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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED                           March 31, 2020

OR

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

FOR THE TRANSITION PERIOD FROM                TO                     .

Commission File Number   0-18592

GRAPHIC

MERIT MEDICAL SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Utah

    

87-0447695

(State or other jurisdiction of incorporation or organization)

(IRS Employer Identification No.)

1600 West Merit Parkway, South Jordan, Utah 84095

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (801) 253-1600

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

Title of each class

Trading Symbol

Name of exchange on which registered

Common Stock, no par

MMSI

NASDAQ Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days. Yes   No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes   No

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

Large Accelerated Filer 

Accelerated Filer 

Non-Accelerated Filer 

Smaller Reporting Company 

Emerging Growth Company 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

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

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

Common Stock

    

55,384,036

Title or class

Number of Shares
Outstanding at May 5, 2020

TABLE OF CONTENTS

PART I.

   

FINANCIAL INFORMATION

3

Item 1.

Financial Statements (Unaudited)

3

Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019

3

Consolidated Statements of Income (Loss) for the three months ended March 31, 2020 and 2019

5

Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2020 and 2019

6

Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2020 and 2019

7

Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019

8

Condensed Notes to Consolidated Financial Statements

10

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

28

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

36

Item 4.

Controls and Procedures

37

PART II.

OTHER INFORMATION

39

Item 1.

Legal Proceedings

39

Item 1A.

Risk Factors

39

Item 6.

Exhibits

42

SIGNATURES

43

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

MARCH 31, 2020 AND DECEMBER 31, 2019

(In thousands)

    

March 31, 

    

December 31, 

    

2020

    

2019

ASSETS

 

(unaudited)

 

  

CURRENT ASSETS:

 

  

 

  

Cash and cash equivalents

$

50,080

$

44,320

Trade receivables — net of allowance for uncollectible accounts — 2020 — $4,124 and 2019 — $3,108

 

150,050

 

155,365

Other receivables

 

9,246

 

10,016

Inventories

 

227,776

 

225,698

Prepaid expenses and other current assets

 

16,284

 

12,497

Prepaid income taxes

 

3,486

 

3,491

Income tax refund receivables

 

5,586

 

3,151

Total current assets

 

462,508

 

454,538

PROPERTY AND EQUIPMENT:

 

  

 

  

Land and land improvements

 

27,695

 

27,554

Buildings

 

153,896

 

153,863

Manufacturing equipment

 

247,878

 

244,368

Furniture and fixtures

 

58,955

 

57,623

Leasehold improvements

 

43,950

 

43,311

Construction-in-progress

 

91,802

 

83,685

Total property and equipment

 

624,176

 

610,404

Less accumulated depreciation

 

(239,316)

 

(231,619)

Property and equipment — net

 

384,860

378,785

OTHER ASSETS:

 

  

 

  

Intangible assets:

 

  

 

  

Developed technology — net of accumulated amortization —2020 — $162,135 and 2019 — $149,947

 

366,551

 

379,529

Other — net of accumulated amortization — 2020 — $59,934 and 2019 — $65,607

 

63,693

 

65,783

Goodwill

 

352,242

 

353,193

Deferred income tax assets

 

3,716

 

3,788

Right-of-use operating lease assets

79,133

80,244

Other assets

 

36,569

 

41,461

Total other assets

 

901,904

 

923,998

TOTAL ASSETS

$

1,749,272

$

1,757,321

See condensed notes to consolidated financial statements.

(continued)

3

MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

MARCH 31, 2020 AND DECEMBER 31, 2019

(In thousands)

    

March 31, 

    

December 31, 

    

2020

    

2019

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

(unaudited)

    

  

CURRENT LIABILITIES:

 

  

  

Trade payables

$

56,012

$

54,623

Accrued expenses

 

87,095

 

105,184

Current portion of long-term debt

 

7,500

 

7,500

Short-term operating lease liabilities

11,670

11,550

Income taxes payable

 

3,014

 

2,799

Total current liabilities

 

165,291

 

181,656

LONG-TERM DEBT

 

438,137

 

431,984

DEFERRED INCOME TAX LIABILITIES

 

45,027

 

45,236

LONG-TERM INCOME TAXES PAYABLE

 

347

 

347

LIABILITIES RELATED TO UNRECOGNIZED TAX BENEFITS

 

1,990

 

1,990

DEFERRED COMPENSATION PAYABLE

 

14,066

 

14,855

DEFERRED CREDITS

 

2,088

 

2,122

LONG-TERM OPERATING LEASE LIABILITIES

71,642

 

72,714

OTHER LONG-TERM OBLIGATIONS

 

70,886

 

56,473

Total liabilities

 

809,474

 

807,377

COMMITMENTS AND CONTINGENCIES (Notes 4, 8, 9 and 10)

 

  

 

  

STOCKHOLDERS’ EQUITY:

 

  

 

  

Preferred stock — 5,000 shares authorized as of March 31, 2020 and December 31, 2019; no shares issued

 

 

Common stock, no par value; shares authorized — 2020 and 2019 - 100,000; issued and outstanding as of March 31, 2020 - 55,338 and December 31, 2019 - 55,213

 

590,065

 

587,017

Retained earnings

 

364,492

 

368,221

Accumulated other comprehensive loss

 

(14,759)

 

(5,294)

Total stockholders’ equity

 

939,798

 

949,944

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$

1,749,272

$

1,757,321

See condensed notes to consolidated financial statements.

