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MMSI > SEC Filings for MMSI > Form 10-K on 12-Mar-2014All Recent SEC Filings

Show all filings for MERIT MEDICAL SYSTEMS INC

Form 10-K for MERIT MEDICAL SYSTEMS INC


12-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

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 Notes thereto, which are included in Item 8 of this report. Although our financial statements are prepared in accordance with accounting principles which are generally accepted in the United States of America ("GAAP"), our management believes that certain non-GAAP financial measures provide investors with useful information regarding the underlying business trends and performance of our ongoing operations, and can be useful for period-over-period comparisons of such operations. Included in our management's discussion and analysis of our financial condition and results of operation are references to some non-GAAP financial measures. Readers should consider these non-GAAP measures in addition to, not as a substitute for, financial reporting measures prepared in accordance with GAAP. These non-GAAP financial measures exclude some, but not all, items that may affect our net income. Additionally, these financial measures may not be comparable with similarly-titled measures of other companies.

OVERVIEW

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 the embolotherapeutic products we acquired through our acquisition of BioSphere. Our endoscopy segment consists of gastroenterology and pulmonology devices which assist in the palliative treatment of expanding esophageal, tracheobronchial and biliary strictures caused by malignant tumors.

For the year ended December 31, 2013, we reported record sales of approximately $449.0 million, up approximately $54.8 million or 13.9%, over 2012 sales of approximately $394.3 million. Gross profits as a percentage of sales was 43.3% for the year ended December 31, 2013, compared to 46.2% for the year ended December 31, 2012.

During the year ended December 31, 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, 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 the intangible assets we acquired from Ostial, which resulted in an intangible asset write-down of approximately $8.1 million related to those assets. These adjustments reduced operating income for year ended December 31, 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 year ended December 31, 2013 was approximately $16.6 million, or $0.39 per share, as compared to $19.7 million, or $0.46 per share, for the year ended December 31, 2012.

Our endoscopy segment made significant progress and generated operating income of approximately $1.2 million for the year ended December 31, 2013, when compared to an operating loss of approximately $770,000 for the year ended December 31, 2012. This increase in operating income for the year ended December 31, 2013 over the prior year was largely driven by higher sales and lower operating expenses associated with the endoscopy segment.

During the year ended December 31, 2013, we completed the construction of two new buildings in the U.S. to expand our production, warehouse and administration offices. The new South Jordan, Utah building of 253,000 square feet was completed in February of 2013 and the new Pearland, Texas facility of 94,000 square was completed in December of 2013. We anticipate that the additional costs associated with the operation of our new Texas facility could increase our selling, general and administrative expenses and could decrease gross profits and earnings for 2014. We believe the total impact of such costs will be approximately $3.0 to $3.5 million. Some of the building costs will be expensed into selling, general and administrative costs as opposed to cost of sales, during a transition period of approximately six months, as we believe it will take this long to complete the movement and qualification of production equipment from the old facility into the new facility. We anticipate that our new U.S. facilities will allow us to expand our manufacturing operations for new and existing products and increase our research and development pilot lab capacity for new product development, given the growth we are experiencing in our international markets.

During the fourth quarter of 2013, we acquired from Datascope the Safeguard Pressure Assisted Device, which assists in obtaining and maintaining hemostasis after a femoral procedure, and the Air-Band Radial Compression Device, which is indicated to assist hemostasis of the radial artery puncture site while maintaining visibility. During the fourth quarter of 2013, we also purchased from Radial Assist, the Rad Board, Rad Board Xtra, Rad Trac, and Rad Rest devices. The Rad Board is designed to


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provide a larger work space for physicians and an area for patients to rest their arms during radial procedures. The Rad Board Xtra is designed to work in conjunction with the Rad Board by extending the usable work space and allowing for a 90-degree perpendicular extension of the arm for physicians who prefer doing procedures at a 90-degree angle. The Rad Trac is also designed to be used with the Rad Board and facilitates easy placement and removal of the Rad Board with the patient still on the table. The Rad Rest is a disposable, single-use product designed to stabilize the arm by ergonomically supporting the elbow, forearm and wrist during radial procedures. With the purchase of these products for radial procedures, along with our existing radial products and those under development, we plan to launch a complete line of radial approach products to a U.S. market which is growing rapidly and to an international market where, in some countries, this procedure accounts for more that 50% of percutaneous coronary interventions.

