MERIT MEDICAL SYSTEMS, INC. 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, 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," "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.
Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including the following:
? risks relating to managing growth, particularly if accomplished through
acquisitions, and the integration of acquired businesses;
? risks relating to protection of our intellectual property;
? risks relating to the outbreak of COVID-19, and the consequences of the
resulting pandemic throughout the world;
claims by third parties that we infringe their intellectual property rights,
? which could cause us to incur significant legal or licensing expenses and
prevent us from selling our products;
? changes in general economic conditions, geopolitical conditions,
policies and other factors beyond our control;
? changes in international and national economic and industry conditions;
FDA regulatory clearance processes, which are expensive, time-consuming and
? uncertain, and the failure to obtain and maintain required regulatory
clearances and approvals, which could prevent us from commercializing our
products;
? international regulatory requirements and delays and failure to obtain and
maintain required regulatory clearances and approvals;
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greater scrutiny and regulation by governmental authorities, including risks
? relating to the subpoena we received in
of Justice seeking information on our marketing and promotional practices;
? risks relating to physicians' use of our products in unapproved circumstances;
? consolidation in the healthcare industry, group purchasing organizations or
public procurement policies leading to demands for price concessions;
? disruption of our information technology systems, our critical information
systems or a breach in the security of our systems;
? changes in or failure to comply with governing regulations;
? restrictions and limitations in our debt agreements and instruments, which
could affect our ability to operate our business and our liquidity;
? fluctuations in foreign currency exchange rates negatively impacting our
financial results;
expending significant resources for research, development, testing and
? regulatory approval or clearance of our products under development and any
failure to develop the products, any failure of the products to be effective or
any failure to obtain approvals for commercial use;
? violations of laws targeting fraud and abuse in the healthcare industry;
? loss of key personnel;
termination or interruption of, or a failure to monitor, our supply
? relationships or increases in the prices of our component parts, finished
products, third-party services or raw materials, particularly petroleum-based
products;
? limits on reimbursement imposed by governmental and other programs;
? product liability claims;
failure to report adverse medical events to the FDA or other governmental
? authorities, which may subject us to sanctions that may materially harm our
business;
failure to maintain or establish sales capabilities on our own or through third
? parties, which may result in our inability to commercialize our products in
countries where we lack direct sales and marketing capabilities;
? employees, independent contractors, consultants, manufacturers and distributors
engaging in misconduct or other improper activities, including noncompliance;
? commencement or continuation of litigation which adversely affects our
financial condition or results of operations;
? inability to compete in markets, particularly if there is a significant change
in relevant practices or technology;
? inability to generate sufficient cash flow to fund our debt obligations,
capital expenditures, and ongoing operations;
? uncertainties about theUnited Kingdom's ("UK") withdrawal from theEuropean Union ("EU"); 32 Table of Contents
? uncertainties relating to the LIBOR calculation and the expected
discontinuation of LIBOR after 2021;
? inability to accurately forecast customer demand for our products or manage our
inventory;
? the addressable market for our product groups being smaller than our estimates;
failure to comply with export control laws, customs laws, sanctions laws and
? other laws governing our operations in the
could subject us to civil or criminal penalties, other remedial measures and
legal expenses;
? risks relating to work stoppage, transportation interruptions, severe weather,
natural disasters and outbreak of disease;
? fluctuations in our effective tax rate adversely affecting our business,
financial condition or results of operation;
? risks relating to our revenues being derived from a few products and medical
procedures;
? actions of activist shareholders being potentially disruptive and costly and
causing change that conflicts with our strategic direction;
? effects of evolving
privacy and data protection;
? failure to comply with applicable environmental laws and regulations;
? volatility of the market price of our common stock; and
? other factors referenced in our press releases and in our filings with the
Additional factors that may have a direct bearing on our operating results are discussed in Part I, Item 1A "Risk Factors" in the Annual Report on Form 10 K and Part II, Item 1A "Risk Factors" in this report.
Disclosure 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. 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.
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For the three-month period ended June 30, 2020 , we reported sales of
approximately $218.4 million , down approximately $(37.2) million or (14.5)%,
compared to sales for the three-month period ended June 30, 2019 of
approximately $255.5 million . For the six-month period ended June 30, 2020 , we
reported sales of approximately $461.9 million , down approximately $(32.0)
million or (6.5)%, compared to sales from the six-month period ended June 30,
2019 of approximately $493.9 million .
