Merit Medical Systems, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unaudited consolidated results; amounts below are in U.S. dollars unless stated otherwise. Merit designs, manufactures and markets medical products, reporting in cardiovascular and endoscopy segments.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $221.7 million | $179.3 million | $649.5 million | $537.0 million |
| Gross profit | $102.0 million | $80.5 million | $290.1 million | $240.6 million |
| Gross margin | 46.0% | 44.9% | 44.7% | 44.8% |
| Operating income | $21.1 million | $0.9 million | $45.0 million | $19.9 million |
| Net income (loss) | $16.6 million | $(3.6) million | $32.8 million | $20.7 million |
| Diluted EPS | $0.30 | $(0.07) | $0.62 | $0.42 |
- Sales rose 23.6% in Q3 and 21.0% for the first nine months. Cardiovascular sales increased 22.8% and 20.7%, respectively; endoscopy sales increased 43.8% and 26.7%.
- International sales were $95.6 million in Q3 (43.1% of sales) and $288.9 million for the nine months (44.5%). Nine-month growth was 29.2%.
- Nine-month operating cash flow was $62.9 million, versus $43.4 million. Investing cash outflow was $182.8 million, including $122.8 million for acquisitions and $47.0 million of property and equipment expenditures. Financing cash inflow was $140.4 million.
- Cash and equivalents were $52.0 million at September 30, 2018, up from $32.3 million at year-end 2017. Working capital was $247.8 million and the current ratio was 2.77.
- Total debt carrying value was $208.9 million, including $22.0 million current debt. The company reported $202.3 million borrowed under its main credit agreement and approximately $248.4 million of additional availability, subject to leverage limits. It said it was in compliance with debt covenants.
Changes versus prior comparable periods
- Q3 net income improved from a loss to profit. Management attributed the change to higher sales and gross margin, and the absence of the $12.1 million acquired in-process research and development charge recorded in Q3 2017, primarily related to IntelliMedical.
- Nine-month net income rose to $32.8 million from $20.7 million. Higher sales, lower SG&A as a share of sales, and the absence of 2017 acquired in-process R&D expense helped; the prior period included a $10.8 million Argon bargain-purchase gain that did not recur.
- Q3 gross margin expanded by 1.1 percentage points, attributed to product mix—including acquired BD products—and manufacturing efficiencies. Nine-month margin slipped 0.1 percentage point, with BD integration costs and acquisition-related amortization partly offset by mix and efficiencies.
- Debt declined from year-end after the July equity offering; proceeds were primarily used to repay borrowings. Outstanding borrowings under the main credit agreement were about $69.8 million lower than at December 31, 2017.
Outlook, management commentary, risks and unusual items
- Management expected the remainder of 2018 to benefit from recently awarded tenders, new product releases, production of the Laurane product line in Ireland, manufacturing efficiencies, cost savings, and sales of biopsy and drainage products. It also cited potential offsets from product mix, distributor-market growth, labor costs and logistics. No specific revenue or earnings guidance was provided.
- A competitor’s supply shortages contributed an estimated $4.0 million to Q3 sales of certain Merit products; the duration and extent of this demand benefit were uncertain.
- In February, Merit acquired selected BD product lines for approximately $100.3 million. Those products contributed about $11.8 million of Q3 sales and $30.3 million for the nine months; separate earnings were not practicably determinable. Other 2018 transactions included DirectACCESS and the NinePoint distribution agreement. NinePoint products generated approximately $1.4 million of Q3 and $2.5 million of nine-month sales.
- On October 1, 2018, Merit signed an agreement to acquire Cianna Medical for up to $200 million, comprising $135 million cash at closing and potential earn-outs. Closing was anticipated in Q4 2018 and remained subject to customary conditions, including regulatory clearance and Cianna stockholder approval.
- Merit recorded a $657,000 impairment of Quellent-related intangible assets, citing slower-than-anticipated sales growth and uncertainty about future sales. Its annual goodwill test found reporting-unit fair values significantly above carrying amounts.
- The Department of Justice investigation into certain marketing and promotional practices remained ongoing. Legal expenses related to the subpoena were approximately $4.3 million for the first nine months of 2018. Merit said the investigation’s scope, duration and outcome could not be predicted and that an unfavorable outcome could be materially adverse.
- The 2017 Tax Act tax amounts remained provisional. Management had not decided whether to change its assertion that foreign earnings were indefinitely reinvested; repatriation could involve material foreign withholding taxes. Cash held by the China subsidiary is subject to restrictions on transfers abroad.
- Principal stated risks include acquisition integration and financing, regulatory clearance and compliance, product liability and recalls, inventory forecasting, foreign currency and interest-rate exposure, debt covenants, and competition. Management said current cash, operating cash flows and borrowing capacity should fund planned operations for at least the next 12 months; further significant acquisitions could require additional financing.
Important facts for investors to verify
- How much of reported growth came from acquired businesses versus comparable, internally generated sales, and whether the competitor-related demand increase persists.
- Whether gross-margin improvement is sustained as BD integration and acquisition-related amortization continue, and how inventory growth and turns develop.
- Cianna’s closing, funding and earn-out requirements, and the resulting impact on debt, liquidity and integration capacity.
- Developments, costs and potential exposure from the ongoing DOJ investigation.
- Debt covenant headroom, interest costs, and availability under the credit facility, especially if additional acquisitions are pursued.
- Final tax-accounting conclusions under the 2017 Tax Act and any implications for overseas cash availability.