(concluded)

4

MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(In thousands, except per share amounts - unaudited)

    

Three Months Ended

March 31, 

    

2020

    

2019

NET SALES

$

243,525

$

238,349

COST OF SALES

 

139,741

 

133,713

GROSS PROFIT

 

103,784

 

104,636

OPERATING EXPENSES:

 

  

 

  

Selling, general and administrative

 

78,808

 

78,270

Research and development

 

14,872

 

16,043

Impairment and other charges

 

3,845

 

Contingent consideration expense

 

4,897

 

775

Acquired in-process research and development

 

 

25

Total operating expenses

 

102,422

 

95,113

INCOME FROM OPERATIONS

 

1,362

 

9,523

OTHER INCOME (EXPENSE):

 

  

 

  

Interest income

 

79

 

357

Interest expense

 

(3,144)

 

(2,764)

Other expense - net

 

(289)

 

(270)

Total other expense — net

 

(3,354)

 

(2,677)

INCOME (LOSS) BEFORE INCOME TAXES

 

(1,992)

 

6,846

INCOME TAX EXPENSE

 

1,162

 

651

NET INCOME (LOSS)

$

(3,154)

$

6,195

EARNINGS (LOSS) PER COMMON SHARE:

 

  

 

  

Basic

$

(0.06)

$

0.11

Diluted

$

(0.06)

$

0.11

AVERAGE COMMON SHARES:

 

  

 

  

Basic

 

55,246

 

54,917

Diluted

 

55,246

 

56,490

See condensed notes to consolidated financial statements.

5

MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(In thousands - unaudited)

    

Three Months Ended

March 31, 

    

2020

    

2019

Net income (loss)

$

(3,154)

$

6,195

Other comprehensive income (loss):

 

  

 

  

Cash flow hedges

 

(7,182)

 

(2,577)

Income tax benefit (expense)

 

1,849

 

663

Foreign currency translation adjustment

 

(4,125)

 

(615)

Income tax benefit (expense)

 

(7)

 

14

Total other comprehensive loss

 

(9,465)

 

(2,515)

Total comprehensive income (loss)

$

(12,619)

$

3,680

See condensed notes to consolidated financial statements.

6

MERIT MEDICAL SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(In thousands - unaudited)

Accumulated Other

Common Stock

Retained

Comprehensive

    

Total

    

Shares

    

Amount

    

Earnings

    

Income (Loss)

BALANCE — January 1, 2020

$

949,944

 

55,213

$

587,017

$

368,221

$

(5,294)

Net loss

 

(3,154)

 

  

 

  

 

(3,154)

 

  

Cumulative effect adjustment upon adoption of ASU 2016-13, Credit Losses

(575)

(575)

Other comprehensive loss

 

(9,465)

 

  

 

  

 

  

 

(9,465)

Stock-based compensation expense

 

2,641

 

  

 

2,641

 

  

 

  

Options exercised

 

2,369

 

174

 

2,369

 

  

 

  

Issuance of common stock under Employee Stock Purchase Plan

 

371

 

13

 

371

 

  

 

  

Shares surrendered in exchange for payment of payroll tax liabilities

(866)

 

(23)

 

(866)

Shares surrendered in exchange for exercise of stock options

(1,467)

 

(39)

 

(1,467)

BALANCE — March 31, 2020

$

939,798

 

55,338

$

590,065

$

364,492

$

(14,759)

Accumulated Other

Common Stock

Retained

Comprehensive

    

Total

    

Shares

    

Amount

    

Earnings

    

Income (Loss)

BALANCE — January 1, 2019

$

932,775

54,893

$

571,383

$

363,425

$

(2,033)

Net income

 

6,195

 

  

 

  

 

6,195

 

  

Reclassify deferred gain on sale-leaseback upon adoption of ASC 842

93

93

Other comprehensive loss

 

(2,515)

 

  

 

  

 

  

 

(2,515)

Stock-based compensation expense

 

1,766

 

  

 

1,766

 

  

 

  

Options exercised

 

1,365

 

95

 

1,365

 

  

 

  

Issuance of common stock under Employee Stock Purchase Plan

 

432

 

7

 

432

 

  

 

  

BALANCE — March 31, 2019

$

940,111

 

54,995

$

574,946

$

369,713

$

(4,548)

See condensed notes to consolidated financial statements.

7

MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(In thousands - unaudited)

Three Months Ended

March 31, 

    

2020

    

2019

CASH FLOWS FROM OPERATING ACTIVITIES:

 

  

 

  

Net income (loss)

$

(3,154)

$

6,195

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

  

 

  

Depreciation and amortization

 

23,320

 

22,348

Loss on sales and/or abandonment of property and equipment

 

37

 

288

Write-off of certain intangible assets and other long-term assets

 

3,925

 

Acquired in-process research and development

 

 

25

Amortization of right-of-use operating lease assets

3,134

2,964

Fair value adjustments to contingent consideration

4,897

775

Amortization of deferred credits

 

(35)

 

(35)

Amortization of long-term debt issuance costs

 

151

 

201

Stock-based compensation expense

 

2,777

 

1,766

Changes in operating assets and liabilities, net of effects from acquisitions:

 

 

  

Trade receivables

 

3,445

 

(11,557)

Other receivables

 

613

 

1,090

Inventories

 

(4,983)

 

(1,340)

Prepaid expenses and other current assets

 

(3,126)

 

19

Prepaid income taxes

 

 

(53)

Income tax refund receivables

 

(2,475)

 

(442)

Other assets

 

(577)

 

(2,092)

Trade payables

 

4,340

 

(878)

Accrued expenses

 

(1,621)

 

(2,976)

Income taxes payable

 

2,109

 

(879)

Deferred compensation payable

 

(789)

 

1,261

Operating lease liabilities

(2,945)

(3,054)

Other long-term obligations

 

(179)

 

(121)

Total adjustments

 

32,018

 

7,310

Net cash provided by operating activities

 

28,864

 

13,505

CASH FLOWS FROM INVESTING ACTIVITIES:

 

  

 

  

Capital expenditures for:

 

  

 

  

Property and equipment

 

(13,950)

 

(18,255)

Intangible assets

 

(1,062)

 

(853)

Proceeds from the sale of property and equipment

 

 

3

Cash received for settlement of current note receivable

 

250

 

Cash paid in acquisitions, net of cash acquired

 

 

(1,942)

Net cash used in investing activities

 

(14,762)

 

(21,047)

See condensed notes to consolidated financial statements.

