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MMSI > SEC Filings for MMSI > Form 10-Q on 9-Aug-2013All Recent SEC Filings

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Form 10-Q for MERIT MEDICAL SYSTEMS INC


9-Aug-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 the Credit 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 a substantial portion 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 our operations or financial condition; 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


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gastroenterology and pulmonology medical devices which assist in the palliative treatment of expanding esophageal, tracheobronchial and biliary strictures caused by malignant tumors.

For the quarter ended June 30, 2013, we reported record revenues of $109.9 million, up 9.3% from the three months ended June 30, 2012 of $100.5 million. Revenues for the six months ended June 30, 2013 were a record $213.8 million, compared to $196.1 million for the first six months of 2012, an increase of 9.0%.

Gross profit as a percentage of sales decreased to 42.8% and 42.1% for three and six-month periods ended June 30, 2013, respectively, compared to 46.8% and 46.5% for the three and six-month periods ended June 30, 2012, respectively. This decrease in gross profit for both periods was due to higher costs of approximately 1.4% and 1.8% of sales, respectively, resulting from lower production volumes for the first three and six months of 2013, amortization of developed technology costs of approximately 1.2% and 1.3% of sales, respectively, associated with the purchase of Thomas Medical, and the newly initiated Medical Device Excise Tax ("MDET") of approximately 1.0% of sales for both periods of 2013, which was part of the Affordable Care Act of 2010. During the six months ended June 30, 2013, we also had a non-recurring finished goods inventory mark-up costs of 0.3% 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 42.4% of sales for the six months ended June 30, 2013. Our gross profit for the second quarter of 2013 improved 140 basis points from the first quarter of 2013. This improvement was largely the result of higher production volumes in the second quarter of 2013, when compared to the first quarter 2013.

Net income for the three months ended June 30, 2013 was $3.8 million, or $.09 per share, compared to $6.1 million, or $.14 per share, for the three months ended June 30, 2012, a decrease of 38.4%. Net income for the six-month period ended June 30, 2013 was $4.4 million, or $.10 per share, compared to $11.8 million, or $0.28 per share, for the corresponding period of 2012. 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 an operating income of approximately $260,000 for the six months ended June 30, 2013, when compared to an operating loss of approximately $607,000 for the corresponding period of 2012. This increase in operating income for the six months ended June 30, 2013 was largely driven by lower operating expenses.

Several factors negatively affected our financial results for the three and six-month periods ended June 30, 2013. We experienced reduced U.S. medical procedure counts utilizing our products in the three and six-month periods ended June 30, 2013, as our overall U.S. direct sales growth was only up 2.3% and 2.6%, respectively (excluding Thomas Medical sales), when compared to the comparable periods of 2012. Our gross profit was negatively affected by higher costs from lower production volumes for three and six-month periods ended June 30, 2013, which increased our product costs, amortization of developed technology costs associated with the purchase of Thomas Medical, and the initiation of the MDET.

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 and the ConcierGE® Guiding Catheter. 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. During the second quarter of 2013, we began cost-cutting initiatives related to selling, general and administrative expenses of approximately $4.5 million, which we believe positively impacted our performance in the second quarter of 2013. We also believe these initiatives will increase our net income during the remainder of 2013. Our selling, general and administrative expenses decreased to 28.7% and 29.8% of sales for the three and six- month periods ended June 30, 2013, respectively, compared to 30.1% and 30.5% for the three and six-month periods ended June 30, 2012, respectively. 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 and six-month periods ended June 30, 2013 and 2012:
                                          Three Months Ended        Six Months Ended
                                               June 30,                 June 30,
                                          2013         2012        2013         2012
Net sales                                 100%         100%        100%         100%
Gross profit                              42.8         46.8        42.1         46.5
Selling, general, and administrative
expenses                                  28.7         30.1        29.8         30.5
Research and development expenses          7.9          6.6         8.3          6.6
Acquired in-process research and
development                                 -           2.0          -           1.1
Income from operations                     6.2          8.2         4.0          8.3
Other income (expense) - net              (1.6)         0.6        (1.6)         0.3
Income before income tax expense           4.6          8.8         2.4          8.5
Net income                                 3.4          6.1         2.1          6.0

