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Management's Discussion of Results of Operations (Excerpts)

For purposes of readability, Zenith attempts to strip out all tables in excerpts from the Management Discussion. That information is contained elsewhere in our articles. The idea of this summary is simply to review how well we believe Management does its reporting. Also, this highlights what Management believes is important.

In our Decision Matrix at the end of each article, a company with 0 to 2 gets a "-1", and 3 to 5 gets a "+1."

On a scale of 0 to 5, 5 being best, Zenith rates this company's Management's Discussion as a 5.


Overview

CONMED Corporation (“CONMED”, the “Company”, “we” or “us”) is a medical 
technology company that provides surgical devices and equipment for minimally 
invasive procedures. The Company’s products are used by surgeons and physicians 
in a variety of specialties including orthopedics, general surgery, gynecology, 
neurosurgery and gastroenterology.

We adjusted our product line disclosures to align with the way we review net 
sales beginning in fiscal year 2017. In doing so, we consolidated our surgical 
visualization line into our orthopedic surgery product line disclosure. Our 
product lines consist of orthopedic surgery and general surgery. Orthopedic 
surgery consists of sports medicine instrumentation and small bone, large bone 
and specialty powered surgical instruments as well as, imaging systems for use 
in minimally invasive surgery procedures including 2DHD and 3DHD vision 
technologies and service fees related to the promotion and marketing of sports 
medicine allograft tissue. General surgery consists of a complete line of 
endo-mechanical instrumentation for minimally invasive laparoscopic and 
gastrointestinal procedures, a line of cardiac monitoring products as well as 
electrosurgical generators and related instruments.

A significant amount of our products are used in surgical procedures with 
approximately 80% of our revenues derived from the sale of single-use products. 
Our capital equipment offerings also facilitate the ongoing sale of related 
disposable products and accessories, thus providing us with a recurring revenue 
stream. We manufacture substantially all of our products in facilities located 
in the United States and Mexico. We market our products both domestically and 
internationally directly to customers and through distributors. International 
sales approximated 48% and 46% during the three months ended September 30, 2017 
and 2016, respectively, and 48% and 47% during the nine months ended September 
30, 2017 and 2016, respectively.

Business Environment

On January 4, 2016, we acquired SurgiQuest, Inc. ("SurgiQuest") for $265 
million in cash (on a cash-free, debt-free basis). SurgiQuest develops, 
manufactures and markets the AirSeal® System, the first integrated access 
management technology for use in laparoscopic and robotic procedures. This 
proprietary and differentiated access system is complementary to our current 
general surgery offering. In connection with the SurgiQuest acquisition, we 
assumed a lawsuit filed in 2013 by Lexion Medical (“Lexion”) against 
SurgiQuest. On April 11, 2017 the trial for this lawsuit concluded with the 
jury awarding $2.2 million in compensatory damages with an additional $10.0 
million in punitive damages to Lexion. Refer to Note 3 to the consolidated 
condensed financial statements for further details on this acquisition and Note 
13 to the consolidated condensed financial statements for further details on 
the lawsuit.

We plan to continue to restructure both operations and administrative functions 
as necessary throughout the organization. We have successfully executed our 
restructuring plans over the past few years, however, we cannot be certain 
future activities will be completed in the estimated time period or that 
planned cost savings will be achieved.

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, 2016 describes the 
significant accounting policies used in preparation of the Consolidated 
Financial Statements. On an ongoing basis, we evaluate the critical accounting 
policies used to prepare our consolidated financial statements, including, but 
not limited to, those related to:


• revenue recognition;


• inventory valuation;



• goodwill and intangible assets;



• pension plan;



• stock-based compensation costs; and



• income taxes.

There have been no material changes in these aforementioned critical accounting 
policies.

