Annual Report 1998
MERIT MEDICAL SYSTEMS, INC.
Table of Contents and Financial Highlights
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Letter from the President 1
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Products and Technology 5
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Selected Financial Data 15
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Management's Discussion and Analysis 16
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Financial Information 20
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Corporate Information 35
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Year Ended December 31,
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1998 1997 1996 1995 1994
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Operating Data:
Sales $68,377,357 $60,579,011 $50,455,766 $42,587,284 $33,324,245
Gross profit 25,943,484 22,812,895 21,136,149 17,599,286 14,325,230
Income before taxes 4,290,346 1,775,516 3,630,152 2,000,695 1,993,265
Net income 2,451,159 787,532 2,162,608 1,221,237 1,250,847
Net income per share $ .33 $ .11 $ .31 $ .18 $ .19
Weighted average
shares outstanding 7,488,225 7,369,668 7,051,911 6,851,164 6,678,041
Balance Sheet Data:
Working capital $15,779,725 $14,737,971 $12,761,211 $ 9,518,971 $ 9,032,899
Total assets 50,664,786 45,269,678 41,718,553 34,503,858 27,024,267
Long-term debt 3,388,835 3,913,686 4,822,126 1,778,953 827,592
Stockholders' equity $29,086,368 $25,802,149 $22,487,123 $19,264,525 $17,537,029
Corporate Headquarters
Merit Medical Systems, Inc.
1600 West Merit Parkway
South Jordan, Utah 84095
801-253-1600
President's letter to Shareholders
Dear Shareholders:
Your Company experienced a very rewarding and exciting year in 1998. Merit
recorded the highest revenues and net income in its history, despite continuing
challenges in health care reform. Considerable improvements made in Merit's
European operations, which includes the Ireland manufacturing facility and the
European direct sales force, were the major contributing factors to these
financial benchmarks.
During 1998 the Ireland facility became profitable by converting research
and development expenditures into manufacturing allocations for the new
Tomcat(tm) PTCA guide wire. In addition, this facility began producing other
products for sale by the Company's European and domestic sales forces. Merit
created additional manufacturing space at the Ireland facility by moving its
warehouse and customer service functions to a more central location in
Maastricht, The Netherlands, thereby improving the Company's distribution
capabilities and response times in foreign markets.
Also, management effected cost-cutting measures during the year.
Particularly, the manufacturing facility in New York was closed. Guide wire and
catheter technologies were transferred from this facility to either Ireland or
the Salt Lake headquarters to assist with our primary use strategy. By moving
these operations to existing facilities, Merit saves approximately $250,000 per
year in duplicate operating expenses.
Financial Performance
Merit's strategy of marketing its existing and new products by a direct
sales force both domestically and in Europe resulted in a record year in terms
of revenues and earnings per share. Revenues for the fiscal year were $68.4
million compared with $60.6 million in 1997, a gain of 13 percent. Net income
rose to a record $2.452 million, or $0.33 per share, compared to $0.787 million,
or $0.11 per share in 1997. The Company's cost of sales rose only 12.4 percent
and its gross profit margin expanded two basis points to 37.9 percent.
1
Revenue growth slowed somewhat from previous years due to changes in the
health care environment and Merit's close monitoring of its margin-sensitive
custom kits, as well as effects on sales from discontinued items pertaining to
the closure of our manufacturing facility in New York. Margins continued to
increase due to several factors, including pricing strategies on kits, a better
sales mix of higher margin products, economies of scale and contributions from
new products.
Merit maintained its control on overall costs throughout the year. With the
Ireland manufacturing facility becoming operational, research and development
costs declined to 4.7 percent from 7.3 percent in 1997. The Company continues to
invest heavily in research and development, however, with over thirty projects
ongoing. As selling, general and administrative costs are mostly fixed, these
expenditures continued to decline as a percent of sales to 25.6 percent from 26
percent in 1997. Income from operations grew to 7.6 percent of sales from 4.4
percent of sales the prior year, and income before taxes grew to 6.4 percent of
sales compared with 2.9 percent in 1997.
Changing Environment
As most people are now aware, the health care industry has been going
through sweeping changes for the last several years. These changes are being
driven by the ways in which hospitals are reimbursed for the procedures they
perform and the products they purchase. These reimbursement procedures have
caused hospitals to maximize purchasing efficiencies and reduce overall costs,
resulting in rapid consolidation among industry vendors as they attempt to
provide "one-stop shopping" for the hospitals. In addition, hospitals have been
purchased by large hospital product purchasing consortium groups which are
becoming more dominant on a nationwide basis.
These purchasing groups are now determining the vendors and products used
by their hospitals in an attempt to consolidate suppliers, bundle products
together and further reduce costs. Merit recognizes that hospital buying groups
are now looking at cardiac catheterization labs as an area for cost reduction.
The Company has developed an internal team solely for the purpose of responding
to these organizations, and for submitting and securing bids for their hospital
members. In November 1998, a national contract was awarded to Merit by Tenet
Healthcare Corporation for Merit's proprietary inflation devices. Additional
contracts with other national groups are being negotiated for many of Merit's
products.
2
In order to evolve its core competency of injection and insert molding
of plastic parts, Merit is developing a rapidly growing OEM contract business
for third parties. A small sales force has been established to meet the growing
demands of our OEM customers. New, proprietary opportunities in emerging
technologies are being identified that have not come under the scrutiny of
purchasing organizations. In the first quarter of 1999 Merit established a
presence on the Internet with the web site, www.merit.com. One of the major
focuses of this new site is the Company's OEM business. Merit plans to further
develop the OEM portion of this site to include an E-commerce application from
which a customer can design and directly order his own product. By utilizing its
strengths in national accounts and OEM manufacturing, along with the continued
introduction of new products, Merit should be able to preserve and grow its
existing business in a steady and profitable manner.
Merit Medical is the world market leader in inflation devices used for PTCA
balloon angioplasty and/or stent deployment and has a strong market position
with other molded plastic products used in cardiology and radiology. We have
made a conscious decision to augment our base business in this molded parts
arena to include differentiated, high-quality components like new needles,
syringes, manifolds, hemostasis valves, check relief valves and other products
with sustainable competitive advantages. Last year the Company introduced nine
new products, including the Tomcat(tm) guide wire, the Fountain(tm) Infusion
Catheter and the Squirt(tm) Fluid Delivery System. Merit's new product pipeline
has many products under development, several of which are planned for 1999
introduction.
Looking Ahead
In order to continue its growth strategy beyond the year 2000, Merit has
developed a carefully structured plan centered on several fronts. We have
focused on cardiology and radiology procedures by developing primary use
products for emerging technologies that provide better outcomes for patients or
better safety for hospital personnel. This expansion has provided several
opportunities for new product ideas and improvements to products currently used
in these procedures.
For the last two years, Merit has been directing its research and
development efforts toward primary use products-those that are more invasive in
nature such as guide wires and catheters-and has plans to extend this strategy
into multiple fronts. Merit Medical has developed a state-of-the-art guide wire
manufacturing facility in Galway, Ireland. In 1998 the Company launched its
first interventional PTCA guide wire and will be introducing many different
types of guide wires in 1999 and beyond. It is Merit's intention to expand these
capabilities and utilize existing resources in Ireland to create a Center of
Excellence in guide wire technology and production.
3
Merit's satellite manufacturing facility in Salt Lake City has been
developing expertise in catheter technology, some of which was acquired in 1997
from the facility in New York. Several different types of catheters are being
researched and the Company anticipates designating this facility as a Center of
Excellence in catheter technology.
For over two years, your company has been in the process of implementing a
new Oracle database system for use with its accounting, operations and computer
systems. I am happy to report that the system went live last November. This
system ensures that Merit is Y2K compliant, as well as enabling the Company to
better monitor and control its day-to-day operations. Merit is investing in its
labor force to address availability of new hires, turnover and a number of other
issues. Last year the Company began a new pilot program for Spanish-speaking
employees to learn English. Called the "English as a Second Language Program,"
or ESL, this program is designed to broaden the capabilities of its
Spanish-speaking employees, presenting them with additional career opportunities
within Merit and better utilizing their excellent work ethics. If the pilot
program is deemed successful, Merit intends to expand its ESL program to other
nationalities within its work force.
There are considerable challenges facing us in 1999, particularly in terms
of maintaining and growing the base business. Stabilizing the pricing of our
products and securing national accounts will be two hurdles we face. We believe
these challenges create opportunities. Merit has secured the European CE mark
for most of its products. This allows us the opportunity to develop distribution
relationships with small medical device companies with fine products but lacking
the CE mark and no distribution capabilities. As an adjunct to this philosophy,
our European sales network is being expanded. Merit currently has 13 direct
sales representatives, with plans to add two more sales people in 1999.
