Q1 2022 Merit Medical Systems Inc Earnings Call
Welcome to the first quarter of fiscal year 2022 earnings Conference call for Merit Medical Systems, Inc.
At this time all participants have been placed in listen only mode. Please note that this conference call is being recorded.
Holding will be available on the company's website.
A replay shortly I would now like to turn the call over to Mr. Fred Propolis Merit Medical systems, founder Chairman and Chief Executive Officer. Please go ahead.
Thank you and welcome everyone to Merit medical systems first quarter of fiscal year 2022 earnings conference call I'm joined today on the call with Robert <unk>, Our Chief Financial Officer, and Treasurer, and Brian Lloyd, Our Chief legal officer and corporate Secretary.
Brian would you mind, taking us through the safe Harbor provisions. Please.
Thank you Fred before we get started I would like to remind everyone that this presentation contains forward looking statements that receive safe Harbor protection under federal Securities laws.
Although we believe these forward looking statements are based upon reasonable assumptions they are subject to unknown risks and uncertainties.
Realization of any of these risks or uncertainties as well as extraordinary events or transactions impacting our company could cause actual results to differ materially from those currently anticipated.
In addition, any forward looking statements represent our views only as of today April 27 2022.
And should not be relied upon as representing our views as of any other date.
We specifically disclaim any obligation to update such statements, except as required by applicable law.
Please refer to the section entitled Cautionary statement regard regarding forward looking statements in today's presentation for important information regarding such statements.
Please also refer to our most recent filings with the SEC for a discussion of factors that could cause actual results to differ from these forward looking statements.
Our financial statements are prepared in accordance with accounting principles, which are generally accepted in the United States.
However, we believe certain non-GAAP financial measures provide investors with useful information regarding the underlying business trends and performance of our ongoing operations.
And can be useful for period over period comparisons of such operations.
This presentation also contains certain non-GAAP financial measures.
A reconciliation of non-GAAP financial measures to the most directly comparable U S. GAAP measures is included in today's press release and presentation furnished to the SEC under form 8-K.
Please refer to the section of our presentation entitled non-GAAP financial measures for important information regarding non-GAAP financial measures discussed on this call.
Readers should consider non-GAAP financial measures in addition to and not as a substitute for financial reporting measures prepared in accordance with GAAP.
Please note that these calculations may not be comparable with similarly titled measures of other companies.
Both today's press release and our presentation are available on the investors page of our website.
I will now turn the call back to Fred.
Thank you, Brian and let me start with a brief agenda.
What we will cover during our remarks today I will start with an overview of our better than expected revenue results for the first quarter.
After my opening remarks rubble power will provide you with a more in depth review of our quarterly financial results.
And the formal financial guidance for 2022 that we have reaffirmed in today's press release.
As well as a summary of our balance sheet and financial conditions.
We will then open the call up for your questions.
Now beginning with a review of our first quarter revenue performance.
We reported total GAAP revenue of $275 4 million in the first quarter up 10, 6% year over year.
Our total graph revenue growth was driven by an eight 2% growth in U S shales and 13.8% growth in international sales.
Our total revenue increased 11, 3% year over year in the first quarter on an organic constant currency basis, excluding the headwind of our GAAP revenue growth related to changes in exchange rate compared to the prior year period.
Our total constant currency growth was driven primarily by a seven point, a 4% increase in U S shales.
And a 16, 6% increase in international sales.
Our first quarter revenue exceeded the growth expectations that we discussed in our fourth quarter call specifically that our constant currency revenue would increase in the range of a problem, maybe 6% to 8% year over year.
The strong revenue results in quarter, one were driven by solid execution from our team.
Stronger than anticipated demand during the month of March, particularly in the U S.
And more favorable than anticipated sales trends in the APAC and rest of world regions.
Now let me provide you with a more detailed review of our revenue results in the first quarter, beginning with our sales performance in each of our primary reportable product categories.
Now note unless otherwise stated all growth rates are on a year over year and constant currency basis.
First quarter total revenue growth was driven by 11, 5% growth in sales of cardiovascular products and seven 6% growth in sales of endoscopy products.
Sales of our peripheral interventional products increased 14% representing approximately half of the total cardiovascular segment growth.
Within the peripheral intervention or P I product category.
Sales of our radar localization products increased 27%.
And were the largest driver of total P I growth in quarter one.