Consolidated Results of Operations

Net sales increased 2.9% and 2.6% as reported in the three and nine months 
ended September 30, 2017, respectively, compared to the same periods a year ago 
mainly due to growth in our General Surgery product line. Foreign exchange had 
a 50 basis point favorable and 40 basis point unfavorable impact on reported 
sales growth for the three and nine months ended September 30, 2017, 
respectively. Single-use product sales grew 4.5% and 3.7% in the three and nine 
months ended September 30, 2017, respectively, as reported and 4.0% and 4.2% on 
a constant currency basis in the three and nine months ended September 30, 
2017, respectively. These increases were partially offset by 3.3% and 2.0% 
declines in capital products as reported and 3.8% and 1.6% declines in capital 
products on a constant currency basis for the same periods.


• Orthopedic surgery sales decreased 0.8%, as reported, in both the three and 
nine months ended September 30, 2017, and decreased 1.6% and 0.4% on a constant 
currency basis as increased sales of sports medicine single-use products were 
offset by capital equipment declines.

• General surgery sales increased 7.1% and 6.8% as reported and 7.0% and 7.3% 
on a constant currency basis in the three and nine months ended September 30, 
2017 driven primarily by sales growth of our AirSeal®, smoke management and 
endoscopic technologies products.

Cost of Sales

Cost of sales increased to $87.6 million in the three months ended September 
30, 2017 as compared to $83.6 million in the three months ended September 30, 
2016. Cost of sales increased to $266.8 million in the nine months ended 
September 30, 2017 as compared to $258.1 million in the nine months ended 
September 30, 2016. Gross profit margins decreased 0.9 percentage points to 
53.9% in the three months ended September 30, 2017 as compared to 54.8% in the 
three months ended September 30, 2016. The decrease in gross profit margins of 
0.9 percentage points in the three months ended September 30, 2017 was mainly a 
result of cost related to our ongoing restructuring and product mix, offset by 
the impact of favorable foreign currency exchange rates on sales. Gross profit 
margins decreased 0.4 percentage points to 53.5% in the nine months ended 
September 30, 2017 as compared to 53.9% in the nine months ended September 30, 
2016. The decrease in gross profit margins of 0.4 percentage points in the nine 
months ended September 30, 2017 was mainly due to higher costs related to 
manufacturing variances in 2017 compared to the same period a year ago and the 
impact of unfavorable foreign currency exchange rates on sales in 2017 compared 
to the same period a year ago. These were offset by lower restructuring costs 
in 2017 mainly driven by the discontinuation of our Altrus product offering 
during 2016.

Selling and Administrative Expense

Selling and administrative expense increased to $80.8 million in the three 
months ended September 30, 2017 as compared to $79.0 million in the three 
months ended September 30, 2016 and increased to $259.4 million in the nine 
months ended September 30, 2017 as compared to $251.7 million in the nine 
months ended September 30, 2016. Selling and administrative expense as a 
percentage of net sales decreased to 42.5% in the three months ended September 
30, 2017 as compared to 42.8% in the three months ended September 30, 2016 and 
increased to 45.2% in the nine months ended September 30, 2017 as compared to 
45.0% in the nine months ended September 30, 2016.

The significant factors affecting the 0.3 percentage point decrease in selling 
and administrative expense in the three months ended September 30, 2017 as 
compared to the same period a year ago included (1) a $2.6 million decrease in 
costs associated with the SurgiQuest acquisition in 2016 as further described 
in Notes 3 and 11 to the consolidated condensed financial statements and (2) a 
$0.3 million decrease in legal fees associated with the SurgiQuest, Inc. vs. 
Lexion Medical litigation as further described in Notes 11 and 13. These 
decreases were offset by (1) a $1.9 million gain on the sale of our Centennial, 
CO facility in 2016 as further described in Note 11 and (2) higher selling and 
administrative expense to support the growth of the Company.

