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MMSI > SEC Filings for MMSI > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for MERIT MEDICAL SYSTEMS INC

Form 10-Q for MERIT MEDICAL SYSTEMS INC


12-Nov-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-


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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, as amended, 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; potential disruption of our operations due to severe weather conditions or natural disasters; 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, including 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.

For the quarter ended September 30, 2013, we reported record revenues of $115.2 million, up 20.1% from the three months ended September 30, 2012 of $95.9 million. Revenues for the nine months ended September 30, 2013 were a record $329.0 million, compared to $292.1 million for the first nine months of 2012, an increase of 12.7%.

Gross profit as a percentage of sales decreased to 44.3% and 42.9% for the three and nine-month periods ended September 30, 2013, respectively, compared to 47.3% and 46.7% for the three and nine-month periods ended September 30, 2012, respectively. The reduction in gross profit for both periods was due primarily to higher costs of approximately 1.5% and 1.7% of sales, respectively, resulting from lower production volumes for the three and nine months ended September 30, 2013, amortization of developed technology costs of approximately 1.2% of sales for both periods of 2013 associated with our acquisition of Thomas Medical in December 2012, and the effect of the newly-initiated Medical Device Excise Tax ("MDET") of approximately 1.0% of sales for both periods of 2013, which was assessed pursuant to the provisions of the Affordable Care Act of 2010. During the three and nine months ended September 30, 2013, we also had non-recurring finished goods inventory mark-up costs of 0.1% and 0.2% of sales, respectively, related to the Thomas Medical acquisition. Excluding the non-recurring Thomas Medical finished goods inventory mark-up costs, gross margins would have been 44.4% and 43.1% of sales, respectively, for the three and nine months ended September 30, 2013. Our gross profit for the third quarter of 2013 improved 150 basis points from the second quarter of 2013. This improvement was largely the result of higher production volumes in the third quarter of 2013, when compared to the second quarter of 2013.


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During the three and nine months ended September 30, 2013, we reduced the amount of the contingent consideration liability related to the Ostial PRO Stent Positioning System, which we acquired in January 2012, by approximately $3.8 million. Under the terms of the Asset Purchase Agreement we executed with Ostial Solutions, LLC ("Ostial"), we are obligated to make contingent purchase price payments based on a percentage of future sales of products utilizing the Ostial PRO Stent Positioning System. The adjustment to the contingent consideration liability triggered a review of our Ostial intangible assets, which resulted in an intangible asset write-down of approximately $8.1 million related to those assets. These adjustments reduced operating income for each of the three and nine-month periods ended September 30, 2013 by approximately $4.3 million, or approximately $2.7 million net of tax. The reduction of the Ostial contingent consideration liability and the impairment of the Ostial intangible assets was the result of our assessment that we are not likely to generate the level of revenues from sales of the Ostial PRO Stent Positioning System that we anticipated at the acquisition date.

Net income for the three months ended September 30, 2013 was $5.6 million, or $.13 per share, compared to $7.2 million, or $.17 per share, for the three months ended September 30, 2012. Net income for the nine-month period ended September 30, 2013 was $10.0 million, or $0.23 per share, compared to $19.1 million, or $0.45 per share, for the corresponding period of 2012. The decrease was primarily attributable to the write-down of intangible assets and reduction of contingent consideration liability related to the Ostial PRO Stent Positioning System, lower gross margins, and higher interest expense included in other expenses. Excluding the write-down of intangible assets and contingent consideration liability related to the Ostial PRO Stent Positioning System of approximately $4.3 million, or approximately $2.7 million net of tax, net income for the three and nine months ended September 30, 2013 would have been approximately $8.3 million and $12.7 million, respectively.

Our endoscopy segment made significant progress and generated operating income of approximately $638,000 and $897,000, respectively, for the three and nine months ended September 30, 2013, when compared to an operating loss of approximately $87,000 and $694,000, respectively, for the corresponding periods of 2012. This increase in operating income for the three and nine months ended September 30, 2013 was largely driven by higher sales and lower operating expenses associated with the endoscopy segment.

Subsequent to the quarter ended September 30, 2013, we completed asset acquisitions from Datascope Corporation for approximately $27.5 million (which consisted primarily of the SAFEGUARD® Pressure Assisted Device and AIR-BAND™ Radial Compression Device) and from Radial Assist, LLC (which consisted primarily of the RAD BOARD®, RAD BOARD®XTRA™, RAD TRAC™, and RAD REST® devices) for $2.5 million. The trailing twelve-month revenues attributable to the assets we acquired in these two acquisitions were approximately $7.5 million. We believe these products will assist us in our efforts to provide a complete offering for radial artery access procedures, which is a growing market in the U.S. and internationally.

We expect to launch a number of new products during the remainder of 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 ASAP LP™ Aspiration Catheter, the Worley™ Snare System, the Bearing nsPVA™ Embolization Particles, the DialEase™ Splittable Sheath, the EndoMAXX EDT™ Esophageal Stent and the ConcierGE® Guiding Catheter. We believe our earnings will increase 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 had a positive impact on our financial performance for the three and nine-month periods ended September 30, 2013. Our selling, general and administrative expenses decreased to 27.2% and 28.9% of sales for the three and nine-month periods ended September 30, 2013, respectively, compared to 30.1% and 30.3% for the three and nine-month periods ended September 30, 2012, respectively.


