MERIT MEDICAL SYSTEMS INC - Quarter Report: 2011 March (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011.

 

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, including Zip Code)

 

(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  x  No  o

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).  Yes  o  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller public company. . See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

 

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

 

 

 

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MERIT MEDICAL SYSTEMS, INC.

 

INDEX TO FORM 10-Q

 

			PAGE
PART I.		FINANCIAL INFORMATION
	Item 1.	Financial Statements (Unaudited)
		Consolidated Balance Sheets as of March 31, 2011 and December 31, 2010	1
		Consolidated Statements of Operations for the three months ended March 31, 2011 and 2010	3
		Consolidated Statements of Cash Flows for the three months ended March 31, 2011 and 2010	4
		Condensed Notes to Consolidated Financial Statements	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	18
	Item 4.	Controls and Procedures	19
PART II.		OTHER INFORMATION
	Item 1. Legal Proceedings		19
	Item 1A. Risk Factors		19
	Item 6. Exhibits		20
	SIGNATURES		21

 

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Part I - FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

MARCH 31, 2011 AND DECEMBER 31, 2010

(In thousands)

 

		March 31,			December 31,
		2011			2010
		(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	3,465		$	3,735
Trade receivables - net of allowances of $492 and $593, respectively		41,031			37,362
Employee receivables		161			110
Other receivables		1,267			1,242
Inventories		60,353			60,597
Prepaid expenses and other assets		3,988			2,541
Deferred income tax assets		4,651			4,647
Income tax refunds receivable		472			2,067
Total current assets		115,388			112,301
PROPERTY AND EQUIPMENT:
Land and land improvements		12,579			12,586
Building		50,399			50,274
Manufacturing equipment		94,176			92,839
Furniture and fixtures		19,091			18,313
Leasehold improvements		12,360			12,121
Construction-in-progress		21,903			13,775
Total		210,508			199,908
Less accumulated depreciation		(74,926		)	(71,853		)
Property and equipment—net		135,582			128,055
OTHER ASSETS:
Intangibles - net of accumulated amortization of $10,573 and $8,996, respectively		56,828			57,184
Goodwill		58,659			58,675
Deferred income tax assets		4,296			4,140
Other assets		9,664			9,125
Total other assets		129,447			129,124
TOTAL ASSETS		$	380,417		$	369,480

 

See condensed notes to consolidated financial statements.

(Continued)

 

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MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

MARCH 31, 2011 AND DECEMBER 31, 2010

(In thousands)

 

		March 31,			December 31,
		2011			2010
		(unaudited)
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Trade payables		$	18,229		$	20,092
Accrued expenses		18,914			18,890
Advances from employees		329			307
Income taxes payable		945			887
Total current liabilities		38,417			40,176
LONG-TERM DEBT		82,564			81,538
DEFERRED INCOME TAX LIABILITIES		1,507			1,267
LIABILITIES RELATED TO UNRECOGNIZED TAX BENEFITS		3,527			3,527
DEFERRED COMPENSATION PAYABLE		4,477			4,258
DEFERRED CREDITS		1,736			1,763
OTHER LONG-TERM OBLIGATIONS		1,375			1,336
Total liabilities		133,603			133,865
STOCKHOLDERS’ EQUITY:
Preferred stock—5,000 shares authorized as of March 31, 2011 and December 31, 2010; no shares issued
Common stock—no par value; 100,000 shares authorized; 35,892 and 35,496 shares issued at March 31, 2011 and December 31, 2010, respectively		71,138			67,091
Retained earnings		174,303			167,664
Accumulated other comprehensive income		1,373			860
Total stockholders’ equity		246,814			235,615
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	380,417		$	369,480

 

See condensed notes to consolidated financial statements.

(Concluded)

 

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MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010

(In thousands, except earnings per common share - unaudited)

 

		Three Months Ended
		March 31,
		2011			2010
NET SALES		$	86,631		$	67,432
COST OF SALES		46,846			38,997
GROSS PROFIT		39,785			28,435
OPERATING EXPENSES:
Selling, general and administrative		24,591			19,032
Research and development		4,984			3,057
Total operating expenses		29,575			22,089
INCOME FROM OPERATIONS		10,210			6,346
OTHER INCOME (EXPENSE):
Interest income		2			8
Interest expense		(425		)	(35		)
Other income		11			11
Total other expense - net		(412		)	(16		)
INCOME BEFORE INCOME TAXES		9,798			6,330
INCOME TAX EXPENSE		3,159			1,822
NET INCOME		$	6,639		$	4,508
EARNINGS PER COMMON SHARE:
Basic		$	.19		$	.13
Diluted		$	.18		$	.13
AVERAGE COMMON SHARES:
Basic		35,593			35,226
Diluted		36,254			35,948

 

See condensed notes to consolidated financial statements.

