is substantial in relation to our shareholders' equity, as well as interest and debt service requirements that are -22- significant compared to our cash flow from operations. As of December 31, 2004, we had $294.5 million of debt outstanding, representing 40% of total capitalization and which does not include the $49 million of accounts receivable sold under the accounts receivable sales agreement. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources". The degree to which we are leveraged could have important consequences to investors, including but not limited to the following: o a substantial portion of our cash flow from operations must be dedicated to debt service and will not be available for operations, capital expenditures, acquisitions, dividends and other purposes; o our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or general corporate purposes may be limited or impaired, or may be at higher interest rates; o we may be at a competitive disadvantage when compared to competitors that are less leveraged; o we may be hindered in our ability to adjust rapidly to market conditions; o our degree of leverage could make us more vulnerable in the event of a downturn in general economic conditions or other adverse circumstances applicable to us; and o our interest expense could increase if interest rates in general increase because most of our borrowings, including our borrowings under our credit agreement, are and will continue to be at variable rates of interest. We may not be able to generate sufficient cash to service our indebtedness, which could require us to reduce our expenditures, sell assets, restructure our indebtedness or seek additional equity capital. Our ability to satisfy our obligations will depend upon our future operating performance, which will be affected by prevailing economic conditions and financial, business and other factors, many of which are beyond our control. We may not have sufficient cash flow available to enable us to meet our obligations. If we are unable to service our indebtedness, we will be forced to adopt an alternative strategy that may include actions such as foregoing acquisitions, reducing or delaying capital expenditures, selling assets, restructuring or refinancing our indebtedness or seeking additional equity capital. We cannot assure you that any of these strategies could be implemented on terms acceptable to us, if at all. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" for a discussion of our indebtedness and its implications. We may be unable to continue to sell our accounts receivable, which could require us to seek alternative sources of financing. Under our accounts receivable sales agreement, there are certain statistical ratios which must be maintained relating to the pool of receivables in order for us to continue selling to the purchaser. These ratios relate to sales dilution and losses on accounts receivable. If new accounts receivable arising in the normal course of business do not qualify for sale or the purchaser otherwise ceases to purchase our receivables, we may require access to alternate sources of working capital, which may be more expensive or difficult to obtain. Our accounts receivable sales agreement, as amended, -23- also requires us to obtain a commitment (the "purchaser commitment"), on an annual basis from the purchaser to fund the purchase of our accounts receivable. The purchaser commitment was amended effective October 21, 2004 whereby it was extended for an additional year. In the event we are unable to renew our purchaser commitment in the future, we would need to access alternate sources of working capital which may be more expensive or difficult to obtain. If we infringe third parties' patents, or if we lose our patents or they are held to be invalid, we could become subject to liability and our competitive position could be harmed. Much of the technology used in the markets in which we compete is covered by patents. We have numerous U.S. patents and corresponding foreign patents on products expiring at various dates from 2005 through 2022 and have additional patent applications pending. See "Research and Development" for a further description of our patents. The loss of our patents could reduce the value of the related products and any related competitive advantage. Competitors may also be able to design around our patents and to compete effectively with our products. In addition, the cost of enforcing our patents against third parties and defending our products against patent infringement actions by others could be substantial. We cannot assure you that: o pending patent applications will result in issued patents, o patents issued to or licensed by us will not be challenged by competitors, o our patents will be found to be valid or sufficiently broad to protect our technology or provide us with a competitive advantage, or o we will be successful in defending against pending or future patent infringement claims asserted against our products. Ordering patterns of our customers may change resulting in reductions in sales. Our hospital and surgery center customers purchase our products in quantities sufficient to meet their anticipated demand. Likewise, our health care distributor customers purchase our products for ultimate resale to health care providers in quantities sufficient to meet the anticipated requirements of the distributors' customers. Should inventories of our products owned by our hospital, surgery center and distributor customers grow to levels higher than their requirements, our customers may reduce the ordering of products from us. This could result in reduced sales during a financial accounting period. Our significant international operations subject us to risks associated with operating in foreign countries. A significant portion of our revenues are derived from foreign sales. As a result, our international presence exposes us to certain inherent risks, including: o devaluations and fluctuations in currency exchange rates; o imposition of limitations on conversions of foreign currencies into dollars or remittance of dividends and other payments by international subsidiaries; -24- o imposition or increase of withholding and other taxes on remittances and other payments by international subsidiaries; o trade barriers; o political risks, including political instability; o reliance on third parties to distribute our products; o hyperinflation in certain foreign countries; and o imposition or increase of investment and other restrictions by foreign governments. We cannot assure you that such risks will not have a material adverse effect on our business and results of operations. We can be sued for producing defective products and our insurance coverage may be insufficient to cover the nature and amount of any product liability claims. The nature of our products as medical devices and today's litigious environment should be regarded as potential risks which could significantly and adversely affect our financial condition and results of operations. The insurance we maintain to protect against claims associated with the use of our products have deductibles and may not adequately cover the amount or nature of any claim asserted against us. We are also exposed to the risk that our insurers may become insolvent or that premiums may increase substantially. See "Legal Proceedings" for a further discussion of the risk of product liability actions and our insurance coverage. Damage to our physical properties as a result of windstorm, earthquake, fire or other natural or man-made disaster may cause a financial loss and a loss of customers. Although we maintain insurance coverage for physical damage to our property and the resultant losses that could occur during a business interruption, we are required to pay deductibles and our insurance coverage is limited to certain caps. For example, our deductible for windstorm damage to our Florida property amounts to 1% of any loss and coverage for earthquake damage to our California properties is limited to $5 million. Further, while insurance reimburses us for our lost gross earnings during a business interruption, if we are unable to supply our customers with our products for an extended period of time, there can be no assurance that we will regain the customers' business once the product supply is returned to normal. -25- Item 2. Properties Facilities The following table sets forth certain information with respect to our principal operating facilities. We believe that our facilities are generally well maintained, are suitable to support our business and adequate for present and anticipated needs. Location Square Feet Own or Lease Lease Expiration - --------------------------- ----------- ------------ ---------------- Utica, NY (two facilities) 650,000 Own -- Largo, FL 278,000 Own -- Rome, NY 120,000 Own -- Centennial, CO 65,000 Own -- Tampere, Finland 5,662 Own -- El Paso, TX 96,000 Lease March 2010 Billerica, MA 60,000 Lease September 2007 Juarez, Mexico 44,000 Lease December 2009 Montreal, Canada (two April 2007 & facilities) 20,940 Lease March 2009 Santa Barbara, CA 18,600 Lease December 2008 Frenchs Forest, Australia 16,909 Lease July 2008 Tampere, Finland 15,457 Lease Open Ended Brussels, Belgium 14,660 Lease August 2012 Anaheim, CA 14,037 Lease October 2012 Mississauga, Canada 13,500 Lease May 2008 Swindon, Wiltshire, UK 10,000 Lease December 2015 Portland, OR 9,107 Lease September 2008 Seoul, Korea 7,513 Lease August 2005 Frankfurt, Germany 6,900 Lease December 2012 Shepshed, Leicestershire,UK 5,000 Lease October 2015 Barcelona, Spain 2,691 Lease May 2009 Rungis Cedex, France 2,637 Lease November 2011 Graz, Austria 2,174 Lease October 2008 San Juan Capistrano, CA 2,000 Lease January 2006 Tirat ha-Carmel, Israel 1,076 Lease December 2006 Maastricht, Netherlands 258 Lease July 2005 -26- Item 3. Legal Proceedings From time to time, we are a defendant in certain lawsuits alleging product liability, patent infringement, or other claims incurred in the ordinary course of business. These claims are generally covered by various insurance policies, subject to certain deductible amounts and maximum policy limits. When there is no insurance coverage, as would typically be the case primarily in lawsuits alleging patent infringement, we establish sufficient reserves to cover probable losses associated with such claims. We do not expect that the resolution of any pending claims will have a material adverse effect on our financial condition or results of operations. There can be no assurance, however, that future claims, the costs associated with claims, especially claims not covered by insurance, will not have a material adverse effect on our future performance. Manufacturers of medical products may face exposure to significant product liability claims. To date, we have not experienced any material product liability claims, but any such claims arising in the future could have a material adverse effect on our business or results of operations. We currently maintain commercial product liability insurance of $25 million per incident and $25 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 or that such insurance will be available in the future at a reasonable cost to us. Our operations are 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. 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 could not have a material adverse effect on our financial condition or results of operations. In November 2003, we commenced litigation against Johnson & Johnson and several of its subsidiaries, including Ethicon, Inc. for violation of federal and state antitrust laws. The lawsuit claims that Johnson & Johnson engaged in illegal and anticompetitive conduct with respect to sales of product used in endoscopic surgery, resulting in higher prices to consumers and the exclusion of competition. We have sought relief which includes an injunction restraining Johnson & Johnson from continuing its anticompetitive practice as well as receiving the maximum amount of damages allowed by law. Our claims against Johnson & Johnson are currently in the discovery stage. While we believe that our claims are well-grounded in fact and law, there can be no assurance that we will be successful in our claim. In addition, the costs associated with pursuing this claim may be material. Item 4. Submission of Matters to a Vote of Security Holders Not Applicable. -27- PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters Our common stock, par value $.01 per share, is traded on the Nasdaq Stock Market under the symbol "CNMD". At March 9, 2005, there were 1,142 registered holders of our common stock and approximately 10,433 accounts held in "street name". The following table sets forth quarterly high and low sales prices for the years ended December 31, 2003 and 2004, as reported by the Nasdaq Stock Market. 2003 -------------------------- Period High Low -------------------------- First Quarter $20.74 $13.95 Second Quarter 20.83 16.69 Third Quarter 22.00 18.21 Fourth Quarter 24.30 19.52 2004 -------------------------- Period High Low -------------------------- First Quarter $29.54 $23.72 Second Quarter 30.89 24.00 Third Quarter 27.92 20.73 Fourth Quarter 30.02 25.47 We did not pay cash dividends on our common stock during 2003 or 2004 and do not currently intend to pay dividends for the foreseeable future. Future decisions as to the payment of dividends will be at the discretion of the Board of Directors, subject to conditions then existing, including our financial requirements and condition and the limitation and payment of cash dividends contained in debt agreements. Our Board of Directors has authorized a share repurchase program; See Note 8 to the Consolidated Financial Statements for further discussion. Information relating to compensation plans under which equity securities of CONMED Corporation are authorized for issuance is set forth in the section captioned "Stock Option Plans" in CONMED Corporation's definitive Proxy Statement or other informational filing for our 2005 Annual Meeting of Stockholders and all such information is incorporated herein by reference. -28- Item 6. Selected Financial Data The following table sets forth selected historical financial data for the years ended December 31, 2000, 2001, 2002, 2003 and 2004. The financial data set forth below should be read in conjunction with the information under "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7 of this Form 10-K and the Financial Statements of the Company and the notes thereto. FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA
Years Ended December 31, ---------------------------------------------------------------------- 2000 2001 2002 2003 2004 ---------------------------------------------------------------------- (in thousands, except per share data) Statements of Operations Data (1): Net sales $ 395,873 $ 428,722 $ 453,062 $ 497,130 $ 558,388 Cost of sales (2) 188,223 204,374 215,891 237,433 271,496 --------- --------- --------- --------- --------- Gross profit 207,650 224,348 237,171 259,697 286,892 --------- --------- --------- --------- --------- Selling and administrative 126,807 140,560 139,735 157,453 183,183 Research and development 14,870 14,830 16,087 17,306 20,205 Write-off of in-process research and development (3) -- -- -- 7,900 16,400 Other expense (income)(4) 1,509 -- 2,000 (2,917) 3,943 --------- --------- --------- --------- --------- Income from operations 64,464 68,958 79,349 79,955 63,161 Loss on early extinguishment of debt (5) -- -- 1,475 8,078 825 Interest expense 34,286 30,824 24,513 18,868 12,774 --------- --------- --------- --------- --------- Income before income taxes 30,178 38,134 53,361 53,009 49,562 Provision for income taxes 10,864 13,728 19,210 20,927 16,097 --------- --------- --------- --------- --------- Net income (6) $ 19,314 $ 24,406 $ 34,151 $ 32,082 $ 33,465 ========= ========= ========= ========= ========= Earnings Per Share (7) Basic $ 0.84 $ 1.02 $ 1.25 $ 1.11 $ 1.13 ========= ========= ========= ========= ========= Basic adjusted for SFAS 142 (6) $ 1.08 $ 1.25 $ 1.25 $ 1.11 $ 1.13 ========= ========= ========= ========= ========= Diluted $ 0.83 $ 1.00 $ 1.23 $ 1.10 $ 1.11 ========= ========= ========= ========= ========= Diluted adjusted for SFAS 142 (6) $ 1.07 $ 1.23 $ 1.23 $ 1.10 $ 1.11 ========= ========= ========= ========= ========= Weighted Average Number of Common Shares In Calculating (7): Basic earnings per share 22,967 24,045 27,337 28,930 29,523 ========= ========= ========= ========= ========= Diluted earnings per share 23,271 24,401 27,827 29,256 30,105 ========= ========= ========= ========= ========= Other Financial Data: Depreciation and amortization $ 29,487 $ 30,148 $ 22,370 $ 24,854 $ 26,868 Capital expenditures 14,050 14,443 13,384 9,309 12,419 Ratio of earnings to fixed charges (8) 1.85 2.20 3.12 3.72 4.63 Balance Sheet Data (at period end): Cash and cash equivalents $ 3,470 $ 1,402 $ 5,626 $ 5,986 $ 4,189 Total assets 679,571 701,608 742,140 805,058 872,825 Long-term debt (including current portion) 378,748 335,929 257,387 264,591 294,522 Total shareholders' equity 230,603 283,634 386,939 433,490 447,983
-29- (1) Results of operations of acquired businesses have been recorded in the financial statements since the date of acquisition. See additional discussion in Note 2 to the Consolidated Financial Statements. (2) Includes acquisition-related charges of $1.6 million in 2001, $1.3 million in 2003 and $4.4 million in 2004. Amounts recorded in 2004 consisted of $2.3 million related to the step-up to fair value of inventory acquired as a result of the Bard Endoscopic Technologies acquisition and $2.1 million representing the incremental costs incurred during the transition period in which we are continuing to purchase the acquired products from C.R. Bard. See additional discussion in Note 2 to the Consolidated Financial Statements. (3) During 2003, we recorded a $7.9 million charge to write-off in-process research and development assets acquired as a result of our purchase of Bionx Implants, Inc. discussed in Note 2 to the Consolidated Financial Statements. No benefit for income taxes was recorded as these costs are not deductible for income tax purposes. During 2004, we recorded a $16.4 million charge to write-off the tax-deductible in-process research and development assets acquired as a result of our purchase of the business operations of the Endoscopic Technologies Division of C.R. Bard, Inc. discussed in Note 2 to the Consolidated Financial Statements. (4) Includes a severance charge of $1.5 million related to the restructuring of our arthroscopy sales force in 2000; $2.0 million charge related to the settlement of a patent infringement case in 2002; $9.0 million gain on the settlement of a contractual dispute, $2.8 million in pension settlement costs and $3.2 million in acquisition-related charges in 2003; $2.4 million charge related to the termination of a product offering and $1.5 million in acquisition-related charges in 2004. See additional discussion in Note 12 to the Consolidated Financial Statements. (5) Includes in 2002, 2003 and 2004, charges of $1.5 million, $8.1 million and $0.8 million, respectively, related to losses on early extinguishment of debt. See additional discussion in Note 6 to the Consolidated Financial Statements. (6) Effective January 1, 2002, the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," ("SFAS 142") were adopted relative to the cessation of amortization for goodwill and certain intangible assets. Had we accounted for goodwill and certain intangibles in accordance with SFAS 142 for all periods presented, net income would have been $24.9 million in 2000 and $30.1 million in 2001. (7) Earnings per share and the number of shares used in the calculation of earnings per share have been restated to retroactively reflect a three-for-two split of our common stock effected in the form of a common stock dividend and paid on September 7, 2001. (8) The ratio of earnings to fixed charges is calculated by dividing fixed charges into income before income taxes plus fixed charges. Fixed charges include interest expense and the estimated interest component of rent expense. -30- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with Selected Financial Data (Item 6), and our Consolidated Financial Statements and related notes contained elsewhere in this report. Overview of CONMED Corporation CONMED Corporation ("CONMED", the "Company", "we" or "us") is a worldwide developer, manufacturer and distributor of a broad portfolio of advanced surgical instruments and medical devices with an emphasis on minimally invasive procedures and monitoring. Our products are used by surgeons and physicians in a variety of specialties including orthopedics, general surgery, gynecology, neurosurgery and gastroenterology. We offer surgical products and technologies to our customers through six principal product lines. These product lines and the percentage of consolidated revenues associated with each, are as follows: 2002 2003 2004 Arthroscopy 36% 37% 37% Powered Surgical Instruments 25 25 23 Electrosurgery 15 15 15 Patient Care 16 14 14 Endosurgery 8 9 8 Endoscopic Technologies -- -- 3 --- --- --- Consolidated Net Sales 100% 100% 100% === === === A significant amount of our products are used in surgical procedures with approximately 75% of our revenues derived from the sale of disposable products. We manufacture substantially all of our products in facilities located in the United States. We market our products both domestically and internationally directly to customers and through distributors. International sales approximated 29%, 33% and 35% in 2002, 2003 and 2004, respectively. Business Environment, Opportunities and Challenges The aging of the worldwide population along with lifestyle changes, continued cost containment