UTAH MEDICAL PRODUCTS INC - Annual Report: 2017 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2017

Commission File Number: 001-12575

(Exact name of registrant as specified in its charter)

 

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ☐   No ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes ☐   No ☒

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 ☒   No ☐

 

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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒   No ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☒

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting 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 Act).  Yes ☐   No ☒

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter.  As of June 30, 2017, the aggregate market value of the voting and nonvoting common equity held by non-affiliates of the registrant was $242,289,134.

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.  As of March 5, 2018, common shares outstanding were 3,725,763.

DOCUMENTS INCORPORATED BY REFERENCE.  The Company's definitive proxy statement for the Annual Meeting of Stockholders is incorporated by reference into Part III, Item 10, 11, 12, 13 and 14 of this Form 10-K.

INDEX TO FORM 10‑K

ITEM 1 – BUSINESS

Currency amounts throughout this report are in thousands except per-share amounts and where noted.

Utah Medical Products, Inc. ("UTMD" or "the Company") is in the business of producing high quality cost‑ effective medical devices that are predominantly proprietary, disposable and for hospital use.  Success depends on 1) recognizing needs of clinicians and patients, 2) rapidly designing or acquiring economical solutions that gain premarketing regulatory concurrence, 3) reliably producing products that meet those clinical needs, and then 4) selling through

 

UTMD's success in providing reliable solutions comes from its proven ability to integrate a number of engineering and technical disciplines in electronics, software, mechanical packaging, instrumentation, plastics processing and materials.   The resulting differentiated devices represent significant incremental improvements in patient safety, clinical outcomes and/or total cost over preexisting clinical tools. UTMD's experience is that, in the case of labor‑saving devices, the improvement in cost‑effectiveness of clinical procedures also leads to an improvement in overall healthcare including lower risk of complications.  UTMD markets a broad range of medical devices used in critical care areas, especially the neonatal intensive care unit (NICU), the labor and delivery (L&D) department and the women's health center in hospitals, as well as products sold to outpatient clinics and physician's offices.

The opportunity to apply solutions to recognized needs results from an excellent core of practicing clinicians who introduce ideas to the Company, and key employees who are both clinical applications savvy and development engineering adept.

Domestically, except for the Filshie Clip System, UTMD's medical devices are sold directly to clinical end user facilities or their appointed stocking distributor.  In addition, some of UTMD's devices are sold through specialty distributors, national hospital distribution companies and other medical device manufacturers.  Outside the U.S. (OUS), products are sold directly to end users in Canada, the United Kingdom (UK), France, Ireland and Australia, and through other medical device companies and through independent medical products distributors in many other countries.  UTMD has representation globally in the major developed countries as well as many underdeveloped countries through several hundred distributors, 128 of which purchased at least five thousand dollars in UTMD medical devices during 2017.

UTMD was formed as a Utah corporation in 1978.  UTMD sold stock to the public one time in 1982 for $1,750 (before offering costs of $321).  Since 1992, UTMD has returned $116,269 in the form of share repurchases, and an additional $50,939 in cash dividends, to its public stockholders.

Utah Medical Products Ltd., a wholly-owned subsidiary with manufacturing located in Ireland, was formed in 1995 to better serve UTMD's OUS customers. In 1997, UTMD purchased Columbia Medical, Inc. (CMI), a company specializing in silicone injection molding, assembly and marketing vacuum-assisted obstetrical delivery systems.  In 1998, UTMD acquired the neonatal product line of Gesco International, a subsidiary of Bard Access Systems and C.R. Bard, Inc.  In 2004, UTMD acquired Abcorp, Inc., its supplier of fetal monitoring belts.  In 2011, UTMD purchased all of the common shares of Femcare Holdings Ltd (Femcare) of the United Kingdom, and its subsidiaries. The addition of Femcare provided product and distribution channel diversification and expansion.  Sales of the products, or derivatives of the products, from the four acquisitions noted above, comprised 63% of UTMD's consolidated 2017 sales.  In late 2016, UTMD formed Utah Medical Products Canada Ltd (dba Femcare Canada) as a sales and distribution operation to directly serve Canadian medical facilities.

UTMD's corporate headquarters are located at 7043 South 300 West, Midvale, Utah 84047 USA.  The corporate office telephone number is 01 (801) 566‑1200.  Ireland operations are located at Athlone Business and Technology Park, Athlone, County Westmeath, Ireland.  The Ireland telephone number is 353 (90) 647-3932.  United Kingdom operations are located at 32 Premier Way, Romsey, Hampshire SO51 9DQ, United Kingdom.  The UK phone number is 44 (179) 452-5100.  Australia operations are located at Unit 12, 5 Gladstone Road, Castle Hill, NSW 2154, Australia.  The Australia phone number is 612 9045 4110.  Canada operations are located at 6355 Kennedy Road #15, Mississauga, ON L5T 2L5, Canada. The Canada phone number is 01 (905) 795-1102.

Labor and Delivery/ Obstetrics:

 

Electronic Fetal Monitoring (EFM) is the standard of care in labor and delivery throughout the modern world.  While not all pregnancies are high risk, fetal emergencies can occur suddenly in seemingly normal labors.  The use of EFM allows conservation of nursing personnel and has virtually eliminated intrapartum fetal death.  Accurate determination of contraction strength increases the safety of labor augmentation and reduces the need for Cesarean section for desultory labor. Infusion of fluid through an intrauterine catheter may cushion the umbilical cord and improve oxygenation of the fetus.

To assist the physician in controlling the effectiveness of administration of oxytocin and monitoring effects of amnioinfusion, contraction intensities, uterine resting tones and peak contraction pressures are closely monitored through the use of an invasive intrauterine pressure catheter system.  In addition, to help identify the possible onset of fetal hypoxia, correlation of the changes in fetal heart rate (FHR) relative to the frequency and duration of contractions are often electronically monitored.  UTMD's intrauterine pressure (IUP) catheters provide for clinician choices from a traditional fluid-filled system to INTRAN® PLUS, for over twenty-five years the most widely accepted transducer-tipped system.  In addition, adjunct toco belts and chart paper are provided by UTMD to provide a package of fetal monitoring supplies.  UTMD's IUP catheters include:

UTMD markets tocodynamometer belts, catheters and accessories as outlined above, but does not market electronic monitors, the capital equipment that processes the electrical signals.  In addition to products currently offered, UTMD has continued to investigate the feasibility of tools that enhance fetal monitoring techniques.

UTMD's VAD Systems include CMI® soft silicone bell-shaped birthing cups and reusable hand-held vacuum pumps which are the safest products available for use in vacuum-assisted operative deliveries. UTMD's soft silicone cup is a bell-shaped cup design that should be preferred for fetal well-being in low or outlet fetal stations with occiput anterior presentations, which represent more than 90% of the cases where VAD is indicated.  Operative vaginal deliveries using forceps or vacuum-assisted delivery systems provide knowledgeable physicians with a trial vaginal operative delivery prior to a more invasive C-section intervention. Although there are risks associated with vaginal operative deliveries which may currently represent 3-4% of all U.S. hospital births, the procedures are generally regarded as safer long term for the mother, and at least as safe for the fetus, as abdominal (Cesarean) delivery in comparable clinical situations.  UTMD's bell-shaped soft silicone TENDER TOUCH® cups enjoy a low reported complication rate compared to other vacuum cup designs, as evidenced by the FDA Medical Device Reporting System (MAUDE) which publicly lists serious injuries reported by hospitals using specific brand names of products.

AROM-COT™ is a finger cover with a patented prong design to rupture maternal membranes with less patient pain and anxiety.  MUC-X is an aspiration device used immediately after birth to clear neonatal respiratory passages and reduce exposure to potential infections.  CORDGUARD® is a product which unifies the multiple steps of clamping the neonate's cord close to the umbilicus, severing the cord without splattering blood, drawing a clean cord blood sample and assisting in the removal of the placenta.  CORDGUARD's sharpless, closed system reduces the risk of exposure to potentially infected blood, and consequently reduces the high cost of exposure treatment under OSHA and CDC guidelines. In addition, CORDGUARD facilitates obtaining neonatal blood that is otherwise hard to obtain safely and cleanly. BT-CATH® is a patented uterine balloon tamponade catheter for controlling severe postpartum hemorrhage. Its benefits include the ease of rapid deployment and ability to monitor further bleeding after the tamponade has been placed. Abcorp toco belts and straps for fetal monitoring by an external tocodynamometer are provided in latex-free form in several configurations.  In 2014, UTMD extended the product line to include Bari-Belts™ and Bari-Bands™, a series of abdominal belts designed specifically for bariatric patients and bands to accommodate patients of all shapes and sizes.  In 2015, UTMD obtained FDA clearance to market a new mechanical cervical ripening device, the CVX-RIPE™ catheter, designed to mechanically improve the favorability of the cervix of pregnant patients at term gestation, for whom induction of labor is medically indicated. The CVX-Ripe utilizes two adjacent conical silicone balloons, similar to the shape of an hourglass.  This design is intended to allow the clinician to gently apply internal pressure to the cervical canal, as well as both the internal and external os, to reduce the time needed to allow induction as well as the total time to achieve a successful vaginal delivery. 

Neonatal Intensive Care:

 

The DISPOSA-HOOD is an infant respiratory hood that is used in the NICU to administer oxygen to neonates and flush CO2 (carbon dioxide) while maintaining a neutral thermal environment (NTE) critical to proper physiologic responses.  The DISPOSA-HOOD, placed over the infant's head, incorporates a round diffusor connection specifically designed to disperse the incoming gases along the inner surfaces of the hood, rather than allowing them to blow directly on the infant's head.  The design allows more precise FIO2 (fractional inspired oxygen) control, minimizes convective heat loss from the head, provides optimum flows for elimination of CO2 by ventilation and allows for humidification. DISPOSA-HOOD, in contrast to an incubator, allows for excellent access to and visualization of the underdeveloped infant.  Because it is a disposable product, it also prevents potential cross‑contamination that might occur with an incubator. Less invasive than nasal cannulae, Disposa-Hood avoids potential damage to fragile premature neonatal nasal/ orotracheal tissues, as well as facial tissues as cannulae are often secured with tape.   A nasal cannula by itself cannot provide a NTE.

UTMD's DELTRAN blood pressure monitoring system has been adapted specifically for use in the NICU.  The streamlined version eliminates needles used for blood sampling, avoids the loss of scarce neonatal blood volume and provides a closed system that reduces the risk of infection.  The system features excellent visualization of clearing volume, and one-handed use.  UTMD continues its customization of Deltran kits for specific hospital applications.

In the third quarter of 1998, UTMD acquired the neonatal product line of Gesco International.  GESCO, best known for optimally biocompatible silicone catheters, gained an early distinctive reputation for its focus on the special developmental needs of tiny, critically-ill babies.

A class of catheters called umbilical vessel catheters (UVCs) are specially designed for administering vital medications and fluids immediately following birth through the infant's umbilical vessel into the inferior vena cava.  Because of the neonate's small size and lack of vascular development, there is no better access to vital organs.  The catheters are also called umbilical artery catheters (UACs) when placed in one of the umbilical arteries to measure blood pressure or monitor metabolic processes through blood analysis.  In developing its UMBILI-CATH™ product line, Gesco pioneered the use of soft, biocompatible silicone catheters, helping to reduce the number of insertions required as well as other complications associated with invasive applications.  UTMD has expanded the UVC product line to include catheters made from a proprietary thermosensitive polyurethane (Tecoflex®) that offers many of the flexibility and biocompatibility advantages of silicone after insertion, with the greater rigidity of polyurethane preferred by many clinicians for insertion. In addition, GESCO provides a convenient catheterization procedure tray of instruments and supplies necessary to place UVC catheters, as well as perform other similar procedures.

    The primary distinction of GESCO products is that they were developed with the special needs of the neonate in mind, not just cut-down or smaller versions of adult devices.  For example, in the case of invasive catheters, the introducer, the soft rounded distal tip, mode of securing to the patient after insertion to avoid migration, luer-locking hub with minimal dead space, number of lumens, catheter radiopaque striping for visualization, variations in catheter lengths and diameters and special packaging are all features specially designed for neonates. UTMD continues to modify product features to incorporate current neonatal practitioner preferences.

The soft, biocompatible silicone catheter concept had important advantages in other applications including peripherally inserted central venous catheters (PICC lines), enteral feeding tubes, urinary drainage catheters and chest drainage tubes.  GESCO developed and marketed initial versions of all of these neonatal products.  In order to keep pace with the trend of caring for smaller babies, UTMD has added smaller diameter versions of its URI-CATH® and NUTRI-CATH® products. At the request of customers who prefer a stiffer catheter for insertion, UTMD added a Tecoflex polyurethane oral-connection only Nutri-Cath series in 2009.

In 2000, UTMD gained FDA premarketing clearance of a PICC family of products specifically designed to minimize trauma to the critically ill neonate, named PICC-NATE®.  The PICC-NATE product line was designed with the input of experienced neonatal medical practitioners for use as a long-term indwelling catheter system for single-use, therapeutic central venous infusion of drug solutions, blood products or other fluids and for blood sampling.  The soft, strong silicone PICC-Nate comes in two diameter sizes and two hub configurations.  In early 2003, UTMD added a Tecoflex polyurethane version that offers many of the flexibility and biocompatibility advantages of silicone after insertion, with the greater rigidity of polyurethane preferred by many clinicians for insertion.

In 2006, UTMD developed a unique enteral feeding-only extension set named NUTRI-LOK® that addresses important safety risks in the NICU – inadvertent connections with IV lines and inadvertent disconnections of components of the system spanning the dispensing container through the infusion catheter.    In October 2007, UTMD added dispensing syringes with interlocking connectors to its NUTRI-CATH/NUTRI-LOK family of enteral feeding devices.  In 2008, UTMD expanded the NUTRI-LOK system with specialty extension sets for GI tubes and for continuous connection to a fluid pump. In 2009, UTMD added a Kangaroo bag for larger feeds along with other NUTRI-LOK accessories.  In 2011, UTMD added variations in adapters and extension sets used with NUTRI-CATH.  Recognizing the important need to prevent misadministration of enteral feeding or medication by the wrong route, the FDA in February 2015 released its final guidance, "Safety Considerations to Mitigate the Risks of Misconnections with Small Bore Connectors Intended for Enteral Applications."  The guidance includes compliance with ISO 80369-3 standard connectors. This new standard was released to create a universal connection that is not compatible with a luer connection or any other type of small bore medical connector.  In 2016, UTMD introduced an alternative enteral feeding family of devices incorporating ENFit™ ISO 80369-3 compliant connectors.  These purple connectors replace the current Nutri-Lok connectors on catheters and extension sets. UTMD also distributes ENFit oral syringes.

In 2006, UTMD completed the replacement of all DEHP plasticizer PVC materials in its Gesco product line that may come in contact with neonatal patients, addressing another safety concern related specifically to the possible maldevelopment of male neonates.

Other GESCO specialty products include a disposable peritoneal dialysis (PD) set that is a pre-assembled, sterile, closed system, called DIALY-NATE®.  PD is an ideal method to aid compromised renal function in a neonate because critically-ill pediatric patients may not have sufficient blood volume to support hemodialysis. DIALY-NATE is provided in a form that allows timely PD implementation.  In 2008, UTMD added a DIALY-NATE version that can be used with a variety of fluid warming systems.  In 2010, UTMD introduced a bifurcated system that allows for higher volume manual PD applications.  Since 2013, additional custom configurations have been added to satisfy specific clinical preferences.