Gross profit as a percentage of sales decreased to 38.6% for the three-month
period ended June 30, 2020 as compared to 43.8% for the three-month period ended
June 30, 2019 . Gross profit as a percentage of sales decreased to 40.7% for the
six-month period ended June 30, 2020 as compared to 43.9% for the six-month
period ended June 30, 2019 .
Net loss for the three-month period ended June 30, 2020 was approximately
$(19.1) million , or $(0.34) per share, as compared to net income of
approximately $6.9 million , or $0.12 per share, for the three-month period ended
June 30, 2019 . Net loss for the six-month period ended June 30, 2020 was
approximately $(22.2) million , or $(0.40) per share, as compared to net income
of approximately $13.1 million , or $0.23 per share, for the six-month period
ended June 30, 2019 .
Recent Developments and Trends and Impact of COVID-19
In addition to the trends identified in the 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 2020 has been impacted, and we believe it will continue to be impacted, by the following recent events and trends:
Despite the challenges presented by the COVID-19 pandemic, we continued to
? implement initiatives we have been working on for several months. We are in the
process of moving 14 products to our
facilities, as well as consolidating certain satellite facilities.
? We announced the closure of the
which we initially acquired in our ITL acquisition in 2017.
Sales in many of our end markets began to improve near the end of the quarter
? after the initial declines due to COVID-19. However, with COVID-19 cases
increasing, the pace of recovery of elective procedures is still uncertain.
In
? vial, used to collect specimens with suspected presence of COVID-19. Sales of
this new product were approximately
We have actively managed inventory levels, temporarily reduced executive
? management and other employee compensation, limited discretionary spending and
delayed capital spending.
As of
? borrowing capacity of approximately
June 30, 2020 .
We are committed to being part of the solution to the COVID-19 pandemic and have taken the following actions to protect and serve our customers, employees, shareholders, and communities:
? Produced nasopharyngeal CulturaTM swabs and test kits, with sales of
approximately
? Offered serological antibody testing to employees through the Merit Care clinic
at our
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Implemented certain cost reduction and operating efficiency initiatives,
? including decreased discretionary spending, delayed product launches, deferred
capital spending and reduced research and development projects, among other
initiatives.
? Established additional cleaning and sanitation procedures to help prevent the
spread of COVID-19 within our facilities.
Created new processes to encourage the safety of our employees, including
formal policies restricting certain travel, temperature screenings and mask
? requirements at most of our manufacturing locations, social distancing through
modified workspaces, mandatory telecommuting for certain positions, and modified on-site food service practices.
Implemented temporary graded salary reductions to increase liquidity, with
? highly compensated employees and executives having the most significant
reductions and no reductions for manufacturing employees and other employees
below certain compensation levels.
RESULTS OF OPERATIONS
The following table sets forth certain operational data as a percentage of sales
for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
Net sales 100 % 100 % 100 % 100 %
Gross profit 38.6 43.8 40.7 43.9Selling, general and administrative expenses 30.6 31.3 31.5 32.0 Research and development expenses 6.4 6.4
6.3 6.6
Legal settlement 8.3 - 3.9 -
Impairment and other charges 1.8 0.2 1.7 0.1Contingent consideration expense 0.2 0.9 1.1 0.6 Acquired in-process research and development expense - 0.2 - 0.1 Income (loss) from operations (8.7) 4.8 (3.8) 4.4 Other expense - net (1.5) (1.3) (1.4) (1.2)
Income (loss) before income taxes (10.2) 3.5
(5.3) 3.2 Net income (loss) (8.7) 2.7 (4.8) 2.6 Sales
Sales for the three-month period endedJune 30, 2020 decreased by (14.5)%, or approximately$(37.2) million , compared to the corresponding period in 2019. Sales for the six-month period endedJune 30, 2020 decreased by (6.5)%, or approximately$(32.0) million , compared to the corresponding period in 2019. Sales were negatively affected across all product categories due to the impact of COVID-19, with sales of products used in elective procedures most significantly 35 Table of Contents
impacted. Listed below are the sales by product category within each of our
financial reporting segments for the three and six-month periods ended
Three Months Ended Six Months Ended
June 30, June 30,
% Change 2020 2019 % Change 2020 2019
Cardiovascular