With the addition of many new products in primary use niches and by closely
monitoring the margin-sensitive portions of our business, we believe we have an
excellent opportunity to continue top-line growth and expand the bottom line. We
look forward to 1999 with enthusiasm as we implement these strategies. I thank
you, the shareholders, for your continued support and confidence in Merit
Medical and its drive for excellence throughout the years to come.
Best personal regards,
/s/ Fred P. Lampropoulos
Fred P. Lampropoulos
Chairman, Chief Executive Officer and President
4
Products and Technology
Worldwide, cardiology procedures including balloon angioplasty and stent
placement are growing at an average rate of about 15 percent per annum. The
aging population rate, along with the use of new technology, has fueled this
growth. Radiology procedures, such as diagnostic angiograms, and the use of
thrombolytic procedures to dissolve and remove blood clots has kept pace with
the aging population, growing at about 10 percent per annum. Worldwide, over 11
million people each year are referred to either a radiology or cardiology
laboratory in a hospital to undergo diagnostic angiograms.
Serving Customers' Needs Through Innovation
The driving force behind Merit Medical's growth has been its strength in
serving customers' needs by producing high-quality products that improve
clinical and economic outcomes. Many of Merit's key products have been developed
by collaborating with clinical users. Merit Medical is well known in cardiac
catheterization and radiology laboratories around the world for its innovation
and quality of products. Developing these customer relationships over time has
enabled Merit to maintain and expand its leadership position.
Several years ago, it became evident to Merit that clinicians used varied
methods of combining Merit's products to perform diagnostic and therapeutic
procedures according to their particular needs. In order to address the many
different techniques used, Merit developed a custom kit strategy that allows
each hospital or clinician to order exactly the type of products they want in a
bundled format. Merit's custom kit program has become enormously popular since
its inception in the early 1990's and now accounts for about 50 percent of its
overall business.
5
Merit Medical has long been a leader in many of the disposable products
needed to perform diagnostic and therapeutic procedures in the cardiology and
radiology markets. These products include inflation devices, syringes, needles,
pressure monitoring devices, contrast administration kits, manifold kits,
hemostasis valves, blood management systems, diagnostic and therapeutic
catheters, guide wires, introducers, stopcocks, and high-pressure tubing. The
market segments into which these products are sold account for roughly $600
million annually.
6
Existing Products
Stand-alone products consist of the same products a hospital might purchase
in a kit, but are sold separately. Merit's inflation devices are the Company's
leading stand-alone product line and, through their innovation and quality, have
established a world market leadership position. The inflation devices, which are
used to inflate angioplasty balloons or deploy stents, come in three different
models, depending upon the amount and accuracy of information the clinician
desires during the procedure.
The Basix(tm) inflation device provides the means for a clinician to safely
and effectively inflate a balloon during an angioplasty procedure, or deploy a
stent. Its features include a 20ml syringe barrel with unmatched visual clarity,
and it provides a strong vacuum during deflation. In addition it has a simple,
analog gauge attached to the barrel which allows the clinician to view the
inflation pressure being applied to the balloon or stent.
The second model, the Monarch25(tm), features a patented, digital display
attached to the barrel of the syringe. It features higher-pressure performance
and lets clinicians toggle display readings from ATM to PSI. It also allows
access to previous inflations, highest pressure and duration of the inflation.
The third model, the IntelliSystem25(tm), is the flagship of this product
line. Rather than having a small display attached to the barrel of the syringe,
the IntelliSystem25(tm) provides a separate, patented digital monitor with a
microprocessor. The monitor clearly displays the pressure, time and number of
each inflation. It also tracks the time elapsed from the previous inflation,
highest inflation pressure, and other information the clinician may need for an
extremely accurate reading during the procedure. Merit is the only company that
offers all three inflation device choices for clinicians around the world.
7
Merit frequently receives proposals involving new product development
opportunities. A careful assessment is made to determine how well each
opportunity fits with Merit's core competencies in injection and insert molding
of plastics, electronic and sensor-based technologies, and wire and catheter
technologies. With these basic guidelines in mind, Merit has developed a new
product strategy to enter markets with devices that involve more invasive
procedures and will yield higher margins.
8
New Products
The Fountain(tm) Infusion Catheter, introduced last year, fits well with
Merit's existing catheter technology and strategy to enter more invasive
markets. This innovative, patented catheter line was developed to help address
the need for clinicians to dissolve, or lyse, blood clots in peripheral arteries
and veins in order to restore blood flow. Pulsed infusion of thrombolytic drugs
to dissolve these obstructions has been successful in dialysis grafts,
peripheral bypass grafts, and peripheral arteriesand veins. The procedure to
dissolve blood clots essentially combines the use of thrombolytic drugs with
mechanical delivery to the site of the obstruction using Merit's Fountain(tm)
Infusion Catheter.
As an adjunct to the Fountain(tm) catheter, the Squirt(tm) Infusion System
was developed to allow doctors to deliver fluid into a patient's blood vessels
using a one-handed method. Previously, doctors had to bring together syringes
and other devices and create a small pumping system to infuse the fluid through
the catheter. In order to activate the pumping system, it was necessary to use
both hands to alternately pulse the syringes. The patented Squirt(tm) Infusion
System saves doctors time and effort and, importantly, allows them a free hand
to manipulate the position of the catheter during the lysing process.
Merit Medical's new product development efforts have been extremely active
over the last several years and are accelerating. In 1998, Merit introduced nine
new products, three of which have the potential to significantly impact Merit's
revenues and earnings. Two of these products, the Tomcat(tm) guide wire and the
Fountain(tm) Infusion Catheter, were introduced in response to Merit's strategy
to enter new market segments with more invasive products. The third product, the
Squirt(tm) Infusion System, is a proprietary delivery system that works in
conjunction with the Fountain(tm) catheter to infuse fluids into a peripheral
vessel.
9
The Tomcat(tm) line of PTCA guide wires was an important new product
introduced in 1998. This device is used to guide a balloon angioplasty catheter
through a vessel's tortuous pathway, penetrating an arterial lesion (blockage in
an artery) in the patient's heart. Following over two years in the development
process, Merit is proud of the high quality and excellent performance of this
guide wire. Clinicians have labeled this product as one of the very best guide
wires on the market. The technology and know-how needed to produce this product
have been developed internally over the last several years and allow Merit to
continue developing new guide wires for additional market niches.
10
New Products
Merit Medical was one of the first companies to introduce a 25 ATM
inflation device, which is used for angioplasty balloon inflation for PTCA and
stent deployment, and has since broadened its product offering in that line. The
most recent addition to the 25 ATM product line came in April 1998 with the
addition of the new basixCOMPAK(tm) inflation syringe with an angled gauge for
easier visibility. The basixCOMPAK(tm) syringe is substantially smaller than its
predecessors and takes less room on the procedure table, yet combines all of the
features and benefits of larger devices. Sales of this device have rapidly
expanded during 1998 and show the market's strong acceptance for this fine
product. In addition to the basixCOMPAK(tm) device, Merit is developing a new,
improved IntelliSystem(tm) monitor. Introduction of this new device is scheduled
for late fiscal 1999.
To complement the Company's industry-leading line of inflation devices,
Merit developed a complete angioplasty accessory pack. These packs include a new
Access-Plus(tm) hemostasis valve to complement the Passage(tm) or Access-9(tm)
hemostasis valves, torque device and guide wire introducer. Merit's hemostasis
valves include a special, airless rotator to eliminate bubbles, exclusive
Sherlock(tm) connector for easier connection, and a clear inner lumen for
improved visualization. The Access-9(tm) model has a 9-french inner diameter
which allows the entry of alternate therapy devices while maintaining
hemostasis.
11
Tiny balloons are placed via long, thin catheters into an artery obstructed
by plaque or blood clots. The balloon is seated directly in the center of the
lesion and inflated with contrast solution under pressure using Merit's
inflation device, compressing the obstruction into the wall of the artery.
12
New Products
The acceleration of Merit's research and development program goes hand in
hand with its strategy of improving the overall product mix to yield higher
margins. New products are under development to expand Merit's clinical expertise
and broaden its offerings in both the guide wire and catheter arenas. Early in
1999, Merit plans to introduce three new products-two catheter lines and a guide
wire extension with tool-which leverages and strengthens Merit's current
technology.
The Company is expanding its existing products into new markets. There is a
growing interest in markets outside of cardiology and radiology for the use of
the IntelliSystem(tm) monitor to more accurately measure pressures in clinical
applications such as discography, trigeminal nerve compression, esophageal
dilation and retinal detachment. Another example is the use of the Squirt(tm)
universal fluid dispensing syringe for wound irrigation in trauma centers,
emergency rooms, burn units and alternate care units such as nursing homes.
Other new products are upgrades in quality and performance to existing
devices; some are line extensions which broaden Merit's product offering; while
others are innovative, new products which will allow Merit to gain entry into
new niches. In conjunction with the sale of existing products, the impact upon
sales from these new products will help continue Merit's revenue growth.