Other specialty NICU devices include a silicone oral protection device used to prevent palatal soft tissue injury by orotracheal tubes, called PALA-NATE® a pre-assembled, closed urinary drainage system, called URI-CATH®, which reduces risk of infection and valuable nursing time, and a lumbar sampling kit with a tiny, specially-beveled needle for obtaining cerebral spinal fluid samples, called MYELO-NATE®.

GESCO's first patented product, HEMO-NATE®, is a disposable filter designed to remove microaggregates from stored blood prior to transfusion into a neonate where any deficiency can have an overwhelmingly negative impact on a neonate's chances for survival, given an under-developed vasculature and small total blood volume.  In 2001, UTMD introduced a new filter and an improved blood bag spike for HEMO-NATE, and a needleless version.

UTMD expects to continue to improve and expand its neonatal product line, seeking to reinforce a reputation as having the most reliable and developmentally-friendly specialty products available for the NICU.

Gynecology /Urology /Electrosurgery:

 

The LETZ System (loop excision of the transformation zone) is used to excise cervical intraepithelial neoplasia (CIN) and other lower genital tract lesions related to human papilloma virus (HPV) infections.  The electrosurgery procedure with hemostasis has become the standard of care for HPV cervical infection treatment, replacing cold knife scalpel, laser and cryotherapy procedural approaches because it is economical, safe, effective, quick and easy to perform, has fewer potential side effects and requires little physician training.  A major incentive for performing the LETZ procedure is that it may be performed using local anesthetic in a physician's office, eliminating the time and expense of hospital or surgical center admittance.  Most importantly clinically, in contrast to laser (tissue ablation) and cryotherapy (freezing of tissue), LETZ provides a fine tissue specimen for pathological assessment.

UTMD's LETZ System includes disposable electrodes, the FINESSE® electrosurgical generator and other miscellaneous components.  A disposable loop electrode used to excise the tissue specimen is a pencil‑like tube with a thin tungsten wire loop attached.  The loop is available in varying sizes and includes a Safe‑T‑Gauge® that can be positioned so the physician can accurately monitor and control the amount of tissue being excised. Excising too much tissue can compromise fertility and result in premature birth. UTMD continues to augment its specialty electrodes. For example, the Company introduced a patented conization electrode for deep endocervical disease called C-LETZ®, designed to limit the removal of healthy tissue margins that might compromise adequate cervical function. UTMD also will continue to provide other components to augment the use of its market-leading specialty electrodes with other manufacturers' electrosurgical generators.

After more than 20 years on the market, in 2012 UTMD completed a significant redesign, and achieved certification to the latest EN 60601 international safety standards, for a FINESSE+ electrosurgical generator.  The FINESSE+ design includes dispersive pad contact monitoring for improved patient safety, improved circuitry for computer controlled-output that provides a precise tissue specimen for histopathology, a more efficient output stage resulting in less heat generation and longer electronic component life, an update to electronic components which reduces the number of required components and increases service life, and an easy change internal filter for integral smoke evacuation, a unique feature of FINESSE.  UTMD obtained FDA premarketing clearance for FINESSE+ in January 2013.

UTMD has FDA clearance to market its electrosurgical system and tools for use in general surgery applications, including dermatology, plastic surgery and otolaryngology.  In 2002, UTMD introduced a product line of ultra-fine tipped microdissection needles, called OptiMicro™ Needles.  These electrosurgical needles are particularly useful in small-scale plastic and reconstructive surgery applications.  In 2009, UTMD added extended length OptiMicro needle versions useful in certain head and neck procedures. FILTRESSE is a stand-alone surgical smoke filtration system that combines high filtration efficiency, low cost and convenient use in a surgical office setting. Other electrosurgery tools and accessories include disposable electrosurgical pens, dispersive pads, footswitches, filter packs, speculums, retractors, forceps, tenacula and hooks.  UTMD acquired the distribution rights to a unique reusable four-way expander system which facilitates access to, and visualization of, the cervix, eliminating the need for less effective specula and lateral retractors.  In 2007, UTMD developed OptiSpec®, a patented ultra-bright light for cervical visualization without physician distraction during exams, pap smears and other vaginal procedures requiring direct cervical visualization without the use of a colposcope.  In 2011, UTMD acquired Femcare's single patient use trocars and cannulae available in shielded, bladeless, optical bladeless, blunt and thoracic designs.  In addition, UTMD acquired Femcare's laparoscopic instrument range and accessories which includes instruments suitable for all routine laparoscopic procedures requiring dissection, cutting, grasping and coagulation, e.g., monopolar scissors, various grasping forceps, dissecting forceps, L and J hooks, spatulae, Veress needles, suction and irrigation tubing, insufflation tubing and connectors, pressure infusor bags and control valves.

EPITOME is an electrosurgical scalpel which delivers precise performance in surgical incision and excision with hemostasis while minimizing thermal side effects.  Where rapid yet precise dissection of dense tissue is necessary, such as in mammaplasty or abdominoplasty, UTMD believes that EPITOME has no close substitute.  Furthermore, an independent study concludes that the EPITOME scalpel provides a significant improvement over other devices in wound healing.  EPITOME allows a rapid incision without countertraction, yielding limited morbidity, less post-surgical pain and cosmetically superior results.   EPITOME is useful where minimization of thermal tissue injury is important but control of bleeding needed. A bendable version of EPITOME with a smaller active electrode was introduced in 1998.  Designed to significantly reduce the chance of tissue burns due to inadvertent electrode contact and where a smaller, bent scalpel tip is needed, the bendable EPITOME is of particular value, e.g., to thoracic surgeons in harvesting the internal mammary artery during coronary artery bypass surgery, as well as to otolaryngologists for tonsillectomies or uvulopalatoplasties.

   UTMD acquired the Filshie Clip System as part of its acquisition of Femcare in March 2011. In 2017, sales of Filshie Clips, applicators and accessories represented 36% of UTMD's total U.S. Dollar denominated sales. The Filshie Clip is a female surgical contraception device used for tubal ligation, i.e., placed on the fallopian tubes, generally laparoscopically, but also post partum during a C-Section procedure. The Filshie Clip, in use for over 30 years, is the safest and most effective tubal occlusive device, is as easy or easier to place as any of the alternative surgical techniques, and has a substantially higher probability of reversibility when compared to all of the other approaches for women who later decide they may like to get pregnant. Femcare has obtained numerous regulatory approvals for the Filshie Clip System, which in 2017 was sold directly by UTMD to medical facilities in Canada, Ireland, France, the UK and Australia, and through specialty distributors in many other countries.

   There are several tubal ligation methods with varying degrees of effectiveness, safety and opportunity to be reversed.  The traditional tubal ligation approach, informally known as "getting one's tubes tied", is a form of female sterilization in which the fallopian tubes are severed and sealed, permanently occluded or pinched shut.  If the sterilization procedure is carried out postpartum, the Pomeroy technique is often adopted. During this procedure a small loop of the fallopian tube is tied with a suture and the top section removed by cutting. A traditional method for interval sterilization is with the use of Bipolar Cautery (electrocautery). With this method, a current flows between the tips of forceps when applied to the fallopian tube. This current then "burns" a portion of the fallopian tube shut. Although these common methods are relatively easy to perform, the failure rate of these methods, defined as the percentage of patients having undergone the procedure who subsequently get pregnant, has been reported to be about 3%. The Filshie Clip, which can be used at either interval or post-partum, is at least as easy to use and has a failure rate an order of magnitude less than Bipolar Cautery and the Pomeroy technique.

   Apart from Bipolar Cautery and the Pomeroy technique, other mechanical devices are the Falope Ring (or Yoon Ring) and the Hulka Clip. Both these older methods have a higher failure rate than the Filshie Clip, are associated with more post-operative pain and have generally been abandoned in favor of other sterilization techniques. Sterilization carried out with the Falope Ring also reduces the chances of a successful reversal being carried out.

   In more recent years, hysteroscopic sterilization was introduced as an alternative to laparoscopic tubal ligation. The competing device is the ESSURE by Conceptus, Inc. (acquired by Bayer AG in 2013).  Although Bayer stopped marketing the device outside the U.S. in late 2016 and early 2017, it remains available for use in the U.S.  The device, considered a permanent implant, is inserted transvaginally.  Bayer reports that Essure is similar to the Filshie Clip in its sterilization effectiveness as measured after successful application, but Essure's "typical" effectiveness including reported misapplication rate has been documented in the medical literature to be substantially lower. Filshie Clips are immediately effective upon application and do not require follow-up physician visits. Essure takes some time after placement to become effective, requiring interim alternative contraception and an additional subsequent procedure to confirm that the tubes are blocked.  Essure is not reversible (allowing later pregnancy) without significant surgical intervention and post-operative patient pain is reportedly significantly greater than using Filshie Clips.

The U.S. FDA released the Filshie Clip for marketing in 1996 after a Femcare PMA submission. Now the Filshie Clip is effectively marketed in the U.S. through an exclusive distribution agreement with CooperSurgical Inc. (CSI).  In 2017, sales to CSI by Femcare represented 25% of total global Filshie Clip System sales.  In late 2016, the FDA approved the use of Femcare's Sterishot single use applicator for applying Filshie clips. An applicator is a precision instrument which closes the implanted Filshie clip on the Fallopian tube to achieve proper permanent tubal ligation. Reused applicators require extra handling, cleaning, resterilization and storage which have the potential to damage or misalign the delicate mechanism. Timely periodic servicing and recalibration is needed.  In addition, the reuse of a surgical instrument introduces the possibility of infection if not properly cleaned and resterilized between procedures.  The precalibrated, single use sterile Sterishot eliminates these safety, effectiveness and cost exposures. CSI began purchasing Sterishot kits in 2017. After more than eight years since being introduced outside the U.S. (OUS), the patented Sterishot is used in the majority of Filshie clip ligation procedures OUS.

PATHFINDER PLUS is a proprietary endoscopic irrigation device that allows a uro/gyn surgeon to precisely irrigate, clearing the visual field, with the same hand that controls the endoscope, eliminating the need for a separate assistant to irrigate without visualization.  An example of a procedure where Pathfinder has found success is ureteroscopic stone ablation.

The Add-a-Cath introducer is a Femcare device designed for easy and safe suprapubic introduction of a catheter for bladder drainage.  Suprapubic catheterization is generally well-recognized as a drainage method with fewer complications than with urethral catheterization.   In 2013, UTMD introduced suprapubic catheterization procedure kits featuring the Add-a-Cath introducer, which UTMD now distributes directly to end users in the U.S. under the trade name "Supra-Foley".

LIBERTY is a device for the conservative treatment and effective control of urinary incontinence in women.  UTMD believes that LIBERTY is the easiest-to-use, most cost effective incontinence treatment available that yields a therapeutic effect, not just a cover-up. LIBERTY consists of a battery operated electrical stimulation unit and an intravaginal electrode probe.  This physiotherapy technique, which can be done in the privacy of the home, involves passive strengthening of the periurethral muscles.  Pulsed, low voltage, high frequency current is applied primarily to the pudendal neuromuscular tissue causing the pelvic area muscles to contract, leading to better muscle tone.  Because electrical stimulation has no known adverse side effects, LIBERTY provides women suffering from mild to moderate incontinence an effective, lower cost and lower risk alternative to more traumatic treatments such as surgery and drug therapy.

In cooperation with Mayo Clinic, UTMD developed an advanced curette for uterine endometrial tissue sampling in the doctor's office.  The sampling procedure is intended primarily to rule out precancer or cancerous change of the uterus in premenopausal women with abnormal uterine bleeding, or women with postmenopausal bleeding.  The device is part of a class of catheters designed to be used without dilatation of the cervix and without general anesthetic.  The inherent weakness of this type of device, which is related to its small size, is that it may not remove enough tissue of the endometrium for an accurate histologic assessment, in contrast to a more invasive D&C hospital procedure.  The tip of the EndoCurette was specially designed to obtain a more thorough tissue specimen compared to other catheters used without the need for dilatation, and without an increase in patient discomfort.

In order to further assess persistent abnormal or dysfunctional uterine bleeding and other suspected abnormalities of the uterus, or as a next step after endometrial tissue sampling with an EndoCurette, gynecologists may utilize transvaginal ultrasound imaging of the uterus.  UTMD's TVUS/HSG-Cath was designed and released for marketing in 2007 to provide effective cervical occlusion that allows distention of the uterus to differentiate anterior and posterior endometrium, among other irregularities, together with minimal visual obstruction of the uterus near the internal os.  In addition, the TVUS/HSG-Cath may be used in hysterosalpingography radiographic procedures to assess the patency of fallopian tubes.  A related device acquired in 2011 is Femcare's Spackman Style uterine cannula designed for the manipulation of the uterus and injection of fluid to test the patency of the fallopian tubes.

LUMIN® is a gynecological tool developed by UTMD for reliably and safely manipulating the uterus in laparoscopic procedures.  LUMIN combines the strength, range of motion and versatility of the higher end reusable instruments with the lower cost and cleanliness of the inexpensive less functional disposable instruments presently on the market, while at the same time reducing the number of tools needed to move and secure the uterus.

 

In pressure monitoring, a transducer is used to convert physiological (mechanical) pressure into an electrical signal that is displayed on electronic monitoring equipment.  UTMD developed and is now distributing its disposable transducer as a stand‑alone product, and as a component in sterile blood pressure monitoring kits through direct representatives and other medical companies in the U.S., as well as independent distributors and other medical device companies OUS.

The Company believes that the DELTRAN DPT which it designed over thirty years ago and currently manufactures, remains the standard in terms of accuracy, reliability and ease of use.   Introduced in 1998, the DELTRAN PLUS provides a closed system for blood sampling, without the use of needles, reducing the risk of an unwanted infection for both the patient and the practitioner.  In 2009, in conjunction with its other NICU devices, UTMD continued to configure neonatal Deltran custom kits which satisfy the special needs of conserving limited blood volume and protecting the neonate from infection.

Components included in blood pressure monitoring kit configurations include flush devices, stopcocks, fluid administration sets, caps, pressure tubing, interface cables and organizers.  The Company sells similar components designed for other medical device company applications which incorporate UTMD's technologies and designs.  DELTA-CAL™ is a calibration device used to check proper functioning of an arterial pressure system.  In addition, UTMD sells plastic molded parts on a subcontract basis to a number of medical and non-medical device companies.  In addition, partly as a result of its excellent quality system and ISO13485 certification, UTMD performs subcontract assembly, testing and packaging of components that are proprietary to other medical device firms.  UTMD believes that this practice helps better utilize its investment in fixed plant and equipment, and spreads overhead costs resulting in better gross profit margins on finished device sales.

UTMD divides its sales into "domestic" U.S. sales and "outside the U.S." sales, which are finished device and component sales to entities outside the U.S.

1)  Domestic sales.

For domestic sales to end-users of finished devices, marketing efforts are complex and fragmented.  UTMD's marketing focus is with clinicians who take responsibility for obtaining optimal patient care outcomes, primarily through clinical meetings, trade shows and the Internet.  In competitive bidding processes, UTMD works primarily with administrators who are responsible for hospital purchasing decisions.

UTMD competes primarily on the basis of improved patient safety and reliable device performance in the hands of a trained clinician.  A number of UTMD's devices are strong brands because they are well-recognized by clinicians as clinically different and have been in use for decades.  UTMD's broad offering of finished devices is comprised of dozens of specialty device types.  Although there may be only a few competitors for each type, in the aggregate UTMD has dozens of U.S. medical device competitors.  There are at least two competitors with significant market share for each of UTMD's device types.