pressures on healthcare systems and the desire of clinicians and administrators to use less invasive (or noninvasive) procedures are important trends which are driving the growth for our surgical and patient care products. We have historically used strategic business acquisitions and exclusive distribution relationships to diversify our product offerings, increase our market share in certain product lines and realize economies of scale. In 2003 we made important progress in broadening our Arthroscopy product line with the acquisition of Bionx Implants, Inc. (the "Bionx acquisition" - See Note 2 to the Consolidated Financial Statements). In January 2004, we announced an agreement with Dolphin Medical, Inc., a subsidiary of OSI Systems, Inc., under which we became the -31- exclusive North American distributor for a full line of Dolphin(R) pulse oximetry products. These products are included in our Patient Care product line. On September 30, 2004 we completed the acquisition of certain products of the Endoscopic Technologies Division of C.R. Bard, Inc. (the "Bard Endoscopic Technologies acquisition" - See Note 2 to the Consolidated Financial Statements). The acquired product line consists of various disposable products used by gastroenterologists to diagnose and treat diseases of the digestive tract. Several of the products are used in conjunction with electrosurgical devices to cause hemostasis following the removal of diseased tissue. It is anticipated that these products will complement our current Electrosurgery product offerings. Manufacturing of the products is currently being conducted in various C.R. Bard facilities under a transition agreement. It is anticipated that future manufacturing will be shifted to our facilities during the third quarter of 2005. Continued innovation and commercialization of new proprietary products and processes are essential elements of our long-term growth strategy. In February 2005, we unveiled several new products at the American Academy of Orthopedic Surgeons Annual Meeting which will enhance our arthroscopy and powered instrument product offerings. Our reputation as an innovator is exemplified by these recent product introductions, which include an Advantage(R) Turbo Arthroscopic Shaver System; PINN-ACL(R) cross pin device; Lightwave(TM) suction ablator; PowerProMax(TM) powered instrument handpieces, batteries and attachments; ThRevo(TM) triple-loaded suture anchor; and SuperRevo(R)/Bio-Anchor(R)/Duet(TM)/Impact(TM) suture anchors pre-threaded with Herculine(TM). Our current research initiatives include the development of reflectance technology products. This technology permits non-invasive analysis of blood oxygen levels in clinical situations which previously could not be accomplished using traditional non-invasive techniques ("Pro2(R)"). We anticipate a 2005 product launch in the United States and Europe. Additionally, in 2003 we acquired technology for a product referred to as Endotracheal Cardiac Output Monitor ("ECOM"). Our ECOM product offering is expected to replace catheter monitoring of cardiac output with a specially designed endotracheal tube which utilizes proprietary bio-impedance technology. A large portion of the development of this product, as well as future product enhancements, will be conducted in our newly created research subsidiary in Israel. In June 2004, CONMED and our Israeli subsidiary were awarded a $1 million grant from the Israel-U.S. Binational Industrial Research and Development Foundation to assist in product development. We anticipate a 2006 product launch in the United States and Europe. Certain of our products, particularly our line of surgical suction instruments, tubing and ECG electrodes, are more commodity in nature, with limited opportunity for product differentiation. These products compete in mature, price sensitive markets. As a result, while sales volumes have continued to increase, we have experienced and expect that we will continue to experience pricing and margin pressures in these product lines. We believe that we may continue to profitably compete in these product lines by maintaining and improving our low cost manufacturing structure. In addition, we expect to continue to use cash generated from these low margin, low capital intensive products to invest in, improve and expand higher margin product lines. -32- Critical Accounting Estimates Preparation of our financial statements requires us to make estimates and assumptions which affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Consolidated Financial Statements describes the significant accounting policies used in preparation of the Consolidated Financial Statements. The most significant areas involving management judgments and estimates are described below and are considered by management to be critical to understanding the financial condition and results of operations of CONMED Corporation. Revenue Recognition Revenue is recognized when title has been transferred to the customer which is generally at the time of shipment. The following policies apply to our major categories of revenue transactions: o Sales to customers are evidenced by firm purchase orders. Title and the risks and rewards of ownership are transferred to the customer when product is shipped. Payment by the customer is due under fixed payment terms. o We place certain of our capital equipment with customers in return for commitments to purchase disposable products over time periods generally ranging from one to three years. In these circumstances, no revenue is recognized upon capital equipment shipment and we recognize revenue upon the disposable product shipment. The cost of the equipment is amortized over the term of individual commitment agreements. o 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. o The Company's terms of sale to customers generally do not include any obligations to perform future services. Limited warranties are generally provided for capital equipment sales and provisions for warranty are provided at the time of product sale based upon an analysis of historical data. o 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 $7.5 million, $8.3 million and $9.3 million for 2002, 2003 and 2004, respectively. o We sell to a diversified base of customers around the world and, therefore, believe there is no material concentration of credit risk. o We assess the risk of loss on accounts receivable and adjust the allowance for doubtful accounts based on this risk assessment. Historically, losses on accounts receivable have not been material. Management believes that the allowance for doubtful accounts of $1.2 -33- million at December 31, 2004 is adequate to provide for probable losses resulting from accounts receivable. Inventory Reserves We maintain reserves for excess and obsolete inventory resulting from the inability to sell our products at prices in excess of current carrying costs. The markets in which we operate are highly competitive, with new products and surgical procedures introduced on an on-going basis. Such marketplace changes may result in our products becoming obsolete. We make estimates regarding the future recoverability of the costs of our products and record a provision for excess and obsolete inventories based on historical experience, expiration of sterilization dates and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write-downs may be required. We believe that our current inventory reserves are adequate. Business Acquisitions We have a history of growth through acquisitions, including the Bard Endoscopic Technologies acquisition in 2004. Assets and liabilities of acquired businesses are recorded under the purchase method of accounting 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. Other intangible assets primarily represent allocations of purchase price to identifiable intangible assets of acquired businesses. We have accumulated goodwill of $334.5 million and other intangible assets of $195.2 million as of December 31, 2004. In accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," ("SFAS 142"), goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to at least annual impairment testing. The identification and measurement of goodwill impairment involves the estimation of the fair value of our business. Estimates of fair value are based on the best information available as of the date of the assessment, which primarily incorporate management assumptions about expected future cash flows and contemplate other valuation techniques. Future cash flows may be affected by changes in industry or market conditions or the rate and extent to which anticipated synergies or cost savings are realized with newly acquired entities. Intangible assets with a finite life are amortized over the estimated useful life of the asset. Intangible assets which continue to be subject to amortization are also evaluated to determine whether events and circumstances warrant a revision to the remaining period of amortization. An intangible asset is determined to be impaired when estimated undiscounted future cash flows indicate that the carrying amount of the asset may not be recoverable. An impairment loss is recognized by reducing the recorded value to its current fair value. Although no goodwill or other intangible asset impairment has been recorded to date, there can be no assurance that future impairment will not occur. It is our policy to perform annual impairment tests in the fourth quarter. In connection with the Bard Endoscopic Technologies acquisition, significant estimates were made in the $16.4 million valuation of purchased in-process research and development assets. The purchased in-process research and development value relates to next generation gastro-intestinal products, which are expected to be released between the fourth quarter of 2005 and second quarter of 2006. The acquired projects include enhancements and upgrades to existing device technology, -34- introduction of new device functionality and the development of new technology for gastro-intestinal applications. The value of the in-process research and development was calculated using a discounted cash flow analysis of the anticipated net cash flow stream associated with the in-process technology of the related product sales. Estimated future net cash flows were discounted back to their present values using a discount rate of 17%, which was based on the weighted-average cost of capital for publicly-traded companies within the medical device industry, adjusted for the stage of completion of each of the in-process research and development projects. The risk and return considerations surrounding the stage of completion were based on costs, man-hours and complexity of the work completed versus to be completed and other risks associated with achieving commercial feasibility. In total, these projects were approximately 40% complete as of the acquisition date. The total budgeted costs for the projects were approximately $8.5 million and the remaining costs to complete these projects were approximately $5.0 million as of the acquisition date. The major risks and uncertainties associated with the timely and successful completion of these projects consist of the ability to confirm the safety and efficacy of the technologies and products based on the data from clinical trials and obtaining the necessary regulatory approvals. In addition, no assurance may be made that the underlying assumptions used to forecast the future cash flows or the timely and successful completion of such projects will materialize, as estimated. For these reasons, among others, actual results may vary significantly from estimated results. See Note 2 to the Consolidated Financial Statements for further discussion. Pension Plan We sponsor a defined benefit pension plan covering substantially all our employees. Overall benefit levels provided under the plan were reduced effective January 1, 2004 resulting in a reduction in the projected benefit obligation of approximately $6.4 million. Major assumptions used in accounting for the plan include the discount rate, expected return on plan assets, rate of increase in employee compensation levels and expected mortality. Assumptions are determined based on Company data and appropriate market indicators, and are evaluated annually as of the plan's measurement date. A change in any of these assumptions would have an effect on net periodic pension costs reported in the consolidated financial statements. Lower market interest rates have resulted in us lowering the discount rate used in determining pension expense from 6.25% in 2004 to 5.75% in 2005. This change in assumption will result in higher pension expense during 2005. We have used an expected rate of return on pension plan assets of 8.0% for purposes of determining the net periodic pension benefit cost. In determining the expected return on pension plan assets, we consider the relative weighting of plan assets, the historical performance of total plan assets and individual asset classes and economic and other indicators of future performance. In addition, we consult with financial and investment management professionals in developing appropriate targeted rates of return. We have estimated our rate of increase in employee compensation levels at 3.0% consistent with our internal budgeting. -35- As of December 31, 2004, the Company changed from the 1984 Unisex Pension mortality table to the 1994 Group Annuity Reserving mortality table for purposes of determining expected mortality. This change in assumption will result in higher pension expense during 2005. Based on these and other factors, 2005 pension expense is estimated at approximately $4.5 million. Actual expense may vary significantly from this estimate. See Note 10 to the Consolidated Financial Statements for further discussion. Income Taxes The recorded future tax benefit arising from net deductible temporary differences and tax carryforwards is approximately $22.7 million at December 31, 2004. Management believes that our earnings during the periods when the temporary differences become deductible will be sufficient to realize the related future income tax benefits. We have established a valuation allowance to reflect the uncertainty of realizing the benefits of certain net operating loss carryforwards recognized in connection with the Bionx acquisition. Any subsequently recognized tax benefits associated with the valuation allowance would be allocated to reduce goodwill. 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. Valuation allowances related to deferred tax assets may be impacted by changes to tax laws, changes to statutory tax rates and future taxable income levels. See Note 7 to the Consolidated Financial Statements for further discussion. Results of Operations The following table presents, as a percentage of net sales, certain categories included in our consolidated statements of income for the periods indicated: Year Ended December 31, ----------------------- 2002 2003 2004 ---- ---- ---- Net sales ............................... 100.0% 100.0% 100.0% Cost of sales ........................... 47.7 47.8 48.6 ------- ------- ------- Gross margin ......................... 52.3 52.2 51.4 Selling and administrative expense ...... 30.8 31.7 32.8 Research and development expense ........ 3.6 3.4 3.6 Write-off of purchased in-process research and development assets ....... -- 1.7 2.9 Other expense (income), net ............. 0.4 (0.6) 0.8 ------- ------- ------- Income from operations ............... 17.5 16.0 11.3 Loss on early extinguishment of debt .... 0.3 1.6 0.1 Interest expense ........................ 5.5 3.7 2.3 ------- ------- ------- Income before income taxes .............. 11.7 10.7 8.9 Provision for income taxes .............. 4.2 4.2 2.9 ------- ------- ------- Net income ........................... 7.5% 6.5% 6.0% ======= ======= ======= -36- 2004 Compared to 2003 Sales for 2004 were $558.4 million, an increase of $61.3 million (12.3%) compared to sales of $497.1 million in 2003. The Bionx acquisition and Bard Endoscopic Technologies acquisition accounted for $3.3 million and $15.7 million of the increase, respectively, and favorable foreign currency exchange rates accounted for $9.7 million. The Bionx acquisition and Bard Endoscopic Technologies acquisition are described more fully in Note 2 to the Consolidated Financial Statements. o Arthroscopy sales increased $22.9 million (12.6%) in 2004 to $204.9 million from $182.0 million in 2003, principally as a result of the Bionx acquisition and increased sales of our procedure specific, knee reconstruction, soft tissue fixation and video imaging products for arthroscopy and general surgery. This increase was offset in part by reduced sales of integrated operating room systems and equipment. o Powered surgical instrument sales increased $6.6 million (5.4%) in 2004 to $128.6 million from $122.0 million in 2003, principally as a result of increased sales of our PowerPro(R) line of large bone instruments. This increase was partially offset by decreased sales of our small bone instruments and specialty product offerings. o Patient care sales increased $5.9 million (8.4%) in 2004 to $75.9 million from $70.0 million in 2003, principally as a result of increased sales of our pulse oximetry monitoring devices, ECG electrodes, surgical suction instruments and other patient care products. o Electrosurgery sales increased $8.6 million (11.1%) in 2004 to $85.9 million from $77.3 million in 2003, principally as a result of increased sales of electrosurgical disposable ground pads and pencils. o Endosurgery sales increased $1.6 million (3.5%) in 2004 to $47.4 million from $45.8 million in 2003, as a result of increased sales of our various laparoscopic instrument products and systems. o Endoscopic Technologies sales for 2004 were $15.7 million representing the inclusion of results of operations for the former Endoscopic Technologies Division of C.R. Bard since the date of acquisition. Cost of sales increased to $271.5 million in 2004 compared to $237.4 million in 2003, primarily as a result of increased sales volumes in each of our principal product lines as described above. Gross profit margins decreased from 52.2% in 2003 to 51.4% in 2004. We incurred $4.4 million and $1.3 million of acquisition-related expenses during 2004 and 2003, respectively, which have been included in cost of sales. The decrease in gross margin percentage in 2004 as compared to 2003 is principally due to the increase in acquisition-related expenses. The $4.4 million of acquisition-related charges included in costs of sales in 2004, consists of the following: $2.3 million of expense which represents a portion of the step-up to fair value recorded relating to the sale of inventory acquired through the Bard Endoscopic Technologies acquisition; and $2.1 million in charges representing the incremental costs we are incurring during a transition period in which we are continuing to purchase the acquired products from C.R. Bard. During 2005, we expect to continue to experience higher incremental costs until -37- manufacturing of the acquired products is integrated into our facilities during the third quarter of 2005. Selling and administrative expense increased to $183.2 million in 2004 as compared to $157.5 million in 2003. Selling and administrative expense as a percentage of net sales increased to 32.8% in 2004 from 31.7% in 2003. This increase of 1.1 percentage points is attributable to increased selling expenses primarily associated with the transition to a larger, independent sales agent based sales force in our arthroscopy and powered surgical instrument product lines (0.6 percentage points) and increased administrative expenses associated with litigation against Johnson & Johnson (See Note 11 to the Consolidated Financial Statements) and our Sarbanes-Oxley compliance program (0.5 percentage points). Research and development expense was $20.2 million in 2004 compared to $17.3 million in 2003. As a percentage of net sales, research and development expense increased to 3.6% in 2004 from 3.4% in 2003. The increase in research and development expense as a percentage of sales is principally a result of increased spending on the development of our Pro2(R) reflectance pulse oximetry system and endotracheal cardiac output monitor for our Patient Care business. The addition of the Endoscopic Technologies business in September 2004 also contributed to the increase in research and development expense. As discussed in Note 2 to the Consolidated Financial Statements, we wrote-off $16.4 million and $7.9 million of purchased in-process research and development assets associated with the Bard Endoscopic Technologies acquisition and Bionx acquisition in 2004 and 2003, respectively. As discussed in Note 12 to the Consolidated Financial Statements, other expense in 2004 consisted primarily of $2.4 million of expenses associated with the termination of our surgical lights product offering and $1.5 million of expenses related to the Bard Endoscopic Technologies acquisition. We expect to incur an additional $1.6 million in expenses associated with the termination of our surgical lights product offering in 2005. As discussed in Note 12 to the Consolidated Financial Statements, other income in 2003 consisted of a $9.0 million net gain on the settlement of a contractual dispute, $2.8 million in pension settlement costs associated with the restructuring of our orthopedic sales force and $3.2 million in acquisition costs related primarily to the acquisition of CORE Dynamics, Inc. (the "CORE acquisition" - See Note 2 to the Consolidated Financial Statements) and Bionx acquisition. During 2004, we recorded $0.8 million in losses on the early extinguishment of debt related to the refinancing of a portion of the term loans under our senior credit agreement through the issuance of 2.50% convertible senior subordinated notes. See additional discussion under Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources and Note 6 to the Consolidated Financial Statements. Interest expense in 2004 was $12.8 million compared to $18.9 million in 2003. The decrease in interest expense is primarily a result of lower weighted average borrowings outstanding in 2004 as compared to 2003 and lower weighted average interest rates on our borrowings (4.17% in 2004 as compared to 5.99% in 2003) inclusive of the implicit finance charge on our accounts receivable sale facility. The decrease in weighted average interest rates on our borrowing is primarily a result of our redemption of $130.0 million in 9% senior subordinated notes in 2003 (See Note 6 to the Consolidated Financial Statements) in favor of lower cost bank debt. -38- A provision for income taxes has been recorded at an effective rate of 32.5% in 2004 and 39.5% in 2003. The effective rate for 2004 was lower than that recorded in 2003 and the United States statutory rate of 35.0% as a result of an increase in the estimated benefits to be realized from the Extraterritorial Income Exclusion ("ETI") tax rules on foreign sales. The effective rate in 2003 increased from the statutory rate as a result of the non-deductibility for income tax purposes of the Bionx in-process research and development charge discussed above. On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the "Act"). The Act provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010. In return, the Act also provides for a two-year phase-out of the existing ETI for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. We expect the net effect of the phase out of the ETI and the phase in of this new deduction to result in an increase in the effective rate of approximately two percentage points for 2005 compared to the 2004 effective tax rate of 32.5%. See additional discussion and a reconciliation of the United States statutory income tax rate to our effective tax rate in Note 7 to the Consolidated Financial Statements. 