Merit Medical Systems, Inc. (NASDAQ:MMSI) Q2 2022 Earnings Conference Call July 27, 2022 5:00 PM ET
Company Participants
Fred Lampropoulos – Founder, Chairman & Chief Executive Officer
Brian Lloyd – Chief Legal Officer & Corporate Secretary
Raul Parra – Chief Financial Officer & Treasurer
Conference Call Participants
Operator
Welcome to the Second Quarter of Fiscal Year 2022 Earnings Conference Call for Merit Medical Systems, Inc. At this time, all participants have been placed in a listen-only mode. Please note that this conference call is being recorded and that the recording will be available on the company’s website for replay shortly.
I would now like to turn the call over to Fred Lampropoulos, Medical Systems Founder, Chairman and Chief Executive Officer. Please go ahead, sir.
Fred Lampropoulos
Thank you, and welcome, everyone, to Merit Medical’s second quarter of fiscal year ’22 earnings conference call. I’m joined today with Raul Parra, our Chief Financial Officer and Treasurer; and Brian Lloyd, our Chief Legal Officer and Corporate Secretary.
Brian, would you mind taking us through the safe harbor statements, please?
Brian Lloyd
Thank you, Fred.
I would like to remind everyone that this presentation contains forward-looking statements that receive Safe Harbor protection under federal securities laws. Although we believe these forward-looking statements are based upon reasonable assumptions, they are subject to unknown risks and uncertainties. The realization of any of these risks or uncertainties as well as extraordinary events or transactions impacting our company could cause actual results to differ materially from those currently anticipated. In addition, any forward-looking statements represent our views only as of today, July 27, 2022, and should not be relied upon as representing our views as of any other date. We specifically disclaim any obligation to update such statements, except as required by applicable law. Please refer to the section entitled Cautionary Statement — regarding — forward-looking Statements in today’s presentation for important information regarding such statements.
Please also refer to our most recent filings with the SEC for a discussion of factors that could cause actual results to differ from these forward-looking statements. Our financial statements are prepared in accordance with accounting principles, which are generally accepted in the United States. However, we believe certain non-GAAP financial measures provide investors with useful information regarding the underlying business trends and performance of our ongoing operations and can be useful for period-over-period comparisons of such operations. This presentation also contains certain non-GAAP financial measures. A reconciliation of non-GAAP financial measures to the most directly comparable U.S. GAAP measures is included in today’s press release and presentation furnished to the SEC under Form 8-K.
Please refer to the section of our presentation entitled – non-GAAP Financial Measures for important information regarding non-GAAP financial measures discussed on this call. Readers should consider non-GAAP financial measures in addition to, not as a substitute for financial reporting measures prepared in accordance with GAAP. Please note that these calculations may not be comparable with similarly titled measures of other companies. Both today’s press release and our presentation are available on the Investors page of our website.
I will now turn the call back to Fred.
Fred Lampropoulos
Thank you, Brian. And let me start with a brief agenda of what we will cover during our prepared remarks. I will start with an overview of better-than-expected revenue results for the second quarter. After my opening remarks, Raul will provide you with a more in-depth review of our quarterly financial results and the formal financial guidance for 2022 that we updated in today’s press release as well as a summary of our balance sheet and financial condition. We will then open the call for your questions.
Now beginning with a review of our second quarter revenue performance. We reported total GAAP revenues of $295 million in the second quarter, up 5.2% year-over-year. Our total GAAP revenue growth was driven by 3.7% growth in U.S. sales and 7.2% growth in international sales. Our total revenue increased 7.4% year-over-year in the second quarter on an organic constant currency basis, excluding the headwind to our GAAP revenue growth related to changes in exchange rates compared to the prior year period. We delivered constant currency revenue results that exceeded the growth expectations that we discussed in our quarter one earnings call. Specifically, we shared our expectation for constant currency revenue growth in the range of a flat top 2% year-over-year in Q2. We — the strong constant currency revenue results were driven by solid execution from our team, stronger-than-anticipated demand in the U.S. and more favorable than anticipated international sales trends, particularly in the EMEA and Rest of World regions.