As a general rule, because of UTMD's differences in design and reliability, competitors' devices represent substitutes rather than equivalent devices.  The Company's primary marketing challenge is to keep its customers focused on those differences and their important clinical benefits.  In recent years, UTMD's access to U.S. hospital clinicians has become increasingly restricted and the involvement of clinicians in medical device purchasing decisions, which is critical to the Company's success, has declined.  To the degree that U.S. hospitals become less focused on patient safety and clinical outcomes and more on out-of-pocket unit price, UTMD's competitive position weakens.

In 2017, UTMD sold components and finished devices to 148 other companies in the U.S. (OEM sales). For over 39 years, the Company has utilized its manufacturing capabilities and engineering know-how to produce high quality components and finished devices for other companies.  For U.S. companies which wish to distribute their products outside the U.S., UTMD's maintenance of certification to current ISO 13485 medical device quality standards is an important benefit.  UTMD's website, which lists its capabilities, is often the basis for contacts for new OEM work.

Although there are other manufacturers in the U.S. with similar manufacturing capabilities, UTMD's primary competition comes from East Europe, India and China device component manufacturers which have much lower wage rate structures. To the extent that the U.S. Dollar (USD) gains strength in any period of time against foreign currencies, UTMD's ability to be cost-competitive with foreign manufacturers is diminished.

2)  Outside the U.S. (OUS) sales.

OUS sales in 2017, as a percentage of consolidated total USD sales, represented 51% compared to 50% in 2016.  In contrast to the previous three years when the USD consistently and significantly strengthened relative to other currencies, the net negative impact of FX changes in 2017 was minimal.  Prior to 2011, with only a few exceptions, UTMD's OUS sales were to other medical device companies and distributors, not to clinical end user facilities. After the acquisition of Femcare in 2011, UTMD began a transition to marketing directly to end users in countries where the Filshie Clip System had achieved significant acceptance. This also allows increased distribution opportunities for other UTMD devices which previously did not have significant third party distributor interest.  In 2017, UTMD distributed directly to medical facilities in Canada, the UK, France, Ireland and Australia. The Company's devices are also sold OUS through over 270 independent regional distributors. UTMD's website provides information that frequently results in unsolicited contacts from OUS entities.

An important success factor in the medical device industry is access to medical practitioners.  In the U.S., the hospital supplier environment has consolidated as a result of group purchasing organizations (GPOs), or their equivalents.  It is UTMD's assessment that U.S. hospitals are not currently saving costs under GPO contracts when it comes to specialty medical devices that can reduce complications, utilization rates, clinician time and unwanted side effects, because administrators are focused purely on out-of-pocket costs and miss the broader total cost of care issues.

The longer term overall cost of care in the U.S. will continue to increase, with quality of care lower, as innovative suppliers are excluded from participating in the marketplace as a result of unnecessary regulatory and other purely administrative burdens. The length of time and number of administrative steps required in evaluating new products for use in hospitals has grown substantially. As a potential negative factor to future performance, as UTMD introduces new products it believes are safer and more effective, it may find itself excluded from certain customers because of the existence of long term supply agreements for existing products. UTMD may also be unable to establish viable relationships with other medical device companies that do have access to users but lack an interest in the Company's approach or demand too great a financial or administrative burden.

When U.S. hospital customers request it, UTMD provides its devices through national distribution companies, also known as Med/Surg distributors.  Sales to Med/Surg distributors in 2017 comprised 14% of total domestic direct sales (excluding Filshie Clip System sales to CSI).

  In the U.S., Canada, Ireland, France, the UK and Australia, UTMD sells its products with the support of its own directly employed customer service and sales force, independent consultants and selective independent manufacturer representatives.  Direct sales representatives focus on applications for UTMD devices where customer training and support may be important. The direct sales force is comprised both of "outside" representatives operating remotely in specific geographic areas, and "inside" representatives who operate primarily by telephone from corporate offices.  Direct representatives are trained to understand the medical procedures being performed within UTMD's clinical focus. Through the use of its one-on-one contacts with physicians and other clinical practitioners directly involved in patient care, the direct sales force positions UTMD to gain market leadership with specific solutions to clinical issues. In addition to its direct representatives, UTMD utilizes third party consulting clinical specialists to augment its customer training programs.

Additionally, UTMD sells component parts as well as finished devices to other companies for use with their product lines.  This OEM distribution channel is simply maximizing utilization of manufacturing capabilities that are otherwise needed for UTMD's primary business, and does not compete with or dilute UTMD's direct distribution and marketing programs.

OUS, the Company distributes directly to end user facilities in Canada, the UK, France, Ireland and Australia, and sells to over 270 regional distributors and OEMs (other medical device manufacturers and/or distributors) in over a hundred countries. Ten percent of UTMD's independent OUS distributors represented 79% of UTMD's indirect OUS sales in the years of 2015 - 2017.

New product development has been a key ingredient to UTMD's market identity.  Product development takes several interrelated forms: 1) improvements, enhancements and extensions of current product lines in response to clinical needs or clinician requests, 2) introduction of new or augmented devices that represent a significant improvement in safety, effectiveness and/or total cost of care, and 3) acquisitions of products or technology from others.  Manufacturing process development is an equally important aspect that cannot be separated from the successful design and development of devices.

Because of UTMD's reputation as a focused product developer, its financial strength and its established clinician user base, it enjoys a substantial inflow of new product development ideas.  Internal development, joint development, product acquisitions and licensing arrangements are all included as viable options in the investigation of opportunities.  Only a small percentage of ideas survive feasibility screening.  For internal development purposes, projects are assigned to a project manager who assembles an interdisciplinary, cross-functional development team.  The team's objective is to have a clinically acceptable, manufacturable and regulatory-released product ready for marketing by a specific date.  Several projects, depending on the level of resources required, are underway at UTMD at any given time. Only a few assigned projects succeed in attaining a product that meets all of the Company's criteria. In particular, this includes a product that is highly reliable, easy to use, cost-effective, safe, useful and differentiated from the competition. Once a product is developed, tooled, fully tested and cleared for marketing by the applicable regulatory entity(ies) in the U.S. and/or other countries, there remains a reasonable probability it cannot be successfully marketed for any number of reasons, not the least of which is being beaten to the market by a competitor with a better solution, or not having access to users because of limitations in marketing and distribution resources or exclusionary contracts of GPOs.

UTMD's current product and process development projects are in the following areas: 1) augmentation and internal manufacturing of existing UTMD devices, 2) neonatal intensive care, 3) specialized procedures for the assessment and treatment of cervical/uterine disease, 4) labor and delivery procedures, and 5) product and process development for OEM customers. Internal product development expenses are expected to remain in the range of 1-2% of sales.

At December 31, 2017, the Company had 172 employees, eight regular consultants, 21 independent manufacturer's sales representatives and an additional eleven subcontract production employees in Utah.  The subcontract employees represent UTMD's desire to provide handicapped persons additional work opportunities, hired through the Utah state-supported Work Activity Center.  The Company utilizes independent consultants, some of which were prior employees. Almost all of UTMD's internally-manufactured devices are made either in Utah or in Ireland. The average tenure with the Company of the 125 employees in the U.S. is over fifteen years, and the tenure of the 28 employees in Ireland is over fourteen years. This experience conveys an important benefit due to the level of training required to produce consistently high quality medical devices and appreciation of how UTMD's devices provide unique benefits for clinicians and patients.  The Company's continued success will depend to a large extent upon its ability to retain skilled and experienced employees and consultants.  No assurances can be given that the Company will be able to retain or attract such people in the future, although management is committed to providing an environment in which reliable, creative and high achieving people wish to work.

None of the Company's officers or directors is bound by restrictive covenants from prior employers that limit their ability to contribute to UTMD's programs.  All professional employees agree to a code of conduct and sign a strict confidentiality agreement as a condition of employment, and as consideration for receipt of stock option awards and participation in the annual sales and management bonus program.  All employees participate in contemporaneous performance‑based bonus programs.  None of the Company's employees is represented by labor unions or other collective bargaining groups.

The Company currently owns eleven unexpired and one pending U.S. patents, numerous associated patents in sovereignties OUS and is the licensee of certain other technology. There can be no assurance, however, that patents will be issued with respect to any pending applications, that marketable products will result from the patents or that issued patents can be successfully defended in a patent infringement situation.  The Company also owns thirty-two U.S. registered trademarks which have achieved significant brand recognition. The Company believes that its trademarks and tradenames, many of which have become well known in the global medical community through decades of successful use of the associated medical devices, likely have and will continue to have substantially more intangible value than its patents.

The ability of the Company to achieve commercial success depends in part on the protection afforded by its patents and trademarks.  However, UTMD believes that the protections afforded by patents and trademarks are less important  to  UTMD's business, taken as a whole,  than a medical device's established incremental clinical utility, which may be dominated by a number of other factors including relative cost, ease of use, ease of training/adoption, perceived clinical value of different design features, risk of use in applicable procedures, the reliability of achieving a desired outcome in the hands of different users and market access to potential users.  In cases where competitors introduce products that may infringe on UTMD's technology or trademarks, the Company has an obligation to its stockholders to defend its intangible property to the extent that it can afford to do so, and that it is material to the Company's success. The Company must also defend itself when competitors allege that UTMD may be infringing their technologies.

As a matter of policy, UTMD has acquired and will continue to acquire the use of technology from third parties that can be synergistically combined with UTMD proprietary product ideas.  During 2017, royalties included in cost of goods sold were $204.  Other royalties have been previously paid as a lump sum, or were incorporated into the price of acquisitions or into the cost of purchased components which practice certain patents of third parties.  Also as a matter of policy, UTMD licenses its proprietary technology to others in circumstances where licensing does not directly compete with UTMD's own marketing initiatives.  UTMD's future financial performance may also depend on the marketing ability of other companies that license UTMD's technology.  During 2017 the Company received $86 in royalty income, compared to $91 in 2016 and $93 in 2015.

UTMD's products and manufacturing processes are subject to regulation by the U.S. Food & Drug Administration ("FDA"), as well as other regulatory entities globally.  The FDA has authority to regulate the marketing, manufacturing, labeling, packaging and distribution of medical devices in the U.S.  In addition, requirements exist under other federal laws and under state, local and foreign statutes that may apply to the manufacturing and marketing of the Company's medical devices.

All manufacturers of medical devices must register with the FDA and list all medical devices produced by them.   In addition, prior to commercial distribution of some devices for human use, a manufacturer must file a notice with the FDA, setting forth certain information regarding the safety and effectiveness of the device that is acceptable in content to the FDA.

Devices which are classified in Class I are subject only to the general controls concerning adulteration, misbranding, good manufacturing practices, record keeping and reporting requirements.  Devices classified in Class II must, in addition, comply with special controls or performance standards promulgated by the FDA.

Except for the Filshie Clip System, all of UTMD's present devices are unclassified, Class I or Class II devices.  The Filshie Clip System is a Class III device which has more stringent regulatory controls. The Company is in compliance with all applicable U.S. regulatory standards including CFR Part 820, the FDA Quality System Regulation (QSR) effective in 1997, also known as cGMPs (current good manufacturing practices).   The Company's most recent FDA inspection was in July 2014, which did not result in the issuance of any FDA-483 observations.

In 1994, UTMD received certification of its quality system under the ISO9001/EN46001 standards ("ISO" stands for "International Organization of Standardization") which it maintained until December 2003.  In October 2003, UTMD's Utah facility was certified under the more stringent ISO13485 standard for medical devices. UTMD's Ireland facility was certified under the concomitant ISO13488 standard.  In July 2006, both facility ISO certifications were upgraded to the even more stringent ISO13485:2003 standard.  Currently, UTMD's facilities in the UK, Ireland and Utah are all certified under the most recent ISO13485:2012 standard. UTMD remains on a continuous periodic audit schedule by its independent notified body in order to stay current with international regulatory standards, and retain its certifications. UTMD has received CE Mark certifications (demonstrates proof of compliance with the European Community's ISO standards) for essentially all of its products. The U.S. FDA QSR was developed in harmony with the ISO standards.

Most of the components which the Company purchases from various vendors are readily available from a number of sources.  That notwithstanding, the Company maintains safety stocks that anticipate the time required to source and qualify new vendors.  Alternative sourcing of various components is continually underway.  Vendors are qualified by Corporate Quality Assurance. In the few cases where the Company has a sole source, it either maintains or has agreement with the supplier to maintain excess safety stocks that would cover the time required to develop and qualify a new source. The Company has a vendor quality monitoring program that includes routinely checking incoming material for conformance to specifications, as required per written procedures.

UTMD regards the OUS marketplace as an important element of its growth strategy. UTMD is keenly aware that not only are OUS markets different from the U.S. market, but also that each country has its own set of driving influences that affects the dynamics of the nature of care given and medical devices used.  The Company operates four OUS facilities; in Romsey, Hampshire, England; in Castle Hill, NSW, Australia; in Mississauga, Ontario, Canada and in Athlone, County Westmeath, Ireland.  These facilities offer a number of advantages: 1) from a marketing point of view, better response to Europe, Asia, Africa and Australia customers, including a better understanding of customer needs, less costly distribution and, in the EU, duty-free access to 500 million patients; 2) from a regulatory point of view, faster new product introductions; and 3) from a manufacturing point of view, reduced dependence on one manufacturing site and increased capacity for meeting customer needs.

Total 2017 trade revenues in USD terms from customers OUS were $21,129 (51% of total sales), compared to $19,809 (50% of total sales) in 2016 and $19,793 (49% of total sales) in 2015.  OUS trade sales (U.S. exports) from the U.S. to OUS customers were $5,357 in 2017, $5,587 in 2016 and $5,714 in 2015.  U.S. exports represented 25%, 28% and 29% of total OUS trade sales in 2017, 2016 and 2015, respectively.  The U.S. export numbers exclude Utah intercompany sales of components and finished devices to UTMD foreign subsidiaries, which then distribute U.S.-made components and finished devices as part of their sales to OUS customers.

For sales by OUS geographic area, please see note 10 to the Consolidated Financial Statements.

Backlog is defined as orders received and accepted by UTMD which have not shipped yet.  As a supplier of primarily disposable hospital products, the nature of UTMD's non-distributor or non-OEM business requires fast response to customer orders.  Virtually all direct shipments to end user facilities are accomplished within a few days of acceptance of purchase orders. Consequently, UTMD's backlog at any point in time is comprised mainly of orders from OEM and independent distributors, which purchase in larger quantities at less frequent intervals. Backlog shippable in less than 90 days was $3,140 as of January 1, 2018, $1,774 as of January 1, 2017 and $2,463 as of January 1, 2016.

The Company's business is generally not affected by seasonal factors, but it is affected by uneven purchasing patterns of OEM customers and independent distributors.

The risk of product liability lawsuits is a negative factor in the medical device industry because devices are frequently used in inherently risky situations to help clinicians achieve a more positive outcome than what might otherwise be the case.  In any lawsuit against a company where an individual plaintiff suffers permanent physical injury, a possibility of a large award for damages exists whether or not a causal relationship exists. However, no such damages have been awarded against UTMD in its 39-year history of shipping many millions of devices.

Except for the Filshie Clip System, UTMD is self-insured for product liability risk, and reserves funds against its current performance on an ongoing basis to provide for its costs of defense should any lawsuits be filed. The Company's average cost of defense over the last twenty-five years was $18 per year, well below the deductible level of product liability insurance policies. This experience validates that the most important aspect of product liability risk management is the safe design and reliable integrity of manufactured products, not a third party insurance contract.

