Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related condensed notes thereto, which are included in Part I of this report. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties that may adversely impact our operations and financial results. These risks and uncertainties are discussed in Part I, Item 1A “Risk Factors” in the 2021 Annual Report on Form 10-K and in Part II, Item 1A “Risk Factors” in this report.
OVERVIEW
The following discussion and analysis of our financial condition and results of operations 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, market and sell 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 four product categories: peripheral intervention, cardiac intervention, custom procedural solutions, and OEM. Within these product categories, we sell a variety of products, including cardiology and radiology devices (which assist in diagnosing and treating coronary arterial disease, peripheral vascular disease and other non-vascular diseases), as well as embolotherapeutic, cardiac rhythm management, electrophysiology, critical care, breast cancer localization and guidance, biopsy, and interventional oncology and spine devices. 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, 2022, we reported sales of $275.4 million, up $26.5 million or 10.6%, compared to sales for the three-month period ended March 31, 2021 of $248.9 million. For the three-month period ended March 31, 2022, foreign currency fluctuations (net of hedging) decreased our net sales by $1.7 million, assuming applicable foreign exchange rates in effect during the comparable prior-year period.
Gross profit as a percentage of sales decreased to 43.9% for the three-month period ended March 31, 2022, compared to 45.0% for the three-month period ended March 31, 2021.
Net income for the three-month period ended March 31, 2022 was $10.5 million, or $0.18 per share, compared to net income of $11.0 million, or $0.19 per share, for the three-month period ended March 31, 2021.
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Recent Developments and Trends
In addition to the trends identified in the 2021 Annual Report on Form 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Overview,” our business in 2022 has been impacted, and we believe will continue to be impacted, by the following recent developments and trends:
● Our revenue results during the three-month period ended March 31, 2022 were driven by stronger-than-anticipated demand during the month of March 2022 and more favorable sales trends in our Asia Pacific (“APAC”) and “Rest of World” (“ROW”) operations.
● Our initiatives in SKU optimization, network consolidation, product line transfers and manufacturing initiatives are helping offset inflationary cost pressures in raw materials and logistics expense.
● Following the retirement of our Chief Operating Officer (“COO”), Ronald A. Frost, on April 19 th , 2022 we appointed Neil Peterson as COO. During his 27 years at Merit, Mr. Peterson has held multiple positions of increasing responsibility within the company, including the past five years as Vice President, Operations. In that position, Mr. Peterson was responsible for oversight of all operations at Merit’s headquarters facilities in South Jordan, Utah.
● As of March 31, 2022, we had cash, cash equivalents, and restricted cash of $55.8 million and net available borrowing capacity of approximately $475 million.
RESULTS OF OPERATIONS
The following table sets forth certain operational data as a percentage of sales for the periods indicated:
Three Months Ended
March 31,
2022
2021
Net sales
100
%
100
%
Gross profit
43.9
45.0
Selling, general and administrative expenses
30.5
32.6
Research and development expenses
6.3
6.5
Impairment charges
0.6
—
Contingent consideration expense
0.9
0.2
Income from operations
5.5
5.7
Income before income taxes
5.1
5.1
Net income
3.8
4.4
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Sales
Sales for the three-month period ended March 31, 2022 increased by 10.6%, or $26.5 million, compared to the corresponding period in 2021. Listed below are the sales by product category within each of our financial reporting segments for the three-month periods ended March 31, 2022 and 2021 (in thousands, other than percentage changes):
Three Months Ended
March 31,
% Change
2022
2021
Cardiovascular
Peripheral Intervention
13.8
%
$
105,773
$
92,914
Cardiac Intervention
9.0
%
81,487
74,737
Custom Procedural Solutions
1.9
%
46,262
45,421
OEM
19.6
%
33,414
27,934
Total
10.8
%
266,936
241,006
Endoscopy
Endoscopy devices
7.2
%
8,479
7,907
Total
10.6
%
$
275,415
$
248,913
Cardiovascular Sales. Our cardiovascular sales for the three-month period ended March 31, 2022 were $266.9 million, up 10.8% when compared to the corresponding period of 2021 of $241.0 million. Sales for the three-month period ended March 31, 2022 were favorably affected by increased sales of:
(a) Peripheral intervention products, which increased by $12.9 million, or 13.8%, from the corresponding period of 2021. This increase was driven primarily by sales of our radar localization, drainage, angiography, access, biopsy, delivery systems, and embolotherapy products.
