Merit Medical Systems, Inc. — Q3 2017 Form 10-Q
Business context and reporting period. Merit designs, manufactures and markets single-use medical products for interventional, diagnostic and therapeutic procedures. This unaudited filing covers the quarter and nine months ended September 30, 2017; comparisons are with the same 2016 periods. Results include multiple 2017 acquisitions, notably Argon’s critical care division, Catheter Connections and other product or technology purchases.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $179.3m | $157.0m | $537.0m | $446.1m |
| Gross profit | $80.5m | $67.8m | $240.6m | $194.8m |
| Gross margin | 44.9% | 43.2% | 44.8% | 43.7% |
| Operating income | $0.9m | $3.0m | $19.9m | $22.3m |
| Net income (loss) | $(3.6)m | $1.0m | $20.7m | $12.6m |
| Diluted EPS | $(0.07) | $0.02 | $0.42 | $0.28 |
| Operating cash flow | — | $43.4m | $36.3m |
Balance sheet and liquidity at September 30, 2017
- Cash and cash equivalents were $23.4m, versus $19.2m at December 31, 2016; $21.6m was held by foreign subsidiaries, including $14.5m in China subject to local transfer approvals.
- Working capital was $192.1m and the current ratio was 2.78:1, compared with $155.1m and 2.76:1 at year-end 2016.
- Total debt was $277.9m, including $17.0m current and $261.0m long-term, down from $324.4m at year-end. The company reported approximately $91.0m of available borrowing capacity under its main credit agreement, based on required leverage limits, and believed it was covenant-compliant.
- For the first nine months, investing cash outflow was $134.9m, including $103.5m net cash paid for acquisitions and $29.5m of property and equipment expenditures. Financing cash inflow was $95.7m; the March public offering generated approximately $136.6m net proceeds, used primarily to repay debt.
Material changes and drivers
- Sales rose 14.2% in Q3 and 20.4% year to date. Cardiovascular sales increased 14.8% and 20.7%, respectively; stand-alone devices were a major growth contributor, including sales from acquired product lines. Endoscopy sales rose 2.2% in Q3 and 12.9% year to date.
- Management attributed higher gross margins to product mix and operating efficiencies. Despite higher sales, operating income fell: Q3 cardiovascular reported a $1.2m operating loss versus $1.9m income a year earlier; endoscopy operating income increased to $2.1m from $1.1m.
- Q3 included $12.1m of acquired in-process R&D expense for IntelliMedical’s steerable guidewire technology, which was expensed because technological feasibility had not been reached and there was no alternative future use. The charge was identified as the principal reason for the quarterly net loss and was not deductible for tax purposes.
- Nine-month results benefited from a $10.8m Argon bargain-purchase gain. The gain remained provisional, and purchase-price allocations for Argon and certain other acquisitions were subject to further adjustment.
- SG&A increased 22.6% year to date, with acquisition and integration costs, additional staff and amortization among the factors. The company incurred $10.6m of costs in the first nine months responding to a Department of Justice subpoena, including $2.1m in Q3.
Outlook, risks and contingencies
- The filing gives no specific revenue or earnings guidance. Management said existing cash, expected operating cash flow, equipment financing and credit-facility borrowings should fund current and planned operations for the next 12 months and the foreseeable future; further significant acquisitions could require additional financing.
- The DOJ investigation into certain marketing and promotional practices was ongoing. The company could not predict its scope, duration or outcome, anticipated continued substantial response costs, and warned of possible significant damages, injunctions, fines or civil or criminal claims or penalties.
- Debt is secured by substantially all company assets and subject to financial covenants. Liquidity and covenant headroom, interest-rate exposure, and ability to fund acquisitions and obligations remain relevant risks.
- Other disclosed risks include acquisition integration and commercialization, product liability and recalls, regulatory and reimbursement changes, foreign exchange movements, supplier availability, inventory obsolescence, and competition. Management reported no material change in internal control over financial reporting during the quarter.
- After quarter-end, Merit acquired ITL Healthcare Pty Ltd on October 2, 2017, for approximately $11.3m, financed with cash and existing credit facilities; accounting and purchase-price allocation were still under evaluation.
Important facts for investors to verify
- Progress, potential exposure and ongoing legal costs related to the DOJ subpoena and investigation.
- Whether acquired businesses and technologies deliver expected sales, margins and integration benefits, and the final acquisition valuations and contingent-payment obligations.
- Debt covenant compliance, available borrowing capacity, repayment requirements and the effect of interest-rate changes.
- Whether receivables and inventory growth convert into cash; inventory was $145.6m, up $24.9m since year-end, and trailing-twelve-month inventory turns declined to 2.92 from 3.00 a year earlier.
- Cash accessibility, including funds held in China and other foreign subsidiaries, and the financing and performance implications of the October ITL acquisition.