   The best defense the Company believes that it has is the consistent conformance to specifications of its proven safe and effective products.  Over the time span of the last twenty-five years, UTMD has been named as a defendant in a total of eight lawsuits.  Four lawsuits involved a patient injury related to operative vaginal deliveries where a UTMD VAD birthing cup or hand pump was used. The VADS devices in all four cases did conform to specifications. UTMD was ultimately dismissed as a defendant in all four VADS lawsuits, and legal costs were not material to performance. In the first of the other two lawsuits not involving a Femcare device, regarding the use of EndoCurette, there was no evidence of patient injury. The lawsuit was settled in 2010 for an immaterial amount to avoid the diversion of management time and substantial costs of litigation, even though UTMD was confident that the case was without merit. In the second, UTMD was brought into a lawsuit by a defendant physician, speculating a design deficiency in a Finesse electrosurgical generator (ESU) which had been in use for eighteen years before the injury event, and used successfully by the same physician in multiple procedures after the event. The injured patient did not allege any fault by UTMD.  The case was settled in 2012 without any UTMD involvement or liability.  Excluding the Filshie Clip System acquired in 2011, there have been no product liability lawsuits during the last six years.

   Because the Filshie Clip is a Class III device, Femcare does further insure its product liability risk through a third-party insurance company at a cost of about £54 per year. The deductible level of the Femcare policy is $150 per claim for the U.S. and Canada, and £50 elsewhere in the world.  Since acquiring Femcare in 2011, UTMD has had to defend two U.S. claims for failed sterilizations (not serious injuries), during which time approximately two million clips were used.

   In 2014, a patient claimed damages for becoming pregnant eight years after the placement of Filshie Clips. Her medical record indicated that she chose to employ Filshie Clips after being advised by her physician that he believed there would be a 1% chance of pregnancy.  The case was dismissed after the patient who was also a malpractice attorney declined to respond in discovery.  In 2017, UTMD was served with a complaint by a patient who had experienced an uncomplicated pregnancy and childbirth.  A malpractice lawsuit had been filed against the attending physician in 2015, but the physician's insurance company subsequently went bankrupt.  Discovery in the case is presently on stay until insurance coverage obligations can be sorted out.  To UTMD's knowledge, there is no evidence of defective clips. A claim of defective design doesn't have merit, either, supported by the successful use of millions of clips. A claim of failure to properly warn of a remote chance of pregnancy doesn't have merit as UTMD's IFU is clear that there is such a risk.  The Company expects that the case will be resolved, consistent with its past experience, at an immaterial cost.

   In summary, during the last twenty-five year period of time during which over forty million finished devices were distributed by UTMD, there have been no judgments resulting from a claim of defect in UTMD's design or manufacture of its devices, or a fault in its informational materials. In the current tort system in the U.S., meritless product liability cases do get filed where aggressive attorneys calculate that a company will find it cheaper to settle for some nominal amount in lieu of potentially substantial defense costs of going to court.

This report contains certain forward-looking statements and information relating to the Company that are based on the beliefs of management as well as assumptions made by management based on information currently available.  When used in this document, the words "anticipate," "believe," "project," "estimate," "expect," "intend" and similar expressions, as they relate to the Company or its management, are intended to identify forward-looking statements.  Such statements reflect the current view of the Company respecting future events and are subject to certain risks, uncertainties and assumptions, including the risks and uncertainties stated throughout the document.  Although the Company has attempted to identify important factors that could cause the actual results to differ materially, there may be other factors that cause the forward statement not to come true as anticipated, believed, projected, expected, or intended.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may differ materially from those described herein as anticipated, believed, projected, estimated, expected or intended.  Financial estimates are subject to change and are not intended to be relied upon as predictions of future operating results, and the Company assumes no obligation to update or disclose revisions to those estimates.

ITEM 1A – RISK FACTORS

The voluminous Acts, administrative rules to enforce the Acts and promised efforts to reform the Acts, make the U.S. medical device marketplace unpredictable, particularly for the thousands of small medical device manufacturers including UTMD that do not have the overhead structure that the larger medical device companies can afford.  Fortunately, the U.S. Congress suspended the MDET for the years of 2016-2019. To the extent that the Acts will in the future continue to place additional burdens on small medical device companies in the form of the excise tax on medical device sales, additional oversight of marketing and sales activities and new reporting requirements, the result is likely to continue to be negative for UTMD's ability to effectively compete and support continued investments in new product development and marketing of specialty devices in the U.S.

The Company's experience in 2001-2005, when the FDA improperly sought to shut it down, highlights the ongoing risk of being subject to a regulatory environment which can be arbitrary and capricious. The risks associated with such a circumstance relate not only to the substantial costs of litigation in millions of dollars, but also loss of business, the diversion of attention of key employees for an extended period of time, including new product development and routine quality control management activities, and a tremendous psychological and emotional toll on dedicated and diligent employees.

Since the FDA reserves to itself the interpretation of which vague industry standards comprise law at any point in time, it is impossible for any medical device manufacturer to ever be confident that it is operating within the Agency's version of the law.  The unconstitutional result is that all companies, including UTMD, are considered guilty prior to proving their innocence.

Premarketing submission administrative burdens and substantial increases in "user fees" increase product development costs and result in delays to revenues from new or improved devices.  It recently took two and a half years to gain FDA approval of the use of a clearly safer single use Filshie Clip applicator, which had been in use for over seven years OUS, in lieu of a reused applicator approved in the U.S. since 1996, made of substantially equivalent materials for the same intended use applying the same implanted clip.

GPOs, theoretically acting as bargaining agents for member hospitals, but actually collecting revenues from the companies that they are negotiating with, have made a concerted effort to turn medical devices that convey special patient safety advantages and better health outcomes, like UTMD's, into undifferentiated commodities. GPOs have been granted an antitrust exemption by the U.S. Congress. Otherwise, their business model based on "kickbacks" would be a violation of law.  These bureaucratic entities do not recognize or understand the overall cost of care as it relates to safety and effectiveness of devices, and they create a substantial administrative burden that is primarily related to collection of their administrative fees.

As the level of complexity and uncertainty in the medical device industry increases, evidenced, for example, by the unpredictable regulatory environment, the Company's views of the future and product/ market strategy may not yield financial results consistent with the past.

An aging population is placing greater burdens on healthcare systems, particularly hospitals. The length of time and number of administrative steps required in adopting new products for use in hospitals has grown substantially in recent years.  Smaller companies like UTMD typically do not have the administrative resources to deal with broad new administrative requirements, resulting in either loss of revenue or increased costs.  As UTMD introduces new products it believes are safer and more effective, it may find itself excluded from certain clinical users because of the existence of long term supply agreements for preexisting products, particularly from competitors which offer hospitals a broader range of products and services.  Restrictions used by hospital administrators to limit clinician involvement in device purchasing decisions makes communicating UTMD's clinical advantages much more difficult.

UTMD's devices are frequently used in inherently risky situations to help physicians achieve a more positive outcome than what might otherwise be the case.  In any lawsuit where an individual plaintiff suffers permanent physical injury, the possibility of a large award for damages exists whether or not a causal relationship exists.

UTMD's distributors have varying expertise in marketing and selling specialty medical devices.  They also sell other devices that may result in less focus on the Company's products.  In some countries, notably China, Pakistan and India not subject to similarly rigorous standards, a distributor of UTMD's products may eventually become a competitor with a cheaper but lower quality version of UTMD's devices.

In a small company with limited resources, the distraction or loss of key personnel at any point in time may be disruptive to performance.  The Company's benefits programs are key to recruiting and retaining talented employees.  An increase in UTMD's employee healthcare plan costs, for example, may cause the Company to have to reduce coverages which in turn represents a risk to retaining key employees.

Since a significant portion of UTMD's sales are invoiced in foreign currencies and consolidated financial results are reported in USD terms, a stronger USD can have negative revenue effects. Conversely, a weaker USD would increase foreign subsidiary operating costs in USD terms. For the portion of sales to foreign entities made in fixed USD terms, a stronger USD makes the devices more expensive and weakens demand.  For the portion invoiced in a foreign currency, not only USD-denominated sales are reduced, but also gross profits may be reduced because finished distributed products and/or U.S. made raw materials and components are likely being purchased in fixed USD.

ITEM 1B – UNRESOLVED STAFF COMMENTS

None

ITEM 2 ‑ PROPERTIES

Office and Manufacturing Facilities.

UTMD is a vertically‑integrated manufacturing company.  Capabilities include silicone and plastics-forming operations including injection molding, insert and over-molding, thermoforming and extrusion; sensor production; manual and automated assembly of mechanical, electrical and electronic components; parts printing; various testing modalities; advanced packaging in clean room conditions; and a machine shop for mold‑making and fabrication of assembly tools and fixtures.  Capabilities also include an R&D laboratory for both electronic and chemical processes, software development resources, communications and computer systems networked real time OUS, and administrative offices.

At the beginning of 2018, the Company's operations were located in 110,000 square feet of facilities near Salt Lake City, Utah, a 77,000 square foot facility in Athlone, County Westmeath, Ireland, a 38,600 square foot facility in Romsey, Hampshire, England, a 3,200 square foot facility in Castle Hill NSW, Australia, and a 4,700 square foot facility in Mississauga, Ontario, Canada.  Manufacturing is currently carried out primarily in the Utah and Ireland facilities, with some in the UK.

In late 2016 UTMD purchased a 38,600 square foot in Romsey and subsequently fitted-out the building in 2017. In November 2017, Femcare UK's operations moved into the refurbished building.  UTMD now owns all of its facilities.  The prior UK lease and all associated potential liabilities have been terminated. UTMD owns its property and facilities with the exception of a long‑term lease with 15 years remaining on one section of its Midvale parking lot.

 

ITEM 3 ‑ LEGAL PROCEEDINGS

The Company may be a party from time to time in litigation incidental to its business.  Presently, there is no litigation or threatened litigation for which the Company believes the outcome may be material to its financial results.

ITEM 4 ‑ RESERVED

ITEM 5 ‑ MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information.

UTMD's common stock trades on the NASDAQ Global Market (symbol:UTMD).  The following table sets forth the high and low sales price information as reported by NASDAQ for the periods indicated:

Stockholders.

The approximate number of beneficial stockholders of UTMD's common stock as of March 6, 2018 was 4,000.

Dividends.

The following sets forth cash dividends paid during the past two years:

 

 

*A dividend of $0.27 per share, with a record date of December 15, 2017, was paid on January 3, 2018.

 

Issuer Purchases of Equity Securities.

UTMD did not purchase any of its own securities during 2017.

ITEM 6 ‑ SELECTED FINANCIAL DATA

 

Dollar amounts are in thousands, except per share data.

The following selected consolidated financial data of UTMD and its subsidiaries for the five years ended December 31, 2017, are derived from the audited financial statements and notes of UTMD and its subsidiaries, certain of which are included in this report.  The selected consolidated financial data should be read in conjunction with UTMD's Consolidated Financial Statements and the notes included elsewhere in this report.

 

 

ITEM 7 ‑ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Currency amounts are in thousands except per-share amounts and where noted.  Currencies are abbreviated as follows: the U.S. Dollar (USD or $), the Great Britain Pound (GBP or £), the Euro (EUR or €), the Australian Dollar (AUD or A$) and the Canadian Dollar (CAD or C$).

The following comments should be read in conjunction with the accompanying financial statements.

Overview

Excellent growth in year 2017 financial results were accomplished primarily as a result of Utah Medical Products, Inc. (UTMD) converting from distributing the Filshie Clip System in the countries of Canada and France through third party distributors to selling directly to medical facility users. Although UTMD substantially exceeded management expectations for 2017 financial performance, the results became masked by the recognition of a one-time repatriation tax (REPAT) on foreign subsidiary cash and cumulative earnings (E&P).  The REPAT impact of the U.S. "Tax Cuts and Jobs Act", which was enacted in December 2017, is included in 2017 results according to U.S. Generally Accepted Accounting Principles (GAAP).  All income statement categories of UTMD's 2017 operating performance were unaffected by the REPAT tax except for provision for income taxes, Net Income (NI) and Earnings Per Share (EPS).

Income statement results in 2017 compared to 2016 were as follows:

 

The estimated REPAT tax booked in the 2017 income statement tax provision according to GAAP was $6,288.  As a result of the REPAT tax provision, GAAP NI and EPS in 2017 compared to 2016 were 30% and 29% lower respectively.  In UTMD management's view, comparing GAAP NI and EPS between 2017 and 2016 does not provide stockholders with any meaningful insight about UTMD's financial performance.

The associated key 2017 profit margins (profits as a percentage of sales) compared to the prior calendar year improved as follows:

 

   The 2017 GPM expansion of 3.4 percentage points leveraged the GP contribution to OI by $1.4 million. In addition, even though UTMD assumed direct sales and marketing (S&M) roles and launched an additional facility in Canada, the Company was able to reduce consolidated operating expenses (OE), which further leveraged OI to a total increase of $2.8 million with only a $2.1 million increase in consolidated sales.

US GAAP NI for the 2017 calendar year was $8,505 including the one-time $6,288 REPAT tax and a $228 reduction to the income tax provision due to a net reduction in deferred tax liabilities (DTL) and deferred tax assets (DTA) from the U.S. enacting lower future income tax rates. The 2017 U.S. GAAP $8,505 NI compares to $12,128 in 2016. The 2016 NI included, as stockholders may recall, a $123 reduction to the income tax provision in fourth quarter (4Q) 2016 (resulting in a $123 increase to 2016 NI) due to a reduction in the DTL from the UK enacting lower future income tax rates. Because the REPAT tax and net DTL adjustment are one-time tax events not related to normal operations, UTMD management believes that the presentation of results excluding the 2016 favorable adjustment in DTL, and the 2017 unfavorable REPAT tax provision offset slightly by the favorable DTL adjustment, provides meaningful supplemental information to both management and investors that is more clearly indicative of UTMD's operating results in 2017 compared to 2016.

The resulting non-GAAP NI and EPS excluding the 2017 REPAT provision and DTL adjustment, and the prior 2016 DTL adjustment, follow:

 

In summary, UTMD achieved $3.90 in "normal" 2017 EPS compared to $3.19 in 2016. For the year 2017, a 5% increase in sales yielded a 21% increase in (non-GAAP) NI and a 22% increase in (non-GAAP) EPS.

The Company's continued excellent positive cash flow in 2017 allowed it to increase cash dividends paid to stockholders and use $1.6 million in cash for investment in Property, Plant and Equipment (PP&E), primarily to fit-out a 38,600 square foot owned facility in the UK to replace its previously leased facility.

Measures of the Company's liquidity and overall financial condition improved as of the end of 2017 compared to the end of 2016 as the result of continued strong positive cash flow from normal operations, but were diluted by the assessment of the REPAT tax. UTMD increased its cash balances to $40 million at the end of 2017 compared to $26 million at the end of 2016.  Current assets increased 43% and total assets increased 22%.  Although the Company remained without debt, total liabilities increased $7,676.  The accrued REPAT tax added $6,288, and delaying the payment date of the 4Q 2017 dividend from late December to early January added another $1,005 to accrued liabilities. As a result, UTMD's total debt ratio (total liabilities to total assets) was 16% at the end of 2017 compared to 9% at the end of 2016.  Stockholders' Equity increased to $78.1 million from $69.2 million at the end of 2016 largely from $8.5 million in GAAP NI. The return on average Stockholders' Equity (ROE) prior to the payment of dividends was 11.5% in 2017 compared to 17.5% in 2016. Excluding the effect of the REPAT tax on NI and average stockholders' equity and before dividends, UTMD's 2017 ROE was 19% compared to 17% in 2016.

Productivity of Assets and Working Capital Assets.

Assets.

