CNMD 6.30.12 10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934


 

For the quarterly period ended
Commission File Number
June 30, 2012
0-16093


CONMED CORPORATION
(Exact name of the registrant as specified in its charter)


New York
(State or other jurisdiction of
incorporation or organization)
16-0977505
(I.R.S. Employer
Identification No.)
525 French Road, Utica, New York
(Address of principal executive offices)
13502
(Zip Code)


(315) 797-8375
(Registrant's telephone number, including area code)


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 ý   No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files). ý

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one).

Large accelerated filer ý    Accelerated filer o    Non-accelerated filer o    Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o No ý

The number of shares outstanding of registrant's common stock, as of July 26, 2012 is 28,420,667 shares.





CONMED CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2012

PART I FINANCIAL INFORMATION
 
Item Number
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II OTHER INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 



Table of Contents

PART I                      FINANCIAL INFORMATION
Item 1.
CONMED CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited, in thousands except per share amounts)
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2011
 
2012
 
2011
 
2012
Net sales
$
183,236

 
$
189,695

 
$
366,686

 
$
384,011

 
 
 
 
 
 
 
 
Cost of sales
91,781

 
89,963

 
179,515

 
183,368

 
 
 
 
 
 
 
 
Gross profit
91,455

 
99,732

 
187,171

 
200,643

 
 
 
 
 
 
 
 
Selling and administrative expense
67,862

 
73,707

 
137,940

 
148,513

 
 
 
 
 
 
 
 
Research and development expense
6,797

 
7,192

 
14,478

 
14,287

 
 
 
 
 
 
 
 
Other expense
98

 
1,775

 
792

 
3,763

 
 
 
 
 
 
 
 
 
74,757

 
82,674

 
153,210

 
166,563

 
 
 
 
 
 
 
 
Income from operations
16,698

 
17,058

 
33,961

 
34,080

 
 
 
 
 
 
 
 
Amortization of debt discount
1,113

 

 
2,207

 

 
 
 
 
 
 
 
 
Interest expense
1,707

 
1,551

 
3,512

 
2,988

 
 
 
 
 
 
 
 
Income before income taxes
13,878

 
15,507

 
28,242

 
31,092

 
 
 
 
 
 
 
 
Provision for income taxes
5,198

 
5,211

 
10,567

 
10,828

 
 
 
 
 
 
 
 
Net income
$
8,680

 
$
10,296

 
$
17,675

 
$
20,264

 
 
 
 
 
 
 
 
Comprehensive income
$
10,802

 
$
7,687

 
$
22,826

 
$
18,732

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Per share data:
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Net Income
 

 
 

 
 

 
 

Basic
$
0.31

 
$
0.36

 
$
0.62

 
$
0.72

Diluted
0.30

 
0.36

 
0.61

 
0.71

 
 
 
 
 
 
 
 
Dividends per share of common stock
$

 
$
0.15

 
$

 
$
0.30

 
 
 
 
 
 
 
 
Weighted average common shares
 

 
 

 
 

 
 

Basic
28,448

 
28,327

 
28,356

 
28,178

Diluted
28,883

 
28,672

 
28,820

 
28,577


 
See notes to consolidated condensed financial statements.
 








1

Table of Contents

CONMED CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited, in thousands except share and per share amounts)
 
 
December 31,
2011
 
June 30,
2012
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
26,048

 
$
16,246

Accounts receivable, net
135,641

 
136,095

Inventories
168,438

 
159,151

Deferred income taxes
10,283

 
10,906

Prepaid expenses and other current assets
16,314

 
15,037

Total current assets
356,724

 
337,435

Property, plant and equipment, net
139,187

 
140,844

Deferred income taxes
2,389

 
2,443

Goodwill
234,815

 
234,839

Other intangible assets, net
195,531

 
191,741

Other assets
6,948

 
153,929

Total assets
$
935,594

 
$
1,061,231

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 

 
 

Current liabilities:
 

 
 

Current portion of long-term debt
$
54,557

 
$
22,534

Accounts payable
21,162

 
29,058

Accrued compensation and benefits
31,142

 
24,370

Income taxes payable
6,470

 
1,870

Other current liabilities
17,853

 
57,415

Total current liabilities
131,184

 
135,247

 
 
 
 
Long-term debt
88,952

 
145,437

Deferred income taxes
92,785

 
99,417

Other long-term liabilities
49,602

 
87,747

Total liabilities
362,523

 
467,848

 
 
 
 
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 shares authorized; 31,299,203 shares
 

 
 

issued in 2011 and 2012, respectively
313

 
313

Paid-in capital
321,994

 
321,259

Retained earnings
354,439

 
366,219

Accumulated other comprehensive loss
(26,348
)
 
(27,880
)
Less: 3,358,078 and 2,888,975 shares of common stock
 

 
 

in treasury, at cost in 2011 and 2012, respectively
(77,327
)
 
(66,528
)
Total shareholders’ equity
573,071

 
593,383

Total liabilities and shareholders’ equity
$
935,594

 
$
1,061,231



 See notes to consolidated condensed financial statements.

2

Table of Contents

CONMED CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
Six Months Ended
 
June 30,
 
2011
 
2012
Cash flows from operating activities:
 
 
 
Net income
$
17,675

 
$
20,264

Adjustments to reconcile net income
 

 
 

to net cash provided by operating activities:
 

 
 

Depreciation
8,983

 
9,274

Amortization of debt discount
2,207

 

Amortization, all other
9,857

 
13,790

Stock-based compensation expense
2,232

 
2,574

Deferred income taxes
8,981

 
6,091

     Increase (decrease) in cash flows
 

 
 

from changes in assets and liabilities:
 

 
 

 Accounts receivable
(4,541
)
 
(1,027
)
 Inventories
78

 
3,078

 Accounts payable
2,309

 
1,345

   Income taxes payable
143

 
(4,589
)
   Accrued compensation and benefits
(5,684
)
 
(6,730
)
       Other assets
(2,226
)
 
(1,779
)
       Other liabilities
209

 
(9,014
)
 
22,548

 
13,013

Net cash provided by operating activities
40,223

 
33,277

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of property, plant and equipment
(8,576
)
 
(11,596
)
Payments related to business acquisitions and distribution agreement
(72
)
 
(64,116
)
Net cash used in investing activities
(8,648
)
 
(75,712
)
 
 
 
 
Cash flows from financing activities:
 

 
 

     Net proceeds from common stock issued
 

 
 

  under employee plans
5,495

 
7,868

Payments on senior credit agreement
(22,675
)
 
(32,063
)
Proceeds from senior credit agreement

 
57,000

Payments on mortgage notes
(438
)
 
(475
)
Dividends paid on common stock

 
(4,328
)
Other, net
(3,148
)
 
4,925

Net cash provided by
 
 
 
(used in) financing activities
(20,766
)
 
32,927

 
 
 
 
Effect of exchange rate changes
 
 
 
on cash and cash equivalents
1,105

 
(294
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
11,914

 
(9,802
)
 
 
 
 
Cash and cash equivalents at beginning of period
12,417

 
26,048

 
 
 
 
Cash and cash equivalents at end of period
$
24,331

 
$
16,246

 
 
 
 
Non-cash financing activities:
 
 
 
   Dividends payable
$

 
$
4,262

See notes to consolidated condensed financial statements.

3

Table of Contents

CONMED CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited, in thousands except per share amounts)

Note 1 – Operations

CONMED Corporation (“CONMED”, the “Company”, “we” or “us”) is a medical technology company with an emphasis on surgical devices and equipment for minimally invasive procedures and monitoring.  The Company’s products serve the clinical areas of arthroscopy, powered surgical instruments, electrosurgery, cardiac monitoring single-uses, endosurgery and endoscopic technologies.  They are used by surgeons and physicians in a variety of specialties including orthopedics, general surgery, gynecology, neurosurgery, and gastroenterology.

Note 2 - Interim financial information

The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statements.  Results for the period ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

The consolidated condensed financial statements and notes thereto should be read in conjunction with the financial statements and notes for the year ended December 31, 2011 included in our Annual Report on Form 10-K.

