Merit Medical Systems, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Financial statements are unaudited; dollar amounts below are in U.S. dollars. Merit designs, manufactures and markets single-use medical products for interventional and diagnostic procedures, reporting cardiovascular and endoscopy segments.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $128.9m | $109.9m | $248.1m | $213.8m |
| Gross profit / margin | $55.6m / 43.2% | $47.0m / 42.8% | $107.7m / 43.4% | $90.0m / 42.1% |
| Operating income / margin | $7.4m / 5.7% | $6.8m / 6.2% | $13.9m / 5.6% | $8.5m / 4.0% |
| Net income | $3.7m | $3.8m | $6.5m | $4.4m |
| Diluted EPS | $0.09 | $0.09 | $0.15 | $0.10 |
| Operating cash flow | — | $20.1m | $14.4m |
Sales increased 17.3% in Q2 and 16.0% for the first half. Cardiovascular revenue grew 17.7% and 16.5%, respectively; endoscopy revenue increased 7.0% and 5.0%. Q2 international sales were $50.6m, about 39% of total sales, up 24% year over year.
Gross margin improved, which management attributed primarily to lower fixed overhead cost per unit from higher production volumes. In Q2, net income was essentially flat despite sales growth: higher SG&A, R&D and interest expense offset operating gains. First-half net income rose 47.9%; the prior-year comparison included a $0.5m research and development tax credit that lowered the 2013 effective tax rate.
Financial position and liquidity
- At June 30, cash and equivalents were $9.4m, versus $7.5m at December 31, 2013. First-half cash from operations was $20.1m; investing used $21.1m, including $18.7m of property and equipment spending; financing provided $3.0m.
- Working capital was $108.9m and the current ratio was 2.53:1. Receivables were $67.3m and inventory was $86.5m; inventory increased $4.1m during the half.
- Total debt was $248.4m, comprising $87.5m term debt and $160.9m revolving borrowings. Approximately $29.0m of additional borrowing capacity was available, subject to the credit agreement. Debt matures December 19, 2017; substantially all assets secure the facility.
- The company reported compliance with all credit covenants. A $150m interest-rate swap initially hedged floating-rate exposure; $142.5m was fixed at 3.23% at quarter-end. Management estimated that a 1 percentage-point interest-rate change would affect annual interest expense and pretax income by approximately $1.1m, assuming borrowings stayed constant.
Changes, outlook and risks
- SG&A rose to 30.0% of sales in Q2 from 28.7%; management cited sales-force expansion and reorganization, international growth investments, and temporary costs during the Pearland facility transition. R&D expense increased in dollars but declined as a share of sales.
- Management said the U.S. sales-force reorganization and international expansion were progressing and expected them to support future growth and profitability, while acknowledging higher near-term costs. No specific revenue or earnings guidance was provided. Management believed cash, operating cash flow, available credit and potential equipment financing would fund operations for at least the next 12 months.
- Price pressure, particularly from U.S. hospitals, remains a headwind. Other disclosed risks include product liability and recalls, regulation and reimbursement changes, competition, supplier and inventory risks, foreign-exchange exposure, acquisition execution, and the need to generate cash for debt and investment needs.
- Merit held about $6.9m of cash at foreign subsidiaries, including $5.3m in China, where transfers abroad require government approval. About 20% of Q2 revenue was denominated in foreign currencies.
- A lawsuit against Bard over an alleged breach of a purchasing agreement was in discovery; trial was anticipated for January 2015, and the potential outcome or loss range could not be estimated. A separate patent-infringement action concerning aspiration catheters was dismissed with prejudice in May 2014. The company said other ordinary-course claims were not expected to be material, while noting unfavorable developments could have adverse effects.
- Merit acquired a roughly 19% interest in G Medix for approximately $1.8m in May 2014. It also noted adoption of the new revenue-recognition standard was planned for January 1, 2017; the impact was still being evaluated.
Important facts for investors to verify
- Whether sales growth and gross-margin gains persist as pricing pressure and product mix evolve.
- Whether higher SG&A, facility-transition costs and interest expense constrain earnings and cash generation.
- Debt covenant headroom, borrowing availability, refinancing obligations and exposure to changing interest rates.
- Working-capital trends, especially receivables and inventory growth, and the location and accessibility of foreign cash.
- Developments in the Bard litigation, acquisition performance, and the future impact of revenue-standard adoption.