The significant factors affecting the 0.2 percentage point increase in selling 
and administrative expenses in the nine months ended September 30, 2017 
compared to the same periods a year ago included (1) $12.2 million in costs 
associated with the SurgiQuest, Inc. vs. Lexion Medical litigation verdict as 
further described in Notes 11 and 13 in the consolidated condensed financial 
statements, (2) a $2.0 million increase in legal fees associated with this 
litigation as well as other legal matters as further described in Note 11, (3) 
a $1.9 million gain on the sale of our Centennial, CO facility in 2016 and (4) 
higher selling and administrative expense to support the growth of the Company. 
These increases were offset by (1) a $13.5 million decrease in costs associated 
with the SurgiQuest acquisition in 2016 as further described in Notes 3 and 11 
to the consolidated condensed financial statements and (2) a $2.8 million 
decrease in severance and other related costs from the restructuring of certain 
of our sales, marketing and administrative functions as further described in 
Note 11.

Research and Development Expense

Research and development expense remained relatively flat at $8.3 million in 
the three months ended September 30, 2017 as compared to $8.4 million in the 
three months ended September 30, 2016 and decreased to $23.9 million in the 
nine months ended September 30, 2017 as compared to $24.6 million in the nine 
months ended September 30, 2016. As a percentage of net sales, research and 
development expense decreased 0.2 percentage points to 4.3% in the three months 
ended September 30, 2017 as compared to 4.5% in the three months ended 
September 30, 2016 and decreased 0.2 percentage points to 4.2% in the nine 
months ended September 30, 2017 as compared to 4.4% in the nine months ended 
September 30, 2016 due to the timing of our projects.

Other Expense

Other expense in the nine months ended September 30, 2016 related to costs 
associated with our fifth amended and restated senior credit agreement entered 
into on January 4, 2016. These costs include a $2.7 million charge related to 
commitment fees paid to certain of our lenders that provided a financing 
commitment for the SurgiQuest acquisition and a loss on the early 
extinguishment of debt of $0.3 million. There were no such costs in 2017.

Interest Expense

Interest expense increased to $4.8 million in the three months ended September 
30, 2017 from $3.9 million in the three months ended September 30, 2016 and 
increased to $13.3 million in the nine months ended September 30, 2017 from 
$11.4 million in the nine months ended September 30, 2016 due to higher 
interest rates compared to the same period a year ago. The weighted average 
interest rates on our borrowings increased to 3.68% in the three months ended 
September 30, 2017 as compared to 2.97% in the three months ended September 30, 
2016 and increased to 3.44% in the nine months ended September 30, 2017 from 
2.90% in the nine months ended September 30, 2016.

Provision for Income Taxes

Income tax expense has been recorded at an effective tax rate of 16.9% for the 
three months ended September 30, 2017 compared to income tax expense recorded 
at an effective tax rate of 26.5% in the three months ended September 30, 2016. 
The decrease in the effective tax rate for the three months ended September 30, 
2017 was due to additional tax benefits related to the resolution of certain 
SurgiQuest acquisition tax matters. Income tax expense for the nine months 
ended September 30, 2017 has been recorded at an effective tax rate of 15.8% 
compared to income tax expense recorded at an effective tax rate of 25.5% in 
the nine months ended September 30, 2016. The decrease in the effective rate 
for the nine months ended September 30, 2017 was the result of additional tax 
benefits related to the resolution of certain SurgiQuest acquisition tax 
matters, state tax benefits and stock option benefits recorded in accordance 
with ASU 2016-09 (Improvement of Employee Share Based Payment Accounting) as 
further described in Note 14 to the consolidated condensed financial 
statements. There can be no assurance the recording of the tax effects 
resulting from the implementation of ASU 2016-09 will not have any material 
impact in future periods. 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, 2016, under Note 7 to the 
consolidated financial statements.

Non-GAAP Financial Measures

Net sales “on a constant currency basis” is a non-GAAP measure. The Company 
analyzes net sales on a constant currency basis to better measure the 
comparability of results between periods. To measure percentage sales growth in 
constant currency, the Company removes the impact of changes in foreign 
currency exchange rates that affect the comparability and trend of net sales.