Peripheral Intervention (18.2) % $ 72,635 $ 88,848 (7.9) % $ 159,710 $ 173,481
Cardiac Intervention (17.1) % 66,005 79,643 (8.9) % 138,596 152,183
Custom Procedural Solutions (4.0) % 45,319 47,216 (0.1) % 92,940 93,077
OEM (8.9) % 28,218 30,959 (3.3) % 56,475 58,405
Total (14.0) % 212,177 246,666 (6.2) % 447,721 477,146
Endoscopy
Endoscopy devices (30.1) % 6,194 8,866 (15.3) % 14,175 16,735
Total (14.5) % $ 218,371 $ 255,532 (6.5) % $ 461,896 $ 493,881
Cardiovascular Sales. Our cardiovascular sales for the three-month period ended
June 30, 2020 were approximately $212.2 million , down (14.0)% when compared to
the corresponding period of 2019 of approximately $246.7 million . Sales for the
three-month period ended June 30, 2020 were unfavorably affected by decreased
sales of:
Peripheral intervention products (particularly our biopsy, localization,
(a) vertebral compression fracture, embolotherapy, angiography, and intervention
products) which decreased by approximately
the corresponding period of 2019;
Cardiac intervention products (particularly our intervention, access,
(b) angiography and cardiac rhythm management/electrophysiology ("CRM/EP")
products) which decreased by approximately
the corresponding period of 2019;
OEM products (particularly our angiography and CRM/EP products, offset
(c) partially by increased kit, fluid management, and sensors sales) which
decreased by approximately
period of 2019; and
Custom procedural solutions products (particularly our kits and trays,partially offset by increased sales of our critical care products which saw
(d) increased demand due to COVID-19, including
CulturaTM nasopharyngeal swabs used to collect and transport samples for
COVID-19 testing) which decreased by approximately
from the corresponding period of 2019.
Our cardiovascular sales for the six-month period endedJune 30, 2020 were approximately$447.7 million , down (6.2)%, when compared to the corresponding period for 2019 of approximately$477.1 million . Sales for the six-month period endedJune 30, 2020 were unfavorably affected by decreased sales of:
Peripheral intervention products (particularly our biopsy, localization,
(a) vertebral compression fracture, embolotherapy, angiography, and intervention
products) which decreased by approximately
the corresponding period of 2019;
Cardiac intervention products (particularly our intervention, angiography and
(b) CRM/EP products) which decreased by approximately
from the corresponding period of 2019; and
OEM products (particularly our angiography and CRM/EP products, offset
(c) partially by increased kit, fluid management, and intervention sales) which
decreased by approximately $(1.9) million , or (3.3)%, from the corresponding
period of 2019.
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Endoscopy Sales. Our endoscopy sales for the three-month period ended
June 30, 2020 were approximately $6.2 million , down (30.1)%, when compared to
sales in the corresponding period of 2019 of approximately $8.9 million . Our
endoscopy sales for the six-month period ended June 30, 2020 were approximately
$14.2 million , down (15.3)%, when compared to sales in the corresponding period
of 2019 of approximately $16.7 million . Sales for the three and six-month
periods ended June 30, 2020 were unfavorably affected by deceased sales of the
NinePoint Medical, Inc. ("NinePoint") NvisionVLE® Imaging System, our EndoMAXX®
Fully Covered Esophageal Stents, and other stents, partially offset by increased
sales of our AEROmini® Fully Covered Tracheobronchial Stents.
International Sales. International sales for the three-month period ended
June 30, 2020 were approximately $100.2 million , or 45.9% of net sales, down
(9.6)% when compared to the corresponding period of 2019 of approximately $110.9
million . The decrease in our international sales for the second quarter of 2020
compared to the second quarter of 2019 included lower sales in most countries
and regions due to the impact of COVID-19, with decreased sales in the Middle
East of $(2.1) million or (40.6)%, France of $(1.6) million or (27.6)%, Germany
of $(1.5) million or (18.2)%, and the United Kingdom of $(1.3) million or
(29.1)%, among others, partially offset by increased sales in China of $2.7
million or 8.4%.
International sales for the six-month period ended June 30, 2020 were
approximately $202.7 million , or 43.9% of net sales, down (4.0)% when compared
to the corresponding period of 2019 of approximately $211.2 million . The
decrease in our international sales for the second quarter of 2020 compared to
the second quarter of 2019 included decreased sales in China of $(2.3) million
or (4.0)%, the Middle East of approximately $(2.9) million or (31.5)%, Japan of
$(1.7) million or (8.7)%, the United Kingdom of approximately $(1.7) million or
(18.7)%, and France of approximately $(1.2) million or (10.9)%, among others.