 

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MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010

(In thousands - unaudited)

 

		Three Months Ended
		March 31,
		2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	6,639		$	4,508
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,794			3,290
Losses on sales and/or abandonment of property and equipment		4			108
Write-off of certain patents and trademarks		14			24
Amortization of deferred credits		(27		)	(29		)
Purchase of trading investments		(111		)	(141		)
Net unrealized gains on trading investments		(163		)	(33		)
Deferred income taxes		93			1
Stock-based compensation		335			304
Tax benefit attributable to appreciation of common stock options exercised		(1,055		)
Changes in operating assets and liabilities, net of effects from acquisitions:
Trade receivables		(3,316		)	(4,101		)
Employee receivables		(47		)	11
Other receivables		17			171
Inventories		245			353
Prepaid expenses and other assets		(1,402		)	(451		)
Income tax refund receivable		(107		)	16
Other assets		22
Trade payables		(4,259		)	(1,108		)
Accrued expenses		(48		)	(58		)
Advances from employees		15			563
Income taxes payable		2,702			1,612
Deferred compensation payable		219			59
Other long-term obligations		39			(29		)
Total adjustments		(2,036		)	562
Net cash provided by operating activities		4,603			5,070
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for:
Property and equipment		(8,540		)	(4,322		)
Patents and trademarks		(889		)	(218		)
Proceeds from the sale of property and equipment					7
Cash paid in acquisitions					(250		)
Net cash used in investing activities		(9,429		)	(4,783		)

 

See condensed notes to consolidated financial statements.

(Continued)

 

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MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010

(In thousands - unaudited)

 

		Three Months Ended
		March 31,
		2011			2010
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock		$	2,810		$	220
Borrowings on line of credit					1,500
Payments on line of credit					(2,000		)
Proceeds from issuance of long-term debt		22,700
Payment on long-term debt		(21,674		)
Payment of taxes related to an exchange of common stock		(154		)
Excess tax benefits from stock-based compensation		1,055
Net cash provided by (used in) financing activities		4,737			(280		)
EFFECT OF EXCHANGE RATES ON CASH		(181		)	(148		)
NET DECREASE IN CASH AND CASH EQUIVALENTS		(270		)	(141		)
CASH AND CASH EQUIVALENTS:
Beginning of period		3,735			6,133
End of period		$	3,465		$	5,992
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION—Cash paid during the period for (including capitalized interest of $60 and $0, respectively):
Interest		$	402		$	30
Income taxes		$	376		$	353
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Property and equipment purchases in accounts payable		$	3,770		$	1,619
Accrued purchase price		$			$	750

 

During the three months ended March 31, 2011, 13,116 shares of Merit’s common stock were surrendered in exchange for Merit’s recording of payroll tax liabilities in the amount of approximately $154,000, related to the exercise of stock options.  The shares were valued based upon the closing price of Merit’s common stock on the surrender date.

 

During the three months ended March 31, 2011, 6,721 shares of Merit’s common stock, with a value of approximately $79,000 were surrendered in exchange for the exercise of stock options.

 

See condensed notes to consolidated financial statements.

(Concluded)

 

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MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED 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 months ended March 31, 2011 and 2010 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 made 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 March 31, 2011, and our results of operations and cash flows for the three-month periods ended March 31, 2011 and 2010. The results of operations for the three-month period ended March 31, 2011 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, 2010 filed with the Securities and Exchange Commission (the “SEC”).

