Merit Medical Systems, Inc. — Q3 2014 Form 10-Q
Business context and period. Merit designs, manufactures and markets single-use medical products for interventional and diagnostic procedures. This unaudited filing covers the three and nine months ended September 30, 2014; comparisons are with the corresponding 2013 periods. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $128.8m | $115.2m | $376.9m | $329.0m |
| Gross profit | $57.4m | $51.0m | $165.1m | $141.0m |
| Gross margin | 44.6% | 44.3% | 43.8% | 42.9% |
| Operating income | $12.1m | $8.4m | $25.9m | $16.9m |
| Net income | $7.8m | $5.6m | $14.3m | $10.0m |
| Diluted EPS | $0.18 | $0.13 | $0.33 | $0.23 |
| Operating cash flow | — | $31.6m | $33.6m |
Sales increased 11.8% in Q3 and 14.6% for the nine-month period. Management attributed gross-margin improvement mainly to higher production volumes, lower fixed overhead cost per unit and favorable product mix, particularly BioSphere products. Nine-month operating cash flow was lower year over year, while net income rose.
- Segments: Cardiovascular sales were $124.2m in Q3 (+12.0%) and $363.8m for nine months (+14.9%); operating income was $11.5m and $25.2m, respectively. Endoscopy sales were $4.6m in Q3 (+6.1%) and $13.1m for nine months (+5.4%); operating income was $0.6m and $0.7m, respectively. Cardiovascular growth reflected several product lines, including stand-alone devices, catheters, embolization devices and inflation devices.
- Expenses and tax: Q3 SG&A was $36.3m and R&D $8.7m; nine-month SG&A was $111.7m and R&D $27.1m. The effective tax rate rose to 24.3% for Q3 and 25.6% year to date, versus 12.9% and 14.0%; management cited a smaller relative impact from discrete tax benefits and a greater share of U.S. earnings.
- Cash flow and investment: Nine-month investing cash outflow was $26.6m, including $24.3m of property and equipment spending and $4.2m net cash paid for acquisitions. Financing cash outflow was $5.2m. Cash declined $1.0m to $6.4m.
Financial position and liquidity
At September 30, 2014, working capital was $111.9m, versus $100.3m at year-end 2013, and the current ratio was 2.51:1. Cash was $6.4m; inventory was $92.9m, up from $82.4m, and trade receivables were $69.4m, up from $60.2m. Total debt was $240.5m, comprising $85.0m term debt and $155.5m revolver borrowings; approximately $19.1m of borrowing capacity remained. Debt matures under the credit agreement on December 19, 2017, with $218.0m of principal scheduled for 2017. The debt is secured by substantially all company assets. Merit reported compliance with all credit covenants.
A swap fixed the rate on $141.3m of debt at 3.23%; other disclosed borrowing rates were 2.41% on $39.7m and 2.49% on approximately $59.5m. Management estimated that a one-percentage-point rate change would alter annual interest expense and pretax income by approximately $1.0m, assuming borrowings stayed constant. About $6.0m of cash was held by foreign subsidiaries, including $5.3m in China, where transfers abroad require government approval.
Changes, outlook and notable items
- Q3 GAAP net income increased 38.5%, but management said income excluding the net effects of intangible impairment and contingent-consideration adjustments was approximately $8.0m versus $8.1m a year earlier. For nine months, adjusted net income as described by management was approximately $14.5m versus $12.5m, up 16.1%. The reported comparisons therefore include significant prior-year unusual adjustments.
- The company recorded a $1.1m Q3 impairment charge for Ostial-related intangible assets; the income statement also included a $0.8m contingent-consideration benefit. Management linked the impairment to slower-than-expected sales growth and uncertainty around future sales of the acquired product. The 2013 comparable period included substantially larger impairment and contingent-consideration adjustments.
- Merit entered into agreements for rights to manufacture and sell certain angioplasty balloon catheters, paying $2.0m with up to $5.0m additional milestone payments; it also paid approximately $0.8m for manufacturing and export licenses. It acquired an approximately 19% stake in G Medix for about $1.8m. These investments add contingent funding and commercialization considerations.
- Management said it expects existing cash, operating cash flow, credit availability and potential equipment financing to fund current and planned operations for the next 12 months and foreseeable future. Significant future acquisitions could require additional debt or equity financing. No specific earnings or revenue guidance was provided.
- The U.S. direct sales force was reorganized into cardiovascular and interventional procedure divisions. Management reported U.S. direct-sales growth of 10.1% in Q3 and 10.7% year to date, while noting the reorganization and international expansion increased near-term SG&A. A new Tijuana facility was under construction, with completion anticipated by summer 2015; management planned to move selected high-labor-cost production lines there over three years.
- International sales were $50.9m, or about 40% of Q3 sales, up 21% year over year. Foreign exchange movements increased Q3 revenue by approximately $0.7m but reduced gross profit by 0.15%.
- Merit settled its dispute with Bard on October 30, 2014. Bard granted Merit a non-exclusive worldwide license to manufacture and distribute the SecureLoc safety introducer needle under Merit’s trademark and a covenant not to sue for the relevant patent term. Management said other ordinary-course litigation was not expected to be material, while acknowledging unfavorable outcomes could be adverse.
- Key stated risks include product liability and recalls, regulatory and reimbursement changes, intellectual-property disputes, pricing pressure, acquisition integration and commercialization, supplier disruptions, foreign exchange, inventory obsolescence, and the ability to generate cash for debt service. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether sales growth and gross-margin gains persist after considering product mix, pricing pressure and the planned manufacturing transition.
- Inventory and receivables growth, cash conversion, and the effect of working-capital investment on operating cash flow.
- Debt repayment capacity, covenant headroom, remaining revolver availability and exposure to floating interest rates.
- Future Ostial product sales, impairment assumptions and contingent-consideration remeasurement; distinguish reported results from management’s adjusted comparisons.
- Progress, spending and expected savings from the Tijuana facility and sales-force reorganization, as well as the commercial contribution of recent licenses and acquisitions.
- Foreign cash accessibility, exchange-rate exposure, and any material developments in litigation, product regulation or reimbursement.