Gross Profit
Our gross profit as a percentage of sales decreased to 38.6% for the three-month period endedJune 30, 2020 , compared to 43.8% for the three-month period endedJune 30, 2019 . The decrease in gross profit percentage was primarily due to changes in product mix driven by the COVID-19 pandemic, increased obsolescence expense associated with lower forecasted demand for certain of our products as a result of COVID-19 and product obsolescence from the planned restructuring of our pack business inAustralia , and increased amortization expense from our acquisitions of Brightwater inJune 2019 and STD Pharmaceutical inAugust 2019 . Our gross profit as a percentage of sales decreased to 40.7% for the six-month period endedJune 30, 2020 , compared to 43.9% for the six-month period endedJune 30, 2019 . The decrease in gross profit percentage was primarily due to changes in product mix driven by the COVID-19 pandemic, increased obsolescence expense associated with lower forecasted demand for certain of our products as a result of COVID-19 in addition to specific reserves of inventory sold under our distribution agreement withNinePoint and product obsolescence from the planned restructuring of our pack business inAustralia , and increased amortization expense from our acquisitions of Brightwater inJune 2019 and STD Pharmaceutical inAugust 2019 , partially offset by improvements in manufacturing variances
from
operational efficiencies.
Operating Expenses
Selling, General and Administrative Expense. Selling, general and administrative
("SG&A") expenses decreased approximately $(13.2) million , or (16.5)%, for the
three-month period ended June 30, 2020 compared to the corresponding period of
2019. As a percentage of sales, SG&A expenses were 30.6% of sales for the
three-month period ended June 30, 2020 , compared to 31.3% for the corresponding
period of 2019. For the three months ended June 30, 2020 compared to the
corresponding period of 2019, overall compensation expenses were lower as a
result of cost cutting initiatives and other cost management efforts related to
the COVID-19 pandemic (including layoffs, targeted furloughs, and temporary
salary reductions), and discretionary spending was lower as a result of reduced
travel, training, and shows and conventions, among other items.
SG&A expenses decreased approximately $(12.7) million , or (8.0)%, for the
six-month period ended June 30, 2020 compared to the corresponding period of
2019. As a percentage of sales, SG&A expenses were 31.5% of sales for the
three-month period ended June 30, 2020 , compared to 32.0% for the corresponding
period of 2019. For the six months
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endedJune 30, 2020 compared to the corresponding period of 2019, overall compensation expenses were lower as a result of cost cutting initiatives and other cost management efforts related to the COVID-19 pandemic (including layoffs, targeted furloughs, and temporary salary reductions), and discretionary spending was lower as a result of reduced travel, training, and shows and conventions, among other items. Research and Development Expenses. Research and development ("R&D") expenses for the three-month period endedJune 30, 2020 were approximately$14.0 million , down (14.1)%, when compared to R&D expenses in the corresponding period of 2019 of approximately$16.3 million . R&D expenses for the six-month period endedJune 30, 2020 were approximately$28.9 million , down (10.7)%, when compared to R&D expenses in the corresponding period of 2019 of approximately$32.4 million . The decrease in R&D expenses for the three and six months endedJune 30, 2020 compared to the same periods in 2019 was largely due to lower compensation expenses (including layoffs, targeted furloughs, and temporary salary reductions), lower discretionary expenses (including reduced travel expenses) as a result of cost cutting initiatives and the COVID-19 pandemic, and a reduced number of research and development projects. Legal Settlement. We recorded a settlement in the first six months of 2020 of$18.2 million in connection with an agreement in principle with theDepartment of Justice ("DOJ") to fully resolve the DOJ's investigation of certain marketing and promotional practices. Impairment and Other Charges. For the three and six-month periods endedJune 30, 2020 we recorded impairment charges of approximately$3.9 million and$7.7 million , respectively. These impairments included a$3.5 million write-off in the first quarter of 2020 of our purchase option to acquire Bluegrass Vascular due to our decision not to exercise our option to purchase this company,$0.4 million impairment in the first quarter of property and equipment related to our distribution agreement withNinePoint ,$2.4 million impairment in the second quarter of the customer list intangible asset from our ITL acquisition, and$1.5 million impairment in the second quarter of our right-of-use operating lease asset associated with closure of a facility inCalifornia . For the three and six-month periods endedJune 30, 2019 , we recorded impairment of certain intangible assets of$0.5 million based on changes in revenue expectations associated with the related product lines and restructuring. Contingent Consideration Expense. For the three and six-month periods endedJune 30, 2020 and 2019, we recognized contingent consideration expense from changes in the estimated fair value of our contingent consideration obligations stemming from our previously disclosed business acquisitions. Expense in each period relates to changes in the probability and timing of achieving certain revenue and operational milestones, as well as expense for the passage of time.