 

2.  Inventories. Inventories are stated at the lower of cost or market.  Inventories at March 31, 2011 and December 31, 2010 consisted of the following (in thousands):

 

		March 31,			December 31,
		2011			2010
Finished goods		$	28,674		$	30,780
Work-in-process		9,951			7,012
Raw materials		21,728			22,805
Total		$	60,353		$	60,597

 

3.   Comprehensive Income.  Comprehensive income for the three-month periods ended March 31, 2011 and 2010 consisted of net income, the mark to market adjustment on an interest rate swap and foreign currency translation adjustments.  Comprehensive income for the three-month periods ended March 31, 2011 and 2010 has been computed as follows (in thousands):

 

		Three Months Ended
		March 31,
		2011			2010
Net income		$	6,639		$	4,508
Interest rate swap, net of tax of $121		191			—
Foreign currency translation gain (loss)		322			(28		)
Comprehensive income		$	7,152		$	4,480

 

4. Stock-based Compensation.  Stock-based compensation expense for the three-month periods ended March 31, 2011 and 2010 has been categorized as follows (in thousands):

 

		Three Months Ended
		March 31,
		2011			2010
Cost of sales		$	51		$	51
Research and development		13			14
Selling, general and administrative		271			239
Stock-based compensation		$	335		$	304

 

The excess income tax benefit created from the exercises of stock options was approximately $1.1 million and $0 for the three-month periods ended March 31, 2011 and 2010, respectively.  As of March 31, 2011, the total

 

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remaining unrecognized compensation cost related to non-vested stock options, net of expected forfeitures, was approximately $2.6 million and is expected to be recognized over a weighted average period of 2.5 years. We use the Black-Scholes methodology to value the stock-based compensation expense for options.

 

5. Earnings Per Common Share. The following table sets forth the computation of the number of shares used in calculating basic and diluted net income  per share  (in thousands, except per share amounts):

 

		Net					Per Share
		Income			Shares		Amount
Three months ended March 31, 2011:
Basic EPS		$	6,639		35,593		$	0.19
Effect of dilutive stock options and warrants					661
Diluted EPS		$	6,639		36,254		$	0.18
Stock options excluded from the calculation of common stock equivalents as the impact was antidilutive					844

 

		Net					Per Share
		Income			Shares		Amount
Three months ended March 31, 2010:
Basic EPS		$	4,508		35,226		$	0.13
Effect of dilutive stock options and warrants					722
Diluted EPS		$	4,508		35,948		$	0.13
Stock options excluded from the calculation of common stock equivalents as the impact was antidilutive					1,311

 

6. Acquisitions. On September 10, 2010, we completed our acquisition of BioSphere Medical, Inc. (“BioSphere”) in an all cash merger transaction valued at approximately $96 million, inclusive of all common equity and Series A Preferred preferences.  BioSphere develops and markets embolotherapeutic products for the treatment of uterine fibroids, hypervascularized tumors and arteriovenous malformations.  We anticipate that the acquisition of BioSphere will give us a platform technology applicable to multiple therapeutic areas with significant market potential while leveraging existing interventional radiology call points.  Two immediate applications for the embolotherapy are uterine fibroids and primary liver cancer.  The gross amount of trade receivables we acquired from BioSphere is approximately $4.6 million, of which $51,000 is expected to be uncollectible.  Our consolidated financial statements for the three months ended March 31, 2011 reflect sales subsequent to the acquisition date of approximately $7.7 million related to our BioSphere acquisition.  We report sales and operating expenses related to this acquisition in our cardiovascular segment.  Computation of the earnings related to this acquisition is impractical, as we cannot split out sales costs related to Biosphere’s products as our sales representatives are selling multiple products in the cardiovascular business segment.  As of December 31, 2010, the purchase price was allocated as follows as (in thousands):

 

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Assets Acquired
Marketable securities		$	9,673
Trade receivables		4,529
Inventories		5,694
Other assets		1,340
Property and equipment		546
Deferred income tax assets		16,012
Intangibles
Developed technology		19,000
Customer list		7,900
License agreement		380
Trademark		3,200
Goodwill		34,016
Total assets acquired		102,290
Liabilities Assumed
Accounts payable		322
Accrued expenses		3,617
Deferred income tax liabilities		729
Liabilities related to unrecognized tax benefits		961
Other liabilities		936
Total liabilities assumed		6,565
Net assets acquired, net of cash acquired of $274		$	95,725

 

Changes have been made to the assets acquired and liabilities assumed during the three-month period ended March 31, 2011, but these changes were not significant.

 

With respect to the assets we acquired from BioSphere, we are amortizing developed technology over 15 years and a license agreement over 10 years and customer lists on an accelerated basis over 10 years.  While U.S. trademarks can be renewed indefinitely, we currently estimate that we will generate cash flow from the acquired trademarks for a period of 15 years from the acquisition date.  The total weighted-average amortization period for these acquired intangible assets is 13.6 years.