Year-end 2017 total consolidated assets were $92,745 comprised of $49,188 in current assets, $11,621 in consolidated net PP&E and $31,936 in net intangible assets.  This compares to $76,191 total assets at the end of 2016 comprised of $34,474 in current assets, $9,966 in consolidated net PP&E and $31,751 in net intangible assets. Total asset turns (total consolidated sales divided by average total assets for the year) in 2017 were 49%, compared to 50% in 2016.  The 2017 increase in assets, primarily cash, was greater than the increase in sales.

    Current assets increased $14,714 due to a $13,595 increase in cash and investments, a $412 increase in accounts and other receivables and a $702 increase in year-end inventories. Year-end 2017 and 2016 cash and investment balances were $39,955 and $26,360, representing 43% and 35% of total assets, respectively.  Net (after allowance for doubtful accounts) year-end trade accounts receivable (A/R) balances increased $412 due to $1,349 stronger 4Q 2017 sales than in 4Q 2016. Average days in A/R from date of invoice on December 31, 2017 were 32 days based on 4Q 2017 shipments, about the same aging as at the end of 2016.  The Company believes any older A/R will be collected or are within its reserve balances for uncollectible amounts.  Average 2017 consolidated inventory turns were 3.1 compared to 3.6 in 2016 based on the applicable year's cost of goods sold.  The Company's cash reserves allowed it to increase inventories to take advantage of quantity discounts from vendors.

Working capital (current assets minus current liabilities) at year-end 2017 was 40% higher at $43,909 compared to $31,451 at year-end 2016.  Consistent with Federal rules, 2017 ending current liabilities included $503 (8%) of the total REPAT tax liability which did not exist at the end of 2016.  As the timing of the required payment of the State portion of the REPAT tax is still unknown, UTMD divided the estimated liability the same as for the Federal portion, i.e. 8% current.  If all of the State REPAT tax becomes due within one year, current liabilities would be $979 higher.  Even with $979 higher current liabilities, the end of 2017 working capital significantly exceeds UTMD's needs for normal operations, funding future growth and timely payment of accrued REPAT tax liabilities.

PP&E includes Utah, Ireland and England manufacturing molds, production tooling and equipment, test equipment, and product development laboratory equipment.  In addition, PP&E includes computers and software, warehouse equipment, furniture and fixtures, facilities and real estate for all five locations in Utah, Ireland, UK, Canada and Australia, the fungible market value of which increases UTMD's enterprise value relative to most of its industry peers. In late 2017, UTMD in the UK finished set-up and seamlessly began operations in a 38,600 square foot facility in Romsey, Hampshire.  The manufacturing facilities in Utah, Ireland and the UK are standalone buildings, whereas the distribution facilities in Australia and Canada are part of larger industrial condominiums.  Ending 2017 net consolidated PP&E (depreciated book value of all fixed assets) increased $1,655 as a result of capital expenditures of $1,597, depreciation of $660 and the effect of foreign currency exchange (FX) rates on year-end foreign subsidiary asset balances.

The following end-of-year FX rates in USD applied to assets and liabilities of each applicable foreign subsidiary:

 

The year-end 2017 net book value (after accumulated depreciation) of consolidated PP&E was 36% of purchase cost.  End-of-year PP&E turns (Net Sales divided by Net PP&E) was 3.6 in 2017 compared to 3.9 in 2016 due to the new facility in the UK and a weaker USD.  The future leverage in productivity of fixed assets which will not have to be increased to support new business activity will be a source of future profitability.  In 2018, PP&E purchases to support ongoing operations are not expected to exceed depreciation of fixed assets.

  Net intangible assets (after accumulated amortization) are comprised of the capitalized costs of obtaining patents and other intellectual property, as well as the value of identifiable intangible assets (IIA) and goodwill resulting from acquisitions. Net intangible assets were $31,936 (34% of total assets) at the end of 2017 compared to $31,751 (42% of total assets) at the end of 2016.  Per US GAAP, intangible assets are categorized as either 1) IIA, which are amortized over the estimated useful life of the assets, or 2) goodwill, which is not amortized or expensed until the associated economic value of the acquired asset becomes impaired. The two categories of Femcare intangibles at year-end 2017 were net IIA of $17,764 and goodwill of $6,900. The accumulated amortization of Femcare IIA as of December 31, 2017 since the March 18, 2011 acquisition was $14,785. UTMD's goodwill balance was $14,092 at the end of 2017, 44% of total net intangibles. Because the products associated with UTMD's acquisitions of Columbia Medical in 1997, Gesco in 1998, Abcorp in 2004 and Femcare in 2011 continue to be viable parts of UTMD's overall business, UTMD does not expect the current goodwill value associated with the four acquisitions to become impaired in 2018. Amortization of intangibles was $2,113 in 2017 compared to $2,223 in 2016. The 2017 non-cash amortization expense of Femcare IIA was $2,055 (£1,595) compared to $2,167 (£1,599) in 2016.  The USD difference was essentially due to the change in USD/GBP FX rate. The 2018 non-cash amortization expense of Femcare IIA will again be £1,595, or $2,201 if the USD/GBP average FX rate is 1.38.

Liabilities.

The $6,288 accrued REPAT tax liability resulting from the U.S. "Tax Cuts and Jobs Act" (the Tax Act), which was enacted in December 2017, is included in 2017 end liabilities. This liability was not present in the 2016 end balance sheet. The Federal payment requirement is 8% of the REPAT tax liability per year for the first five years, 15% in the sixth year, 20% in the seventh year and 25% in the eighth year. Because the State of Utah typically uses Federal taxable income as a basis, the REPAT provision includes an estimated $1,065 portion payable to the State.  Consistent with Federal rules, eight percent of the total REPAT tax liability ($503) is included in UTMD's 2017 end current liabilities, with the remaining $5,785 in longer term liabilities. If the State, on a worst case basis for cash flow, decides that its entire REPAT tax levy is to be paid within one year, then the portion of the total REPAT tax liability included in 2017 end current liabilities would be $1,482 ($979 higher current liabilities and $979 lower long term liabilities). Slightly offsetting the REPAT tax liabilities was a $230 reduction in UTMD's U.S. deferred tax liability due to the Tax Act's enactment of a lower future income tax rate.

  In addition to the liability changes associated with the Tax Act, UTMD decided to delay the payment of its 4Q 2017 cash stockholder dividend from late December 2017 to early January 2018, which added another $1,005 to 2017 ending accrued liabilities that was not present in the year-end 2016 balance sheet.

  As a result of the above, using the Federal REPAT tax timing of payment rules, year-end 2017 current liabilities were $2,258 higher than at the end of 2016. Total liabilities were $7,676 higher at the end of 2017 compared to the end of 2016. The resulting 2017 year-end total debt ratio was 16% compared to 10% at the end of 2016.

  The year-end DTL balance created as a result of the fifteen year deferred tax consequence of the amortization of Femcare's IIA was $3,102, down from $3,209 at the end of 2016. The smaller decline in this DTL, despite $2,055 in 2017 amortization of IIA, was due to a 10% weaker USD compared to the GBP at the end of 2017 compared to the end of 2016.   In addition to liabilities stated on the balance sheet, UTMD has operating lease and purchase obligations described in Note 7 to the financial statements.

Results of Operations.

Under accounting standards applicable for 2017, the Company believed that revenue should be recognized at the time of shipment as title generally passes to the customer at the time of shipment, or completion of services performed under contract.  Revenue recognized by UTMD is based upon documented arrangements and fixed contracts in which the selling price is fixed prior to acceptance and completion of an order.  Revenue from product or service sales is generally recognized at the time the product is shipped or service completed and invoiced, and collectibility is reasonably assured.  Over 99% of UTMD's revenue is recognized at the time UTMD ships a physical medical device to a customer, where the selling price for the item shipped was agreed prior to UTMD's acceptance and completion of the customer order. There are no post-shipment obligations which have been or are expected to be material to financial results.

There are circumstances under which revenue may be recognized when product is not shipped, which have met the criteria of SAB 104:  the Company provides engineering services, for example, design and production of manufacturing tooling that may be used in subsequent UTMD manufacturing of custom components for other companies.  This revenue is recognized when UTMD's service has been completed according to a fixed contractual agreement.

   Beginning on January 1, 2018, the Company adopted ASU 2014-09, the new revenue recognition accounting standard.  Management completed an extensive assessment and implementation of the standard, including UTMD's various contracts with customers and associated performance obligations and the Company's conclusions regarding its revenue recognition practices and procedures. Other items like commissions and rights of return were also evaluated by the Company. Management is confident that the Company has properly evaluated the standard's requirements and has arrived at appropriate conclusions in recognizing revenue in accordance with the new standard.  Those practices and procedures the Company will use to recognize revenue under the new standard are not significantly different than the methods used previously since UTMD has traditionally recognized revenue upon shipping a physical product to a customer, which is also when the Company has met its performance obligations under contracts it has with its customers that represent over 99% of its revenue. While the Company's revenue not associated with shipping a physical product is immaterial, management believes the Company's practices in recognizing that revenue is also in accordance with ASU 2014-09.

Terms of sale are established in advance of UTMD's acceptance of customer orders.  In the U.S., Ireland, UK and Australia prior to 2017, UTMD generally accepted orders directly from and shipped directly to end user clinical facilities, as well as third party medical/surgical distributors, under UTMD's Standard Terms and Conditions (T&C) of Sale. The same was true in 2017 with the addition of direct shipments to end user facilities in Canada and France. About 14% of UTMD's domestic end user sales, excluding Femcare's Filshie Clip System sales to its exclusive U.S. distributor, CooperSurgical Inc. (CSI), go through third party med/surg distributors which contract separately with clinical facilities to provide purchasing, storage and scheduled delivery functions for the applicable facility.  UTMD's T&C of Sale to end user facilities are substantially the same in the U.S., Canada, Ireland, UK, France and Australia.

UTMD may have separate discounted pricing agreements with a specific clinical facility or group of affiliated facilities based on volume of purchases.  Pricing agreements which are documented arrangements with clinical facilities, or groups of affiliated facilities, if applicable, are established in advance of orders accepted or shipments made.  For existing customers, past actual shipment volumes typically determine the fixed price by part number for the next agreement period of one year. For new customers, the customer's best estimate of volume is usually accepted by UTMD for determining the ensuing fixed prices for the agreement period. Prices are not adjusted after an order is accepted. For the sake of clarity, the separate pricing agreements with clinical facilities based on volume of purchases disclosure is not inconsistent with UTMD's disclosure above that the selling price is fixed prior to the acceptance of a specific customer order.

UTMD's global consolidated trade sales are comprised of domestic and outside the U.S. (OUS) sales. Domestic sales include 1) direct domestic sales, sales of finished devices to end-user facilities and med/surg distributors in the U.S.; 2) domestic OEM sales, sales of components or finished products, which may not be medical devices, to other companies for inclusion in their products; and 3) sales of the Filshie Clip System by Femcare UK to CSI.  OUS sales are export sales from UTMD in the U.S. to customers outside the U.S. invoiced in USD, and all sales from UTMD subsidiaries in Ireland, Canada, Australia and the UK (other than Femcare UK sales to CSI) which may be invoiced in EUR, GBP, CAD, AUD or USD.  The term "trade" means sales to customers which are not part of UTMD.  Each UTMD entity except Femcare Australia and Femcare Canada also had 2017 intercompany sales of components and/or finished devices to other UTMD entities.

Global consolidated trade sales in 2017 were $41,414 compared to $39,298 in 2016 and $40,157 in 2015.  The primary contributors to the $2,117 (+5.4%) increase were 1) direct sales to end-user facilities in Canada and France, which were $1,850 higher than 2016 sales to UTMD's distributors in Canada and France, and 2) $832 (+28%) higher Filshie Clip System domestic sales to CSI;  offset by 3) a loss of $516 in sales of BPM kits to an OEM distributor in Germany. In contrast to 2016 compared to 2015 when the negative impact of FX rates on sales lowered sales by $600, the negative $68 impact in 2017 was minimal.

Domestic Sales.

Total domestic U.S. sales were up $798 (+4%) in 2017, at $20,286 compared to $19,488 in 2016. Domestic sales in 2017 were 49% of total consolidated sales compared to 50% in 2016.  The primary contributors to the 2017 higher domestic sales were $832 (+28%) higher sales to CSI, Femcare's US distributor of the Filshie Clip System, and $188 (+6%) higher sales of components and finished devices used in other companies' products (OEM customers).  Direct sales of UTMD finished devices to domestic end-users were $223 (2%) lower.

In 2017, CSI for the first time purchased $476 in Sterishot single-use Filshie Clip applicator kits, approved by the U.S. FDA in December 2016. The Sterishot applicators have been widely accepted outside the U.S. since 2009 as a result of the obvious lower risk of infection that is inherent with reused surgical instruments in laparoscopic procedures, and the elimination of the need for recalibration and repair of delicate instruments. Conversion to single use applicators has an expansive impact on sales.

Domestic OEM sales in 2017 represented 8% of total sales compared to 7% in 2016.  UTMD sold components and finished devices to 148 different U.S. companies in 2017 compared to 139 companies in 2016, for use in their product offerings.  From a financial perspective, OEM sales help dilute manufacturing overhead and improve UTMD's GPM from better utilization of existing capabilities.

Direct (non-CSI) domestic sales of UTMD finished devices to U.S. end user facilities were $13,401 (32% of total sales) compared to $13,624 (35% of total sales) in 2016.  By product category, domestic direct sales of neonatal products were $4,049 (0% higher), labor & delivery (L&D) products $3,761 (3% lower), BPM products $934 (7% higher) and gynecology/urology products excluding the Filshie Clip System $4,657 (4% lower).

  Total OUS sales were up $1,319 (+7%) in 2017, at $21,129 compared to $19,809 in 2016.  Sixty-four percent of (USD denominated) 2017 OUS sales were invoiced in foreign currencies compared to 58% in 2016.

UTMD's FX rates for income statement purposes are transaction-weighted averages. The average FX rates from the applicable foreign currency to USD during 2017 compared to 2016 FX rates were:

 

  Because a significant portion of UTMD's sales are invoiced in foreign currencies, changes in FX rates can potentially have a material effect on period-to-period USD-denominated sales.  In contrast to the previous three years when the USD consistently and significantly strengthened relative to other currencies, the combined net impact of FX changes in the full year of 2017 was minimal.  Because of the BREXIT referendum in mid-2016, UTMD's first half (1H) 2017 sales were $282 lower than they would have been with the 1H 2016 GBP FX rate. After 4Q 2016, the GBP FX rate stabilized and gradually strengthened relative to the USD so that the negative GBP FX effect on sales in 2017 as a whole was only ($232). In contrast, the EUR and the AUD strengthened in 2017 compared to 2016, almost offsetting the negative GBP FX rate impact on sales. As a result, UTMD's total consolidated revenues for the year would have been up only another $68 with combined constant currency (same FX rates in 2017 as in 2016). Since there were no CAD sales in 2016, the CAD FX rate change had no impact on the sales comparison between 2017 and 2016.

  As a portion of total sales, 33% of UTMD's USD-equivalent 2017 sales were invoiced in foreign currencies compared to 29% in 2016.  The increase was due to the addition of CAD sales for sales direct to end user facilities in Canada from UTMD's newly established distribution subsidiary, Utah Medical Products Canada, Inc. (dba Femcare Canada).  Sales of the Filshie Clip System to Femcare's third party Canada distributor in 2016 were invoiced in EUR if manufactured and shipped by UTMD's Ireland subsidiary, or in GBP if shipped from UTMD's UK subsidiary. In 2017, the GBP, EUR, AUD and CAD converted sales represented 10%, 10%, 6% and 7% of total 2017 USD sales, respectively.  This compares to 12% GBP, 11% EUR and 6% AUD of total 2016 USD sales. There were no CAD sales in 2016.