Note 3 – Comprehensive income

Comprehensive income consists of the following:
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2011
 
2012
 
2011
 
2012
 
 
 
 
 
 
 
 
Net income
$
8,680

 
$
10,296

 
$
17,675

 
$
20,264

 
 
 
 
 
 
 
 
Other comprehensive income:
 
 
 
 
 
 
 
Pension liability, net of
 
 
 
 
 
 
 
income tax
266

 
461

 
497

 
923

Cash flow hedging gain (loss),
 
 
 
 
 
 
 
net of income tax
271

 
292

 
(775
)
 
(1,269
)
Foreign currency
 
 
 
 
 
 
 
translation adjustment
1,585

 
(3,362
)
 
5,429

 
(1,186
)
 
 
 
 
 
 
 
 
Comprehensive income
$
10,802

 
$
7,687

 
$
22,826

 
18,732

 
 
 
 
 
 
 
 

 

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Table of Contents

Accumulated other comprehensive income (loss) consists of the following:

 
Cash Flow
Hedging
Gain (Loss)
 
Pension
Liability
 
Cumulative
Translation
Adjustments
 
Accumulated
Other
Comprehensive
Income (Loss)
 
 
 
 
 
 
 
 
Balance, December 31, 2011
$
2,973

 
$
(31,250
)
 
$
1,929

 
$
(26,348
)



 


 


 





 


 


 


Pension liability,


 


 


 


net of income tax

 
923

 

 
923




 


 


 


Cash flow hedging loss,

 

 

 

net of income tax
(1,269
)
 

 

 
(1,269
)



 


 


 


Foreign currency translation


 


 


 


adjustments

 

 
(1,186
)
 
(1,186
)



 


 


 


Balance, June 30, 2012
$
1,704

 
$
(30,327
)
 
$
743

 
$
(27,880
)

Note 4 – Fair value of financial instruments
 
 We enter into derivative instruments for risk management purposes only.  We operate internationally and, in the normal course of business, are exposed to fluctuations in interest rates, foreign exchange rates and commodity prices. These fluctuations can increase the costs of financing, investing and operating the business. We use forward contracts, a type of derivative instrument, to manage certain foreign currency exposures.
 
By nature, all financial instruments involve market and credit risks. We enter into forward contracts with major investment grade financial institutions and have policies to monitor the credit risk of those counterparties.  While there can be no assurance, we do not anticipate any material non-performance by any of these counterparties.
 
Foreign Currency Forward Contracts. We hedge certain forecasted intercompany transactions denominated in foreign currencies through the use of forward contracts.   We account for these forward contracts as cash flow hedges.  To the extent these forward contracts meet hedge accounting criteria, changes in their fair value are not included in current earnings but are included in accumulated other comprehensive loss.  These changes in fair value will be recognized into earnings as a component of sales or cost of sales when the forecasted transaction occurs.  The notional contract amounts for forward contracts outstanding at June 30, 2012 which have been accounted for as cash flow hedges totaled $107.9 million.  Net realized gains (losses) recognized for forward contracts accounted for as cash flow hedges approximated $(2.3) million and $1.4 million for the three months ended June 30, 2011 and 2012, respectively and $(3.5) million and $2.3 million for the six months ended June 30, 2011 and 2012, respectively. Net unrealized gains on forward contracts outstanding, net of tax, which have been accounted for as cash flow hedges and which have been included in other comprehensive income, totaled $1.7 million at June 30, 2012.  These unrealized gains and any subsequent changes in fair value will be recognized in the consolidated statements of operations in 2012 and 2013 as the related forward contracts mature and gains and losses are realized.

We also enter into forward contracts to exchange foreign currencies for United States dollars in order to hedge our currency transaction exposures on intercompany receivables denominated in foreign currencies.  These forward contracts settle each month at month-end, at which time we enter into new forward contracts.  We have not designated these forward contracts as hedges and have not applied hedge accounting to them.  The notional contract amounts for forward contracts outstanding at June 30, 2012 which have not been designated as hedges totaled $51.7 million.  Net realized gains (losses) recognized in connection with those forward contracts not accounted for as hedges approximated $(0.6) million and $0.3 million for the three months ended June 30, 2011 and 2012, respectively, offsetting gains (losses) on our intercompany receivables of $0.4 million and $(0.7) million for the three months ended June 30, 2011 and 2012, respectively.   Net realized losses recognized in connection with those forward contracts not accounted for as hedges approximated $(1.6) million and $(0.4) million for the six months ended June 30, 2011 and 2012, respectively, offsetting gains (losses) on our intercompany receivables of $1.6 million and $(0.3) million for the six months ended June 30, 2011 and 2012, respectively. These gains and losses have been recorded in selling and administrative expense in the consolidated statements of operations.
 


5

Table of Contents

We record these forward foreign exchange contracts at fair value; the following tables summarize the fair value for forward foreign exchange contracts outstanding at December 31, 2011 and June 30, 2012:
 
December 31, 2011
Asset
Balance Sheet
Location
 
Fair
Value
 
Liabilities
Balance Sheet
Location
 
Fair
Value
 
 
Net
 Fair
Value
Derivatives designated as hedged instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Prepaid expenses and other current assets
 
$
5,042

 
Prepaid expenses and other current assets
 
$
(326
)
 
 
$
4,716

 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Prepaid expenses and other current assets
 
41

 
Prepaid expenses and other current assets
 
(95
)
 
 
(54
)
 
 
 
 
 
 
 
 
 
 
 
Total derivatives
 
 
$
5,083

 
 
 
$
(421
)
 
 
$
4,662


June 30, 2012
Asset
Balance Sheet
Location
 
Fair
Value
 
Liabilities
Balance Sheet
Location
 
Fair
Value
 
 
Net
Fair
Value
Derivatives designated as hedged instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Prepaid expenses and other current assets
 
$
3,211

 
Prepaid expenses and other current assets
 
$
(509
)
 
 
$
2,702

 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 

 
 
 
 

 
 
 

 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Prepaid expenses and other current assets
 
1

 
Prepaid expenses and other current assets
 
(147
)
 
 
(146
)
 
 
 
 
 
 
 
 
 
 
 
Total derivatives
 
 
$
3,212

 
 
 
$
(656
)
 
 
$
2,556

 
Our forward foreign exchange contracts are subject to a master netting agreement and qualify for netting in the consolidated balance sheets.  Accordingly, we have recorded the net fair value of $4.7 million and $2.6 million in prepaid expenses and other current assets at December 31, 2011 and June 30, 2012, respectively.
 
Fair Value Disclosure. Financial Accounting Standards Board (“FASB”) guidance defines fair value and establishes a framework for measuring fair value and related disclosure requirements. This guidance applies when fair value measurements are required or permitted. The guidance indicates, among other things, that a fair value measurement assumes that the transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. Fair value is defined based upon an exit price model.

As of June 30, 2012, we do not have any significant non-recurring measurements of nonfinancial assets and nonfinancial liabilities.
 
Valuation Hierarchy. A valuation hierarchy was established for disclosure of the inputs to the valuations used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets in markets that are not active, inputs other than quoted prices that are observable for

6

Table of Contents

the asset or liability, including interest rates, yield curves and credit risks, or inputs that are derived principally from or corroborated by observable market data through correlation. Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
 
Valuation Techniques. Assets and liabilities carried at fair value and measured on a recurring basis as of June 30, 2012 consist of forward foreign exchange contracts.  The value of the forward foreign exchange contract assets and liabilities were determined within Level 2 of the valuation hierarchy and are listed in the table above.
 
The carrying amounts reported in our balance sheets for cash and cash equivalents, accounts receivable, accounts payable and long-term debt excluding the Notes approximate fair value.  The fair value of the Notes was determined within Level 2 of the valuation hierarchy and approximated $0.3 million at both December 31, 2011 and June 30, 2012 based on their quoted market price.  




Note 5 - Inventories

Inventories consist of the following:
 
December 31,
2011
 
June 30,
2012
 
 
 
 
Raw materials
$
52,351

 
$
46,743

Work-in-process
15,499

 
15,823

Finished goods
100,588

 
96,585

Total
$
168,438

 
$
159,151

 
Note 6 – Earnings and dividends per share

Basic earnings per share (“basic EPS”) is computed by dividing net income by the weighted average number of common 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, restricted stock units, performance share units and stock appreciation rights (“SARs”) during the period. The following table sets forth the computation of basic and diluted earnings per share for three and six months ended June 30, 2011 and 2012.


Three months ended June 30,
 
Six months ended June 30,
 
2011
 
2012
 
2011
 
2012



 


 


 


Net income
$
8,680

 
$
10,296

 
$
17,675

 
$
20,264




 


 


 


Basic – weighted average shares outstanding
28,448

 
28,327

 
28,356

 
28,178




 


 


 


Effect of dilutive potential securities
435

 
345

 
464

 
399




 


 


 


Diluted – weighted average shares outstanding
28,883

 
28,672

 
28,820

 
28,577




 


 


 





 


 


 


Net income
 

 
 

 
 

 
 

Basic
$0.31
 
$0.36
 
$0.62
 
$0.72
Diluted
$0.30
 
$0.36
 
$0.61
 
$0.71

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The shares used in the calculation of diluted EPS exclude options and SARs to purchase shares where the exercise price was greater than the average market price of common shares for the period.  Shares excluded from the calculation of diluted EPS aggregated 0.6 million and 0.4 million for the three months ended June 30, 2011 and 2012, respectively.  Shares excluded from the calculation of diluted EPS aggregated 0.7 million and 0.4 million for the six months ended June 30, 2011 and 2012, respectively.