Operating Income (Loss)
The following table sets forth our operating income (loss) by financial reporting segment for the three and six-month periods endedJune 30, 2020 and 2019 (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 Operating Income (Loss) Cardiovascular$ (20,462) $ 9,855 $ (18,960) $ 17,474 Endoscopy 1,467 2,346 1,327 4,250 Total operating income (loss)$ (18,995) $ 12,201 $ (17,633) $ 21,724 Cardiovascular Operating Income (Loss). Our cardiovascular operating loss for the three-month period endedJune 30, 2020 was approximately$(20.5) million , compared to operating income in the corresponding period of 2019 of approximately$9.9 million . The decrease in cardiovascular operating income was primarily a result of decreased sales and lower gross margins, the$18.2 million legal settlement expense related to the DOJ inquiry, increased impairment expense ($1.5 million from the impairment of a right-of-use operating lease asset associated with closure of a facility inCalifornia and$2.4 million from the impairment of the customer list intangible asset initially acquired in our ITL acquisition), partially offset by lower contingent consideration expense from fair value adjustments related to liabilities from completed 38
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acquisitions and lower compensation and discretionary expenses resulting from cost cutting initiatives and the COVID-19 pandemic.
Our cardiovascular operating loss for the six-month period endedJune 30, 2020 was approximately$(19.0) million , compared to operating income in the corresponding period of 2019 of approximately$17.5 million . The decrease in cardiovascular operating income was primarily a result of decreased sales and lower gross margins, the$18.2 million legal settlement expense related to the DOJ inquiry, increased impairment expense ($3.5 million related to an option to purchase Bluegrass Vascular, which expired unexercised;$1.5 million from the impairment of a right-of-use operating lease asset associated with closure of a facility inCalifornia ; and$2.4 million from the impairment of the customer list intangible asset initially acquired in our ITL acquisition) and higher contingent consideration expense from fair value adjustments related to liabilities from completed acquisition, partially offset by lower compensation and discretionary expenses resulting from cost cutting initiatives and the COVID-19 pandemic. Endoscopy Operating Income. Our endoscopy operating income for the three-month period endedJune 30, 2020 was approximately$1.4 million , compared to approximately$2.3 million for the corresponding period of 2019. This decrease was a result of lower sales (largely due to decreased demand during the COVID-19 pandemic), and lower gross margins, partially offset by lower compensation and discretionary expenses related to cost cutting initiatives and the COVID-19 pandemic. Our endoscopy operating income for the six-month period endedJune 30, 2020 was approximately$1.3 million , compared to approximately$4.3 million for the corresponding period of 2019. This decrease was a result of lower sales (largely due to decreased demand during the COVID-19 pandemic), lower gross margins (due in part to$1.4 million of inventory obsolescence related to products sold under our distribution agreement withNinePoint ), partially offset by lower compensation and discretionary expenses related to cost cutting initiatives
and the COVID-19 pandemic. Other Expense
Our other expense for the three-month periods endedJune 30, 2020 and 2019 was approximately$(3.3) million and$(3.2) million , respectively. The change in other expense was primarily related to a decrease in interest income due to the impairment of the loan receivable withNinePoint in the fourth quarter of 2019, partially offset by decreased interest expense as a result of a lower effective interest rate. Our other expense for the six-month periods endedJune 30, 2020 and 2019 was approximately$(6.7) million and$(5.9) million , respectively. The increase in other expense was primarily a result of a decrease in interest income due to the impairment of the loan receivable withNinePoint during the fourth quarter
of 2019. Effective Tax Rate Our provision for income taxes for the three-month periods endedJune 30, 2020 and 2019 was a tax expense (benefit) of approximately$(3.2) million and$2.1 million , respectively, which resulted in an effective tax rate of 14.5% and 23.8%, respectively. Our provision for income taxes for the six-month periods endedJune 30, 2020 and 2019 was a tax expense (benefit) of approximately$(2.1) million and$2.8 million , respectively, which resulted in an effective tax rate of 8.6% and 17.6%, respectively. The income tax benefit and corresponding decrease in the effective tax rate for the three and six-month periods endedJune 30, 2020 , when compared to the prior-year periods, was primarily due to a pre-tax loss during the 2020 periods, as well as a change in the jurisdictional mix of earnings. Our effective tax rate differs from theU.S. statutory rate primarily due to the impact of GILTI, state income taxes, foreign taxes, other non-deductible permanent items and discrete items (such as share-based compensation and certain legal settlements).