2003 Compared to 2002 Sales for 2003 were $497.1 million, an increase of $44.0 million (9.7%) compared to sales of $453.1 million in 2002. The CORE acquisition and Bionx acquisition accounted for $7.2 million and $12.6 million of the increase, respectively, and favorable foreign currency exchange rates accounted for $10.8 million. The Bionx and CORE acquisitions are described more fully in Note 2 to the Consolidated Financial Statements. o Arthroscopy sales increased $19.4 million (11.9%) in 2003 to $182.0 million from $162.6 million in 2002. This increase was primarily attributable to the Bionx acquisition and inclusion of full year results from two businesses acquired during 2002 engaged in the design, manufacture and installation of integrated operating room systems and equipment. o Powered surgical instrument sales increased $7.7 million (6.7%) in 2003 to $122.0 million from $114.3 million in 2002, primarily as a result of increased sales of our new PowerPro(R) line of powered instrument products. o Patient care sales increased $0.3 million (0.4%) in 2003 to $70.0 million from $69.7 million in 2002 as sales of our ECG and surgical suction product lines continued to face significant competition and pricing pressures. o Electrosurgery sales increased $7.6 million (10.9%) in 2003 to $77.3 million from $69.7 million in 2002, primarily as a result of increased sales of our new System 5000(R) electrosurgical generator. o Endosurgery sales increased $9.0 million (24.5%)in 2003 to $45.8 million from $36.8 million in 2002, principally as a result of the inclusion of full year sales from the CORE acquisition. Cost of sales increased to $237.4 million in 2003 compared to $215.9 million in 2002, primarily as a result of the increased sales volumes in each of our principal product lines as described above. Gross profit margins decreased from -39- 52.3% in 2002 to 52.2% in 2003. As discussed in Note 2 to the Consolidated Financial Statements, during 2003, we incurred $1.3 million of acquisition-related charges which have been included in cost of sales. Additionally, as noted above, our ECG and surgical suction product lines continue to face significant competition and pricing pressures resulting in lower gross margins for these product lines. Selling and administrative expense increased to $157.5 million in 2003 as compared to $139.7 million in 2002. As a percentage of sales, selling and administrative expense increased to 31.7% in 2003 from 30.8% in 2002. This increase of 0.9 percentage points is primarily attributable to the transition to a larger, independent sales agent based sales force in our arthroscopy and powered surgical instrument product lines. During 2003, we restructured our arthroscopy and powered surgical instrument sales force by increasing our domestic sales force from 180 to 230 sales representatives. The increase is part of our integration plan for the Bionx acquisition. As part of the sales force restructuring, we converted 90 direct employee sales representatives into nine independent sales agent groups. As a result of this restructuring, we now have 18 exclusive sales agent groups managing 230 arthroscopy and powered surgical instrument sales representatives. The transition of the sales force and greater number of sales staff is expected to result in higher future sales growth in our arthroscopy and powered surgical instrument product lines. Research and development expense was $17.3 million in 2003 compared to $16.1 million in 2002. As a percentage of sales, research and development expense decreased to 3.4% in 2003 from 3.6% in 2002 due to higher net sales. The increase in research and development spending is principally as a result of the Bionx acquisition and represents continued research and development efforts focused primarily on product development in the arthroscopy and powered surgical instrument product lines. As discussed in Note 2 to the Consolidated Financial Statements, during the first quarter of 2003 we wrote-off purchased in-process research and development assets of $7.9 million associated with the Bionx acquisition. As discussed in Note 12 to the Consolidated Financial Statements, other income in 2003 consisted primarily of a $9.0 million net gain on the settlement of a contractual dispute, $2.8 million in pension settlement costs associated with the restructuring of our orthopedic sales force and $3.2 million in costs related primarily to the CORE acquisition and Bionx acquisition. Other expense in 2002 consisted of a $2.0 million loss on the settlement of a patent dispute. As discussed in Note 6 to the Consolidated Financial Statements, we repurchased $130.0 million of our 9% senior subordinated notes during 2003 and recorded a loss on the early extinguishment of debt in the amount of $8.1 million. This amount represents call premium and unamortized deferred financing costs associated with the purchase. During 2002, we recorded an expense in the amount of $1.5 million related to the refinancing of our debt agreements. Interest expense in 2003 was $18.9 million compared to $24.5 million in 2002. The decrease in interest expense is primarily a result of lower weighted average borrowings outstanding in 2003 as compared to 2002 and lower weighted average interest rates on our borrowings (5.99% in 2003 as compared to 7.45% in 2002) inclusive of the implicit finance charge on our accounts receivable sale facility. The decrease in weighted average interest rates on our borrowing is primarily a result of our redemption of $130.0 million in 9% senior subordinated notes in 2003 -40- (See Note 6 to the Consolidated Financial Statements) in favor of lower cost bank debt. A provision for income taxes has been recorded at an effective rate of 39.5% in 2003 and 36.0% in 2002. The effective rate for 2003 was substantially higher than that recorded in 2002 and the United States statutory rate of 35.0% as a result of the non-deductibility for income tax purposes of the Bionx in-process research and development charge discussed above. A reconciliation of the United States statutory income tax rate to our effective tax rate is included in Note 7 to the Consolidated Financial Statements. Liquidity and Capital Resources Our liquidity needs arise primarily from capital investments, working capital requirements and payments on indebtedness under the senior credit agreement. We have historically met these liquidity requirements with funds generated from operations, including sales of accounts receivable and borrowings under our revolving credit facility. In addition, we use term borrowings, including borrowings under our senior credit agreement and borrowings under separate loan facilities, in the case of real property purchases, to finance our acquisitions. We also have the ability to raise funds through the sale of stock or we may issue debt through a private placement or public offering. Operating cash flows Our net working capital position was $159.9 million at December 31, 2004. Net cash provided by operating activities was $48.4 million, $58.4 million and $74.8 million for 2002, 2003 and 2004, respectively. Net cash provided by operating activities in 2004 was favorably impacted by the following noncash charges to income: depreciation, amortization, deferred income taxes, pension costs in excess of pension contributions, the write-off of purchased in-process research and development assets and the write-off of unamortized deferred financing costs. Also benefiting cash flow from operations were the income tax benefit of stock option exercises, increased sales of accounts receivable, increases in accounts payable and accrued compensation and decreases in inventory. Net cash provided by operating activities in 2004 was unfavorably impacted principally by increases in other assets and decreases in other liabilities as a result of timing of cash payments, increased cash payments for income taxes and increases in accounts receivable as a result of increased sales levels. Investing cash flows Capital expenditures were $13.4 million, $9.3 million and $12.4 million for 2002, 2003 and 2004, respectively. These capital expenditures represent the ongoing capital investment requirements of our business and are expected to continue at the same approximate rate during 2005. Net cash flow used in investing activities in 2004 consisted primarily of $81.3 million in payments related to the Bard Endoscopic Technologies acquisition. Financing cash flows Net cash provided by (used in) financing activities during 2004 consisted of the following: $15.2 million in proceeds from the issuance of common stock under -41- our stock option plans and employee stock purchase plan (See Note 8 to the Consolidated Financial Statements); $114.9 million in net repayments under the senior credit agreement; $5.1 million in net repayments on mortgage notes; $150.0 million in gross proceeds from the issuance of 2.50% convertible senior subordinated notes; $5.8 million in payments related to the offering of the 2.50% convertible senior subordinated notes; $6.2 million net change in cash overdrafts; and the repurchase of 1.1 million shares of our common stock at an aggregate cost of approximately $30.0 million. Our senior credit agreement consists of a $100 million revolving credit facility and a $260 million term loan. At December 31, 2004 there were no amounts outstanding on the revolving credit facility. The aggregate amount outstanding on the term loan was $128.1 million at December 31, 2004. The term loan is scheduled to be repaid in quarterly installments over a period of approximately 5 years, with scheduled principal payments of $2.6 million annually through December 2007 increasing to $60.3 million in 2008 and the remaining balance outstanding due in December 2009. We have made all scheduled term loan repayments as they have come due. We may also be required, under certain circumstances, to make additional principal payments based on excess annual cash flow as defined in the senior credit agreement. No such payments were required during 2004. Interest rates on the term facility and the revolving credit facility are at the London Interbank Offered Rate ("LIBOR") plus 2.25% (4.65% at December 31, 2004). The senior credit agreement is collateralized by substantially all of our personal property and assets, except for our accounts receivable and related rights which have been sold in connection with our accounts receivable sales agreement (See Note 1 to the Consolidated Financial Statements). The senior credit agreement contains covenants and restrictions which, among other things, require maintenance of certain working capital levels and financial ratios, prohibit dividend payments and restrict the incurrence of certain indebtedness and other activities, including acquisitions and dispositions. The senior credit agreement contains a material adverse effect clause which could limit our ability to access additional funding under our revolving credit facility should a material adverse change in our business occur. We are also required, under certain circumstances, to make mandatory prepayments from net cash proceeds from any issue of equity and asset sales. Outstanding debt assumed in connection with the 2001 purchase of property in Largo, Florida utilized by our CONMED Linvatec subsidiary consists of a note bearing interest at 7.50% per annum with semiannual payments of principal and interest through June 2009 (the "Class A note"); and a note bearing interest at 8.25% per annum compounded semiannually through June 2009, after which semiannual payments of principal and interest will commence, continuing through June 2019 (the "Class C note"). The principal balances outstanding on the Class A note and Class C note aggregated $8.3 million and $8.2 million, respectively, at December 31, 2004. These loans are secured by our Largo, Florida property. On November 11 2004, we completed an offering, in a private placement, of $150.0 million in 2.50% convertible senior subordinated notes (the "Notes") due 2024. This offering has allowed us to fix interest rates on $150.0 million of our total outstanding long-term debt at 2.50%. The Notes represent our subordinated unsecured obligations and are convertible under the following circumstances, as defined in the bond indenture, into a combination of cash and CONMED common stock: when the closing price of our common stock for each of 20 or more consecutive trading days in a period of 30 consecutive trading days exceeds 130% of the applicable conversion price; after any 10 consecutive trading day period in which the average trading price per $1,000 principal amount of the Notes was equal to or less than 97% of the average conversion value of the Notes; if we call a Note for -42- redemption; and based on certain corporate transactions such as if we are party to a consolidation, merger or binding share exchange in which over 50% of our outstanding shares of common stock would be converted into cash, securities or other property, or if another fundamental change (as defined in the bond indenture) occurs. Upon conversion, the holder of each Note will receive the conversion value of the Note payable in cash up to the principal amount of the Note and CONMED common stock for the Note's conversion value in excess of such principal amount. Amounts in excess of the principal amount are at an initial conversion rate, subject to adjustment, of 26.1849 shares per $1,000 principal amount of the Note (which represents an initial conversion price of $38.19 per share). The Notes mature on November 15, 2024 and are not redeemable by us prior to November 15, 2011. Holders of the Notes will be able to require that we repurchase some or all of the Notes on November 15, 2011, 2014 and 2019. We have determined that the Notes contain two embedded derivatives. The embedded derivatives are recorded at fair value in other long-term liabilities and changes in their value are recorded through the consolidated statement of income. The embedded derivatives have a nominal value, and it is our belief that any change in their fair value would not have a material adverse effect on our business, financial condition or results of operations. The Notes offering resulted in gross proceeds of $150.0 million, less $5.8 million in initial purchaser's discount and other offering related payments which are being amortized to interest expense over a 7 year period through November 15, 2011 (the earliest date at which we may be required to repurchase some or all of the Notes). Net proceeds from the offering and cash on hand were used to repay $82.2 million on the term loan and a further $45.0 million in borrowings then outstanding on the revolving credit facility under our senior credit agreement. (The revolving credit facility borrowings were used to finance a portion of the Bard Endoscopic Technologies acquisition--See Note 2 to the Consolidated Financial Statements). Additionally, in conjunction with the Notes offering, we repurchased $30.0 million of our common stock in privately negotiated transactions. As a result of the $82.2 million prepayment on the term loan, we recorded $0.8 million in losses on the early extinguishment of debt related to the write-off of unamortized deferred financing fees. Initial purchasers for the Notes included UBS Securities LLC, Banc of America Securities LLC, Citigroup Global Markets Inc. and JP Morgan Securities Inc. (the "initial purchasers"). The Notes were resold by the initial purchasers to qualified institutional buyers within the meaning of Rule 144A under the Securities Act of 1933, as amended. The Notes and the underlying common stock issuable upon conversion have not been registered under the Securities Act or any applicable state securities laws and may not be offered or sold in the United States, absent registration or an applicable exemption from such registration requirements. We have filed a registration statement with the Securities and Exchange Commission on Form S-3, which is not yet effective, which will enable the qualified institutional buyers to resell their holdings in the Notes. On February 15, 2005, we announced that our Board of Directors has authorized a share repurchase program under which we may repurchase up to $50.0 million of our common stock, although no more than $25.0 million may be purchased in any calendar year. 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. We expect to repurchase shares to offset the dilutive effect of the issuance of shares under our employee stock option and employee stock purchase plans, but we may also repurchase shares depending upon market conditions and the market price of our common stock. We expect to finance -43- repurchases from cash-on-hand and amounts available under our senior credit agreement. Management believes that cash flow from operations, including accounts receivable sales, cash and cash equivalents on hand and available borrowing capacity under our senior credit agreement will be adequate to meet our anticipated operating working capital requirements, debt service, funding of capital expenditures and common stock repurchases in the foreseeable future. See "Item 1. Business - Forward Looking Statements." Off-Balance Sheet Arrangements We have an accounts receivable sales agreement pursuant to which we and certain of our subsidiaries sell on an ongoing basis certain accounts receivable to CONMED Receivables Corporation ("CRC"), a wholly-owned, bankruptcy-remote, special-purpose subsidiary of CONMED Corporation. CRC may in turn sell up to an aggregate $50.0 million undivided percentage ownership interest in such receivables (the "asset interest") to a bank (the "purchaser"). The purchaser's share of collections on accounts receivable are calculated as defined in the accounts receivable sales agreement, as amended. Effectively, collections on the pool of receivables flow first to the purchaser and then to CRC, but to the extent that the purchaser's share of collections may be less than the amount of the purchaser's asset interest, there is no recourse to CONMED or CRC for such shortfall. For receivables which have been sold, CONMED Corporation and its subsidiaries retain collection and administrative responsibilities as agent for the purchaser. As of December 31, 2003 and 2004, the undivided percentage ownership interest in receivables sold by CRC to the purchaser aggregated $44.0 million and $49.0 million, respectively, which has been accounted for as a sale and reflected in the balance sheet as a reduction in accounts receivable. Expenses associated with the sale of accounts receivable, including the purchaser's financing costs to purchase the accounts receivable, were $0.8 million and $1.0 million, in 2003 and 2004, respectively, and are included in interest expense. There are certain statistical ratios, primarily related to sales dilution and losses on accounts receivable, which must be calculated and maintained on the pool of receivables in order to continue selling to the purchaser. The pool of receivables is in full compliance with these ratios. Management believes that additional accounts receivable arising in the normal course of business will be of sufficient quality and quantity to meet the requirements for sale under the accounts receivables sales agreement. In the event that new accounts receivable arising in the normal course of business do not qualify for sale, then collections on sold receivables will flow to the purchaser rather than being used to fund new receivable purchases. To the extent that such collections would not be available to CONMED in the form of new receivables purchases, we would need to access an alternate source of working capital, such as our $100 million revolving credit facility. Our accounts receivable sales agreement, as amended, also requires us to obtain a commitment (the "purchaser commitment"), on an annual basis, from the purchaser to fund the purchase of our accounts receivable. The purchaser commitment was amended effective October 20, 2004 whereby it was extended for an additional year under substantially the same terms and conditions. Contractual Obligations The following table summarizes our contractual obligations for the next five years and thereafter (amounts in thousands). Purchase obligations represent purchase orders for goods and services placed in the ordinary course of business. There were no capital lease obligations as of December 31, 2004. -44-