 

In connection with our BioSphere acquisition, we paid approximately $522,000 in long-term debt issuance costs to Wells Fargo Bank (“Wells Fargo”) for our long-term debt (see Note 10).  These costs consist of loan origination fees and legal costs that we intend to amortize over five years, which is the contract term of an unsecured Credit Agreement, dated September 10, 2010 (the “Credit Agreement”) with lenders who are or may become party thereto (collectively, the “Lenders”) and Wells Fargo, as administrative agent for the Lenders.  We also incurred approximately $63,000 of acquisition-related costs during the three months ended March 31, 2011, which are included in selling, general and administrative expense in the accompanying consolidated statements of income

 

During the fourth quarter of 2010, we terminated several of our exclusive BioSphere sales distributor agreements in European countries where we already had previously established direct sales relationships.  In connection with the termination of these agreements, we agreed to purchase customer lists from the terminated distributors.  The total purchase price of the customer lists was approximately $1.3 million and was allocated to customer lists.  We are amortizing the customer lists on an accelerated basis over 10 years.

 

On February 19, 2010, we entered into a manufacturing and technology license agreement with a medical device manufacturer for certain medical products.  We made an initial payment of $250,000 in February of 2010, a second payment of $250,000 in May of 2010, a third payment of $250,000 in November of 2010 and accrued an additional $250,000 in accrued expenses at December 31, 2010.  The final payment is due upon reaching certain milestones set forth in the agreement.  We believe it is probable that we will be required to make the final payment.  We have included the $1.0 million intangible asset in license agreements and are amortizing the asset over an estimated life of 10 years.

 

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The following table summarizes our unaudited consolidated results of operations for the three months ended March 31, 2010, as well as the unaudited pro forma consolidated results of operations as though the BioSphere acquisition had occurred on January 1, 2010 (in thousands, except per share amounts):

 

		Three Months Ended
		March 31, 2010
		As Reported			Pro Forma
Sales		$	67,432		$	74,552
Net income		4,508			2,893
Earnings per common share:
Basic		$	.13		$	.08
Diluted		$	.13		$	.08

 

The unaudited pro forma information set forth above is for informational purposes only and should not be considered indicative of actual results that would have been achieved if BioSphere had been acquired at the beginning of 2010, or results that may be obtained in any future period.

 

7. Segment Reporting. We report our operations in two operating segments: cardiovascular and endoscopy.  Our cardiovascular segment consists of cardiology and radiology medical device products which assist in diagnosing and treating coronary artery disease, peripheral vascular disease and other non-vascular diseases.  Our endoscopy segment consists of gastroenterology and pulmonary medical device products which assist in the palliative treatment of expanding esophageal, tracheobronchial and biliary strictures caused by malignant tumors. We evaluate the performance of our operating segments based on operating income (loss).  Financial information relating to our reportable operating segments and reconciliations to the condensed consolidated totals is as follows (in thousands):

 

		Three Months Ended
		March 31,
		2011			2010
Revenues
Cardiovascular		$	83,927		$	64,960
Endoscopy		2,704			2,472
Total revenues		$	86,631		$	67,432
Operating Income (Loss)
Cardiovascular		$	11,188		$	6,980
Endoscopy		(978		)	(634		)
Total operating income		$	10,210		$	6,346

 

8. Recent Accounting Pronouncements.  In December 2010, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance to address diversity in practice about pro forma revenue and earnings disclosure requirements.  This guidance specifies that if a public entity presents comparative financial statements, the entity shall disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only.  This guidance also expands the supplemental pro forma disclosures to include a description of the nature and amount of material nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. This guidance is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  We will apply these required disclosures to any future business combinations.

 

In December 2010, the FASB issued authoritative guidance which modifies the requirements of step one of the goodwill impairment test for reporting units with zero or negative carrying amounts.  This guidance modifies step one so that for those reporting units, an entity is required to perform step two of the goodwill impairment test if it

 

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is more likely than not that a goodwill impairment exists.  In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist.  This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010.  The adoption of this guidance did not have a material effect on our consolidated financial statements.