On February 29, 2012, the Board of Directors adopted a cash dividend policy and declared an initial quarterly dividend of $0.15 per share. The initial quarterly dividend of $4.3 million was paid on April 5, 2012 to shareholders of record as of March 15, 2012. The second quarter dividend for 2012 was paid on July 6, 2012 to shareholders of record as of June 15, 2012. The total dividend payable at June 30, 2012 was $4.3 million and is included in other current liabilities in the consolidated condensed balance sheet.


Note 7 – Goodwill, other intangible assets, and other assets

The changes in the net carrying amount of goodwill for the six months ended June 30, 2012 are as follows:

Balance as of January 1, 2012
$
234,815

 
 
Foreign currency translation
24

 
 
Balance as of June 30, 2012
$
234,839



  Goodwill associated with each of our principal operating reporting units is as follows:

 
December 31,
2011
 
June 30,
2012
CONMED Electrosurgery
$
16,645

 
$
16,645

 
 
 
 
CONMED Endosurgery
42,439

 
42,439

 
 
 
 
CONMED Linvatec
175,731

 
175,755

 
 
 
 
Balance
$
234,815

 
$
234,839


Total accumulated impairment losses (associated with our CONMED Patient Care and CONMED Endoscopic Technologies operating units) aggregated $106,991 at both December 31, 2011 and June 30, 2012.

  Other intangible assets consist of the following:


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Table of Contents

 
December 31, 2011
 
June 30, 2012
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Gross
Carrying
Amount
 
Accumulated
Amortization
Amortized intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Customer relationships
$
133,965

 
$
(45,112
)
 
$
133,965

 
$
(47,576
)
 
 
 
 
 
 
 
 
Patents and other intangible assets
52,702

 
(34,368
)
 
52,774

 
(35,766
)
 
 
 
 
 
 
 
 
Unamortized intangible assets:
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Trademarks and tradenames
88,344

 

 
88,344

 

 
 
 
 
 
 
 
 
Balance
$
275,011

 
$
(79,480
)
 
$
275,083

 
$
(83,342
)

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 29 years.  Customer relationships are being amortized over a weighted average life of 33 years.  Patents and other intangible assets are being amortized over a weighted average life of 14 years.  

Amortization expense related to intangible assets which are subject to amortization totaled $1,626 and $3,249 in the three and six months ended June 30, 2011 and $1,930 and $3,862 in the three and six months ended June 30, 2012, respectively, and is included in selling and administrative expense on the consolidated condensed statements of income.
 
The estimated amortization expense for the year ending December 31, 2012, including the six month period ended June 30, 2012 and for each of the five succeeding years is as follows:
 
2012
$
7,722

2013
7,499

2014
6,884

2015
6,502

2016
6,390

2017
6,390


On January 3, 2012, the Company entered into a Sports Medicine Joint Development and Distribution Agreement (the "JDDA") with Musculoskeletal Tissue Foundation (“MTF”) to obtain (i) MTF's worldwide promotion rights with respect to allograft tissues within the field of sports medicine, and (ii) an exclusive license to an autograft (patient's own) blood Platelet-Rich Plasma (“PRP”) therapy technology and products (collectively, the “Transaction”).
     
Under the JDDA, we acquired the worldwide marketing, educational and promotion rights for sports medicine allograft tissue. We also acquired certain assets relating to instrument sets used for allograft procedures and approximately 35 MTF sales and marketing employees joined the Company. The JDDA has a term of 25 years with renewals thereafter. This transaction was not accounted for as a business combination as it does not meet the definition of a business as defined by ASC 805. The initial consideration from the Company includes a $63.0 million up-front payment for the rights and certain assets, with an additional $84.0 million contingently payable over a four year period depending on MTF meeting supply targets, as further set forth in the JDDA ($34 million is due within the next fiscal year with the remainder due in equal installments in each year thereafter). As compensation for our marketing efforts, the Company will receive services fees amounting to 50% of the revenue streams relating to MTF's sports medicine allograft product line and 100% of the revenue from the PRP products. At June 30, 2012, the gross carrying amount of this arrangement amounted to $149.4 million and the related accumulated amortization was $3.0 million. This has been recorded in other assets. $84.0 million related to the contingent payment is accrued in other current and other long term liabilities as we believe it is probable MTF will meet the supply targets. The Company is amortizing the upfront payment as well as the accrued $84.0 million over the 25 year term of the JDDA. Amortization expense is recorded as a reduction to sales.

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Note 8 – 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 six months ended June 30, are as follows:
 
 
2011
 
2012
 
 
 
 
Balance as of January 1,
$
3,363

 
$
3,618

 


 


Provision for warranties
2,247

 
2,127

 


 


Claims made
(2,082
)
 
(2,043
)
 


 


Balance as of June 30,
$
3,528

 
$
3,702

 
Note 9 – Pension plan

Net periodic pension costs consist of the following:
 

Three months ended June 30,
 
Six months ended June 30,
 
2011
 
2012
 
2011
 
2012



 


 


 


Service cost
$
70

 
$
65

 
$
141

 
$
130




 


 


 


Interest cost on projected

 

 

 

benefit obligation
664

 
860

 
1,759

 
1,719




 


 


 


Expected return on plan assets
(1,132
)
 
(1,131
)
 
(2,189
)
 
(2,262
)



 


 


 


Net amortization and deferral
423

 
731

 
789

 
1,463




 


 


 


Net periodic pension cost
$
25

 
$
525

 
$
500

 
$
1,050

 
We contributed $6.5 million during the first quarter of 2012 related to the 2011 plan year. We are required and expect to make a total of $2.7 million in contributions to our pension plan for the 2012 plan year. We contributed $0.7 million during the second quarter of 2012 and expect to contribute the remaining $2.0 million during the remainder of 2012 and the first quarter of 2013.

Note 10 – Other expense

Other expense consists of the following:
 

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Three months ended June 30,
 
Six months ended June 30,
 
2011
 
2012
 
2011
 
2012



 


 


 


Administrative consolidation costs
$
98

 
$
1,231

 
$
792

 
$
1,504

Costs associated with legal arbitration

 
544

 

 
1,555

Costs associated with purchase of a distributor

 

 

 
704




 


 


 


Other expense
$
98

 
$
1,775

 
$
792

 
$
3,763


During 2011, we consolidated certain administrative functions in our Utica, New York facility.  For the three and six months ended June 30, 2011, we incurred $0.1 million and $0.8 million, respectively, in related costs consisting principally of severance charges. During 2012, we restructured certain administrative functions related to our CONMED Linvatec division. For the three and six months ended June 30, 2012, we incurred $1.2 million and $1.5 million, respectively, in related costs consisting principally of severance charges.
 
During 2012, we incurred legal costs related to a contractual dispute with a former distributor as further described in Note 12. For the three and six months ended June 30, 2012, we incurred costs totaling $0.5 million and $1.6 million, respectively.

During the six months ended June 30, 2012 we incurred $0.7 million in costs associated with the purchase of the Company's former distributor in the Nordic region of Europe.
 
Note 11 — Business segments and geographic areas

CONMED conducts its business through five principal operating segments, CONMED Endoscopic Technologies, CONMED Endosurgery, CONMED Electrosurgery, CONMED Linvatec and CONMED Patient Care.  We believe each of our segments are similar in the nature of their products, production processes, customer base, distribution methods and regulatory environment.  Our CONMED Endosurgery, CONMED Electrosurgery and CONMED Linvatec operating segments also have similar economic characteristics and therefore qualify for aggregation.  Our CONMED Patient Care and CONMED Endoscopic Technologies operating units do not qualify for aggregation since their economic characteristics do not meet the criteria for aggregation as a result of the lower overall operating margin in these segments.

CONMED Endosurgery, CONMED Electrosurgery and CONMED Linvatec consist of a single aggregated reportable segment comprising a complete line of endo-mechanical instrumentation for minimally invasive laparoscopic procedures, electrosurgical generators and related surgical instruments, arthroscopic instrumentation for use in orthopedic surgery and small bone, large bone and specialty powered surgical instruments.  CONMED Patient Care product offerings include a line of vital signs and cardiac monitoring products as well as suction instruments & tubing for use in the operating room.  CONMED Endoscopic Technologies product offerings include a comprehensive line of minimally invasive endoscopic diagnostic and therapeutic instruments used in procedures which require examination of the digestive tract.