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Results of Operations

The following table sets forth certain operational data as a percentage of sales
for the three and nine-month periods ended September 30, 2013 and 2012:
                                          Three Months Ended       Nine Months Ended
                                            September 30,            September 30,
                                          2013         2012        2013         2012
Net sales                                 100%         100%        100%         100%
Gross profit                              44.3         47.3        42.9         46.7
Selling, general, and administrative
expenses                                  27.2         30.1        28.9         30.3
Research and development expenses          6.3          7.4         7.6          6.9
Intangible asset impairment charge         7.0           -          2.5           -
Contingent consideration benefit          (3.6)          -         (1.2)          -
Acquired in-process research and
development                                 -           0.3          -           0.8
Income from operations                     7.3          9.5         5.1          8.7
Other income (expense) - net              (1.7)          -         (1.6)         0.2
Income before income tax expense           5.6          9.4         3.5          8.8
Net income                                 4.9          7.5         3.0          6.5

Sales. Sales for the three months ended September 30, 2013 increased by 20.1%, or approximately $19.3 million, compared to the corresponding period of 2012. Sales for the nine months ended September 30, 2013 increased by 12.7%, or approximately $37.0 million, compared to the corresponding period of 2012. Listed below are the sales by business segment for the three and nine-month periods ended September 30, 2013 and 2012 (in thousands):

                                               Three Months Ended                      Nine Months Ended
                                                 September 30,                           September 30,
                                % Change       2013           2012      % Change      2013          2012
Cardiovascular
Stand-alone devices               15%      $    31,792     $ 27,528        7%      $  91,577     $  85,869
Custom kits and procedure trays   15%           26,389       22,915       10%         77,163        69,959
Inflation devices                 (4)%          16,450       17,092       (8)%        48,012        51,950
Catheters                         17%           18,779       16,082       15%         55,013        47,812
Embolization devices               6%            8,977        8,489       (4)%        23,819        24,746
CRM/EP                             -%            8,472            -        -%         20,982             -
Total                             20%          110,859       92,106       13%        316,566       280,336

Endoscopy
Endoscopy devices                 14%            4,351        3,801        6%         12,467        11,721

Total                             20%      $   115,210     $ 95,907       13%      $ 329,033     $ 292,057

Our cardiovascular sales growth of 20.4% for the three months ended September 30, 2013, and 12.9% for the nine months ended September 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 ($8.5 million and $21.0 million for the three and nine-month periods ended September 30, 2013, respectively), catheters (particularly our peritoneal dialysis catheter acquired from MediGroup, Prelude® sheath product line and micro catheter product line), custom kits and procedure trays, and stand alone devices (particularly our Merit Laureate® hydrophilic guide wires and EN Snare® endovascular snare).

Our endoscopy sales increased 14.5% for the three months ended September 30, 2013, and increased 6.4% for the nine months ended September 30, 2013, when compared to the corresponding periods of 2012. The increase in sales for the three and nine-month periods ended September 30, 2013, when compared to the corresponding periods of 2012, was primarily the result of sales of our EndoMAXX™ fully-covered esophageal stent.

Gross Profit. Gross profit as a percentage of sales decreased to 44.3% and 42.9% for the three and nine-month periods ended September 30, 2013, respectively, compared to 47.3% and 46.7% for the three and nine-month periods ended September 30, 2012, respectively. The reduction in gross profit for both periods was due primarily to higher costs of approximately 1.5% and 1.7% of sales, respectively, resulting principally from lower production volumes for the three and nine months ended September 30, 2013,


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amortization of developed technology costs of approximately 1.2% of sales for both periods of 2013, associated with the purchase of Thomas Medical, and the effects of the MDET of approximately 1.0% of sales for both periods of 2013. During the three and nine months ended September 30, 2013, we also had non-recurring finished goods inventory mark-up costs of 0.1% and 0.2% of sales, respectively, related to the products we acquired in the Thomas Medical acquisition. Excluding the non-recurring Thomas Medical finished goods inventory mark-up costs, gross margins would have been 44.4% and 43.1% of sales, respectively, for the three and nine months ended September 30, 2013. Our gross profit for the third quarter of 2013 improved 150 basis points from the second quarter of 2013. This improvement was largely the result of higher production volumes in the third quarter of 2013, when compared to the second quarter of 2013.

Operating Expenses. Selling, general and administrative expenses decreased to 27.2% of sales for the three months ended September 30, 2013, from 30.1% of sales for the three months ended September 30, 2012. Selling, general and administrative expenses decreased to 28.9% of sales for the nine months ended September 30, 2013, compared with 30.3% of sales for the nine months ended September 30, 2012. The decrease in both periods was primarily due to the implementation of cost-cutting initiatives in expenses such as shows and conventions, 401(k) employer matching contributions, and bonuses. During the three and nine months ended September 30, 2013, we recorded an intangible write-down of approximately $8.1 million related to the acquisition of our Ostial PRO Stent Positioning System. In connection with this write-down, we lowered the contingent consideration liability related to this acquisition by approximately $3.8 million. These adjustments increased operating expenses for the three and nine months ended September 30, 2013 by approximately $4.3 million.