Sales. Sales for the three months ended June 30, 2013 increased by 9.3%, or approximately $9.3 million, compared to the corresponding period of 2012. Sales for the six months ended June 30, 2013 increased by 9.0%, or approximately $17.7 million, compared to the corresponding period of 2012. Listed below are the sales by business segment for the three and six-month periods ended June 30, 2013 and 2012 (in thousands):

                                               Three Months Ended                      Six Months Ended
                                                    June 30,                               June 30,
                                % Change       2013          2012       % Change      2013          2012
Cardiovascular
Stand-alone devices                3%      $   30,286     $  29,495        2%      $  59,786     $  58,341
Custom kits and procedure trays    8%          26,277        24,224        8%         50,774        47,044
Inflation devices                (13)%         15,953        18,385       (9)%        31,562        34,858
Catheters                         18%          18,939        16,017       14%         36,234        31,730
Embolization devices             (12)%          7,431         8,439       (9)%        14,842        16,257
CRM/EP                             -%           7,067             -        -%         12,509             -
Total                             10%         105,953        96,560        9%        205,707       188,230

Endoscopy
Endoscopy devices                 (1)%          3,922         3,972        2%          8,116         7,920

Total                              9%      $  109,875     $ 100,532        9%      $ 213,823     $ 196,150

Our cardiovascular sales growth of 9.7% for the three months ended June 30, 2013, and 9.3% for the six months ended June 30, 2013, when compared to the corresponding periods of 2012, was largely the result of increased sales of our cardiac rhythm management ("CRM") and electrophysiology ("EP") products acquired from Thomas Medical ($7.1 million and $12.5 million for the three and six-month periods ended June 30, 2013, respectively), catheters (particularly our peritoneal dialysis catheter acquired from MediGroup, aspiration catheter product line, micro catheter product line and micro catheter product line) and custom kits and procedure trays.

Our endoscopy sales decreased 1.3% for the three months ended June 30, 2013, and increased 2.5% for the six months ended June 30, 2013, when compared to the corresponding periods of 2012. The decrease in sales for the second quarter of 2013, when compared to the second quarter of 2012, was primarily the result of lower sales of OEM bipolar coagulation probes. The increase in sales for the six months ended June 30, 2013, when compared to the corresponding period in 2012, was primarily related to an increase in our sales of the EndoMAXX™ fully covered esophageal stent.

Gross Profit. Gross profit as a percentage of sales decreased to 42.8% and 42.1% for three and six-month periods ended June 30, 2013, respectively, compared to 46.8% and 46.5% for the three and six-month periods ended June 30, 2012, respectively. This decrease in gross profit for both periods was due primarily to higher costs of approximately 1.4% and 1.8% of sales, respectively, resulting principally from lower production volumes for the first three and six months of 2013, amortization of developed technology costs of approximately 1.2% and 1.3% of sales, respectively, associated with the purchase of Thomas Medical, and the newly-


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initiated MDET of approximately 1.0% of sales for both periods in 2013. During the six months ended June 30, 2013, we also had non-recurring finished goods inventory mark-up costs of 0.3% 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 42.4% of sales for the six months ended June 30, 2013.

Operating Expenses. Selling, general and administrative expenses decreased to 28.7% of sales for the three months ended June 30, 2013, from 30.1% of sales for the three months ended June 30, 2012. Selling, general and administrative expenses decreased to 29.8% of sales for the six months ended June 30, 2013, compared with 30.5% of sales for the six months ended June 30, 2012. The decrease in both periods was primarily due to the implementation of cost-cutting initiatives in expenses such as reduced headcount, shows and conventions, 401(k) employer match, and bonuses.

Research and Development Expenses. Research and development expenses increased to 7.9% of sales for the three months ended June 30, 2013, compared with 6.6% of sales for the three months ended June 30, 2012. Research and development expenses increased to 8.3% of sales for the six months ended June 30, 2013, compared to 6.6% of sales for the six months ended June 30, 2012. The increase in research and development expenses for both periods 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 and six months ended June 30, 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 or loss by business segment for the three and six-month periods ended June 30, 2013 and 2012, respectively (in thousands):

                            Three Months Ended           Six Months Ended
                                 June 30,                    June 30,
                             2013           2012        2013         2012
Operating Income (Loss)
Cardiovascular          $    6,649        $ 8,499     $  8,277    $ 16,836
Endoscopy                      131           (277 )        260        (607 )
Total operating income  $    6,780        $ 8,222     $  8,537    $ 16,229

Cardiovascular Operating Income. During the three months ended June 30, 2013, we reported income from operations of approximately $6.6 million from our cardiovascular business segment, compared to income from operations of approximately $8.5 million for the corresponding period of 2012. For the six months ended June 30, 2013, we reported income from operations of approximately $8.3 million from our cardiovascular business segment, compared to income from operations of approximately $16.8 million for the corresponding period of 2012. When compared to the prior year periods, operating income for the three and six-month periods ended June 30, 2013 was unfavorably affected by lower gross margins and increases in research and development expenses.