(continued)

8

MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(In thousands - unaudited)

    

Three Months Ended

March 31, 

2020

2019

CASH FLOWS FROM FINANCING ACTIVITIES:

 

  

 

  

Proceeds from issuance of common stock

$

1,261

$

1,733

Proceeds from issuance of long-term debt

 

30,665

 

43,119

Payments on long-term debt

(24,540)

(54,119)

Contingent payments related to acquisitions

 

(12,754)

 

(554)

Payment of taxes related to an exchange of common stock

 

(866)

 

Net cash used in financing activities

 

(6,234)

 

(9,821)

EFFECT OF EXCHANGE RATES ON CASH

 

(2,108)

 

(474)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

5,760

 

(17,837)

CASH AND CASH EQUIVALENTS:

 

  

 

  

Beginning of period

 

44,320

 

67,359

End of period

$

50,080

$

49,522

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

 

  

 

  

Cash paid during the period for:

 

  

 

  

Interest (net of capitalized interest of $392 and $241, respectively)

$

3,198

$

2,721

Income taxes

$

1,637

$

1,934

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES

 

  

 

  

Property and equipment purchases in accounts payable

$

5,383

$

4,588

Current note receivable converted to equity investment

$

899

$

Right-of-use operating lease assets obtained in exchange for operating lease liabilities

$

2,800

$

1,162

See condensed notes to consolidated financial statements.

(concluded)

9

MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.   Basis of Presentation. The interim consolidated financial statements of Merit Medical Systems, Inc. ("Merit," "we" or "us") for the three months ended March 31, 2020 and 2019 are not audited. Our consolidated financial statements are prepared in accordance with the requirements for unaudited interim periods and, consequently, do not include all disclosures required to be made in conformity with accounting principles generally accepted in the United States of America. In the opinion of our management, the accompanying consolidated financial statements contain all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of our financial position as of March 31, 2020 and December 31, 2019, and our results of operations and cash flows for the three-month periods ended March 31, 2020 and 2019. The results of operations for the three-month periods ended March 31, 2020 and 2019 are not necessarily indicative of the results for a full-year period. Within the financial statements and tables presented, certain columns and rows may not total due to the use of rounded numbers for disclosure purposes. Percentages and earnings per share amounts presented are calculated from the underlying amounts. These interim consolidated financial statements should be read in conjunction with the financial statements included in our Annual Report on Form 10-K (the "2019 Form 10-K") for the year ended December 31, 2019, which was filed with the Securities and Exchange Commission (the "SEC") on March 2, 2020.

Reclassifications

Certain reclassifications have been made to the 2019 periods to conform to the 2020 presentation. In the consolidated statements of cash flows, the fair value adjustment to contingent consideration is presented as a reconciling item between net income (loss) and cash flows from operating activities in 2020, with a corresponding reclassification of $775,000 made in the prior period for comparability, along with corresponding reclassifications to the change in certain operating assets and liabilities.

2.   Recently Issued Financial Accounting Standards.

Recently Adopted

In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 became effective for us on January 1, 2020. The adoption of this standard did not have a material impact on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820), which removes, modifies and adds various disclosure requirements related to fair value disclosures. ASU 2018-13 became effective for us beginning on January 1, 2020. We modified our disclosures beginning in the three-month period ended March 31, 2020 to conform with this guidance (see Note 14).

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which replaced the incurred loss impairment methodology for financial assets with a methodology that reflects expected credit losses. The new credit loss model must be applied to loans, accounts receivable, and other financial assets. ASU 2016-13 became effective for us beginning on January 1, 2020. We adopted this standard using a modified retrospective approach with a cumulative-effect adjustment to retained earnings of $575,000 as of the beginning of 2020. See Note 14 for additional disclosures related to our allowance for current expected credit losses. The adoption of this guidance did not have a material impact on our statements of operations or cash flows.

We currently believe that all other issued and not yet effective accounting standards are not relevant to our financial statements.

10

3.   Revenue from Contracts with Customers. We recognize revenue when a customer obtains control of promised goods. The amount of revenue recognized reflects the consideration we expect to receive in exchange for these goods.

Disaggregation of Revenue

The disaggregation of revenue is based on product category and geographical region. Beginning in the first quarter of 2020, we revised our product categories to more clearly reflect how we sell our products to our customers. We presented historical information under the new revised product categories in a Current Report on Form 8-K, filed with the SEC on April 3, 2020.

We design, develop, manufacture and market medical products for interventional and diagnostic procedures. For financial reporting purposes, we report our operations in two operating segments: cardiovascular and endoscopy. Our cardiovascular segment consists of four product categories: peripheral intervention, cardiac intervention, custom procedural solutions, and OEM. Within these product categories, we sell a variety of products, including cardiology and radiology devices (which assist in diagnosing and treating coronary arterial disease, peripheral vascular disease and other non-vascular diseases), as well as embolotherapeutic, cardiac rhythm management, electrophysiology, critical care, breast cancer localization and guidance, biopsy, interventional oncology and spine devices. Our endoscopy segment consists of gastroenterology and pulmonology devices which assist in the palliative treatment of expanding esophageal, tracheobronchial and biliary strictures caused by malignant tumors.