Sales of our access and geography in biopsy product, which together represented roughly one third of our total pie business increased 17%.
And sales of our drainage products, which were strong again this quarter, increasing 16% year over year.
Sales of our cardiac intervention products increased 10% representing the second largest.
Second largest contributor to total cardiovascular segment growth.
Within the cardiac intervention or she I product categories.
How 'bout intervention products were the largest drivers of total product category growth, increasing 18% with sales of our basics and map lines continuing to deliver strong contributions to the growth increasing 24% in quarter one.
Sales of our angiography products also contributed meaningfully to our total Ci product category growth, increasing 17% in quarter one.
Driven substantially by continued strong demand for our diagnostic guide wires manifolds and cardiology diagnostic catheters.
Sales of our OEM products were stronger than expected in quarter, one increasing 20%.
Driven significantly by improving demand from larger customers replenishing inventory levels in multiple categories, including kitchen coatings and angiographic products.
We are pleased to see that sales of our C. P. S products returned to growth up 4% in quarter, one fueled by mid single digit growth in sales of kitchen trays.
Finally sales in our endoscopy segment increased 8% in quarter, one driven primarily by a 13% increase in sales how about Endo Max line and a 14% increase in the sales of other stent.
Now turning to a brief summary of our sales performance on a geographic basis.
As I mentioned, our first quarter shelves in the U S increased 7.4% year over year and our international sales increased 16, 6% year over year, both on a constant currency basis.
Importantly, our first quarter sales results reflect improving growth trends in both the U S and O U S markets on both a two year and three year basis.
In summary, we are encouraged by the improving growth trends and proud of our team's strong execution. Despite another quarter marked by challenging operating environment.
That strong execution is not limited to driving better than expected revenue results and frankly, we are seeing it across the organization, including our ethics to advance our foundations for growth program.
As discussed on prior calls we have launched more than 40 initiatives intended to drive value creation for merit across many areas, including SKU route optimization network consolidation compensation and benefit and of course product line transfers and manufacturing initiatives.
Year two of the foundations for growth program is off to a strong start and we were enjoying the early benefits of our work to date as the program is helping to offset the inflationary cost pressures, we're seeing in certain raw materials shipping and freight expenses.
We are also seeing the early benefits of improving our manufacturing efficiency in the area of product line transfers continuous improvement in line efficiency and an SKU rationalization.
We remain committed to the financial targets that we outlined in the foundation for growth program for the three year period ending December 31.
2023, which called for our constant currency organic revenue increase.
At a CAGR of at least 5% non-GAAP operating margins of at least 18% and tumor with cash flow generated more than $300 million.
Now with that said I'll turn the time over to Ralph who will take you through a more detailed review of our first quarter financial result.
And over our 2022 financial guidance, which we reaffirmed in today's press released.
Mr Power.
Thank you Fred given Fred's detailed discussion of our revenue results I will begin with a review of our financial performance across the rest of the P&L.
For the avoidance of doubt unless otherwise noted my commentary will focus on the Companys non-GAAP results during the first quarter of fiscal year 2022.
We have included reconciliations from our GAAP reported results to the related non-GAAP items in our press release and presentation available on our website.
Gross profit increased approximately 7% year over year in the first quarter, our gross margin for the first quarter was 47, 7% compared to 49, 2% in the prior year period. The 151 basis point decrease in gross margins year over year was primarily due to increased absenteeism from the COVID-19 pandemic.
Which drove unfavorable manufacturing variances higher freight costs and higher obsolescence expense.
Set partially by changes in product mix.
As expected our first quarter results reflect the inflationary headwinds we are seeing in logistics labor and to a lesser extent in raw materials.
Specifically, we estimate that the year over year increase in logistics expense represented a headwind to our non-GAAP gross margins of approximately 145 basis points in the first quarter.
First quarter operating expenses increased 9% compared to the first quarter of 2021 the.
The year over year increase in operating expenses was driven primarily by a 12% increase in SG&A expense, partially offset by a 3% decrease in R&D expense.
Compared to the prior year period.
The increase in SG&A expense was primarily due to higher selling expense, including commissions and bonus expense on the increase in sales year over year. The decrease in R&D expense was driven primarily by lower manufacturing R&D expenses, partially offset by increased clinical expenses for certain R&D projects, including clinical trials for our <unk>.