The following is net sales information by product line and reportable segment:
 

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Three months ended June 30,
 
Six months ended June 30,
 
2011
 
2012
 
2011
 
2012
 


 


 


 


Arthroscopy
$
70,646

 
$
81,012

 
$
146,065

 
$
167,248

Powered Surgical Instruments
38,255

 
37,143

 
76,291

 
75,720

CONMED Linvatec
108,901

 
118,155

 
222,356

 
242,968

CONMED Electrosurgery
26,053

 
24,455

 
49,625

 
46,934

CONMED Endosurgery
19,133

 
18,168

 
37,031

 
36,320

CONMED Linvatec, Endosurgery,

 

 

 

and Electrosurgery
154,087

 
160,778

 
309,012

 
326,222

CONMED Patient Care
16,636

 
15,577

 
33,260

 
31,600

CONMED Endoscopic Technologies
12,513

 
13,340

 
24,414

 
26,189

Total
$
183,236

 
$
189,695

 
$
366,686

 
$
384,011



Total assets, capital expenditures, depreciation and amortization information are impracticable to present by reportable segment because the necessary information is not available.

The following is a reconciliation between segment operating income and income before income taxes:
 
 
Three months ended June 30,

Six months ended June 30,
 
2011
 
2012
 
2011
 
2012
 
 
 
 
 
 
 
 
CONMED Endosurgery, Electrosurgery and Linvatec
$
20,529

 
$
20,615

 
$
44,804

 
$
41,569

CONMED Patient Care
(999
)
 
(564
)
 
(1,735
)
 
(1,227
)
CONMED Endoscopic Technologies
355

 
27

 
165

 
(118
)
Corporate
(3,187
)
 
(3,020
)
 
(9,273
)
 
(6,144
)
Income from operations
16,698

 
17,058

 
33,961

 
34,080

 


 


 


 


Amortization of debt discount
1,113

 

 
2,207

 

Interest expense
1,707

 
1,551

 
3,512

 
2,988

 


 


 


 


Income before income taxes
$
13,878

 
$
15,507

 
$
28,242

 
$
31,092



Note 12 – 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. Likewise, from time to time, the Company may receive a subpoena from a government agency such as the Securities and Exchange Commission, Equal Employment Opportunity Commission, the Occupational Safety and Health Administration, the Department of Labor, the Treasury Department, or other federal and state agencies or foreign governments or government agencies.  These subpoenas may or may not be routine inquiries, or may begin as routine inquiries and over time develop into enforcement actions of various types.  The product liability claims are generally covered by various insurance policies, subject to certain deductible amounts, maximum policy limits and certain exclusions in the respective policies or as required as a matter of law.  In some cases we may be entitled to indemnification by third parties.  When there is no insurance coverage, as would typically be the case primarily in lawsuits alleging patent infringement or in connection with certain government investigations, or indemnification obligations of a third party, we establish reserves sufficient to cover probable losses associated with such claims.  We do not expect that the resolution of any pending claims or investigations will have a material adverse effect on our financial condition, results of operations or cash flows.  There can be no assurance, however, that future claims or

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investigations, or the costs associated with responding to such claims or investigations, especially claims and investigations not covered by insurance, will not have a material adverse effect on our financial condition, results of operations or cash flows.

Manufacturers of medical products may face exposure to significant product liability claims. To date, we have not experienced any product liability claims that have been material to our financial statements or condition, 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, that the carriers will be solvent or that such insurance will be available to us in the future at a reasonable cost.

Our operations are subject, and in the past have been subject, to a number of environmental laws and regulations governing, among other things, air emissions, wastewater discharges, the use, handling and disposal of hazardous substances and wastes, soil and groundwater remediation and employee health and safety. In some jurisdictions environmental requirements may be expected to become more stringent in the future. In the United States certain environmental laws can impose liability for the entire cost of site restoration upon each of the parties that may have contributed to conditions at the site regardless of fault or the lawfulness of the party’s activities.  While we do not believe that the present costs of environmental compliance and remediation are material, there can be no assurance that future compliance or remedial obligations would not have a material adverse effect on our financial condition, results of operations or cash flows.

During the second quarter of 2012, we resolved a contractual dispute with a former distributor for $0.5 million. The total costs incurred related to this contractual dispute in the six months ended June 30, 2012 were $1.6 million. This matter is now resolved and we do not expect any further expenses related to this claim.
 


Note 13 – New accounting pronouncements
 
In May 2011, the FASB issued new authoritative guidance to provide a consistent definition of fair value and ensure that fair value measurements and disclosure requirements are similar between GAAP and International Financial Reporting Standards. This guidance changes certain fair value measurement principles and enhances the disclosure requirements for fair value measurements. We adopted this guidance effective January 1, 2012.  The implementation of this new guidance did not have a material impact on our consolidated financial statements.

In June 2011, the FASB amended its guidance on the presentation of comprehensive income in financial statements to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items that are recorded in other comprehensive income. The new accounting guidance requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. We adopted this guidance effective January 1, 2012. The implementation of this new guidance did not have a material impact on our consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08 which provides an entity the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test for goodwill impairment. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. The implementation of this new guidance did not have a material impact on our consolidated financial statements.














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Note 14 – Restructuring

We incurred the following restructuring costs: 

Three months ended June 30,
 
Six months ended June 30,
 
2011
 
2012
 
2011
 
2012



 


 


 


  Facility consolidation costs
$
986

 
$
1,202

 
$
1,740

 
$
2,676




 


 


 


Restructuring costs

 

 

 

  included in cost of sales
$
986

 
$
1,202

 
$
1,740

 
$
2,676




 


 


 





 


 


 


Administrative

 

 

 

  consolidation costs
$
98

 
$
1,231

 
$
792

 
$
1,504




 


 


 


Restructuring costs

 

 

 

  included in other expense
$
98

 
$
1,231

 
$
792

 
$
1,504

 
During 2011 and 2012, we continued our operational restructuring plan which includes the transfer of additional production lines from manufacturing facilities located in the United States to our manufacturing facility in Chihuahua, Mexico. During the second quarter of 2012, we began the consolidation of our Finland operations into our Largo, Florida and Utica, New York manufacturing facilities.  We incurred $1.0 million and $1.7 million in costs associated with the restructuring during the three and six months ended June 30, 2011, respectively.  We incurred $1.2 million and $2.7 million in costs associated with the restructuring during the three and six months ended June 30, 2012, respectively. These costs were charged to cost of goods sold and include severance and other charges associated with the transfer of production to Mexico and consolidation of our Finland operations.

Restructuring costs included in other expense are described more fully in Note 10.



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Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
 AND RESULTS OF OPERATIONS
 

Forward-Looking Statements
 
In this Report on Form 10-Q, we make forward-looking statements about our financial condition, results of operations and business. Forward-looking statements are statements made by us concerning events that may or may not occur in the future.  These statements may be made directly in this document or may be “incorporated by reference” from other documents.  Such statements may be identified by the use of words such as “anticipates”, “expects”, “estimates”, “intends” and “believes” and variations thereof and other terms of similar meaning.

Forward-Looking Statements are not Guarantees of Future Performance
 
Forward-looking statements involve known and unknown risks, uncertainties and other factors, including those that 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 those identified under “Risk Factors” in our Annual Report on Form 10-K for the year-ended December 31, 2011 and the following, among others:

general economic and business conditions;
changes in foreign exchange and interest rates;
cyclical customer purchasing patterns due to budgetary and other constraints;
changes in customer preferences;
competition;
changes in technology;
the introduction and acceptance of new products;
the ability to evaluate, finance and integrate acquired businesses, products and companies;
changes in business strategy;
the availability and cost of materials;
the possibility that United States or foreign regulatory and/or administrative agencies may initiate enforcement actions against us or our distributors;
future levels of indebtedness and capital spending;
quality of our management and business abilities and the judgment of our personnel;
the availability, terms and deployment of capital;
the risk of litigation, especially patent litigation as well as the cost associated with patent and other litigation;
the risk of a lack of allograft tissue due to reduced donations of such tissues or due to tissues not meeting the appropriate high standards for screening and/or processing of such tissues; and
changes in regulatory requirements.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below and “Risk Factors” and “Business” in our Annual Report on Form 10-K for the year-ended December 31, 2011 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 Quarterly Report on Form 10-Q or to reflect the occurrence of unanticipated events.

Overview:

CONMED Corporation (“CONMED”, the “Company”, “we” or “us”) is a medical technology company with six principal product lines.  These product lines and the percentage of consolidated revenues associated with each, are as follows:
 

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Three months ended June 30,

Six months ended June 30,
 
2011

2012

2011

2012
 











Arthroscopy
38.6
%

42.7
%

39.8
%

43.6
%
Powered Surgical Instruments
20.9


19.6


20.8


19.7

Electrosurgery
14.2


12.9


13.5


12.2

Endosurgery
10.4


9.6


10.1


9.5

Patient Care
9.1


8.2


9.1


8.2

Endoscopic Technologies
6.8


7.0


6.7


6.8

Consolidated net sales
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%

A significant amount of our products are used in surgical procedures with the majority of our revenues derived from the sale of single-use products.  We manufacture substantially all of our products in facilities located in the United States, Mexico, and Finland.  We market our products both domestically and internationally directly to customers and through distributors.  International sales represent a significant portion of our business.  During the three and six months ended June 30, 2012, international sales approximated 50.8% and 50.7%, respectively, of total net sales.