Payments Due by Period Less than 1-3 3-5 More than Total 1 Year Years Years 5 Years -------- -------- -------- -------- --------- Long-term debt ...................... $294,522 $ 4,037 $ 8,601 $124,112 $157,772 Purchase Obligations ................ 73,059 72,783 255 21 -- Operating lease obligations ..................... 13,990 2,796 5,208 3,795 2,191 -------- -------- -------- -------- -------- Total contractual obligations ..................... $381,571 $ 79,616 $ 14,064 $127,928 $159,963 ======== ======== ======== ======== ========
In addition to the above contractual obligations, we are required to make periodic interest payments on our long-term debt obligations; (See additional discussion under Item 7A. "Quantitative and Qualitative Disclosures About Market Risk--Interest Rate Risk") and Note 6 to the Consolidated Financial Statements. We may also be required to make contributions to our pension plan which are not expected to exceed $4.5 million in 2005 (See Note 10 to the Consolidated Financial Statements). Stock-based Compensation We have reserved shares of common stock issuance to employees and directors under three shareholder-approved stock option plans. The exercise price on all outstanding options is equal to the quoted fair market value of the stock at the date of grant. Stock options are non-transferable other than on death and generally become exercisable over a five year period from date of grant and expire ten years from date of grant (See Note 8 to the Consolidated Financial Statements). New Accounting Pronouncements See Note 14 to the Consolidated Financial Statements for a discussion of new accounting pronouncements. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Market risk is the potential loss arising from adverse changes in market rates and prices such as commodity prices, foreign currency exchange rates and interest rates. In the normal course of business, we are exposed to various market risks, including changes in foreign currency exchange rates and interest rates. We manage our exposure to these and other market risks through regular operating and financing activities and as necessary through the use of derivative financial instruments. Foreign currency risk A significant portion of our operations consist of sales activities in foreign jurisdictions. As a result, our financial results may be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the markets in which we distribute products. As of December 31, 2004, we have not entered into any foreign exchange forward or option contracts designed to hedge the effect of foreign currency transactions. We have mitigated the effect of foreign currency exchange rate risk by transacting a significant portion of our foreign sales in United States dollars. During 2004, changes in currency exchange rates increased sales by approximately $9.7 million and income before income taxes by approximately $6.4 million. In the future, we will continue -45- to evaluate our foreign currency exposure and assess the need to enter into derivative contracts which hedge foreign currency transactions. Interest rate risk At December 31, 2004, we had approximately $128.1 million of variable rate long-term debt under our senior credit agreement; we are not a party to any interest rate swap agreements as of December 31, 2004. Assuming no repayments other than our 2005 scheduled term loan payments, if market interest rates for similar borrowings average 1.0% more in 2005 than they did in 2004, interest expense would increase, and income before income taxes would decrease by $1.3 million. Comparatively, if market interest rates for similar borrowings average 1.0% less in 2005 than they did in 2004, our interest expense would decrease, and income before income taxes would increase by $1.3 million. Item 8. Financial Statements and Supplementary Data Our 2004 Financial Statements, as well as the report thereon of PricewaterhouseCoopers LLP dated March 15, 2005, are included elsewhere herein. Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosures There were no changes in or disagreement with accountants on accounting and financial disclosure during the last two fiscal years. Item 9A. Controls and Procedures As of the end of the period covered by this report, an evaluation was carried out by CONMED Corporation's management, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the fourth quarter of the year ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Management's Report on Internal Control over Financial Reporting and the Report of Independent Registered Public Accounting Firm thereon are set forth in Part II, Item 8 of the Annual Report on Form 10-K. Item 9B. Other Information Not applicable. -46- PART III Item 10. Directors and Executive Officers of the Registrant The information required by this item is incorporated herein by reference to the sections captioned "Proposal One: Election of Directors" and "Directors, Executive Officers, Senior Officers, and Nominees for the Board of Directors" in CONMED Corporation's definitive Proxy Statement or other informational filing to be filed with the Securities and Exchange Commission on or about April 15, 2005. Item 11. Executive Compensation The information required by this item is incorporated herein by reference to the sections captioned "Compensation of Executive Officers", "Stock Option Plans", "Pension Plans" and "Board of Directors Interlocks and Insider Participation; Certain Relationships and Related Transactions" in CONMED Corporation's definitive Proxy Statement or other informational filing to be filed with the Securities and Exchange Commission on or about April 15, 2005. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by this item is incorporated herein by reference to the section captioned "Security Ownership of Certain Beneficial Owners and Management" in CONMED Corporation's definitive Proxy Statement or other informational filing to be filed with the Securities and Exchange Commission on or about April 15, 2005. Item 13. Certain Relationships and Related Transactions The information required by this item is incorporated herein by reference to the section captioned "Board of Directors Interlocks and Insider Participation; Certain Relationships and Related Transactions" in CONMED Corporation's definitive Proxy Statement or other informational filing to be filed with the Securities and Exchange Commission on or about April 15, 2005. Item 14. Principal Accounting Fees and Services The information required by this item is incorporated herein by reference to the section captioned "Audit Fees" in CONMED Corporation's definitive Proxy Statement or other informational filing to be filed with the Securities and Exchange Commission on or about April 15, 2005. -47- PART IV Item 15. Exhibits and Financial Statement Schedules Index to Financial Statements (a)(1) List of Financial Statements Page in Form 10-K ----------------- Management's Report on Internal Control 54 Over Financial Reporting Report of Independent Registered Public 55 Accounting Firm Consolidated Balance Sheets at December 31, 57 2003 and 2004 Consolidated Statements of Income for the 58 Years Ended December 31, 2002, 2003 and 2004 Consolidated Statements of Shareholders' 59 Equity for the Years Ended December 31, 2002, 2003 and 2004 Consolidated Statements of Cash Flows for 61 the Years Ended December 31, 2002, 2003 and 2004 Notes to Consolidated Financial Statements 63 (2) List of Financial Statement Schedules Valuation and Qualifying Accounts (Schedule 91 II) All other schedules have been omitted because they are not applicable, or the required information is shown in the financial statements or notes thereto. (3) List of Exhibits The exhibits listed on the accompanying Exhibit Index on page 50 below are filed as part of this Form 10-K. -48- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the date indicated below. CONMED CORPORATION March 15, 2005 By: /s/ Eugene R. Corasanti ----------------------- Eugene R. Corasanti (Chairman of the Board, Chief Executive Officer) Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrants and in the capacities and on the dates indicated. Signature Title Date - --------- ----- ---- Chairman of the Board /s/ EUGENE R. CORASANTI Chief Executive Officer - ----------------------------- and Director March 15, 2005 Eugene R. Corasanti /s/ JOSEPH J. CORASANTI President, Chief Operating - ----------------------------- Officer and Director March 15, 2005 Joseph J. Corasanti Vice President-Finance /s/ ROBERT D. SHALLISH JR. and Chief Financial Officer - ----------------------------- (Principal Financial Officer) March 15, 2005 Robert D. Shallish, Jr. Vice President - Corporate /s/ LUKE A. POMILIO Controller (Principal - ----------------------------- Accounting Officer) Luke A. Pomilio March 15, 2005 /s/ BRUCE F. DANIELS - ----------------------------- Bruce F. Daniels Director March 15, 2005 /s/ Jo ANN GOLDEN - ----------------------------- Jo Ann Golden Director March 15, 2005 /s/ STEPHEN M. MANDIA - ----------------------------- Stephen M. Mandia Director March 15, 2005 /s/ WILLIAM D. MATTHEWS - ----------------------------- William D. Matthews Director March 15, 2005 /s/ STUART J. SCHWARTZ - ----------------------------- Stuart J. Schwartz Director March 15, 2005 -49- Exhibit Index Exhibit No. Description - ----------- ----------- 2.1 - Agreement of Purchase and Sale, dated as of February 5, 2001 by and between Linvatec Corporation and Largo Lakes, I, II and IV, Inc. et al (Incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001). 2.2 - Agreement and Plan of Merger dated January 13, 2003 by and among CONMED Corporation, Arrow Merger Corporation and Bionx Implants, Inc. (Incorporated by reference to Exhibit 2.5 of the Company's Annual Report on Form 10-K for the year ended December 31, 2002). 2.3 - Asset Purchase Agreement, dated August 18, 2004 by and between CONMED Corporation and C.R. Bard, Inc. et al (Incorporated by reference to Exhibit 2.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004). 2.4 - First Amendment to Asset Purchase Agreement, dated September 29, 2004 by and between CONMED Corporation and C.R. Bard, Inc. et al (Incorporated by reference to Exhibit 2.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004). 3.1 - Amended and Restated By-Laws, as adopted by the Board of Directors on December 26, 1990 (Incorporated by reference to the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on March 7, 1991). 3.2 - 1999 Amendment to Certificate of Incorporation and Restated Certificate of Incorporation of CONMED Corporation (Incorporated by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1999). 4.1 - See Exhibit 3.1. 4.2 - See Exhibit 3.2. 4.3 - Guarantee and Collateral Agreement, dated August 28, 2002, made by CONMED Corporation and certain of its subsidiaries in favor of JP Morgan Chase Bank (Incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002). 4.4 - First Amendment to Guarantee and Collateral Agreement, dated June 30, 2003, made by CONMED Corporation and certain of its subsidiaries in favor of JP Morgan Chase Bank and the several banks and other financial institutions or entities from time to time parties thereto -50- Exhibit No. Description - ----------- ----------- (Incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003). 4.5 Indenture dated November 10, 2004 between CONMED Corporation and The Bank of New York, as Trustee (Incorporated by reference to the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on November 16, 2004). 10.1+ - Employment Agreement between the Company and Eugene R. Corasanti, dated December 16, 1996 (Incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996). 10.2+ - Amendment to December 16, 1996 Employment Agreement between the Company and Eugene R. Corasanti, dated March 7, 2002 (Incorporated by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the year ended December 31, 2001). 10.3+ - Amended and restated Employment Agreement, dated November 12, 2004, by and between CONMED Corporation and Joseph J. Corasanti, Esq. (Incorporated by reference to the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on November 16, 2004). 10.4 - 1992 Stock Option Plan (including form of Stock Option Agreement) (Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 25, 1992). 10.5 - Amended and Restated Employee Stock Option Plan (including form of Stock Option Agreement) (Incorporated by reference to Exhibit 10.6 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996). 10.6 - Stock Option Plan for Non-Employee Directors of CONMED Corporation (Incorporated by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996). 10.7 - Amendment to Stock Option Plan for Non-employee Directors of CONMED Corporation (Incorporated by reference to the Company's Definitive Proxy Statement for the 2002 Annual Meeting filed with the Securities and Exchange Commission on April 17, 2002). 10.8 - 1999 Long-term Incentive Plan (Incorporated by reference to the Company's Definitive Proxy Statement for the 1999 Annual Meeting filed with the Securities and Exchange Commission on April 16, 1999). 10.9 - Amendment to 1999 Long-term Incentive Plan (Incorporated by reference to the Company's Definitive Proxy Statement -51- Exhibit No. Description - ----------- ----------- for the 2002 Annual Meeting filed with the Securities and Exchange Commission on April 17, 2002). 10.10 - 2002 Employee Stock Purchase Plan (Incorporated by reference to the Company's Definitive Proxy Statement for the 2002 Annual Meeting filed with the Securities and Exchange Commission on April 17, 2002). 10.11 - Amended and Restated Credit Agreement, dated June 30, 2003, among CONMED Corporation, JP Morgan Chase Bank and the several banks and other financial institutions or entities from time to time parties thereto (Incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003). 10.12 - First Amendment to Amended and Restated Credit Agreement, dated December 23, 2003, among CONMED Corporation, JP Morgan Chase Bank and the several other financial institutions or entities from time to time parties thereto (Incorporated by reference to Exhibit 4.4 of the Company's Annual Report on Form 10-K for the year ended December 31, 2003). 10.13 - Purchase and Sale Agreement dated November 1, 2001 among CONMED Corporation, et al and CONMED Receivables Corporation (Incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001). 10.14 - Amendment No. 1 dated October 23, 2003 to the Purchase and Sale Agreement dated November 1, 2001 among CONMED Corporation, et al and CONMED Receivables Corporation (Incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003). 10.15 - Amended and Restated Receivables Purchase Agreement, dated October 23, 2003, among CONMED Receivables Corporation, CONMED Corporation, and Fleet National Bank (Incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003). -52- 10.16 - Second Amendment to Amended and Restated Credit Agreement, dated September 23, 2004, by and among CONMED Corporation, JP Morgan Chase Bank and other financial institutions from time to time party thereto (Incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004). 10.17 - Amendment No. 1, dated October 20, 2004 to the Amended and Restated Receivables Purchase Agreement, dated October 23, 2003, among CONMED Receivables Corporation, CONMED Corporation and Fleet Bank (Incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004). 10.18 - Registration Rights Agreement, dated November 10, 2004, among CONMED Corporation and UBS Securities LLC on behalf of Several Initial Purchasers (Incorporated by reference to the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on November 16, 2004). 12* - Computation of ratio of earnings to fixed charges. 14 - Code of Ethics. The CONMED code of ethics may be accessed via the Company's website at http://www.conmed.com/ investor-ethics.htm 21* - Subsidiaries of the Registrant. 23* - Consent, dated March 15, 2005, of PricewaterhouseCoopers LLP, independent registered public accounting firm. 31.1* - Certification of Eugene R. Corasanti pursuant to Rule 13a-15(f) and Rule 15d-15(f) of the Securities Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2* - Certification of Robert D. Shallish, Jr. pursuant to Rule 13a-15(f) and Rule 15d-15(f) of the Securities Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1* - Certifications of Eugene R. Corasanti and Robert D. Shallish, Jr. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Filed herewith + Management contract or compensatory plan or arrangement. -53- MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of CONMED Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Management assessed the effectiveness of CONMED's internal control over financial reporting as of December 31, 2004. In making its assessment, management utilized the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in "Internal Control-Integrated Framework". Management has concluded that based on its assessment, CONMED's internal control over financial reporting was effective as of December 31, 2004. Management's assessment of the effectiveness of CONMED's internal control over financial reporting as of December 31, 2004 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page 55. /s/ Eugene R. Corasanti - --------------------------- Eugene R. Corasanti Chairman of the Board and Chief Executive Officer /s/ Robert D. Shallish, Jr. - --------------------------- Robert D. Shallish, Jr. Vice President-Finance and Chief Financial Officer -54- REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of CONMED Corporation: We have completed an integrated audit of CONMED Corporation's 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below. Consolidated financial statements and financial statement schedule - ------------------------------------------------------------------ In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of CONMED Corporation and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. Internal control over financial reporting - ----------------------------------------- Also, in our opinion, management's assessment, included in "Management's Report on Internal Control over Financial Reporting", appearing on page 54, that the Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in "Internal Control - Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management's assessment and on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all -55- material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. PricewaterhouseCoopers LLP Syracuse, New York March 15, 2005 -56- CONMED CORPORATION CONSOLIDATED BALANCE SHEETS December 31, 2003 and 2004 (In thousands except share and per share amounts)
2003 2004 ---- ---- ASSETS Current assets: Cash and cash equivalents ........................................... $ 5,986 $ 4,189 Accounts receivable, less allowance for doubtful accounts of $1,672 in 2003 and $1,235 in 2004 ................... 60,449 74,593 Inventories ......................................................... 120,945 127,935 Deferred income taxes ............................................... 10,188 13,733 Prepaid expenses and other current assets ........................... 3,538 2,492 --------- --------- Total current assets ........................................ 201,106 222,942 --------- --------- Property, plant and equipment, net ....................................... 97,383 101,465 Goodwill, net ............................................................ 290,562 334,483 Other intangible assets, net ............................................. 193,969 195,234 Other assets ............................................................. 22,038 18,701 --------- --------- Total assets ................................................ $ 805,058 $ 872,825 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt ................................... $ 4,143 $ 4,037 Accounts payable .................................................... 18,320 28,913 Accrued compensation and benefits ................................... 10,685 12,655 Income taxes payable ................................................ 10,877 5,870 Accrued interest .................................................... 279 748 Other current liabilities ........................................... 10,551 10,838 --------- --------- Total current liabilities ................................... 54,855 63,061 --------- --------- Long-term debt ........................................................... 260,448 290,485 Deferred income taxes .................................................... 46,143 51,433 Other long-term liabilities .............................................. 10,122 19,863 --------- --------- Total liabilities ........................................... 371,568 424,842 --------- --------- Commitments and contingencies Shareholders' equity: Preferred stock, par value $.01 per share; authorized 500,000 shares, none outstanding ................................ -- -- Common stock, par value $.01 per share; 100,000,000 authorized; 29,140,644 and 30,135,835, issued in 2003 and 2004, respectively .................................. 291 301 Paid-in capital ..................................................... 237,076 256,551 Retained earnings ................................................... 194,473 227,938 Accumulated other comprehensive income (loss) ....................... 2,069 (6,399) Less: Treasury stock, at cost; 37,500 and 1,156,500 shares in 2003 and 2004, respectively .................................... (419) (30,408) --------- --------- Total shareholders' equity .................................. 433,490 447,983 --------- --------- Total liabilities and shareholders' equity .................. $ 805,058 $ 872,825 ========= =========