We intend to continue to invest in emerging international markets such as Brazil, Russia, India and China, in an effort to expand our market opportunities.

RESULTS OF OPERATIONS

The following table sets forth certain operational data as a percentage of sales for the years indicated:

                                              2013    2012   2011
Net sales                                     100%    100%   100%
Gross profit                                  43.3    46.2   46.0
Selling, general, and administrative expenses 28.6    31.0   29.1
Research and development expenses              7.5    7.0    6.1
Acquired in-process research and development    -     0.6    1.6
Intangible asset impairment charge             1.8     -      -
Contingent consideration benefit              (0.9)    -      -
Income from operations                         6.2    7.5    9.2
Income before income taxes                     4.4    7.0    9.1
Net income                                     3.7    5.0    6.4

Listed below are the sales by product category within each business segment for the years ended December 31, 2013, 2012 and 2011 (in thousands):

                          % Change      2013       % Change      2012       % Change      2011
Cardiovascular
Stand-alone devices         10%      $ 125,445       12%      $ 114,242       15%      $ 101,959
Custom kits and procedure
trays                       10%        103,700        3%         94,586       11%         91,532
Inflation devices           (4)%        66,182        2%         68,979        8%         67,353
Catheters                   16%         75,131       17%         64,878       23%         55,357
Embolization devices        (1)%        33,395        8%         33,870       247%        31,229
CRM/EP                     1,359%       28,271        -%          1,938        -%              -
Total                       14%        432,124        9%        378,493       21%        347,430

Endoscopy
Endoscopy devices            7%         16,925       31%         15,795       33%         12,019

Total                       14%      $ 449,049       10%      $ 394,288       21%      $ 359,449

Cardiovascular Sales. Our cardiovascular sales for the year ended December 31, 2013 were approximately $432.1 million, up 14.2%, when compared to the corresponding period for 2012 of approximately $378.5 million. Sales for the year ended December 31, 2013 were favorably affected by sales of our cardiac rhythm management ("CRM") and electrophysiology ("EP") products acquired from Thomas Medical of $26.3 million, an increase in sales of our stand-alone devices (particularly our Merit LaureateŽ


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hydrophilic guide wires, newly-acquired Safeguard product and EN Snare endovascular snare) of approximately $11.2 million, or 9.8%; an increase in sales of catheter devices (particularly our peritoneal dialysis catheter acquired from MediGroup, micro catheter product line, Prelude sheath product line and Maestro microcatheter) of approximately $10.2 million, or 15.8%; and an increase in sales of custom kits and procedure trays of approximately $9.1 million, or 9.6%. Our cardiovascular sales for the year ended December 31, 2012 were approximately $378.5 million, up 8.9%, when compared to the corresponding period for 2011 of approximately $347.4 million. Cardiovascular sales for the year ended December 31, 2012 were favorably affected by an increase in sales of our stand-alone devices (particularly our hemostasis valves, guidewires and Scion Clo-SurPLUS P.A.D.) of approximately $12.3 million, or 12.0%; an increase in sales of catheter devices (particularly our Prelude sheath product line, micro catheter product line, aspiration catheter product line and diagnostic catheters) of approximately $9.5 million, or 17.2%; and an increase in custom kits and procedure trays of approximately $3.1 million, or 3.3%. Our cardiovascular sales for the year ended December 31, 2011 were approximately $347.4 million, up 20.8%, when compared to the corresponding period for 2010 of approximately $287.7 million. Cardiovascular sales for the year ended December 31, 2011 were favorably affected by an increase in sales of our embolization devices of approximately $22.2 million, or 246.9%, compared to $9.0 million for the three and one-half months in 2010, an increase in sales of our stand-alone devices (particularly our Merit Laureate Hydrophilic guide wire, hemostasis valves and manifolds) of approximately $13.4 million, or 15.1%; and increased sales of catheter devices (particularly our Prelude sheath product line, aspiration catheter product line and diagnostic catheter product line) of approximately $10.5 million, or 23.5%.

