Merit Medical Systems, Inc. — Q2 2013 Form 10-Q
Business and period: Merit designs, manufactures, and markets single-use medical products for interventional and diagnostic procedures. This unaudited filing covers the quarter and six months ended June 30, 2013; balance-sheet comparisons are with December 31, 2012. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $109.9m | $100.5m | $213.8m | $196.2m |
| Gross profit / margin | $47.0m / 42.8% | $47.0m / 46.8% | $90.0m / 42.1% | $91.2m / 46.5% |
| Operating income | $6.8m | $8.2m | $8.5m | $16.2m |
| Net income | $3.8m | $6.1m | $4.4m | $11.8m |
| Diluted EPS | $0.09 | $0.14 | $0.10 | $0.28 |
- Revenue rose 9.3% in Q2 and 9.0% for the first half. Cardiovascular sales drove growth; Q2 cardiovascular revenue increased 9.7%, while endoscopy revenue declined 1.3%. Thomas Medical products contributed $7.1m of Q2 sales and $12.5m in the first half.
- Gross margin fell 4.0 percentage points in Q2 and 4.4 points for the half. Management cited lower production volumes, amortization of Thomas Medical developed technology, and the newly imposed Medical Device Excise Tax. First-half margin also included a one-time 0.3%-of-sales inventory markup; excluding it, management reported a 42.4% margin.
- Operating expenses increased overall: R&D rose to $8.6m in Q2 and $17.8m for the half, reflecting product-development and regulatory staffing, including Thomas Medical-related costs. SG&A declined as a percentage of sales, to 28.7% in Q2 and 29.8% for the half, after cost reductions. Endoscopy moved to operating profit of $0.1m in Q2 and $0.3m for the half, from losses in the comparable periods.
- Net income declined 38.4% in Q2 and 62.7% for the half. Management attributed the declines principally to lower gross margins, higher R&D spending, and higher interest expense. First-half effective tax rate was 15.2%, versus 29.2% a year earlier, benefiting from foreign earnings mix and the reinstated federal R&D credit.
Cash flow, liquidity, and debt
- For the six months, operating cash flow was $14.4m, down from $21.6m. Investing cash use was $32.0m, including $30.4m in property and equipment expenditures; financing provided $21.0m. Cash increased $3.4m to $13.1m.
- At June 30, working capital was $97.5m, the current ratio was 2.40, and current assets were $167.3m against current liabilities of $69.8m. Cash included $11.0m held by foreign subsidiaries; $8.9m was held in China, where transfers abroad require government approval.
- Debt totaled $256.8m ($97.5m term loan and $159.3m revolving borrowings), versus $237.6m at year-end. The company had approximately $15.7m of borrowing availability. A $150m interest-rate swap fixed the rate on that portion; disclosed June 30 rates on outstanding borrowings ranged from 2.45% to 3.23%.
- Covenant breach: The June 30 consolidated leverage ratio was 3.97:1, above the 3.50:1 limit. Wells Fargo subsequently waived the breach as of June 30; the company reported compliance with its other covenants. Debt is secured by substantially all company assets, and the agreement includes leverage, fixed-charge coverage, and capital-expenditure restrictions.
Outlook, risks, and unusual items
- Management expected to launch multiple products in 2013 and said earnings could grow if launches and cost initiatives succeed. It began approximately $4.5m of SG&A cost-cutting initiatives in Q2 and was reviewing planned R&D spending. No specific revenue or earnings guidance was provided.
- Management said existing cash, expected operating cash flow, remaining credit availability, and a potential approximately $24m sale-leaseback of its Pearland, Texas facility were expected to fund operations for the next 12 months and foreseeable future. It was discussing a credit-agreement amendment with Wells Fargo to improve leverage-covenant flexibility.
- Management cited reduced U.S. procedure counts and U.S. direct-sales growth, excluding Thomas Medical, of 2.3% in Q2 and 2.6% for the half. Other stated risks include product liability and recalls, regulatory and reimbursement changes, competition, acquisition integration and commercialization, inventory obsolescence, foreign-exchange movements, and the ability to generate cash for debt and investment needs.
- Thomas Medical, acquired in December 2012, added products and substantial acquired intangible assets; related amortization and acquisition financing affected current-period results. Contingent acquisition consideration was valued at $6.7m at June 30. Ordinary-course litigation was not considered likely to be material, though the filing notes an adverse resolution could have a material effect.
Important facts for investors to verify
- Whether the company obtains a covenant amendment and maintains compliance in subsequent quarters.
- Whether operating cash flow, margins, and leverage improve as production volumes recover and cost initiatives take effect.
- Whether planned product launches, Thomas Medical integration, and the potential facility sale-leaseback deliver the expected commercial and liquidity benefits.
- How much foreign cash is practically available for U.S. needs, and whether China transfer restrictions or other liquidity constraints change.