Merit Medical Systems, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited. Merit designs, manufactures and sells single-use medical products for interventional and diagnostic procedures. It reports cardiovascular and endoscopy segments.
Financial performance and position
| Metric | Q1 2017 | Q1 2016 / prior date |
|---|---|---|
| Net sales | $171.1 million | $138.1 million; up 23.9% |
| Gross profit / margin | $75.9 million / 44.4% | $60.1 million / 43.5% |
| Operating income / margin | $5.6 million / 3.3% | $7.7 million / 5.6% |
| Net income | $14.8 million | $4.4 million |
| EPS | $0.33 basic; $0.32 diluted | $0.10 basic and diluted |
| Operating cash flow | $15.2 million | $11.6 million |
| Cash and equivalents | $26.5 million | $19.2 million at Dec. 31, 2016 |
| Total debt | $237.4 million | $324.4 million at Dec. 31, 2016 |
| Working capital / current ratio | $167.1 million / 2.59 | $155.1 million / 2.76 at Dec. 31, 2016 |
Net income included a $12.2 million gain on bargain purchase from the Argon acquisition; the gain was described as provisional and was not taxable. The resulting effective tax rate was 4.5%, versus 26.3% a year earlier. Excluding the gain, the reported increase in net income does not represent a comparable improvement in operating income. Gross margin improved, but operating income declined as SG&A rose 38.5% to $57.8 million, including acquisition and integration costs, $4.8 million of DOJ inquiry expenses, higher headcount, amortization and international expansion.
Cardiovascular sales rose 24.3% to $164.8 million, including contributions from acquired products; endoscopy sales rose 13.5% to $6.3 million. Cardiovascular operating income fell to $4.0 million from $6.6 million, while endoscopy operating income increased to $1.6 million from $1.1 million.
Investing cash outflow was $58.3 million, including $47.5 million paid for acquisitions; capital expenditures were $10.2 million. Financing cash flow was $50.7 million. A March public offering of 5.175 million shares generated approximately $136.5 million net of underwriting discounts and other offering costs, with proceeds used primarily to repay debt. Debt fell during the quarter; the company reported $136.5 million of additional borrowing availability under its principal credit agreement and said it was in compliance with covenants. Cash included $25.6 million held by foreign subsidiaries, including $15.5 million in China subject to transfer-approval requirements.
Material changes, outlook and risks
- Acquisitions: Merit acquired Argon’s critical care business and Catheter Connections on January 31, 2017. Reported Q1 sales included approximately $7.2 million from Argon products and $1.8 million from Catheter Connections products. Argon’s purchase-price allocation and bargain-purchase gain remained provisional. Acquired intangible assets increase future amortization expense.
- DOJ inquiry: The company is responding to an October 2016 Department of Justice subpoena concerning marketing and promotional practices. It incurred $4.8 million of related expense in Q1, expects expenses in a similar range in subsequent quarters and said they could be higher. Scope, duration and outcome were not predictable; potential consequences could include damages, injunctions, fines or civil or criminal penalties.
- Liquidity and debt: Management said existing cash, anticipated operating cash flows, equipment financing and credit availability should fund current and currently planned operations for the next 12 months and foreseeable future. Significant future acquisitions could require additional financing. Credit covenants tighten over time, and substantially all assets secure the main credit facility.
- Outlook: The filing provides no specific revenue or earnings guidance. Management expected 2017 to remain subject to trends discussed in its 2016 Form 10-K. Risks cited include acquisition integration and commercialization, product and regulatory matters, foreign-exchange movements, debt restrictions, reimbursement changes, competition and supply or cost pressures.
- Other items: Foreign-exchange changes reduced Q1 gross revenue by about $1.3 million and gross margin by about $0.5 million. Management considered disclosure controls effective at a reasonable assurance level; acquisition integration was ongoing, with no material control change then expected.
Most important facts for investors to verify
- Whether Argon’s provisional purchase accounting and $12.2 million bargain-purchase gain change when the measurement period is completed.
- The scope, duration, expense trajectory and eventual outcome of the DOJ investigation and subpoena.
- Underlying operating trends excluding acquisition contributions and one-time bargain-purchase income, particularly SG&A growth and cardiovascular operating margins.
- Acquisition integration, acquired-product performance, amortization burden and inventory growth; inventory was $134.3 million and trailing-twelve-month inventory turns declined to 2.91 from 3.10 a year earlier.
- Debt repayment, covenant headroom, available borrowing capacity, interest-rate exposure and the accessibility of cash held overseas, especially in China.