13
There are more than twenty products in the pipeline with intended
introduction dates later in 1999 and 2000. Some of these include line extensions
to Merit's guide wire and catheter technologies. For example, the 5 french size
Fountain(tm) Infusion Catheter is used primarily in the upper to mid-leg and
arms. In the first half of 1999 Merit will make available to clinicians a new
line of smaller 4 French Fountain(tm) catheters which will expand the market to
include lower arms and areas below the knee.
14
Selected Financial Data
Year Ended December 31,
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1998 1997 1996 1995 1994
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Operating Data:
Sales $ 68,377,357 $ 60,579,011 $ 50,455,766 $ 42,587,284 $ 33,324,245
Cost of sales 42,433,873 37,766,116 29,319,617 24,987,998 18,999,015
Gross profit 25,943,484 22,812,895 21,136,149 17,599,286 14,325,230
Selling, general, and
administrative expenses 17,528,002 15,726,651 14,311,049 12,808,805 10,232,215
Research and
development expenses 3,244,477 4,446,795 2,533,171 2,330,324 2,069,882
Income from operations 5,171,005 2,639,449 4,291,929 2,460,157 2,023,133
Other expense 880,659 863,933 661,777 459,462 29,868
Income before
income tax expense 4,290,346 1,775,516 3,630,152 2,000,695 1,993,265
Income tax expense 1,687,379 944,981 1,277,431 700,418 775,453
Minority interest in (income)
loss of subsidiary (151,808) (33,003) (190,113) (79,040) 33,035
Net income 2,451,159 797,532 2,162,608 1,221,237 1,250,847
Net income per share $ .33 $ .11 $ .31 $ .18 $ .19
Weighted average
shares outstanding 7,488,225 7,369,668 7,051,911 6,851,164 6,678,041
Balance Sheet Data:
Working capital $ 15,779,725 $ 14,737,971 $ 12,761,211 $ 9,518,971 $ 9,032,899
Total assets 50,664,786 45,269,678 41,718,553 34,503,858 27,024,267
Long-term debt 3,388,835 3,913,686 4,822,126 1,778,953 827,592
Stockholders' equity $ 29,086,368 $ 25,802,149 $ 22,487,123 $ 19,264,525 $ 17,537,029
15
Management's Discussion & Analysis
OVERVIEW
Since its inception in 1987, Merit has made significant progress toward
accomplishing its business plan objectives, including becoming a world leader
for accessories in the cardiology and radiology markets, and developing
world-class facilities with manufacturing, quality and regulatory capabilities
supported by state-of-the-art accounting, data and communications systems.
There have been many challenges in accomplishing Merit's business
objectives, such as major changes and reforms in the health care industry,
particularly in the United States. The Company has experienced increased product
and price competition in its markets. The Company also has managed rapid growth
with limited capital.
Near the end of 1997, Merit's management evaluated the Company's market
position in diagnostic and therapeutic accessory products and determined that
bold new initiatives would be required to expand the Company's technology bases
and product lines, resulting in growth in revenues, margins and profitability.
Merit's growth strategy resulted in increased research and development
expenditures to design, develop and deliver new, proprietary niche products.
These new products are being marketed though the Company's distribution system
to existing and new customers.
Merit's product development strategy has focused on vascular access markets
with product families such as angiographic needles, guide wires, and catheters.
To accomplish this expansion, the Company has made long-term investments,
increasing its marketing and research and development capabilities in Utah,
California, and Ireland. In January, 1997, Merit acquired a small, medical
device company in New York which offered vascular access products. The acquired
technology, along with major R&D efforts in both Salt Lake and Ireland, have led
to the introduction of a line of angiographic needles, a thrombolytic catheter
and a specialty guide wire with other new, proprietary products to follow.
The Company's facility in Ireland has developed and begun to manufacture a
significant new product-a PTCA (balloon angioplasty) guide wire. The Company's
72% owned subsidiary, Sentir, has expanded its marketing of high-quality sensors
to new markets such as the defense and automotive industries. These initiatives
required substantial expenditures, resulting in lower earnings in 1997. However,
management believes the Company is now well positioned for growth and expansion
of products, markets and profits.
1998 proved to be a record-breaking year for the Company, and Merit was
able to achieve substantially all of its major financial objectives: Sales
growth of 13% while achieving an increase in gross margin percentage; the
ramp-up of manufacturing in our Galway, Ireland facility including the transfer
of our hemostasis product; the completion of the development of the TomCat guide
wire, and the ramp-up of production of this product with the associated
reduction in R&D expenses. The resulting profitability in Ireland caused a
significant improvement in Merit's effective tax rate of 39%, down from 53% in
1997. All of these factors resulted in an increase in earnings compared to 1997.
16
Management's Discussion & Analysis
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
operational data as a percent of sales:
1998 1997 1996
100.0% 100.0% 100.0%
------ ------ ------
Sales
Gross profit 37.9 37.7 41.9
Selling, general and administrative 25.6 26.0 28.4
Research and development 4.7 7.3 5.0
Income from operations 7.6 4.4 8.5
Income before income tax expense 6.3 2.9 7.2
Net Income 3.6 1.3 4.3
Sales increased by $7,798,346, or 12.9%, in 1998 compared to an increase of
$10,123,245, or 20.1%, in 1997, and an increase of $7,868,482, or 18.5%, in
1996. Sales growth from 1996 through 1998 was favorably affected by the
introduction of new products and increased sales of existing products sold
separately and packaged in custom kits, and increased penetration of the market
by Merit's inflation devices. International sales in 1998 were approximately
$15,198,000, or 22%, compared to $13, 722,000, or 23%, in 1997, and $11,900,000,
or 24%, in 1996. These increases were primarily a result of the ongoing growth
in the direct sales force in Europe, as well as greater acceptance of the
Company's products in other international markets. Direct sales in France,
Germany, the U.K., Belgium, the Netherlands and Canada were $7,334,793,
$6,615,697, and $5,350,786 in 1998, 1997 and 1996, respectively.
Gross profit as a percent of sales was 37.9%, 37.7%, and 41.9% in 1998,
1997, and 1996, respectively. Margins improved in 1998 compared to 1997 through
increased production volumes, automation and efficiencies in the manufacturing,
and some tighter price controls on some of the Company's low margin products.
The decrease in gross profit in 1997 from 1996 was due to several factors,
including increased sales of lower-margin custom kits; price competition,
especially in European markets; a strong U.S. dollar affecting the currency
translation of the Company's European sales; and domestic wage increases in
response to competition for direct-labor employees. Gross margins were also
affected by start-up and transition costs in the Company's newly organized
Vascular Access Division relating to acquisition of assets from UMI.
Selling, general and administrative expense increased $1,801,351, or
11.5%, in 1998 over 1997 and $1,415,602, or 9.9%, in 1997 over 1996. These
additional expenditures were related principally to the costs of implementing
and supporting the Company's new Oracle system and the development of new
business opportunities such as acquisitions, product distribution agreements,
and the O.E.M segment of the business. Although total selling, general and
administrative expenses have increased during the periods, these expenses as a
percent of sales declined to 25.6% in 1998 compared to 26.0% in 1997 and 28.4%
in 1996. These reductions have been accomplished - despite substantial
expenditures related to starting up the Company's European operations- in part
through a Company-wide focus on achieving greater productivity. In addition,
increased sales have permitted the Company to achieve economies of scale through
the spread of fixed costs over a greater number of units.
17
Management's Discussion & Analysis
Research and development expenditures for 1998 were $3,244,477, a decrease
of 27%, compared to $4,446,795 in 1997. This decrease primarily was due to the
conversion of much of the R&D expenses in Ireland to production resources for
the manufacture of the newly introduced line of guide wires. Research and
development costs in 1997 grew by 76% from 1996, which as a percent of sales was
4.7%, 7.3% and 5.0% for 1998, 1997 and 1996, respectively. This major increase
in 1997 was related to new product development and reflected management's
decision to expand into new markets for the future growth of the Company.
These factors significantly affected income from operations in 1998 which
increased to $5,171,005, up 95.9%, compared to $2,639,449 in 1997, a decrease of
38.5% from $4,291,929 in 1996. The income tax provision for 1998 was $1,687,379,
an effective rate of 39.3%, compared to $944,981, or 53.2 % in 1997 and
$1,277,431or 35.2% in 1996. The Company's consolidated effective tax rate in
1997 was high principally because the tax benefits of losses associated with the
start-up of international operations were limited to Ireland's manufacturing tax
rate of 10%. The effective tax rate improved significantly in 1998 as Ireland
became profitable and their lower tax rate improved the Company's overall
effective tax rate.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1998 the Company's working capital was $15,779,725,
representing a current ratio of 2.0 to 1. During 1997 the Company increased its
secured bank line of credit to $10.5 million. In 1998 the Company negotiated a
reduction in the interest rate and fees for its line of credit, significantly
reducing the cost of this capital. The Company had $7,634,607 outstanding under
its line of credit at December 31, 1998. Merit has financed leasehold
improvements and equipment acquisitions through secured notes payable and
capital lease arrangements with an outstanding balance of $5,197,805 at December
31, 1998. For the year ended December 31, 1998 the Company generated cash from
operations in the amount of $1,674,728.
