Merit Medical Systems, Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; interim financial statements are unaudited. Merit designs, manufactures, and markets single-use medical products for interventional and diagnostic procedures, reporting cardiovascular and endoscopy segments.
Financial performance and liquidity
| Metric | Q1 2013 | Q1 2012 |
|---|---|---|
| Net sales | $103.9 million | $95.6 million |
| Gross profit / margin | $43.0 million / 41.4% | $44.2 million / 46.2% |
| Operating income | $1.8 million | $8.0 million |
| Net income | $0.7 million | $5.7 million |
| Diluted earnings per share | $0.02 | $0.14 |
| Cash from operating activities | $2.9 million | $7.5 million |
- Sales increased 8.7%, while net income declined 88.3%. Cardiovascular sales rose to $99.8 million; endoscopy sales rose to $4.2 million.
- Gross margin fell 4.8 percentage points. Management attributed the decline to lower production volumes, Thomas Medical developed-technology amortization, the medical-device excise tax, and acquisition-related inventory mark-up. Excluding the latter nonrecurring cost, management reported a 42.0% gross margin.
- Research and development expense rose to $9.1 million from $6.4 million, or 8.8% of sales versus 6.7%. Other expense increased to $1.5 million, principally due to higher debt and interest expense.
- The income tax line was a $459,000 benefit, including an approximately $500,000 discrete benefit from reinstatement of the 2012 federal R&D tax credit.
- Cash and equivalents were $9.0 million at quarter-end; working capital was $100.9 million and the current ratio was 2.65. Operating cash flow was $2.9 million; capital expenditures for property and equipment were approximately $20.0 million.
- Total debt was $254.3 million, comprising a $97.5 million term loan and $156.8 million of revolving borrowings. Available credit was approximately $18.2 million. Debt is secured by substantially all company assets and matures in 2017.
Material changes and management commentary
- Thomas Medical, acquired in December 2012, contributed $5.4 million of CRM/EP sales in the quarter. Management said related OEM sales were below expectations because some customers had stocked up before the acquisition. The acquisition also increased amortization and included a nonrecurring inventory mark-up cost.
- Management cited slower U.S. procedure counts; U.S. direct sales growth excluding Thomas Medical was 2.3%. It also said company-wide efforts to improve inventory turns reduced production volumes and increased unit costs.
- Endoscopy recorded $129,000 of operating income, versus a $331,000 operating loss in the prior-year quarter, which management attributed to improved sales and margins and lower operating expenses.
- Management expects earnings to grow if new products launch successfully and cost initiatives take effect. It identified multiple planned 2013 product launches and approximately $4.5 million of SG&A cost-cutting initiatives; it also planned to review or defer certain R&D spending. No specific earnings or revenue guidance was provided.
Risks, contingencies, and unusual items
- Debt covenant: The quarter-end consolidated leverage ratio was 3.60:1, above the 3.50:1 limit. Wells Fargo subsequently waived the breach as of March 31. Merit was otherwise in compliance and was discussing a credit-agreement amendment to increase covenant flexibility. Future covenant compliance remains a key risk.
- Foreign-subsidiary cash totaled approximately $8.6 million, including $7.3 million in China, where transfers abroad are subject to government approval. Management stated that cash, expected operating cash flows, and available borrowing capacity should fund operations for the next 12 months and foreseeable future.
- Acquisition-related contingent consideration was $6.7 million at quarter-end and is remeasured using projected revenues and other significant estimates. Goodwill was $175.1 million; management identified acquisition integration and realization of anticipated benefits as relevant considerations.
- Ordinary-course product liability, intellectual-property, contractual, and employment claims were not considered likely to be material by management, but an unfavorable resolution could be adverse. The filing also identifies regulatory, product-liability, reimbursement, competition, supplier, foreign-exchange, and product-development risks.
- The company uses a $150.0 million interest-rate swap at a fixed 2.98%; remaining borrowings are exposed to variable rates. Management estimated that a one-percentage-point rate change on unhedged borrowings would change annual interest expense by approximately $1.0 million.
Important facts for investors to verify
- Confirm the scope and duration of the lender’s covenant waiver and the outcome of discussions to amend the credit agreement; monitor leverage, available capacity, and covenant headroom.
- Assess whether U.S. procedure trends and Thomas Medical OEM sales recover, and whether acquired products deliver the expected growth.
- Track gross-margin recovery, production volumes, the excise-tax effect, and whether the announced SG&A savings and planned launches are achieved.
- Review cash generation against substantial capital spending and debt service, and consider constraints on foreign cash, particularly in China.
- Monitor the assumptions supporting acquisition-related goodwill, intangible assets, and contingent consideration, as well as any significant litigation or regulatory developments.