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MMSI > SEC Filings for MMSI > Form 10-Q on 9-May-2014All Recent SEC Filings

Show all filings for MERIT MEDICAL SYSTEMS INC

Form 10-Q for MERIT MEDICAL SYSTEMS INC


9-May-2014

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, 2013 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


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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, 2013.

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

For the three-month period ended March 31, 2014, we reported record sales of approximately $119.2 million, up approximately $15.3 million, or 14.7%, from the three months ended March 31, 2013 of $103.9 million.

Gross profit as a percentage of sales increased to 43.6% for the first quarter of 2014, compared to 41.4% for the first quarter of 2013. The increase was primarily related to lower average fixed overhead unit costs as the result of higher production volumes for the first quarter of 2014 when compared to the corresponding period of 2013.

Net income for the three months ended March 31, 2014 was approximately $2.8 million, or $0.07 per share, as compared to $671,000, or $0.02 per share, for the three months ended March 31, 2013. The increase in net income was attributable primarily to increased sales and higher gross margins, which were partially offset by increases in selling, general, and administrative expenses and interest expense and a higher effective income tax rate.

Beginning January 1, 2014, we reorganized our U.S. direct sales force into two divisions: the cardiovascular division ("CVD") and the interventional procedure division ("IPD"). The CVD has 54 sales representatives and the IPD has 35 sales representatives. We undertook the reorganization in an effort to address the diversity and complexity of our product offerings. We believe this reorganization to our U.S. direct sales force will contribute to improved sales growth of our newly acquired products and facilitate the launch of new products, most of which have higher gross profit margins than the gross margin of many of our existing products.

Our international sales growth was strong for the quarter ended March 31, 2014. Sales for the first quarter of 2014 were approximately $46.3 million, or 39% of total sales, up 23% from the same period in 2013. The increase in international sales was primarily driven by increased growth in Europe direct sales of approximately $3.2 million, China sales of approximately $2.8 million, and Russia sales of approximately $880,000.

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.


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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, 2014 and 2013 indicated:
                                                Three Months Ended
                                                    March 31,
                                                2014         2013
Net sales                                       100%         100%
Gross profit                                    43.6%        41.4%
Selling, general, and administrative expenses   30.9%        30.9%
Research and development expenses               7.4%         8.8%
Income from operations                          5.4%         1.7%
Other expense - net                            (2.2)%       (1.5)%
Income before income taxes                      3.3%         0.2%
Net income                                      2.4%         0.6%

Sales. Sales for the three months ended March 31, 2014 increased by 14.7%, or approximately $15.3 million, compared to the corresponding period of 2013. Listed below are the sales by product category within each business segment for the three-month periods ended March 31, 2014 and 2013 (in thousands):

                                              Three Months Ended
                                                  March 31,
                                % Change      2014          2013
Cardiovascular
Stand-alone devices               18%      $   34,727    $  29,499
Custom kits and procedure trays    3%          25,216       24,497
Inflation devices                 10%          17,230       15,609
Catheters                         16%          20,082       17,295
Embolization devices              28%           9,519        7,412
CRM/EP                            49%           8,133        5,442
Total                             15%         114,907       99,754

Endoscopy
Endoscopy devices                  3%           4,329        4,194

Total                             15%      $  119,236    $ 103,948

Our cardiovascular sales increased $15.1 million, or approximately 15%, for the quarter ended March 31, 2014 on sales of approximately $114.9 million, compared to sales of $99.8 million for the corresponding period of 2013. This improvement was largely the result of increased sales of our stand-alone devices (particularly our Safeguard Pressure Assisted Device, hemostasis product line, and tubing product line), catheters (particularly our cardiology diagnostic catheters, prelude introducer sheath product line and micro catheter product line) cardiac rhythm management ("CRM") and electrophysiology ("EP") devices.

Our endoscopy sales increased 3% for the quarter ended March 31, 2014, on sales of approximately $4.3 million, when compared to the corresponding period of 2013 of approximately $4.2 million, primarily related to an increase in sales of our EndoMAXX™ fully covered esophageal stent.

Gross Profit. Gross profit as a percentage of sales was up to 43.6% for the first quarter of 2014, compared to 41.4% for the first quarter of 2013. The increase was primarily related to lower average fixed overhead unit costs as the result of higher production volumes for the first quarter of 2014, when compared to the comparable prior period of 2013.


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Operating Expenses. Selling, general, and administrative expenses increased $4.6 million but remained essentially unchanged at 30.9% as a percentage of sales for the three months ended March 31, 2014, compared with 30.9% as a percentage of sales for the three months ended March 31, 2013. Excluding Thomas Medical acquisition costs and severance-related costs of approximately $945,000 for the first quarter of 2013, selling, general, and administrative expenses would have been 30.0%. The increase in selling, general, and administrative expenses, absent these non-recurring costs, was primarily related to headcount additions to support our domestic sales force reorganization, international sales expansions, and costs associated with our new facility in Pearland, Texas, which are currently being recorded as selling, general, and administrative expenses during a transition period of approximately six months as we complete the movement and qualification of production equipment from the old facility to the new facility.