Historically, the Company has incurred significant expenses in connection
with product development and introduction of new products. This was particularly
true in 1998 with regard to an increase in inventory and equipment and the
ramp-up of European operations. Substantial capital has also been required to
finance growth in inventories and receivables in the U.S.. The Company's
principal source of funding for these and other expenses has been the cash
generated from operations, secured loans on equipment, bank lines of credit and
sales of equity. The Company believes that its present sources of liquidity and
capital are adequate for its current operation.
MARKET RISK DISCLOSURES
The Company does not engage in significant derivative financial
instruments. The Company does experience risk associated with foreign currency
fluctuations, and interest rate risk associated with its variable rate debt;
however, such risks have not been material to the Company and , accordingly, the
Company has not deemed it necessary to enter into agreements to hedge such
risks. The Company may enter into such agreements in the event that such risks
become material in the future.
18
Management's Discussion & Analysis
YEAR 2000
In 1996 the Company began the conversion of the principal computer software
systems to a new integrated system to support future growth and improve
productivity. The Company has completed a review of its business information
systems with regard to Year 2000 compliance and is either replacing or
correcting those computer systems that have been found to have date-related
deficiencies. A new Oracle integrated business information system for the order
administration, financial and manufacturing processes was implemented and
completed in November 1998.
Through December 31, 1998 the Company has incurred approximately $3.5
million in costs to improve the Company's information technology systems and for
Year 2000 readiness efforts. Of this amount, most represents the costs of
implementing and transitioning to new computer hardware and software for its
Oracle enterprise-wide business systems. Substantially all of these costs have
been capitalized. The Company anticipates incurring an additional $500,000 in
connection with the Year 2000 readiness efforts. The Company expects to have all
Year 2000 readiness efforts completed by September 30, 1999.
The Company believes its non-IT systems and products being shipped today
have been assessed and found to be Year 2000 compliant. The Company relies on
third-party providers for materials and services such as telecommunications,
utilities, financial services and other key services. Interruption of those
materials or services due to Year 2000 issues could affect the Company's
operations. The Company has completed the process of contacting its major
suppliers and has determined that all major suppliers are in the process of
ensuring Year 2000 compliance. However, since the Company is dependent on key
third parties, there can be no guarantee that the Company's efforts will prevent
a material adverse impact on its financial position, results of operations or
liquidity in future periods in the event that a significant number of suppliers
and/or customers experience business disruptions as a result of their lack of
Year 2000 readiness.
The Company is in the process of implementing the Oracle system in its
Irish facility with a planned completion date for the end of the third quarter
of 1999. Both the Company's cost estimates and completion time frames could be
influenced by the Company's ability to successfully identify all Year 2000
issues, the nature and amount of corrective action required, the availability
and cost of trained personnel in this area and the Year 2000 success that key
third parties and customers attain While these and other unforeseen factors
could have a material adverse impact on the Company's financial position,
results of operations or liquidity in future periods, management believes that
it has implemented an effective Year 2000 compliance program that will minimize
the possible negative consequences to the Company.
Throughout 1999, the Company will determine areas where contingency
planning is needed. The planning efforts will include, but are not limited to,
identification and mitigation of potential serious business interruptions,
adjustments of inventory levels to meet customer needs, and establishing crisis
response processes to address unexpected problems.
The foregoing discussion of the Company's Year 2000 readiness includes
forward looking statements, including estimates of the time frames and costs for
addressing the known Year 2000 issues confronting the Company, and is based upon
management's current estimates, which were derived using numerous assumptions.
There can be no assurance that these estimates will be achieved, and actual
events and results could differ materially from those anticipated. Specific
factors that might cause such material differences include, but are not limited
to, the availability of personnel with required remediation skills, the ability
of the Company to identify and correct or replace all relevant computer code and
the success of third parties with whom the Company does business in addressing
their Year 2000 issues.
19
Consolidated Balance Sheets
DECEMBER 31, 1998 AND 1997
ASSETS 1998 1997
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents $ 851,910 $ 976,692
Trade receivables - net of allowance for uncollectible
accounts: 1998 - $197,331; 1997 - $175,114 10,436,485 9,599,443
Employee and related party receivables 472,994 288,812
Irish Development Agency grant receivable 198,445 747,888
Inventories 17,785,743 14,535,440
Prepaid expenses and other assets 636,124 538,259
Deferred income tax assets 739,595 782,435
------------ ------------
Total current assets 31,121,296 27,468,969
------------ ------------
PROPERTY AND EQUIPMENT:
Land 1,065,985 1,101,544
Building 932,448
Automobiles 89,469 112,633
Manufacturing equipment 13,669,599 10,909,529
Furniture and fixtures 7,963,835 4,817,738
Leasehold improvements 5,035,288 4,483,071
Construction-in-progress 1,182,669 2,747,414
------------ ------------
Total 29,006,845 25,104,377
Less accumulated depreciation and amortization (12,043,130) (9,648,746)
------------ ------------
Property and equipment - net 16,963,715 15,455,631
------------ ------------
OTHER ASSETS:
Intangible assets - net of accumulated amortization:
1998 - $1,014,617; 1997 - $821,641 2,333,456 2,024,050
Cost in excess of the fair value of assets acquired - net
of accumulated amortization: 1998 - $31,615; 1997 - $15,015 150,673 167,273
Prepaid royalty - net of accumulated amortization:
1998 - $578,572; 1997 - $492,857 21,428 107,143
Deposits 74,218 46,612
------------ ------------
Total other assets 2,579,775 2,345,078
------------ ------------
TOTAL $ 50,664,786 $ 45,269,678
------------ ------------
(Continued)
20
Consolidated Balance Sheets
DECEMBER 31, 1998 AND 1997
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
------------ ------------
CURRENT LIABILITIES:
Line of credit $ 7,634,607 $ 4,624,727
Current portion of long-term debt 1,808,970 1,802,932
Trade payables 3,573,333 3,438,349
Accrued expenses 2,055,849 2,414,050
Advances from employees 74,090 81,245
Income taxes payable 194,722 369,695
------------ ------------
Total current liabilities 15,341,571 12,730,998
DEFERRED INCOME TAX LIABILITIES 1,275,651 883,002
LONG-TERM DEBT 3,388,835 3,913,686
DEFERRED CREDITS 1,023,861 1,543,151
------------ ------------
Total liabilities 21,029,918 19,070,837
------------ ------------
MINORITY INTEREST IN SUBSIDIARY 548,500 396,692
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 6, 10, and 11)
STOCKHOLDERS' EQUITY:
Preferred stock - 5,000,000 shares authorized as of December 31, 1998
and 1997, no shares issued
Common stock - no par value; 20,000,000 shares
authorized; 7,508,914 and 7,395,091 shares issued
at December 31, 1998 and 1997, respectively 17,793,094 17,178,971
Retained earnings 11,564,928 9,113,769
Accumulated other comprehensive loss (271,654) (490,591)
------------ ------------
Total stockholders' equity 29,086,368 25,802,149
------------ ------------
TOTAL $ 50,664,786 $ 45,269,678
------------ ------------
See notes to consolidated financial statements.
(Concluded)
21
Consolidated Statements of Operations
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
1998 1997 1996
------------ ------------ ------------
SALES $ 68,377,357 $ 60,579,011 $ 50,455,766
COST OF SALES 42,433,873 37,766,116 29,319,617
------------ ------------ ------------
GROSS PROFIT 25,943,484 22,812,895 21,136,149
------------ ------------ ------------
EXPENSES:
Selling, general, and administrative 17,528,002 15,726,651 14,311,049
Research and development 3,244,477 4,446,795 2,533,171
------------ ------------ ------------
Total 20,772,479 20,173,446 16,844,220
------------ ------------ ------------
INCOME FROM OPERATIONS 5,171,005 2,639,449 4,291,929
------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest income 33,662 28,223 23,377
Interest expense (826,778) (854,859) (707,878)
Miscellaneous income (expense) (87,543) (37,297) 22,724
------------ ------------ ------------
Other expense - net (880,659) (863,933) (661,777)
------------ ------------ ------------
INCOME BEFORE INCOME TAX EXPENSE 4,290,346 1,775,516 3,630,152
INCOME TAX EXPENSE (1,687,379) (944,981) (1,277,431)
MINORITY INTEREST IN INCOME OF
SUBSIDIARY (151,808) (33,003) (190,113)
------------ ------------ ------------
NET INCOME $ 2,451,159 $ 797,532 $ 2,162,608
------------ ------------ ------------
EARNINGS PER COMMON SHARE -
Basic and diluted $ .33 $ .11 $ .31
------------ ------------ ------------
AVERAGE COMMON SHARES -
Basic 7,420,224 7,263,253 6,878,165
------------ ------------ ------------
Diluted 7,488,225 7,369,668 7,051,911
------------ ------------ ------------
See notes to consolidated financial statements.
