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MMSI > SEC Filings for MMSI > Form 10-Q on 10-May-2013All Recent SEC Filings

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Form 10-Q for MERIT MEDICAL SYSTEMS INC


10-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Disclosure Regarding Forward-Looking Statements

This Report includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements in this Report, other than statements of historical fact, are forward-looking statements for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of our management for future operations, any statements concerning proposed new products or services, any statements regarding the integration, development or commercialization of the business or assets acquired from other parties, any statements regarding future economic conditions or performance, and any statements of assumptions underlying any of the foregoing. All forward-looking statements included in this Report are made as of the date hereof and are based on information available to us as of such date. We assume no obligation to update any forward-looking statement. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "plans," "anticipates," "intends," "believes," "estimates," "potential," or "continue," or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that any such expectation or any forward-looking statement will prove to be correct. Our actual results will vary, and may vary materially, from those projected or assumed in the forward-looking statements. Our financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including risks relating to product recalls and product liability claims; potential restrictions on our liquidity or our ability to operate our business by our current debt agreement, and the consequences of any default under that agreement; possible infringement of our technology or the assertion that our technology infringes the rights of other parties; the potential imposition of fines, penalties, or other adverse consequences if our employees or agents violate the U.S. Foreign Corrupt Practices Act or other laws or regulations; expenditures relating to research, development, testing and regulatory approval or clearance of our products and the risk that such products may not be developed successfully or approved for commercial use; greater governmental scrutiny and regulation of the medical device industry; reforms to the 510(k) process administered by the U.S. Food and Drug Administration (the "FDA"); laws targeting fraud and abuse in the healthcare industry; potential for significant adverse changes in, or our failure to comply with, governing regulations; increases in the price of commodity components; negative changes in economic and industry conditions in the United States and other countries; termination or interruption of relationships with our suppliers, or failure of such suppliers to perform; our potential inability to successfully manage growth through acquisitions, including the inability to commercialize technology acquired through recent, proposed or future acquisitions; fluctuations in Euro and GBP exchange rates; our need to generate sufficient cash flow to fund our debt obligations, capital expenditures, and ongoing operations; concentration of our revenues among a few products and procedures; development of new products and technology that could render our existing products obsolete; market acceptance of new products; volatility in the market price of our common stock; modification or limitation of governmental or private insurance reimbursement policies; changes in health care markets related to health care reform initiatives; failures to comply with applicable environmental laws; changes in key personnel; work stoppage or transportation risks; uncertainties associated with potential healthcare policy changes which may have a material adverse effect on Merit; introduction of products in a timely fashion; price and product competition; availability of labor and materials; cost increases; fluctuations in and obsolescence of inventory; and other factors referred to in our Annual Report on Form 10-K for the year ended December 31, 2012 and other materials filed with the Securities and Exchange Commission. All subsequent forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Actual results will differ, and may differ materially, from anticipated results. Financial estimates are subject to change and are not intended to be relied upon as predictions of future operating results, and we assume no obligation to update or disclose revisions to those estimates. Additional factors that may have a direct bearing on our operating results are discussed in Part I, Item 1A "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2012.

OVERVIEW

The following discussion and analysis of our financial condition and results of operation should be read in conjunction with the consolidated financial statements and related condensed notes thereto, which are included in Part I of this Report.

We design, develop, manufacture and market single-use medical products for interventional and diagnostic procedures. For financial reporting purposes, we report our operations in two operating segments: cardiovascular and endoscopy. Our cardiovascular segment consists of cardiology and radiology devices which assist in diagnosing and treating coronary arterial disease, peripheral vascular disease and other non-vascular diseases and includes our embolotherapeutic products. Our endoscopy segment consists of gastroenterology and pulmonology medical devices which assist in the palliative treatment of expanding esophageal, tracheobronchial and biliary strictures caused by malignant tumors.


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We reported record revenues for the quarter ended March 31, 2013. Revenues for the quarter ended March 31, 2013 were $103.9 million, up 8.7% over revenues of $95.6 million for the three months ended March 31, 2012.