See notes to consolidated financial statements. -57- CONMED CORPORATION CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2002, 2003 and 2004 (In thousands except per share amounts)
2002 2003 2004 ---- ---- ---- Net sales ................................................. $ 453,062 $ 497,130 $ 558,388 Cost of sales ............................................. 215,891 237,433 271,496 --------- --------- --------- Gross profit .............................................. 237,171 259,697 286,892 --------- --------- --------- Selling and administrative expense ........................ 139,735 157,453 183,183 Research and development expense .......................... 16,087 17,306 20,205 Write-off of purchased in-process research and development assets ...................... -- 7,900 16,400 Other expense (income) .................................... 2,000 (2,917) 3,943 --------- --------- --------- 157,822 179,742 223,731 --------- --------- --------- Income from operations .................................... 79,349 79,955 63,161 Loss on early extinguishment of debt ...................... 1,475 8,078 825 Interest expense .......................................... 24,513 18,868 12,774 --------- --------- --------- Income before income taxes ................................ 53,361 53,009 49,562 Provision for income taxes ................................ 19,210 20,927 16,097 --------- --------- --------- Net income ................................................ $ 34,151 $ 32,082 $ 33,465 ========= ========= ========= Earnings per share: Basic ............................................ $ 1.25 $ 1.11 $ 1.13 Diluted .......................................... 1.23 1.10 1.11
See notes to consolidated financial statements. -58- CONMED CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years Ended December 31, 2002, 2003 and 2004 (In thousands)
Accumulated Common Stock Other ------------ Paid-in Retained Comprehensive Treasury Shareholders' Shares Amount Capital Earnings Income (Loss) Stock Equity ------ ------ ------- -------- ------------- ----- ------ Balance at December 31, 2001 ......... 25,262 253 160,757 128,240 (5,197) (419) 283,634 -------- -------- --------- -------- -------- -------- --------- Common stock issued under employee plans ......... 546 5 5,012 5,017 Tax benefit arising from common stock issued under employee plans ............... 1,970 1,970 Common stock issuance ............ 3,000 30 66,093 66,123 Repurchase of common stock warrant ................ (2,000) (2,000) Comprehensive income: Foreign currency translation adjustments ........ 1,010 Cash flow hedging (net of income tax expense of $596) ............ 1,058 Minimum pension liability (net of income tax benefit of $2,264) .......... (4,024) Net income ...................... 34,151 Total comprehensive income ....... 32,195 -------- -------- --------- -------- -------- -------- --------- Balance at December 31, 2002 ......... 28,808 $ 288 $ 231,832 $162,391 $ (7,153) $ (419) $ 386,939 -------- -------- --------- -------- -------- -------- --------- Common stock issued under employee plans ......... 248 2 3,198 3,200 Tax benefit arising from common stock issued under employee plans ......... 390 390 Common stock issued in connection with business acquisitions ................. 85 1 1,656 1,657
See notes to consolidated financial statements. (continued) -59- CONMED CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years Ended December 31, 2002, 2003 and 2004 (In thousands)
Accumulated Common Stock Other ---------------- Paid-in Retained Comprehensive Treasury Shareholders' Shares Amount Capital Earnings Income (Loss) Stock Equity ------ ------ ------- ------- ------------- ----- ------ Comprehensive income: Foreign currency translation adjustments ............. 3,082 Cash flow hedging (net of income tax expense of $593) ................. 1,054 Minimum pension liability (net of income tax expense of $2,861) ............... 5,086 Net income ........................... 32,082 Total comprehensive income ............ 41,304 ------ ------ --------- --------- -------- --------- --------- Balance at December 31, 2003 .............. 29,141 $ 291 $ 237,076 $ 194,473 $ 2,069 $ (419) $ 433,490 ====== ====== ========= ========= ======== ========= ========= Common stock issued under employee plans .............. 995 10 15,578 15,588 Tax benefit arising from common stock issued under employee plans .............. 3,897 3,897 Repurchase of common stock ............ (29,989) (29,989) Comprehensive income: Foreign currency translation adjustments ............. 2,133 Cash flow hedging (net of income tax benefit of $82) .................. (146) Minimum pension liability (net of income tax benefit of $5,630) .................. (10,455) Net income ........................... 33,465 Total comprehensive income ............ 24,997 ------ ------ --------- --------- -------- --------- --------- Balance at December 31, 2004 .............. 30,136 $ 301 $ 256,551 $ 227,938 $ (6,399) $ (30,408) $ 447,983 ====== ====== ========= ========= ======== ========= =========
See notes to consolidated financial statements. -60- CONMED CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2002, 2003 and 2004 (In thousands)
2002 2003 2004 ---- ---- ---- Cash flows from operating activities: Net income ......................................................... $ 34,151 $ 32,082 $ 33,465 --------- --------- --------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation ................................................... 9,203 10,539 10,962 Amortization ................................................... 13,167 14,315 15,906 Deferred income taxes .......................................... 10,664 13,715 4,301 Income tax benefit of stock option exercises ......................................... 1,970 390 3,897 Contributions to pension plans less than (in excess of) net pension cost ............................ (1,999) (11,082) 3,619 Write-off of purchased in-process research and development assets ............................ -- 7,900 16,400 Write-off of deferred financing costs .......................... 1,475 2,181 825 Increase (decrease) in cash flows from changes in assets and liabilities, net of effects from acquisitions: Sale of accounts receivable ................................ (3,000) 7,000 5,000 Accounts receivable ........................................ (2,151) (6,405) (19,144) Inventories ................................................ (15,213) (3,411) 1,441 Accounts payable ........................................... 4,641 (4,732) 4,350 Income taxes payable ....................................... 4,217 2,188 (2,532) Accrued compensation and benefits .......................... (1,584) (338) 1,626 Accrued interest ........................................... (1,160) (3,515) 469 Other assets ............................................... (3,790) (3,138) (3,884) Other liabilities .......................................... (2,184) 694 (1,861) --------- --------- --------- 14,256 26,301 41,375 --------- --------- --------- Net cash provided by operating activities .................. 48,407 58,383 74,840 --------- --------- --------- Cash flows from investing activities: Payments related to business acquisitions, net of cash acquired ........................................... (17,375) (55,079) (81,645) Purchases of property, plant and equipment, net .................... (13,384) (9,309) (12,419) Other investing activities ......................................... -- (4,085) -- --------- --------- --------- Net cash used in investing activities ...................... (30,759) (68,473) (94,064) --------- --------- --------- Cash flows from financing activities: Net proceeds from issuance of common stock ......................... 66,123 -- -- Net proceeds from common stock issued under employee plans ........................................... 5,017 3,200 15,200 Repurchase of common stock ......................................... -- -- (29,989) Repurchase of warrant on common stock .............................. (2,000) -- -- Redemption of 9.0% senior subordinated notes ....................... -- (130,000) -- Payments on senior credit agreement ................................ (182,997) (22,000) (114,937) Proceeds of senior credit agreement ................................ 105,138 160,000 -- Payments on mortgage notes ......................................... (683) (796) (5,132)
See notes to consolidated financial statements. (continued) -61- CONMED CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2002, 2003 and 2004 (In thousands)
2002 2003 2004 ---- ---- ---- Proceeds from issuance of 2.50% convertible senior subordinated notes .......................................... -- -- 150,000 Payments related to issuance of debt ............................... (1,513) (1,950) (5,848) Net change in cash overdrafts .......................................... (3,484) (373) 6,209 --------- --------- --------- Net cash provided by (used in) financing activities ........................................... (14,399) 8,081 15,503 --------- --------- --------- Effect of exchange rate changes on cash and cash equivalents ......................................... 975 2,369 1,924 --------- --------- --------- Net increase (decrease) in cash and cash equivalents ............................................ 4,224 360 (1,797) Cash and cash equivalents at beginning of year .............................................................. 1,402 5,626 5,986 --------- --------- --------- Cash and cash equivalents at end of year ............................... $ 5,626 $ 5,986 $ 4,189 ========= ========= ========= Supplemental disclosures of cash flow information: Cash paid during the year for: Interest ................................................... $ 24,453 $ 21,698 $ 12,680 Income taxes ............................................... 5,478 5,507 11,994
Supplemental disclosures of non-cash investing and financing activities: As more fully described in Note 2, we assumed $3.4 million, $12.1 million and $3.5 million in liabilities in connection with business acquisitions in 2002, 2003 and 2004, respectively. As more fully described in Note 2, during 2003 we issued approximately 85,000 shares of our common stock valued at approximately $1.7 million as part of the consideration for the purchase of several businesses in 2002. See notes to consolidated financial statements. -62- CONMED CORPORATION 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 specializing in instruments, implants and video equipment for arthroscopic sports medicine and powered surgical instruments, such as drills and saws, for orthopedic, ENT, neurosurgery and other surgical specialties. We are a leading developer, manufacturer and supplier of RF electrosurgery systems used routinely to cut and cauterize tissue in nearly all types of surgical procedures worldwide, endosurgery products such as trocars, clip appliers, scissors and surgical staplers, and a full line of ECG electrodes for heart monitoring and other patient care products. We also offer integrated operating room systems and equipment. Our newest product line, CONMED Endoscopic Technologies offers a portfolio of innovative disposable products used by gastroenterologists to diagnose and treat diseases of the digestive tract. Our products are used in a variety of clinical settings, such as operating rooms, surgery centers, physicians' offices and hospitals. 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. Estimates are used in accounting for, among other things, allowances for uncollectible accounts, rebates and sales allowances, inventory allowances, purchased in-process research and development, pension benefits, goodwill and intangible assets, contingencies and other accruals. We base our estimates on historical experience and on various other assumptions which are believed to be reasonable under the circumstances. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may differ from those estimates. Estimates and assumptions are reviewed periodically, and the effect of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Cash and cash equivalents We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. -63- Accounts receivable sale On November 1, 2001, we entered into a five-year accounts receivable sales agreement pursuant to which we and certain of our subsidiaries sell on an ongoing basis certain accounts receivable to CONMED Receivables Corporation ("CRC"), a wholly-owned, bankruptcy-remote, special-purpose subsidiary of CONMED Corporation. CRC may in turn sell up to an aggregate $50.0 million undivided percentage ownership interest in such receivables (the "asset interest") to a bank ("the "purchaser"). The purchaser's share of collections on accounts receivable are calculated as defined in the accounts receivable sales agreement, as amended. Effectively, collections on the pool of receivables flow first to the purchaser and then to CRC, but to the extent that the purchaser's share of collections may be less than the amount of the purchaser's asset interest, there is no recourse to CONMED or CRC for such shortfall. For receivables which have been sold, CONMED Corporation and its subsidiaries retain collection and administrative responsibilities as agent for the purchaser. As of December 31, 2003 and 2004, the undivided percentage ownership interest in receivables sold by CRC to the purchaser aggregated $44.0 million and $49.0 million, respectively, which has been accounted for as a sale and reflected in the balance sheet as a reduction in accounts receivable. Expenses associated with the sale of accounts receivable, including the purchaser's financing costs to purchase the accounts receivable, were $0.8 million and $1.0 million, in 2003 and 2004, respectively, and are included in interest expense. There are certain statistical ratios, primarily related to sales dilution and losses on accounts receivable, which must be calculated and maintained on the pool of receivables in order to continue selling to the purchaser. The pool of receivables is in full compliance with these ratios. Management believes that additional accounts receivable arising in the normal course of business will be of sufficient quality and quantity to meet the requirements for sale under the accounts receivable sales agreement. In the event that new accounts receivable arising in the normal course of business do not qualify for sale, then collections on sold receivables will flow to the purchaser rather than being used to fund new receivable purchases. To the extent that such collections would not be available to CONMED in the form of new receivables purchases, we would need to access an alternate source of working capital, such as our $100 million revolving credit facility. Our accounts receivable sales agreement, as amended, also requires us to obtain a commitment (the "purchaser commitment"), on an annual basis, from the purchaser to fund the purchase of our accounts receivable. The purchaser commitment was amended effective October 20, 2004 whereby it was extended for an additional year under substantially the same terms and conditions. Inventories Inventories are valued at the lower of cost or market. Cost is determined on the FIFO (first-in, first-out) method of accounting. 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 40 years Leasehold improvements Shorter of life of asset or life of lease Machinery and equipment 2 to 15 years -64- Goodwill and other intangible assets Goodwill represents the excess of purchase price over fair value of identifiable net assets of acquired businesses. Other intangible assets primarily represent allocations of purchase price to identifiable intangible assets of acquired businesses. Goodwill and other intangible assets had been amortized over periods ranging from 5 to 40 years through December 31, 2001. Because of our history of growth through acquisitions, goodwill and other intangible assets comprise a substantial portion (60.7% at December 31, 2004) of our total assets. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"). We adopted SFAS 142 effective January 1, 2002. As a result of the adoption of this standard, amortization of goodwill and certain intangibles has been discontinued. We perform impairment tests of goodwill and indefinite-lived intangible assets and evaluate the useful lives of acquired intangible assets subject to amortization. These tests and evaluations are performed in accordance with SFAS 142. No impairment losses or adjustments to useful lives have been recognized as a result of these tests. It is our policy to perform annual impairment tests in the fourth quarter. Other long-lived assets We review asset carrying amounts for impairment (consisting of intangible assets subject to amortization and property, plant and equipment) 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. Equity investments We have several investments in the common stock of other companies in our industry which represent less than 20% of the voting stock of these companies and in which we do not have the ability to exercise significant influence. We have accounted for these investments under the cost method. We review these investments for impairment whenever events or circumstances indicate that the carrying amounts of these investments may not be recoverable. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the investment, an impairment loss is recognized by reducing the recorded value to its current fair value. Fair value of financial instruments The carrying amounts reported in our balance sheets for cash and cash equivalents, accounts receivable, accounts payable and long-term debt excluding the 2.50% convertible senior subordinated notes (the "Notes") approximate fair value. The fair value of the Notes approximated $156.0 million at December 31, 2004, based on their quoted market price. 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 -65- 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 income (loss). Transaction gains and losses are included in net income. Income taxes We provide for income taxes in accordance with the provisions of SFAS No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under the liability method specified by SFAS 109, deferred tax assets and liabilities are based on the difference between the financial statement and tax basis of assets and liabilities as measured by the tax rates that are anticipated to be in effect when these differences reverse. The deferred tax provision generally represents the net change in the assets and liabilities for deferred tax. A valuation allowance is established when it is necessary to reduce deferred tax assets to amounts for which realization is more likely than not. Revenue recognition Revenue is recognized when title has been transferred to the customer, which is generally at the time of shipment. The following policies apply to our major categories of revenue transactions: o Sales to customers are evidenced by firm purchase orders. Title and the risks and rewards of ownership are transferred to the customer when product is shipped. Payment by the customer is due under fixed payment terms. o We place certain of our capital equipment with customers in return for commitments to purchase disposable products over time periods generally ranging from one to three years. In these circumstances, no revenue is recognized upon capital equipment shipment and we recognize revenue upon the disposable product shipment. The cost of the equipment is amortized over the term of individual commitment agreements. o 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. o The Company's terms of sale to customers generally do not include any obligations to perform future services. Limited warranties are generally provided for capital equipment sales and provisions for warranty are provided at the time of product sale based upon an analysis of historical data. o 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 $7.5 million, $8.3 million and $9.3 million for 2002, 2003 and 2004, respectively. -66- o We sell to a diversified base of customers around the world and, therefore, believe there is no material concentration of credit risk. o We assess the risk of loss on accounts receivable and adjust the allowance for doubtful accounts based on this risk assessment. Historically, losses on accounts receivable have not been material. Management believes that the allowance for doubtful accounts of $1.2 million at December 31, 2004 is adequate to provide for probable losses resulting from accounts receivable. Earnings per share We compute basic earnings per share ("basic EPS") by dividing net income by the weighted average number of shares outstanding for the reporting period. Diluted earnings per share ("diluted EPS") gives effect to all dilutive potential shares outstanding resulting from employee stock options during the period. The following table sets forth the calculation of basic and diluted earnings per share at December 31, 2002, 2003 and 2004, respectively:
2002 2003 2004 ---- ---- ---- Net income ........................................... $34,151 $32,082 $33,465 ======= ======= ======= Basic-weighted average shares outstanding ............ 27,337 28,930 29,523 Effect of dilutive potential securities .............. 490 326 582 ------- ------- ------- Diluted-weighted average shares outstanding .......... 27,827 29,256 30,105 ======= ======= ======= Basic EPS $ 1.25 $ 1.11 $ 1.13 ======= ======= ======= Diluted EPS $ 1.23 $ 1.10 $ 1.11 ======= ======= =======