Our cardiovascular sales increased during 2013, 2012 and 2011, notwithstanding the fact that the markets for many of our products experienced slight pricing declines as our customers tried to reduce their costs. Substantially all of the increases in our revenues during the three years were attributable to increased unit sales. Sales by our European direct sales force are subject to foreign currency exchange rate fluctuations between the natural currency of a foreign country and the U.S. Dollar. Foreign currency exchange rate fluctuations increased sales by 0.2% in 2013 compared to 2012, decreased sales by 0.7% in 2012 compared to 2011, and decreased sales by 0.5% in 2011 compared to 2010. New products and market share gains in our existing product lines were additional sources of revenue growth.

Endoscopy Sales. Our endoscopy sales for the year ended December 31, 2013 were approximately $16.9 million, up 7.2%, when compared to sales in the corresponding period of 2012 of approximately $15.8 million. This increase was primarily the result of sales of our EndoMAXX Fully-Covered Esophageal stent. Our endoscopy sales for the year ended December 31, 2012 were approximately $15.8 million, up 31.4%, when compared to sales in the corresponding period of 2011 of approximately $12.0 million. This increase was primarily related to the increase sales related to our new EndoMAXX Fully-Covered Esophageal Stent. Our endoscopy sales for 2011 were approximately $12.0 million, compared to 2010 sales of approximately $9.0 million. This increase was due primarily to an increase in sales of approximately $2.4 million of our AeroŽ Tracheobronchial stent, in large part accelerated by a competitor's withdrawal from the airway stent market.

International Sales. International sales for the year ended December 31, 2013 were approximately $165.8 million, or 37% of total sales, up 13.3% from the same period in 2012; international sales for the year ended December 31, 2012 were approximately $146.3 million, or 37% of total sales, up 16.2% from the same period in 2011; and international sales for the year ended December 31, 2011 were approximately $125.9 million, or 35% of total sales, up 32.2% from the same period in 2010. The increase in our international sales during 2013 was primarily related to year-over-year sales increases in China of approximately $5.4 million, up 20%; Europe Direct of approximately $5.3 million, up 13% (would have been up 11% in constant currency); and Russia of approximately $2.4 million, up 54%. The increase in our international sales during 2012 was primarily related to year-over-year sales increases in China of approximately $5.9 million, up 29%; Europe Direct of approximately $2.7 million, up 7% (would have been up 16% in constant currency); United Arab Emirates ("UAE") of approximately $2.0 million, up 55%; Russia of approximately $1.8 million, up 67%; Japan of approximately $1.8 million, up 14%; and Brazil of approximately $1.7 million, up 50%. The increase in our international sales during 2011 was primarily related to year-over-year sales increases in Europe Direct of approximately $9.7 million, up 31%; China of approximately $8.1 million, up 66%; Europe, the Middle East, and Africa ("EMEA") distributor of approximately $5.6 million, up 46%; and Pacific Rim (excluding China) of approximately $4.8 million, up 21%. Our total European direct sales were approximately $46.2 million, $42.6 million, and $39.9 million in 2013, 2012, and 2011, respectively.

Gross Profit. Our gross profit as a percentage of sales was 43.3%, 46.2%, and 46.0% in 2013, 2012 and 2011, respectively. The decrease in gross profit in 2013 was primarily related to amortization of developed technology costs of 1.3% associated with the Thomas Medical and Datascope acquisitions, implementation of the Medical Device Excise Tax of 1.0% which was part of the Affordable Care Act, and higher standard costs of 0.9% resulting from lower production volumes at the beginning of 2013. Gross profit for 2012, compared to the corresponding period of 2011, remained relatively unchanged. The increase in gross profit in 2011 was attributable primarily to an increase in sales of higher-margin BioSphere products of approximately 1.9% of sales and higher prices and unit sales through our distribution system in China of approximately 0.6% of sales.