22
Consolidated Statements of Stockholders' Equity
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
Accumulated
Other
Compre-
Common Stock hensive Retained
Total Shares Amount Loss Earnings
------------ ------------ ------------ ------------ ------------
BALANCE, JANUARY 1, 1996 $ 19,264,525 6,786,239 $ 13,088,265 $ 22,631 $ 6,153,629
Comprehensive income:
Net income 2,162,608 2,162,608
Foreign currency translation adjustment (36,720) (36,720)
------------ ------------ ------------ ------------ ------------
Comprehensive income 2,125,888
Tax benefit attributable to appreciation of
common stock options exercised 65,679 65,679
Issuance of common stock for cash 309,370 39,996 309,370
Options and warrants exercised for cash 643,028 104,117 643,028
Issuance of common stock under Employees
Stock Purchase Plans 78,633 11,938 78,633
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1996 22,487,123 6,942,290 14,184,975 (14,089) 8,316,237
Comprehensive income:
Net income 797,532 797,532
Foreign currency translation adjustment (476,502) (476,502)
------------ ------------ ------------ ------------ ------------
Comprehensive income 321,030
Tax benefit attributable to appreciation of
common stock options exercised 222,887 222,887
Issuance of common stock for cash 273,202 35,582 273,202
Options and warrants exercised 1,316,812 227,200 1,316,812
Issuance of common stock under Employee
Stock Purchase Plans 245,129 42,056 245,129
Stock issued in connection with UMI acquisition 975,000 152,424 975,000
Shares surrendered in exchange for the recording
of payroll tax liabilities (7,534) (861) (7,534)
Shares surrendered in exchange for the exercise
of stock options (31,500) (3,600) (31,500)
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1997 25,802,149 7,395,091 17,178,971 (490,591) 9,113,769
Comprehensive income:
Net income 2,451,159 2,451,159
Foreign currency translation adjustment 218,937 218,937
------------ ------------ ------------ ------------ ------------
Comprehensive income 2,670,096
Tax benefit attributable to appreciation of
common stock options exercised 33,398 33,398
Issuance of common stock for cash 81,850 13,819 81,850
Issuance of common stock under Employee
Stock Purchase Plans 267,549 52,425 267,549
Options and warrants exercised 370,914 64,840 370,914
Shares surrendered in exchange for the
exercise of stock options (139,588) (17,261) (139,588)
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1998 $ 29,086,368 7,508,914 $ 17,793,094 $ (271,654) $ 11,564,928
------------ ------------ ------------ ------------ ------------
See notes to consolidated financial statements.
23
Consolidated Statements of Cash Flows
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
1998 1997 1996
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,451,159 $ 797,532 $ 2,162,608
----------- ----------- -----------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,923,484 2,796,425 2,497,850
Losses on sales and abandonment of
property and equipment 46,897 11,245 6,867
Amortization of deferred credits (114,607) (91,155) (73,619)
Deferred income taxes 435,489 (22,951) 162,475
Tax benefit attributable to appreciation of
common stock options exercised 33,398 222,887 65,679
Minority interest in income of subsidiary 151,808 33,003 190,113
Changes in operating assets and liabilities, net of effects from
purchase of UMI:
Trade receivables (837,042) (2,220,364) (651,119)
Employee and related party receivables (184,182) 38,613 35,841
Irish Development Agency grant receivable 549,443 (330,997) 142,637
Inventories (3,250,303) (79,236) (1,695,565)
Prepaid expenses and other assets (97,865) (19,436) (115,409)
Deposits and other (27,606) 122,565 (122,193)
Trade payables 134,984 872 381,188
Accrued expenses (358,201) 133,378 526,563
Advances from employees (7,155) (26,662) 55,044
Income taxes payable (174,973) 353,789 (113,879)
----------- ----------- -----------
Total adjustments (776,431) 921,976 1,292,473
----------- ----------- -----------
Net cash provided by operating activities 1,674,728 1,719,508 3,455,081
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for:
Property and equipment (4,138,219) (1,046,890) (2,736,477)
Intangible assets (522,671) (521,270) (486,414)
UMI acquisition (70,486)
Proceeds from the sale of property and equipment 584,688 22,645 41,156
----------- ----------- -----------
Net cash used in investing activities (4,076,202) (1,616,001) (3,181,735)
----------- ----------- -----------
(Continued)
24
Consolidated Statements of Cash Flows
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
1998 1997 1996
----------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from (payments on) line of credit $ 3,009,880 $ 90,854 $(1,337,666)
Proceeds from:
Issuance of common stock 580,725 1,835,143 1,031,031
Long-term debt 677,802 2,200,000
Principal payments on:
Long-term debt (2,172,753) (1,764,343) (1,068,415)
Deferred credits (37,899) (74,917) (69,467)
----------- ----------- ------------
Net cash provided by financing activities 2,057,755 86,737 755,483
----------- ----------- ------------
EFFECT OF EXCHANGE RATES ON CASH 218,937 (476,502) (36,720)
----------- ----------- ------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (124,782) (286,258) 992,109
CASH AND CASH EQUIVALENTS
AT BEGINNING OF YEAR 976,692 1,262,950 270,841
----------- ----------- ------------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 851,910 $ 976,692 $ 1,262,950
----------- ----------- ------------
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION - Cash paid during the year for:
Interest (including capitalized interest
of $93,142, $109,701, and $177,133 during
1998, 1997, and 1996, respectively) $ 995,417 $ 782,676 $ 761,430
----------- ----------- ------------
Income taxes $ 1,393,465 $ 591,192 $ 1,163,156
----------- ----------- ------------
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
* During 1998, 1997, and 1996, the Company entered into capital lease
obligations and notes payable for $867,629, $1,270,259, and $2,522,076,
respectively, for manufacturing equipment.
* In connection with the sale in 1998 of the Company's manufacturing
facility in Castlerea, Ireland, the buyer assumed debt of the Company in
the amount of $258,275.
* During 1997, options to purchase 861 shares of the Company's common
stock were surrendered in exchange for the Company's recording of
payroll tax liabilities in the amount of $7,534.
* During 1998 and 1997, 17,261 and 3,600 shares of Company common stock
with a value of $139,588 and $31,500 were surrendered in exchange for
the exercise of stock options.
* During 1997, the Company acquired UMI for 152,424 shares of Company
restricted common stock. In connection with this acquisition, the
Company recorded the following as of the acquisition date:
Assets acquired $ 863,198
Cost in excess of fair market value 182,288
----------
Total purchase price $1,045,486
----------
See notes to consolidated financial statements. (Concluded)
25
Notes to Consolidated Financial Statements
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization - Merit Medical Systems, Inc. (Merit) and its wholly-owned
subsidiaries, Merit Holdings, Inc. (MHI), and Merit Medical International, Inc.
(MMI), and Merit's majority-owned subsidiary, Sentir, Inc. (Sentir),
(collectively, the Company) develop, manufacture, and market disposable medical
products primarily for use in the diagnosis and treatment of cardiovascular
disease which is considered to be one segment line of business. The Company
manufactures its products in plants located in the United States and, beginning
in 1997, in Ireland. The Company has export sales to dealers and has direct
sales forces in the United States, Canada, and Western Europe (see Note 8).
The consolidated financial statements of the Company have been prepared in
accordance with generally accepted accounting principles. The following is a
summary of the more significant of such policies.
Use of Estimates in Preparing Financial Statements - The preparation of
financial statements in conformity with generally accepted accounting principles
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. Actual results could differ
from those estimates.
Principles of Consolidation - The consolidated financial statements include
those of Merit, MMI, MHI, and Sentir. All material intercompany balances and
transactions have been eliminated in consolidation.
Revenue Recognition - Sales are recognized at the time the products are shipped.
Inventories - Inventories are stated at the lower of cost (computed on a
first-in, first-out basis) or market.
Long-lived Assets - Impairment of long-lived assets is determined in accordance
with Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for
the Impairment of Long-lived Assets and of Long-lived Assets to be Disposed Of,"
which was adopted on January 1, 1996. There were no impairments as of December
31, 1998 or 1997.
Property and Equipment - Property and equipment are recorded at cost.
Depreciation and amortization are computed using the straight-line method over
estimated useful lives as follows:
Building 30 years
Automobiles 4 years
Manufacturing equipment 5 to 10 years
Furniture and fixtures 3 to 10 years
Leasehold improvements 4 to 25 years
Intangible Assets - Costs associated with obtaining patents, issued and pending,
and trademarks have been capitalized and are amortized over the patent or
trademark period or charged to expense if not approved. Costs associated with
obtaining customer lists are amortized over two years.