(b) Cardiac intervention products, which increased by $6.8 million, or 9.0%, from the corresponding period of 2021. This increase was driven primarily by sales of our intervention and angiography products, offset partially by decreased sales of our fluid management products (including our Medallion® Syringes, which saw increased demand in the prior period due to COVID-19 vaccination efforts).
(c) OEM products, which increased by $5.5 million, or 19.6%, from the corresponding period of 2021. This increase was driven primarily by sales of our angiography products, kits and coatings, offset partially by decreased sales of our cardiac rhythm management/electrophysiology (“CRM/EP”) products.
(d) Custom procedural solutions products, which increased by $0.8 million, or 1.9%, from the corresponding period of 2021. This increase was driven primarily by sales of our kits and trays, offset partially by decreased sales of our critical care products.
Endoscopy Sales . Our endoscopy sales for the three-month period ended March 31, 2022 were $8.5 million, up 7.2%, when compared to sales in the corresponding period of 2021 of $7.9 million. Sales for the three-month period ended March 31, 2022 were favorably affected by increased sales of our EndoMAXX® fully covered esophageal stent and other stents.
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Geographic Sales
Listed below are sales by geography for the three-month periods ended March 31, 2022 and 2021 (in thousands, other than percentage changes):
Three Months Ended
March 31,
% Change
2022
2021
United States
8.2
%
$
152,992
$
141,372
International
13.8
%
122,423
107,541
Total
10.6
%
$
275,415
$
248,913
United States Sales. U.S. sales for the three-month period ended March 31, 2022 were $153.0 million, or 55.5% of net sales, up 8.2% when compared to the corresponding period of 2021. The increase in our domestic sales in the three-month period ended March 31, 2022 compared to the three-month period ended March 31, 2021 was driven primarily by our U.S. Direct and OEM businesses.
International Sales . International sales for the three-month period ended March 31, 2022 were $122.4 million, or 44.5% of net sales, up 13.8% when compared to the corresponding period of 2021 of $107.5 million. The increase in our international sales for the three-month period ended March 31, 2022, compared to the three-month period ended March 31, 2021, included increased sales in our APAC operations of $9.3 million or 18.1%, in our ROW operations of $3.1 million or 46.1%, and in our EMEA operations of $2.5 million or 5.0%.
Gross Profit
Our gross profit as a percentage of sales decreased to 43.9% for the three-month period ended March 31, 2022, compared to 45.0% for the three-month period ended March 31, 2021. The decrease in gross profit percentage was primarily due to unfavorable manufacturing variances from the impact of inflationary pressures, higher freight costs and increased obsolescence expense, offset partially by changes in product mix and lower amortization expense as a percentage of sales (primarily due to higher sales compared to the corresponding period of 2021).
Operating Expenses
Selling, General and Administrative Expense. Selling, general and administrative ("SG&A") expenses increased $3.0 million, or 3.7%, for the three-month period ended March 31, 2022 compared to the corresponding period of 2021. As a percentage of sales, SG&A expenses were 30.5% for the three-month period ended March 31, 2022, compared to 32.6% for the corresponding period of 2021. For the three-month period ended March 31, 2022, SG&A expenses increased compared to the corresponding period of 2021 primarily due to labor related costs, including higher commissions, salaries and wages, partially offset by lower consulting costs. We incurred $5.1 million of corporate transformation and restructuring costs, including consulting charges, during the three-month period ended March 31, 2022 in connection with our Foundations for Growth program, compared to corporate transformation and restructuring costs of $5.4 million for the three-month period ended March 31, 2021.
Research and Development Expenses. Research and development ("R&D") expenses for the three-month period ended March 31, 2022 were $17.4 million, up 6.8%, when compared to R&D expenses in the corresponding period of 2021 of $16.3 million. The increase in R&D expenses for the three-month period ended March 31, 2022 compared to the corresponding period in 2021 was largely due to higher labor-related costs, increased clinical expenses for certain R&D projects (including clinical trials for our Embosphere® Microspheres and WRAPSODY TM Endoprosthesis) and higher expenses related to implementation of the Medical Device Regulation in the European Union.
