Merit Medical - 10-Q quarterly report FY

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005.

OR

o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM        TO        .

Commission File Number   0-18592

MERIT MEDICAL SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)

1600 West Merit Parkway, South Jordan, UT, 84095

(Address of Principal Executive Offices)

(801) 253-1600

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ý  No  o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  ý  No  o

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date.

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

•                  During the six months ended June 30, 2005 and 2004, 48,795 and 19,715 matured shares (i.e. shares owned for more than six months) of Merit common stock were surrendered in exchange for Merit’s recording of payroll tax liabilities in the amount of approximately $691,000 and $384,000, respectively, related to the exercise of stock options.  The matured shares were valued based upon the closing price of the Merit common stock on the surrender date.

•                  During the six months ended June 30, 2005 and 2004, 26,231 and 12,146 matured shares of Merit common stock, with a value of approximately $371,000 and $219,000, respectively, were surrendered in exchange for the exercise of stock options.

•                  During the six months ended June 30, 2005, Merit acquired substantially all of the assets of Sub-Q, Inc. (“Sub-Q”) (including know-how and certain formulas, but excluding patents), in a purchase transaction for $1,085,785, which included a $1.0 million promissory note advanced to Sub-Q during 2004 which was applied to the purchase price.  The purchase price was preliminarily allocated between fixed assets for $174,203, other intangibles for $750,000 and goodwill for $161,582.

•                  As of June 30, 2005 and 2004, $6,256,866 and $2,621,481, respectively, of additions to plant, equipment, and other asset purchases were accrued in accounts payable.

See notes to consolidated financial statements.

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MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.  Basis of Presentation. The interim consolidated financial statements of Merit Medical Systems, Inc. (“Merit,” “we” or “us”) for the three and six-month periods ended June 30, 2005 and 2004 are not audited. Our consolidated financial statements are prepared in accordance with the requirements for unaudited interim periods, and consequently, do not include all disclosures required to be in conformity with accounting principles generally accepted in the United States of America. In the opinion of management, the accompanying consolidated financial statements contain all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of our financial position as of June 30, 2005, and our results of operations and cash flows for the three and six-month periods ended June 30, 2005 and 2004. The results of operations for the three and six-month periods ended June 30, 2005 are not necessarily indicative of the results for a full-year period.  These interim consolidated financial statements should be read in conjunction with the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission (the “SEC”).

Stock-Based Compensation.  We account for stock compensation arrangements under the intrinsic value method outlined in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, (APB Opinion No. 25) and currently intend to continue to do so until we adopt the provisions of Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment, (SFAS No. 123R).  Accordingly, no compensation cost has been recognized for our stock compensation arrangements.  If the compensation cost for our compensation plans had been determined consistent with SFAS No. 123, our net income and earnings per common share and common share equivalent would have changed to the pro forma amounts indicated below (in thousands, except per share data):

For options with a vesting period, compensation expense is recognized on a ratable basis over the service period which corresponds to the vesting period. Compensation expense is recognized immediately for options that are fully vested on the date of grant.  On February 3, 2005, Merit accelerated the vesting of 427,448 options with an exercise price of $21.67, which was in excess of the current market price.  The acceleration of these options

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increased the pro-forma compensation cost for the six months ended June 30, 2005 by approximately $1.9 million, net of tax.

Reclassifications.  Subsequent to the issuance of our quarterly report on Form 10-Q for the three months ended June 30, 2004, we determined that certain of our liabilities associated with the acquisition of properties, plant and equipment were incorrectly reflected as cash inflows for operating activities and cash outflows for investing activities.  Management has concluded that the error was not material to our financial statements, and accordingly the prior period presented has been corrected by reducing net cash from operating activities and net cash used for investing activities by approximately $2.2 million.  In addition, certain other amounts have been reclassified in the prior year’s financial statements to conform with the current year’s presentation.

2.  Inventories. Inventories at June 30, 2005 and December 31, 2004 consisted of the following (in thousands):

3.  Reporting Comprehensive Income.  Comprehensive income for the three and six-month periods ended June 30, 2005 and 2004 consisted of net income and foreign currency translation adjustments.  As of June 30, 2005 and December 31, 2004, the cumulative effect of such adjustments reduced stockholders’ equity by $389,886 and $398,445, respectively.  Comprehensive income for the three and six-month periods ended June 30, 2005 and 2004 has been computed as follows (in thousands):

4. Acquisitions.  On March 11, 2005, we acquired substantially all of the assets of Sub-Q (including know-how and certain formulas, but excluding patents), in a purchase transaction for $1,085,785, which included a $1.0 million promissory note advanced to Sub-Q during 2004 which was applied to the purchase price.  The purchase price was preliminarily allocated between fixed assets for $174,203, other intangibles (know-how and formulas) for $750,000 and goodwill for $161,582. The acquisition was accounted for as a purchase in accordance with SFAS No. 141, Business Combinations. The amount allocated to goodwill will be reviewed annually for impairment or more frequently if impairment indicators arise, in accordance with SFAS No. 142.  Sub-Q is a Delaware corporation, formed in June of 1998, and located in San Clemente, California.  Sub-Q was involved in the development, manufacture and marketing of vascular sealing devices.  In addition, Sub-Q was developing proprietary gel foam products that may be used as an embolic and/or to stop bleeding in many areas of health care including, among others, interventional cardiology and radiology, wound care, gynecology, emergency room procedures, and surgery.  With the purchase of the Sub-Q assets, we plan to develop proprietary products to be used in interventional cardiology and radiology and, potentially, for additional medical applications.

