Merit Medical Systems, Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Unaudited results; amounts below are in U.S. dollars unless noted. Merit designs, manufactures and markets single-use medical devices, reporting cardiovascular and endoscopy segments.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $115.2m | $95.9m | $329.0m | $292.1m |
| Gross profit / margin | $51.0m / 44.3% | $45.3m / 47.3% | $141.0m / 42.9% | $136.5m / 46.7% |
| Operating income | $8.4m | $9.1m | $16.9m | $25.3m |
| Net income | $5.6m | $7.2m | $10.0m | $19.1m |
| Diluted EPS | $0.13 | $0.17 | $0.23 | $0.45 |
- Revenue rose 20.1% in Q3 and 12.7% year to date. Cardiovascular revenue was $110.9m in Q3 and $316.6m year to date; endoscopy revenue was $4.4m and $12.5m, respectively.
- Gross margin declined, principally due to lower production volumes, acquired Thomas Medical technology amortization (about 1.2% of sales), and the medical-device excise tax (about 1.0% of sales). Q3 gross margin improved 150 basis points from Q2 2013 as production volumes increased.
- Q3 operating expenses included an $8.1m Ostial intangible impairment, partly offset by a $4.1m contingent-consideration benefit. Management said these items reduced operating income by about $4.3m, or net income by about $2.7m after tax.
- SG&A fell to 27.2% of Q3 sales and 28.9% year to date, versus 30.1% and 30.3%, respectively, in 2012, reflecting cost-cutting initiatives. R&D was $25.1m year to date, up from $20.1m.
- The effective tax rate was 12.9% for Q3 and 14.0% year to date, versus 20.0% and 26.0%. Management cited foreign earnings mix, releases of uncertain-tax-position reserves, and the reinstated federal R&D credit for 2012.
Cash flow, balance sheet and debt
- For the first nine months, operating cash flow was $33.6m, compared with $32.2m in 2012. Property and equipment capital expenditures were $48.0m; an additional $1.1m was spent on patents and trademarks. Cash declined $0.6m to $9.1m.
- At September 30, cash was $9.1m, working capital $98.9m, and the current ratio 2.6 to 1. Total debt was $251.2m ($10.0m current; $241.2m long-term), versus $237.6m at year-end 2012. About $18.8m of borrowing capacity remained under the then-current agreement.
- Debt was secured by substantially all company assets and matured in December 2017. A $150m interest-rate swap fixed the benchmark LIBOR component on approximately $146.3m of borrowings; management estimated a 1-percentage-point rate change on the remaining borrowings would change annual interest expense by about $1.1m.
- Cash included $8.5m held by foreign subsidiaries, including $7.4m in China, where transfers abroad require government approval.
Changes, outlook and risks
- Growth reflected acquired Thomas Medical products and increased sales of catheters, custom kits and stand-alone devices. Inflation-device sales declined 4% in Q3 and 8% year to date; embolization-device sales declined 4% year to date. Endoscopy returned to operating profit: $0.6m in Q3 and $0.9m year to date, versus losses in the comparable 2012 periods.
- Management expected to launch several products during the remainder of 2013 and said earnings could increase if product launches and cost-reduction efforts were successful. No specific earnings or revenue guidance was provided. Management believed cash, operating cash flow, credit availability and a potential Pearland, Texas facility sale-leaseback would fund operations for the next 12 months and foreseeable future; the approximately $24m sale-leaseback was anticipated, not reported as completed.
- On October 4, 2013, a credit-agreement amendment increased borrowing capacity by $40m and temporarily relaxed leverage limits. Also that day, Merit acquired Datascope assets for about $27.5m and Radial Assist assets for about $2.5m; their combined trailing-12-month revenue was reported at approximately $7.5m. Initial acquisition accounting was incomplete.
- Ostial product revenue expectations fell below acquisition-date expectations, prompting the impairment and contingent-liability remeasurement. Other risks cited include debt covenant and refinancing/liquidity exposure, product liability and recalls, regulatory and reimbursement changes, foreign-exchange movements, supplier and inventory risks, competition, and acquisition integration. Management said ordinary-course litigation was not expected to be material, while noting unfavorable developments could have a material adverse effect.
Important facts for investors to verify
- Whether revenue growth, particularly from acquired products, translates into sustained organic growth and improved gross margins.
- Whether the Ostial impairment and lower revenue expectations indicate further impairment or contingent-consideration adjustments.
- Post-amendment debt capacity, covenant headroom, interest costs and compliance; the filing does not provide a clear post-amendment borrowing balance.
- Completion and proceeds of the proposed Pearland sale-leaseback, and the funding and returns of the October acquisitions.
- Cash conversion and capital needs: nine-month operating cash flow was below property and equipment spending, before patents, trademarks and acquisitions.