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Selling, General and Administrative Expenses. Our selling, general and administrative expenses increased approximately $6.5 million, or 5.4%, in 2013 compared to 2012; approximately $17.6 million, or 17%, in 2012 compared to 2011; and approximately $16.9 million, or 19%, in 2011 compared to 2010. The decrease in selling, general and administrative as a percentage of sales of 28.6% for 2013, when compared to 2012 of 31.0%, was primarily related to the implementation of cost-cutting initiatives in expenses such as trade shows and conventions, 401(k) employer match and bonuses. The increase in selling, general and administrative expenses in 2012, compared to 2011, was primarily due to the hiring of additional domestic and international sales and marketing representatives, in an effort to expand our sales distribution and increase market share for new and existing products. In connection with the Thomas Medical acquisition, we incurred approximately $2.7 million, or 0.7% of total sales, in non-recurring severance costs and acquisition costs included in selling, general and administrative costs for 2012. The increase in selling, general and administrative expenses in 2011 was primarily related to the addition of sales and marketing employees, trade show expenses, commission payments and amortization of intangibles relating to the BioSphere acquisition and commencement of our Chinese distribution system. Selling, general and administrative expenses as a percentage of sales were 28.6% (28.0% if not for approximately $489,000 and approximately $2.4 million, respectively, of non-recurring transaction costs attributable to acquisitions and severance expenses), 31.0% (30.3 % without non-recurring Thomas Medical acquisition costs), and 29.1% in 2013, 2012 and 2011, respectively.

Research and Development Expenses. Research and development expenses increased by 21.9% to approximately $33.9 million in 2013, compared to approximately $27.8 million in 2012. The increase in research and development expenses for the year ended December 31, 2013 was primarily due to research and development costs associated with the acquisition of the products we acquired from Thomas Medical, headcount additions for research and development to support new product development, and personnel increases in Merit's regulatory department to support registrations in foreign countries to expand international product offerings. Research and development expenses increased by 26.7% to approximately $27.8 million in 2012, compared to approximately $21.9 million in 2011. The increase was primarily due to headcount additions for our research and development group to support new products and personnel increases in our regulatory department to support product registrations in foreign countries as we expanded our international sales distribution. Research and development expenses increased 43.1% to approximately $21.9 million in 2011, compared to approximately $15.3 million in 2010. The increase was primarily related to headcount additions to support various new product launches, regulatory costs for seeking product approvals from the FDA and international regulatory agencies, additional regulatory costs incurred for the start-up of our Hi-Quality clinical trial and the development of several new products for our endoscopy product line. Our research and development expenses as a percentage of sales were 7.5% for 2013, 7.0% for 2012, and 6.1% for 2011. We have a pipeline of new products and we believe that we have an effective level of capabilities and expertise to continue the flow of new internally-developed products into the future with average gross margins that are higher than our historical gross margins.

During 2012, we incurred in-process research and development charges of approximately $2.5 million related to the purchase of several new product technologies. These technologies included the purchase of four patents for the development of future products, primarily a new cross-support catheter and an exclusive license for certain nanotechnology. During 2011, we incurred in-process research and development charges of approximately $5.8 million related to the purchase of several new product technologies. These technologies included the acquisition of intellectual property for a vena cava filter for $1.0 million, flexible sheath technology for approximately $1.9 million, and support guide catheter technology for $2.0 million. In addition to these acquisitions, we abandoned the development of certain biomaterial technology and our covered biliary in-process research and development, resulting in charges of $500,000 and $400,000, respectively, during the year ended December 31, 2011.

Our operating profits by business segment for the years ended December 31, 2013, 2012 and 2011 were as follows (in thousands):

                          2013         2012         2011
Operating Income (Loss)
Cardiovascular          $ 26,597    $ 30,411     $ 38,010
Endoscopy                  1,247        (770 )     (4,820 )
Total operating income  $ 27,844    $ 29,641     $ 33,190

Cardiovascular Operating Income. Our cardiovascular operating income for the year ended December 31, 2013 was approximately $26.6 million, compared to operating income of approximately $30.4 million for the year ended December 31, 2012. The decrease was due primarily to lower gross profits during the year ended December 31, 2013. Our cardiovascular operating income for the year ended December 31, 2012 was approximately $30.4 million, compared to operating income of approximately $38.0 million for the year ended December 31, 2011. The decrease was due primarily to higher selling, general and administrative expenses and higher research and development expenses during the year ended December 31, 2012. Our cardiovascular operating


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income for the year ended December 31, 2011 was approximately $38.0 million, compared to operating income of approximately $30.2 million for the year ended December 31, 2010. The increase was favorably affected by higher sales and gross margins, and was negatively affected by higher selling, general and administrative expenses, research and development expenses and acquired in-process research and development expenses.

