Business context and reporting period
Merit Medical Systems, Inc. designs, develops, manufactures and markets single-use medical products for interventional and diagnostic procedures. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2015. The company reports cardiovascular and endoscopy segments.
Key financial metrics
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $136.1 million | $128.8 million | $403.7 million | $376.9 million |
| Gross profit / margin | $59.2 million / 43.5% | $57.4 million / 44.6% | $175.5 million / 43.5% | $165.1 million / 43.8% |
| Operating income | $8.5 million | $12.1 million | $29.5 million | $25.9 million |
| Net income | $4.8 million | $7.8 million | $17.4 million | $14.3 million |
| Diluted EPS | $0.11 | $0.18 | $0.39 | $0.33 |
For the nine months, operating cash flow was $57.0 million, versus $31.6 million a year earlier. Property and equipment capital expenditures were $39.5 million, versus $24.3 million. Cash declined by $1.5 million during the period to $5.9 million.
At September 30, 2015, working capital was $108.5 million and the current ratio was 2.26. Total debt was $210.2 million, including $10.0 million current; the company reported $32.2 million of available borrowing capacity. Stockholders’ equity was $458.6 million. The credit agreement leverage ratio was 2.49, and the company reported compliance with all credit covenants.
Material changes versus comparable periods
- Revenue increased 5.7% in Q3 and 7.1% for the first nine months. Cardiovascular sales grew 5.4% and 6.8%, respectively; endoscopy sales grew 11.1% and 15.9%.
- Q3 net income fell 37.9%, principally due to lower gross margin, higher operating expenses as a share of sales and a higher effective tax rate. Nine-month net income rose 21.6%, reflecting revenue growth, lower operating expenses as a share of sales and reduced interest expense.
- Q3 gross margin declined 1.1 percentage points year over year; the nine-month margin declined 0.3 points. Management cited Tijuana facility start-up overhead, lower embolic-product production volumes and international distributor discounts, partly offset by lower Euro-denominated manufacturing costs.
- Q3 operating income declined to $8.5 million from $12.1 million. Cardiovascular operating income fell to $8.0 million from $11.5 million, while nine-month cardiovascular operating income rose to $27.3 million from $25.2 million. Nine-month endoscopy operating income increased to $2.2 million from $0.7 million.
- Debt decreased by $14.3 million from December 31, 2014. Cash declined from $7.4 million to $5.9 million, while inventories increased by $8.5 million to $100.3 million.
Outlook, commentary and risks
Management expects gross profit and earnings to improve as production shifts to the Tijuana facility, but noted that much of the improvement may not occur until the facility is efficiently utilized, expected sometime between late 2016 and early 2017. The company began production there in early July 2015 and planned additional production-line transfers in Q4 2015 and Q1 2016. Management anticipated $1.5–$2.5 million of operating expenses classified as SG&A rather than cost of sales during the transition. It also recorded a one-time $0.8 million termination fee related to its former contract manufacturer.
The filing gives no specific revenue or earnings guidance. Management stated that existing cash, expected operating cash flow, credit availability and potential equipment financing should fund planned operations for the next 12 months and foreseeable future; significant future acquisitions could require additional financing. Q3 included a $1.0 million acquired in-process R&D charge for a steerable-snare project. The company also entered into or completed several product-technology licenses and asset purchases during 2015.
Key risks include execution and costs of the Tijuana transition, inventory obsolescence, acquisition integration and commercialization, product liability and regulatory matters, foreign-exchange exposure, debt and covenant constraints, and reliance on product and procedure markets. The company reported ordinary-course litigation and said it did not believe the matters were likely to be material, while acknowledging an unfavorable resolution could materially affect results or liquidity. Its annual goodwill impairment test, completed in Q3, found reporting-unit fair values above carrying amounts.
Important facts for investors to verify
- Progress on Tijuana production transfers, utilization timing, transition expenses and expected margin benefits.
- Whether revenue growth continues and whether cardiovascular operating profitability recovers from Q3’s decline.
- Inventory growth, inventory turns, operating cash conversion and capital spending needs.
- Debt repayment, borrowing availability, leverage covenant headroom and refinancing exposure at the December 2017 maturity.
- Acquired-product commercialization, contingent consideration, and any developments in litigation, regulatory or product-liability matters.