The following tables present revenue from contracts with customers for the three-month periods ended March 31, 2020 and 2019 (in thousands):

Three Months Ended

Three Months Ended

March 31, 2020

March 31, 2019

    

United States

    

International

    

Total

    

United States

    

International

    

Total

Cardiovascular

 

  

 

  

 

  

 

  

 

  

 

  

Peripheral Intervention

$

55,803

$

31,272

$

87,075

$

55,600

$

29,033

$

84,633

Cardiac Intervention

 

28,595

43,996

 

72,591

 

27,016

 

45,524

 

72,540

Custom Procedural Solutions

 

25,414

22,207

 

47,621

 

23,815

 

22,046

 

45,861

OEM

 

23,666

4,591

 

28,257

 

24,061

 

3,385

 

27,446

Total

 

133,478

102,066

 

235,544

 

130,492

 

99,988

 

230,480

 

Endoscopy

Endoscopy devices

 

7,578

 

403

 

7,981

 

7,568

 

301

 

7,869

Total

$

141,056

$

102,469

$

243,525

$

138,060

$

100,289

$

238,349

11

4.   Acquisitions. On August 1, 2019, we entered into a share purchase agreement to acquire Fibrovein Holdings Limited, which is the owner of 100% of the capital stock of STD Pharmaceutical Products Limited, a UK private company engaged in the manufacture, distribution and sale of pharmaceutical sclerotherapy products (“STD Pharmaceutical”). The purchase consideration consisted of an upfront payment of approximately $13.7 million, net of cash acquired. We also recorded a contingent consideration liability of approximately $934,000 related to royalties potentially payable pursuant to the terms of the share purchase agreement. We accounted for this acquisition as a business combination. The sales and results of operations related to the acquisition have been included in our cardiovascular segment since the acquisition date and were not material. Acquisition-related costs associated with the STD Pharmaceutical acquisition, which were included in selling, general and administrative expenses, were not material. The purchase price was preliminarily allocated as follows (in thousands):

Assets Acquired

    

  

Trade receivables

$

277

Inventories

 

843

Prepaid expenses and other assets

 

49

Intangible assets

 

Developed technology

10,428

Goodwill

4,975

Total assets acquired

 

16,572

Liabilities Assumed

 

  

Trade payables

 

(53)

Accrued expenses

 

(29)

Deferred income tax liabilities

 

(1,890)

Total liabilities assumed

 

(1,972)

Total net assets acquired

$

14,600

We are amortizing the developed technology intangible asset acquired in the STD Pharmaceutical acquisition over 12 years. The goodwill consists largely of the synergies we hope to achieve from combining operations and is not expected to be deductible for income tax purposes.

On June 14, 2019, we consummated an acquisition transaction contemplated by a merger agreement to acquire Brightwater Medical, Inc. ("Brightwater"). The purchase consideration consisted of an upfront payment of $35 million plus a final working capital adjustment of approximately $39,000, net of cash acquired, with potential earn-out payments of up to an additional $5 million for achievement of CE certification with respect to the Brightwater ConvertX®, a single-use device used to replace a series of devices and procedures used to treat severe obstructions of the ureter, and up to an additional $10 million for the achievement of sales milestones specified in the merger agreement. The ConvertX device is designed to be implanted once and converted from a nephroureteral catheter to a nephroureteral stent without requiring sedation or local anesthesia. Brightwater recently received FDA clearance for the ConvertX biliary stent device. We accounted for this acquisition as a business combination. The sales and results of operations related to the acquisition have been included in our cardiovascular segment since the acquisition date and were not material. Acquisition-related costs associated with

12

the Brightwater acquisition, which were included in selling, general and administrative expenses, were not material. The purchase price was preliminarily allocated as follows (in thousands):

Assets Acquired

    

Trade receivables

$

55

Inventories

 

349

Property and equipment

 

409

Other long-term assets

 

30

Intangible assets

 

  

Developed technology

 

31,960

Customer lists

 

83

Trademarks

 

250

Goodwill

 

17,492

Total assets acquired

 

50,628

Liabilities Assumed

 

  

Trade payables

 

(58)

Accrued expenses

 

(261)

Other long-term obligations

 

(1,522)

Deferred income tax liabilities

 

(4,148)

Total liabilities assumed

 

(5,989)

Total net assets acquired

$

44,639

We are amortizing the developed technology intangible asset acquired in the Brightwater acquisition over 13 years, the related trademarks over five years and the customer list on an accelerated basis over one year. The total weighted-average amortization period for these acquired intangible assets is approximately 12.9 years. The goodwill consists largely of the synergies and economies of scale we hope to achieve from combining the acquired assets and operations with our historical operations and is not expected to be deductible for income tax purposes.

The pro forma impact of these acquisitions was not significant, either individually or in the aggregate, on our financial results for the three-month period ended March 31, 2019. Operating results attributable to the STD Pharmaceutical and Brightwater acquisitions were included in our consolidated statements of income (loss) for the three-month period ended March 31, 2020.

