Merit Medical Systems, Inc. — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; unaudited. Merit designs, manufactures and markets single-use medical products for interventional and diagnostic procedures. Its operating segments are cardiovascular and endoscopy. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $95.9 | $90.5 | $292.1 | $268.4 |
| Gross profit | $45.3 | $41.1 | $136.5 | $123.3 |
| Gross margin | 47.3% | 45.4% | 46.7% | 46.0% |
| Operating income | $9.1 | $6.5 | $25.3 | $27.6 |
| Net income | $7.2 | $4.6 | $19.1 | $18.1 |
| Diluted EPS | $0.17 | $0.11 | $0.45 | $0.47 |
- Q3 revenue increased 6.0%; nine-month revenue increased 8.8%. Cardiovascular revenue rose 5% in Q3 and 8% for the nine months; endoscopy revenue grew 29% and 31%, respectively.
- Q3 gross-margin improvement reflected production efficiencies, higher-margin product mix and stronger China sales. SG&A and R&D increased as a share of sales: nine-month SG&A was 30.3% versus 28.5%, and R&D was 6.9% versus 5.9%.
- Nine-month operating income declined despite higher sales and gross profit, partly reflecting increased selling and R&D costs and $2.5 million of acquired in-process R&D expense. Q3 acquired in-process R&D expense was $0.3 million versus $3.4 million a year earlier.
- The effective tax rate fell to 20.0% in Q3 from 31.7%, and to 26.0% for the nine months from 33.3%. Management attributed the decline to tax-reserve releases, deductions and credits, and a higher share of earnings in lower-tax foreign jurisdictions.
Cash flow, balance sheet and funding
- Nine-month operating cash flow was $32.2 million, versus $30.4 million. Investing cash outflow was $70.6 million, including $49.3 million of property and equipment spending, $1.1 million for patents and trademarks, and $23.6 million paid for acquisitions. Financing provided $37.8 million; cash declined $0.7 million to $9.5 million.
- Cash and cash equivalents were $9.5 million at September 30, 2012, versus $10.1 million at year-end 2011. Working capital was $96.3 million and the current ratio was 2.8 to 1. Receivables and inventory rose with sales; inventory increased $8.9 million to $78.8 million.
- Long-term debt increased to $64.5 million from $30.7 million at year-end. The company reported $60.5 million of additional borrowing availability and compliance with its debt covenants. Borrowing rates were fixed at 1.47% on $54.5 million and 1.48% on $10.0 million; the facility matures in September 2015.
- Capital spending for property and equipment was $49.3 million for the nine months. Management anticipated approximately $65 million for full-year 2012, including approximately $34 million for building construction. It reported $67.4 million incurred toward construction projects with an anticipated total cost of approximately $88 million.
Business developments, outlook and risks
- Management cited international markets as a key growth driver: international sales were 37% of nine-month revenue versus 35% in 2011. It planned further investment in China, India, Brazil, Russia, the Middle East, the Balkans and Pacific Rim markets.
- Endoscopy’s operating loss narrowed to $0.1 million in Q3 and $0.7 million for the nine months. Management linked improvement to sales growth and margin gains, and expected a new contract stent manufacturer by year-end to help margins if successful. No numerical earnings or revenue guidance was provided.
- Management identified several planned product launches and expected substantial sales growth over the next several years from the Merit Laureate hydrophilic guidewire. U.S. distribution resumed in September after FDA 510(k) clearance; in October, the FDA stated it appeared the company had addressed the violation in its February warning letter.
- Acquisition and product-rights activity included the Ostial Solutions asset purchase, Scion distribution rights, and smaller license, distribution and investment transactions. The Ostial deal includes up to $13.5 million in contingent payments tied to future sales; contingent consideration liabilities totaled $6.9 million at quarter-end. These estimates are remeasured using projected revenues and other significant assumptions.
- Key risks include medical-device regulation and product clearances, product liability and intellectual-property claims, execution and commercialization of acquisitions, customer/product concentration, foreign exchange, reimbursement and healthcare policy changes, supplier and inventory risks, and the ability to fund debt service and substantial capital spending. Most cash was held by foreign subsidiaries; transfers from China require government approval.
- A patent infringement dispute was settled during Q3 for an immaterial amount, with a fully paid-up license and no future settlement payments. The filing also corrected certain 2011 cash-flow statement line items; management said the correction was not material and did not affect cash balances, the balance sheet or income statement.
Important facts for investors to verify
- Whether planned capital expenditures, construction and acquisitions remain within available cash, operating cash flow and debt capacity.
- Whether revenue growth and gross-margin gains continue, particularly in international markets and endoscopy, and whether endoscopy reaches profitability.
- How contingent acquisition payments, acquired technology and product launches perform relative to management’s revenue assumptions.
- Whether cash held overseas is practically available for U.S. needs, and whether foreign-exchange movements, regulatory matters or debt covenants materially affect results.