Because non-GAAP financial measures are not standardized, it may not be 
possible to compare this financial measure with other companies' non-GAAP 
financial measures having the same or similar names. This adjusted financial 
measure should not be considered in isolation or as a substitute for reported 
net sales growth, the most directly comparable GAAP financial measure. This 
non-GAAP financial measure is an additional way of viewing net sales that, when 
viewed with our GAAP results, provides a more complete understanding of our 
business. The Company strongly encourages investors and shareholders to review 
our financial statements and publicly-filed reports in their entirety and not 
to rely on any single financial measure.

Liquidity and Capital Resources

Our liquidity needs arise primarily from capital investments, working capital 
requirements and payments on indebtedness under the fifth amended and restated 
senior credit agreement, described below. 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, including borrowings under the amended and restated 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. Management believes that cash flow from 
operations, including cash and cash equivalents on hand and available borrowing 
capacity under our fifth amended and restated 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.

Operating cash flows

Our net working capital position was $217.4 million at September 30, 2017. Net 
cash provided by operating activities was $44.8 million and $26.2 million in 
the nine months ended September 30, 2017 and 2016, respectively, generated on 
net income of $8.8 million and $8.0 million for the nine months ended September 
30, 2017 and 2016, respectively.

The increase in cash flows from operating activities for the nine months ended 
September 30, 2017 compared to September 30, 2016 is mainly related to the 
prior year having significant cash outflows resulting from the SurgiQuest, Inc. 
acquisition whereby 2017 has a $12.2 million accrual related to the Lexion 
trial verdict, as further described in Note 13 to the consolidated condensed 
financial statements. This is partially offset by higher inventory levels at 
September 30, 2017 as we increase production during the third quarter in 
anticipation of higher fourth quarter sales and increases in other assets due 
to higher levels of equipment used for demonstration.

Investing cash flows

Net cash used in investing activities in the nine months ended September 30, 
2017 consisted of capital expenditures, the purchase of a business and asset 
acquisitions. Capital expenditures were $9.2 million and $10.4 million in the 
nine months ended September 30, 2017 and 2016, respectively, and are expected 
to approximate $15.0 million in 2017. The purchase of a business in the second 
quarter of 2017 and asset acquisitions in the third quarter of 2017 totaled 
$15.2 million. The decrease in cash used in investing activities compared to 
the same period a year ago is the result of $256.5 million in payments during 
the nine months ended September 30, 2016 associated with the SurgiQuest 
acquisition.

Financing cash flows

Financing activities in the first nine months of 2017 resulted in a use of cash 
of $7.2 million compared to cash provided of $189.9 million in the same period 
a year ago. Below is a summary of the significant financing activities:


• During 2016, we had borrowings of $175.0 million on our term loan under our 
fifth amended and restated credit agreement as further described below. During 
2017 and 2016, we repaid $6.6 million on our term loan in accordance with the 
agreement. During 2017, we had net borrowings on our revolving line of credit 
of $17.0 million compared to $61.7 million in borrowings in 2016.

• During 2016, we had debt issuance costs of $5.6 million in conjunction with 
our fifth amended and restated credit agreement.

• During 2016, we made our final payment of $16.7 million associated with the 
distribution and development agreement with Musculoskeletal Transplant 
Foundation.

• Dividend payments were $16.7 million and $16.6 million during 2017 and 2016, 
respectively.


On January 4, 2016, we entered into a fifth amended and restated senior credit 
agreement consisting of: (a) a $175.0 million term loan facility and (b) a 
$525.0 million revolving credit facility both expiring on January 4, 2021. The 
term loan is payable in quarterly installments increasing over the term of the 
facility. Proceeds from the term loan facility and borrowings under the 
revolving credit facility were used to repay the then existing senior credit 
agreement and to finance the acquisition of SurgiQuest. Interest rates are at 
LIBOR plus 2.00% (3.24% at September 30, 2017). For those borrowings where we 
elect to use the alternative base rate, the base rate will be the greater of 
the Prime Rate, the Federal Funds Rate plus 0.50% or the one-month Eurocurrency 
Rate plus 1.00%.