The shares used in the calculation of diluted EPS exclude options to purchase shares where the exercise price was greater than the average market price of common shares for the year. Such shares aggregated approximately 0.7 million, 1.3 million and 0.1 million at December 31, 2002, 2003 and 2004, respectively. In accordance with EITF (Emerging Issues Task Force) Issue 04-8, "The Effect of Contingently Convertible Debt on Diluted Earnings per Share", the shares used in the calculation of diluted EPS exclude the potential shares contingently issuable under our 2.50% convertible senior subordinated notes because they are not dilutive. The maximum number of shares we may issue with respect to the Notes is 5,750,000. See Note 6 for further discussion of the Notes. Stock-based Compensation Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") defines a fair value based method of accounting for an employee stock option whereby compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period. A company may elect to adopt SFAS 123 or elect to continue accounting for its stock option or similar equity awards using the method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), where compensation cost is measured at the date of grant based on the excess of the market value of the underlying stock over the exercise price. We have elected to continue to account for our stock-based compensation -67- plans under the provisions of APB 25. No compensation expense has been recognized in the accompanying financial statements relative to our stock option plans. Pro forma information regarding net income and earnings per share is required by SFAS 123 and has been determined as if we had accounted for our employee stock options under the fair value method of that statement. The weighted average fair value of options granted in 2002, 2003 and 2004 was $9.32, $5.81 and $14.59, respectively. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for options granted in 2002, 2003 and 2004, respectively: Risk-free interest rates of 2.70%, 3.13% and 4.04%; volatility factors of the expected market price of the Company's common stock of 41.10%, 32.08% and 51.20%; a weighted-average expected life of the option of 5.0 years in 2002 and 2003, and 7.3 years in 2004; and that no dividends would be paid on common stock. For purposes of the pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The following table illustrates the effect on net earnings as if the fair value provisions of SFAS 123 had been applied to stock-based employee compensation:
2002 2003 2004 ---- ---- ---- Net income -- as reported ........................................ $34,151 $32,082 $33,465 ------- ------- ------- Pro forma stock-based employee compensation expense, net of related income tax effect .............................................. (2,156) (2,383) (4,598) ------- ------- ------- Net income -- pro forma .......................................... $31,995 $29,699 $28,867 ======= ======= ======= Earnings per share - as reported: Basic ........................................................ $ 1.25 $ 1.11 $ 1.13 Diluted ...................................................... $ 1.23 $ 1.10 $ 1.11 Earnings per share - pro forma: Basic ........................................................ $ 1.17 $ 1.03 $ 0.98 Diluted ...................................................... $ 1.15 $ 1.02 $ 0.96
In December 2004, SFAS 123 was revised to require that all share-based payments be recognized in the financial statements based on their fair values. We will be required to adopt revised SFAS 123 in the third quarter of 2005 (See additional discussion in Note 14). -68- Accumulated other comprehensive income (loss) Accumulated other comprehensive income (loss) consists of the following:
Accumulated Minimum Cumulative Cash Other Pension Translation Flow Comprehensive Liability Adjustments Hedges Income (loss) --------- ----------- ------ ------------- Balance, December 31, 2003 .......................... -- $ 1,923 $ 146 $ 2,069 Foreign currency translation adjustments ................................... -- 2,133 -- 2,133 Cash flow hedging (net of income taxes) ................................. -- -- (146) (146) Minimum pension liability (net of income taxes) ........................... (10,455) -- -- (10,455) -------- -------- -------- -------- Balance, December 31, 2004 .......................... (10,455) $ 4,056 $ -- $ (6,399) ======== ======== ======== ========
Reclassifications Certain prior year amounts have been reclassified to conform with the presentation used in 2004. Note 2 -- Business Acquisitions Assets and liabilities of acquired businesses are recorded under the purchase method of accounting 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. The results of operations of acquired businesses have been included in the consolidated statements of income since the date of acquisition. In 2002, we completed the acquisition of several businesses relating to our Patient Care and Endoscopy product lines, including the December 31, 2002 acquisition of CORE Dynamics, Inc. (the "CORE acquisition"). During the same period, we also completed the acquisition of two businesses engaged in the design, manufacture and installation of integrated operating room systems and equipment. Consideration for acquisitions completed during 2002 aggregated $17.4 million in cash, $1.7 million in CONMED common stock and the assumption of approximately $3.4 million in liabilities. Under the terms of certain of the acquisition agreements, we agreed to pay additional consideration dependent upon future sales or profitability and the satisfactory execution of a plan to transition and consolidate manufacturing of an acquired business into our facilities. Any future consideration paid will be recorded in goodwill and is not expected to be material. Goodwill recorded in 2002 approximated $16.2 million and was deductible for income tax purposes. In 2003, we completed several acquisitions relating to our Patient Care and Electrosurgery product lines totaling $6.1 million in cash and recorded additional contingent consideration related to 2002 acquisitions of $2.0 million. Goodwill recorded in 2003 related to these acquisitions approximated $5.9 million and was deductible for income tax purposes. These acquisitions did not have a material effect on our results of operations for the year ended December 31, 2003. -69- In March 2003, we also completed the acquisition of Bionx Implants, Inc. (the "Bionx acquisition") relating to our Arthroscopy product line, for $47.0 million in cash plus the assumption of approximately $12.1 million in liabilities. The Bionx acquisition was funded primarily through borrowings on our revolving credit facility (See Note 6). Included in cost of sales during 2003 are $1.3 million of acquisition-related charges, consisting principally of the following: $0.5 million in charges as a result of the step-up to fair value recorded related to the sale of inventory acquired as a result of the Bionx acquisition and the CORE acquisition; $0.5 million in inventory charges as a result of the discontinuation of certain of our Arthroscopy product lines in favor of those acquired as a result of the Bionx acquisition; and $0.3 million in other transition-related charges. An additional $3.2 million in acquisition-related costs incurred in 2003 not related to cost of sales have been recorded in other expense as discussed in Note 12. Based on a third-party valuation, $7.9 million of the Bionx acquisition purchase price represents the estimated fair value of projects for which the related products, as of the acquisition date had not reached technological feasibility and had no future use. Accordingly, the purchased in-process research and development assets were written off in accordance with FASB Interpretation No. 4, "Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method". No benefit for income taxes was recorded on the write-off of purchased IPRD as these costs were not deductible for income tax purposes. Goodwill recorded in 2003 related to the Bionx acquisition approximated $25.2 million and was not deductible for income tax purposes. In September 2004, we acquired the business operations of the Endoscopic Technologies Division of C.R. Bard, Inc. (the "Bard Endoscopic Technologies acquisition") for aggregate consideration of $81.3 million in cash. We funded the Bard Endoscopic Technologies acquisition through available cash on hand of $31.3 million with an additional $50.0 million drawn under our revolving credit facility (See Note 6). The acquired business included various tangible and intangible assets associated with a comprehensive line of single-use medical devices employed by gastro-intestinal and pulmonary physicians to diagnose and treat diseases of the digestive tract and lungs using minimally invasive endoscopic techniques. The acquired business operations had 2003 revenues approximating $54.0 million and is the third largest domestic supplier of these products to the market. Manufacturing of the acquired products is currently being conducted in various C.R. Bard facilities under a transition agreement. It is anticipated that future manufacturing will be integrated into our facilities during the third quarter of 2005. Included in cost of sales during 2004 is $2.3 million of expense which represents a portion of the step-up to fair value recorded relating to the sale of inventory acquired through the Bard Endoscopic Technologies acquisition Unaudited pro forma statements of income for the years ended December 31, 2002, 2003 and 2004, assuming the Bionx acquisition occurred as of January 1, 2002 and 2003 and assuming the Bard Endoscopic Technologies acquisition occurred as of January 1, 2003 and 2004 are presented below. These pro forma statements of income have been prepared for comparative purposes only and do not purport to be indicative of the results of operations which actually would have resulted had the Bionx acquisition and Bard Endoscopic Technologies acquisition occurred on the dates indicated, or which may result in the future. -70- 2002 2003 2004 ---- ---- ---- Net sales ................................ $471,530 $555,084 $604,566 Net income ............................... 31,746 28,090 33,749 Net income per share Basic ................................ $ 1.16 $ 0.97 $ 1.14 Diluted .............................. $ 1.14 0.96 1.12 The following table summarizes the estimated fair values of the assets acquired and liabilities assumed in the Bard Endoscopic Technologies acquisition as of the date of acquisition. Goodwill and identifiable intangible assets associated with the Bard Endoscopic Technologies acquisition are deductible for income tax purposes. Inventory................................. $15,544 Property, plant and equipment............. 2,371 Identifiable intangible assets............ 6,600 In-process research and development....... 16,400 Goodwill.................................. 43,876 ------- Total assets acquired..................... 84,791 ------- Current liabilities assumed............... (3,492) ------- Net assets acquired....................... $81,299 ======= Based on a third-party valuation, $16.4 million of the purchase price represents the fair value of development-stage projects for which the related products, as of the acquisition date had not reached technological feasibility, had not received regulatory approval and had no alternative future use. Accordingly, the entire amount of in-process research and development assets were written-off in accordance with FASB Interpretation No. 4, "Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method". The $16.4 million write-off of purchased in-process research and development assets is deductible for income tax purposes. Approximately 62% of the aggregate purchased in-process research and development value relates to next generation gastro-intestinal products, which are expected to be released between the fourth quarter of 2005 and second quarter of 2006. The remaining two acquired projects include enhancements and upgrades to existing device technology, introduction of new device functionality and the development of new technology for gastro-intestinal applications. The value of the in-process research and development was calculated using a discounted cash flow analysis of the anticipated net cash flow stream associated with the in-process technology of the related product sales. Estimated net cash flows were discounted back to their present values using a discount rate of 17%, which was based on the weighted-average cost of capital for publicly-traded companies within the medical device industry, adjusted for the stage of completion of each of the in-process research and development projects. The risk and return considerations surrounding the stage of completion were based on costs, man-hours and complexity of the work completed versus to be completed and other risks associated with achieving commercial feasibility. In total, these projects were approximately 40% complete as of the acquisition date. The total budgeted costs for the projects were approximately $8.5 million and the remaining costs to complete these projects were approximately $5.0 million as of the acquisition date. -71- The major risks and uncertainties associated with the timely and successful completion of these projects consist of the ability to confirm the safety and efficacy of the technologies and products based on the data from clinical trials and obtaining the necessary regulatory approvals. In addition, no assurance may be made that the underlying assumptions used to forecast the cash flows or the timely and successful completion of such projects will materialize, as estimated. For these reasons, among others, actual results may vary significantly from estimated results. The $6.6 million of identifiable intangible assets consists of trademarks and tradenames, customer-related intangibles and patents. Components of the fair value of acquired intangible assets are as follows:
Weighted Average Useful Life Fair Value (Years) Asset ---------- ------- ----- Customer relationships........................ $ 4,900 20 Finite-lived Patents....................................... $ 1,300 9 Finite-lived Trademarks and tradenames..................... $ 400 Indefinite-lived
Note 3 -- Inventories Inventories consist of the following at December 31,:
2003 2004 ---- ---- Raw materials ........................................ $ 35,352 $ 40,781 Work in process ...................................... 14,583 13,427 Finished goods ....................................... 71,010 73,727 --------- --------- $ 120,945 $ 127,935 ========= =========
Note 4 -- Property, Plant and Equipment Property, plant and equipment consist of the following at December 31,:
2003 2004 ---- ---- Land ................................................. $ 4,200 $ 4,200 Building and improvements ............................ 75,224 78,637 Machinery and equipment .............................. 83,105 92,789 Construction in progress ............................. 3,768 3,675 --------- --------- 166,297 179,301 Less: Accumulated depreciation ............. (68,914) (77,836) --------- --------- $ 97,383 $ 101,465 ========= =========
We lease various manufacturing facilities, office facilities and equipment under operating leases. Rental expense on these operating leases was approximately -72- $2,064, $1,959 and $2,649 for the years ended December 31, 2002, 2003 and 2004, respectively. The aggregate future minimum lease commitments for operating leases at December 31, 2004 are as follows: 2005.................................. $2,796 2006.................................. 2,701 2007.................................. 2,507 2008.................................. 2,261 2009.................................. 1,534 Thereafter............................ 2,191 Note 5 - Goodwill and Other Intangible Assets The changes in the net carrying amount of goodwill for the year ended December 31, are as follows: 2003 2004 ---- ---- Balance as of January 1, ....................... $ 262,394 $ 290,562 Goodwill acquired .............................. 31,210 43,876 Adjustments to goodwill resulting from business acquisitions finalized ....................... (3,285) 176 Foreign currency translation ................... 243 (131) --------- --------- Balance as of December 31, ..................... $ 290,562 $ 334,483 ========= ========= Goodwill associated with each of our principal operating units at December 31, is as follows: 2003 2004 ---- ---- CONMED Electrosurgery .......................... $ 15,961 $ 16,249 CONMED Endoscopic Technologies ................. -- 43,876 CONMED Endosurgery ............................. 42,367 42,388 CONMED Linvatec ................................ 175,594 175,120 CONMED Patient Care ........................... 56,640 56,850 --------- --------- Balance as of December 31, ..................... $ 290,562 $ 334,483 ========= ========= -73- Other intangible assets consist of the following:
December 31, 2003 December 31, 2004 ----------------- ----------------- Gross Gross Carrying Accumulated Carrying Accumulated Amortized intangible assets: Amount Amortization Amount Amortization ------ ------------ ------ ------------ Customer relationships ............................. $ 105,712 $ (15,447) $ 110,612 $ (18,290) Patents and other intangible assets ................ 33,258 (16,498) 35,444 (19,876) Unamortized intangible assets: Trademarks and tradenames .......................... 86,944 -- 87,344 -- --------- --------- --------- --------- $ 225,914 $ (31,945) $ 233,400 $ (38,166) ========= ========= ========= =========
Other intangible assets primarily represent allocations of purchase price to identifiable intangible assets of acquired businesses. The weighted average amortization period for intangible assets which are amortized is 22 years. Customer relationships are being amortized over a weighted average life of 37 years. Patents and other intangible assets are being amortized over a weighted average life of 10 years. Customer relationship assets were acquired in connection with the 1997 acquisition of Linvatec Corporation, 2003 Bionx acquisition and 2004 Bard Endoscopic Technologies acquisition. These assets represent the value associated with business expected to be generated from acquired customers as of the acquisition date. Asset values were determined by measuring the present value of the projected future earnings attributable to these assets. Additionally, while the useful lives of these assets are not limited by contract or any other economic, regulatory or other known factors, the weighted average useful life of 37 years was determined as of acquisition date by historical customer attrition. In accordance with SFAS 142 and as clarified by EITF Issue 02-17, "Recognition of Customer Relationship Intangible Assets Acquired in a Business Combination", customer relationships evidenced by customer purchase orders are contractual in nature and therefore continue to be recognized separate from goodwill and are amortized over their weighted average 37 year life. Trademarks and tradenames were recognized in connection with the 1997 acquisition of Linvatec Corporation, 2003 Bionx acquisition and 2004 Bard Endoscopic Technologies acquisition. We continue to market products, release new product and product extensions and maintain and promote these trademarks and tradenames in the marketplace through legal registration and such methods as advertising, medical education and trade shows. It is our belief that these trademarks and tradenames will generate cash flow for an indefinite period of time. Therefore, in accordance with SFAS 142, our trademarks and tradenames intangible assets are not amortized. -74- Amortization expense related to intangible assets for the year ending December 31, 2004 and estimated amortization expense for each of the five succeeding years is as follows: 2004 $ 6,221 2005 5,646 2006 5,077 2007 5,064 2008 4,950 2009 4,556 Note 6 -- Long Term Debt Long-term debt consists of the following at December 31,: 2003 2004 ---- ---- Revolving line of credit .............................. $ -- $ -- Term loan borrowings on senior credit facility ........ 243,000 128,063 2.50% Convertible senior subordinated notes ........... -- 150,000 Mortgage notes ........................................ 21,591 16,459 -------- -------- Total long-term debt .......................... 264,591 294,522 Less: Current portion ................................. 