 

In January 2010, the FASB issued additional authoritative guidance on fair value disclosures.  The new guidance clarifies two existing disclosure requirements and requires two new disclosures as follows: (1) a “gross” presentation of activities (purchases, sales, and settlements) within the Level 3 rollforward reconciliation, which will replace the “net” presentation format; and (2) detailed disclosures about the transfers in and out of Level 1 and 2 measurements.  This guidance is effective for the first interim or annual reporting period beginning after December 15, 2009, except for the gross presentation of the Level 3 rollforward information, which is required for annual reporting periods beginning after December 15, 2010, and for interim reporting periods within those years.  We adopted the fair value disclosure guidance on January 1, 2010, except for the gross presentation of the Level 3 rollforward information which we adopted on January 1, 2011.  The adoption of this guidance did not have a material effect on our consolidated financial statements.

 

9.  Income Taxes.  Our overall effective tax rate for the three months ended March 31, 2011 and 2010 was 32.2% and 28.8%, respectively, which resulted in a provision for income taxes of $3.2 million and $1.8 million, respectively.  The increase in the effective income tax rate for the first quarter of 2011, when compared to the first quarter of 2010, was primarily related to the increased profit of our U.S. operations which are taxed at a higher rate than our foreign operations income (primarily Ireland).

 

10.  Long-Term Debt. In connection with our acquisition of BioSphere, we entered into the Credit Agreement with the Lenders and Wells Fargo.  Pursuant to the terms of the Credit Agreement, the Lenders have agreed to make revolving credit loans up to an aggregate amount of $125 million.  Wells Fargo has also agreed to make swingline loans from time to time through the maturity date of September 10, 2015 in amounts equal to the difference between the amounts actually loaned by the Lenders and the aggregate credit commitment.

 

On September 10, 2015, all principal, interest and other amounts outstanding under the Credit Agreement are payable in full.  At any time prior to the maturity date, we may repay any amounts owing under all revolving credit loans and all swingline loans in whole or in part, without premium or penalty.

 

Revolving credit loans made under the Credit Agreement bear interest, at our election, at either (i) the base rate (described below) plus 0.25%, (ii) the London Inter-Bank Offered Rate (“LIBOR”) Market Index Rate (as defined in the Credit Agreement)  plus 1.25%, or (iii) the LIBOR Rate (as defined in the Credit Agreement) plus 1.25%.  Swingline loans bear interest at the LIBOR Market Index Rate plus 1.25%.  Interest on each loan featuring the base rate or the LIBOR Market Index Rate is due and payable on the last business day of each calendar month; interest on each loan featuring the LIBOR Rate is due and payable on the last day of each interest period selected by us when selecting the LIBOR Rate as the benchmark for interest calculation.  For purposes of the Credit Agreement, the base rate means the highest of (i) the prime rate (as announced by Wells Fargo), (ii) the federal funds rate plus 0.50%, and (iii) LIBOR for an interest period of one month plus 1.0%.

 

The Credit Agreement contains covenants, representations and warranties and other terms, that are customary for revolving credit facilities of this nature.  In this regard, the Credit Agreement requires us to maintain a leverage ratio and EBITDA ratio, consolidated net income and limits the amount of annual capital expenditures.  Additionally, the Credit Agreement contains various negative covenants with which we must comply, including, but not limited to, limitations respecting: the incurrence of indebtedness, the creation of liens on our property, mergers or similar combinations or liquidations, asset dispositions, investments in subsidiaries, and other provisions customary in similar types of agreements.  As of March 31, 2011, we were in compliance with all financial covenants set forth in the Credit Agreement.

 

As of March 31, 2011, we had outstanding borrowings of approximately $82.6 million under the Credit Agreement, with available borrowings of approximately $42.4 million, based on the leverage ratio in the terms of the Credit Agreement.  Our interest rate as of March 31, 2011 was a fixed rate of 2.73% on $55.0 million as a result of an interest rate swap, a fixed rate of 1.51% on $25.0 million and a variable floating rate of 1.56% on approximately $2.6 million.

 

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11.   Derivatives.

 

Interest Rate Swap.  On October 25, 2010, we entered into a $55 million pay-fixed, receive-variable interest rate swap with Wells Fargo at a fixed interest rate of 2.73%.  The variable portion of the interest rate swap is tied to the one-Month LIBOR (the benchmark interest rate).  The interest rates under both the interest rate swap and the underlying debt are reset, the swap is settled with the counterparty, and interest is paid, on a monthly basis.  The interest rate swap expires September 10, 2015.