Gross profit as a percentage of sales decreased to 41.4% for the first quarter of 2013, compared to 46.2% for the first quarter of 2012. This decrease was due to higher costs of 1.9% of sales resulting from lower production volumes for the first quarter of 2013, amortization of developed technology costs of 1.3% of sales associated with the purchase of Thomas Medical, the newly initiated Medical Device Excise Tax ("MDET") of 1.0% of sales which was part of the Affordable Care Act of 2010, and non-recurring finished goods inventory mark-up costs of 0.6% of sales related to the Thomas Medical acquisition. Excluding the non-recurring Thomas Medical finished goods inventory mark-up costs, gross margins would have been 42.0% of sales for the first quarter of 2013.

Net income for the three months ended March 31, 2013 was $671,000, compared to $5.7 million for the three months ended March 31, 2012, a decrease of 88.3%. The decrease was primarily attributable to lower gross margins, increased investments in research and development and higher interest expense included in other expenses.

Our endoscopy segment made significant progress and generated its first operating income of $129,000 for the quarter ended March 31, 2013, when compared to the operating loss of approximately $331,000 for the corresponding period of 2012. This increase in operating income for the quarter ended March 31, 2013 was largely driven by an increase in sales and gross margins and lower operating expenses.

Several factors negatively affected our first quarter 2013 financial results. We experienced reduced U.S. medical procedure counts utilizing our products in the first quarter of 2013, as our overall U.S. direct sales growth was only up 2.3% (excluding Thomas Medical sales) when compared to the first quarter of 2012. Our OEM sales during the first quarter of 2013 that were attributable to products we acquired as a result of our acquisition of Thomas Medical Products, Inc. ("Thomas Medical") in December of 2012 were lower than we anticipated, primarily due to customers having excess inventory that they had purchased in December, prior to our acquisition, to meet incentive quotas. Our gross profit was negatively affected by higher costs from lower production volumes for the first quarter, which increased our product costs, and the initiation of the MDET. We continue to make significant investments in research and development in an effort to launch new products with higher gross margins.

We believe our earnings will grow going forward if we are successful with the release of new products and the implementation of cost cutting initiatives we have initiated. We expect to launch a number of new products in 2013, including the TIO™ Three-in-One Oral Airway Bite Block, the One Snare™ Single-Loop Device, the basixTOUCH™ Inflation Device, the PHD™ Hemostasis Valve, the PreludeEASE™ Hydrophilic Radial Sheath, the ASAP LP™ Aspiration Catheter, the Worley™ Snare System, the Bearing™ NS PVA Embolization Particles, Steerable EP Sheath, the DialEase™ Splittable Sheath, the EndoMAXX EDT™ Esophageal Stent, the Merit SureCross™ Support Catheter and the ConcierGE® Guiding Catheter. We have begun cost cutting initiatives related to selling, general and administrative expenses of approximately $4.5 million which we believe will increase our net income going forward in 2013. We also intend to review certain of our planned research and development expenses in an effort to identify opportunities to cut expenses or delay certain projects to reduce our research and development expenses as a percentage of overall sales.


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Results of Operations

The following table sets forth certain operational data as a percentage of sales
for the three-month periods ended March 31, 2013 and 2012:
                                               Three Months Ended
                                                    March 31,
                                                2013        2012
Net sales                                       100%        100%
Gross profit                                    41.4        46.2
Selling, general, and administrative expenses   30.9        30.9
Research and development expenses               8.8          6.7
Acquired in-process research and development     -           0.2
Income from operations                          1.7          8.4
Other expense - net                            (1.5)       (0.09)
Income before income tax expense                0.2          8.3
Net income                                      0.6          6.0

Sales. Sales for the three months ended March 31, 2013 increased by 8.7%, or approximately $8.3 million, compared to the first three months of 2012. Listed below are the sales by business segment for the quarters ended March 31, 2013 and 2012 (in thousands):

                                              Three Months Ended
                                                  March 31,
                                % Change       2013         2012
Cardiovascular
Stand-alone devices                2%      $    29,499    $ 28,847
Custom kits and procedure trays    7%           24,497      22,820
Inflation devices                 (5)%          15,609      16,473
Catheters                         10%           17,295      15,713
Embolization devices              (5)%           7,412       7,817
CRM/EP                             -%            5,442           -
Total                              9%           99,754      91,670