Now let me provide you with a more detailed review of our revenue results in the second quarter, beginning with the sales performance in each of our primary reportable product categories. Note, unless otherwise stated, all growth rates are approximated and are on a year-over-year and constant currency basis. Second quarter total revenue was driven by a 7.5% growth in sales of cardiovascular products and a 4.4% growth in sales of endoscopy products. Sales of our peripheral interventional products increased 7%, representing the largest driver of total cardiovascular segment growth in quarter two. We — within the PI product category, sales of our angiography products increased 18% and were the largest driver of our total PI growth year-over-year. Sales of our embolics, access and drainage products increased nearly 8% year-over-year in quarter two and together contributed roughly 1/2 of our total PI growth year-over-year. Notably, sales of our Scout radar localization products increased 9% year-over-year, driven by continued positive demand for this highly differentiated wireless radar-guided localization system used to assess breast surgeons in identifying tumors for removal during breast conserving surgery.
Within our cardiac intervention business, sales increased 7% in quarter two, representing the second largest contributor to total Cardiovascular segment growth year-over-year. We had standout contributions in total CI growth in quarter two from sales of our intervention products, which increased 12% year-over-year, driven by sales of our basics inflation device, continuing to deliver strong contributions to growth increasing 14% in quarter two and a notable pickup in demand for our PhD hemostatic valve products. Sales of our OEM products were all stronger than expected in quarter two, increasing 15% year-over-year, driven by improving demand from larger customers in multiple categories, including cardiac intervention and access, fluid management, coatings and kits.
We are pleased to see that sales of our CPS products posted a 5% growth in quarter two, fueled by low double-digit growth in sales of trades. Finally, sales in our Endoscopy segment increased 4% in quarter two, ahead of expectations as we saw strong demand for our Elation esophageal balloon products, which offset the expected business disruption related to issues with a third-party contract manufacturer discussed in our last earnings call.
Now turning to a brief summary of sales performance on a geographic basis, our second quarter sales in the U.S. increased 2.6% year-over-year on a constant currency basis. Importantly, our second quarter sales results reflect improving U.S. growth trends on both a 2- and 3-year basis. Our second quarter international sales increased 13.6% year-over-year on a constant currency basis. And encouragingly, despite the challenging global macro environment in quarter two, our international sales results reflect improving growth trends on a 2-year basis and largely consistent growth trends on a 3-year basis. We saw contributions to our total international growth in each of our 3 primary regions around the world with EMEA sales growth representing the largest driver of total international growth in quarter two. EMEA growth was driven by demand from customers in Western Europe, the Nordic regions and Africa and sales to customers in Russia, which was not contemplated in our quarter two outlook given the ongoing conflict in that region of the world.
APAC posted mid-single-digit growth in quarter two, which was modestly softer than expected, with strong sales in Japan, Southeast Asia and Greer more than offsetting the 1% sales decline in China. Our rest of the world region posted 57% growth year-over-year in quarter two, which was well ahead of expectations as we saw particularly strong demand from customers in Latin America and Brazil. In summary, we’re encouraged by the improving growth trends and proud of our team’s strong execution despite another quarter marked by a challenging operating environment.
Before we turn the call over to Raul, I wanted to comment on a few other noteworthy items in the quarter. First, we delivered another quarter of impressive profitability improvement, margin expansion and free cash flow generation in quarter two. We — our non-GAAP gross profit, non-GAAP operating income and non-GAAP net income increased 7%, 23% and 20% year-over-year, respectively, in quarter two. Our non-GAAP gross margins increased 69 basis points year-over-year despite continued inflationary headwinds, and our non-GAAP operating margin increased 280 basis points year-over-year to a record 19.1%. We also generated $31.5 million of free cash flow in the quarter. We believe our financial results in the second quarter and the first half of 2022 represent further evidence that we are making progress towards our goal of enhancing Merit’s long-term growth and profitability profile.
We remain committed to the financial targets that we outlined in the Foundations for Growth program for the 3-year period ending December 31, 2023, which call for our constant currency organic revenue to increase at a CAGR of at least 5% non-GAAP operating margins of at least 18% and cumulative free cash flow generated of more than $300 million. Second, we are pleased with the progress in recent months towards our strategic initiative to expand the body of clinical evidence for our products. Specifically, our clinical study, the WAVE study of the Rhapsody endovascular stent graft an investigational device being studied for the treatment of stenosis or occlusion within dialysis upload circuit continues to progress.
We have 40 clinical sites actively enrolling patients. We also announced first patient enrollment in 2 new studies in recent months, the RAP study and the STREAMLORK study. The RAP study will evaluate the clinical benefits associated with the use of the RAPS cell and preblendoprosthesis in patients receiving hemodialysis that experience a narrowing or stenosis or blockage occlusion of blood vessels required for dialysis vascular access. This is a prospective multicenter observational study of up to 500 subjects without broccoli we’re receiving hemodialysis at medical facilities throughout Europe, South America, Australia, New Zealand. — clinical outcomes of patients after the initial placement of the rapid cell in Permian Endoprosthesis will be evaluated over a 2-year period in accordance with instructions for associated with its CE mark.