5. Recently Issued Accounting Standards.  In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R. This Statement supersedes APB Opinion No. 25, and its related implementation

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sheath introducer and the Viceroy™ inflation device.  Management believes the market acceptance of Merit’s new and existing products, if achieved, will further enhance future top and bottom-line growth.

Results of Operations

The following table sets forth certain operational data as a percentage of sales for the three and six-month periods ended June 30, 2005 and 2004:

Sales.  Sales for the three months ended June 30, 2005 increased by 9%, or approximately $3.5 million, compared to the same period of 2004.  Sales for the six months ended June 30, 2005 increased by 8%, or approximately $6.1 million, compared to the same period of 2004.  We report sales in five product categories.  Listed below are the sales relating to these product categories for the three and six-month periods ended June 30, 2005 and 2004:

Sales growth for the three and six-month periods ended June 30, 2005, was favorably affected by an approximately two percent increase due to the introduction of new products, a two percent increase due to new procedure tray business acquired from MedSource in the fourth quarter of 2004, a one percent increase due to positive fluctuations in the exchange rate between the Euro and the U.S. Dollar when compared to the same periods in 2004, and the remainder resulting primarily from procedural growth and market share gains.  Substantially all of the increase in revenues was attributable to increased unit sales as the markets for many of our products are experiencing slight pricing declines.

Gross Profit.  Gross margins were down to 43.1% and 43.2% of sales for the three and six-month periods ended June 30, 2005, respectively, when compared to 46.3% and 45.0% of sales for the three and six-month periods ended June 30, 2004, respectively.  This decline resulted primarily from negative margins in the new procedure tray business acquired from MedSource.  The effect was a reduction of gross margins by 1.4% and 1.2%, respectively, for the three and six-month periods ended June 30, 2005.  Gross margins for the three and six-month periods ended June 30, 2005 were also affected by increases in material costs, overhead (i.e. supplies, new facilities, and utilities) and labor related costs.

Operating Expenses.  Selling, general and administrative expenses decreased to 22.0% of sales for the three months ended June 30, 2005, compared with 22.6% of sales for the three months ended June 30, 2004.  The small decrease in selling, general and administrative expenses related primarily to lower legal costs and bonuses.  For the six months ended June 30, 2005, selling, general and administrative expenses increased slightly to 23.0% compared with 22.6% of sales for the six months ended June 30, 2004.  The increase in selling, general and administrative expenses as a percentage of sales during the six months ended June 30, 2005, was due primarily to costs associated

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with the buy-out of a distribution agreement ($200,000), severance for two employees ($155,000), and external audit fees to complete the audit of management’s assessment of the effectiveness of internal control over financial reporting under section 404 of the Sarbanes-Oxley Act of 2002 ($72,000).  Research and development expenses increased to 4.1% and 4.0% of sales for the three and six-month periods ended June 30, 2005, respectively, compared to 3.3% and 3.2% of sales for the three and six-month periods ended June 30, 2004, respectively.  This increase was primarily attributable to additional headcount and expenses associated with our efforts to launch seven new products during 2005.

Other Income.  Other income for the second quarter of 2005 was approximately $123,000, compared to approximately $140,000 for the same period in 2004.  The decrease in other income during the second quarter of 2005, when compared to the same period in 2004, was primarily the result of foreign exchange losses of approximately $22,000 relating to the Company’s hedging of the Euro and British Pound Sterling ("GBP").  Other income for the six months ended June 30, 2005 was approximately $284,000, compared to approximately $347,000 for the same period in 2004.  The decrease in other income for the six months ended June 30, 2005 when compared to the same period in 2004 was primarily the result of a gain from the settlement of a legal dispute of $100,000 in 2004.  Absent this legal settlement, other income for the six months ended June 30, 2005 would have increased compared to the prior year’s period primarily as the result of an increase in interest income of approximately $69,000, when compared to the same period in 2004.

Income Taxes.  Our effective tax rate for the three months ended June 30, 2005 was 36.0%, compared to 37.2% for the same period of 2004.  For the six months ended June 30, 2005, our effective tax rate was 36.0%, compared to 37.0% for the same period in 2004.  The decrease in the effective tax rate for the three and six-month periods ended June 30, 2005 was principally the result of increased profitability in our Irish operation, when compared to the prior year’s periods, which is taxed at a lower effective income tax rate than our U.S. effective income tax rate.