Microspheres and Rhapsody Endo prosthesis.
Projects total operating income in the first quarter increased 1.4 million or 4% year over year to $40 2 million.
Our operating margin for Q1 was 14, 6% compared to 15, 6% in the prior year period.
The year over year change in operating margin was driven primarily by the 151 basis point decline in our non-GAAP gross margin offset partially by a 50 basis point reduction in our non-GAAP operating expense margin compared to the prior year period.
First quarter other expense net.
Was approximately 900000.
Compared to $1 3 million last year the.
The change in other expense net was primarily related to decreased interest expense as a result of lower average debt balance despite a higher effective interest rate.
First quarter net income was $30 4 million or <unk> 53 per share compared to $29 9 million or <unk> 52 per share in the prior year period.
We are very pleased with our profitability performance in the first quarter, where we reported year over year growth in non-GAAP net income and diluted earnings per share. Despite the incremental pressure on our gross margin and a higher than expected tax rate in the period.
Turning to a review of our balance sheet and financial condition as of March 31, 2022, we had cash on hand of $55 8 million.
Long term debt obligations of approximately $253 million and available borrowing capacity of approximately $475 million.
This compares to cash on hand of $67 8 million long term debt obligations of approximately $243 million and available borrowing capacity of approximately $490 million as of December 31 2021.
Our net leverage ratios as of March 31st was one times on an adjusted basis.
With respect to our cash flow generation in the first quarter.
As expected our use of cash for working capital increased compared to the prior year period.
In recent quarters, we have discussed our strategy to proactively invest in our inventory balances to build the requisite safety stock and ensure high customer service levels. This.
This strategy represented roughly one third of our total working capital use of cash in the first quarter their largest use of cash in working capital. This quarter came from items that were essentially timing related and thus were unique to Q1 and are not expected to impact future quarters, specifically cash used and accrued expenses totaled 23 point.
5 million consisting of approximately $18 3 million for the settlement payment related to the consolidated Securities class action lawsuit with a balance of accrued expenses use of cash related to payments of payroll related bonuses.
We continue to expect strong free cash flow generation this year and our target of approximately 75 million of free cash flow in 2022 remains unchanged of note. This free cash flow target assumes planned investments related to the foundations for growth program that are expected to drive our capex investment in the range of $55 million to $60 million in 2022.
Yeah.
Turning to a review our fiscal year 2022 financial guidance, which we reaffirmed in todays press release for the 12 months ended December 31, 2022, we continue to expect GAAP net revenue growth of approximately 4% to 6% year over year.
This GAAP net revenue range assumes a headwind from the changes in foreign currency exchange rates in the range of approximately 3 million to $3 5 million, representing a headwind of approximately 30 basis points to our forecasted GAAP growth rate this year.
The GAAP net revenue guidance range also assumes net revenue from growth of approximately 4% to 6% in the cardiovascular segment and net revenue from growth of approximately 6% to 8% year over year in endoscopy segment.
With respect to profitability guidance for 2022 we continue to expect GAAP net income in the range of $75 4 million to 84 point.
The $84 million or $1 30 to $1.45 per diluted share non-GAAP net income in the range of $140 million to $148 7 million or $2.41 to $2.56 per diluted share.
For modeling purposes, our fiscal year 2022 financial guidance continues to assume non-GAAP gross margins in a range of approximately 51% to 56% compared to 49, 3% in fiscal year 2021 .
non-GAAP operating margins in a range of approximately 16, 6% to 17, 3% compared to 16% in fiscal year 2021 .
non-GAAP other expense of approximately $6 million.
And diluted shares outstanding of approximately $58 million.
Of note, we have updated our assumptions for full year 2022 tax rate to a range of 22% to 23% versus 22% previously discussed.
Lastly, given the continued uncertainty in the global macro environment, we would like to provide additional transparency related to our growth and profitability expectations for the second quarter of 2022, specifically, we expect our total revenue to be in the range of approximately a 1% decrease to an approximate 1% ish.
Increase year over year on a GAAP basis, and approximately flat to up to 2% increase year over year on a constant currency basis in the second quarter of 2022.
Our growth expectations for the second quarter of 2022 reflects two items of note.
<unk>.
Our revenue increased 28% year over year in the second quarter of 2021, driven by 34% increase in the U S and 21% increase.
Our growth in international markets.
