Merit Medical Systems, Inc. — Q2 2018 Form 10-Q
Business context and reporting period. Merit designs, manufactures, and sells single-use medical products for interventional and diagnostic procedures. This unaudited filing covers the three and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods. Operations are reported in cardiovascular and endoscopy segments.
Financial performance
| Metric | Q2 2018 | Q2 2017 | H1 2018 | H1 2017 |
|---|---|---|---|---|
| Net sales | $224.8m | $186.5m | $427.8m | $357.6m |
| Gross profit / margin | $100.0m / 44.5% | $84.1m / 45.1% | $188.1m / 44.0% | $160.1m / 44.8% |
| Operating income | $15.1m | $13.4m | $23.9m | $19.0m |
| Net income | $10.9m | $9.5m | $16.2m | $24.3m |
| Diluted EPS | $0.21 | $0.19 | $0.31 | $0.50 |
| Operating cash flow | — | — | $35.0m | $34.6m |
Q2 sales increased 20.5%; H1 sales increased 19.6%. Cardiovascular sales rose 20.4% in Q2 and 19.7% in H1; endoscopy sales rose 22.3% and 18.2%, respectively. International sales were $100.4m in Q2 and $193.3m in H1, representing 44.6% and 45.2% of sales.
Gross margin declined year over year in both periods. Management attributed the reduction primarily to acquisition-related amortization, higher inventory obsolescence, and freight costs associated with building global supply. SG&A was $69.1m in Q2 and $134.0m in H1; R&D was $15.3m and $29.6m, respectively. The effective tax rate was 5.4% in Q2 and 9.6% in H1.
Liquidity, cash flow, and debt
- At June 30, cash and equivalents were $43.5m, current assets $371.0m, and current liabilities $139.6m. Working capital was $231.4m and the current ratio was 2.66, versus 2.73 at year-end 2017.
- H1 investing cash outflow was $162.5m, including $118.7m of net cash paid for acquisitions, $31.6m of property and equipment spending, and a $10.5m loan to NinePoint. Financing cash inflow was $138.1m.
- Total debt carrying value was $413.6m, including $22.0m current and $391.6m long-term. Borrowings under the principal credit agreement were approximately $407m, with about $47.8m of availability based on the required leverage ratio. The company reported compliance with its debt covenants.
- Of reported cash, $41.9m was held by foreign subsidiaries, including $22.9m in China, where transfer of funds abroad is subject to government approval. Management said existing cash, operating cash flows, and available borrowings should fund operations for the next 12 months and foreseeable future.
Material changes and notable items
- H1 net income fell to $16.2m from $24.3m, despite higher sales. The principal comparison effect was the $11.6m Argon bargain-purchase gain recognized in H1 2017, which did not recur; higher interest expense also weighed on 2018 results. Q2 net income, by contrast, increased to $10.9m from $9.5m.
- Merit acquired specified BD product-line assets for approximately $100.3m in February 2018; BD products generated $18.5m of H1 sales. Other 2018 developments included the DirectACCESS assets, QXMédical distribution rights, and NinePoint distribution and purchase-option agreement. NinePoint products generated approximately $1.1m of sales after the April agreement.
- Debt increased to fund acquisitions. Interest expense was $5.7m in H1, versus $4.3m a year earlier. A $175m interest-rate swap fixed part of the borrowing exposure; the company estimated that a one-percentage-point rate change would affect annual interest expense and pretax income by approximately $2.3m, assuming borrowings remained unchanged.
- On July 30, 2018, after quarter-end, Merit completed a 4.025m-share public offering, receiving approximately $205.4m net proceeds and using them primarily to repay revolving borrowings. Shares outstanding were 54,735,486 as of August 6, compared with 50.635m at June 30.
Outlook, risks, and contingencies
The filing provides no quantified full-year earnings or revenue guidance. Management expected remaining-2018 sales to benefit from awarded tenders, new product releases, and production of the Laurane product line in Ireland. It expected net income to benefit from manufacturing efficiencies, cost-saving measures, and biopsy and drainage product sales, partly offset by product mix, distributor-market growth, higher labor costs, and global logistics expenses. Management also cited increased demand for certain Merit products following a competitor’s supply shortages; the duration and extent of that demand are uncertain.
The Department of Justice investigation into marketing and promotional practices, initiated by a 2016 subpoena, remained ongoing. Merit incurred $3.3m of related legal expense in H1 2018 and said it could not predict the investigation’s scope, duration, or outcome; potential consequences could be material. The company also identified acquisition integration, regulatory clearance and compliance, product liability, inventory forecasting, currency exposure, debt restrictions, and healthcare-market pricing and reimbursement as risks. It reported no off-balance-sheet arrangements.
Investor verification points
- Determine how much reported sales growth reflects acquired businesses, foreign exchange, and underlying organic growth; management did not provide a consolidated organic-growth figure.
- Track whether gross-margin pressure from amortization, obsolescence, and freight moderates, and whether anticipated efficiencies and product launches support the stated outlook.
- Verify the post-quarter offering’s debt repayment, updated borrowings and interest costs, remaining facility availability, and any resulting leverage or dilution effects.
- Monitor receivables and inventory growth, operating cash conversion, and restrictions on access to foreign-held cash.
- Follow developments in the DOJ investigation, related legal spending, and any regulatory or litigation contingencies.