Business Environment and Opportunities

The aging of the worldwide population along with lifestyle changes, continued cost containment pressures on healthcare systems and the desire of clinicians and administrators to use less invasive (or noninvasive) procedures are important trends which are driving the long-term growth in our industry.  We believe that with our broad product offering of high quality surgical and patient care products, we can capitalize on this growth for the benefit of the Company and our shareholders.
 
In order to further our growth prospects, we have historically used strategic business acquisitions and exclusive distribution relationships to continue to diversify our product offerings, increase our market share and realize economies of scale.
 
We have a variety of research and development initiatives focused in each of our principal product lines as continued innovation and commercialization of new proprietary products and processes are essential elements of our long-term growth strategy.  Our reputation as an innovator is exemplified by recent new product introductions such as the PressFT™ Suture Anchor, absorbable and non-absorbable implants for use in arthroscopic stabilization procedures of the shoulder and labral repair of the hip; Y-Knot™ All-suture Anchor, a suture anchor implant comprised entirely of high strength suture for instability repair procedures in the shoulder; the Sequent™ Meniscal Repair System, which offers suture-locking implant cleats that will provide a knotless repair and allow the surgeon to complete an entire meniscal repair with one device without leaving the joint; XACTPIN™ Graft Passing Guide Pin is specifically engineered for fast, accurate and minimally invasive referencing of the Aperture to Cortex length; Hip Preservation System™, from access to repair, the system is committed to optimizing patient outcomes by providing a comprehensive solution of joint preserving instrumentation and techniques; Bullseye® Anatomic Cruciate Reconstruction System; the Hall® Lithium Power Battery System offers lithium ion battery technology which will provide greater power and longevity during surgery when compared to present batteries and the Altrus® Thermal Tissue Fusion System which utilizes thermal energy to seal, cut, grasp, and dissect vessels up to 7mm in size utilizing a closed feedback loop between the energy source and the single-use handpiece to precisely control the desired effect on tissue.

Business Challenges

Significant volatility in the financial markets and foreign currency exchange rates and depressed economic conditions in both domestic and international markets, have presented significant business challenges since the second half of 2008. While we returned to revenue growth in 2010 and 2011 and are cautiously optimistic that the domestic economic environment is improving, conditions in Europe and elsewhere may present significant business challenges for the Company, and there can be no assurance that improvement in the overall economic environment will be sustained. We will continue to monitor and manage the impact of the overall economic environment on the Company.

Over the past few years we successfully completed certain of our operational restructuring plans whereby we consolidated manufacturing and distribution centers as well as restructured certain of our administrative functions. We continue to restructure both operations and administrative functions as necessary throughout the organization. However, we cannot be certain such

16

Table of Contents

activities will be completed in the estimated time period or that planned cost savings will be achieved.

Our facilities are subject to periodic inspection by the United States Food and Drug Administration (“FDA”) and foreign regulatory agencies or notified bodies for, among other things, conformance to Quality System Regulation and Current Good Manufacturing Practice (“CGMP”) requirements and foreign or international standards. We are committed to the principles and strategies of systems-based quality management for improved CGMP compliance, operational performance and efficiencies through our Company-wide quality systems initiatives. However, there can be no assurance that our actions will ensure that we will not receive a warning letter or be the subject of other regulatory action, which may include consent decrees or fines, that we will not conduct product recalls or that we will not experience temporary or extended periods during which we may not be able to sell products in foreign countries.

Critical Accounting Policies

Preparation of our financial statements requires us to make estimates and assumptions which affect the reported amounts of assets, liabilities, revenues and expenses.  Note 1 to the consolidated financial statements in our Annual Report on Form 10-K for the year-ended December 31, 2011 describes 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.  There have been no significant changes in our critical accounting estimates during the six months ended June 30, 2012.

Revenue Recognition

Revenue is recognized when title has been transferred to the customer which is at the time of shipment.  Service fees earned for our marketing efforts related to sports medicine allograft tissue are recorded in accordance with the contractual terms of the agreement with Musculoskeletal Tissue Foundation ("MTF"). The following policies apply to our major categories of revenue transactions:

Sales to customers are evidenced by firm purchase orders. Title and the risks and rewards of ownership are transferred to the customer when product is shipped under our stated shipping terms.  Payment by the customer is due under fixed payment terms.

We place certain of our capital equipment with customers on a loaned basis in return for commitments to purchase related single-use products over time periods generally ranging from one to three years.  In these circumstances, no revenue is recognized upon capital equipment shipment as the equipment is loaned and subject to return if certain minimum single-use purchases are not met.  Revenue is recognized upon the sale and shipment of the related single-use products.  The cost of the equipment is amortized over its estimated useful life.

Product returns are only accepted at the discretion of the Company and in accordance with our “Returned Goods Policy”.  Historically the level of product returns has not been significant.  We accrue for sales returns, rebates and allowances based upon an analysis of historical customer returns and credits, rebates, discounts and current market conditions.

Our terms of sale to customers generally do not include any obligations to perform future services.  Limited warranties are provided for capital equipment sales and provisions for warranty are provided at the time of product sale based upon an analysis of historical data.

Amounts billed to customers related to shipping and handling have been included in net sales.  Shipping and handling costs are included in selling and administrative expense.

We sell to a diversified base of customers around the world and, therefore, believe there is no material concentration of credit risk.

We assess the risk of loss on accounts receivable and adjust the allowance for doubtful accounts based on this risk assessment.  Historically, losses on accounts receivable have not been material.  Management believes that the allowance for doubtful accounts of $1.2 million at June 30, 2012 is adequate to provide for probable losses resulting from accounts receivable.



17

Table of Contents


Inventory Valuation

We write-off excess and obsolete inventory resulting from the inability to sell our products at prices in excess of current carrying costs.  The markets in which we operate are highly competitive, with new products and surgical procedures introduced on an on-going basis.  Such marketplace changes may result in our products becoming obsolete.  We make estimates regarding the future recoverability of the costs of our products and record a provision for excess and obsolete inventories based on historical experience, expiration of sterilization dates and expected future trends.  If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write-downs may be required.

Goodwill and Intangible Assets

We have a history of growth through acquisitions.  Assets and liabilities of acquired businesses are recorded at their estimated fair values as of the date of acquisition.  Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired businesses.  Other intangible assets primarily represent allocations of purchase price to identifiable intangible assets of acquired businesses.  We have accumulated goodwill of $234.8 million and other intangible assets of $191.7 million as of June 30, 2012.

In accordance with FASB guidance, goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to at least annual impairment testing.  It is our policy to perform our annual impairment testing in the fourth quarter.  The identification and measurement of goodwill impairment involves the estimation of the fair value of our reporting units.  Estimates of fair value are based on the best information available as of the date of the assessment, which primarily incorporate management assumptions about expected future cash flows and other valuation techniques.  Future cash flows may be affected by changes in industry or market conditions or the rate and extent to which anticipated synergies or cost savings are realized with newly acquired entities.  The Company evaluates EBITDA multiples to value its reporting units relative to the Company's market capitalization plus a market-based control premium. The market-based control premium is defined as the premiums paid by acquirers of comparable businesses. The sum of the individual reporting units' estimated market values are compared to the Company's market value, with the sum of the individual values typically being larger than the market value of the Company. The Company considers premiums paid by acquirers of comparable businesses to determine the reasonableness of the implied control premium.

During the fourth quarter of 2011, we completed our goodwill impairment testing with data as of October 1, 2011.  For our CONMED Electrosurgery, CONMED Endosurgery and CONMED Linvatec operating units, our impairment testing utilized CONMED Corporation’s EBITDA multiple adjusted for a market-based control premium with the resultant fair values exceeding carrying values by 42% to 107%.

We estimated the fair value of the CONMED Patient Care operating unit utilizing both a market-based approach and an income approach. Under the income approach, we utilized a discounted cash flow valuation methodology and measured the goodwill impairment in accordance with ASC 350. The first step of the impairment test determined the carrying value exceeded fair value and therefore we proceeded to Step 2. Under Step 2, we calculated the amount of impairment loss by measuring the amount the carrying value of goodwill exceeded the implied fair value of the goodwill. We determined the goodwill of our CONMED Patient Care operating unit was impaired as a result of lower future earnings due to pricing pressures in a number of our product lines and consequently we recorded a goodwill impairment charge of $60.3 million in the fourth quarter of 2011 to reduce the carrying amount of the unit's goodwill to its implied fair value.