We expect sales of endoscopy devices to decrease approximately 20% to 22% year over year in the second quarter as we are managing through some business disruption related to issues with a third party contract manufacturer.
We view this disruption is transitory and expect to return to normalized growth trends in the second half of 2022.
With respect to our profitability expectations for the second quarter, we expect to see improving non-GAAP gross margin trends offset by low to mid single digit growth in non-GAAP operating expenses compared to the prior year period. The modest decline in non-GAAP operating margin combined with a higher tax rate is expected to drive an approximate 5% to 10% decline.
Our non-GAAP net income and EPS.
With that I'll turn the call back to Fred.
Oh, Thank you in closing the.
Despite the challenging operating environment in quarter one.
We are proud that we were able to deliver revenue results that exceeded our guidance.
We are confident in our 2022 guidance, which calls for total revenue growth on a constant currency basis.
46% year over year.
We expect to see progressive improvement in our operating environment, specifically access to patients in elective procedures over the first half of 2022 .
We also continue to expect to report improving non-GAAP gross and operating margins and strong free cash flow in 2022, driven by strong execution and contributions from our multi year strategic initiatives related to the foundations for growth program.
The benefits from this program are helping us to navigate the inflationary environment well.
And while we have avoided material business impacts related to global supply change disruptions to date. This is something we are watching closely as.
As more and more companies are struggling in this area.
Our team continues to execute well and remains focused on our strategic initiatives, while standing ready to adapt quickly to changes in our markets.
We would like to thank all of the team members around the world that made our performance in the first quarter possible.
Now that wraps up our prepared remarks, and we'll turn the time back over to our administrator and open up the line for questions.
Thank you, Sir if you'd like to ask a question. Please signal by pressing star one on your telephone keypad, if you're using a speaker phone. Please make sure. Your mute function is turned off to allow your signal to reach our equipment we do.
Ask that you limit yourself to one question and one follow up if you would like to ask additional questions. We invite you to add yourself to the queue again by pressing star one.
And our first question will come from Jason Bedford with Raymond James You May proceed with your question.
Good afternoon, and thanks for taking the question. So I'll ask two fundamental questions. So first on gross margin I. Appreciate some of the year over year dynamics, but can you just walk us through some of the sequential dynamics, meaning.
Fourth quarter revenue similar actually to the first quarter here, but but carried a higher gross margin I'm. Just wondering if you could walk through kind of the difference there between the gross margin for Q1 two.
Yeah, I think first of all Jason there's a level of seasonality.
From Q4 to Q1 that you have to kind of account for them just as we do the shutdown in December we ramp up production in and in January .
One of the primary things or maybe that exaggerated that was the absenteeism that we saw from omni crime in January which drove unfavorable manufacturing variances.
Obviously, the higher freight costs and higher obsolescence.
Lessons expense.
As it relates to the prior year or two you know had an impact but you know on.
On the plus side. It was it was offset partially offset by by good product mix. So again I think it was ASIC as expected you know the Omnicom. Obviously, you know maybe it was a little bit more exaggerated than we had hoped but nevertheless, I think we saw sequential improvement.
With January being the worst and then it just got better from there with a strong March.
Okay. That's helpful. And then just wanted to ask kind of a broad question on the pipeline and new product flow. It seems like there's been a few more releases out there from merit on new product flow can you walk through some of the new products that you would highlight either that have recently been launched or that are upcoming.
Yeah, Jason. Thank you you know we introduced a power costs to meet Trey that has about 80% of the products in there our merit are made.
Good.
And there's a participant in the marketplace.
That has not been able to deliver.
And merit had the products we developed a.
About for Newmont Forex.
All of that internally and we're able to turn that project around relatively quickly and then we are we felt that the opportunity just opened out so.
You know we did a press release on that and it served two purposes.
And of course, let's say the community now, but more importantly is that the industry now and a lot of these things getting picked up by hospitals and think you know and different administrators.
Administrators, and so that actually helped to drive sales.
So that would be one of them and one that we're spending a lot of time on a ramping up because we think it has a big opportunity.
Yeah, there are other products and we have a full pipeline for this year some of the products very candidly that were introduced in during the beginning of Covid never really got a fair shot so things like our valve fountain catheter are now out there and that's picking up interest.
And particularly in treating pulmonary embolus, which are a function of a number of patients. Let me see what else I know that we have quite a roll out.