The STREAMLOk study is a Canadian registry intended to demonstrate the utility of the Scout surgical guidance system to improve workflow and efficiency in Canadian centers diagnosing and treat breast cancer. The secondary objective of the study is to further evaluate the safety and performance of the Scout surgical guidance system when used according to the IFU in 500 consented patients with VRad scores of 4C or 5. By assessing the utility of the refractor insertion at the time of biopsy, this study is designed to measure the impact on patient visits to the breast center for invasive procedures between biopsy and surgery and quantify this value to the Canadian public health care system. Now with respect to our efforts to expand clinician awareness of the clinical efficacy of our products, — we continue to work with KOLs to identify opportunities to feature our products and leading publications and look forward to Dr. Katarina Malagari’s abstract on the European MCRC registry study, which was completed in December 2021.
The European MCRC study evaluated the use and value transarterial chemoablization of metastatic colorectal cancer to the liver with Merit’s HepaSphere microspheres loaded with a rinotecan. DaviMolagar’s abstract was accepted for the Siris meeting that will be in Barcelona in September. Our marketing and medical fairs team were excited to host the inaugural Wasa Summit meeting here in South Jordan, this week. And I would just say it is a wonderful meeting to meet with these KOLs. This is a multi-day meeting offered a valuable opportunity to engage with them from around the world in a variety of topics, including an overview of our endovascular intervention and embolic platforms, new technologies, our WAVE and RAP studies and GAE planning.
Finally, I wanted to highlight another area where our team has been executing well towards one of our key strategic initiatives, specifically the development, clearance and commercialization of new products. During the first half of 2022, we have highlighted our progress in these areas with 4 notable press releases. We received breakthrough device designation for impose microspheres in the use in genicular artery embolization for synthetic knee opioid-use me, RCO arthritis. We received clearance for the Scout BX delivery system, a notable addition to the merit Oncology breast and soft tissue localization portfolio. This system addresses roughly 40% of breast biopsies performed under stereotactic or MRI guidance and the related need for an additional visit for refectory placement prior to surgery. The Scout BX is compatible with most commonly used stereotactic and MRR guided breast biopsy devices on the market, allowing the patient to avoid an additional office visit and procedure.
We also announced the launch of our new Scout Mini reflector, the Scout many reflector is designed for use in soft tissue such as breast and lymph nodes and measures 8 millimeters in length, 33% shorter than the standard Scott reflector offering more utility in difficult to localized areas. The Scout Mini reflector offers enhanced directionality to achieve more precise pinpointing affected tissues within plus or minus 1 millimeter of accuracy, consistent with Merit’s standard scout reflectors. The Scout minoreflector supports multiple treatment needs including placement in breast tissue and lymph nodes and can be used pre or post neo-adjunctive chemotherapy at the time of biopsy and for bracketing. Discount indication for use also supports placement in other soft tissue malignancies, broadening the use of Scout technology outside the traditional use for breast cancer treatment.
And finally, I keep saying finally, we announced the launch of the RESOLVE pneumothorax trade. The resolve pneumothorax trade is the latest addition of Merit’s vascular peripheral drainage offering of a portfolio of interventional catheters, stent systems, drainage systems, bottles, procedure trades, sets and complementary procedures. The new RESOLVE pneumothorx trade contains all products needed to perform in the thoracostomy a minimally invasive technique that allows patients to avoid an open surgical procedure to drain fluids or air from the test. Each trade component is placed in order of use, supporting procedural efficiency and ease of use.
Now, I’m proud of the team’s continued commitment to strong execution in the areas of development, clearance and commercialization of new products. Now with that said, and this will be my last filing. Let me turn the call over to Raul, who will take you through the detailed review of our second quarter financial results and our 2022 financial guidance, which we updated in today’s press release.
Raul?
Raul Parra
Thank you, Fred. Given Fred’s detailed discussion of our revenue results, I will begin with a review of our financial performance across the rest of the P&L. For the avoidance of doubt, unless otherwise noted, my commentary will focus on the company’s non-GAAP results during the second quarter of fiscal year 2022.
