Merit Medical Systems, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015; unaudited. Merit designs, manufactures, and markets single-use medical products for interventional and diagnostic procedures. Its reportable segments are cardiovascular and endoscopy. Amounts below are in U.S. dollars; financial statement amounts are in millions unless otherwise stated.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $138.1 | $128.9 | $267.7 | $248.1 |
| Gross profit / margin | $60.9 / 44.1% | $55.6 / 43.2% | $116.3 / 43.4% | $107.7 / 43.4% |
| Operating income / margin | $12.2 / 8.9% | $7.4 / 5.7% | $20.9 / 7.8% | $13.9 / 5.6% |
| Net income | $7.4 | $3.7 | $12.6 | $6.5 |
| Diluted EPS | $0.17 | $0.09 | $0.28 | $0.15 |
Six-month operating cash flow was $40.4 million, versus $20.1 million a year earlier. Investing cash outflow was $26.5 million, including $25.4 million of property and equipment expenditures; financing cash outflow was $9.0 million. Cash increased $4.7 million to $12.1 million.
At June 30, 2015, working capital was $113.0 million and the current ratio was 2.42. Total debt was $209.8 million, down $14.7 million from year-end; long-term debt was $199.8 million. Approximately $35.2 million of borrowing capacity remained under the credit agreement. The company reported a 2.42-to-1 credit-agreement leverage ratio and compliance with all covenants. Debt is secured by substantially all assets and matures December 19, 2017. Approximately $137.5 million of borrowings was fixed at 2.98% through an interest-rate swap; other disclosed borrowing rates were 1.94% and 2.04%.
Changes versus prior year
- Sales rose 7.2% in Q2 and 7.9% in the first half. Cardiovascular sales grew 6.5% and 7.5%, respectively; endoscopy sales grew 26.1% and 18.6%.
- Q2 gross margin improved 0.9 percentage points; first-half gross margin was unchanged. Management attributed the quarterly improvement primarily to lower Euro-denominated manufacturing costs as the U.S. dollar strengthened.
- Operating expenses declined as a percentage of sales. Lower interest expense, higher sales, and improved operating leverage contributed to net income increases of 99% in Q2 and 92% in the first half. Higher effective tax rates partly offset the improvement.
- Endoscopy operating income increased to $1.0 million in Q2 from $0.1 million, and to $1.6 million for the first half from $0.2 million. Cardiovascular operating income also increased in both periods.
Outlook, commentary, and risks
- The new Tijuana facility began production in early July 2015. Merit hired approximately 170 workers from its former contract manufacturer and expects to transfer additional product lines from other facilities over the next three years. It expects $1.5–$2.5 million of transition-period costs to be recorded in SG&A rather than cost of sales, in addition to an $0.8 million one-time termination fee recorded in SG&A. Management expects margin and earnings improvement as the facility becomes efficiently utilized, potentially between late 2016 and early 2017. The West Jordan site was expected to be vacated by year-end 2015.
- Management said cash, operating cash flow, available credit, and potential equipment financing should fund operations and currently planned needs for the next 12 months and foreseeable future. Significant future acquisitions could require additional debt or equity financing. No formal earnings or revenue guidance is provided in the filing text.
- Foreign exchange is a material exposure: approximately 20% of Q2 revenue was denominated in foreign currencies. Management estimates a 10% strengthening or weakening of the U.S. dollar against the Euro would change net income by approximately $1.0 million in the favorable or unfavorable direction, respectively. The company uses a natural hedge and short-term forward contracts.
- Risks include debt service and covenant constraints, product liability and recalls, regulatory and reimbursement changes, product development and market acceptance, supplier disruption, competition, inventory obsolescence, acquisition integration, and currency and interest-rate movements. Cash held in China is subject to restrictions on transfers outside the country.
- Ordinary-course litigation includes potential product liability, intellectual property, contractual, and employment matters. Management did not believe existing matters were likely to be material, but unfavorable developments could materially affect the business, financial condition, results, or liquidity.
Important facts for investors to verify
- Whether Tijuana production transfers proceed as planned, and whether the projected transition costs and later margin benefits are realized.
- Debt maturities, covenant headroom, borrowing availability, and the ability to reduce debt while funding elevated capital expenditures.
- How much of reported growth and margin improvement reflects underlying demand versus currency effects; monitor Euro, GBP, and other exposures.
- Whether the company’s inventory, receivables, intangible assets, and contingent consideration remain appropriately valued as demand and acquired-product performance evolve.
- Potential developments in litigation, regulatory matters, and customer or supplier relationships; the filing does not quantify a probable material loss.