Merit Medical Systems, Inc. — Q1 2015 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2015, compared with Q1 2014. Merit designs, manufactures and sells single-use medical products for interventional and diagnostic procedures. Its segments are cardiovascular and endoscopy. Unless otherwise stated, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q1 2015 | Q1 2014 / prior date |
|---|---|---|
| Net sales | $129.6 | $119.2 |
| Gross profit / margin | $55.4 / 42.7% | $52.0 / 43.6% |
| Operating income / margin | $8.7 / 6.7% | $6.5 / 5.4% |
| Net income | $5.2 | $2.8 |
| Diluted EPS | $0.12 | $0.07 |
| Operating cash flow | $19.3 | $8.0 |
| Cash and equivalents | $9.9 | $7.4 at Dec. 31, 2014 |
| Total debt | $212.9 | $224.5 at Dec. 31, 2014 |
Sales increased 8.7% year over year and net income rose 83.3%. Gross margin declined 0.9 percentage points. SG&A was $36.9 million, or 28.5% of sales, versus 30.9%; R&D was $9.7 million, or 7.5% of sales. The effective tax rate increased to 30.7% from 27.4%.
Cardiovascular sales grew 8.6% to $124.8 million; endoscopy sales grew 11.2% to $4.8 million. Within cardiovascular, catheters rose 16.8%, custom kits and procedure trays 9.8%, and CRM/EP sales fell 9.5%. Operating income improved in both segments: cardiovascular to $8.1 million from $6.4 million, and endoscopy to $0.6 million from $0.1 million.
Cash flow, balance sheet and liquidity
Operating cash flow was $19.3 million, compared with $8.0 million in Q1 2014. Investing cash outflow was $9.4 million, including $9.5 million of property and equipment spending and $1.3 million paid for acquisitions, partly offset by $1.8 million of sale-leaseback proceeds. Financing cash outflow was $7.3 million, primarily reflecting $43.4 million of debt repayments against $31.8 million of new borrowings. Cash increased $2.6 million during the quarter.
Working capital was $116.2 million, versus $116.9 million at year-end; the current ratio was 2.62. Merit reported $31.2 million of available borrowing capacity under its credit agreement. Debt was secured by substantially all assets, with maturity in December 2017; the company reported compliance with all credit covenants. Its credit-agreement leverage ratio was 2.62 to 1, against a 3.00-to-1 maximum for 2015. The company said existing cash, operating cash flows, available borrowings and potential equipment financing should cover planned needs for the next 12 months and foreseeable future.
Approximately $9.8 million of cash was held by foreign subsidiaries, including $7.6 million in China, where transfers abroad are subject to local government approval. Inventory declined to $88.3 million from $91.8 million, and trailing 12-month inventory turns improved to 3.37 from 3.12.
Material changes, outlook and risks
- Drivers and margin pressure: Higher sales, lower SG&A as a share of revenue and reduced interest expense supported earnings growth. Gross margin was pressured by lower production volumes and distributor discounts related to foreign-currency devaluation; lower Euro-denominated manufacturing costs and raw materials partly offset the pressure.
- Foreign exchange: Management said the stronger U.S. dollar reduced reported foreign-currency revenue but benefited costs through a natural hedge. About 20% of Q1 revenue was denominated in foreign currencies. The filing estimates a 10% dollar strengthening against the Euro would increase net income by about $1.0 million, while a 10% weakening would reduce it by about that amount. A $150 million interest-rate swap was used to hedge interest-rate exposure; its fair value was a $0.3 million liability at quarter-end.
- Manufacturing transition: Merit expected its new Tijuana facility to begin production in Q3 2015 and planned to move additional product lines there in Q3 or Q4. It anticipated $1.5–$2.5 million of SG&A expense during an approximately nine-month transition. Management expected gross-profit and earnings benefits over the following three years as production shifted, with efficient utilization potentially occurring between late 2016 and early 2017. It expected to vacate its leased West Jordan site by year-end 2015.
- Acquisition commitments and unusual items: Merit paid $1.0 million in Q1 toward a previously accrued product-license obligation and may owe another $3.0 million if specified milestones are achieved. It also paid $0.25 million for additional technology distribution rights. Contingent consideration remeasurement added $0.1 million of operating expense. No specific full-year earnings or revenue guidance was provided.
- Risks and contingencies: The company cited medical-device regulation and product liability, debt and covenant restrictions, foreign exchange, supplier and inventory risks, reimbursement and healthcare-policy changes, competition, and acquisition execution among its risks. It said ordinary-course litigation was not expected to be material, but an unfavorable outcome could be materially adverse.
Important facts for investors to verify
- Whether Tijuana production starts on schedule, transition costs remain within the stated range, and planned margin benefits materialize.
- Whether sales growth and improved operating cash flow persist while gross margin remains below the prior-year level.
- Debt reduction, leverage-covenant headroom, interest-rate exposure, and the amount of borrowing capacity actually available.
- Foreign-currency effects, including the concentration of cash overseas and restrictions on transfers from China.
- Whether product-license milestone payments, contingent consideration, litigation or other commitments change materially.