Endoscopy
Endoscopy devices                  6%            4,194       3,948

Total                              9%      $   103,948    $ 95,618

Our cardiovascular sales increased $8.1 million, or approximately 9%, for the quarter ended March 31, 2013 on sales of approximately $99.8 million, compared to sales of $91.7 million for the corresponding period of 2012. This improvement was largely the result of increased sales of our cardiac rhythm management ("CRM") and electrophysiology ("EP") products acquired from Thomas Medical of $5.4 million, custom kits and procedure trays and catheters (particularly our peritoneal dialysis catheter acquired from MediGroup and micro catheter product line).

Our endoscopy sales increased 6% for the quarter ended March 31, 2013, on sales of approximately $4.2 million, when compared to the corresponding period of 2012 of approximately $3.9 million, primarily related to an increase in our sales EndoMAXX™ fully covered esophageal stent.

Gross Profit. Gross profit as a percentage of sales was down to 41.4% for the first quarter of 2013, compared to 46.2% for the first quarter of 2012. This decrease was due primarily to higher costs of 1.9% of sales resulting from lower production volumes for the first quarter of 2013 as the result of a company-wide objective to improve inventory turns, amortization of developed technology costs of 1.3% of sales associated with the purchase of Thomas Medical, the MDET of 1.0% of sales, and non-recurring finished goods inventory mark-up costs of 0.6% of sales related to the Thomas Medical acquisition. Excluding the non-recurring finished goods inventory mark-up costs, gross margins would have been 42.0% of sales for the first quarter of 2013.

Operating Expenses. Selling, general, and administrative expenses remained essentially unchanged at 30.9% of sales for the three months ended March 31, 2013, compared with 30.9% of sales for the three months ended March 31, 2012.


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Research and Development Expenses. Research and development expenses were 8.8% of sales for the three months ended March 31, 2013, compared with 6.7% of sales for the three months ended March 31, 2012. The increase in research and development expenses, when compared to the first three months of 2012, was primarily due to headcount additions for research and development to support new products, personnel increases in the regulatory department to support registrations in foreign countries to expand international product offerings, and research and development costs associated with the acquisition of Thomas Medical.

During the three months ended March 31, 2013, we did not record any charges for acquired in-process research and development.

Operating Income (Loss). The following table sets forth our operating income
(loss) by business segment for the quarters ended March 31, 2013 and 2012 (in thousands):

                            Three Months Ended
                                 March 31,
                             2013           2012
Operating Income (Loss)
Cardiovascular          $    1,628        $ 8,338
Endoscopy                      129           (331 )
Total operating income  $    1,757        $ 8,007

Cardiovascular Operating Income. During the first quarter of 2013, we reported income from operations of approximately $1.6 million from our cardiovascular business segment, compared to income from operations of approximately $8.3 million for the corresponding period of 2012. The decrease in operating income was primarily affected by lower gross margins, increases in research and development expenses and higher interest expense included in other expenses.

Endoscopy Operating Income (Loss). During the first quarter of 2013, we reported income from operations of approximately $129,000 from our endoscopy business segment, compared to a loss from operations of approximately $331,000 for the corresponding period of 2012. The increase in operating income was primarily the result of higher sales and gross margins, and lower operating expenses.

Other Expense - Net. Other expense for the first quarter of 2013 was approximately $1.5 million, compared to other expense of approximately $90,000 for the first quarter of 2012. The increase in other expense for the first quarter of 2013, when compared to the first quarter of 2012, was principally the result of higher average outstanding debt balances and the corresponding increase in interest expense.

Income Taxes. Our overall effective tax rate for the three months ended March 31, 2013 was (217.2)% compared to 27.4% for the three months ended March 31, 2012. Our provision for income taxes for the three months ended March 31, 2013 totaled $459,000 of benefit compared to $2.2 million of expense for the corresponding period of 2012. The fluctuation was primarily driven by a decrease in income before tax and a discrete tax benefit of approximately $500,000 associated with the estimated benefit of the federal research and development credit for 2012. On January 2, 2013, the American Taxpayer Relief Act of 2012, which included a reinstatement of the federal research and development credit for the tax year ended December 31, 2012, was signed into law. As a result, we recognized the retroactive benefit of the federal research and development credit for 2012 as a discrete item in the first quarter of 2013, the period in which the reinstatement was enacted.