Intangible assets with a finite life are amortized over the estimated useful life of the asset and are evaluated each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization.  Intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The carrying amount of an intangible asset subject to amortization is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the asset.  An impairment loss is recognized by reducing the carrying amount of the intangible asset to its current fair value.
 
Customer relationship assets arose principally as a result of the 1997 acquisition of Linvatec Corporation.  These assets represent the acquisition date fair value of existing customer relationships based on the after-tax income expected to be derived during their estimated remaining useful life.  The useful lives of these customer relationships were not and are not limited by contract or any economic, regulatory or other known factors.  The estimated useful life of the Linvatec customer relationship assets was determined as of the date of acquisition as a result of a study of the observed pattern of historical revenue attrition during the 5 years immediately preceding the acquisition of Linvatec Corporation.  This observed attrition pattern was then applied to the existing customer relationships to derive the future expected retirement of the customer relationships.  This analysis indicated an

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Table of Contents

annual attrition rate of 2.6%.  Assuming an exponential attrition pattern, this equated to an average remaining useful life of approximately 38 years for the Linvatec customer relationship assets.  Customer relationship intangible assets arising as a result of other business acquisitions are being amortized over a weighted average life of 15 years.  The weighted average life for customer relationship assets in aggregate is 33 years.
 
We evaluate the remaining useful life of our customer relationship intangible assets each reporting period in order to determine whether events and circumstances warrant a revision to the remaining period of amortization.  In order to further evaluate the remaining useful life of our customer relationship intangible assets, we perform an analysis and assessment of actual customer attrition and activity as events and circumstances warrant.  This assessment includes a comparison of customer activity since the acquisition date and review of customer attrition rates.  In the event that our analysis of actual customer attrition rates indicates a level of attrition that is in excess of that which was originally contemplated, we would change the estimated useful life of the related customer relationship asset with the remaining carrying amount amortized prospectively over the revised remaining useful life.
 
We test our customer relationship assets for recoverability whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  Factors specific to our customer relationship assets which might lead to an impairment charge include a significant increase in the annual customer attrition rate or otherwise significant loss of customers, significant decreases in sales or current-period operating or cash flow losses or a projection or forecast of losses.  We do not believe that there have been events or changes in circumstances which would indicate the carrying amount of our customer relationship assets might not be recoverable.

Pension Plan

We sponsor a defined benefit pension plan (“the plan”) covering substantially all our United States-based employees.  The plan was frozen effective May 14, 2009.  Major assumptions used in accounting for the plan include the discount rate, expected return on plan assets 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.

The weighted-average discount rate used to measure pension liabilities and costs is set by reference to the Citigroup Pension Liability Index. However, this index gives only an indication of the appropriate discount rate because the cash flows of the bonds comprising the index do not precisely match the projected benefit payment stream of the plan. For this reason, we also consider the individual characteristics of the plan, such as projected cash flow patterns and payment durations, when setting the discount rate.  The rates used in determining 2011 and 2012 pension expense are 5.41% and 4.30%, respectively.

We have used an expected rate of return on pension plan assets of 8.0% for purposes of determining the net periodic pension benefit cost.  In determining the expected return on pension plan assets, we consider the relative weighting of plan assets, the historical performance of total plan assets and individual asset classes and economic and other indicators of future performance.  In addition, we consult with financial and investment management professionals in developing appropriate targeted rates of return.
 
For the three and six months ending June 30, 2012 we recorded pension expense of $0.5 million and $1.1 million, resepectively.  Pension expense in 2012 is expected to be $2.1 million compared to expense of $1.0 million in 2011. We are required and expect to make $2.7 million in contributions to our pension plan for the 2012 plan year. We contributed $0.7 million during the second quarter of 2012 and expect to contribute the remaining $2.0 million during the remainder of 2012 and the first quarter of 2013.
 
See Note 9 to the Consolidated Condensed Financial Statements for further discussion.

Stock Based Compensation

All share-based payments to employees, including grants of employee stock options, restricted stock units, performance share units and stock appreciation rights are recognized in the financial statements based at their fair values.  Compensation expense is generally recognized using a straight-line method over the vesting period.  Compensation expense for performance share units is recognized using the graded vesting method.

Income Taxes

The recorded future tax benefit arising from deductible temporary differences and tax carryforwards is approximately

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$34.3 million at June 30, 2012.  Management believes that earnings during the periods when the temporary differences become deductible will be sufficient to realize the related future income tax benefits.

The Company is subject to taxation in the United States and various states and foreign jurisdictions. Taxing authority examinations can involve complex issues and may require an extended period of time to resolve. Our Federal income tax returns have been examined by the Internal Revenue Service (“IRS”) for calendar years ending through 2010. Tax years subsequent to 2010 are subject to future examination.
 

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:

 
Three months ended June 30,
 
Six months ended June 30,
 
2011
 
2012
 
2011
 
2012

 
 
 
 
 
 
 
Net sales
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Cost of sales
50.1

 
47.4

 
49.0

 
47.8

Gross profit
49.9

 
52.6

 
51.0

 
52.2

Selling and administrative expense
37.0

 
38.9

 
37.6

 
38.6

Research and development expense
3.7

 
3.8

 
4.0

 
3.7

Other expense
0.1

 
0.9

 
0.2

 
1.0

       Income from operations
9.1

 
9.0

 
9.2

 
8.9

Amortization of bond discount
0.6

 

 
0.6

 

Interest expense
0.9

 
0.8

 
1.0

 
0.8

Income before income taxes
7.6

 
8.2

 
7.6

 
8.1

Provision for income taxes
2.8

 
2.8

 
2.9

 
2.8

Net income
4.8
%
 
5.4
%
 
4.7
%
 
5.3
%

Three months ended June 30, 2012 compared to three months ended June 30, 2011
 
Sales for the quarterly period ended June 30, 2012 were $189.7 million , an increase of $6.5 million (3.5%) compared to sales of $183.2 million in the same period a year ago with increases in our Arthroscopy and Endoscopic Technologies product lines.  The distribution agreement with Musculoskeletal Tissue Foundation (“MTF”) accounted for a 3.9% quarterly sales increase offset by decreases in our Powered Instruments, Endosurgery, Electrosurgery and Patient Care product lines. In local currency, excluding the effects of the hedging program, sales increased 3.8%.  Sales of capital equipment decreased $4.3 million (-10.7%) to $35.8 million in the quarterly period ended June 30, 2012 from $40.1 million in the same period a year ago; sales of single-use products increased $10.8 million (7.5%) to $153.9 million in the quarterly period ended June 30, 2012 from $143.1 million in the same period a year ago.  On a local currency basis, excluding the effects of our hedging program, sales of capital equipment decreased 10.3% while single-use products increased 7.8%.  We believe the overall decline in capital sales is driven by capital purchasing constraints in hospitals due to the depressed economic conditions.

Cost of sales decreased to $90.0 million in the quarterly period ended June 30, 2012 as compared to $91.8 million in the same period a year ago on overall increases in sales volumes as described above.  Gross profit margins increased 2.7 percentage points to 52.6% in the quarterly period ended June 30, 2012 as compared to 49.9% in the same period a year ago.  The increase in gross profit margins of 2.7 percentage points is primarily a result of the distribution agreement with MTF (1.6 percentage points) and product mix (1.1 percentage points).

Selling and administrative expense increased to $73.7 million in the quarterly period ended June 30, 2012 as compared to $67.9 million in the same period a year ago. Selling and administrative expense as a percentage of net sales increased to 38.9% in the quarterly period ended June 30, 2012 as compared to 37.0% in the same period a year ago. This increase of 1.9 percentage points is attributable to higher selling expenses related to the distribution agreement with MTF.  

Research and development expense totaled $7.2 million in the quarterly period ended June 30, 2012 as compared to $6.8

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million in the same period a year ago.  As a percentage of net sales, research and development expense increased to 3.8% in the quarterly period ending June 30, 2012 compared to 3.7% in the same period a year ago. The increase of 0.1 percentage points is mainly a result of higher spending across the Company.

As discussed in Note 10 to the Consolidated Condensed Financial Statements, other expense in the quarterly period ended June 30, 2012 consisted of a $1.2 million charge related to administrative consolidation expenses in our CONMED Linvatec division and $0.5 million in costs associated with a contractual dispute with a former distributor. Other expense in the quarterly period ended June 30, 2011 consisted of a $0.1 million charge related to the consolidation of certain of our administrative functions in our Utica, NY facility.

Amortization of debt discount was $1.1 million in the quarterly period ended June 30, 2011.