5. Inventories. Inventories at March 31, 2020 and December 31, 2019, consisted of the following (in thousands):

    

March 31, 2020

    

December 31, 2019

Finished goods

$

126,495

$

134,467

Work-in-process

 

24,592

 

17,602

Raw materials

 

76,689

 

73,629

Total inventories

$

227,776

$

225,698

6.   Goodwill and Intangible Assets. The changes in the carrying amount of goodwill for the three-month period ended March 31, 2020 were as follows (in thousands):

    

2020

    

Goodwill balance at January 1

$

353,193

Effect of foreign exchange

 

(951)

Goodwill balance at March 31

$

352,242

13

Total accumulated goodwill impairment losses aggregated to approximately $8.3 million as of March 31, 2020 and December 31, 2019. We did not have any goodwill impairments for the three-month periods ended March 31, 2020 and 2019. The total goodwill balance as of March 31, 2020 and December 31, 2019 was related to our cardiovascular segment.

Other intangible assets at March 31, 2020 and December 31, 2019, consisted of the following (in thousands):

March 31, 2020

Gross Carrying

Accumulated

Net Carrying

    

Amount

    

Amortization

    

Amount

Patents

$

23,764

$

(7,396)

$

16,368

Distribution agreements

 

5,754

 

(4,656)

 

1,098

License agreements

 

22,017

 

(8,337)

 

13,680

Trademarks

 

30,235

 

(10,202)

 

20,033

Customer lists

 

39,357

 

(29,343)

 

10,014

In-process technology

 

2,500

 

 

2,500

Total

$

123,627

$

(59,934)

$

63,693

December 31, 2019

Gross Carrying

Accumulated

Net Carrying

    

Amount

    

Amortization

    

Amount

Patents

    

$

22,703

$

(6,863)

$

15,840

Distribution agreements

 

8,012

 

(6,794)

 

1,218

License agreements

 

26,987

 

(12,746)

 

14,241

Trademarks

 

30,240

 

(9,477)

 

20,763

Covenants not to compete

 

964

 

(964)

 

Customer lists

 

39,984

 

(28,763)

 

11,221

In-process technology

 

2,500

 

 

2,500

Total

$

131,390

$

(65,607)

$

65,783

Aggregate amortization expense for the three-month periods ended March 31, 2020 and 2019 was approximately $15.0 million and $14.8 million, respectively.

We evaluate long-lived assets, including amortizing intangible assets, for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. We perform the impairment analysis at the asset group for which the lowest level of identifiable cash flows is largely independent of the cash flows of other assets and liabilities. We compare the carrying value of the amortizing intangible assets acquired to the undiscounted cash flows expected to result from the asset group and determine whether the carrying amount is recoverable. We determine the fair value of our amortizing assets based on estimated future cash flows discounted back to their present value using a discount rate that reflects the risk profiles of the underlying activities. We did not identify indicators of impairment in any intangible assets based on our qualitative assessment for the three-month periods ended March 31, 2020 and 2019.

Estimated amortization expense for the developed technology and other intangible assets for the next five years consists of the following as of March 31, 2020 (in thousands):

Year Ending December 31,

Estimated Amortization Expense

Remaining 2020

$

44,365

2021

 

51,932

2022

 

50,625

2023

49,417

2024

 

46,465

7.   Income Taxes. Our provision for income taxes for the three-month periods ended March 31, 2020 and 2019 was a tax expense of approximately $1.2 million and $651,000, respectively, which resulted in an effective tax rate of

14

(58.3)% and 9.5%, respectively. The increase in the income tax expense and the corresponding change in the effective income tax rate for the three-month period ended March 31, 2020, when compared to the prior-year period, was primarily due to discrete expenses related to the fair value adjustment of the contingent consideration liabilities of recent equity acquisitions and the write-off of our purchase option to acquire Bluegrass Vascular Technologies, Inc. (“Bluegrass Vascular”) due to our decision not to exercise our option to purchase this business (see Note 14).

8.   Revolving Credit Facility and Long-Term Debt. Principal balances outstanding under our long-term debt obligations as of March 31, 2020 and December 31, 2019, consisted of the following (in thousands):

    

March 31, 2020

    

December 31, 2019

Term loans

$

146,250

$

148,125

Revolving credit loans

 

299,875

 

291,875

Less unamortized debt issuance costs

 

(488)

 

(516)

Total long-term debt

 

445,637

 

439,484

Less current portion

 

7,500

 

7,500

Long-term portion

$

438,137

$

431,984

Third Amended and Restated Credit Agreement

On July 31, 2019, we entered into a Third Amended and Restated Credit Agreement (the "Third Amended Credit Agreement"). The Third Amended Credit Agreement is a syndicated loan agreement with Wells Fargo Bank, National Association and other parties. The Third Amended Credit Agreement amends and restates in its entirety our previously outstanding Second Amended and Restated Credit Agreement and all amendments thereto. The Third Amended Credit Agreement provides for a term loan of $150 million and a revolving credit commitment up to an aggregate amount of $600 million, inclusive of sub-facilities for multicurrency borrowings, standby letters of credit and swingline loans. On July 31, 2024, all principal, interest and other amounts outstanding under the Third Amended Credit Agreement are payable in full. At any time prior to the maturity date, we may repay any amounts owing under all term loans and revolving credit loans in whole or in part, without premium or penalty, other than breakage fees (as defined in the Third Amended Credit Agreement).

Revolving credit loans denominated in dollars and term loans made under the Third Amended Credit Agreement bear interest, at our election, at either the Base Rate or the Eurocurrency Rate (as such terms are defined in the Third Amended Credit Agreement) plus the Applicable Margin (as defined in the Third Amended Credit Agreement). Revolving credit loans denominated in an Alternative Currency (as defined in the Third Amended Credit Agreement) bear interest at the Eurocurrency Rate plus the Applicable Margin. Swingline loans bear interest at the Base Rate plus the Applicable Margin (as defined in the Third Amended Credit Agreement). Interest on each loan featuring the Base Rate is due and payable on the last business day of each calendar quarter; interest on each loan featuring the Eurocurrency Rate is due and payable on the last day of each interest period applicable thereto, and if such interest period extends over three months, at the end of each three-month interval during such interest period.