  USD-denominated trade (excludes intercompany) sales of devices to OUS customers by UTMD's Ireland facility (UTMD Ltd) were $1,712 (25%) lower in 2017 compared to 2016 because 1) $1,390 in 2016 trade sales to UTMD distributors in Canada and France were converted to intercompany sales in 2017 (zero trade sales), and 2) BPM kit sales to UTMD's Germany OEM distributor, which were $516 in 2016, were discontinued in 2017 (zero trade sales).  In EUR terms, UTMD Ltd 2017 sales including intercompany shipments were 15% lower for the year.

USD-denominated 2017 trade sales of devices to domestic UK, domestic France and international distributor customers of Femcare-Nikomed, Ltd (UK subsidiary), excluding intercompany sales, were $1,249 (+16%) higher compared to 2016, due to 1) the fact that 2017 direct trade sales in France exceeded sales to the France and Canada distributors in 2016 by $828, and 2) sales to CSI, Femcare's exclusive U.S. distributor of the Filshie Clip System, were $832 higher than in 2016.  Sales to CSI were in USD currency, but UK subsidiary foreign currency sales were $157 lower compared to 2016 as a result of negative FX rates. In GBP terms, UK subsidiary 2017 sales including intercompany shipments were 24% higher for the year.

USD-denominated sales of devices to end-users in Australia by Femcare's Australia distribution subsidiary (Femcare Australia) were 4% lower in 2017 compared to 2016.  AUD sales in 2017 were about 7% lower than in 2016.

Sales to distributors in Canada and France in 2016 included a $500 distributor marketing rights payment which was absent in 2017. Also, 2017 direct sales in Canada and France were reduced by a $25 repurchase of distributor inventory.

Looking forward, based on the end of 2017 FX rates, 2018 foreign currency sales on the whole should benefit in USD terms for the first time in several years because of a relative USD weakness compared at least to the first three quarters of 2017.

UTMD groups its sales into four general product categories:  1) obstetrics, comprised of labor and delivery management tools for monitoring fetal and maternal well-being, for reducing risk in performing difficult delivery procedures and for improving clinician and patient safety;  2) gynecology/ electrosurgery/ urology, comprised of tools for gynecological procedures associated primarily with cervical/ uterine disease including LETZ, endometrial tissue sampling, transvaginal uterine sonography, diagnostic laparoscopy, surgical contraception and other MIS procedures; specialty excision and incision tools; conservative urinary incontinence therapy devices; and urology surgical procedure devices;  3) neonatal critical care, comprised of devices that provide developmentally-friendly care to the most critically ill babies, including providing vascular access, enteral feeding, administering vital fluids, oxygen therapy while maintaining a neutral thermal environment, providing protection and assisting in specialized applications; and 4) blood pressure monitoring/ accessories/ other, comprised of specialized components as well as molded parts and assemblies sold on an OEM basis to other companies.  In these four categories, UTMD's primary revenue contributors enjoy significant brand awareness by clinical users.

Global revenues by product category:

 

 

OUS revenues by product category:

 

 

*includes molded components and finished medical and non-medical devices sold to OEM customers.

As a summary description of revenues in the above tables:

In calendar year 2018, for varying reasons, UTMD expects overall revenues about the same as in 2017.  Lower sales to CSI will offset continued good growth in Filshie Clip System sales OUS, if CSI's beginning of year forecast becomes reality. An average weaker USD should help improve foreign currency sales. UTMD's China distributor of BPM kits has placed an annual order $0.8 million lower than in 2017.  Neonatal ICU sales OUS are expected to achieve double-digit growth. Domestic direct sales of niche devices should remain about the same, while domestic OEM sales are expected to grow faster than in 2017.

b)  Gross Profit (GP).  UTMD's 2017 consolidated GP, the surplus after subtracting costs of manufacturing, which includes purchasing raw materials, forming components, assembling, inspecting, testing, packaging, sterilizing and shipping products, from net revenues, was $26,395 (63.7% of sales) compared to $23,690 (60.3% of sales) in 2016, and $24,185 (60.2% of sales) in 2015.  The significant expansion in UTMD's 2017 average GPM was primarily the result of converting wholesale third party distributor sales into direct end user sales in Canada and France.  There was an additional favorable mix change in that low margin BPM product sales to an international OEM, which represented 3% of total OUS  sales in 2016, were replaced by higher margin other product sales.  In Utah, manufacturing was simply able to get more done with fewer people, aided by another favorable experience year for Utah's self-insured health benefit plan.  The Company also helped control raw materials (RM) costs by investing in increased RM inventory.

Because UTMD's medical devices are differentiated and not subject to GPO agreements or other significant commodity pricing pressures, the Company was generally able to avoid selling price reductions.

UTMD's Ireland subsidiary's (UTMD Ltd's) GP was EUR 3,234 in 2017 compared to EUR 3,988 in 2016 and EUR 3,312 in 2015.  The associated GPMs were 47.5% in 2017, 49.5% in 2016 and 48.5% in 2015.  The lower GP in 2017 was due to the conversion of 2016 trade sales to distributors in Canada and France into intercompany sales in 2017, and to the lower absorption of overhead as a result of loss of substantial BPM sales to a Germany OEM customer.

Femcare UK GP was GBP 5,317 in 2017 compared to GBP 4,138 in 2016, and GBP 4,607 in 2015. The increase in 2017 was due to higher sales of Filshie Clip System sales to CSI in the U.S. and the conversion to selling direct to end users in France. The GPM improved to 71.7% in 2017 compared to 69.4% in 2016 and 68.8% in 2015.

Femcare Australia and Femcare Canada are purely distribution operations for UTMD finished devices in their respective countries.  Australia GP was AUD 1,846 in 2017 compared to AUD 2,049 in 2016 and AUD 1,971 in 2015.  The respective Femcare Australia GPMs were 62.7% in 2017, 65.1% in 2016 and 58.4% in 2015.  Canada GP was CAD 2,300 (60.2% of sales) in 2017.

In the U.S., GP was $12,497 in 2017 compared to $12,547 in 2016 and $12,222 in 2015. GPMs were 55.0% in 2017, 54.3% in 2016 and 54.2% in 2015.  The consistent U.S. GPs are largely a function of UTMD's experienced manufacturing personnel. The 2017 GPM improved somewhat from improved production planning and lower overhead expenses.

A summation of the above 2017 GP of each subsidiary will not yield consolidated total GP because of elimination of profit in inventory of intercompany goods.  With the same level of projected sales, UTMD does not expect to be able to maintain the same GPM in 2018 as in 2017. OUS manufacturing overhead costs will be higher in USD terms as a result of a weaker USD.  U.S. manufacturing overhead costs will be higher due to an employee cost of living adjustment in mid-2017, and an already apparent vendor price increase trend.

   c) Operating Income (OI).  OI results from subtracting OE from GP.  OI in 2017 was $19,011 (45.9% of sales) compared to $16,187 in 2016 (41.2% of sales), and $15,651 (39.0% of sales) in 2015.  The substantial improvement in 2017 OIM was due to 5% higher sales combined with an expanded GPM and 2% lower consolidated OE.  The UTMD Ltd OIM in 2017 was 42.7% compared to 45.9% in 2016, and 44.5% in 2015.  Femcare UK's 2017 OIM was 40.1% compared to 30.3% in 2016, and 32.5% in 2015. Femcare AUS's 2017 OIM was 50.0% compared to 54.3% in 2016, and 46.5% in 2015.  Femcare Canada's 2017 OIM was 51.5%. UTMD U.S. OIM in 2017 was 39.8% compared to 38.1% in 2016, and 35.4% in 2015.

OE include sales and marketing (S&M) expenses, product development (R&D) expenses and general and administrative (G&A) expenses. Consolidated OE were $7,385 (17.8% of sales) in 2017 compared to $7,503 (19.1% of sales) in 2016, and $8,534 (21.3% of sales) in 2015. The following table provides a comparison of OE categories for the last three years.

 

Description of OE Categories

i) S&M expenses:  S&M expenses are the costs of communicating UTMD's differences and product advantages, providing training and other customer service in support of the use of UTMD's solutions, attending clinical meetings and medical trade shows, administering customer agreements, advertising, processing orders, shipping, paying commissions to outside independent representatives and, if applicable, paying the MDET in the U.S. In markets where UTMD sells directly to end-users, which in 2017 included the U.S., Ireland, UK, Australia, France and Canada, the largest components of S&M expenses were the cost of employing direct sales representatives, including associated costs of travel, subsistence and communications and the cost of customer service required to timely process orders.  The theoretical trade-off between higher gross profit margins for selling directly at end user prices is higher S&M expenses as a percent of sales. However, the S&M expenses associated with direct France sales were effectively absorbed by the UK subsidiary without increasing S&M resources. The S&M expenses associated with UTMD's new Canada subsidiary, Femcare Canada, in its first year were substantially absorbed by existing S&M resources in the U.S.

S&M expenses include all customer support costs including training. In general, training is not required for UTMD's products since they are well-established and have been clinically widely used. Written "Instructions For Use" are packaged with all finished devices. Although UTMD does not have any explicit contracts with customers to provide training, it does provide hospital in-service and clinical training as required and reasonably requested.

UTMD promises prospective customers that it will provide, at no charge in reasonable quantities, electronic media and other instructional materials developed for the use of its products. UTMD provides customer support from offices in the U.S., Canada, Ireland, UK and Australia by telephone to answer user questions and help troubleshoot any user issues. Occasionally, on a case-by-case basis, UTMD may utilize the services of an independent practitioner to provide educational assistance to clinicians. All in-service and training expenses are routinely expensed as they occur.  Except for the consulting services of independent practitioners and occasional use of marketing consultants, all of these services are allocated from fixed S&M overhead costs included in OE.  Historically, marginal consulting costs have been immaterial to financial results, which is also UTMD's expectation for the future.

The MDET, a component of the Patient Protection and Affordable Care Act, (known commonly as Obamacare) was effective between 2013 and 2015. In December 2015, U.S. legislators suspended the MDET for 2016 and 2017, and in January 2018, further suspended it for 2018 and 2019. The excise tax was 2.3% of domestic sales of medical devices listed with the FDA. Medical devices designed for human use were taxed, whether or not they were sold for human use, e.g. veterinarian uses or laboratory use were also taxed.  The impact of the tax was felt beyond 2.3%, as costs associated with administering, tracking, collecting and paying the tax were significant.

S&M expenses in 2017 were $1,544 (3.7% of 2017 sales) compared to $1,673 (4.3% of sales) in 2016, and $2,164 (5.4% of sales) in 2015. Lower USD S&M expenses were due in part to the weaker GBP and in part to UTMD not hiring some replacements for sales reps in the U.S. that it had previously planned. S&M OE excluding the MDET were 4.7% of sales in 2015. With the planned addition of S&M resources in 2018 and a weaker USD, S&M expenses as a percentage of total revenues are expected to increase.

ii) R&D expenses:  R&D expenses include the costs of investigating clinical needs, developing innovative concepts, testing concepts for viability, validating methods of manufacture, completing any necessary premarketing clinical trials, regulatory documentation and other activities required for design control, responding to customer requests for product enhancements, and assisting manufacturing engineering on an ongoing basis in developing new processes or improving existing processes. R&D expenses were $447 (1.1% of sales) in 2017 compared to $475 (1.2% of sales) in 2016, and $522 (1.3% of sales) in 2015. Although no new UTMD devices were launched in 2017, R&D played a significant and continuing role in manufacturing process improvements that became evident in improved 2017 GPMs, in addition to continuing work on new product projects. UTMD does not pre-announce new devices that are being developed. R&D expenses in 2018 are expected to be higher than in 2017.

iii)  G&A expenses:  G&A expenses include the "front office" functional costs of executive management and outside directors, finance and accounting, corporate information systems, human resources, stockholder relations, corporate risk management, corporate governance, protection of intellectual property, amortization of identifiable intangibles and legal costs.  G&A expenses in 2017 were $5,393 (13.0% of sales) compared to $5,355 (13.6% of sales) in 2016, and $5,848 (14.6% of sales) in 2015.  The table above helps clarify several specific categories of G&A expenses. G&A expenses in Canada's first year of operation were $160 higher than in 2016 during set-up. Amortization of the 2011 acquired Femcare IIA is part of G&A expenses. Although the IIA amortization expense in 2017 was only £4 lower than in 2016, because of the weaker GBP after the BREXIT referendum, the 2017 USD IIA amortization expense was $112 lower than in 2016.  The resulting G&A noncash amortization expense of Femcare IIA was 5.0% of total sales in 2017 compared to 5.5% of sales in 2016. The Femcare IIA amortization expense will continue until March 2026 (or until the value of any remaining IIA becomes impaired).

In summary, in 2018 not including unforeseen litigation expenses or possible acquisition costs, UTMD expects OE to be higher than in 2017 due to 1) a weaker USD relative to all foreign currencies, rendering same level foreign subsidiary expenses higher in USD terms, 2) the addition of S&M resources and 3) higher R&D expenses.

d)  Non-operating Income (NOI), Non-operating Expense (NOE) and EBT.  NOI includes royalties from licensing UTMD's technology, rent from leasing underutilized property to others, income earned from investing the Company's excess cash and gains or losses from the sale of assets or remeasurement of foreign currency bank account balances into USD, offset by NOE which includes interest on bank loans, bank service fees and excise taxes. The period-to-period remeasured value of EUR cash balances held in the UK and GBP balances held in Ireland generates a gain or loss which is booked at reporting period end as NOI or NOE.

Net NOI (combination of NOE and NOI) was $71 in 2017 compared to Net NOI of $235 in 2016, and Net NOE of $105 in 2015. The primary cause of the $164 lower NOI in 2017 compared to 2016 was a £95 lower gain in the remeasured value of EUR cash held in the UK, and $28 lower licensing royalties in the UK.  A description of NOE and NOI components follows:

1)  Interest Expense.  There was no interest expense in 2017 or 2016.  In 2015, $65 in interest expense was incurred on the remaining balances of loans needed to help acquire Femcare in 2011. Absent an acquisition or large repurchase of shares that requires new borrowing, UTMD does not expect any interest expense in 2018.

2)  Investment of excess cash.  Consolidated investment income (including gains and losses on sales of investments) was $17 in 2017 compared to $12 in 2016, and $5 in 2015.  Cash is generally currently held in non-interest bearing bank accounts because avoiding the bank operating fees which would result from lower balances offsets the interest that can be earned at current interest rates. UTMD estimates investment income will again be nominal in 2018.

3)  Royalties.  Femcare receives a royalty from licensing the use of the Filshie Clip System intangibles to CSI as part of its U.S. exclusive distribution agreement. Royalties in 2017 were $86 compared to $91 in 2016 and $93 in 2015.  UTMD expects to receive about $86 in CSI royalties in 2018.  Presently, there are no arrangements under which UTMD is receiving royalties from other parties.

4)  Gains/ losses from remeasured currency in bank accounts.  As noted above, UTMD recognized 2017 NOI of $4 and 2016 NOI of $129 from gains on remeasured foreign currency bank balances, compared to NOE of $141 in 2015 from losses on remeasured foreign currency bank balances. EUR and AUD currency cash balances in the UK, and GBP currency cash bank balances in Ireland, are subject to remeasured currency translation gains/ losses as a result of period to period changes in FX rates.  Because of UTMD's subsidiaries' profitability, the subsidiaries may continue to accumulate cash until uses of cash that increase stockholder value are identified.  The one-time REPAT tax implemented by the U.S. Congress in late 2017 imposed a 15.5% tax on all of UTMD's cash held OUS. Year-end 2017 foreign currency cash balances were valued at the following FX rates: 1.2021 USD/EUR; 0.7988 USD/CAD, 0.7815 USD/AUD and 1.3523 USD/GBP.  No remeasured currency gains or losses are included in UTMD's projections for 2018.