We have included reconciliations from our GAAP reported results to the related non-GAAP items in our press release and presentation available on our website. Gross profit increased approximately 7% year-over-year in the second quarter. Our gross margin for the second quarter was 49.3% compared to 48.7% in the prior year period. The 69 basis point increase in gross margins year-over-year was primarily due to changes in product mix and lower obsolescence expense, offset partially by unfavorable manufacturing variances primarily related to purchase price variances and higher freight costs compared to the prior year period.
As expected, our second quarter results reflect the inflationary headwinds we are seeing in logistics, labor and increasingly in raw materials. Specifically, while our prior guidance assumed higher raw material costs compared to the second quarter of 2021, our second quarter results included an incremental headwind to our non-GAAP gross margins of approximately 50 basis points from higher-than-expected raw material expenses. Second quarter operating expenses decreased 2% compared to the second quarter of 2021. The year-over-year decrease in operating expenses was driven by a 1% decrease in SG&A expense and a 5% decrease in R&D expense compared to the prior year period.
Our operating expense performance in Q2 was better than expected and reflects continued prudent expense management as well as modest delays in hiring expenditures given the ongoing challenges in the labor market. Total operating income in the second quarter increased $10.7 million or 23% year-over-year to $56.4 million. Our operating margin for Q2 was 19.1% compared to 16.3% in the prior year period. The year-over-year change in operating margin was primarily driven by the 69 basis point increase in our non-GAAP gross margin and a 210 basis point reduction in our non-GAAP operating expense margin compared to the prior year period.
Second quarter other expense net was $1.1 million compared to $1.9 million last year. The change in other expense net was primarily related to decreased interest expense as a result of lower average debt balance despite a higher effective interest rate. Second quarter net income was $42.3 million or $0.73 per share compared to $35.3 million or $0.62 per share in the prior year period. We are very pleased with our profitability performance in the second quarter, where we reported year-over-year growth in non-GAAP net income and diluted earnings per share of 20% and 19%, respectively, despite the incremental pressure on our gross margin and a higher-than-expected tax rate in the period.
Turning to a brief review of our financial results over the first half of 2022. Total revenue for the 6 months ended June 30 was $570.4 million, up $41.2 million year-over-year or 9% growth on a constant currency basis. Gross profit increased 7% year-over-year to approximately $277 million, representing 48.6% of sales in the first half of 2022 compared to 48.9% of sales in the prior year period, a 36 basis point decrease year-over-year. Operating profit increased 14% year-over-year to $96.6 million. representing 16.9% of sales in the first half of 2022 compared to 16% of sales in the prior year period, a 95 basis point increase year-over-year. Net income increased 12% year-over-year to $72.7 million or $1.26 per share compared to $65.2 million or $1.14 per share in the prior year period.
Turning to a review of our balance sheet and financial condition. As of June 30, 2022, we had cash, cash equivalents and restricted cash of $65.2 million, long-term debt obligations of approximately $246 million and available borrowing capacity of approximately $481 million. This compares to cash on hand of $67.8 million, long-term debt obligations of approximately $243 million and available borrowing capacity of approximately $490 million as of December 31, 2021. Our net leverage ratio as of June 30 was 0.8x on an adjusted basis. With respect to our cash flow generation in the second quarter, our strong profitability performance in the second quarter of 2022, combined with strategic working capital investments, resulted in strong free cash flow generation of $31.5 million in the second quarter.
As expected, our use of cash for working capital increased compared to the prior year period. In recent quarters, we have discussed our strategy to proactively invest in our inventory balances to build a requisite safety stock and ensure high customer service levels. This strategy represented roughly 1/2 of our total working capital use of cash in the second quarter. We generated $34 million of free cash flow during the 6 months ended June 30, 2022. We continue to expect strong free cash flow generation this year and remain on track to deliver our goal of generating at least $75 million of free cash flow in 2022. Of note, this free cash flow target assumes planned investments related to the Foundations for Growth program that are expected to drive our CapEx investments in the range of $55 million to $60 million to $60 million in 2022.
Turning to a review of our fiscal year 2022 financial guidance, which we updated in today’s press release. For the 12 months ended December 31, 2022, we now expect GAAP net revenue growth of approximately 5% to 6% year-over-year. This GAAP net revenue range now assumes a headwind from the changes in foreign currency exchange rates in the range of approximately $18.6 million, representing a headwind of approximately 170 basis points to our forecasted GAAP growth rate this year. This FX impact reflects an incremental headwind of $15 million to $15.6 million as compared to our prior 2022 guidance had assumed. Note, roughly 1/3 of this incremental FX headwind was realized in Q2 with the balance of the increase expected to impact our GAAP revenue results in the second half of 2022. The GAAP net revenue guidance range now assumes net revenue from growth of approximately 5% to 6% in the Cardiovascular segment and net revenue in our Endoscopy segment in the range of a 5% decline to an 8% increase year-over-year.
