Merit Medical Systems, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited, compared with Q1 2017. Merit designs, manufactures and markets single-use medical products through its cardiovascular and endoscopy segments. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 / prior date |
|---|---|---|
| Net sales | $203.0 | $171.1; up 18.7% |
| Gross profit / gross margin | $88.1 / 43.4% | $75.9 / 44.4% |
| Operating income / operating margin | $8.8 / 4.3% | $5.6 / 3.3% |
| Net income | $5.3 | $14.8 |
| Diluted EPS | $0.10 | $0.32 |
| Cash from operations | $7.9 | $15.2 |
| Cash and cash equivalents | $34.2 | $32.3 at Dec. 31, 2017 |
| Total debt, including current portion | $386.5 | $278.5 at Dec. 31, 2017 |
| Working capital / current ratio | $219.4 / 2.76 | $200.5 / 2.73 at Dec. 31, 2017 |
Operating cash flow was lower year over year, with cash absorbed by higher receivables and inventory. Investing activities used $117.3 million, including $100.2 million for acquisitions and $16.2 million of property and equipment spending. Financing activities provided $109.5 million, primarily reflecting additional borrowing. Cash increased by $1.8 million during the quarter.
Changes and drivers versus Q1 2017
- Sales growth was broad-based: cardiovascular revenue rose 18.9% to $195.9 million and endoscopy rose 13.7% to $7.2 million. International sales increased 34.8% to $93.0 million, or 45.8% of total sales.
- Growth included acquired products and favorable currency effects, so reported growth should not be read as organic growth. BD products contributed approximately $6.3 million of sales from February 14 through March 31; Argon critical-care products contributed $12.5 million, versus $7.2 million a year earlier.
- Gross margin declined 1.0 percentage point, which management attributed mainly to acquisition-related amortization, inventory obsolescence, negative production variances and product mix. SG&A rose 12.4% to $64.9 million but fell as a share of sales, from 33.8% to 32.0%. R&D rose 14.3% to $14.3 million.
- Net income fell largely because Q1 2017 included a $12.2 million bargain-purchase gain from the Argon acquisition, which did not recur. The prior-period gain also contributed to the reported increase in the effective tax rate, from 4.5% to 17.1%.
Outlook, financing, risks and unusual items
- The filing provides no quantified revenue or earnings guidance. Management said it expects 2018 to be affected by trends discussed in its 2017 Form 10-K and believes cash, expected operating cash flow and credit availability will fund current and currently planned operations for the next 12 months and foreseeable future.
- In February, Merit acquired selected BD biopsy and drainage product assets for approximately $100.1 million, funded principally with additional debt. The purchase-price allocation was preliminary and included $79.9 million of developed technology and $5.4 million of goodwill. Integration, realization of expected benefits and competition from BD are risks.
- At March 31, borrowings under the main credit agreement were approximately $380 million, with about $76.9 million of additional availability based on the required leverage ratio. $175 million was hedged at a fixed rate; $205 million bore a floating rate of 3.14%. Merit reported compliance with its debt covenants. The agreement is secured by substantially all assets and matures July 6, 2021; the separate approximately $7.0 million HSBC loan matures July 10, 2018, subject to an extension option.
- Approximately $29.8 million of cash was held by foreign subsidiaries, including $19.9 million in China, where transfers abroad require government approval. Management considers foreign earnings indefinitely reinvested; withholding taxes could be material if earnings are distributed.
- The Department of Justice investigation into certain marketing and promotional practices remains ongoing. Merit said it cannot predict the scope, duration or outcome and expects substantial continuing costs. Related legal expense was $1.7 million in Q1 2018, versus $4.8 million in Q1 2017; adverse outcomes could include significant damages, injunctions, fines or civil or criminal penalties.
- Tax effects of the 2017 Tax Act remained provisional at quarter-end; the company had not decided its accounting policy for future GILTI effects. In April, Merit committed $20.5 million in total consideration for NinePoint agreements, including exclusive global distribution rights, an option to acquire up to 100% of NinePoint, and a loan. Accounting treatment was still under evaluation.
- Other principal risks identified include acquisition integration and growth management, regulatory and product-liability exposure, pricing and reimbursement pressure, foreign-exchange and interest-rate changes, supply and inventory management, and the ability to generate cash for debt service and investment.
Important facts for investors to verify
- How much of sales growth reflects underlying demand versus acquisitions, pricing and currency, and whether acquired product lines meet expectations.
- Whether gross-margin pressure, inventory growth and working-capital consumption improve in subsequent quarters.
- Debt levels, leverage covenant headroom, floating-rate exposure and refinancing or extension of the HSBC loan.
- Developments, costs and potential financial consequences of the DOJ investigation, and any material outcome of other claims.
- Final acquisition accounting and the results of integrating BD and other acquired businesses; the NinePoint agreements’ accounting and commercial progress.
- Resolution of provisional Tax Act estimates, foreign-earnings plans and any related tax or withholding consequences.