4,143 4,037 -------- -------- $260,448 $290,485 ======== ======== Effective August 28, 2002 we entered into a $200.0 million credit agreement (the "senior credit agreement") with JP Morgan Chase Bank and other financial institutions from time to time party thereto. The senior credit agreement consisted of a $100.0 million revolving credit facility and a $100.0 million term loan. During 2002, deferred financing costs in the amount of $1.5 million which related to the approximately three years remaining on the prior credit agreement were written-off as a loss on the early extinguishment of debt. Effective June 30, 2003 we entered into an Amended and Restated Credit Agreement (the "amended senior credit agreement") whereby the term loan amount was increased by $160.0 million. Proceeds of the amended senior credit agreement were used to reduce outstanding borrowings on the revolving credit facility, fund the redemption of $130.0 million in 9.0% senior subordinated notes, including accrued interest, fund payment of 4.5% call premium on the senior subordinated notes and fund bank and legal fees associated with the amendment. During 2003, we recorded a loss on the early extinguishment of debt in the amount of $8.1 million. This amount represents $5.9 million of the 4.5% call premium and $2.2 million of unamortized deferred financing costs associated with the redemption of the 9.0% senior subordinated notes. At December 31, 2004 the amended senior credit agreement consisted of a $100.0 million revolving credit facility and a $128.1 million term loan. There were no borrowings outstanding on the revolving credit facility at December 31, 2004. The term loan is scheduled to be repaid in quarterly installments over a period of approximately 5 years, with scheduled principal payments of $2.6 million annually through December 2007 increasing to $60.3 million in 2008 and the -75- remaining balance outstanding due in 2009. We may also be required, under certain circumstances, to make additional principal payments based on excess cash flow as defined in the amended senior credit agreement. No such payments were required during 2003 and 2004. Interest rates on the term facility and revolving credit facility are at LIBOR plus 2.25% (4.65% at December 31, 2004). The amended senior credit agreement is collateralized by substantially all of our personal property and assets, except for our accounts receivable and related rights which have been sold in connection with our accounts receivable sales agreement (See Note 1). The senior credit agreement contains covenants and restrictions which, among other things, require maintenance of certain working capital levels and financial ratios, prohibit dividend payments and restrict the incurrence of certain indebtedness and other activities, including acquisitions and dispositions. The senior credit agreement contains a material adverse effect clause which could limit our ability to access additional funding under our revolving credit facility should a material adverse change in our business occur. We are also required, under certain circumstances, to make mandatory prepayments from net cash proceeds from any issue of equity and asset sales. Outstanding debt assumed in connection with the 2001 purchase of property in Largo, Florida utilized by our CONMED Linvatec subsidiary consists of a note bearing interest at 7.50% per annum with semiannual payments of principal and interest through June 2009 (the "Class A note"); and a note bearing interest at 8.25% per annum compounded semiannually through June 2009, after which semiannual payments of principal and interest will commence, continuing through June 2019 (the "Class C note"). The principal balances outstanding on the Class A note and Class C note aggregated $8.3 million and $8.2 million, respectively, at December 31, 2004. These loans are secured by our Largo, Florida property. On November 11 2004, we completed an offering, in a private placement, of $150.0 million in 2.50% convertible senior subordinated notes due 2024. The Notes represent our subordinated unsecured obligations and are convertible under the following circumstances, as defined in the bond indenture, into a combination of cash and CONMED common stock: when the closing price of our common stock for each of 20 or more consecutive trading days in a period of 30 consecutive trading days exceeds 130% of the applicable conversion price; after any 10 consecutive trading day period in which the average trading price per $1,000 principal amount of the Notes was equal to or less than 97% of the average conversion value of the Notes; if we call a Note for redemption; and based on certain corporate transactions such as if we are party to a consolidation, merger or binding share exchange in which over 50% of our outstanding shares of common stock would be converted into cash, securities or other property, or if another fundamental change (as defined in the bond indenture) occurs. Upon conversion, the holder of each Note will receive the conversion value of the Note payable in cash up to the principal amount of the Note and CONMED common stock for the Note's conversion value in excess of such principal amount. Amounts in excess of the principal amount are at an initial conversion rate, subject to adjustment, of 26.1849 shares per $1,000 principal amount of the Note (which represents an initial conversion price of $38.19 per share). The Notes mature on November 15, 2024 and are not redeemable by us prior to November 15, 2011. Holders of the Notes will be able to require that we repurchase some or all of the Notes on November 15, 2011, 2014 and 2019. We have determined that the Notes contain two embedded derivatives. The embedded derivatives are recorded at fair value in other long-term liabilities and changes in their value are recorded through the consolidated statement of income. The embedded derivatives have a nominal value, and it is our belief that any change -76- in their fair value would not have a material adverse effect on our business, financial condition or results of operations. The Notes offering resulted in gross proceeds of $150.0 million, less $5.8 million in initial purchaser's discount and other offering related payments which are being amortized to interest expense over a 7 year period through November 15, 2011 (the earliest date at which we may be required to repurchase some or all of the Notes). Net proceeds from the offering and cash on hand were used to repay $82.2 million on the term loan and a further $45.0 million in borrowings then outstanding on the revolving credit facility under our senior credit agreement. (The revolving credit facility borrowings were used to finance a portion of the Bard Endoscopic Technologies acquisition--See Note 2). Additionally, in conjunction with the Notes offering, we repurchased $30.0 million of our common stock in privately negotiated transactions. As a result of the $82.2 million prepayment on the term loan, we recorded $0.8 million in losses on the early extinguishment of debt related to the write-off of unamortized deferred financing fees. The scheduled maturities of long-term debt outstanding at December 31, 2004 are as follows: 2005......................... $ 4,037 2006......................... 4,208 2007......................... 4,393 2008......................... 62,342 2009......................... 61,770 Thereafter................... 157,772 Note 7 -- Income Taxes The provision for income taxes for the years ended December 31, 2002, 2003 and 2004 consists of the following: 2002 2003 2004 ---- ---- ---- Current tax expense: Federal ............................. $ 7,251 $ 5,486 $ 9,138 State ............................... 540 665 975 Foreign ............................. 755 1,061 1,683 ------- ------- ------- 8,546 7,212 11,796 Deferred income tax expense ............. 10,664 13,715 4,301 ------- ------- ------- Provision for income taxes .......... $19,210 $20,927 $16,097 ======= ======= ======= -77- A reconciliation between income taxes computed at the statutory federal rate and the provision for income taxes for the years ended December 31, 2002, 2003 and 2004 follows: 2002 2003 2004 ---- ---- ---- Tax provision at statutory rate based on income before income taxes ............ 35.00% 35.00% 35.00% Extraterritorial income exclusion ............ (1.78) (2.36) (5.30) State income taxes ........................... .66 .90 2.75 Nondeductible intangible amortization ........ .17 .17 .18 Nondeductible write-off of purchased in-process research and developments assets -- 5.22 -- Other nondeductible permanent differences .... .40 .51 .36 Other, net ................................... 1.55 .04 (.51) ----- ----- ----- 36.00% 39.48% 32.48% ===== ===== ===== The tax effects of the significant temporary differences which comprise the deferred tax assets and liabilities at December 31, 2003 and 2004 are as follows: 2003 2004 ---- ---- Assets: Inventory .................................... $ 8,948 $ 10,791 Net operating losses of acquired subsidiaries 11,025 8,025 Deferred compensation ........................ 1,361 1,602 Accounts receivable .......................... 262 509 Additional minimum pension liability ......... -- 5,630 Other ........................................ 2,390 2,024 Valuation allowance .......................... (8,462) (5,887) -------- -------- 15,524 22,694 -------- -------- Liabilities: Goodwill and intangible assets ............... 43,695 51,707 Depreciation ................................. 5,721 6,412 Employee benefits ............................ 1,980 1,530 State taxes .................................. -- 745 Interest rate swap ........................... 83 -- -------- -------- 51,479 60,394 -------- -------- Net liability ........................................ $(35,955) $(37,700) ======== ======== -78- Earnings before income taxes consists of the following U.S. and foreign income: 2002 2003 2004 ---- ---- ---- U.S. income ........................ $51,198 $49,275 $45,876 Foreign income ..................... 2,163 3,734 3,686 ------- ------- ------- Total income ....................... $53,361 $53,009 $49,562 ======= ======= ======= The net operating loss carryforwards of acquired subsidiaries begin to expire in 2008. We have established a valuation allowance to reflect the uncertainty of realizing the benefits of certain net operating loss carryforwards recognized in connection with the Bionx acquisition. Any subsequently recognized tax benefits associated with the valuation allowance would be allocated to reduce goodwill. On October 22, 2004 , the President signed the American Jobs Creation Act of 2004 (the "Act"). The Act provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010. In return, the Act also provides for a two-year phase-out of the existing extra-territorial income exclusion (ETI) for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. Under the guidance in FASB Staff Position No. FAS 109-1, Application of FASB Statement No. 109, "Accounting for Income Taxes," to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004, the deduction will be treated as a "special deduction" as described in FASB Statement No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this deduction will be reported in the period in which the deduction is claimed on our tax return. The Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations and, as of today, uncertainty remains as to how to interpret numerous provisions in the Act. We are not yet in a position to decide on whether, and to what extent, we might repatriate foreign earnings that have not yet been remitted to the U.S. We have not provided for federal income taxes on the undistributed earnings of our foreign operations as it has been our intention to permanently reinvest undistributed earnings (approximately $11.1 million as of December 31, 2004). Note 8 -- Shareholders' Equity The 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, 2003 and 2004, no preferred stock had been issued. In connection with the 1997 acquisition of Linvatec Corporation, we issued to Bristol-Myers Squibb Company a warrant exercisable in whole or in part for up to 1.5 million shares of our common stock at a price of $22.82 per share. On May 6, 2002, we purchased the warrant for $2.0 million in cash and subsequently cancelled it. The purchase resulted in a $2.0 million reduction to paid-in capital. -79- On May 29, 2002, we completed a public offering of 3.0 million shares of our common stock. Net proceeds from the offering approximated $66.1 million and were used to reduce indebtedness under our credit facility. In November 2004, we repurchased 1.1 million shares of our common stock in privately negotiated transactions at an aggregate cost of $30 million. This repurchase coincided with our 2.50% convertible senior subordinated notes transaction (See Note 6). On February 15, 2005, our Board of Directors authorized a share repurchase program under which we may repurchase up to $50.0 million of our common stock, although no more than $25.0 million may be purchased in any calendar year. 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. We have reserved 6.7 million shares of common stock for issuance to employees and directors under three stock option plans (the "Plans") of which approximately 696,000 shares remain available for grant at December 31, 2004. In May 2004, the total number of shares available for issuance to employees and directors under the Plans was increased by 1.0 million shares. The exercise price on all outstanding options is equal to the quoted fair market value of the stock at the date of grant. Stock options are non-transferable other than on death and generally become exercisable over a five year period from date of grant and expire ten years from date of grant. The following is a summary of incentive stock option activity under the Plans: Weighted- Number Average of Exercise Options Price ------- ----- Outstanding at December 31, 2001 ..................... 3,434 14.69 Granted ...................................... 742 23.42 Forfeited .................................... (40) 15.27 Exercised .................................... (546) 8.88 ------ ------ Outstanding at December 31, 2002 ..................... 3,590 17.27 Granted ...................................... 669 17.44 Forfeited .................................... (84) 19.49 Exercised .................................... (181) 11.84 ------ ------ Outstanding at December 31, 2003 ..................... 3,994 $17.55 Granted ...................................... 659 25.03 Forfeited .................................... (152) 19.16 Exercised .................................... (940) 15.28 ------ ------ Outstanding at December 31, 2004 ..................... 3,561 $19.45 ====== ====== Exercisable: December 31, 2002 ............................ 1,875 $15.55 December 31, 2003 ............................ 2,590 17.19 December 31, 2004 ............................ 2,435 18.90 -80-
Stock Weighted Options Weighted Stock Options Weighted Average Exercisable Average Range of Outstanding at Average Remaining Exercise at December 31, Exercise Exercise Prices December 31,2004 Life (Years) Price 2004 Price --------------- ---------------- ------------ ----- --------------- ----- $5.89 to $8.84 5 0.4 $ 8.28 5 $ 8.28 $8.84 to $11.78 69 4.4 9.90 51 10.04 $11.78 to $14.73 566 5.5 14.23 465 14.20 $14.73 to $17.67 693 4.6 16.26 564 16.36 $17.67 to $20.62 974 6.5 18.90 661 19.11 $20.62 to $23.56 383 7.6 21.80 148 21.72 $23.56 to $26.50 795 8.6 25.45 541 25.48 $26.50 to $29.50 76 9.2 29.45 -- -- ----- ----- Total 3,561 2,435 ===== =====
During 2002 we adopted a shareholder-approved Employee Stock Purchase Plan (the "Employee Plan"), under which we have 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 through the exercise of stock options granted by the Company at a purchase price equal to the lesser of (1)85% of the fair market value of the common stock at the beginning of a semi-annual period and (2) 85% of the fair market value of the common stock at the end of such semi-annual period. During 2004, we issued approximately 55,000 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 9 -- Business Segments and Geographic Areas CONMED conducts its business through five principal operating units, CONMED Endoscopic Technologies, CONMED Endosurgery, CONMED Electrosurgery, CONMED Linvatec and CONMED Patient Care. In accordance with Statement of Financial Accounting Standards No. 131 "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"), our chief operating decision-maker has been identified as the President and Chief Operating Officer, who reviews operating results and makes resource allocation decisions for the entire company. All five operating units qualify for aggregation under SFAS 131 due to their identical customer base and similarities in economic characteristics, nature of products and services, procurement, manufacturing and distribution processes. Based upon the aggregation criteria for segment reporting, we have grouped our operating units into a single segment comprised of medical instruments and systems used in surgical and other medical procedures. The following is net sales information by product line: 2002 2003 2004 ---- ---- ---- Arthroscopy ........................ $162,532 $182,061 $204,887 Powered Surgical Instruments ...... 114,302 122,031 128,572 Electrosurgery ..................... 69,674 77,337 85,912 Patient Care ....................... 69,753 69,937 75,879 Endosurgery ........................ 36,801 45,764 47,400 Endoscopic Technologies ............ -- -- 15,738 -------- -------- -------- Total .............................. $453,062 $497,130 $558,388 ======== ======== ======== -81- The following is net sales information for geographic areas: 2002 2003 2004 ---- ---- ---- United States ................. $320,312 $333,473 $364,819 Canada ........................ 15,980 24,620 27,384 United Kingdom ................ 18,625 19,883 27,120 Japan ......................... 18,820 18,265 19,793 All other countries ........... 79,325 100,889 119,272 -------- -------- -------- Total ......................... $453,062 $497,130 $558,388 ======== ======== ======== 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, 2003 and 2004. No single customer represented over 10% of our consolidated net sales for the years ended December 31, 2002, 2003 and 2004. Note 10 -- Employee Benefit Plans We sponsor an employee savings plan ("401(k) plan") and a defined benefit pension plan (the "pension plan") covering substantially all our employees. Overall benefit levels provided under the pension plan were reduced effective January 1, 2004 resulting in a reduction in the projected benefit obligation of approximately $6.4 million. Total employer contributions to the 401(k) plan were $2.0 million, $2.2 million and $1.8 million during the years ended December 31, 2002, 2003 and 2004, respectively. We use a December 31, measurement date for our pension plan. Unrecognized gains and losses are amortized on a straight-line basis over the average remaining service period of active participants. The following table provides a reconciliation of the projected benefit obligation, plan assets and funded status of the pension plan at December 31,: 2003 2004 ---- ---- Accumulated Benefit Obligation $ 32,044 $ 43,337 ======== ======== Change in benefit obligation Projected benefit obligation at beginning of year .... $ 33,639 $ 38,878 Adjustment for plan amendment ........................ -- (6,352) Service cost ......................................... 4,167 3,144 Interest cost ........................................ 2,419 2,377 Actuarial loss ....................................... 6,794 13,759 Benefits paid ........................................ (8,141) (2,934) -------- -------- Projected benefit obligation at end of year .......... $ 38,878 $ 48,872 -------- -------- Change in plan assets Fair value of plan assets at beginning of year ....... $ 18,169 $ 33,632 Actual gain on plan assets ........................... 4,075 2,490 Employer contribution ................................ 19,529 -- Benefits paid ........................................ (8,141) (2,934) -------- -------- Fair value of plan assets at end of year ............. $ 33,632 $ 33,188 -------- -------- -82- Change in funded status Funded status .................................... $ 5,246 $ 15,684 Unrecognized net actuarial loss .................. (14,634) (27,461) Unrecognized transition liability ................ (48) (44) Unrecognized prior service cost .................. (118) 5,886 Additional minimum pension liability ............. -- 16,084 -------- -------- Accrued (prepaid) pension cost ................... $ (9,554) $ 10,149 ======== ======== Amounts recognized in the consolidated balance sheets consist of the following at December 31,: 2003 2004 ---- ---- Accrued pension liability ........................ $ -- $ 10,149 Prepaid pension asset ............................ (9,554) -- Accumulated other comprehensive income (loss) .... -- (16,084) -------- -------- Net amount recognized ............................ $ (9,554) $ (5,935) ======== ======== The following actuarial assumptions were used to determine our accumulated and projected benefit obligations as of December 31,: 2003 2004 ---- ---- Discount rate .................................... 6.25% 5.75% Expected return on plan assets ................... 8.00% 8.00% Rate of compensation increase .................... 3.00% 3.00% Additionally, as of December 31, 2004, the Company changed from the 1984 Unisex Pension mortality table to the 1994 Group Annuity Reserving mortality table for purposes of determining expected mortality. Net periodic pension cost for the years ended December 31, consist of the following: 2002 2003 2004 ---- ---- ---- Service cost -- benefits earned during the period .............................. $ 3,988 $ 4,167 $ 3,144 Interest cost on projected benefit obligation 2,002 2,419 2,377 Expected return on plan assets .............. (1,595) (1,728) (2,562) Net amortization and deferral ............... 350 750 660 Settlement loss ............................. -- 2,839 -- ------- ------- ------- Net periodic pension cost ................... $ 4,745 $ 8,447 $ 3,619 ======= ======= ======= During the year-ended December 31, 2003, we recognized settlement losses of $2.8 million. See Note 12 for further discussion. During the year ended December 31, 2002, 2003 and 2004, respectively, we recognized a comprehensive loss of $4.0 million, net of income taxes, comprehensive income of $5.1 million, net of income taxes, and a comprehensive loss of $10.5 million, net of income taxes, as a result of changes in the additional minimum pension liability required to be recognized. -83- The following actuarial assumptions were used to determine our net periodic pension benefit cost for the years ended December 31,: 2002 2003 2004 ---- ---- ---- Discount rate .................................... 