Net Income (Loss)
Our net income (loss) for the three-month periods endedJune 30, 2020 and 2019 was approximately$(19.1) million and$6.9 million , respectively. This decrease was a result of several factors, including decreased sales and lower gross margins, the$18.2 million legal settlement expense related to the DOJ inquiry, and increased impairment expense ($1.5 million from the impairment of a right-of-use operating lease asset associated with closure of a facility in
California and$2.4 39 Table of Contents
million from the impairment of the customer list intangible asset initially acquired in our ITL acquisition), partially offset by lower contingent consideration expense from fair value adjustments related to liabilities from completed acquisitions and lower compensation and discretionary expenses resulting from cost cutting initiatives and the COVID-19 pandemic.
Our net income (loss) for the six-month periods endedJune 30, 2020 and 2019 was approximately$(22.2) million and$13.1 million , respectively. The decrease in net income was primarily due to decreased sales and lower gross margins, the$18.2 million legal settlement expense related to the DOJ inquiry, increased impairment expense ($3.5 million related to an option to purchase Bluegrass Vascular, which expired unexercised;$1.5 million from the impairment of a right-of-use operating lease asset associated with closure of a facility inCalifornia ; and$2.4 million from the impairment of the customer list intangible asset initially acquired in our ITL acquisition) and higher contingent consideration expense from fair value adjustments related to liabilities from completed acquisition, partially offset by lower compensation and discretionary expenses resulting from cost cutting initiatives and the COVID-19 pandemic.
LIQUIDITY AND CAPITAL RESOURCES
Capital Commitments, Contractual Obligations and Cash Flows
AtJune 30, 2020 andDecember 31, 2019 , we had cash and cash equivalents of approximately$49.7 million and$44.3 million respectively, of which approximately$43.8 million and$31.7 million , respectively, were held by foreign subsidiaries. We currently believe future repatriation of cash and other property held by our foreign subsidiaries will generally not be subject toU.S. federal income tax. As a result, after evaluation of the permanent reinvestment assertion, we are not permanently reinvested with respect to our historic unremitted foreign earnings. In addition, cash held by our subsidiary inChina is subject to local laws and regulations that require government approval for the transfer of such funds to entities located outside ofChina . As ofJune 30, 2020 , andDecember 31, 2019 , we had cash and cash equivalents of approximately$16.8 million and$11.3 million , respectively, within our subsidiary inChina . Cash flows provided by operating activities. We generated cash from operating activities of approximately$73.2 million and$35.7 million during the six-month periods endedJune 30, 2020 and 2019, respectively. Net cash provided by operating activities increased approximately$37.5 million for the six-month period endedJune 30, 2020 compared to the six-month period endedJune 30, 2019 . Significant factors affecting operating cash flows during these years included:
Net income (loss) was approximately
six-month periods ended
recognized in the six-month period ended
? attributable to decreased sales and gross margins and increased non-cash
expenses including legal settlement expense of
inquiry, which has not been paid,
and
liabilities,
Cash provided by (used for) accounts receivable was approximately
? and
respectively, due primarily to decreases in sales volume and increased allowances due to economic uncertainty,
Cash provided by (used for) inventories was approximately
?