Research and Development Expenses. Research and development expenses decreased to 6.3% of sales for the three months ended September 30, 2013, compared with 7.4% of sales for the three months ended September 30, 2012. This decrease was primarily the result of an Irish government research and development benefit related to our new Vision building in Galway, Ireland. Research and development expenses increased to 7.6% of sales for the nine months ended September 30, 2013, compared to 6.9% of sales for the nine months ended September 30, 2012. The increase in research and development expenses for the nine months ended September 30, 2013 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 our acquisition of Thomas Medical.

During the three and nine months ended September 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 nine-month periods ended September 30, 2013 and 2012, respectively (in thousands):

                            Three Months Ended           Nine Months Ended
                               September 30,               September 30,
                             2013           2012         2013         2012
Operating Income (Loss)
Cardiovascular          $    7,753        $ 9,169     $  16,031    $ 26,005
Endoscopy                      638            (87 )         897        (694 )
Total operating income  $    8,391        $ 9,082     $  16,928    $ 25,311

Cardiovascular Operating Income. During the three months ended September 30, 2013, we reported income from operations of approximately $7.8 million from our cardiovascular business segment, compared to income from operations of approximately $9.2 million for the corresponding period of 2012. For the nine months ended September 30, 2013, we reported income from operations of approximately $16.0 million from our cardiovascular business segment, compared to income from operations of approximately $26.0 million for the corresponding period of 2012. When compared to the prior-year periods, operating income for the three and nine-month periods ended September 30, 2013 was unfavorably affected by a write-down of intangible assets, offset partially by a decrease in the associated contingent consideration liability, related to the Ostial PRO Stent Positioning System and lower gross margins.

Endoscopy Operating Income (Loss). During the three months ended September 30, 2013, we reported income from operations of approximately $638,000 from our endoscopy business segment, compared to a loss from operations of approximately $87,000 for the corresponding period of 2012. For the nine months ended September 30, 2013, we reported income from operations of approximately $897,000 from our endoscopy business segment, compared to a loss from operations of approximately $694,000 for the corresponding period of 2012. The improvement in operating results for the three and nine-month periods ended September 30, 2013, when compared to the corresponding periods of 2012, was largely driven by lower operating expenses.


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Other Income (Expense) - Net. Other expense for the three months ended September 30, 2013 was approximately $2.0 million, compared to other expense of approximately $45,000 for the corresponding period in 2012. Other expense for the nine months ended September 30, 2013 was approximately $5.3 million, compared to other income of approximately $457,000 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 $745,000 of gains on sales of marketable securities recognized during the three and nine-month periods ended September 30, 2012.

Income Taxes. Our overall effective tax rate for the three months ended September 30, 2013 was 12.9%, compared to 20.0% for the corresponding period of 2012. For the nine months ended September 30, 2013, our effective tax rate was 14.0%, compared to 26.0% for the corresponding period of 2012. The effective income tax rates for the three and nine-month periods ended September 30, 2013, when compared to the corresponding periods of 2012, were lower as a result of a higher mix of earnings from our foreign operations, which are taxed at lower rates than our U.S. operations, and the release of reserves for uncertain tax positions due to statute of limitation expirations. In addition, the effective tax rate for the nine months ended September 30, 2013 was lower than the corresponding prior-year period due to 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 federal research and development credit 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 September 30, 2013, we reported net income of approximately $5.6 million, compared to net income of approximately $7.2 million for the corresponding period of 2012. For the nine months ended September 30, 2013, we reported net income of approximately $10.0 million, compared to net income of approximately $19.1 million for the corresponding period of 2012. The decrease was primarily attributable to a write-down of intangible assets, offset partially by a decrease in the associated contingent consideration liability, related to the Ostial PRO Stent Positioning System acquisition, lower gross margins and higher interest expense included in other expenses.

Liquidity and Capital Resources

Our working capital as of September 30, 2013 and December 31, 2012 was $98.9 million and $89.0 million, respectively. The increase in working capital during the nine months ended September 30, 2013 was primarily the result of a decrease in trade payables, mostly from the outstanding amounts related to the completion of our Rex and Anita Bean Building at our headquarters facility. As of September 30, 2013, we had a current ratio of 2.6 to 1.

At September 30, 2013 and December 31, 2012, we had cash and cash equivalents of approximately $9.1 million and $9.7 million respectively, of which approximately $8.5 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 September 30, 2013 and December 31, 2012, we had cash and cash equivalents of approximately $7.4 million and $6.4 million, respectively, held by our subsidiary in China.

During the nine months ended September 30, 2013, our inventory balances decreased by approximately $3.5 million, from $84.6 million at December 31, 2012 to $81.1 million at September 30, 2013. The decrease was primarily the result of an effort to improve inventory turns throughout our company.

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 . . .

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