5)  Other NOI.  Income received from renting unused warehouse space in Ireland and parking lot space in Utah for a cell phone tower, offset by bank fees, miscellaneous non-operating expenses and non-MDET excise taxes resulted in a net NOE of $36 in 2017 compared to NOI of $3 in both 2016 and 2015. UTMD estimates Other NOI will be nominal in 2018.

Income before Taxes (EBT) results from adding net NOI or subtracting net NOE from OI. Consolidated EBT was $19,082 (46.1% of sales) in 2017 compared to $16,422 (41.8% of sales) in 2016, and $15,545 (38.7% of sales) in 2015.  The EBT of UTMD Ltd. (Ireland) was €2,779 (40.8% of sales) in 2017, €3,489 (43.3% of sales) in 2016, and €2,890 (42.2% of sales) in 2015.  Femcare UK's 2017 EBT was £3,155 (42.5% of sales) compared to £2,141 (35.9% of sales) in 2016, and £2,243 (33.5% of sales) in 2015. Femcare AUS's 2017 EBT was AUD 1,473 (50.0% of sales) compared to AUD 1,713 (54.4% of sales) in 2016, and AUD 1,580 (46.8% of sales) in 2015. Femcare Canada's 2017 EBT was CAD 1,906 (49.9% of sales).

As a side note for clarity of results, UTMD's 2017, 2016 and 2015 EBT, as well as all other income statement measures above the EBT line in the Income Statements, were unaffected by the 2017 accrual of the U.S. REPAT tax and the reduction in the DTL from the Tax Act enacted in late 2017, and the reduction in the DTL and income tax provision triggered as a result of changes in UK corporate income tax rates enacted in 2016 and 2015.  Therefore, the year to year comparisons of GP, OI and EBT are good indicators of UTMD's operating performance.

Looking forward, UTMD's consistently high level of EBT will help maximize the benefit to stockholders of the lower U.S. corporate income tax rates recently enacted.

e)  Net Income (NI), EPS and ROE.  NI is EBT minus income taxes, often called the "bottom line". There were tax law changes enacted in the U.S. in 2017, and in the UK in both 2016 and 2015 which affected the income tax provisions in those periods. The lowering of a future income tax rate results in a reduction in DTL. According to US GAAP, the total effect of tax rate changes on DTL balances is recorded as a component of the income tax provision related to continuing operations in the period in which the law is enacted.  The DTL adjustments which lowered the applicable year's consolidated income tax provision were $230 in 2017, $123 in 2016 and $351 in 2015.

   In addition, the U.S. "Tax Cuts and Jobs Act" enacted in December 2017 included a special levy on the cumulative income (E&P) of UTMD's foreign subsidiaries. Foreign cash balances of $29 million were taxed at a 15.5% rate, and the remaining E&P at an 8% rate for accrued Federal income tax purposes. Representatives of the State of Utah have indicated that the State will likely follow the Federal government and also levy a REPAT tax on half the E&P at the State of Utah corporate income tax rate of 5%.  UTMD's end of 2017 tax provision was increased by $6,288 to incorporate the total REPAT tax according to US GAAP, reducing 2017 NI and EPS accordingly.

  Because of the one-time REPAT tax in 2017 and DTL adjustments in each year, calculating and comparing period-to-period income tax provisions as a percentage of EBT does not provide meaningful information to stockholders, in UTMD's opinion. Therefore, NI and EPS are presented both according to US GAAP and also prior to recognition of the REPAT tax and DTL adjustments.

Note:  The tax provision adjustments only affected UTMD's income tax provision, NI and EPS, not consolidated revenues (sales), GP, OI or EBT.

   Ignoring the 2017 REPAT accrued tax provision of $6,288 and 2015 – 2017 DTL adjustments, the (non-US GAAP) consolidated combined income tax provision rate for 2017 was 23.7% of EBT compared to 26.9% in 2016, and 26.1% in 2015. The US GAAP consolidated income tax provision rate for 2017 was 55.4% of EBT compared to 26.1% in 2016, and 23.8% in 2015. The non-US GAAP difference in rates was due primarily to the tax deduction allowed in the UK and Ireland on the remeasured value of their USD cash balances, as well as the mix of income generated and actual tax provisions in sovereignties with varying tax rates. Both UK and Ireland subsidiaries experienced native currency losses on the value of their large USD cash balances in 2017. These currency translation losses are tax deductions in the applicable foreign jurisdiction, but do not affect UTMD's EBT (USD are USD).  But the actual tax (lower) provisions of the OUS subsidiaries do become part of UTMD's consolidated income tax provision.

  In general, year to year fluctuations in the combined tax rate will result from variation in EBT contribution from subsidiaries in jurisdictions with different corporate income tax rates. The UK had an income tax rate of 20% in 1Q 2017 and a rate of 19% thereafter, compared to a rate of 20% in 2016 and a rate of 21% in 1Q 2015 and a rate of 20% thereafter.  The UK also allows a tax deduction for sales of UK patented products which varies from year-to-year based on somewhat complicated rules which are sorted out for UTMD by independent tax accountants. The current UK income tax rate of 19% is scheduled to decline to 17% beginning April 1, 2020. The income tax rate for AUS has been and is planned to remain at 30%.  The income tax rate for Canada was and is expected to remain at 25%. Profits of the Ireland subsidiary are taxed at a 12.5% rate on exported manufactured products, and a 25% rate on rental and other types of income including income from sales of medical devices in Ireland domestically.

Further Comments on the U.S. Corporate Tax Rate.

For the benefit of stockholders, UTMD believes that further discussion of its current understanding of the impact of tax law changes resulting from the 2017 Act might be helpful.

UTMD's effective Federal tax rate in the U.S. after allowable deductions was typically about 29.4% prior to the new tax law. The State of Utah adds a 5% income tax using the Federal taxable income as a basis. The predominant reason that UTMD's prior effective Federal rate was not 34% was a "manufacturing profit deduction" (MPD) which equated to about 8.1% of UTMD's U.S. EBT. There were other factors such as the R&D tax credit and accelerated depreciation for tax purposes which helped reduce UTMD's effective income tax rates, and these other benefits will continue under the Tax Act. The MPD, however, has been discontinued under the Tax Act while the U.S. corporate tax rate has been reduced from 34% to 21%.

As the State of Utah uses Federal taxable income as a taxable base, the State will receive a "windfall" tax increase going forward, because UTMD's EBT upon which the 5% rate is applied will be 8.8% higher due to the loss of the MPD.  There is no present indication that the State of Utah will lower its corporate income tax rate, although they should follow the Tax Act in that regard, in UTMD's opinion, if they are going to also tax UTMD's cumulative foreign subsidiary E&P.

As a rough guideline to help stockholders estimate the effect of the new tax law looking forward, UTMD's effective income tax rate for U.S. EBT should be about 7.9 percentage points lower than in the past. UTMD's 2017 U.S. EBT was about 48% of total EBT (including the EBT of all OUS subsidiaries). Using 2017 EBT as a basis, UTMD's consolidated tax provision would be about 3.8 percentage points lower, equating to about $720 higher NI and $0.20 higher EPS.

In other words, in exchange for $720 per year higher net income, UTMD stockholders incurred $786 per year loss if you spread the REPAT tax evenly over eight years. From an income statement point of view, the impact of the REPAT tax has already been incurred in 2017 GAAP results, and the impact of the lower tax rate will increase future NI and EPS results, and, of course, UTMD intends to continue its consistent growth in EBT.

   The Company believes that investors benefit from referring to the non-GAAP financial measures above in assessing UTMD's performance. The non-GAAP financial measures also facilitate management's internal comparisons for purposes of planning future performance. The non-GAAP financial measures disclosed by UTMD should not be considered a substitute for or superior to financial measures calculated in accordance with GAAP, and the financial results calculated in accordance with GAAP and reconciliations to those financial statements should be carefully evaluated.

EPS are NI divided by the number of shares of stock outstanding (diluted to take into consideration stock option awards which are "in the money," i.e., have exercise prices below the applicable period's weighted average market value).  As noted above, diluted EPS were $2.276 in 2017 ($3.897 prior to the REPAT tax and DTL adjustment), $3.220 ($3.188 prior to the DTL adjustment) in 2016, and $3.140 ($3.047 prior to the DTL adjustment) in 2015.    The 2017 non-GAAP results exceeded management's expectations for the year.

The 2017-ending weighted average number of diluted common shares (the number used to calculate diluted EPS) was 3,737 (in thousands), compared to 3,766 shares in 2016 and 3,772 shares in 2015.  EPS in 2017 benefited from UTMD's November 2016 repurchase of 50,000 shares from an institutional investor. Dilution for "in the money" unexercised options for the year 2017 was 19 shares, compared to 15 shares in 2016 and 20 in 2015.  Actual outstanding common shares as of December 31, 2017 were 3,721.

In summary, after an outstanding year of growth in 2017, UTMD management expects flatter revenues in 2018, with OI challenged by broadly higher costs. Helped by a lower combined income tax rate, UTMD management is targeting 2018 EPS between $3.80 and $3.90. UTMD's calendar year 2018 operating plan for conservative reasons excludes additional share repurchases, acquisitions and potential sales growth from unannounced new products.

Return on stockholders' equity (ROE) is the portion of NI retained by UTMD (after payment of dividends) to internally finance its growth, divided by the average accumulated stockholders' equity (ASE) during the applicable time period. ROE includes balance sheet measures as well as income statement measures.  Maintaining a high ROE is a key management objective for UTMD in order to grow without diluting its stockholders' interest. ROE is the quotient of NI divided by ASE, but it is a function of NIM, productivity of assets and financial leverage. Although UTMD's high NIM is the primary factor that continues to drive its ROE, a repurchase of 50,000 shares for $2,850 in 4Q 2016, $3,960 in cash dividends to stockholders in 2017 and a reduction as a result of the REPAT tax, all helped lower ASE, reducing the denominator in calculating ROE.  Although REPAT tax helped the denominator by lowering ASE $3.1 million, it harmed ROE more in 2017 by also lowering the NIM numerator from 35.2% to 20.5%.  Average 2017 Stockholders' Equity was $73,683. Year-end 2017 Stockholders' Equity was $78,122. Year-end 2017 Stockholders' Equity increased $8,878 from a year earlier.

   UTMD's 2017 ROE was 6% including dividends and US GAAP NI, compared to 12% in both 2016 and 2015.  Before dividends, UTMD's 2017 ROE was 12% compared to 17% in 2016, and 18% in 2015. Using Non-GAAP NI, excluding the effect of the REPAT tax and before dividends, UTMD's 2017 ROE was 19%.

Liquidity and Capital Resources

Cash Flows.

Net cash provided by operating activities, including adjustments for depreciation and other non-cash operating expenses, along with changes in working capital and the tax benefit attributable to exercise of employee incentive stock options, totaled $16,908 in 2017, compared to $14,528 in 2016 and $13,801 in 2015.  The largest changes in 2017 compared to 2016 were all related to the REPAT tax:  the establishment of $5,785 in long-term repatriation tax payable, a decrease of $3,623 in net income, and a $2,213 benefit to cash from a $1,027 increase in accrued expenses following a $1,187 decrease in the prior year. The other significant contributor to the increase in accrued expenses was the $1,005 dividend payable at year-end 2017. A decrease in other receivables benefited cash by $895. Other changes were generally consistent with effective working capital management and sales activity.

The Company's notes payable repayment of $4,777 in 2015 was the most significant use of cash that year. The loans were paid off in early 2015, so no loan principal payments were required in 2016 or 2017. Loans of $26,934 were obtained in 2011 to help finance the acquisition of Femcare. In investing activities, during 2017 UTMD used $1,597 for capital expenditures. During 2017 UTMD fitted-out the 38,600 square foot facility in the UK it purchased in late 2016 to replace its leased facility, and moved operations into the new facility late in the year.

In 2017, UTMD received $302 and issued 8,302 shares of stock upon the exercise of employee and director stock options.  Employees and directors exercised a total of 8,638 option shares in 2017, with 336 shares immediately being retired as a result of optionees trading the shares in payment of the exercise price of the options.  Option exercises in 2017 were at an average price of $37.83 per share.  The Company received a $38 tax benefit from option exercises in 2017, which is only reflected in net income as a result of adopting a new accounting standard in 2017. UTMD did not repurchase any shares of its stock in the open market during 2017. In 2016, UTMD received $376 and issued 11,945 shares of stock upon the exercise of employee and director stock options.  Employees and directors exercised a total of 12,806 option shares in 2016, with 861 shares immediately being retired as a result of optionees trading the shares in payment of the exercise price of the options.  Option exercises in 2016 were at an average price of $33.68 per share.  The Company received a $50 tax benefit from option exercises in 2016. UTMD repurchased 50,000 shares of stock in the open market at a cost of $2,850 during 2016, an average cost of $57.00 per share.  By comparison, in 2015, UTMD received $343 and issued 15,786 shares of stock upon the exercise of employee and director stock options.  Employees and directors exercised a total of 21,800 option shares in 2015, with 6,014 shares immediately being retired as a result of optionees trading the shares in payment of the exercise price of the options and related taxes.  Option exercises in 2015 were at an average price of $29.36 per share.  The Company received a $114 tax benefit from option exercises in 2015. UTMD repurchased 13,000 shares of stock in the open market at a cost of $683 during 2015, an average cost of $52.54 per share.

UTMD did not borrow in any of the three years 2015-2017.  Cash dividends paid were $2,955 in 2017, compared to $3,916 in 2016 and $3,846 in 2015. The $1,005 cash dividend declared for 4Q 2017 was paid in early January 2018, a change from the dividends declared in the 4^th quarters of 2016 and 2015, which were paid in late December.

Management believes that future income from operations and effective management of working capital will provide the liquidity needed to finance internal growth plans.  In an uncertain economic environment, UTMD's cash balances allow management to operate with the long-term best interest of stockholders in mind.  Planned 2018 capital expenditures for ongoing operations are expected to be less than depreciation of current PP&E.

Management plans to utilize cash not needed to support normal operations in one or a combination of the following:  1) in general, to continue to invest at opportune times in ways that will enhance future profitability; 2) to make additional investments in new technology and/or processes; and/or 3) to acquire a product line or company that will augment revenue and EPS growth and better utilize UTMD's existing infrastructure.  If there are no better strategic uses for UTMD's cash, the Company will continue to return cash to stockholders in the form of dividends and share repurchases when the stock appears undervalued.

Management's Outlook.

UTMD is small, but its employees are experienced and remain diligent in their work. UTMD's passion is in providing innovative clinical solutions that will help improve the effectiveness of medical procedures and reduce health risks, particularly for women and their babies.

The safety, reliability and performance of UTMD's medical devices are high and represent significant clinical benefits while providing minimum total cost of care.  UTMD will continue to leverage its reputation as a device innovator which will responsively take on challenges to work with clinicians who use its specialty devices.  In doing so, UTMD will continue to differentiate itself, especially from commodity-oriented competitors.  In 2018, UTMD plans to continue to

 

The Company has a fundamental focus to do an excellent job in meeting clinicians' and patients' needs, while providing stockholders with excellent returns.  In 2017, the value of UTMD's stock increased 12%, ending the year at $81.40/ share, while $1.065 in dividends/ share were paid. Taking a longer term view, as of the end of 2017 from the end of 1998, UTMD's share price increased 1,140%, representing a 14% annually compounded share price increase over the nineteen year time span. If additional returns to stockholders from cash dividends are added, stockholder value increased 1,343% over the nineteen year time span, representing 15% annually compounded growth in value. In comparison, the NASDAQ Composite Index was up 215%, the S&P 500 Index was up 118% and the DJIA was up 169%.