Net Income. During the first quarter of 2013, we reported net income of $671,000, a decrease of 88.3% from $5.7 million for the first quarter of 2012. The decrease in net income was attributable primarily to lower gross margins, and higher operating costs, principally higher investments in research and development and higher interest expense included in other expenses.

Liquidity and Capital Resources

Our working capital as of March 31, 2013 and December 31, 2012 was $100.9 million and $89.0 million, respectively. The increase in working capital during the three months ended March 31, 2013 was primarily the result of decreases in trade payables and accrued expenses and increases in trade receivables and prepaid expenses, which were partially offset by decreases in inventories. As of March 31, 2013, we had a current ratio of 2.65 to 1.

At March 31, 2013 and December 31, 2012, we had cash and cash equivalents of approximately $9.0 million and $9.7 million respectively, of which approximately $8.6 million and $8.1 million, respectively, were held by foreign subsidiaries. For each of


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our foreign subsidiaries, we make an assertion as to whether the earnings are intended to be repatriated to the United States or held by the foreign subsidiary for permanent reinvestment. The cash held by our foreign subsidiaries for permanent reinvestment is generally used to fund the operating activities of our foreign subsidiaries and for further investment in foreign operations. We have accrued a deferred tax liability on our consolidated financial statements for the portion of our foreign earnings that are available to be repatriated to the United States.

In addition, cash held by our subsidiary in China is subject to local laws and regulations that require government approval for the transfer of such funds to entities located outside of China. As of March 31, 2013 and December 31, 2012, we had cash and cash equivalents of approximately $7.3 million and $6.4 million, respectively, held by our subsidiary in China.

During the three months ended March 31, 2013, our inventory balances decreased by approximately $2.1 million, from $84.6 million at December 31, 2012 to $82.5 million at March 31, 2013. The decrease was primarily the result of an effort to improve inventory turns company wide.

We entered into an Amended and Restated Credit Agreement, dated as of December 19, 2012 (the "Credit Agreement"), with the lenders who are or may become party thereto (the "Lenders") and Wells Fargo Bank, National Association, as administrative agent for the Lenders ("Wells Fargo"). Pursuant to the terms of the Credit Agreement, the Lenders have agreed to make revolving credit loans up to an aggregate amount of $175 million. The Lenders also made a term loan in the amount of $100 million, repayable in quarterly installments of $2.5 million until the maturity date of December 19, 2017, at which time the term loan and revolving credit loans, together with accrued interest thereon, will be due and payable. In addition, certain mandatory prepayments are required to be made upon the occurrence of certain events described in the Credit Agreement. Wells Fargo has agreed to make swingline loans from time to time through the maturity date of December 19, 2017 in amounts equal to the difference between the amounts actually loaned by the Lenders and the aggregate revolving credit commitment. The Credit Agreement is collateralized by substantially all of our assets. As of March 31, 2013, Wells Fargo was the sole Lender under the Credit Agreement.

On December 19, 2017, all principal, interest and other amounts outstanding under the Credit Agreement are payable in full. At any time prior to the maturity date, we may repay any amounts owing under all revolving credit loans, term loans, and all swingline loans in whole or in part, subject to certain minimum thresholds, without premium or penalty, other than breakage costs.