Just say that generally we're trying to do a better job of.
Letting.
People know that we've launched new products and it's just it's just part of our FFG initiative as part of communications and we're going to try and be more active in that from that standpoint, we'll keep doing it yet so.
There you go.
Thanks, guys I'll get back in queue. Okay. Thanks.
Thank you. Our next question comes from Jason Bednar with Piper Sandler You May proceed with your question.
Hey, guys. Good afternoon. This is drew on for Jason Thanks for taking the questions and congrats on a nice quarter here.
Thank you.
I do want to start off on the guidance here you know you posted a nice beat on the top and the bottom even offsetting a pretty sizable impact to the gross margin.
So maybe you could just walk us through the decision not to raise either component today, and maybe what I'm kind of curious like getting at here is if you strip out some of the smaller pressures.
Maybe the lockdown in China and currency do you think you would have raised the guidance. This afternoon or are the pressures on supply chain likely to be sticky enough where that probably not the case.
You know I think for US you know if you remember last year, we got off to a hot start in Q1, and we decided to wait until after Q2 to really revisit our guidance I think the same applies this year one quarters, one quarter, we'd like to get at least the second quarter out of the way and then see where we're at and see what else is brewing.
Out there and then.
Revised guidance if needed, but I think we feel optimistic about the business you know things are going well.
That's really I think.
From my standpoint patients as our best friend right now, especially in this environment.
Okay, that's very helpful.
And then you know theres been a couple of public reports about private market interest and merits and somewhat specifics identified regarding prices and announcement dates and that kind of thing I'm sure you can't comment specifically on those reports, but just wondering if you can speak to how you and the board balance.
Opportunities of both near and long term shareholder value creation. Thank you.
Okay. Yeah. Thank you I think the biggest program for merit right now too to enhance shareholder value as our foundation for growth, that's where we spend our time on that's where.
Candidly, where the compensation is aligned with the objectives and so that's where we spend.
Our time, and where we think the greatest and we've seen that many of the evidenced empirical evidence of of that has been the performance of the company over the last few years in terms of rumors we simply do not comment on them. We are publicly held and you know that you know and.
And so as we have a fiduciary responsibility, but other than that that's the same thing that I've been saying for.
30 years.
So that's I think the best way to answer that question.
Thank you.
Thank you Sir.
Thank you. Our next question comes from Larry Biegel said with Wells Fargo. You May proceed with your question.
Good afternoon, and thanks for taking the question and I'll Oh Echo the earlier congratulations on a nice quarter here, Fred and Raul.
<unk>.
Just a few for me here on Fred I'm surprised we haven't gotten to China, yet given.
Given that it's a pretty big part of your business, but what are you seeing on the ground there.
How how much of procedures down in your view right now given the lockdown we've heard other companies say, maybe you know down 20% right now and what are your expectations for the second quarter Yeah.
Larry We don't comment on them are what I will say that we grew at I think 27% in the first quarter. We know the issues are out there we haven't seen direct situations in Beijing, and Joe Wright, who has is our chief commercial officer, Joe do you want to quickly comment.
Yeah, we've seen of course, the lockdowns in Shanghai, and that's impacting the business, but we haven't yet seen that spread so we're confident that our.
R.
Our forecast is included in the in the budget.
And Robert do you want to quickly comment on it yes, I mean, if you look at our guidance.
Obviously assumes that.
Material is a material driver to our mid to mid to high single digit growth in the APAC region.
But we're not going to provide country specific growth assumptions.
Specifically to that other than to say, we provided Q2 total revenue growth expectations today, which includes our near term expectations in the APAC region, China included and previously we thought volume based purchase purchasing tenders would begin in April that's what we said in our Q4 call now expected to begin.
And probably may or June .
We remain committed in China long term and you know.
Introducing new products, expanding our reach and deeper into the Midland territories.
We remain pretty confident in our long term growth in China.
That's helpful.
Just for my follow up here just on inflation, you know how how much incremental inflation do you think you're absorbing this year versus say the last time you guided how how are you offsetting that and I'm just trying to understand you know how we get from the you know the 47.7 I think percent gross margin in the first quarter two.
Relative to the guidance you gave of 51 to 50.6 kind of how do you what what gets better from here. Thanks for taking the questions.
Yeah, well look I think when we when we when we guided you know I R.
Our we did call out a headwind of approximately 120 basis points of inflationary costs in our guidance Larry.