Research and Development Expenses. Research and development expenses were 7.4% of sales for the three months ended March 31, 2014, compared with 8.8% of sales for the three months ended March 31, 2013. The reduction in R&D expense was primarily due to the absence of any severance expense recorded in the first quarter of 2014, compared to approximately $415,000 of severance expense recorded in the first quarter of 2013.

Operating Income. The following table sets forth our operating income by business segment for the three-month periods ended March 31, 2014 and 2013 (in thousands):

                           Three Months Ended
                                March 31,
                             2014           2013
Operating Income
Cardiovascular              6,396           1,628
Endoscopy                      93             129
Total operating income $    6,489         $ 1,757

Cardiovascular Operating Income. During the first quarter of 2014, we reported income from operations of approximately $6.4 million from our cardiovascular business segment, compared to income from operations of approximately $1.6 million for the corresponding period of 2013. The increase in operating income was primarily the result of increased sales and higher gross margins, which were partially offset by increases in selling, general, and administrative expenses and interest expense and a higher effective income tax rate.

Endoscopy Operating Income. During the first quarter of 2014, we reported income from operations of approximately $93,000 from our endoscopy business segment, compared to income from operations of approximately $129,000 for the corresponding period of 2013. The decrease in operating income was primarily the result of higher selling, general, and administrative expenses.

Other Expense - Net. Other expense for the first quarter of 2014 was approximately $2.6 million, compared to other expense of approximately $1.5 million for the first quarter of 2013. The increase in other expense for the first quarter of 2014, when compared to the first quarter of 2013, was principally the result of higher interest expense related to higher debt balances and interest rates.

Income Taxes. Our overall effective tax rate for the three months ended March 31, 2014 was 27.4% compared to (217.2)% for the three months ended March 31, 2013. Our provision for income taxes for the three months ended March 31, 2014 totaled $1.1 million of expense compared to $459,000 of benefit for the corresponding period of 2013. Excluding the reinstatement of the 2012 research and development tax credit of approximately $500,000, our effective tax rate would have been 19.2% for the first quarter of 2013. The increase in the effective tax rate was primarily the result of a higher mix of projected earnings for our U.S. operations which are taxed at a higher rate than our operations in foreign jurisdictions (primarily Ireland).

Net Income. During the first quarter of 2014, we reported net income of $2.8 million, an increase of 320.7% from $671,000 for the first quarter of 2013. The increase in net income was primarily affected by increased sales and higher gross margins, which was partially offset by increases in selling, general, and administrative expenses and interest expense and a higher effective income tax rate.


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Liquidity and Capital Resources

Our working capital as of March 31, 2014 and December 31, 2013 was $108.1 million and $100.3 million respectively. The increase in working capital during the three months ended March 31, 2014 was primarily the result of increases in cash, trade receivables and inventory balances, which were partially offset by increases in accrued expenses and trade payables. As of March 31, 2014, we had a current ratio of 2.56 to 1.

At March 31, 2014 and December 31, 2013, we had cash and cash equivalents of approximately $12.6 million and $7.5 million respectively, of which approximately $10.7 million and $6.9 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 March 31, 2014 and December 31, 2013, we had cash and cash equivalents of approximately $8.7 million and $6.0 million, respectively, held by our subsidiary in China.

During the three months ended March 31, 2014, our inventory balances increased by approximately $2.4 million, from $82.4 million at December 31, 2013 to $84.7 million at March 31, 2014. The trailing twelve months inventory turns for the three-month period ended March 31, 2014 improved to 3.12, compared to 2.90 for the three-month period ended March 31, 2013.