Earnings per Common Share - Effective December 31, 1997, the Company adopted
SFAS No. 128, "Earnings Per Share", and retroactively restated its earnings per
share for 1996, to conform with the statement. Accordingly, net income per
common share is computed by both the basic method, which uses the weighted
average number of the Company's common shares outstanding, and the diluted
method, which includes the dilutive common shares from stock options and
warrants, as calculated using the treasury stock method. The amounts of such
options and warrants are not significant and, accordingly, the Company's basic
and diluted earnings per share are the same.
Prepaid Royalty - The prepaid royalty paid by the Company under an agreement
which grants to the Company a license and certain rights to technology has been
capitalized. Amortization of the prepaid royalty is computed using the
straight-line method over the seven year term of the agreement.
Financial Instruments - The Company's financial instruments, when valued using
market interest rates, would not be materially different from the amounts
presented in the consolidated financial statements.
26
Notes to Consolidated Financial Statements
Statements of Cash Flows - For purposes of the statements of cash flows, the
Company considers interest bearing deposits with an original maturity date of
three months or less to be cash equivalents.
Foreign Currency Translation Adjustment - The financial statements of the
Company's foreign subsidiaries are measured using local currencies as the
functional currency. Assets and liabilities are translated into U.S. dollars at
year-end rates of exchange and results of operations are translated at average
rates for the year. Gains and losses resulting from these translations are
included in accumulated other comprehensive income or loss as a separate
component of stockholders' equity.
Comprehensive Income (Loss) - Effective January 1, 1998, the Company adopted
SFAS No. 130, Reporting Comprehensive Income, and reclassified comprehensive
loss for 1997 and 1996 to conform with SFAS No. 130. This statement requires the
Company to display an amount representing total comprehensive income or loss for
each period. Accumulated other comprehensive loss consists entirely of foreign
currency translation adjustments.
2. ACQUISITION OF UNIVERSAL MEDICAL INSTRUMENT CORPORATION
On January 31, 1997, the Company acquired certain assets of Universal Medical
Instrument Corporation (UMI) in exchange for 152,424 shares of the Company's
restricted common stock. UMI is a privately held company located in Saratoga
County, New York.
The Company's acquisition of UMI's assets was accounted for as a purchase and,
accordingly, the results of operations of UMI are included in the Company's
consolidated financial statements from the date of acquisition. The total
purchase price, including related costs, was allocated to the assets acquired
based on their fair values with the excess purchase price over the fair value of
assets acquired of $182,288 being allocated to goodwill, which is being
amortized over 12 years. The proforma financial information reflecting this
transaction for 1996 has not been presented as it is not materially different
from the Company's historical results.
3. INVENTORIES
Inventories consist of the following at December 31, 1998 and 1997:
1998 1997
Finished goods $ 7,458,133 $ 6,261,203
Work-in-process 1,954,696 2,459,081
Raw materials 8,981,007 6,481,714
Less reserve for obsolete inventory (608,093) (666,558)
------------- -------------
Total $ 17,785,743 $ 14,535,440
------------- -------------
4. INCOME TAXES
Deferred income tax assets and liabilities at December 31, 1998 and 1997 consist
of the following temporary differences and carryforward items:
Current Long-Term
-------------------- -----------------
1998 1997 1998 1997
Deferred income tax assets:
Allowance for uncollectible
accounts receivable $ 79,809 $ 70,535
Accrued compensation expense 126,603 124,997
Tax credits 79,668 29,990 $ 24,681
Inventory capitalization for
tax purposes 116,574 82,411
Inventory obsolescence reserve 210,026 181,729
Net operating losses of
subsidiaries 70,000 256,645 368,690
Other 56,915 36,128 72,713
------- ------- ------- -------
Total deferred income tax assets 739,595 782,435 466,084
27
Notes to Consolidated Financial Statements
Current Long-Term
----------------------------- --------------------------
1998 1997 1998 1997
Deferred income tax liabilities -
differences between tax basis
and financial reporting basis
of property and equipment (1,741,735) $ (883,002)
----------- ----------- ----------- -----------
Net $ 739,595 $ 782,435 $(1,275,651) $ (883,002)
----------- ----------- ----------- -----------
Income tax expense for the years ended December 31, 1998, 1997, and 1996 differs
from amounts computed by applying the statutory Federal rate to pretax income as
follows:
1998 1997 1996
Computed Federal income tax expense at
statutory rate of 35% $ 1,501,621 $ 621,431 $ 1,270,553
State income taxes 186,948 124,878 231,126
Creation of tax credits (133,529) (164,319) (61,435)
Tax benefit of foreign sales corporation (96,808) (106,574) (85,614)
Losses of subsidiaries recorded at
foreign rates 183,622 496,685 289,594
Change in deferred income tax asset valuation
allowance (353,710)
Other - including the effect of graduated rates 45,525 (27,120) (13,083)
----------- ----------- -----------
Total income tax expense $ 1,687,379 $ 944,981 $ 1,277,431
----------- ----------- -----------
Consisting of:
Current $ 1,251,890 $ 967,932 $ 1,114,956
Deferred 435,489 (22,951) 162,475
----------- ----------- -----------
Total $ 1,687,379 $ 944,981 $ 1,277,431
=========== =========== ===========
5. LINE OF CREDIT AND LONG-TERM DEBT
Line of Credit - As of December 31, 1998, the Company had a line of credit for
$10,500,000. The credit line is collateralized by trade receivables,
inventories, property and equipment, and intangible assets and accrues interest
at the bank's prime rate. Under the terms of the line, among other things, the
Company is required to maintain positive earnings for each fiscal quarter during
the term of the loan, maintain a ratio of total liabilities to tangible net
worth not to exceed 1.1 to 1.0, maintain a ratio of current assets to current
liabilities of at least 1.5 to 1.0, maintain minimum working capital of
$9,000,000, and is restricted from paying dividends to shareholders. As of
December 31, 1998 and 1997, the Company owed $7,634,607 and $4,624,727,
respectively, under this line of credit.
Long-term Debt - Long-term debt consists of the following at December 31, 1998
and 1997:
Notes payable to financial institutions;
payable in monthly installments through
2004, including interest at rates 1998 1997
ranging from 6.5% to 9.34%;
collateralized by equipment $4,699,219 $4,777,090
Capital lease obligations (see Note 6) 498,586 939,528
---------- ----------
Total 5,197,805 5,716,618
Less current portion 1,808,970 1,802,932
---------- ----------
Long-term portion $3,388,835 $3,913,686
========== ==========
28
Notes to Consolidated Financial Statements
Scheduled maturities of long-term debt at December 31, 1998 are as follows:
Year ending December 31:
1999 $1,808,970
2000 1,731,877
2001 855,406
2002 433,835
2003 293,723
Thereafter 73,994
----------
Total $5,197,805
----------
6. COMMITMENTS AND CONTINGENCIES
Leases - The Company has noncancelable operating lease agreements for off-site
office and production facilities and equipment. The leases for the off-site
office and production facilities are for 5 years and have renewal options of one
to five years. The Company subleased these facilities during 1997 and 1996.
Total rental income from these subleases for the years ended December 31, 1997
and 1996 was approximately $97,000 and $153,000, respectively. Total rental
expense on these operating leases and on the Company's new manufacturing and
office building (see below) for the years ended December 31, 1998, 1997, and
1996 approximated $3,293,000, $2,783,000, and $2,448,000, respectively.
In June 1993, the Company entered into a 25 year lease agreement with a
developer for a new manufacturing and office building. Under the agreement, the
Company was granted an option to purchase the building at fair market value
after 10 years and, if not exercised, after 25 years. In connection with this
lease agreement, the Company in 1993 sold to the developer 10 acres of land on
which the building was constructed. The $166,136 gain on the sale of the land
has been recorded as a deferred credit and is being amortized as a reduction of
rent expense over ten years. During 1998, 1997, and 1996, $16,614, $16,614, and
$16,614, respectively, of this deferred credit was amortized as a reduction of
rent expense. In connection with the lease agreement, the Company issued to the
developer warrants to purchase 155,461 shares of the Company's common stock at
$4.95 per share subject to carrying cost increases of 3% per year ($5.41 as of
December 31, 1998). The warrants expire in 2005.
The Company leases certain manufacturing and office equipment under long-term
capital lease agreements. Capital leases are collateralized by equipment
approximating $967,000 and $1,607,000 with accumulated amortization of
approximately $200,000 and $296,000 as of December 31, 1998 and 1997,
respectively.
