Merit Medical Systems, Inc. — Q2 2020 Form 10-Q
Business and period: Unaudited results for the three and six months ended June 30, 2020. Merit designs, manufactures and sells medical products for interventional and diagnostic procedures through its cardiovascular and endoscopy segments. The filing attributes significant operating disruption to COVID-19.
Financial performance
| Metric | Q2 2020 | Q2 2019 | H1 2020 | H1 2019 |
|---|---|---|---|---|
| Net sales | $218.4m | $255.5m | $461.9m | $493.9m |
| Gross profit | $84.2m | $112.0m | $188.0m | $216.6m |
| Gross margin | 38.6% | 43.8% | 40.7% | 43.9% |
| Operating income (loss) | $(19.0)m | $12.2m | $(17.6)m | $21.7m |
| Net income (loss) | $(19.1)m | $6.9m | $(22.2)m | $13.1m |
| Diluted EPS | $(0.34) | $0.12 | $(0.40) | $0.23 |
| Operating cash flow | H1: $73.2m | H1 2019: $35.7m |
Liquidity and debt: At June 30, cash and cash equivalents were $49.7m, versus $44.3m at year-end 2019. Current assets were $445.9m and current liabilities $174.2m. Debt outstanding under the credit agreement was approximately $410.9m; additional borrowing capacity was approximately $183.3m. The company reported covenant compliance. H1 capital expenditures were $25.8m; management anticipated full-year 2020 spending of approximately $50–55m on buildings, property and equipment.
Material changes and drivers
- Sales declined 14.5% in Q2 and 6.5% in H1 year over year. Management estimated COVID-19 reduced Q2 net sales by approximately $60m. Elective-procedure products were particularly affected; endoscopy sales fell 30.1% in Q2.
- Cardiovascular sales declined 14.0% in Q2 and 6.2% in H1; endoscopy sales declined 30.1% and 15.3%, respectively. Sales began improving near quarter-end, but the pace of recovery remained uncertain.
- Gross margin contracted, which management attributed to pandemic-related product mix, inventory obsolescence and acquired-intangible amortization, partly offset by manufacturing efficiencies. SG&A and R&D spending fell with cost reductions and lower discretionary spending.
- Q2 included $18.2m of legal settlement expense related to an agreement in principle with the Department of Justice. Impairment and other charges were $3.9m in Q2 and $7.7m in H1, including write-offs and impairments related to Bluegrass Vascular, ITL assets and a California lease.
- H1 operating cash flow rose to $73.2m, supported in part by lower receivables and higher accrued expenses, including the unpaid DOJ settlement accrual. Investing cash use was $27.4m; financing cash use was $39.2m, including $12.9m of contingent acquisition payments and lower net borrowings.
Outlook, risks and contingencies
- Management said existing cash, expected operating cash flow and available credit were expected to fund current and planned operations for the next 12 months and foreseeable future. No specific revenue or earnings guidance was provided.
- COVID-19 impacts remained difficult to predict, including procedure volumes, hospital access for sales representatives, customer and supplier conditions, and possible future impairment or reserve charges. The company implemented furloughs, headcount and salary reductions, deferred spending, delayed product launches and reduced R&D projects.
- The company began producing COVID-19 specimen swabs and transport vials; Q2 sales were approximately $4.4m. It also planned to close its Australian procedure-pack operations and was moving products and consolidating facilities.
- The DOJ agreement in principle contemplated an approximately $18.2m payment; Merit stated it denied the DOJ’s allegations. A securities class-action complaint against the company and two executives sought unspecified damages; the company intended to defend the case. No loss was recorded for that lawsuit because a potential loss was not considered probable or reasonably estimable.
- Other exposures include $69.1m of contingent consideration liabilities, foreign-exchange and variable-rate debt risk, and potential credit losses. The company disclosed an allowance for expected credit losses of $0.8m on notes receivable and its Selio lending commitment.
Investor verification priorities
- Track recovery in elective procedures and whether sales and gross margins rebound; assess the durability of the reported $4.4m swab contribution.
- Verify the final DOJ settlement terms and payment timing, and monitor developments in the securities litigation.
- Review inventory obsolescence, impairment assumptions and the results of subsequent goodwill and intangible-asset assessments.
- Monitor debt, borrowing availability, covenant headroom, contingent consideration payments and the planned $50–55m of 2020 capital spending.
- Assess whether operating cash flow remains strong after considering working-capital movements and the unpaid settlement accrual.