We entered into an Amended and Restated Credit Agreement, dated December 19, 2012, with the lenders who are or may become party thereto (collectively, the "Lenders") and Wells Fargo Bank, National Association ("Wells Fargo"), as administrative agent for the Lenders, which was amended on October 4, 2013 by a First Amendment to the Amended and Restated Credit Agreement by and among Merit, certain subsidiaries of Merit, the Lenders and Wells Fargo as administrative agent for the Lenders (as amended, the "Credit Agreement"). Pursuant to the terms of the Credit Agreement, the Lenders have agreed to make revolving credit loans up to an aggregate amount of $215 million. The Lenders also made a term loan in the amount of $100 million, repayable in quarterly installments in the amounts provided in the Credit Agreement until the maturity date of December 19, 2017, at which time the term 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, upon satisfaction of certain conditions, to make swingline loans from time to time through the maturity date 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. 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 term loan and any revolving credit loans made under the Credit Agreement bear interest, at our election, at either (i) the base rate (described below) plus 0.25% (subject to adjustment if the Consolidated Total Leverage Ratio, as defined in the Credit Agreement, is at or greater than 2.25 to 1), (ii) the London Inter-Bank Offered Rate ("LIBOR") Market Index Rate (as defined in the Credit Agreement) plus 1.25% (subject to adjustment if the Consolidated Total Leverage Ratio, as defined in the Credit Agreement, is at or greater than 2.25 to 1), or (iii) the LIBOR Rate (as defined in the Credit Agreement) plus 1.25% (subject to adjustment if the Consolidated Total Leverage Ratio, as defined in the Credit Agreement, is at or greater than 2.25 to 1). Initially, the term loan and revolving credit loans under the Credit Agreement bear interest, at our election, at either (x) the base rate plus 1.00%, (y) the LIBOR Market Index Rate, plus 2.00%, or (z) the LIBOR Rate plus 2.00%. Swingline loans bear interest at the LIBOR Market Index Rate plus 1.25% (subject to adjustment if the Consolidated Total Leverage Ratio, as defined in the Credit Agreement, is at or greater than 2.25 to 1). Initially, swingline loans bear interest at the LIBOR Market Index Rate plus 2.00%. Interest on each loan featuring the base rate or the LIBOR Market Index Rate is due and payable on the last business day of each calendar month; interest on each loan featuring the LIBOR Rate is due and payable on the last day of each interest period selected by us when selecting the LIBOR Rate as the benchmark for interest calculation. For purposes of the Credit Agreement, the base rate means the highest of (i) the prime rate (as announced by Wells Fargo), (ii) the federal funds rate plus 0.50%, and (iii) LIBOR for an interest period of one month plus 1.00%. Our obligations under the Credit Agreement and all loans made thereunder are fully secured by a security interest in our assets pursuant to a separate collateral agreement entered into in conjunction with the Credit Agreement.

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 4.75 to 1 through the end of 2013, no more than 4.00


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to 1 as of the fiscal quarter ending March 31, 2014, no more than 3.75 to 1 as of the fiscal quarter ending June 30, 2014, no more than 3.50 to 1 as of the fiscal quarter ending September 30, 2014, no more than 3.25 to 1 as of the fiscal quarter ending December 31, 2014, no more than 3.00 to 1 as of any fiscal quarter ending during 2015, no more than 2.75 to 1 as of any fiscal quarter ending during 2016, and no more than 2.50 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 or debt, the issuance of equity, the payment of dividends and certain distributions, the entry into related party transactions and other provisions customary in similar types of agreements. As of March 31, 2014, we were in compliance with all covenants set forth in the Credit Agreement.

As of March 31, 2014, we had available borrowings under the Credit Agreement of approximately $26.6 million. Our interest rate under the Credit Agreement as of March 31, 2014 was a fixed rate of 4.23% on $143.7 million as a result of an interest rate swap (see Note 10), a variable floating rate of 3.41% on $109.3 million and a variable floating rate of 3.49% on approximately $1.4 million. Our Total Leverage Ratio under the Credit Agreement for the quarter ended March 31, 2014, was 3.46 to 1. As a result of the quarterly adjustment of our Total Leverage Ratio, as contemplated by the Credit Agreement, the base interest rate on our term loan and amounts outstanding on our revolving credit loans is scheduled to drop 1% to 2.25%, from the current base rate of 3.25%, on May 25, 2014. The new base rate of 2.25% is scheduled to remain in effect until August 25, 2014, at which time the Credit Agreement provides for a new base rate to be determined.

Capital expenditures for property and equipment were approximately $8.7 million and $20.0 million, respectively, for the three-month periods ended March 31, 2014 and 2013. Our capital expenditures for the quarter ended March 31, 2014 were significantly lower than capital expenditures for the quarter ended March 31, 2013, primarily because during the first quarter of 2013 we were in the final stages of constructing a new production warehouse (including an automated material handling system) and administrative office building totaling 253,000 square feet at our world headquarters in South Jordan, Utah, which we completed in May 2013, and we did not incur comparable expenses during the first quarter of 2014.

We currently believe that our existing cash balances, anticipated future cash flows from operations, borrowings under the Credit Agreement (approximately $26.6 million of borrowing availability as of March 31, 2014), as amended, and potential equipment financing will be adequate to fund our current and currently planned future operations for the next twelve months and the foreseeable future. In the event we pursue and complete significant transactions or acquisitions in the future, additional funds will likely be required to meet our strategic needs, which may require us to raise additional funds in the debt or equity markets.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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 quantities on hand for unmarketable and/or slow-moving products that may expire . . .

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