Interest expense in the quarterly period ended June 30, 2012 was $1.6 million compared to $1.7 million in the same period a year ago.  The decrease in interest expense is due to lower weighted average interests rates on higher weighted average borrowings outstanding in the quarterly period ended June 30, 2012 as compared to the same period a year ago.  The weighted average interest rates on our borrowings decreased to 3.19% in the quarterly period ended June 30, 2012 as compared to 3.74% in the same period a year ago.

A provision for income taxes has been recorded at an effective tax rate of 33.6% for the quarterly period ended June 30, 2012 compared to the 37.5% effective tax rate recorded in the same period a year ago.  The effective tax rate for the quarterly period ended June 30, 2012 is lower than that recorded in the same period a year ago as a result of higher earnings in foreign jurisdictions where the tax rates are lower than the statutory federal rate and due to tax benefits recorded in the second quarter of 2012 as a result of examination results and tax returns filed with multiple taxing authorities.  A reconciliation of the United States statutory income tax rate to our effective tax rate is included in our Annual Report on Form 10-K for the year-ended December 31, 2011, Note 6 to the Consolidated Financial Statements.

Six months ended June 30, 2012 compared to the six months ended June 30, 2011

Sales for the six months ended June 30, 2012 were $384.0 million, an increase of $17.3 million (4.7%) compared to sales of $366.7 million in the same period a year ago with increases in our Arthroscopy and Endoscopic Technologies product lines.  The distribution agreement with Musculoskeletal Tissue Foundation (“MTF”) accounted for 4.0% of the 4.7% increase. In local currency, excluding the effects of the hedging program, sales increased 4.6%.  Sales of capital equipment decreased $6.2 million (7.6%) to $75.8 million in the six months ended June 30, 2012 from $82.0 million in the same period a year ago; sales of single-use products increased $23.5 million (8.3%) to $308.2 million in the six months ended June 30, 2012 from $284.7 million in the same period a year ago.  On a local currency basis, excluding the effects of our hedging program, sales of capital equipment decreased 7.5% while single-use products increased 8.1%.  We believe the overall decline in capital sales is driven by capital purchasing constraints in hospitals due to the depressed economic conditions.

Cost of sales increased to $183.4 million in the six months ended June 30, 2012 as compared to $179.5 million in the same period a year ago on overall increases in sales volumes as described above.  Gross profit margins increased 1.2 percentage points to 52.2% in the six months ended June 30, 2012 as compared to 51.0% in the same period a year ago.  The increase in gross profit margins of 1.2 percentage points is primarily a result of the distribution agreement with MTF (1.6 percentage points) offset by unfavorable foreign exchange rates on sales and higher restructuring charges than the same period a year ago.

Selling and administrative expense increased to $148.5 million in the six months ended June 30, 2012 as compared to $137.9 million in the same period a year ago. Selling and administrative expense as a percentage of net sales increased to 38.6% in the six months ended June 30, 2012 as compared to 37.6% in the same period a year ago. This increase of 1.0 percentage points is attributable to higher selling expenses (1.9 percentage points) related to the distribution agreement with MTF offset by lower administrative expenses (0.9 percentage points).  

Research and development expense totaled $14.3 million in the six months ended June 30, 2012 as compared to $14.5 million in the same period a year ago.  As a percentage of net sales, research and development expense decreased to 3.7% in the six months ended June 30, 2012 compared to 4.0% in the same period a year ago. The decrease of 0.3 percentage points is mainly a result of lower spending on our ECOM project in our CONMED Patient Care division.

As discussed in Note 10 to the Consolidated Condensed Financial Statements, other expense in the six months ended June 30, 2012 consisted of a $1.5 million charge related to administrative consolidation expenses in our CONMED Linvatec division, $0.7 million in costs associated with the acquisition of our former distributor in the Nordic region of Europe and $1.6 million in costs associated with a contractual dispute with a former distributor. Other expense in the six months ended June 30,

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2011 consisted of a $0.8 million charge related to the consolidation of certain of our administrative functions in our Utica, NY facility.

Amortization of debt discount was $2.2 million in the six months ended June 30, 2011.

Interest expense in the six months ended June 30, 2012 was $3.0 million compared to $3.5 million in the same period a year ago.  The decrease in interest expense is due to lower weighted average interests rates on higher weighted average borrowings outstanding in the six months ended June 30, 2012 as compared to the same period a year ago.  The weighted average interest rates on our borrowings decreased to 2.98% in the six months ended June 30, 2012 as compared to 3.67% in the same period a year ago.

A provision for income taxes has been recorded at an effective tax rate of 34.8% for the six months ended June 30, 2012 compared to the 37.4% effective tax rate recorded in the same period a year ago.  The effective tax rate for the six months ended June 30, 2012 is lower than that recorded in the same period a year ago as a result of higher earnings in foreign jurisdictions where the tax rates are lower than the statutory federal rate and due to tax benefits recorded in the second quarter of 2012 as a result of examination results and tax returns filed with multiple taxing authorities.  A reconciliation of the United States statutory income tax rate to our effective tax rate is included in our Annual Report on Form 10-K for the year-ended December 31, 2011, Note 6 to the Consolidated Financial Statements.


Operating Segment Results:

Segment information is prepared on the same basis that we review financial information for operational decision-making purposes.  CONMED conducts its business through five principal operating segments, CONMED Endoscopic Technologies, CONMED Endosurgery, CONMED Electrosurgery, CONMED Linvatec and CONMED Patient Care.  We believe each of our segments are similar in the nature of their products, production processes, customer base, distribution methods and regulatory environment.  Our CONMED Endosurgery, CONMED Electrosurgery and CONMED Linvatec operating segments also have similar economic characteristics and therefore qualify for aggregation.  Our CONMED Patient Care and CONMED Endoscopic Technologies operating units do not qualify for aggregation since their economic characteristics do not meet the criteria for aggregation as a result of the lower overall operating margin in these segments.

The following tables summarize the Company’s results of operations by segment for the three and six months ended June 30, 2011 and 2012.

CONMED Linvatec, CONMED Electrosurgery and CONMED Endosurgery
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2011
 
2012
 
2011
 
2012
 
 
 
 
 
 
 
 
Net sales
$
154,087

 
$
160,778

 
$
309,012

 
$
326,222

 
 
 
 
 
 
 
 
Income from
 
 
 
 
 
 
 
operations
20,529

 
20,615

 
44,804

 
41,569

 
 
 
 
 
 
 
 
Operating margin
13.3
%
 
12.8
%
 
14.5
%
 
12.7
%
 
Product offerings include capital equipment such as electrosurgical generators, video systems, small bone, large bone and specialty hand pieces, and arthroscopic instrumentation for use in orthopedic surgery.  Single-use product offerings include a complete line of endo-mechanical instrumentation for minimally invasive laparoscopic procedures, electrosurgical single-use products including pencils and ground pads and orthopedic single-use products such as burs, blades, and implants.

Arthroscopy sales increased $10.4 million (14.7%) in the quarter ended June 30, 2012 to $81.0 million from $70.6 million in the same period a year ago mainly due to the distribution agreement with MTF offset by lower sales of our video imaging products for arthroscopy and general surgery.  The distribution agreement with MTF accounted for 10.2 % of the 14.7% increase. In local currency, excluding the effects of the hedging program, sales increased 15.0%.  Sales of

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capital equipment decreased $0.1 million (-0.7%) to $13.5 million in the second quarter of 2012 from $13.6 million in the same period a year ago; sales of single-use products increased $10.5 million (18.4%) to $67.5 million in the second quarter of 2012 from $57.0 million in the same period a year ago.  On a local currency basis, excluding the effects of the hedging program, sales of capital equipment remained flat while single-use products increased 18.6%.  We believe the overall decline in capital sales is driven by capital purchasing constraints in hospitals due to the depressed economic conditions. Arthroscopy sales increased $21.2 million (14.5%) in the six months ended June 30, 2012 to $167.2 million from $146.0 million in the same period a year ago mainly due to the distribution agreement with MTF and higher procedure specific product sales offset by lower sales of our video imaging products for arthroscopy and general surgery.  The distribution agreement with MTF accounted for 10.0% of the 14.5% increase. In local currency, excluding the effects of the hedging program, sales increased 14.3%.  Sales of capital equipment decreased $0.4 million (-1.3%) to $30.5 million in the six months ended June 30, 2012 from $30.9 million in the same period a year ago; sales of single-use products increased $21.6 million (18.8%) to $136.7 million in the six months ended June 30, 2012 from $115.1 million in the same period a year ago.  On a local currency basis, excluding the effects of the hedging program, sales of capital equipment decreased 1.0% while single-use products increased 18.4%.  We believe the overall decline in capital sales is driven by capital purchasing constraints in hospitals due to the depressed economic conditions.

