Business context and reporting period
Merit Medical Systems, Inc. filed this Form 10-K for the fiscal year ended December 31, 2016. It designs, manufactures and markets disposable medical devices for diagnostic and interventional procedures, reporting in cardiovascular and endoscopy segments. The filing also presents unaudited fourth-quarter results.
Financial performance and position
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Net sales | $603.8 million | $542.1 million |
| Gross profit / margin | $265.0 million / 43.9% | $235.8 million / 43.5% |
| Operating income / margin | $34.9 million / 5.8% | $37.5 million / 6.9% |
| Net income / diluted EPS | $20.1 million / $0.45 | $23.8 million / $0.53 |
| Cash from operating activities | $53.6 million | $69.5 million |
| Capital expenditures | $32.8 million | $51.0 million |
| Cash and equivalents at year-end | $19.2 million | $4.2 million |
| Working capital at year-end | $155.1 million | $116.1 million |
| Total debt at year-end | $325.0 million | $207.6 million |
Fourth-quarter 2016 sales were $157.7 million versus $138.4 million a year earlier; gross profit was $70.3 million versus $60.3 million; operating income was $12.6 million versus $8.1 million; and net income was $7.5 million versus $6.4 million. Diluted EPS was $0.17 versus $0.14.
International sales were $233.5 million, or 39% of revenue, up 9%. Cardiovascular sales rose 11.4% to $580.2 million; endoscopy sales rose 11.1% to $23.6 million. The top ten products accounted for about 39% of sales, and inflation devices accounted for about 12%.
Material changes versus the prior comparable period
- Annual sales increased 11.4%, while net income fell 15.5% and diluted EPS declined from $0.53 to $0.45. Operating income declined despite higher sales and gross margin.
- Gross margin improved 0.4 percentage points to 43.9%, helped by product mix and suspension of the U.S. medical-device excise tax; higher DFINE-related amortization partly offset the improvement.
- SG&A increased 17.9% to $184.4 million, including headcount growth, $4.5 million of acquisition/integration costs, $10.3 million of severance costs primarily related to DFINE, and $1.0 million responding to a DOJ inquiry. R&D increased 10.8% to $45.2 million.
- Operating cash flow decreased by $15.9 million. Investing cash outflow increased to $159.1 million, principally due to acquisitions. Financing provided $121.1 million, principally reflecting acquisition-related borrowing.
- Debt increased by approximately $117 million year over year, following the July 2016 credit agreement amendment and acquisitions. Year-end borrowings were $325 million, with about $95 million of additional borrowing available under the leverage-based limit.
Outlook, risks, contingencies and unusual items
Management expects continued growth from new products, international expansion and increased physician awareness, but provided no numeric revenue or earnings guidance. It plans approximately $35 million of 2017 capital expenditures and stated that cash, operating cash flow and available financing should fund planned operations for the next 12 months and foreseeable future. Direct-sales conversions may support pricing and growth but raise selling costs; acquired products, including Argon’s critical-care business, may dilute gross margin.
- In October 2016, the company received a DOJ subpoena concerning certain marketing and promotional practices. The investigation remained ongoing; the company said its scope, duration and outcome could not be predicted and disclosed substantial related costs.
- 2016 acquisitions included DFINE for an initial payment of $97.5 million and the HeRO Graft assets for $18.5 million. DFINE contributed $13.5 million of 2016 sales and had a reported pre-tax loss of approximately $6.8 million, excluding specified amortization. The company also acquired Argon critical-care assets and Catheter Connections assets in January 2017 for combined consideration of $48 million.
- Three FDA clinical trials were underway for expanded indications involving QuadraSphere microspheres, Embosphere microspheres and the EndoMAXX EVT stent. Approval or clearance depends on successful trial completion and FDA review.
- Key risks include debt covenants and floating-rate exposure, acquisition integration, foreign exchange, reimbursement and pricing pressure, regulation and product liability, supply constraints, and the possibility that competitor-related demand increases for certain lower-margin products may not persist. A competitor-related increase in demand had strained inventory, manufacturing capacity and allocation decisions.
- The medical-device excise tax was suspended for 2016 and 2017 and was scheduled to resume in 2018 absent further action. The 2017 outlook was also subject to uncertainty around healthcare, tax and trade policy, Brexit and currency movements.
The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting. Management and the auditor excluded DFINE from the 2016 internal-control assessment; DFINE represented 2.2% of annual sales and had been acquired in July.
Important facts for investors to verify
- Progress, costs and potential financial or legal consequences of the DOJ investigation.
- Whether DFINE integration and subsequent acquisitions deliver expected growth and synergies, and their effect on margins, cash flow and debt.
- Debt covenant headroom, refinancing and repayment requirements, and sensitivity to higher interest rates.
- Whether the elevated demand for certain products is sustained and whether production capacity can meet it without further margin or quality pressure.
- FDA trial outcomes and timing, and any changes to reimbursement, excise-tax suspension or other relevant healthcare rules.
- Cash conversion and inventory trends: inventory rose to $120.7 million, while inventory turns declined to 2.99 from 3.10.