With respect to profitability guidance for 2022, we now expect GAAP net income in the range of approximately $62.4 million to $68.3 million or $1.08 to $1.18 per diluted share. Non-GAAP net income in the range of approximately $139.6 million to $145.5 million or $2.42 to $2.52 per diluted share. For modeling purposes, our fiscal year 2022 financial guidance now assumes non-GAAP gross margins in the range of approximately 49% to 49.15% compared to a range of 50.1% to 50.6% previously. The revised gross margin expectations reflect inflationary pressures in the areas of raw materials and in freight and logistics. While we are pleased with the continued progress we are seeing as a result of our FSG initiatives and in the area of pricing, we have seen a material increase in raw material costs in recent months. And these cost increases were not contemplated in our prior guidance assumptions.
With respect to freight and logistics costs, recall that our prior guidance did include the assumptions that we would see freight and logistics headwinds dissipate in the second half of 2022, given easier comparisons based on the uptick in these expenses over the second half of 2021. Our updated guidance now assumes we do not realize the benefits of these easing comparisons as we now assume a higher mix of air freight versus shipping freight over the second half of 2022. Importantly, this is a direct result of our strategic decision to respond to the stronger-than-expected demand for our products around the world. Returning to a review of other key modeling assumptions supporting our updated financial guidance for 2022.
We expect non-GAAP operating margins in the range of approximately 16.6% to 17.1% compared to a range of 6.6% to 17.3% previously. GAAP and non-GAAP other expense of approximately $6.5 million and $4.8 million, respectively, diluted shares outstanding of approximately $57.7 million compared to approximately $58 million previously and the full year 2022 tax rate of approximately 24% versus a range of 22% to 23% previously. Late continued uncertainty in the global macro environment, we would like to provide additional transparency related to our growth and profitability expectations for the third quarter of 2022. Specifically, we expect our total revenue to increase in the range of approximately 1% to 1% to 4% increase year-over-year on a GAAP basis and up approximately 4% to 6% year-over-year on a constant currency basis.
Our growth expectations for the third quarter of 2022 reflects 2 items of note. First, the midpoint of our third growth — third quarter growth expectations assume constant currency sales growth of approximately 3% year-over-year in the U.S. and approximately 7% year-over-year in OUS markets. Second, our third quarter guidance range assumes a notably wide range of sales of endoscopy devices. — specifically, a decline of 37% on the low end to an increase of approximately 12% on the high end as we continue to manage business disruption related to issues with a third-party contract manufacturer. We view this disruption as transitory and expect to return to more normalized growth trends in the fourth quarter.
With respect to our profitability expectations for the third quarter, we expect to see flattish non-GAAP gross margin trends compared to last year and modest declines on a quarter-over-quarter basis, driven by previously mentioned inflationary pressures we are seeing in raw materials and incremental freight and logistics costs compared to the prior year. We also expect to see non-GAAP operating margin trends remain flattish to modest improvements compared to last year. These margin expectations, combined with a notable increase in our non-GAAP tax rate compared to last year are expected to drive a change in non-GAAP net income and EPS in the range of down 4% to 5% year-over-year on the low end to up 3% to 5% year-over-year on the high end.
With that, I’ll turn the call back to Fred.
Fred Lampropoulos
Well, thank you. And in closing, despite the challenging operating environment in quarter two, I’m very, very proud that we were able to deliver revenue and profitability results that exceeded expectations. We’re confident in our 2022 guidance, which now calls for total revenue growth on a constant currency basis of 5% to 6% year-over-year. We continue to expect to see progressive improvement in our operating environment, specifically access to patients and elective procedures as we move through 2022.
I — we also continue to expect to report improving non-GAAP gross and operating margins and strong free cash flow in 2022 driven by strong execution and contributions from our multiyear strategic initiatives related to the Foundations of Growth program. Our team continues to execute well and remains focused on our strategic initiatives while standing ready to adapt quickly to changes in our markets. We would like to thank all of our team members. You really can’t do any of this without the entire team that made globally, by the way, that made our performance over the first half of 2022 possible.
And with that said, I will turn the time back to our operator, and we’ll now open up the line for questions.
Question-and-Answer Session
End of Q&A
Thank you, sir. [Operator Instructions] Thank you. That does conclude our conference call for today. Thank you for your participation.
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