   Combining share price appreciation as a result of a long term profitable financial performance and a capital allocation strategy that includes opportunistic share repurchases with steadily growing quarterly cash dividends paid to stockholders since 2004, longer term UTMD stockholders have experienced excellent returns. Management is committed to continue that performance.

Off Balance Sheet Arrangements

None

Contractual Obligations

The following is a summary of UTMD's significant contractual obligations and commitments as of December 31, 2017:

 

Critical Accounting Policies and Estimates

The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as the reported amounts of revenues and expenses during the reporting period.

Accounting Policy Changes

The Company's management has evaluated the recently issued accounting pronouncements through the filing date of these financial statements and has determined that the application of these pronouncements will not have a material impact on the Company's financial position and results of operations.

ITEM 7A ‑ QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company had manufacturing operations, including related assets, in the U.S. denominated in the U.S. Dollar (USD), in Ireland denominated in the Euro (EUR), and in England denominated in the British Pound (GBP). UTMD also has trading activities in the U.S. and in subsidiaries in other countries denominated in the USD, EUR, GBP, the Australian Dollar (AUD) and the Canadian Dollar (CAD).  The currencies are subject to exchange rate fluctuations that are beyond the control of UTMD.  The exchange rates were .8319, .9474 and .9203 EUR per USD as of December 31, 2017, 2016 and 2015, respectively.  Exchange rates were .7395, .8105 and .6774 GBP per USD as of December 31, 2017, 2016 and 2015, respectively. Exchange rates were 1.2796, 1.3829 and 1.3710 AUD per USD on December 31, 2017, 2016 and 2015, respectively. Exchange rates were 1.2519 and 1.3425 CAD per USD on December 31, 2017 and 2016, respectively. Please see note 1 in Item, 8, below under "Translation of Foreign Currencies" for more information.  UTMD manages its foreign currency risk without separate hedging transactions by either invoicing customers in the local currency where costs of production were incurred, or by converting currencies as transactions occur.

ITEM 8 ‑ FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Currency amounts are in thousands except per-share amounts and where noted.

TABLE OF CONTENTS

 

MANAGEMENT'S REPORT ON INTERNAL CONTROL

OVER FINANCIAL REPORTING

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The Company's internal control over financial reporting includes those policies and procedures that:

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2017. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (1992).

Based on its assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2017.

The Company's independent registered public accounting firm, Jones Simkins LLC, has audited the Company's internal control over financial reporting as of December 31, 2017, and its report is shown on the next page.

Nortons Assurance Limited audited the internal control over financial reporting of Femcare Group Limited as of December 31, 2017, and its report follows the report of Jones Simkins LLC.

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
of Utah Medical Products, Inc.

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Utah Medical Products, Inc. as of December 31, 2017 and 2016, and the related consolidated statements of income and comprehensive income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2017. We also have audited Utah Medical Products, Inc.'s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Utah Medical Products, Inc. as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, based on our audit and the report of the other auditors, Utah Medical Products, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control—Integrated Framework (1992)  issued by COSO.

Basis for Opinion

Utah Medical Products, Inc.'s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on Utah Medical Products, Inc.'s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to Utah Medical Products, Inc. in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We did not audit portions of the consolidated financial statements and we did not examine the effectiveness of internal control over financial reporting for portions of Femcare Group Limited, a wholly owned subsidiary. The portions not audited by us include assets of $26,564,000, and $19,412,000 as of December 31, 2017 and 2016, respectively, and total revenues of $11,371,000, $10,214,000, and $12,548,000, respectively for each of the years in the three-year period ended December 31, 2017. Those portions of the consolidated financial statements and the effectiveness of internal control over financial reporting were audited by other auditors whose reports have been furnished to us, and our opinions, insofar as they relate to the amounts included for Femcare Group Limited and the effectiveness of Femcare Group Limited's internal control over financial reporting, is based solely on the reports of the other auditors.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks.  Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall consolidated financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

JONES SIMKINS LLC

We have served as Utah Medical Products, Inc.'s auditor since 2003.

Logan, Utah

March 5, 2018

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
of Utah Medical Products, Inc.

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the consolidated balance sheets of Femcare Group Limited (the Company), including its subsidiaries, as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2017. We also have audited the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control—Integrated Framework (1992)  issued by COSO.

Basis for Opinion

The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's consolidated financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks.  Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

NORTONS ASSURANCE LIMITED

We have served as the Company's auditor since 2011.

Reading, United Kingdom

March 5, 2018

 

 

 

 

 

Utah Medical Products, Inc. with headquarters in Midvale, Utah and its wholly-owned operating subsidiaries, Femcare Nikomed Ltd located in Romsey, Hampshire, England, Femcare Australia Pty Ltd located in Castle Hill, NSW, Australia, Utah Medical Products Canada, Inc. (dba Femcare Canada) located in Mississauga, Ontario, Canada and Utah Medical Products Ltd., which operates a manufacturing facility in Athlone, Ireland, (in the aggregate, the Company) are in the primary business of developing, manufacturing and globally distributing specialized medical devices for the healthcare industry.  The Company's broad range of products includes those used in critical care areas and the labor and delivery departments of hospitals, as well as outpatient clinics and physicians' offices.  Products are sold directly to end user facilities in the U.S., Ireland, UK, Canada, France and Australia, and through third party distributors in other outside the U.S. (OUS) markets.  Domestically, UTMD has an exclusive distribution relationship with CooperSurgical, Inc. for the Filshie Clip System.  UTMD also sells subcontract manufactured components and finished products to over 145 companies in the U.S. for their medical and non-medical products.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Although actual results could differ from those estimates, management believes it has considered and disclosed all relevant information in making its estimates that materially affect reported performance and current values.

The consolidated financial statements include those of the Company and its subsidiaries.  All intercompany accounts and transactions have been eliminated in consolidation.

For purposes of the consolidated statement of cash flows, the Company considers cash on deposit and short-term investments with original maturities of three months or less to be cash and cash equivalents.

The Company classifies its investments as "available-for-sale."  Securities classified as "available-for-sale" are carried in the financial statements at fair value.  Realized gains and losses, determined using the specific identification method, are included in operations; unrealized holding gains and losses are reported as a separate component of accumulated other comprehensive income.  Declines in fair value below cost that are other than temporary are included in operations.  As of December 31, 2017 the Company retained a freely tradeable investment in Citigroup (C) (see note 3).

The primary concentration of credit risk consists of trade receivables.  In the normal course of business, the Company provides credit terms to its customers.  Accordingly, the Company performs ongoing credit evaluations of its customers and maintains allowances for possible losses which, when realized, have been within the range of management's expectations as reflected by its reserves.

The Company's customer base consists of hospitals, medical device distributors, physician practices and others directly related to healthcare providers, as well as other manufacturing companies.  Although the Company is affected by the well-being of the global healthcare industry, management does not believe significant trade receivable credit risk exists at December 31, 2017 except under an extreme global financial crisis.

The Company maintains its cash in bank deposit accounts in addition to Fidelity Investment accounts.  The Company has not experienced any losses in such accounts and believes it is not exposed to a significant credit risk on cash and cash equivalent balances.

Note 1 – Summary of Significant Accounting Policies (continued)

Accounts receivable are amounts due on product sales and are unsecured.  Accounts receivable are carried at their estimated collectible amounts.  Credit is generally extended on a short-term basis; thus accounts receivable do not bear interest although a late charge may be applied to such receivables that are past the due date.  Accounts receivable are periodically evaluated for collectibility based on past credit history of customers and current market conditions.  Provisions for losses on accounts receivable are determined on the basis of loss experience, known and inherent risk in the account balance and current economic conditions (see note 2).

In 2017, the Company adopted Accounting Standard Update (ASU) 2015-11, "Inventory-Simplifying the Measurement of Inventory," which changed how inventory is valued.  Finished products, work-in-process, raw materials and supplies inventories are stated at the lower of cost and net realizable value (NRV) computed on a first-in, first-out method.  Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.  The adoption of ASU 2015-11 did not have an impact on the Company's financial statements (see note 2).

Property and equipment are stated at cost.  Depreciation and amortization are computed using the straight-line method over estimated useful lives as follows:

 

 

Building and improvements	15-40 years
Furniture, equipment and tooling	3-10 years

 

The Company evaluates its long-lived assets in accordance with Accounting Standards Codification (ASC) 360, "Accounting for the Impairment of Long-Lived Assets."  Long-lived assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that their net book value may not be recoverable.  When such factors and circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amounts.  Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets, and is recorded in the period in which the determination was made.

Costs associated with the acquisition of patents, trademarks, trade names, customer relationships, regulatory approvals & product certifications, license rights and non-compete agreements are capitalized, and are being amortized using the straight-line method over periods ranging from 5 to 20 years. UTMD's goodwill is tested for impairment annually, in the fourth quarter of each year, using a fair value measurement test, in accordance with ASC 350. UTMD also performs impairment tests contemporaneously, if circumstances change that would more than likely reduce the fair value of goodwill below its net book value.  If UTMD determines that its goodwill is impaired, a second step is completed to measure the amount of the impairment loss. UTMD does not expect its goodwill to become impaired in the foreseeable future.  Estimated future amortization expense on intangible assets currently held, using the 2017 year-end 1.3523 USD/GBP and .7815 USD/AUD currency exchange rates, is about $1,981 in 2018, $1,980 in 2019 and 2020, $1,974 in 2021, and $1,973 in 2022 (see note 2).

At December 31, 2017, the Company has stock-based employee compensation plans, which are described more fully in note 9.  The Company accounts for stock compensation under ASC 718, Share-Based Payment.  This statement requires the Company to recognize compensation cost based on the grant date fair value of options granted to employees and directors.  In 2017, the Company recognized $129 in stock-based compensation cost compared to $92 in 2016 and $87 in 2015.

Note 1 – Summary of Significant Accounting Policies (continued)

The Company recognizes revenue at the time of product shipment as UTMD meets its contractual performance obligations to the customer at the time of shipment. Revenue recognized by UTMD is based upon the consideration to which UTMD is entitled from its customers as a result of shipping a physical product, in accordance with the documented arrangements and fixed contracts in which the selling price was fixed prior to the Company's acceptance of an order. Revenue from service sales, which are immaterial to UTMD, is generally recognized when the service is completed and invoiced. As demonstrated by decades of experience in successful and consistent collections, there is very minor and insignificant uncertainty regarding the collectability of invoiced amounts reasonably within the terms of the Company's contracts. There are circumstances under which insignificant revenue may be recognized when product is not shipped, which meet the criteria of ASU 2014-09: the Company provides engineering services, for example, design and production of manufacturing tooling that may be used in subsequent UTMD manufacturing of custom components for other companies.  This revenue is recognized when UTMD's performance obligations have been completed according to a fixed contractual agreement.  UTMD includes handling fees charged to customers in revenues.  

The Company accounts for income taxes under ASC 740, "Accounting for Income Taxes," whereby deferred taxes are computed under the asset and liability method.

In November 2015, the FASB released ASU 2015-17, Income Taxes (Topic 740):  Balance Sheet classification of Deferred Taxes.  ASU 2015-17 requires that all deferred income taxes are classified as noncurrent in a classified statement of financial position.  The Company adopted ASU 2015-17 retrospectively effective January 1, 2017.

On December 22, 2017 the U.S. Tax Cuts and Jobs Act of 2017 (Tax Act) was signed into law.  As a result of the Tax Act, the U.S. statutory tax rate was lowered from 35% to 21% effective January 1, 2018, among other changes.  ASC 740 requires companies to recognize the effect of tax law changes in the period of enactment; therefore, UTMD was required to revalue its deferred tax assets and liabilities at December 31, 2017 at the new rate.

The Tax Act contains a deemed repatriation transition tax (Transition Tax) on accumulated earnings and profits of the Company's non-U.S. subsidiaries that have not been subject to U.S. tax.  The Company plans to elect to pay its net Transition Tax over eight years.

On December 22, 2017, the SEC issued SAB 118 which provides guidance on accounting for the impact of the Tax Act.  SAB 118 provides a measurement period of up to one year from enactment for a company to complete its tax accounting under ASC 740.  Once a company is able to make a reasonable estimate and record a provisional amount for effects of the Tax Act it is required to do so.  Such provisional measurement amounts may change as remaining data is obtained, calculations are prepared and analysis and review are completed.

During the fourth quarter of 2017, the Company recorded a provisional tax charge for the Transition Tax of $6,288 and a provisional tax charge of $228 for the re-measurement of its U.S. deferred tax balances.  Both provisional tax amounts are the Company's reasonable estimate of the impact of the Tax Act based on its understanding and available guidance.  These provisional amounts may change as the Company receives additional clarification and implementation guidance.

The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, in Utah, in the United Kingdom, in Australia, in Ireland and in Canada.

The Company recognizes interest accrued related to unrecognized tax benefits in interest expenses and any related penalties in income taxes. The Company did not recognize any tax-related interest expense or have any tax penalties in any of the three years 2015 through 2017.

The Company has been involved in lawsuits which are an expected consequence of its operations and in the ordinary course of business.  The Company maintains a reserve for legal costs which are probable and estimated based on previous experience and known risk.  The reserve for legal costs at December 31, 2017 and 2016 was $182 and $134, respectively (see note 2).

Note 1 – Summary of Significant Accounting Policies (continued)

The computation of basic earnings per common share is based on the weighted average number of shares outstanding during each year.

The computation of earnings per common share assuming dilution is based on the weighted average number of shares outstanding during the year plus the weighted average common stock equivalents which would arise from the exercise of stock options outstanding using the treasury stock method and the average market price per share during the year.

The shares (in thousands) used in the computation of the Company's basic and diluted earnings per share are reconciled as follows:

Sales tax on revenue-producing transactions is recorded as a liability when the sale occurs.  UTMD is not required to withhold sales tax on OUS sales, and at least 90% of domestic 2017 sales were to customers who are tax exempt or who are in jurisdictions where UTMD is not required to withhold sales tax.

Assets and liabilities of the Company's foreign subsidiaries are translated into U.S. dollars at the applicable exchange rates at year-end.  Net gains or losses resulting from the translation of the Company's assets and liabilities are reflected as a separate component of stockholders' equity.  A negative translation impact on stockholders' equity reflects a current relative U.S. Dollar value higher than at the point in time that assets were actually acquired in a foreign currency.  A positive translation impact would result from a U.S. dollar weaker in value than at the point in time foreign assets were acquired.  Year-end translation gains or losses of non-functional currency bank account balances, e.g. EUR and AUD balances held by the UK subsidiary, are recognized as non-operating income or expense, as applicable.

Income and expense items are translated at the weighted average rate of exchange (based on when transactions actually occurred) during the year.

Note 2 – Detail of Certain Balance Sheet Accounts (continued)

The Company's investments, classified as available-for-sale consist of the following:

 

 

During the three years 2015 through 2017, UTMD did not have any proceeds from sales of available-for-sale securities.

                    

Note 4 – Fair Value Measurements and Financial Instruments 

The Company follows a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements).  A financial instrument's level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

The Company uses the following valuation techniques to measure fair value for its assets and liabilities:

 

The following table provides financial assets carried at fair value measured as of December 31 for the past two years: