Merit Medical Systems, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Financial statements are unaudited. Merit designs, manufactures and markets medical products for interventional and diagnostic procedures, reporting in cardiovascular and endoscopy segments.
Financial performance
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Net sales | $243.5 million | $238.3 million |
| Gross profit | $103.8 million; 42.6% margin | $104.6 million; 43.9% margin |
| Operating income | $1.4 million; 0.6% margin | $9.5 million; 4.0% margin |
| Net income (loss) | $(3.2) million; $(0.06) per diluted share | $6.2 million; $0.11 per diluted share |
| Cash from operations | $28.9 million | $13.5 million |
| Cash and equivalents, March 31 | $50.1 million | $49.5 million at March 31, 2019 |
Q1 2020 sales grew 2.2%. Cardiovascular sales were $235.5 million, up 2.2%; endoscopy sales were $8.0 million, up 1.4%. International sales were $102.5 million, or 42.1% of total revenue, also up 2.2%.
Operating cash flow benefited from noncash expenses and working-capital movements, including improved collections versus the prior-year quarter. Investing cash outflow was $14.8 million, including $14.0 million of property and equipment spending. Financing cash outflow was $6.2 million.
Balance sheet and debt
At March 31, 2020, total assets were $1.749 billion and total liabilities were $809.5 million. Current assets were $462.5 million and current liabilities $165.3 million. Debt principal was approximately $446.1 million, comprising $146.3 million of term loans and $299.9 million of revolver borrowings; cash less debt was approximately $396 million. The company reported approximately $232.1 million of additional borrowing capacity, subject to its credit agreement. It stated that it believed cash, operating cash flows and available borrowings would fund operations for at least the next 12 months.
Debt is due under a credit agreement maturing July 31, 2024, secured by substantially all company assets and subject to financial covenants. Merit said it was in compliance at quarter-end. A $175 million portion was hedged at a fixed rate; remaining borrowings were variable-rate.
Material changes and unusual items
- Despite revenue growth, gross margin fell 1.3 percentage points and operating income declined substantially; the company reported a net loss versus prior-year net income.
- Management attributed margin pressure to pandemic-related product and geographic mix, including lower sales in China, and inventory obsolescence. NinePoint-related inventory obsolescence was approximately $1.4 million.
- Operating expenses included $4.9 million of contingent-consideration expense and $3.8 million of impairment and other charges. The company wrote off a purchase option relating to Bluegrass Vascular after deciding not to acquire the business; related charges included approximately $3.5 million for the option and approximately $3.9 million of intangible and other long-term asset write-offs.
- Cash paid for acquisition-related contingent consideration was $12.8 million, principally related to Cianna Medical. The contingent-consideration liability was $68.9 million at quarter-end.
- The effective tax rate was (58.3)%, reflecting discrete tax effects associated primarily with contingent-consideration fair-value adjustments and the Bluegrass option write-off.
Outlook, management commentary and risks
COVID-19 negatively affected the business in Q1; the filing estimates approximately $16 million of adverse net-sales impact. Hospital procedure restrictions reduced demand for many products, while critical-care and infection-control products saw increased demand. Management said the pandemic’s future impact could not be reliably predicted and could remain adverse for the foreseeable future.
In response, Merit reduced discretionary spending, deferred capital spending and R&D projects, delayed product launches, and announced April furloughs and temporary salary reductions for executives and certain salaried personnel. It also described plans to move 14 products to facilities in Mexico and Texas and consolidate four satellite facilities. A nasopharyngeal swab and transport vial entered production in April; the company reported a $2.4 million purchase order from the State of Utah. Management anticipated 2020 property and equipment spending of approximately $50–$55 million, while noting that COVID-19-related delays and deferred spending could affect plans.
Key uncertainties include the duration of the pandemic, postponed procedures and resulting care backlogs, supplier and customer disruption, product demand, foreign-exchange exposure, debt covenants and access to capital. The company also disclosed an ongoing Department of Justice investigation into marketing and promotional practices, for which its outcome and duration were uncertain, and a securities-law lawsuit filed in December 2019. Management said it did not believe the disclosed litigation was likely to be materially adverse based on information then available, but noted unfavorable outcomes could be material.
Important facts for investors to verify
- Whether elective-procedure recovery and pandemic-related demand shifts affect revenue, product mix and margins in subsequent quarters.
- Cash generation, inventory and receivables collectability, including the effect of customer credit risk and overseas cash-transfer restrictions.
- Debt levels, covenant headroom and the availability of the reported $232.1 million borrowing capacity.
- Further impairment, inventory-reserve or contingent-consideration charges, including assumptions underlying acquisition milestone valuations.
- Progress and potential exposure related to the DOJ investigation and securities lawsuit, as well as the timing and outcome of delayed product launches and facility changes.