Business context and reporting period
Merit Medical Systems, Inc. filed this Form 10-K for the fiscal year ended December 31, 2015. The company designs, manufactures and sells single-use medical devices for cardiovascular, peripheral intervention and endoscopy procedures. It reports two segments: cardiovascular and endoscopy. The filing includes unaudited quarterly results, including the three months ended December 31, 2015.
Financial performance and liquidity
| Metric | FY 2015 | FY 2014 |
|---|---|---|
| Net sales | $542.1 million | $509.7 million |
| Gross profit / margin | $235.8 million / 43.5% | $225.2 million / 44.2% |
| Operating income / margin | $37.5 million / 6.9% | $40.2 million / 7.9% |
| Net income | $23.8 million | $23.0 million |
| Diluted EPS | $0.53 | $0.53 |
| Cash from operations | $69.5 million | $53.3 million |
| Capital expenditures | $51.0 million | $34.2 million |
| Cash and cash equivalents, year-end | $4.2 million | $7.4 million |
| Working capital, year-end | $116.1 million | $116.9 million |
| Long-term debt, including current portion | $207.6 million | $224.5 million |
Sales rose 6.4%, while net income increased about 3.6%; diluted EPS was unchanged. Operating cash flow less property-and-equipment capital expenditures was approximately $18.5 million. Year-end debt was secured by substantially all assets; the company reported $32.4 million of available borrowing capacity under the facility, subject to its leverage terms. Debt matures in December 2017, with $10 million of principal due in 2016 and the remaining scheduled principal in 2017. The company said existing cash, expected operating cash flow, equipment financing and credit availability should fund planned operations for the next 12 months and the foreseeable future.
Material changes versus the prior year
- Cardiovascular revenue increased 5.9% to $520.9 million; endoscopy revenue rose 18.1% to $21.2 million. Endoscopy operating income increased to $3.5 million from $1.6 million, while cardiovascular operating income declined to $34.1 million from $38.6 million.
- Gross margin fell 0.7 percentage point, mainly due to Tijuana facility start-up overhead, lower embolic-product production volumes and distributor discounts; a weaker euro partially offset these pressures.
- Operating cash flow improved by $16.1 million. Inventory increased $14.2 million to $106.0 million, and inventory turns declined to 3.10 from 3.27.
- International sales grew 7.9% to $214.0 million, or 39% of total sales. Foreign-exchange movements reduced 2015 gross revenue by approximately $11.3 million.
- Reported R&D expense increased 11.4% to $40.8 million. The company also recorded a $1.0 million acquired in-process R&D charge. There were no intangible impairment charges in 2015, compared with $1.1 million in 2014.
- Fourth-quarter 2015 sales were $138.4 million versus $132.8 million a year earlier; net income was $6.4 million versus $8.7 million. Fourth-quarter tax expense was $0.1 million versus $3.7 million in 2014, an item investors may wish to examine when assessing quarterly earnings comparability.
Outlook, commentary, risks and unusual items
- Management did not provide revenue or earnings guidance. It forecast approximately $34 million of 2016 spending on buildings, property and equipment and described its product pipeline and international expansion as growth opportunities.
- Management attributed near-term margin pressure partly to start-up costs at the Tijuana manufacturing operation, which began taking over work previously performed by third parties. It expects the facility to help reduce manufacturing costs over time.
- The company cited product-liability claims and recalls, FDA and foreign regulatory requirements, reimbursement and healthcare-reform changes, intellectual-property disputes, supplier concentration and interruptions, foreign-exchange exposure, cybersecurity, acquisition integration, and debt covenants as material risks. Inflation devices represented approximately 14% of 2015 revenue; the largest customer represented approximately 3%.
- The 2.3% U.S. medical-device excise tax reduced 2015 gross profit by $4.3 million; the filing says the tax was suspended for 2016 and 2017. The effective tax rate declined to 23.7% from 27.2%, principally reflecting a higher share of foreign earnings.
- On February 3, 2016, the company amended its credit agreement, describing a $50 million increase in borrowing capacity and a $225 million revolving-loan commitment. On February 4, it acquired the HeRO Graft and related assets for $18.5 million; purchase-price allocation was still under evaluation when the filing was prepared.
- Ordinary-course litigation includes product-liability, intellectual-property, contractual and employment matters. Management did not consider the pending matters likely to be material, while noting an unfavorable resolution could be materially adverse. Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether the Tijuana facility reaches expected efficiency and reverses the gross-margin decline.
- How inventory growth, lower inventory turns and planned capital spending affect cash conversion and free cash flow.
- Debt covenant headroom, borrowing availability under the amended facility, and refinancing or repayment needs ahead of the December 2017 maturity.
- Whether new product approvals, clinical trials and the HeRO Graft acquisition produce expected sales and returns, including the final purchase-price allocation.
- How much 2015 earnings growth depended on the lower effective tax rate and the unusually low fourth-quarter tax provision.
- Exposure to currency movements, reimbursement changes, regulatory delays, supplier concentration and the medical-device excise tax after its scheduled suspension.