The Credit Agreement contains customary covenants, representations and warranties and other terms customary for revolving credit loans of this nature. In this regard, the Credit Agreement requires us to not, among other things, (a) permit the Consolidated Total Leverage Ratio (as defined in the Credit Agreement) to be greater than 3.5 to 1 as of any fiscal quarter ending during 2013, greater than than 3.35 to 1 as of any fiscal quarter ending during 2014, greater than 3 to 1 as of any fiscal quarter ending during 2015, greater than 2.75 to 1 as of any fiscal quarter ending during 2016, and greater than 2.5 to 1 as of any fiscal quarter ending thereafter; (b) for any period of four consecutive fiscal quarters, permit the ratio of Consolidated EBITDA (as defined in the Credit Agreement and subject to certain adjustments) to Consolidated Fixed Charges (as defined in the Credit Agreement) to be less than 1.75 to 1;
(c) subject to certain adjustments, permit Consolidated Net Income (as defined in the Credit Agreement) for certain periods to be less than $0; or (d) subject to certain conditions and adjustments, permit the aggregate amount of all Facility Capital Expenditures (as defined in the Credit Agreement) in any fiscal year beginning in 2013 to exceed $30 million. Additionally, the Credit Agreement contains various negative covenants with which we must comply, including, but not limited to, limitations respecting: the incurrence of indebtedness, the creation of liens or pledges on our assets, mergers or similar combinations or liquidations, asset dispositions, the repurchase or redemption of equity interests and debt, the issuance of equity, the payment of dividends and certain distributions, the entrance into related party transactions and other provisions customary in similar types of agreements. As of March 31, 2013, we failed to comply with the Consolidated Total Leverage Ratio under our Credit Agreement (the "Leverage Covenant"), as our actual ratio was 3.60 to 1; however, Wells Fargo subsequently granted to us a waiver with respect to the Leverage Covenant as of March 31, 2013. Our failure to comply with the Leverage Covenant as of March 31, 2013 was due primarily to several factors that negatively affected our first quarter 2013 financial results. We saw slower U.S. medical procedure counts utilizing our products in the first quarter of 2013, as our overall U.S. direct sales growth was only up 2.3% (excluding Thomas Medical sales) when compared to the first quarter of 2012. Our OEM sales during the first quarter of 2013 that were attributable to products we acquired as a result of our acquisition of Thomas Medical was less than anticipated, primarily due to customers having excess inventory that they had purchased in December, prior to our acquisition, to meet incentive quotas. Our gross profit was negatively affected by higher costs from lower production volumes for the first quarter which increased our product costs and the initiation of the MDET. We continue to make significant investments in research and development in an effort to launch new products with higher gross margins. With the exception of our failure to comply with the Leverage Covenant as of March 31, 2013, which has been waived by Wells Fargo, we were in compliance with all other covenants under the Credit Agreement as of March 31, 2013.


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As of March 31, 2013, we had available borrowings under the Credit Agreement of approximately $18.2 million. Our interest rate under the Credit Agreement as of March 31, 2013 was a fixed rate of 2.98% on $150.0 million as a result of an interest rate swap, a variable floating rate of 2.21% on $97.5 million and a variable floating rate of 2.29% on approximately $6.8 million.

Capital expenditures for property and equipment were approximately $19.6 million and $17.7 million, for the quarters ended March 31, 2013 and 2012, respectively.

Currently, our primary sources of liquidity are cash flows from operations and borrowings under our Credit Agreement (approximately $18.2 million of borrowing availability as of March 31, 2013). We are currently in discussions with Wells Fargo regarding a possible amendment to our Credit Agreement in order to provide us with greater flexibility in the application of the Leverage Covenant. Those discussions are based, in part, on the business and operational challenges we encountered during the quarter ended March 31, 2013, and are intended to reduce the possibility of future defaults under the Leverage Covenant. We currently believe that our existing cash balances, anticipated future cash flows from operations and borrowings under the Credit Agreement will be adequate to fund our current and currently planned future operations for the next twelve months and the foreseeable future.


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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Critical Accounting Policies

The SEC has requested that all registrants address their most critical accounting policies. The SEC has indicated that a "critical accounting policy" is one which is both important to the representation of the registrant's financial condition and results and requires management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We base our estimates on past experience and on various other assumptions our management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results will differ, and may differ materially from these estimates under different assumptions or conditions. Additionally, changes in accounting estimates could occur in the future from period to period. Our management has discussed the development and selection of our most critical financial estimates with the audit committee of our Board of Directors. The following paragraphs identify our most critical accounting policies:

Inventory Obsolescence. Our management reviews on a quarterly basis inventory . . .

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