Endoscopy Operating Income (Loss). During the three months ended June 30, 2013, we reported income from operations of approximately $131,000 from our endoscopy business segment, compared to a loss from operations of approximately $277,000 for the corresponding period of 2012. For the six months ended June 30, 2013, we reported income from operations of approximately $260,000 from our endoscopy business segment, compared to a loss from operations of approximately $607,000 for the corresponding period of 2012. The improvement in operating income (loss) for the three and six-month periods ended June 30, 2013, when compared to the corresponding periods of 2012, was largely driven by lower operating expenses.

Other Income (Expense) - Net. Other expense for the three months ended June 30, 2013 was approximately $1.8 million, compared to other income of approximately $592,000 for the corresponding period in 2012. Other expense for the six months ended June 30, 2013 was approximately $3.3 million, compared to other income of approximately $502,000 for the corresponding period in 2012. The net increase in other expense for both periods was principally the result of higher average outstanding debt balances and the corresponding increase in interest expense and the absence of any gain on sales of marketable securities, compared to approximately $648,000 of gains on sales of marketable securities recognized during the three and six-month periods ended June 30, 2012.

Income Taxes. Our overall effective tax rate for the three months ended June 30, 2013 was 25.0%, compared to 30.8% for the corresponding period of 2012. For the six months ended June 30, 2013, our effective tax rate was 15.2%, compared to 29.2% for


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the corresponding period of 2012. The effective income tax rates for the three and six-month periods ended June 30, 2013, when compared to the corresponding periods of 2012, were lower, primarily as a result of a higher mix of earnings from our foreign operations, which are taxed at a lower rate than our U.S. operations. In addition, the effective tax rate for the six months ended June 30, 2013, relative to the tax rate for the corresponding period of 2012, was favorably affected by the reinstatement of the federal research and development credit for the 2012 tax year. The credit was reinstated by the American Taxpayer Relief Act of 2012, which was signed on January 2, 2013. We recognized the research and development credit for 2012 as a discrete benefit in the first quarter of 2013, the period in which the reinstatement was enacted.

Net Income. During the three months ended June 30, 2013, we reported net income of approximately $3.8 million, compared to net income of approximately $6.1 million for the corresponding period of 2012. For the six months ended June 30, 2013, we reported net income of approximately $4.4 million, compared to net income of approximately $11.8 million for the corresponding period of 2012. The decrease in net income for the three and six-month periods ended June 30, 2013 was primarily attributable 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 June 30, 2013 and December 31, 2012 was $97.5 million and $89.0 million, respectively. The increase in working capital during the six months ended June 30, 2013 was primarily the result of increases in cash and cash equivalents and trade receivables and decreases in accrued expenses, which were partially offset by decreases in inventories. As of June 30, 2013, we had a current ratio of 2.40 to 1.

At June 30, 2013 and December 31, 2012, we had cash and cash equivalents of approximately $13.1 million and $9.7 million respectively, of which approximately $11.0 million and $8.1 million, respectively, were held by foreign subsidiaries. For each of 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 June 30, 2013 and December 31, 2012, we had cash and cash equivalents of approximately $8.9 million and $6.4 million, respectively, held by our subsidiary in China.

During the six months ended June 30, 2013, our inventory balances decreased by approximately $3.0 million, from $84.6 million at December 31, 2012 to $81.6 million at June 30, 2013. The decrease was primarily the result of an effort to improve inventory turns company wide.

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 June 30, 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 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


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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 June 30, 2013, we failed to comply with the Consolidated Total Leverage Ratio under our Credit Agreement (the "Leverage Covenant"), as our actual ratio was 3.97 to 1; however, Wells Fargo subsequently granted to us a . . .

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