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Impairment Charges . For the three-month period ended March 31, 2022, we recorded impairment charges of $1.7 million of intangible assets due to the planned divestiture of the STD Pharmaceutical business, which we completed on April 30, 2022. We recorded no impairment charges during the three-month period ended March 31, 2021 .
Contingent Consideration Expense . For the three-month period ended March 31, 2022, we recognized c ontingent consideration expense from changes in the estimated fair value of our contingent consideration obligations stemming from our previously disclosed business acquisitions of $2.6 million compared to contingent consideration expense of $0.4 million for the three-month period ended March 31, 2021. Expense in each period related to changes in the probability and timing of achieving certain revenue and operational milestones, as well as expense for the passage of time.
Operating Income
The following table sets forth our operating income by financial reporting segment for the three-month periods ended March 31, 2022 and 2021 (in thousands):
Three Months Ended
March 31,
2022
2021
Operating Income
Cardiovascular
$
13,126
$
12,201
Endoscopy
2,107
1,993
Total operating income
$
15,233
$
14,194
Cardiovascular Operating Income. Our cardiovascular operating income for the three-month period ended March 31, 2022 was $13.1 million, compared to cardiovascular operating income in the corresponding period of 2021 of $12.2 million. The increase in cardiovascular operating income during the three-month period ended March 31, 2022 compared to the corresponding period of 2021 was primarily a result of higher sales ($266.9 million compared to $241.0 million), partially offset by increased SG&A and R&D expenses, higher contingent consideration expense, and impairment charges in the three-month period ended March 31, 2022 of $1.7 million.
Endoscopy Operating Income . Our endoscopy operating income for the three-month period ended March 31, 2022 was $2.1 million, approximately flat compared to endoscopy operating income of $2.0 million for the corresponding period of 2021.
Other Expense
Our other expense for the three-month periods ended March 31, 2022 and 2021 was ($1.1) million and ($1.5) million, respectively. The change in other expense was primarily related to decreased interest expense as a result of a lower average debt balance despite a higher effective interest rate.
Effective Tax Rate
Our provision for income taxes for the three-month periods ended March 31, 2022 and 2021 was a tax expense of $3.6 million and $1.7 million, respectively, which resulted in an effective tax rate of 25.6% and 13.7%, respectively. The increase in the income tax expense and the corresponding change in the effective income tax rate for the three-month period ended March 31, 2022, when compared to the prior-year period, was primarily due to decreased benefit from discrete items such as share-based compensation. Our effective tax rate differs from the U.S. statutory rate primarily due to the impact of GILTI inclusions, state income taxes, foreign taxes, other non-deductible permanent items and discrete items (such as share-based compensation).
Net Income
Our net income for the three-month periods ended March 31, 2022 and 2021 was $10.5 million and $11.0 million, respectively. The decrease in our net income for the three-month period ended March 31, 2022 was the result of several
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factors, including lower gross margins as a percentage of sales, higher SG&A and R&D expenses, higher contingent consideration expense ($2.6 million for the three-month period ended March 31, 2022 compared to $0.4 million for the corresponding period of 2021), impairment charges of $1.7 million during the three-month period ended March 31, 2022, and higher income tax expense, partially offset by higher sales.
LIQUIDITY AND CAPITAL RESOURCES
Capital Commitments, Contractual Obligations and Cash Flows
At March 31, 2022 and December 31, 2021, our current assets exceeded current liabilities by $274.3 million and $245.9 million, respectively, and we had cash, cash equivalents and restricted cash of $55.8 million and $67.8 million, respectively, of which $49.8 million and $55.7 million, respectively, were held by foreign subsidiaries. We currently believe f uture repatriation of cash and other property held by our foreign subsidiaries will generally not be subject to U.S. federal income tax . As a result, we are not permanently reinvested with respect to our historic unremitted foreign earnings. 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, 2022, and December 31, 2021, we had cash, cash equivalents and restricted cash of $26.6 million and $28.5 million, respectively, within our subsidiary in China.