The Third Amended Credit Agreement is collateralized by substantially all our assets. The Third Amended Credit Agreement contains affirmative and negative covenants, representations and warranties, events of default and other terms

15

customary for loans of this nature. In particular, the Third Amended Credit Agreement requires that we maintain certain financial covenants, as follows:

    

 

Covenant Requirement

Consolidated Total Leverage Ratio (1)

 

4.0 to 1.0

Consolidated Interest Coverage Ratio (2)

 

3.0 to 1.0

Facility Capital Expenditures (3)

$50 million

(1) Maximum Consolidated Total Net Leverage Ratio (as defined in the Third Amended Credit Agreement) as of any fiscal quarter end.
(2) Minimum ratio of Consolidated EBITDA (as defined in the Third Amended Credit Agreement and adjusted for certain expenditures) to Consolidated interest expense (as defined in the Third Amended Credit Agreement) for any period of four consecutive fiscal quarters.
(3) Maximum level of the aggregate amount of all Facility Capital Expenditures (as defined in the Third Amended Credit Agreement) in any fiscal year.

As of March 31, 2020, we believe we were in compliance with all covenants set forth in the Third Amended Credit Agreement.

As of March 31, 2020, we had outstanding borrowings of approximately $446.1 million under the Third Amended Credit Agreement, with additional available borrowings of approximately $232.1 million, based on the net leverage ratio required pursuant to the Third Amended Credit Agreement. Our interest rate as of March 31, 2020 was a fixed rate of 2.87% on $175 million as a result of an interest rate swap (see Note 9) and a variable floating rate of 2.74% on $271.1 million. Our interest rate as of December 31, 2019 was a fixed rate of 2.62% on $175 million as a result of an interest rate swap and a variable floating rate of 3.30% on $265 million.

Future minimum principal payments on our long-term debt as of March 31, 2020, were as follows (in thousands):

Years Ending

Future Minimum

December 31,

    

Principal Payments

Remaining 2020

 

$

5,625

2021

7,500

2022

8,438

2023

11,250

2024

 

413,312

Total future minimum principal payments

$

446,125

9.   Derivatives.

General. Our earnings and cash flows are subject to fluctuations due to changes in interest rates and foreign currency exchange rates, and we seek to mitigate a portion of these risks by entering into derivative contracts. The derivatives we use are interest rate swaps and foreign currency forward contracts. We recognize derivatives as either assets or liabilities at fair value in the accompanying consolidated balance sheets, regardless of whether or not hedge accounting is applied. We report cash flows arising from our hedging instruments consistent with the classification of cash flows from the underlying hedged items. Accordingly, cash flows associated with our derivative programs are classified as operating activities in the accompanying consolidated statements of cash flows.

We formally document, designate and assess the effectiveness of transactions that receive hedge accounting initially and on an ongoing basis. For qualifying hedges, the change in fair value is deferred in accumulated other comprehensive income, a component of stockholders’ equity in the accompanying consolidated balance sheets, and recognized in earnings at the same time the hedged item affects earnings. Changes in the fair value of derivatives not designated as hedging instruments are recorded in earnings throughout the term of the derivative.

16

Interest Rate Risk. Our debt bears interest at variable interest rates and, therefore, we are subject to variability in the cash paid for interest expense. In order to mitigate a portion of this risk, we use a hedging strategy to reduce the variability of cash flows in the interest payments associated with a portion of the variable-rate debt outstanding under our Third Amended Credit Agreement that is solely due to changes in the benchmark interest rate.

Derivative Instruments Designated as Cash Flow Hedges

On August 5, 2016, we entered into a pay-fixed, receive-variable interest rate swap with a current notional amount of $175 million with Wells Fargo to fix the one-month LIBOR rate at 1.12%. The variable portion of the interest rate swap is tied to the one-month LIBOR rate (the benchmark interest rate). On a monthly basis, the interest rates under both the interest rate swap and the underlying debt reset, the swap is settled with the counterparty, and interest is paid. The interest rate swap is scheduled to expire on July 6, 2021.

On December 23, 2019, we entered into a pay-fixed, receive-variable interest rate swap with a notional amount of $75 million with Wells Fargo to fix the one-month LIBOR rate at 1.71% for the period from July 6, 2021 to July 31, 2024. The variable portion of the interest rate swap is tied to the one-month LIBOR rate (the benchmark interest rate). On a monthly basis, the interest rates under both the interest rate swap and the underlying debt will reset, the swap will be settled with the counterparty, and interest will be paid.

At March 31, 2020 and December 31, 2019, our interest rate swaps qualified as cash flow hedges. The fair value of our interest rate swaps at March 31, 2020 was a liability of approximately $4.8 million, which was partially offset by approximately $1.2 million in deferred taxes. The fair value of our interest rate swaps at December 31, 2019 was an asset of approximately $1.2 million, partially offset by approximately $307,000 in deferred taxes, and a liability of $(290,000), partially offset by approximately $(75,000) in deferred taxes.

Foreign Currency Risk. We operate on a global basis and are exposed to the risk that our financial condition, results of operations, and cash flows could be adversely affected by changes in foreign currency exchange rates. To reduce the potential effects of foreign currency exchange rate movements on net earnings, we enter into derivative financial instruments in the form of foreign currency exchange forward contracts with major financial institutions. Our policy is to enter into foreign currency derivative contracts with maturities of up to two years. We are primarily exposed to foreign currency exchange rate risk with respect to transactions and balances denominated in Chinese Renminbi, Euros, British Pounds, Mexican Pesos, Brazilian Reals, Australian Dollars, Hong Kong Dollars, Swiss Francs, Swedish Krona, Canadian Dollars, Danish Krone, Japanese Yen, and South Korean Won, among others. We do not use derivative financial instruments for trading or speculative purposes. We are not subject to any credit risk contingent features related to our derivative contracts, and counterparty risk is managed by allocating derivative contracts among several major financial institutions.