Endoscopy Net Operating Income (Loss). Our endoscopy net operating income from operations for the year ended December 31, 2013 was approximately $1.2 million, compared to a net operating loss of approximately $770,000 for the year ended December 31, 2012. The generation of net operating income for 2013, compared to a net operating loss for 2012, was largely driven by higher sales and lower operating expenses. Our endoscopy net operating loss from operations for the year ended December 31, 2012 was approximately $770,000, compared to an operating loss of approximately $4.8 million for the year ended December 31, 2011. The decrease in net operating loss from operations for 2012, compared to 2011, was favorably affected by higher sales and gross margins, lower research and development expenses and was negatively affected by higher selling, general and administrative expenses as we added some additional sales representatives to this segment. Our endoscopy net operating loss from operations for the year ended December 31, 2011 was approximately $4.8 million, compared to an operating loss of approximately $13.0 million for the year ended December 31, 2010. Excluding the abandonment of certain biomaterial technology and our covered biliary in-process research and development, which resulted in charges of $500,000 and $400,000, respectively, our net operating loss for the year ended December 31, 2011 would have been $3.9 million. Excluding a goodwill impairment charge of approximately $8.3 million that we recognized during 2010, our net operating loss for 2010 would have been approximately $4.6 million. Excluding these non-recurring charges, the decrease in our 2011 operating loss was favorably affected by higher sales and gross margins, which were partially offset by higher research and development expenses and selling, general and administrative expenses.

Our effective income tax rates for 2013, 2012 and 2011 were 16%, 29% and 30%, respectively. During 2013, our effective tax rate was 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. In addition, the 2013 effective tax rate was lower than the 2012 rate, due primarily to the reinstatement in 2013 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 2013, the period in which the reinstatement was enacted. During 2012, our effective tax rate was negatively impacted by a valuation allowance related to a capital loss carryforward. Excluding the effect of this discrete item, our 2012 effective tax rate would have been approximately 25%. The decrease in the effective income tax rate for the year ended December 31, 2012, when compared to 2011, was the result of a higher mix of foreign income, which is primarily due to our income in Ireland being taxed at a lower rate than our U.S. income. The increase in the effective income tax rate for 2011 compared to 2010 was primarily related to the increased profit of our U.S. operations, which are taxed at a higher rate than our foreign (primarily Ireland) income. Our other expense for the years ended December 2013, 2012, and 2011 was approximately $8.0 million, $2.0 million, and $315,000, respectively. The increase in other expenses for 2013 over 2012 was principally the result of higher average outstanding debt balances and the corresponding increase in interest expense. The increase in other expenses for 2012 over 2011 related primarily to the write-off of approximately $2.4 million of a cost-method investment, which was partially offset by a gain on marketable securities of approximately $745,000. The decrease in other expenses for 2011 over 2010 was primarily the result of cash balances maintained in China, which resulted in increased interest income and foreign exchange gains recognized with the appreciation in the Chinese Yuan, all of which was partially offset by higher interest expenses.
Our net income for 2013, 2012, and 2011 was approximately $16.6 million, $19.7 million, and $23.0 million, respectively. The decrease in net income for 2013, when compared to 2012, was primarily related to lower gross profits, partially offset by lower selling, general and administrative expenses as a percent of sales. Our 2013 net income included intangible asset impairment charges, net of fair value reductions to the related contingent consideration liability, of approximately $4.3 million or approximately $2.7 million net of tax, severance expense of approximately $1.8 million or approximately $1.1 million net of tax, and Thomas Medical's mark-up on finished goods of approximately $744,000 or approximately $461,000 net of tax. Excluding these charges, our 2013 net income would have been $20.9 million, compared to $24.0 million of net income in 2012, excluding the extraordinary items discussed below. The decrease in net income for 2012, when compared to 2011, was unfavorably affected by higher selling, general and administrative expenses and higher research and development expenses. Our 2012 net income included charges related to Thomas Medical acquisition costs including legal, accounting, investment banking, and severance of approximately $2.7 million, or approximately $1.6 million net of tax, an increase in cost of sales related to Thomas Medical's mark-up on finished goods of approximately $831,000, or approximately $508,000 net of tax, charges related to acquired in-process research and development of approximately $2.5 million, or approximately $1.5 million net of tax, and approximately $631,000 related to a deferred income tax valuation allowance related to a certain capital loss carry forwards. Excluding these charges, our 2012 net income would have been . . .

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