Income.  During the second quarter of 2005, we reported income from operations of $7.2 million, a decrease of 9.5% from $7.9 million for the comparable period in 2004.  For the six months ended June 30, 2005, we reported income from operations of $13.4 million, a decrease of 8.5% from $14.6 million for the comparable period in 2004.  The decrease in income from operations for the three and six-month periods ended June 30, 2005 was primarily the result of higher research and development spending, and higher selling, general and administrative expenses when compared to the prior year’s periods, partially offset by increased sales volumes.  These factors contributed to lower net income of $4.7 and $8.8 million for the three and six-month periods ended June 30, 2005, respectively, compared to net income of $5.1 million and $9.4 million for the same periods of 2004.

Liquidity and Capital Resources

Our working capital as of June 30, 2005 and December 31, 2004 was $44.3 million and $54.9 million, respectively.  The decrease in working capital was, in part, the result of cash being used to fund the construction of our new facilities in South Jordan, Utah.  As of June 30, 2005, we had a current ratio of 2.8 to 1. We had $0 outstanding under our line of credit at June 30, 2005.  We generated cash from operations for the six months ended June 30, 2005 in the amount of $9.5 million. We maintain a long-term revolving credit facility (the “Facility”) with a bank, which currently enables us to borrow funds at variable interest rates. The Facility was voluntarily reduced to $500,000 in August 2002. The Facility expires on June 30, 2006.  Based on discussions with representatives of the bank, we believe we could restore the Facility to its former level of $35 million, subject to a favorable credit review.

Historically, we have incurred significant expenses in connection with product development and introduction of new products.  Substantial capital has also been required to finance the increase in our receivables and inventories associated with our increased sales.  During the six months ended June 30, 2005, we paid approximately $9.1 million for progress payments on our facilities under construction in South Jordan, Utah.  In addition, during the six months ended June 30, 2005, we spent approximately $3.8 million to purchase a 102,000 square foot facility in Chester, Virginia and $1.0 million to purchase 5 acres of land just west of our current South Jordan, Utah facilities.  We still have approximately $6.3 million remaining to be paid to complete the facility in South Jordan, Utah.  We anticipate that an additional $2.5 million, in excess of our 2004 annual capital expenditures, will be spent on other production equipment for these new facilities.  Our principal source of funding for these and other expenses has been cash generated from operations, sales of equity, cash from loans on equipment, and bank lines of credit.  We currently believe that our present sources of liquidity and capital are adequate for current operations and for the foreseeable future.

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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 we believe 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 may differ 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 Reserve:  Our management reviews on a regular basis inventory quantities on hand for unmarketable and/or slow moving products that may expire prior to being sold.  This review of inventory quantities for unmarketable and/or slow moving products is based on estimates of forecasted product demand prior to expiration lives.  If market conditions become less favorable than those projected by management, additional inventory write-downs may be required.  We believe that the amount included in our obsolescence reserve has been a historically accurate estimate of the unmarketable and/or slow moving products that may expire prior to being sold.  Our obsolescence reserve was approximately $2.0 million as of June 30, 2005.

Allowance for Doubtful Accounts:  A majority of our receivables are with hospitals, which over our history, have demonstrated favorable collections.  Therefore, we have experienced relatively minimal bad debts from hospital customers and similar write-offs associated with some of our international distributors, typically as a result of terminating a distributor within a foreign country.  The most significant write-offs over our history have come from U.S. packers who bundle our products in surgical trays.

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments.  The allowance is based upon historical experience and a review of individual customer balances.  If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.  Our bad debt reserve was $740,059 at June 30, 2005, which is generally in line with our historical collection experience.

Stock-Based Compensation:  We account for stock compensation arrangements under the intrinsic value method outlined in APB Opinion No. 25, and currently intend to continue to do so until we adopt the provisions of SFAS No. 123R.  Please see the discussion of this point in Note 1 to our Consolidated Financial Statements, under the heading: Stock-Based Compensation.

Factors That May Affect Future Results

Our business, operations and financial condition are subject to certain risks and uncertainties.  Should one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary, and may vary materially, from those anticipated, estimated, projected or expected.  The following is a summary of some of the key factors, discussed in more detail in our Annual Report on Form 10-K, for the year ended December 31, 2004, that may have a direct bearing on our business, operations and financial condition:

•                  We may be unable to compete in our markets, particularly if there is a significant change in relevant procedures or technology, or increase in competitive pressures;

•                  Our products may be subject to recall or product liability claims;

•                  We may be unable to successfully manage growth, particularly if accomplished through acquisitions;

•                  A significant adverse change in, or failure to comply with, governing regulations could adversely affect our business;

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•                  A significant portion of our revenues are derived from a few products and procedures;

•                  Termination of relationships with our suppliers, or failure of such suppliers to perform, could disrupt our business;

•                  We may be unable to protect our proprietary technology, or our technology may infringe on the proprietary technology of others;

•                  Limits on reimbursement imposed by governmental and other programs may adversely affect our business;

•                  Fluctuations in Euro and GBP exchange rates may negatively impact our financial results;

•                  The market price of our common stock has been, and may continue to be, volatile;

•                  We are subject to work stoppage, transportation and related risks;

•                  We are dependent upon key personnel.

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