7.00% 6.75% 6.25% Expected return on plan assets ................... 8.00% 8.00% 8.00% Rate of compensation increase .................... 3.00% 3.00% 3.00% In determining the expected return on pension plan assets, we consider the relative weighting of plan assets, the historical performance of total plan assets and individual asset classes and economic and other indicators of future performance. In addition, we consult with financial and investment management professionals in developing appropriate targeted rates of return. 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 pension plan assets by category is as follows at December 31,: Percentage of Pension Target Plan Assets Allocation 2003 2004 2005 ---- ---- ---- Equity securities ....................... 41% 48% 55% Debt securities ......................... 49 35 35 Other ................................... 10 17 10 --- --- --- Net periodic pension cost ............... 100% 100% 100% === === === As of December 31, 2004, the Plan held 27,562 shares of our common stock, which had a fair value of $0.7 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. Our 2005 pension plan funding is not expected to exceed $4.5 million. The following table summarizes the benefits 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 benefit payments are estimated based on the same assumptions used to measure the Company's projected benefit obligation at December 31, 2004 and reflect the impact of expected future employee service. 2005....................................... $ 2,570 2006....................................... 2,841 2007....................................... 2,609 2008....................................... 2,194 2009....................................... 2,909 2010-2014.................................. 19,196 -84- Note 11 -- Legal Matters From time to time, we are a defendant in certain lawsuits alleging product liability, patent infringement, or other claims incurred in the ordinary course of business. These claims are generally covered by various insurance policies, subject to certain deductible amounts and maximum policy limits. When there is no insurance coverage, as would typically be the case primarily in lawsuits alleging patent infringement, we establish sufficient reserves to cover probable losses associated with such claims. We do not expect that the resolution of any pending claims will have a material adverse effect on our financial condition or results of operations. There can be no assurance, however, that future claims, the costs associated with claims, especially claims not covered by insurance, will not have a material adverse effect on our future performance. Manufacturers of medical products may face exposure to significant product liability claims. To date, we have not experienced any material product liability claims, but any such claims arising in the future could have a material adverse effect on our business or results of operations. We currently maintain commercial product liability insurance of $25 million per incident and $25 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 or that such insurance will be available in the future at a reasonable cost to us. Our operations are 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. 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 could not have a material adverse effect on our financial condition or results of operations. In November 2003, the Company commenced litigation against Johnson & Johnson and several of its subsidiaries, including Ethicon, Inc. for violation of federal and state antitrust laws. The lawsuit claims that Johnson & Johnson engaged in illegal and anticompetitive conduct with respect to sales of product used in endoscopic surgery, resulting in higher prices to consumers and the exclusion of competition. We have sought relief which includes an injunction restraining Johnson & Johnson from continuing its anticompetitive practice as well as receiving the maximum amount of damages allowed by law. Our claims against Johnson & Johnson are currently in the discovery stage. While we believe that our claims are well-grounded in fact and law, there can be no assurance that we will be successful in our claim. In addition, the costs associated with pursuing this claim, which approximated $1.3 million in the year ended December 31, 2004, may be material. -85- Note 12 -- Other expense (income) Other expense (income) for the year ended December 31, consists of the following: 2002 2003 2004 ---- ---- ---- Termination of product offering .............. $ -- $ -- $ 2,396 Gain on settlement of a contractual dispute, net of legal costs ....................... -- (9,000) -- Pension settlement costs ..................... -- 2,839 -- Acquisition-related costs .................... -- 3,244 1,547 Loss on settlement of a patent dispute ....... 2,000 -- -- ------- ------- ------- Other expense (income) ................... $ 2,000 $(2,917) $ 3,943 ------- ------- ------- In March 2003, we agreed to settle a patent infringement case filed by Ludlow Corporation, a subsidiary of Tyco International Ltd., in return for a one-time $1.5 million payment. We recorded a charge to income in the fourth quarter of 2002 to recognize a loss of $1.5 million plus legal costs of approximately $0.5 million. During 2003, we entered into an agreement with Bristol-Myers Squibb Company ("BMS") and Zimmer, Inc., ("Zimmer") to settle a contractual dispute related to the 1997 sale by BMS and its then subsidiary, Zimmer, of Linvatec Corporation to CONMED Corporation. As a result of the agreement, BMS paid us $9.5 million in cash, which was recorded as a gain on settlement of a contractual dispute, net of $0.5 million in legal costs. During 2003, we announced a plan to restructure our arthroscopy and powered surgical instrument sales force by increasing our domestic sales force from 180 to 230 sales representatives. The increase is part of our integration plan for the Bionx acquisition discussed in Note 2. As part of the sales force restructuring, we converted 90 direct employee sales representatives into nine independent sales agent groups. As a result of this restructuring, we now have 18 exclusive independent sales agent groups managing 230 arthroscopy and powered surgical instrument sales representatives. Due to the termination of the 90 direct employee sales representatives, we recorded a charge to other expense of $2.8 million related to settlement losses of pension obligations, pursuant to Statement of Financial Accounting Standards No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits". During 2003, we incurred acquisition-related charges of approximately $4.5 million, of which $1.3 million has been recorded in cost of sales as discussed in Note 2. An additional $3.2 million of acquisition and transition-related costs have been recorded in other expense. The $3.2 million of costs recorded in other expense consist of $1.3 million in retention bonuses, travel, severance and other costs related to acquisitions completed in the fourth quarter of 2002, and $1.9 million of similar costs related to the Bionx acquisition completed in the first quarter of 2003. During 2004, we elected to terminate our surgical lights product line and we instituted a customer replacement program whereby all currently installed surgical lights will be replaced by CONMED. The entire cost of the replacement program, including the write-off of the remaining surgical lights inventory, purchase of new surgical lights from an alternative supplier and installation costs are expected to approximate $4.0 million. During 2004, we recorded a charge of $2.4 million for the write-off of surgical lights inventory and the cost of surgical light replacements performed through December 31, 2004. It is anticipated -86- that the remaining $1.6 million in costs will be incurred in 2005 as the replacement program is completed. During 2004, we incurred $1.5 million of acquisition-related charges associated with the Bard Endoscopic Technologies acquisition which have been recorded in other expense. These expenses principally consist of severance and other transition related charges. Note 13 -- Guarantees We provide warranties on certain of our products at the time of sale. The standard warranty period for our capital and reusable equipment is generally one year. 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 service and product warranties for the year ended December 31, are as follows: 2002 2003 2004 ---- ---- ---- Balance as of January 1, .................. $ 2,909 $ 3,213 $ 3,588 ------- ------- ------- Provision for warranties .................. 4,287 4,209 3,961 Claims made ............................... (3,983) (3,934) (4,025) Warranties acquired ....................... -- 100 -- ------- ------- ------- Balance as of December 31, ................ $ 3,213 $ 3,588 $ 3,524 ======= ======= ======= Note 14 - New Accounting Pronouncements In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"), which replaces SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123R requires that all share-based payments to employees, including grants of employee stock options, be recognized in the financial statements based on their fair values, beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS 123, no longer will be an alternative to financial statement recognition. We are required to adopt SFAS 123R in the third quarter of 2005. Under SFAS 123R, we must determine the appropriate fair value model to be used in valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. Upon adoption, we may choose from two transition methods: the modified-prospective transition approach or the modified-retroactive transition approach. Under the modified-prospective transition approach we would be required to recognize compensation cost for awards that were granted prior to, but not vested as of the date of adoption. Prior periods remain unchanged and pro forma disclosures previously required by SFAS No. 123 continue to be required. Under the modified-retrospective transition method, we would be required to restate prior periods by recognizing compensation cost in the amounts previously reported in the pro forma disclosure under SFAS No. 123. Under this method, we would be permitted to apply this presentation to all periods presented or to the start of the fiscal year in which SFAS No. 123R is adopted. We would also be required to follow the same guidelines as in the modified-prospective transition method for awards granted subsequent to adoption and those that were granted and not yet vested. We are -87- currently evaluating the requirements of SFAS 123R and its impact on our consolidated results of operations and earnings per share. We have not yet determined the method of adoption or the effect of adopting SFAS 123R, and it has not been determined whether the adoption will result in amounts similar to the current pro forma disclosures under SFAS 123. In December 2004, the FASB issued Staff Position ("FSP") No. 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" ("FSP 109-2"). This position provides guidance under FASB Statement No. 109 ("SFAS 109"), "Accounting for Income Taxes", with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the "Jobs Act") on enterprises' income tax expense and deferred tax liability. The Jobs Act was enacted on October 22, 2004. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS 109. See additional discussion in Note 7. In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions" ("SFAS 153"). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, "Accounting for Nonmonetary Transactions," and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for fiscal periods beginning after June 15, 2005. We have considered SFAS 153 and have determined that this pronouncement is not applicable to our current operations. In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - An Amendment of ARB Opinion No. 43, Chapter 4" ("SFAS 151"). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current period charges regardless of whether they meet the criterion of "so abnormal" as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005. We have considered SFAS 151 and have determined that this pronouncement will not materially impact our consolidated results of operations. In November 2004, the FASB issued SFAS No. 152, "Accounting for Real Estate Time-Sharing Transactions - An amendment of SFAS No. 66 and 67". This statement amends SFAS No. 66, "Accounting for Sales of Real Estate, to reference the financial accounting and reporting guidance for real estate time-sharing transactions which is provided in AICPA Statement of Position ("SOP") 04-2, "Accounting for Real Estate Time-Sharing Transactions." This statement also amends SFAS No. 67, "Accounting for Costs and Initial Rental Operations of Real Estate Projects," to state the guidance for (a) incidental costs and (b) costs incurred to sell real estate projects does not apply to real estate time-sharing transactions. The accounting for those costs is subject to guidance in SOP 04-2. SFAS 152 is effective for fiscal years beginning after June 15, 2005. We have considered SFAS 152 and have determined that this pronouncement is not applicable to our current operations. -88- Note 15-- Selected Quarterly Financial Data (Unaudited) Selected quarterly financial data for 2003 and 2004 are as follows:
Three Months Ended ------------------ March June September December ----- ---- --------- -------- 2003 Net sales ....................................... $118,034 $124,540 $120,747 $133,809 Gross profit .................................... 61,656 65,131 63,231 69,679 Net income ...................................... 6,668 2,763 9,706 12,945 EPS Basic ....................................... $ .23 $ .10 $ .34 $ .45 Diluted ..................................... .23 .09 .33 .44 Three Months Ended ------------------ March June September December ----- ---- --------- -------- 2004 Net sales ....................................... $133,964 $130,912 $132,289 $161,223 Gross profit .................................... 70,359 68,714 67,487 80,332 Net income ...................................... 12,039 12,292 1,699 7,435 EPS: Basic ....................................... $ .41 $ .41 $ .06 $ .25 Diluted ..................................... .40 .41 .06 .25
Unusual Items Included In Selected Quarterly Financial Data: 2003 First Quarter During the first quarter of 2003, we recorded a charge of $7.9 million related to the write-off of purchased in-process research and development associated with the Bionx acquisition - See Note 2. The first quarter effective tax rate was increased from 36.0% to 55.1% to reflect the nondeductibility of the $7.9 million charge. During the first quarter of 2003, we recorded a gain of $9.0 million on the settlement of a contractual dispute and acquisition-related charges of $1.3 million to other expense (income)--See Note 12. Second quarter During the second quarter of 2003, we recorded pension settlement losses of $2.1 million and acquisition-related charges of $1.2 million to other expense (income)--See Note 12. During the second quarter of 2003 we recorded losses on the early extinguishment of debt of $7.9 million--See Note 6. Third quarter During the third quarter of 2003, we recorded pension settlement losses of $0.7 million to other expense (income)--See Note 12. -89- Fourth quarter During the fourth quarter of 2003, we reduced the effective tax rate for the year from 41.4% to 39.5% thereby decreasing income tax expense by $1.0 million. 2004 Third quarter During the third quarter of 2004, we recorded a charge in the amount of $13.7 million related to the write-off of the estimated purchase in-process research and development associated with the Bard Endoscopic Technologies acquisition - See Note 2. During the third quarter of 2004, we recorded a charge in the amount of $0.9 million in other expense for costs related to the Bard Endoscopic Technologies acquisition - See Note 12. Fourth quarter During the fourth quarter of 2004, we recorded a charge in the amount of $2.7 million related to the write-off of the finalized purchased in-process research and development associated with the Bard Endoscopic Technologies acquisition - See Note 2. During the fourth quarter of 2004, we recorded $2.3 million of Bard Endoscopic Technologies acquisition-related charges in cost of sales - See Note 2. During the fourth quarter of 2004, we recorded a charge of $2.4 million related to our termination of our surgical lights product line and $0.7 million of acquisition-related costs associated with the Bard Endoscopic Technologies acquisition to other expense - See Note 12. During the fourth quarter of 2004, we recorded losses on the early extinguishment of debt of $0.8 million - See Note 6. -90- SCHEDULE II--Valuation and Qualifying Accounts (in thousands)
Column C -------------------------- Additions -------------------------- Column B ------------ Column E Column A Balance at Charged to Charged to Column D -------------- - -------------------------------- Beginning of Costs and Other ---------- Balance at End Description Period Expenses Accounts Deductions of Period - -------------------------------- ------------ --------- -------- ---------- -------------- 2004 - ---- Allowance for bad debts ................ $ 1,672 $ 380 $ -- $ (817) $ 1,235 Deferred tax asset valuation allowance .................. 8,462 -- -- (2,575) 5,887 2003 - ---- Allowance for bad debts ................ $ 922 $ 741 $ 640 $ (631) $ 1,672 Deferred tax asset valuation allowance .................. -- -- 8,462 -- 8,462 2002 - ---- Allowance for bad debts ................ $ 1,553 $ (144) $ -- $ (487) $ 922 Deferred tax asset valuation allowance .................. 3,410 -- (3,410) -- --
-91- EX-12 2 ex12.txt EXHIBIT 12 CONMED Corporation Computation of Ratio of Earnings to Fixed Charges
2000 2001 2002 2003 2004 ---- ---- ---- ---- ---- Income before income taxes .......................................... $30,178 $38,134 $53,361 $53,009 $49,562 Interest expense ................................... 34,286 30,824 24,513 18,868 12,774 Portion of rentals representative of interest factor ......................................... 1,114 919 688 653 883 ------- ------- ------- ------- ------- Total earnings available for fixed charges .................................. $65,578 $69,877 $78,562 $72,530 $63,219 ======= ======= ======= ======= ======= Interest expense ................................... $34,286 $30,824 $24,513 $18,868 $12,774 Portion of rentals representative of interest factor ......................................... 1,114 919 688 653 883 ------- ------- ------- ------- ------- Total fixed charges ................................ $35,400 $31,743 $25,201 $19,521 $13,657 ======= ======= ======= ======= ======= Ratio of earnings to fixed charges .................................. 1.85 2.20 3.12 3.72 4.63 ======= ======= ======= ======= =======
EX-21 3 ex21.txt EXHIBIT 21 CONMED Corporation Subsidiaries of the Registrant Name State or Country of Incorporation ---- --------------------------------- Aspen Laboratories, Inc. Colorado CONMED Andover Medical, Inc. New York CONMED Endoscopic Technologies, Inc. Massachusetts CONMED Integrated Systems, Inc. New York CONMED Integrated Systems Canada ULC Canada CONMED Israel Ltd. Israel CONMED Receivables Corporation New York Envision Medical Corporation California GWH Limited Partnership Florida Largo Lakes I Limited Partnership Florida Linvatec Corporation Florida Linvatec Austria Austria Linvatec Australia Pty. Ltd Australia Linvatec Biomaterials, Inc. Pennsylvania Linvatec Biomaterials, Ltd. Finland Linvatec Belgium S.A. Belgium Linvatec Canada ULC Canada Linvatec Deutschland GmbH Germany Linvatec Europe SPRL Belgium Linvatec France S.A.R.L. France Linvatec Korea Ltd. Korea Linvatec Nederland B.V. Netherlands Linvatec Spain Spain Linvatec U.K. Ltd. United Kingdom EX-23 4 ex23.txt EXHIBIT 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-58119, 333-48693, 333-74497, 333-78987 and 333-90444) and Form S-3 (Nos. 333-66764 and 333-122364) of CONMED Corporation of our report dated March 15, 2005 relating to the financial statements, financial statement schedule, management's assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which appears in this Form 10-K. PricewaterhouseCoopers LLP Syracuse, New York March 15, 2005 EX-31.1 5 ex31-1.txt Exhibit 31.1 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Eugene R. Corasanti, certify that: 1. I have reviewed this annual report on Form 10-K of CONMED Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. March 15, 2005 /s/ Eugene R. Corasanti ----------------------- Eugene R. Corasanti Chairman of the Board and Chief Executive Officer EX-31.2 6 ex31-2.txt Exhibit 31.2 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Robert D. Shallish, Jr. certify that: 1. I have reviewed this annual report on Form 10-K of CONMED Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. March 15, 2005 /s/ Robert D. Shallish Jr. -------------------------- Robert D. Shallish, Jr. Vice President - Finance and Chief Financial Officer EX-32.1 7 ex32-1.txt Exhibit 32.1 CERTIFICATIONS PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code), each of the undersigned officers of CONMED Corporation, a New York corporation (the "Corporation"), does hereby certify that: The Annual Report on Form 10-K for the year ended December 31, 2004 (the "Form 10-K") of the Corporation fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Corporation. Date: March 15, 2005 /s/ Eugene R. Corasanti ----------------------- Eugene R. Corasanti Chairman of the Board and Chief Executive Officer Date: March 15, 2005 /s/ Robert D. Shallish, Jr. --------------------------- Robert D. Shallish, Jr. Vice President-Finance and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----