respectively, due primarily to reduced production due to economic downturns
related to the pandemic and efforts to manage inventory levels, and
Cash provided by accrued expenses was approximately
? million for the six-month periods ended
due primarily to increased accruals associated with pending legal settlement
expenses estimated at
Cash flows used in investing activities. We used cash in investing activities of approximately$27.4 million and$74.8 million for the six-month periods endedJune 30, 2020 and 2019, respectively. We invested in capital expenditures for property and equipment of approximately$25.8 million and$36.0 million in the six-month periods endedJune 30, 2020 and 2019, respectively. Capital expenditures in each fiscal year were primarily related to investment in buildings, property and equipment to support development and production of new and expanded product lines and to facilitate growth in our 40
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distribution markets. These investments include construction of a new manufacturing and research and development facility inSouth Jordan, Utah completed in early 2020. 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$50 to$55 million in 2020 for buildings, property and equipment. Cash outflows invested in acquisitions for the six-month period endedJune 30, 2019 were approximately$37.3 million and were primarily related to our investment in the equity ofFluidx Medical Technology, LLC and our acquisition of Brightwater. Cash paid for acquisitions in the six-month period endedJune 30, 2020 was approximately$0.1 million . Cash flows provided by (used in) financing activities. Cash provided by (used in) financing activities for the six-month periods endedJune 30, 2020 and 2019 was approximately$(39.2) million and$7.8 million , respectively. In 2020 we completed payment of contingent consideration of$12.9 million , which is classified as a financing activity, principally related to our acquisition ofCianna Medical, Inc. and decreased our net borrowings by approximately$29.1 million . In 2019, our primary financing activities included additional net borrowings under our credit agreement to partially fund our acquisition activity and capital expenditures for property and equipment. As ofJune 30, 2020 , we had outstanding borrowings of approximately$410.9 million under the Third Amended Credit Agreement, with additional available borrowings of approximately$183.3 million , based on the leverage ratio required pursuant to the Third Amended Credit Agreement. Our interest rate as ofJune 30, 2020 was a fixed rate of 2.62% on$175 million as a result of an interest rate swap (see Note 9 to our consolidated financial statements included in Part I, Item 1 of this report) and a variable floating rate of 1.68% on$235.9 million . Our interest rate as ofDecember 31, 2019 was a fixed rate of 2.62% on$175 million as a result of an interest rate swap and a variable floating rate of 3.30% on$265 million . See Note 8 to our consolidated financial statements included in Part I, Item 1 of this report for additional details regarding the Third Amended Credit Agreement and our long-term debt. 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.
Off-Balance Sheet Arrangements
We have committed to provide loans of up to an additional €2 million at the discretion of Selio at a rate of 5% per annum. The current note receivable balance from Selio is$250,000 . Additional loans made to Selio pursuant to our loan agreement, together with the initial advance and all other amounts owed to us by Selio, would be securitized by Selio's assets. Aside from this arrangement, we do not have any off-balance sheet arrangements that have had, or are reasonably likely in the future to have, an effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
TheSEC has requested that all registrants address their most critical accounting policies. TheSEC 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. The following paragraphs identify our most critical accounting policies: Valuation ofGoodwill and Intangible Assets. We allocate any excess purchase price over the fair value of the net tangible and identifiable intangible assets acquired in a business combination to goodwill. We base the fair value of identifiable intangible assets acquired in a business combination on valuations that use information and assumptions that 41
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a market participant would use, including assumptions for estimated revenue projections, growth rates, cash flows, discount rates, useful life, and other relevant assumptions.
We test our goodwill balances for impairment as ofJuly 1 of each year, or whenever impairment indicators arise. When impairment indicators are identified, we may elect to perform an optional qualitative assessment to determine whether it is more likely than not that the fair value of our reporting units has fallen below their carrying value. This assessment involves significant judgment, especially in the current environment due to uncertainties about the duration and impact of the COVID-19 pandemic. During our annual impairment test performed as ofJuly 1 we utilize several reporting units in evaluating goodwill for impairment using a quantitative assessment, which uses a combination of a guideline public company market-based approach and a discounted cash flow income-based approach. The quantitative assessment considers whether the carrying amount of a reporting unit exceeds its fair value, in which case an impairment charge is recorded to the extent the reporting unit's carrying value exceeds its fair value. This analysis requires significant judgment, including estimation of future cash flows and the length of time they will occur, which is based on internal forecasts, and a determination of a discount rate based on our weighted average cost of capital. During our annual test of goodwill balances in 2019, which was completed during the third quarter of 2019, we determined that the fair value of each reporting unit with goodwill exceeded the carrying amount by a significant amount. We evaluate the recoverability of intangible assets subject to amortization whenever events or changes in circumstances indicate that an asset's carrying amount may not be recoverable. This analysis requires similar significant judgments as those discussed above