Cash flows provided by operating activities . We generated cash from operating activities of $12.0 million and $35.2 million during the three-month periods ended March 31, 2022 and 2021, respectively. Net cash provided by operating activities decreased $23.2 million for the three-month period ended March 31, 2022 compared to the three-month period ended March 31, 2021. Significant factors affecting operating cash flows during these periods included:
● Cash provided by (used for) accrued expenses was ($23.5) million and $5.4 million for the three-month periods ended March 31, 2022 and 2021, respectively, due primarily to the payment of approximately $18.25 million into escrow in connection with the settlement of the consolidated securities class action lawsuit (see Note 9 to our consolidated financial statements set forth in Item 1 of this report) and the timing of payment of bonuses and other accrued liabilities in each period.
● Cash provided by (used for) other receivables was $5.8 million and ($0.6) million for the three-month periods ended March 31, 2022 and 2021, respectively, due primarily to the collection of approximately $8.2 million of insurance proceeds in connection with the consolidated securities class action lawsuit (see Note 9 to our consolidated financial statements set forth in Item 1 of this report).
● Cash (used for) inventories was ($9.2) million and ($3.4) million for the three-month periods ended March 31, 2022 and 2021, respectively. The increase in inventory was associated with our strategy to proactively invest in our inventory balances to build the requisite safety stock and encourage high customer service levels.
Cash flows used in investing activities. We used cash in investing activities of $9.9 million and $6.3 million for the three-month periods ended March 31, 2022 and 2021, respectively. We used cash for capital expenditures of property and equipment of $9.5 million and $6.2 million in the three-month periods ended March 31, 2022 and 2021, respectively. Capital expenditures in each period were primarily related to investment in property and equipment to support development and production of our products. Historically, we have incurred significant expenses in connection with facility construction, production automation, product development and the introduction of new products. We anticipate that we will spend approximately $55 to $60 million in 2022 for property and equipment.
Cash flows used in financing activities. Cash used in financing activities for the three-month periods ended March 31, 2022 and 2021 was $14.2 million and $26.2 million, respectively. During the three-month period ended March 31, 2022 we increased our net borrowings by approximately $9.6 million to partially finance the payment of contingent consideration of $24.5 million, principally related to our acquisition of Cianna Medical, Inc. During the three-month period ended March 31, 2021 we decreased our net borrowings by approximately $30.9 million.
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As of March 31, 2022, we had outstanding borrowings of $253 million and issued letter of credit guarantees of $3.4 million under the Third Amended Credit Agreement, with additional available borrowings of approximately $475 million, based on the maximum net leverage ratio and the aggregate revolving credit commitment pursuant to the Third Amended Credit Agreement. Our interest rate as of March 31, 2022 was a fixed rate of 2.71% on $75 million as a result of an interest rate swap and a variable floating rate of 1.46% on $177.8 million. Our interest rate as of December 31, 2021 was a fixed rate of 2.71% on $75 million as a result of an interest rate swap and a variable floating rate of 1.10% on $168.1 million.
We currently believe that our existing cash balances, anticipated future cash flows from operations and borrowings under the Third Amended Credit Agreement 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
Our financial results are affected by the selection and application of accounting policies and methods. In the three-month period ended March 31, 2022 there were no changes to the application of critical accounting policies previously disclosed in Part II, Item 7 of the 2021 Annual Report on Form 10-K.
CAUTIONARY NOTICE 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, without limitation, 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 any 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,” “should,” “anticipates,” “intends,” “seeks,” “believes,” “estimates,” “potential,” “forecasts,” “continue,” or other forms of these words or similar words or expressions, 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 such expectations or any of the forward-looking statements will prove to be correct. Actual results will likely differ, and could differ materially, from those projected or assumed in the forward-looking statements. Prospective investors are cautioned not to unduly rely on any such forward-looking statements.
All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Our actual results will likely 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. If we do update or correct one or more forward-looking statements, investors and others should not conclude that we will make additional updates or corrections.
NOTICE REGARDING TRADEMARKS
This report includes trademarks, tradenames and service marks that are our property or the property of others. Solely for convenience, such trademarks and tradenames sometimes appear without any “™” or “®” symbol. However, failure to include such symbols is not intended to suggest, in any way, that we will not assert our rights or the rights of any applicable licensor, to these trademarks and tradenames.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and qualitative disclosures about exchange rate risk are included in Part II, Item 7A "Quantitative and Qualitative Disclosures About Market Risk" of the 2021 Annual Report on Form 10-K. In the three-month period ended March 31, 2022, there were no material changes from the information provided therein.
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