Derivative Instruments Designated as Cash Flow Hedges

For derivative instruments that are designated and qualify as cash flow hedges, the gain or loss on the derivative instrument is temporarily reported as a component of other comprehensive income (loss) and then reclassified into earnings in the same line item associated with the forecasted transaction and in the same period or periods during which the hedged transaction affects earnings. We entered into forward contracts on various foreign currencies to manage the risk associated with forecasted exchange rates which impact revenues, cost of sales, and operating expenses in various international markets. The objective of the hedges is to reduce the variability of cash flows associated with the forecasted purchase or sale of the associated foreign currencies.

We enter into approximately 150 cash flow foreign currency hedges every month. As of March 31, 2020 and December 31, 2019 we had entered into foreign currency forward contracts, which qualified as cash flow hedges, with notional amounts of $173.2 million and $212.5 million, respectively.

17

Derivative Instruments Not Designated as Cash Flow Hedges

We forecast our net exposure in various receivables and payables to fluctuations in the value of various currencies, and we enter into foreign currency forward contracts to mitigate that exposure. We enter into approximately 20 foreign currency fair value hedges every month. As of March 31, 2020 and December 31, 2019 we had entered into foreign currency forward contracts related to those balance sheet accounts with notional amounts of $65.2 million and $65.0 million, respectively.

Balance Sheet Presentation of Derivative Instruments. As of March 31, 2020 and December 31, 2019, all derivative instruments, both those designated as hedging instruments and those that were not designated as hedging instruments, were recorded gross at fair value on our consolidated balance sheets. We are not subject to any master netting agreements.

The fair value of derivative instruments on a gross basis was as follows on the dates indicated (in thousands):

Fair Value

    

Balance Sheet Location

    

March 31, 2020

    

December 31, 2019

Derivative instruments designated as hedging instruments

 

  

 

  

 

  

Assets

 

  

 

  

 

  

Interest rate swaps

 

Other assets (long-term)

$

$

1,192

Foreign currency forward contracts

 

Prepaid expenses and other assets

 

2,496

 

1,663

Foreign currency forward contracts

 

Other assets (long-term)

 

670

 

466

(Liabilities)

 

  

 

  

 

  

Interest rate swaps

Other long-term obligations

(4,812)

(290)

Foreign currency forward contracts

 

Accrued expenses

 

(3,692)

 

(1,813)

Foreign currency forward contracts

 

Other long-term obligations

 

(1,321)

 

(764)

Derivative instruments not designated as hedging instruments

 

  

 

  

 

  

Assets

 

  

 

  

 

  

Foreign currency forward contracts

 

Prepaid expenses and other assets

$

2,515

$

318

(Liabilities)

 

  

 

  

 

  

Foreign currency forward contracts

 

Accrued expenses

 

(1,006)

 

(1,678)

Income Statement Presentation of Derivative Instruments.

Derivative Instruments Designated as Cash Flow Hedges

Derivative instruments designated as cash flow hedges had the following effects, before income taxes, on other comprehensive income (“OCI”), accumulated other comprehensive income (“AOCI”), and net earnings in our

18

consolidated statements of income, consolidated statements of comprehensive income and consolidated balance sheets (in thousands):

Amount of Gain/(Loss)

Consolidated Statements

Amount of Gain/(Loss)

recognized in OCI

of Income (Loss)

reclassified from AOCI

Three Months Ended March 31, 

Three Months Ended March 31, 

Three Months Ended March 31, 

    

2020

    

2019

    

    

2020

    

2019

    

2020

    

2019

Derivative instrument

 

  

 

  

 

Location in statements of income (loss)

 

  

 

  

 

  

 

  

Interest rate swaps

$

(5,463)

$

(857)

Interest expense

$

(3,144)

$

(2,764)

$

251

$

595

Foreign currency forward contracts

 

(1,494)

 

(1,013)

Revenue

 

243,525

 

238,349

 

78

 

194

Cost of sales

 

(139,741)

 

(133,713)

 

(104)

 

(82)

As of March 31, 2020, approximately $1.2 million, or $0.9 million after taxes, was expected to be reclassified from accumulated other comprehensive income to earnings in revenue and cost of sales over the succeeding twelve months. As of March 31, 2020, approximately $(1.3) million, or $(1.0) million after taxes, was expected to be reclassified from accumulated other comprehensive income to earnings in interest expense over the succeeding twelve months.

Derivative Instruments Not Designated as Hedging Instruments

The following gains/(losses) from these derivative instruments were recognized in our consolidated statements of income (loss) for the periods presented (in thousands):

    

    

Three Months Ended March 31, 

Derivative Instrument

 

Location in statements of income (loss)

 

2020

 

2019

Foreign currency forward contracts

 

Other income (expense)

$

3,418

$

(266)

10.   Commitments and Contingencies.

Loan Commitment. On October 11, 2019, we acquired shares of stock in Selio Medical Limited (“Selio”) representing  an ownership interest of approximately 19.5%, as well as an option to purchase all ordinary shares of Selio throughout a 45 day period commencing from the date Selio receives FDA 510(k) approval of a medical device it is currently developing, and an option to purchase all remaining shares of Selio on the third anniversary date of the agreement if we elect to purchase all ordinary shares. We have also made a loan of $250,000 to Selio and committed to provide additional loans of up to  €2 million at a rate of 5% per annum. Additional loans made to Selio pursuant to our loan agreement, together with the initial advance and all other amounts owed to us by Selio, would be securitized by Selio’s assets.