As you can see our gross margin on the low end was 90% 90 basis points. So we tempered that too, but you know we've got a lot of foundations for growth initiatives that I think continue to you know.
Help our gross margin not only in currently but in the future I mean, theres just a lot of work we called out in our opening remarks over 40 initiatives a big portion of those are in the cost of goods sold line. So.
Despite the inflationary headwinds that we're seeing that and despite the 120 basis points, we baked in we're still on the low end you know looking to expand gross margins by 90 basis points and so I think it will just get better from here and that's the way we've planned for it Fred do you want to say just on the other side I think our pricing initiatives are really.
Really important where as part of our foundation for growth we brought on a fellow but I worked for a major company and Larry I think.
That ability to really look at pricing, where we sit in the marketplace.
Where we think there are the opportunities.
I think I've said it before so and that is we've seen probably a better chance to look at increased prices.
Over our inflationary pressures and and I think the pricing part of it is a big part in it we'll talk about that sometime in the future.
That's very helpful. Thank you.
Thank you. Our next question comes from Mike mentioned with Needham You May proceed with your question.
Yeah, Thanks for taking my questions.
I guess I wanted to start with the currency headwind that youre expecting it seems a little smaller than what we've heard clean somebody who some of the larger med tech companies with similar international exposure.
That maybe because youre doing more of your international business in U S dollars or you are you hedged somehow you know maybe the 30 basis points I mean like Boston scientific today I think it was got into like a 200 basis points headwind. This year for example.
Yeah, I mean look I'm sitting across here from Travis and I'm letting them get warmed up here because I'm gonna let him answer his first question never but.
No.
Just just to call out you know Travis does an excellent job with our hedging you know.
No policies and the work that he does and there is some dynamics, obviously that helps us just because of where we do business that help offset things, but Travis do you want to give them a little bit of color and flavor for what you are looking at so you're absolutely right. It's a currency mix, it's a geographical issue of where we sell product and where we're seeing headwinds and we weren't necessarily seen tailwind.
Relative to the prior period.
So we have a mindset as well as obviously the derivative program that we have in place.
Okay got it.
And then I think you made a comment about procedure growth in March being particularly strong.
So what I'm wondering is there.
Is there something going on where we're actually starting to see some sort of backlog benefit here.
March and April .
And I guess, the U S and in Europe .
Yep.
Mike This is Fred I saw a report recently that talked about procedures being at 106%.
Something I mean, we are seeing more access from our salespeople all the time and its improvement, particularly in the U S and to a lesser extent Europe , but we are seeing that and you know whether it's a back log whether it's I you know.
That I don't know, but just strictly from a procedure or salespeople get more access and there's the need out there. So I think it's a that's the essence of what we see yes, I would just say overall the environment is just improved.
U S was very strong.
This last quarter so.
Okay got it thanks.
Hey.
Thank you. Our next question comes from Jim Sidoti with Sidoti You May proceed with your question.
Hi, good afternoon, thanks for taking the questions.
I just wanted to push you a little bit on your pricing power.
When do you typically raise prices and.
You've done a good job on the gross margin.
You've seen some SG&A costs go up.
You think you'd be able to offset that in the second half of this year with a price increase yes, Jim. We you know we generally don't talk about timing and then I will say that many of the things that we're looking at a time, where some of the national accounts, we have and when they come off and Dave's fat and the other is complex and thats something that Brandon.
That you know the fellow that came into our pricing guy. So it's a long term program, but nevertheless, the point is is not that theres. Some magical thing that happens in the second half. It's a program that we have that's going to be going on in all of our products in the future. Both in terms of introduction prices, where we sit in the marketplace.
Each market and how pricing effects all of this so it's an ongoing program.
That will be very consistent and something that will help our marketing and salespeople.
Going forward, but it's but I think it's very important to our foundation for growth and that's where it comes from and that's another really important point.
And then you know.
Your guidance for free cash flow you know it sounds like it'll be another strong year.
Do you anticipate continuing to use that to pay down debt or would you consider other options for the use of cash.
Well I'll answer it but you know whenever I look at our.
Raul I'm, he loves cash and and the first usage will add to and to keep and pay off our debt is the first thing where we'd look first and.
