Business context and reporting period
Merit Medical Systems, Inc. designs, manufactures and markets medical devices for interventional, diagnostic and therapeutic procedures. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016. Operations are reported in cardiovascular and endoscopy segments.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $157.0 million | $136.1 million | $446.1 million | $403.7 million |
| Gross margin | 43.2% | 43.5% | 43.7% | 43.5% |
| Operating income | $3.0 million | $8.5 million | $22.3 million | $29.5 million |
| Net income | $1.0 million | $4.8 million | $12.6 million | $17.4 million |
| Diluted EPS | $0.02 | $0.11 | $0.28 | $0.39 |
- Q3 sales grew 15.3%; nine-month sales grew 10.5%. Cardiovascular sales rose 15.0% and 10.3%, respectively; endoscopy sales rose 24.3% and 14.5%.
- Q3 operating margin was 1.9%, versus 6.3% a year earlier; nine-month operating margin was 5.0%, versus 7.3%. SG&A reached 33.9% of Q3 sales, up from 28.8%.
- Interest expense was $3.0 million in Q3 and $6.1 million for nine months, compared with $1.5 million and $4.8 million, respectively, in 2015. Q3 included a $978,000 income-tax benefit; the nine-month effective tax rate was 20.0%, versus 29.4%.
- Operating cash flow was $36.3 million for nine months, versus $57.0 million in 2015. Investing cash outflow was $146.8 million, mainly reflecting acquisitions; financing cash inflow was $123.5 million. Cash increased to $17.3 million from $4.2 million at year-end.
- At September 30, working capital was $147.8 million and the current ratio was 2.71. Debt principal outstanding was approximately $328.4 million (balance-sheet carrying amount: $327.8 million), up from $207.6 million at year-end. Approximately $91.6 million of additional borrowing capacity was available under the leverage-based limit; the company reported covenant compliance.
Material changes and unusual items
- Merit acquired DFINE on July 6 for an initial payment of $97.5 million plus approximately $578,000 for a working-capital adjustment. DFINE contributed about $7.0 million in Q3 sales. The acquisition added $26.0 million of goodwill and $74.4 million of developed technology, customer lists and trademarks; purchase accounting was preliminary.
- In February, Merit acquired the HeRO Graft assets for $18.5 million; those products generated $1.9 million of Q3 sales and $5.2 million over nine months. The company also invested $2.5 million for an approximately 18.6% interest in Cagent Vascular.
- Management attributed lower earnings mainly to acquisition and severance costs, higher interest expense following increased borrowing, and higher R&D costs. DFINE-related intangible amortization weighed on Q3 gross margin. Higher-margin product mix and suspension of the U.S. medical-device tax supported nine-month gross margin.
- The cardiovascular segment’s operating income fell to $2.0 million in Q3 from $8.0 million; endoscopy operating income increased to $1.0 million from $552,000.
- Capital spending on property and equipment was $26.5 million for nine months, down from $39.5 million. Inventory increased to $116.9 million from $106.0 million; trailing-twelve-month inventory turns declined to 3.00 from 3.11.
Outlook, risks and contingencies
No specific revenue or earnings guidance is provided. Management said cash balances, 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. It also cited international-market expansion as a continuing focus, with near-term SG&A costs that management believes may support future profitability.
- On October 19, 2016, the company disclosed that the U.S. Attorney’s Office was investigating its marketing and promotion of certain products and had issued an administrative subpoena. Merit said it intended to cooperate and, based on information then available, did not believe the matter was likely to be materially adverse; it cautioned that an unfavorable outcome could materially affect results, liquidity or operations.
- A competitor’s regulatory issues had recently increased demand for certain Merit products. The company warned demand could exceed inventory or manufacturing capacity, requiring customer-allocation decisions and potentially stressing suppliers, staff and quality or reporting controls.
- The amended credit agreement is secured by substantially all company assets and includes tightening maximum leverage limits, other financial covenants and restrictions. A breach could trigger acceleration or foreclosure. Variable-rate exposure and foreign-currency movements are additional risks.
- DFINE integration carries risks including unbudgeted costs, loss of employees, suppliers or customers, and failure to realize expected benefits. The filing notes DFINE was not profitable or cash-flow positive before acquisition.
Investor facts to verify
- Whether the DOJ investigation results in enforcement action, penalties, significant costs or business disruption.
- DFINE integration progress, restructuring costs, contribution to earnings and cash flow, and final purchase-price allocation.
- Debt repayment, borrowing availability, interest costs and ongoing compliance with credit covenants.
- Whether elevated product demand can be met without capacity, inventory, supplier or quality-control problems.
- Cash generation and working-capital trends, especially receivables and inventory, alongside the company’s stated funding outlook.