Powered surgical instrument sales decreased $1.1 million (-2.9%) in the quarterly period ended June 30, 2012 to $37.2 million from $38.3 million in the same period a year ago mainly due to lower sales of our large bone hand piece products.  In local currency, excluding the effects of the hedging program, sales decreased 2.6%.  Sales of capital equipment decreased $2.2 million (-11.9%) to $16.3 million in the second quarter of 2012 from $18.5 million in the same period a year ago; sales of single-use products increased $1.1 million (5.6%) in the second quarter of 2012 to $20.9 million from $19.8 million in the same period a year ago.  On a local currency basis, excluding the effects of the hedging program, sales of capital equipment decreased 11.7% and single-use products increased 5.9%. We believe the overall decline in capital sales is due to a very strong performance in the second quarter of 2011 making for a difficult comparison to sales in 2012. Powered surgical instrument sales decreased $0.6 million (-0.8%) in the six months ended June 30, 2012 to $75.8 million from $76.4 million in the same period a year ago mainly due to lower sales of our large bone hand piece products offset by increases in small bone burs and blades.  In local currency, excluding the effects of the hedging program, sales decreased 0.9%.  Sales of capital equipment decreased $2.8 million (-7.7%) to $33.4 million in the six months ended June 30, 2012 from $36.2 million in the same period a year ago; sales of single-use products increased $2.2 million (5.5%) in the six months ended 2012 to $42.4 million from $40.2 million in the same period a year ago.  On a local currency basis, excluding the effects of the hedging program, sales of capital equipment decreased 7.9% and single-use products increased 5.4%. We believe the overall decline in capital sales is due to a very strong performance in the first half of 2011 making for a difficult comparison to sales in 2012.

Electrosurgery sales decreased $1.7 million (-6.5%) in the quarterly period ended June 30, 2012 to $24.4 million from $26.1 million in the same period a year ago mainly due to lower generator and pencil sales offset by sales of our new vessel sealing products and increased sales of our smoke management products.  In local currency, excluding the effects of the hedging program, sales decreased 6.1%.  Sales of capital equipment decreased $2.0 million (-25.0%) to $6.0 million in the second quarter of 2012 from $8.0 million in the same period a year ago;  sales of single-use products increased $0.3 million (1.7%) to $18.4 million in the second quarter of 2012 from $18.1 million in the same period a year ago.  On a local currency basis, excluding the effects of our hedging program, sales of capital equipment decreased 25.0% while single-use products increased 2.2%.  We believe the overall decline in capital sales is due to a very strong performance in the second quarter of 2011 making for a difficult comparison to sales in 2012 as well as capital purchasing constraints in hospitals due to the depressed economic conditions. Electrosurgery sales decreased $2.8 million (-5.6%) in the six months ended June 30, 2012 to $46.9 million from $49.7 million in the same period a year ago mainly due to lower generator and pencil sales offset by sales of our new vessel sealing products and increased sales of our smoke management products.  In local currency, excluding the effects of the hedging program, sales decreased 5.6%.  Sales of capital equipment decreased $3.0 million (-20.1%) to $11.9 million in the six months ended June 30, 2012 from $14.9 million in the same period a year ago;  sales of single-use products increased $0.2 million (0.6%) to $35.0 million in the six months ended June 30, 2012 from $34.8 million in the same period a year ago.  On a local currency basis, excluding the effects of our hedging program, sales of capital equipment decreased 20.1% while single-use products increased 0.6%. We believe the overall decline in capital sales is due to a very strong performance in the first half of 2011 making for a difficult comparison to sales in 2012 as well as capital purchasing constraints in hospitals due to the depressed economic conditions.

Endosurgery sales decreased $0.9 million (-4.7%) in the quarterly period ended June 30, 2012 to $18.2 million compared to $19.1 million in the same period a year ago mainly due to decreased sales of our trocars and hand held instruments. In local currency, excluding the effects of the hedging program, sales decreased (4.7)%. Endosurgery sales decreased $0.7 million (-1.9%) in the six months ended June 30, 2012 to $36.3 million compared to $37.0 million in the same period

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a year ago mainly due to decreased sales of our trocars and hand held instruments. In local currency, excluding the effects of the hedging program, sales decreased 1.9%.

Operating margins as a percentage of net sales decreased 0.5% percentage points to 12.8% in the quarterly period ended June 30, 2012 compared to 13.3% in the same period a year ago principally as a result of administrative consolidation expenses in our CONMED Linvatec division, costs associated with a contractual dispute with a former distributor and higher selling expenses primarily related to the distribution agreement with MTF. These increases are offset by higher gross margins due to the distribution agreement with MTF and product mix.

Operating margins as a percentage of net sales decreased 1.8% percentage points to 12.7% in the six months ended June 30, 2012 compared to 14.5% in the same period a year ago principally as a result of administrative consolidation expenses in our CONMED Linvatec division, costs associated with the acquisition of our former distributor in the Nordic region of Europe, costs associated with a contractual dispute with a former distributor and higher selling expenses primarily related to the distribution agreement with MTF. These increases are offset by higher gross margins due to the distribution agreement with MTF.


CONMED Patient Care

 
Three months ended June 30,

Six months ended June 30,
 
2011
 
2012
 
2011
 
2012
 
 
 
 
 
 
 
 
Net sales
$
16,636


$
15,577


$
33,260


$
31,600

 











Income (loss) from operations
(999
)

(564
)

(1,735
)

(1,227
)
 











Operating margin
(6.0
)%

(3.6
)%

(5.2
)%

(3.9
)%

Product offerings include a line of vital signs and cardiac monitoring products including pulse oximetry equipment and sensors, ECG electrodes and cables, cardiac defibrillation and pacing pads and blood pressure cuffs.  We also offer a complete line of single-use suction instruments and tubing for use in the operating room, as well as a line of IV products.

Patient Care sales decreased $1.0 million (-6.0%) in the quarter ended June 30, 2012 to $15.6 million from $16.6 million in the same period a year ago mainly due to decreased sales of ECG electrodes and suction instruments.  In local currency, excluding the effects of the hedging program, sales decreased 6.6%.  Patient Care sales decreased $1.6 million (-4.8%) in the six months ended June 30, 2012 to $31.6 million from $33.2 million in the same period a year ago mainly due to decreased sales of ECG electrodes and suction instruments.  In local currency, excluding the effects of the hedging program, sales decreased 5.1%.

Operating margins as a percentage of net sales increased 2.4% percentage points to -3.6% for the quarter ended June 30, 2012 compared to -6.0% in the same period a year ago principally as a result of 2011 including administrative restructuring charges (0.6 percentage points), lower research and development expense (0.9 percentage points) and higher gross margins (0.9 percentage points).

Operating margins as a percentage of net sales increased 1.3% percentage points to -3.9% for the six months ended June 30, 2012 compared to -5.2% in the same period a year ago principally as a result of 2011 including administrative restructuring charges (1.8 percentage points) and lower research and development expense (3.1 percentage points) offset by lower gross margins as a result of lower sales volumes (2.2 percentage points) and higher selling expenses (1.4 percentage points).







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CONMED Endoscopic Technologies

 
Three months ended June 30,

Six months ended June 30,
 
2011
 
2012
 
2011
 
2012
 
 
 
 
 
 
 
 
Net sales
$
12,513


$
13,340


$
24,414


$
26,189

 











Income (loss) from operations
355


27


165


(118
)
 











Operating margin
2.8
%

0.2
%

0.7
%

(0.5
)%
 
Product offerings include a comprehensive line of single-use minimally invasive endoscopic diagnostic and therapeutic instruments used in procedures which require examination of the digestive tract.

Endoscopic Technologies sales increased $0.8 million (6.4%) in the quarter ended June 30, 2012 to $13.3 million compared to $12.5 million in the same period a year ago due to higher sales of polypectomy and biliary products.  In local currency, excluding the effects of the hedging program, sales increased 7.1%.  Endoscopic Technologies sales increased $1.8 million (7.4%) in the six months ended June 30, 2012 to $26.2 million compared to $24.4 million in the same period a year ago due to higher sales throughout the division.  In local currency, excluding the effects of the hedging program, sales increased 7.3%.

Operating margins as a percentage of net sales decreased 2.6 percentage points  to 0.2% in the quarterly period ending June 30, 2012 compared to 2.8% in 2011.  The decrease in operating margins in the quarter ending June 30, 2012 is principally due to lower gross margins (1.3 percentage points) and higher selling and administrative expenses (1.3 percentage points).  

Operating margins as a percentage of net sales decreased 1.2 percentage points  to -0.5% in the six months ended June 30, 2012 compared to 0.7% in 2011.  The decrease in operating margins in the six months ended June 30, 2012 is principally due to lower gross margins (2.7 percentage points) offset by the prior year including $0.2 million in administrative restructuring charges and lower overall administrative expenses as a percentage of sales during 2012.

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 and borrowings under our revolving credit facility.  In addition, we have historically used term borrowings, i