The future minimum lease payments, together with the present value of the net
minimum lease payments as of December 31, 1998, are as follows:
Operating Capital
Leases Leases
Year ending December 31:
1999 $ 3,028,407 $ 198,377
2000 2,517,374 183,845
2001 1,847,510 179,202
2002 1,634,483
2003 1,479,152
Thereafter 22,870,967
------------ ------------
Total minimum lease payments $ 33,377,893 561,424
============ ============
Less amount representing interest and executory costs (62,838)
------------
Present value of net minimum lease payments (see Note 5) $ 498,586
============
29
Notes to Consolidated Financial Statements
Irish Government Development Agency Grants - Through December 31, 1998, the
Company has entered into several grant agreements with the Irish Government
Development Agency of which $198,445 and $747,888 remained in receivables at
December 31, 1998 and 1997, respectively. The grant agreements reimburse the
Company for a portion of the cost of property and equipment purchased in
Ireland, specific research and development projects in Ireland, and costs of
hiring and training employees located in Ireland. The Company has recorded the
grants related to research and development projects and costs of hiring and
training employees as a reduction of operating expenses in 1998, 1997, and 1996
in the amounts of $164,423, $146,476, and $230,654, respectively. Grants related
to the acquisition of property and equipment purchased in Ireland are recorded
as deferred credits and are amortized to income over lives corresponding to the
depreciable lives of such property. During 1998, 1997, and 1996, $97,993,
$74,541, and $57,005, respectively, of the deferred credit was amortized as a
reduction of operating expenses.
Preferred Share Purchase Rights - In August 1997, the Company declared a
dividend of one preferred share purchase right (a "Right") for each outstanding
share of Common Stock which entitles the holder of a Right to purchase one
one-hundredth of a share of Series A Junior Participating Preferred Stock at an
exercise price of $40 in the event a person or group acquires or announces an
intention to acquire 15% or more of the Company's common stock. Until such an
event, the Rights are not exercisable and are transferable with the common stock
and may be redeemed at a price of $.0001 per Right.
Litigation - Bennett vs. Merit Medical Systems, Inc., et. - On February 4, 1994,
an action was filed in the Third District Court of Salt Lake County, State of
Utah by an individual claiming to be a shareholder of the Company and naming the
Company, Fred P. Lampropoulos, President of the Company, and Sentir, a company
founded by Mr. Lampropoulos, as defendants. The claims against the Company were
subsequently dismissed. The complaint also asserted claims on behalf of the
Company (derivative claims) against Mr. Lampropoulos and Sentir, alleging breach
of fiduciary duty and the improper taking of a corporate opportunity in
connection with the formation of Sentir. The relief sought in connection with
the derivative claims included disgorgement, costs, and attorneys' fees. The
Company appointed an independent Special Litigation Committee of the Board to
determine the Company's course of action on the derivative claims which engaged
counsel separate from the Company's usual counsel for purposes of the derivative
claims. On November 7, 1995, pursuant to a Motion filed on behalf of the
Company's Special Litigation Committee, the Court made a minute entry granting
the Motion to Dismiss the derivative claims, without prejudice. On November 4,
1996, the Special Litigation Committee delivered its report essentially
concluding that the derivative claims were not well founded. Nevertheless, on
November 22, 1996, the plaintiff refiled only the derivative claims in the Third
District Court of Salt Lake County, State of Utah and on January 22, 1997, a
Motion to dismiss was filed on behalf of the Company, seeking to terminate the
litigation and asserting that the report of the Special Litigation Committee is
entitled to deference under the law. The motion to dismiss was granted by the
court, and judgment was entered on September 21, 1998. The plaintiff has
appealed the judgment and the appeal is still pending.
7. EMPLOYEE STOCK PURCHASE PLAN AND STOCK OPTIONS AND WARRANTS
The Company offers to its employees an Employee Stock Purchase Plan which allows
the employee on a quarterly basis to purchase shares of the Company's common
stock at the lesser of 85% of the market value on the offering commencement date
or offering termination date. The total number of shares available to employees
to purchase under this plan is 250,000 of which 106,419 have been purchased as
of December 31, 1998.
The Company has a long-term incentive plan which provides for the issuance of
incentive stock options, nonstatutory stock options, and certain corresponding
stock appreciation rights. The maximum number of shares of common stock for
which options may be granted is 2,400,000. Options may be granted to directors,
officers, outside consultants, and key employees of the Company and may be
granted upon such terms and such conditions as the Compensation Committee in its
sole discretion shall determine. In no event, however, shall the exercise price
be less than the fair market value on the date of grant.
Changes in stock options and warrants for the years ended December 31, 1998,
1997, and 1996 are as follows:
30
Notes to Consolidated Financial Statements
Options Warrants
------------------------- -------------------------
Weighted Weighted
Average or Average or
Range of Range of
Exercise Exercise
Shares Price Shares Price
1998:
Granted 203,500 $ 6.41
Exercised 64,840 5.80
Forfeited/expired 47,990 6.41
Outstanding at December 31 1,147,770 7.02 155,461 $ 5.41
Exercisable 486,230 7.45 155,461 5.41
Weighted average fair value of
options and warrants granted
during year $ 3.14
Weighted average fair value of
shares issued under Employee
Stock Purchase Plan $ 0.90
1997:
Granted 522,700 $ 6.65
Exercised 227,200 5.80
Forfeited/expired 43,100 7.19 60,000 $ 7.65
Outstanding at December 31 1,057,100 7.04 155,461 5.25
Exercisable 315,100 7.48 155,461 5.25
Weighted average fair value of
options and warrants granted
during year $ 3.33
Weighted average fair value of
shares issued under Employee
Stock Purchase Plan $ 1.03
1996:
Granted 340,000 $ 8.19 517 $ 6.83
Exercised 84,850 6.08 19,267 6.65
Forfeited/expired 43,750 6.02
Outstanding at December 31 804,700 6.96 215,461 5.85
Exercisable 364,600 6.64 215,461 5.85
Weighted average fair value of
options and warrants granted
during year $ 4.50
Weighted average fair value of
shares issued under Employee
Stock Purchase Plan $ 1.16
31
Notes to Consolidated Financial Statements
The following table summarizes information about stock options and warrants
outstanding at December 31, 1998:
Options and Warrants
Options and Warrants Outstanding Exercisable
- --------------------------------------------------------- --------------------------
Weighted
Average
Remaining Weighted Weighted
Range of Contractual Average Average
Exercise Number Life Exercise Number Exercise
Prices Outstanding (in years) Price Exercisable Price
Options:
$4.87 to $7.25 635,770 3.29 $ 6.13 213,430 $ 6.25
$7.50 to $10.63 512,000 3.21 8.13 272,800 8.40
Warrants:
$5.41 155,461 6.0 $ 5.41 155,461 $5.41
The Company accounts for stock options granted using Accounting Principles Board
(APB) Opinion 25. Accordingly, no compensation cost has been recognized for its
fixed stock option plans. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant dates
for awards under those plans consistent with SFAS No. 123, the Company's net
income and net income per common and common equivalent share would have changed
to the pro forma amounts indicated below (in thousands):
1998 1997 1996
Net income:
As reported $ 2,451,159 $ 797,532 $ 2,162,608
Pro forma 1,840,182 385,340 1,753,765
Net income per common (both basic
and diluted) share:
As reported $ 0.33 $ 0.11 $ 0.31
Pro forma 0.25 0.05 0.25
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1998, 1997, and 1996, dividend yield of 0%;
expected volatility of 55.2%, 57.5%, and 55% for 1998, 1997, and 1996,
respectively; risk-free interest rates ranging from 4.58% to 7.36%; and expected
lives ranging from 2.8 to 4.5 years.
8. SEGMENT REPORTING AND FOREIGN OPERATIONS
During the years ended December 31, 1998, 1997, and 1996, the Company had sales
of approximately $15,198,000, $13,722,000, and $11,900,000 or approximately 22%,
23%, and 24%, respectively, of total sales primarily in Japan, Germany, France,
and United Kingdom.
