Merit Medical Systems, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Results are unaudited. Merit designs, manufactures and markets medical devices, reporting in cardiovascular and endoscopy segments. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $151.1 | $138.1 | $289.1 | $267.7 |
| Gross profit | $66.9 | $60.9 | $127.0 | $116.3 |
| Gross margin | 44.3% | 44.1% | 43.9% | 43.4% |
| Operating income | $11.6 | $12.2 | $19.3 | $20.9 |
| Net income | $7.3 | $7.4 | $11.6 | $12.6 |
| Diluted EPS | $0.16 | $0.17 | $0.26 | $0.28 |
- Q2 sales rose 9.4% year over year; first-half sales increased 8.0%. Cardiovascular sales grew 9.6% in Q2 and 8.0% in the first half; endoscopy sales grew 4.8% and 9.6%, respectively.
- Growth drivers included stand-alone devices and catheters, plus initial HeROGraft sales. Inflation-device sales were flat in Q2 and down 2.6% for the first half, primarily due to lower sales to a large OEM customer and two distributors.
- Despite modestly higher gross margins, operating income declined: SG&A and R&D grew faster than revenue. SG&A was 28.9% of Q2 sales and 29.5% of first-half sales; R&D was 7.6% in both 2016 periods.
- Effective tax rates fell to 26.1% for Q2 and 26.2% for the first half, from 29.7% and 30.1%. Management attributed the decrease mainly to the reinstated federal R&D credit and a greater share of earnings from lower-tax foreign operations.
Cash flow, liquidity and debt
- First-half operating cash flow was $25.4, down from $40.4 a year earlier. Investing used $43.9, including $21.2 of property and equipment spending and $22.8 of acquisition cash outlays. Financing provided $24.7; cash increased $6.3 to $10.5.
- At June 30, working capital was $134.9, the current ratio was 2.59, and cash was $10.5. Inventory was $109.9, up from $106.0 at year-end; trailing-twelve-month inventory turns decreased to 3.09 from 3.30 a year earlier.
- Debt totaled $231.7, versus $207.6 at December 31, 2015. Merit reported $53.2 of available borrowing capacity under the then-current credit agreement and compliance with its covenants. The agreement was secured by substantially all assets; $226.7 of principal was scheduled for 2017 under the pre-amendment facility.
- At June 30, $133.8 of debt was fixed at 2.48% through an interest-rate swap; approximately $98.0 bore a floating rate of 2.16%. A one-percentage-point change in rates on the unhedged borrowings was estimated to change annual interest expense and pretax income by about $1.0.
Material changes, outlook and risks
- On February 4, Merit acquired CryoLife’s HeROGraft device and related assets for $18.5. The acquired products contributed approximately $2.1 of Q2 sales and $3.4 for the first half.
- After quarter-end, on July 6, Merit acquired DFINE for approximately $97.5, including certain indebtedness and subject to a working-capital adjustment. DFINE makes vertebral augmentation and targeted radiofrequency ablation products. Merit was still assessing purchase accounting.
- Also on July 6, Merit replaced its prior credit agreement with a facility providing a $150.0 term loan and up to $275.0 in revolving loans, including a $25.0 swingline reserve. Management said existing cash, operating cash flow and borrowing capacity were expected to fund current and planned operations for the next 12 months and foreseeable future; the filing gives no earnings or revenue guidance.
- Management cited higher acquisition, severance, market-expansion and product-development costs. Gross-margin improvement was attributed partly to a focus on higher-margin products and suspension of the U.S. medical device tax. Foreign-exchange losses increased first-half other expense.
- Risks include integrating DFINE, which was not profitable or cash-flow positive before acquisition; increased debt and restrictive covenants; and an uncertain demand surge for some products following a competitor’s regulatory issues. Merit warned that capacity, inventory, suppliers, staffing, allocation and quality controls could be strained if demand is sustained.
- Merit was involved in ordinary-course litigation, including product-liability, intellectual-property, contractual and employment matters. Management did not believe currently known matters were likely to be materially adverse, while noting an unfavorable resolution could have a material effect.
Important facts for investors to verify
- Whether the competitor-related demand increase persists and whether Merit can meet it without supply, quality or control problems.
- DFINE’s post-acquisition sales, profitability, cash needs, integration costs and realized synergies, as well as final purchase-price allocation.
- Post-acquisition debt, available borrowing capacity, covenant headroom, interest costs and compliance under the July 6 credit agreement.
- Drivers of weaker operating income and cash conversion, including SG&A and R&D spending, receivables, payables and inventory turns.
- Foreign-currency exposure and the effect of tax credits and the medical-device-tax suspension on margins and earnings.