 

At March 31, 2011, the interest rate swap qualified as a cash flow hedge.  During the three months ended March 31, 2011, we recorded a net gain on this hedge of approximately $37,000, which is included in interest expense in the accompanying consolidated statements of operations.  The fair value of our cash flow hedge at March 31, 2011 was approximately $1.5 million, which was offset by approximately $572,000 of deferred tax liability.

 

Foreign Currency Forward Contracts.  On February 28, 2011, we forecasted a net exposure for March 31, 2011 (representing the difference between Euro and Great Britain Pound (“GBP’)-denominated receivables and Euro-denominated payables) of approximately 530,000 Euros and 290,000 GBPs.  In order to partially offset such risks, on February 28, 2011, we entered into a 30-day forward contract for the Euro and GBP with notional amounts of approximately 530,000 Euros and 290,000 GBPs.  We enter into similar transactions at various times during the year to partially offset exchange rate risks we bear throughout the year.  These contracts are marked to market at each month-end.  During the three months ended March 31, 2011 and 2010, the effect on the consolidated statement of operations of all forward contracts and the fair value of our open positions was not material.

 

12.   Fair Value Measurements.  The fair value of a financial instrument is the amount that could be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Financial assets are marked to bid prices and financial liabilities are marked to offer prices.  Fair value measurements do not include transaction costs.  A fair value hierarchy is used to prioritize the quality and reliability of the information used to determine fair values.  Categorization within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.  The fair value hierarchy is defined into the following three categories:

 

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market

 

The following table identifies our financial assets and liabilities carried at fair value measured on a recurring basis as of March 31, 2011 and December 31, 2010 (in thousands):

 

					Fair Value Measurements Using
		Total Fair			Quoted prices in		Significant other			Significant
		Value at			active markets		observable inputs			Unobservable inputs
Description		March 31, 2011			(Level 1)		(Level 2)			(Level 3)
Interest rate swap (1)		$	1,471				$	1,471

 

					Fair Value Measurements Using
		Total Fair			Quoted prices in		Significant other			Significant
		Value at			active markets		observable inputs			Unobservable inputs
Description		December 31, 2010			(Level 1)		(Level 2)			(Level 3)
Interest rate swap (1)		$	1,159				$	1,159

 

(1)          The fair value of the interest rate swap is determined based on forward yield curves.

 

During the three-month periods ended March 31, 2011 and 2010, we had write-offs of approximately $14,000 and $24,000, respectively, related to the measurement of non-financial assets at fair value on a nonrecurring basis subsequent to their initial recognition.

 

The carrying amount of cash and equivalents, receivables, and trade payables approximates fair value because of the immediate, short-term maturity of these financial instruments. The carrying amount of long-term debt

 

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approximates fair value, as determined by borrowing rates estimates to be available to us for debt with similar terms and conditions.

 

13.   Goodwill and Intangible Assets.  The changes in the carrying amount of goodwill for the three months ended March 31, 2011, are as follows (in thousands):

 

		2011
Goodwill balance at January 1		$	58,675
Changes as the result of acquisitions		(16		)
Goodwill balance at March 31		$	58,659

 

Intangible assets at March 31, 2011 and December 31, 2010 consisted of the following (in thousands):

 

		March 31, 2011									December 31, 2010
		Gross						Net			Gross						Net
		Carrying			Accumulated			Carrying			Carrying			Accumulated			Carrying
		Amount			Amortization			Amount			Amount			Amortization			Amount
Patents		$	5,356		$	(1,504	)	$	3,852		$	4,631		$	(1,445	)	$	3,186
Distribution agreement		2,426			(706		)	1,720			2,426			(641		)	1,785
License agreements		1,983			(371		)	1,612			1,833			(352		)	1,481
Trademark		5,785			(738		)	5,047			5,761			(636		)	5,125
Developed technology		36,866			(2,888		)	33,978			36,574			(2,301		)	34,273
In-process technology		400						400			400						400
Covenant not to compete		315			(77		)	238			315			(67		)	248
Customer lists		14,034			(4,053		)	9,981			13,973			(3,287		)	10,686
Royalty agreements		267			(267		)				267			(267		)
Total		$	67,432		$	(10,604	)	$	56,828		$	66,180		$	(8,996	)	$	57,184

 

The aggregate amortization expense for the three months ended March 31, 2011and 2010 was approximately $1.6 million and $670,000, respectively.