regarding goodwill, except that undiscounted cash flows are compared to the carrying amount of intangible assets to determine if impairment exists. In-process technology intangible assets, which are not subject to amortization until projects reach commercialization, are assessed for impairment at least annually and more frequently if events occur that would indicate a potential reduction in the fair value of the assets below their carrying value. During the three months endedJune 30, 2020 , we compared the carrying value of the amortizing intangible assets acquired in ourOctober 2017 acquisition of a custom procedure pack business fromITL Healthcare Pty Ltd. ("ITL") , all of which pertained to our cardiovascular segment, to the undiscounted cash flows expected to result from the asset group and determined that the carrying amount was not recoverable. We then determined the fair value of the amortizing assets related to the ITL acquisition based on estimated future cash flows discounted back to their present value using discount rates that reflect the risk profile of the underlying activities. The primary factor that influenced our estimated cash flows is our planned closure of our procedural pack business inAustralia . We recorded an impairment charge for ITL of approximately$2.4 million during the three months endedJune 30, 2020 . During the three months endedJune 30, 2019 we recorded an impairment charge of$548,000 for the discontinuation of our product associated with the assets acquired in ourJune 2017 acquisition of patent rights and other intellectual property related to the Repositionable Chest Tube and related devices fromLazarus Medical Technologies, LLC . Contingent Consideration. Contingent consideration is an obligation by the buyer to transfer additional assets or equity interests to the former owner upon reaching certain performance targets. Certain of our business combinations involve the potential for the payment of future contingent consideration, generally based on a percentage of future product sales or upon attaining specified future revenue or operational milestones. In connection with a business combination, any contingent consideration is recorded at fair value on the acquisition date based upon the consideration expected to be transferred in the future. We base the fair value of contingent consideration obligations acquired in a business combination on valuations that use information and assumptions that a market participant would use, including assumptions for estimated revenue growth rates, discount rates, probabilities of achieving regulatory approval, performance, or revenue-based milestones and other relevant factors. These assumptions are impacted by our best estimates of the timing and duration of the current COVID-19 pandemic. We re-measure the estimated liability each quarter and record changes in the estimated fair value through operating expense in our consolidated statements of income. Significant increases or decreases in our estimates and developments related to the COVID-19 pandemic could result in changes to the estimated fair value of our contingent consideration liability, as the result of changes in the timing and amount of revenue estimates, as well as changes in the discount
rate
or periods.
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ADDITIONAL INFORMATION
Cybersecurity
We have established controls and procedures to escalate enterprise level issues,
including cybersecurity matters, to the appropriate management levels within our
organization and our Board of Directors, or members or committees thereof, as
appropriate. Under our framework, cybersecurity issues are analyzed by subject
matter experts for potential financial, operational, and reputational risks,
based on, among other factors, the nature of the matter and breadth of impact.
Matters determined to present potential material impacts to the Company's
financial results, operations, and/or reputation are immediately reported by
management to the Board of Directors, or individual members or committees
thereof, as appropriate, in accordance with our escalation framework. In
addition, we have established procedures to ensure that management responsible
for overseeing the effectiveness of disclosure controls is informed in a timely
manner of known cybersecurity risks and incidents that may materially impact our
operations and that timely public disclosure is made as appropriate.
Insider Trading Policy
Our directors and executive officers are subject to our Corporate Policy on
Insider Trading, which is designed to facilitate compliance with insider trading
laws and governs transactions in our common stock and related derivative
securities. Any director, officer or employee in possession of material,
nonpublic information, or who may be deemed to possess such information by
reason of his or her positions, may not (i) trade in the Company's securities;
(ii) share the information with others ("tipping"), or (iii) permit a member of
his or her immediate family to trade in the Company's securities. Our policy
designates certain regular periods, from 15 days prior to the end of a calendar
quarter to two full business days after the release of financial results, in
which trading is prohibited for individuals in information-sensitive positions,
including directors and executive officers. Our policy also prohibits executive
officers and directors (i) trading in Merit stock on a short term basis (minimum
six-month holding period); (ii) engaging in short sales of Merit stock; (iii)
buying or selling put options or call options or other derivative instruments
associated with Merit stock; or (iv) entering into hedging transactions
associated with Merit stock.
Additional periods of trading restriction may be imposed as determined by the
Chief Executive Officer or the Insider Trading Compliance Officers (currently
the Chief Legal Officer and the Chief Financial Officer) in light of material
pending developments. Further, during permitted windows, individuals in
information-sensitive positions are required to seek pre-clearance for trades
from an Insider Trading Compliance Officer, who assesses whether there are any
important pending developments, including cybersecurity matters, which need to
be made public before the individual may participate in the market.
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