Litigation: In the ordinary course of business, we are involved in various claims and litigation matters. These claims and litigation matters may include actions involving product liability, intellectual property, contract disputes, and employment or other matters that are significant to our business. For example, in December 2019 our company, our Chief Executive Officer and our Chief Financial Officer were named in a complaint filed in the Central District of California, which alleges violations of certain federal securities laws. Based upon our review of currently available information, we do not believe that any such actions are likely to be, individually or in the aggregate, materially adverse to our business, financial condition, results of operations or liquidity.

In addition to the foregoing matters, in October 2016, we received a subpoena from the U.S. Department of Justice seeking information on certain of our marketing and promotional practices. We have responded to the subpoena, as well as additional related requests. We have incurred, and anticipate that we will continue to incur, substantial costs in connection with the matter. The investigation is ongoing and at this stage we are unable to predict its scope, duration or outcome. Investigations such as this may result in the imposition of, among other things, significant damages, injunctions, fines, or civil or criminal claims or penalties against our company or individuals. Legal expenses we incurred in responding to the

19

U.S. Department of Justice investigation for the three-month periods ended March 31, 2020 and 2019 were approximately $1.5 million and $1.7 million, respectively.

In the event of unexpected further developments, it is possible that the ultimate resolution of any of the foregoing matters, or other similar matters, if resolved in a manner unfavorable to us, may be materially adverse to our business, financial condition, results of operations or liquidity. Legal costs for these matters, such as outside counsel fees and expenses, are charged to expense in the period incurred.

11.   Earnings (Loss) Per Common Share (EPS). The computation of weighted average shares outstanding and the basic and diluted earnings (loss) per common share consisted of the following (in thousands, except per share amounts):

Three Months Ended

March 31, 

2020

2019

Net income (loss)

$

(3,154)

$

6,195

Average common shares outstanding

 

55,246

 

54,917

Basic EPS

$

(0.06)

$

0.11

Average common shares outstanding

55,246

54,917

Effect of dilutive stock options (1)

1,573

Total potential shares outstanding

55,246

56,490

Diluted EPS

$

(0.06)

$

0.11

Stock options excluded as the impact was anti-dilutive(1)

4,340

976

(1) For the three-month period ended March 31, 2020, 2,242 outstanding stock options were considered antidilutive due to the net loss in the period. Independent of the net loss incurred, the potentially dilutive effect of these options would have been 769 shares.

12.   Stock-Based Compensation Expense. Stock-based compensation expense before income tax expense for the three-month periods ended March 31, 2020 and 2019 consisted of the following (in thousands):

Three Months Ended

March 31, 

    

2020

    

2019

Cost of sales

$

339

$

252

Research and development

 

285

 

192

Selling, general and administrative

 

2,153

 

1,322

Stock-based compensation expense before taxes

$

2,777

$

1,766

Nonqualified Stock Options

During the three-month periods ended March 31, 2020 and 2019, we granted stock options representing 216,494 and 909,603 shares of our common stock, respectively. We use the Black-Scholes methodology to value the stock-based compensation expense for options. In applying the Black-Scholes methodology to the option grants, the fair value of our stock-based awards granted was estimated using the following assumptions for the periods indicated below:

Three Months Ended

 

March 31, 

2020

2019

 

Risk-free interest rate

    

0.52% - 1.67%

  

2.42% - 2.56%

Expected option term

 

4.0 - 5.0 years

 

3.0 - 5.0 years

Expected dividend yield

 

 

Expected price volatility

 

38.65% - 43.24%

  

28.93% - 33.69%

20

The average risk-free interest rate is determined using the U.S. Treasury rate in effect as of the date of grant, based on the expected term of the stock award. We determine the expected term of the stock options using the historical exercise behavior of employees. The expected price volatility was determined using a weighted average of daily historical volatility of our stock price over the corresponding expected option term and implied volatility based on recent trends of the daily historical volatility. For awards with a vesting period, compensation expense is recognized on a straight-line basis over the service period, which corresponds to the vesting period.

We recognize stock-based compensation expense (net of a forfeiture rate) for those awards which are expected to vest on a straight-line basis over the requisite service period. We estimate the forfeiture rate based on our historical experience and expectations about future forfeitures. As of March 31, 2020, the total remaining unrecognized compensation cost related to non-vested stock options was approximately $28.4 million, which was expected to be recognized over a weighted average period of 2.93 years.

Stock-Settled Performance-Based Restricted Stock Units

During the three-month period ended March 31, 2020, we granted stock-settled performance-based restricted stock units (“performance stock units”) to certain of our executive officers representing up to 152,475 shares of our common stock. Conversion of the performance stock units occurs at the end of one, two and three-year performance periods, or one year after the agreement date, whichever is later. The conversion ratio is based upon attaining targeted levels of free cash flow (“FCF”) and relative shareholder return as compared to the Russell 2,000 (“rTSR”), as defined in the award agreements. The payout for each unit is equal to one share of common stock multiplied by a FCF multiplier (between 0% and 200%) and a rTSR multiplier (between 75% and 125%). If FCF is below a specified threshold, no shares will be awarded. The potential maximum payout per performance stock units is 250% of the target shares. Performance stock units convey no shareholder rights, including voting rights, unless and until shares are issued in settlement of the award. As performance stock units represent contingently issuable shares, we have