The Company operates primarily in one segment in which it develops,
manufactures, and markets disposable medical products, principally for use in
the diagnosis and treatment of cardiovascular disease. Major operations outside
the United States include a leased manufacturing and distribution facility in
Ireland and sales subsidiaries in Europe. The following is a summary of the
Company's foreign operations by geographic area for fiscal years 1998, 1997, and
1996:
32
Notes to Consolidated Financial Statements
Transfers
Sales to Between Net
Unaffiliated Geographic Income Identifiable
Customers Areas Revenue (Loss) Assets
Fiscal year ended December 31, 1998:
United States, Canada, and
international distributors $ 60,407,019 $ 1,386,073 $ 61,793,092 $ 3,373,280 $ 41,477,669
Europe direct 7,970,338 2,546,099 10,516,437 (593,677) 9,117,117
Eliminations (3,932,172) (3,932,172) (328,444)
------------ ------------ ------------ ------------ ------------
Consolidated $ 68,377,357 None $ 68,377,357 $ 2,451,159 $ 50,594,786
============ ============ ============ ============ ============
Fiscal year ended December 31, 1997:
United States, Canada, and
international distributors $ 54,226,210 $ 860,482 $ 55,086,692 $ 2,774,516 $ 36,584,122
Europe direct 6,352,801 838,219 7,191,020 (2,110,415) 8,685,556
Eliminations (1,698,701) (1,698,701) 133,431
------------ ------------ ------------ ------------ ------------
Consolidated $ 60,579,011 None $ 60,579,011 $ 797,532 $ 45,269,678
============ ============ ============ ============ ============
Fiscal year ended
December 31, 1996:
United States, Canada, and
international distributors $ 45,106,815 $ 1,212,962 $ 46,319,777 $ 3,315,534 $ 34,013,025
Europe direct 5,348,951 89,081 5,438,032 (1,029,204) 7,705,528
Eliminations (1,302,043) (1,302,043) (123,722)
------------ ------------ ------------ ------------ ------------
Consolidated $ 50,455,766 None $ 50,455,766 $ 2,162,608 $ 41,718,553
============ ============ ============ ============ ============
Transfers between geographic areas are accounted for at amounts which are
generally above cost and consistent with the rules and regulations of governing
tax authorities. Such transfers are eliminated in the consolidated financial
statements. Net income by geographic areas reflects foreign earnings reported by
the foreign entities. Identifiable assets are those assets that can be directly
associated with a particular foreign entity and thus do not include assets used
for general corporate purposes.
9. RELATED PARTY TRANSACTIONS
Receivables from employees at December 31, 1998 and 1997 totaled approximately
$384,000 and $245,000, respectively, (including approximately $249,000 and
$120,000, respectively, from officers of the Company).
10. ROYALTY AGREEMENT
On April 8, 1992, the Company settled litigation involving, among other things,
allegations that certain of the Company's inflation device products infringed
patents issued to another medical product manufacturing company (the Licensor).
Pursuant to the settlement, the Company entered into a license agreement with
the Licensor, whereby the Licensor granted to the Company a nonexclusive right
and license to manufacture and sell products which are subject to the patents
issued to the Licensor. For the rights and license granted under the agreement,
the Company paid the Licensor a nonrefundable prepaid royalty in the amount of
$600,000. The royalty was paid upon execution of the agreement and represents a
prepaid royalty covering the first seven years of the agreement. In addition to
the prepaid royalty, the Company agreed to pay the Licensor a continuing royalty
beginning January 1, 1992 of 5.75% of sales (which will not exceed $450,000 for
any calendar year) made in the United States, of products covered by the license
agreement. Royalties of $450,000 were paid or accrued in each of the years ended
December 31, 1998, 1997, and 1996.
33
Notes to Consolidated Financial Statements
11. EMPLOYEE BENEFIT PLAN
The Company has a contributory 401(k) savings and profit sharing plan (the Plan)
covering all full-time employees who are at least 21 years of age and have a
minimum of one year of service to the Company. The Company may contribute at its
discretion matching contributions up to 2.25% of the employees' compensation.
Additional employer contributions are determined at the discretion of the Board
of Directors. Contributions made by the Company to the Plan for the years ended
December 31, 1998, 1997, and 1996 totaled approximately $18,000, $223,000, and
$227,000, respectively.
The Plan purchased unissued shares of the Company's common stock at market value
during each of the three years ended December 31, 1998 as follows:
Market
Shares Value
Years ended December 31:
1998 13,819 $ 81,850
1997 35,582 273,202
1996 39,996 309,370
12. RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In June 1998 the Financial Accounting Standards Board (FASB) issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities, which
establishes accounting and reporting standards for derivative instruments and
hedging activities. SFAS No. 133 requires that an enterprise recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. SFAS No. 133 is effective
for fiscal years beginning after June 15, 1999. Management believes the adoption
of SFAS No. 133 will not have a material impact on the Company's financial
position or results of operations.
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
of Merit Medical Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Merit Medical
Systems, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Merit Medical Systems, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
March 16, 1999
34
EXECUTIVE OFFICERS
Fred P. Lampropoulos
Chairman, President/Chief Executive Officer
Kent W. Stanger
Secretary-Treasurer, Chief Financial Officer
Leigh Weintraub
Chief Operating Officer
Brian L. Ferrand
Vice President, Sales
BOARD OF DIRECTORS
Fred P. Lampropoulos
Chairman, President/Chief Executive Officer
Kent W. Stanger
Secretary-Treasurer, Chief Financial Officer
Rex C. Bean, Private Investor
Ogden, Utah
Richard W. Edelman, Senior Vice President
Southwest Securities
Dallas, Texas
James J. Ellis, Managing Partner
Ellis/Rosier & Associates
Dallas, Texas
Michael E. Stillabower, M.D.
Chief, Cardiology, Christiana Care Health Systems;
Member, Cardiology Consultants PA
Wilmington, Delaware
CORPORATE OFFICES
Merit Medical Systems, Inc.
1600 West Merit Parkway
South Jordan, Utah 84095
(801) 253-1600
INDEPENDENT ACCOUNTANTS
Deloitte & Touche LLP
Salt Lake City, Utah
LEGAL COUNSEL
Parr Waddoups Brown Gee & Loveless
Securities/General Counsel
Workman, Nydegger & Jensen
Patent Counsel
FORM 10-K
Merit Medical Systems, Inc. filed an annual report on Form 10-K with the
Securities and Exchange Commission for the fiscal year ended December 31, 1998.
A copy may be obtained by written request from Kent W. Stanger, Secretary, at
the Company's offices.
35
ANNUAL MEETING
All shareholders are invited to attend our Annual Meeting on Wednesday, May 26,
1999 at 3:00 p.m. at the Company's corporate offices in South Jordan, Utah.
STOCK TRANSFER AGENT/REGISTRAR
Zions First National Bank
Stock Transfer Department
P. O. Box 30880
Salt Lake City, Utah 84130
PRIMARY MARKET MAKERS
Herzog, Heine, Geduld, Inc. Wien Securities Corp.
Piper Jaffray Cos., Inc. Wilson-Davis & Co., Inc.
Knight Securities L.P. Olsen Payne & Company
Sherwood Securities, Inc. Ernst & Company
Mayer & Schweitzer, Inc. The Brass Utility, L.L.C.
Dain Rauscher, Inc. Island System Corporation
Instinet Corporation
MARKET INFORMATION
The Company's common stock is traded on the NASDAQ National Market System under
the symbol "MMSI." As of December 31, 1998, there were 7,508,914 shares of
common stock outstanding. The following chart sets forth the high and low
closing sale prices for the Company's common stock for the last two years:
High Low
1998
First Quarter $7.63 $5.50
Second Quarter 9.13 6.25
Third Quarter 9.00 5.50
Fourth Quarter 9.00 7.00
1997
First Quarter $10.25 $7.25
Second Quarter 8.25 6.63
Third Quarter 7.63 6.50
Fourth Quarter 8.75 5.50
As of March 27, 1999, the company had approximately 300 shareholders of record,
not including shareholders whose shares are held in securities position
listings.
The Company has never declared or paid any cash dividends on its common stock.
The Company intends to retain any earnings for use in its business and does not
anticipate paying any cash dividends in the foreseeable future.
INVESTOR RELATIONS CONTACT
Nancy Schultz, Director, Corporate Communications
(801) 253-1600
FOR MORE INFORMATION, CONTACT
Kent W. Stanger, Chief Financial Officer
Merit Medical Systems, Inc.
(801) 253-1600
36
DISCLOSURE REGARDING FORWARD -LOOKING STATEMENTS
This Form 10-K Report include "Forward-Looking Statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E
of the Securities Exchange Act of 1934, as amended. All statements other than
statements of historical fact are "Forward-Looking Statements" for purposes of
these provisions, including any projections of earnings, revenues or other
financial items, any statements of the plans and objectives of management for
future operations, any statements concerning proposed new products or services,
any statements regarding future economic conditions or performance, and any
statement of assumptions underlying any of the foregoing. In some cases,
Forward-Looking Statements can be identified by the use of terminology such as
"may," "will," "expects," "plans," "anticipates," "estimates," "potential," or
"continue," or the negative thereof or other comparable terminology. Although
the Company believes that the expectations reflected in the Forward-Looking
Statements contained herein are reasonable, there can be no assurance that such
expectations or any of the ForwardLooking Statements will prove to be correct,
and actual results could differ materially from those projected or assumed in
the Forward-Looking Statements. Future financial condition and results of
operations, as well as any Forward- Looking Statements are subject to inherent
risks and uncertainties, including market acceptance of the Company's products,
potential product recalls, delays in obtaining regulatory approvals, cost
increases, price and product competition, availability of labor and material,
foreign currency fluctuations, changes in health care markets related to health
care reform initiatives and other factors referred to in the Company's press
releases and reports filed with the Securities and Exchange Commission. All
subsequent Forward-Looking Statements attributable to the Company or persons
acting on its behalf are expressly qualified in their entirety by these
cautionary statements.