There were $159.7 million in borrowings outstanding on the term loan as of 
September 30, 2017. There were $346.0 million in borrowings outstanding under 
the revolving credit facility as of September 30, 2017. Our available 
borrowings on the revolving credit facility at September 30, 2017 were $175.6 
million with approximately $3.4 million of the facility set aside for 
outstanding letters of credit.

The fifth amended and restated senior credit agreement is collateralized by 
substantially all of our personal property and assets. The amended and restated 
senior credit agreement contains covenants and restrictions which, among other 
things, require the maintenance of certain financial ratios and restrict 
dividend payments and the incurrence of certain indebtedness and other 
activities, including acquisitions and dispositions. We were in full compliance 
with these covenants and restrictions as of September 30, 2017. We are also 
required, under certain circumstances, to make mandatory prepayments from net 
cash proceeds from any issuance of equity and asset sales.

We have a mortgage note outstanding in connection with the Largo, Florida 
property and facilities bearing interest at 8.25% per annum with semiannual 
payments of principal and interest through June 2019. The principal balance 
outstanding on the mortgage note aggregated $3.2 million at September 30, 2017. 
The mortgage note is collateralized by the Largo, Florida property and 
facilities.

Our Board of Directors has authorized a $200.0 million share repurchase 
program. Through September 30, 2017, we have repurchased a total of 6.1 million 
shares of common stock aggregating $162.6 million under this authorization and 
have $37.4 million remaining available for share repurchases. The repurchase 
program calls for shares to be purchased in the open market or in private 
transactions from time to time. We may suspend or discontinue the share 
repurchase program at any time. We have not purchased any shares of common 
stock under the share repurchase program during 2017. We have financed the 
repurchases and may finance additional repurchases through operating cash flow 
and from available borrowings under our revolving credit facility.

Management believes that cash flow from operations, including cash and cash 
equivalents on hand and available borrowing capacity under our fifth amended 
and restated 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.

Restructuring

During 2017 and 2016, we continued our operational restructuring plan. As part 
of this plan, we engaged a consulting firm to assist us in streamlining our 
product offering and improving our operational efficiency. As a result, we 
identified certain catalog numbers to be discontinued and consolidated into 
existing product offerings and recorded a $1.3 million charge in the three 
months ended September 30, 2017 to write-off inventory which will no longer be 
offered for sale. For the nine months ended September 30, 2017 and 2016, we 
incurred $2.8 million and $1.0 million, respectively, in costs associated with 
the operational restructuring, including severance, inventory and other 
charges. These costs were charged to cost of sales.

During 2016, the Company discontinued our Altrus product offering as part of 
our ongoing restructuring and incurred $4.5 million in non-cash charges which 
were included in cost of sales for the nine months ended September 30, 2016.

During 2017 and 2016, we restructured certain selling and administrative 
functions and incurred severance and other related costs in the amount of $0.4 
million for the three months ended September 30, 2016 and $1.3 million and $4.1 
million for the nine months ended September 30, 2017 and 2016, respectively.

We have reduced our restructuring accrual in current and other long term 
liabilities to $1.3 million at September 30, 2017 primarily through severance 
payments.

During recent years, we had a number of initiatives to consolidate 
manufacturing facilities and restructure our sales and administrative 
functions. Although much of this is complete, we will continue to review our 
operations and sales and administrative functions to reduce costs and 
headcount, as necessary. Such cost reductions will likely result in additional 
charges, including employee termination costs and other exit costs that will be 
charged to cost of sales and selling and administrative expense, as applicable.