Merit Medical Systems, Inc. — 2019 Form 10-K
Business context and reporting period. Merit designs, manufactures and markets single-use medical devices for diagnostic and interventional procedures. It reports two segments: Cardiovascular and Endoscopy. This filing covers the fiscal year ended December 31, 2019; comparisons below are to 2018 unless stated otherwise.
Financial performance and liquidity
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net sales | $994.9 million | $882.8 million | +12.7% |
| Gross profit / margin | $432.4 million / 43.5% | $394.8 million / 44.7% | Margin down 1.2 percentage points |
| Operating income / margin | $15.4 million / 1.6% | $58.6 million / 6.6% | Down 73.7% |
| Income before taxes | $2.2 million | $49.5 million | Down 95.6% |
| Net income / diluted EPS | $5.5 million / $0.10 | $42.0 million / $0.78 | Down 87.0% / 87.2% |
| Operating cash flow | $77.8 million | $86.5 million | Down $8.7 million |
| Capital expenditures | $78.2 million | $63.3 million | Up $14.8 million |
| Cash and cash equivalents | $44.3 million | $67.4 million | Down $23.0 million |
| Long-term debt, including current portion | $439.5 million net carrying value; $440.0 million principal | $395.2 million net carrying value | Principal up $44.5 million |
| Working capital | $272.9 million | $254.5 million | Up $18.4 million |
Cardiovascular sales increased 13.1% to $961.0 million; Endoscopy sales increased 1.8% to $33.9 million. International sales were $419.1 million, or 42.1% of revenue, up 8.5%; China sales rose 22.2% to $113.3 million. The ten largest products generated approximately 32% of sales.
Cash provided by operations was below net income in 2019 in part because of increased inventory and receivables. Investing used $134.5 million, including $53.9 million for acquisitions; financing provided $33.5 million. The company reported approximately $133.8 million of additional borrowing capacity under its credit agreement, subject to leverage limits, and said cash, operating cash flow and available borrowings should fund planned operations for the next 12 months and foreseeable future.
Material changes and unusual items
- Despite revenue growth, profitability contracted sharply: gross margin declined, SG&A rose to 32.9% of sales from 31.3%, and operating margin fell to 1.6% from 6.6%.
- 2019 included a $20.5 million impairment of the NinePoint note receivable and purchase option, plus $1.6 million of accrued interest written off. The company decided not to exercise its option to acquire NinePoint; that option expired in January 2020. The NinePoint charge contributed to Endoscopy’s $10.3 million operating loss, versus $9.3 million operating income in 2018.
- Impairment and other charges totaled $23.8 million, including $3.3 million of acquired intangible-asset impairments. Amortization expense increased to $60.7 million from $41.2 million, largely reflecting acquisitions.
- The effective tax rate was (148.6%), with a $3.3 million income tax benefit, versus a 15.2% rate and $7.5 million tax expense in 2018. The filing attributes the 2019 benefit mainly to stock-option and deferred-compensation tax differences and the lapse of uncertain tax positions; the low pretax income magnified the rate.
- Acquisitions included Brightwater Medical and STD Pharmaceutical/Fibrovein. 2019 international sales growth and Cardiovascular performance also reflected acquired businesses and product lines, including a full year of Cianna Medical sales.
Outlook, management commentary and risks
- COVID-19: As of the filing date, management estimated a $14 million to $19 million adverse effect on worldwide first-quarter 2020 net sales. The filing cautions that the impact could worsen if the outbreak or containment measures continue.
- Cost actions and investment: Management planned to move production of 14 products to Mexico or Texas and consolidate four facilities during 2020–2021, estimating annual savings of $6 million to $10 million. Expected 2020 capital expenditures were approximately $50 million to $55 million.
- Growth and products: Management described international expansion, product development and operational efficiency as strategic priorities. It cited FDA Breakthrough Device Designation for the Wrapsody Endovascular Stent Graft System and ongoing product launches; the filing does not provide formal revenue or earnings guidance.
- Debt and rates: The $440 million credit facility matures July 2024, is secured by substantially all company assets, and includes leverage, interest-coverage and capital-expenditure covenants. Merit reported compliance at year-end. A portion of debt is floating-rate; interest-rate swaps hedge specified amounts. The company estimated a $2.7 million annual change in interest expense and pretax income for each one-percentage-point change in average rates, assuming the unhedged borrowing balance remains unchanged.
- Legal and governance matters: The DOJ investigation into marketing and promotional practices, initiated by a 2016 subpoena, remained ongoing and its outcome could not be predicted; 2019 related legal costs were $6.5 million. A December 2019 securities-law complaint named the company, CEO and CFO; management did not expect currently known litigation to be materially adverse, while acknowledging uncertainty. Starboard Value notified Merit in January 2020 that it intended to nominate up to seven directors.
- Other material risks: Regulatory approval and compliance (including the EU Medical Device Regulation transition), reimbursement and pricing pressure, acquisition integration, product liability, intellectual-property disputes, supply interruptions, foreign exchange, China exposure, cybersecurity, and dependence on key products and procedures. The company reported a $13.5 million adverse currency effect on 2019 sales and $76.7 million in contingent-consideration liabilities.
Important facts for investors to verify
- Whether the 2020 cost-saving plan is achieved, on schedule and net of restructuring costs, and whether capital spending remains within the stated range.
- Actual COVID-19 effects on sales, procedures, supply chains and China operations versus the preliminary first-quarter estimate.
- Underlying organic growth and margins apart from acquisitions, amortization, foreign exchange and the NinePoint impairment; also track Endoscopy recovery after its 2019 loss.
- Cash conversion, inventory and receivables growth, debt repayment capacity, covenant headroom and interest-rate exposure.
- Developments and potential financial consequences of the DOJ investigation, securities litigation and Starboard director nominations.
- Achievement and timing of contingent acquisition milestones, and continued recoverability of acquired goodwill and intangible assets.
The auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded disclosure controls and internal controls were effective as of December 31, 2019.