 

Estimated amortization expense for the intangible assets for the next five years consisted of the following (in thousands):

 

Remaining 2011		$	4,428
2012		5,351
2013		5,138
2014		4,758
2015		4,432

 

14.   Subsequent Event.  On April 21, 2011, our Board of Directors authorized a 5-for-4 forward stock split of our common stock to be effected in the form of a stock dividend of one share of common stock for every four shares of common stock outstanding on the record date.  On May 5, 2011, we completed the forward stock split through a stock dividend to shareholders of record as of May 2, 2011. The Board of Directors also made corresponding adjustments to the number of shares subject to our stock incentive plans and to the number of shares subject to, and the exercise price of, outstanding options and other rights to acquire shares of common stock. All earnings per common share and common share data set forth in the foregoing consolidated financial statements (and condensed notes thereto) have been adjusted to reflect the split.

 

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Disclosure Regarding Forward-Looking Statements

 

This Report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  All statements in this Report, other than statements of historical fact, are forward-looking statements for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of management for future operations, any statements concerning proposed new products or services, any statements regarding the integration, development or commercialization of the business or assets acquired from other parties, any statements regarding future economic conditions or performance, and any statements of assumptions underlying any of the foregoing.  All forward-looking statements included in this Report are made as of the date hereof and are based on information available to us as of such date.  We assume no obligation to update any forward-looking statement.   In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “expects,” “plans,” “anticipates,”  “intends,” “believes,” “estimates,” “potential,” or “continue,” or the negative thereof or other comparable terminology.  Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that any such expectation or any forward-looking statement will prove to be correct.  Our actual results will vary, and may vary materially, from those projected or assumed in the forward-looking statements.  Our financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including risks relating to product recalls and product liability claims; potential restrictions on our liquidity or our ability to operate our business by our current debt agreements; possible infringement of our technology or the assertion that our technology infringes the rights of other parties; the potential imposition of fines, penalties, or other adverse consequences if our employees or agents violate the U.S. Foreign Corrupt Practices Act or other laws or regulations; expenditures relating to research, development, testing and regulatory approval or clearance of our products and the risk that such products may not be developed successfully or approved for commercial use; greater governmental scrutiny and regulation of the medical device industry; reforms to the 510(k) process administered by the U.S. Food and Drug Administration; laws targeting fraud and abuse in the healthcare industry; potential for significant adverse changes in, or failure to comply with, governing regulations; increases in the price of commodity components; negative changes in economic and industry conditions in the United States and other countries; termination or interruption of relationships with our suppliers, or failure of such suppliers to perform; our potential inability to successfully manage growth through acquisitions, including the inability to commercialize technology acquired through recent, proposed or future acquisitions, including the BioSphere acquisition; fluctuations in Euro and GBP exchange rates; our need to generate sufficient cash flow to fund our debt obligations, capital expenditures, and ongoing operations; concentration of our revenues among a few products and procedures; development of new products and technology that could render our existing products obsolete; market acceptance of new products; volatility in the market price of our common stock; modification or limitation of governmental or private insurance reimbursement policies; changes in health care markets related to health care reform initiatives; failure to comply with applicable environmental laws; changes in key personnel; work stoppage or transportation risks; uncertainties associated with potential healthcare policy changes which may have a material adverse effect on Merit; introduction of products in a timely fashion; price and product competition; availability of labor and materials; cost increases; fluctuations in and obsolescence of inventory; and other factors referred to in our Annual Report on Form 10-K for the year ended December 31, 2010 and other materials filed with the Securities and Exchange Commission. All subsequent forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Actual results will differ, and may differ materially, from anticipated results. Financial estimates are subject to change and are not intended to be relied upon as predictions of future operating results, and we assume no obligation to update or disclose revisions to those estimates.  Additional factors that may have a direct bearing on our operating results are discussed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

Overview

 

The following discussion and analysis of our financial condition and results of operation should be read in conjunction with the consolidated financial statements and related condensed notes thereto, which are included in this Quarterly Report on Form 10-Q.

 

We design, develop, manufacture and market single-use medical products for interventional and diagnostic procedures.  For financial reporting purposes, we report our operations in two operating segments: cardiovascular and endoscopy.  Our cardiovascular segment consists of cardiology and radiology devices which assist in diagnosing and treating coronary arterial disease, peripheral vascular disease and other non-vascular diseases and includes the embolotherapeutic products we acquired through our acquisition of BioSphere.  Our endoscopy

 

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