It gives us plenty of power, we see the markets. We see decreases in we started today. We started yesterday. So I think it's the first time, we've seen that there starts to be a little bit of light in terms of opportunities and so I think merits in a very good place and looking at those for the future. So to pay off debt has been consistent with what.
What we've done for the last couple of years, Yeah, and I think one of the things we're going to do this this year. Jim is again I think we have room on the working capital side.
So we're taking advantage of that making sure we have the right inventory levels again, I think we've been you know.
Very lucky and been able to manage through the kind of the logistics and supply chain issues, but nevertheless, we want to make sure that our operations group has a little bit of rope to purchase additional inventory. So we can kind of continue to meet the customer demands that we're seeing out there. So you know.
We will use some of that for working capital and the rest, we'll pay down debt unless something comes our way.
And you talked about an increase in Capex spending is that primarily for utilities here in the U S or outside the U S.
You know, we typically say that roughly $35 million of it is typical maintenance and R&D projects and then the rest would be related to the foundations for growth and we do have an expansion going on in in Mexico for additional clean room space for some of the product line transfers that we're doing.
We're also adding capacity in venlo for some of our R. R.
Coatings coatings projects. Thank you Fred.
So there is a little bit of building going on but again I think we've done the big things and you know.
Historically you guys do you guys know that so it's just incremental investments that we're making at this point.
Thank you.
Thanks, Jim.
Thank you. Our next question comes from Steven Lichtman with Oppenheimer. You May proceed with your question.
Thank you evening guys.
On.
China I think you mentioned for value based purchasing you are expecting a slight Li later.
Timing of that but is that two firmed and if it is confirmed as the.
Expected impact about in line with what you had thought going into the year.
Listen this is anything that we talk about comments from our field sales force and there you know and they're the ones that fetus the information based on what they see on the ground. So that's always where the information come from.
And it's been I think very reliable over the years and so that's that's what it's based on what information we have today.
But as you know China is not the easiest place. So we rely on those guys and they've guided us I think property for a number of years.
Okay, Alright got it.
And then just on tax rate, obviously I assume that the.
Slightly higher rates due to next role of geographic mix and yeah.
I've asked you this a number of times over the years, but what are your latest thoughts in terms of potential too.
We get some leverage there.
Yeah.
We baked in some stock option exercises this year.
You know as you know, we typically guide to a higher rate typically 24% to 25%. This year, we baked in a little bit of stock option benefit just because given historically, we've had more exercises in our tax rate is.
As you know pretty low I think last year was around 18%. So this year, we did bake in a little bit more of.
Of those exercises.
And we just didn't have as many as we had thought in the first quarter and it's all timing related.
And so I think we just took it up a little bit just to account for some of those exercises that we were expecting that just didn't come through.
At least in the first quarter at least in the first quarter, yes, who knows where.
The market.
We live with it every day like you guys.
And just big picture I will you know in terms of language of that line nothing really changes.
So okay good thoughts.
On opportunities there.
I think I missed that first part of the question I.
I heard the leverage of the tax.
On the tax rate line leverage opportunities to bring that you know, we keep having conversations you know with our tax advisors and end.
It's just hard in the current environment, because there is no stability in Congress.
And.
It's hard to plan for something that might change in three years two years.
I mean.
Six months, maybe even right. So it's it's.
We've had initial discussions I know, Mike ball or cheaper.
Chief of accounting has had discussions with with.
With our tax advisers on things that we can do but.
Honestly, it's me right now kind of hesitant to do anything given the environment that we're in.
Got it okay. Thanks, guys.
You bet. Thank you.
Thank you and as a reminder to ask a question you will need to press star one on your telephone. Our next question comes from Bill <unk> with Canaccord. You May proceed with your question.
Great. Thanks, Good evening. Thanks for taking my question. My first is just on the Endo units. The third party manufacturing issues you spoke of looks to me by the $2 million impact in the quarter. What gives you confidence that this won't bleed into the third quarter or fourth quarter.
Yeah.
We've transferred half of that business are on one of the segments already and we have confidence in our new provider, which is a U S company and they are the same folks that are bringing up the second half and replacing a European vendor should we have confidence in them that.
That's why we had a you know a good.
Good relatively first quarter, because we were able to pick up the stuff in the past so we're confident in their ability.
They delivered on everything they said they were going to do and so that's why we're confident on the latter half of the year, where we're engaged in it we're transferring as we speak and Unfortunately, we were disappointed probably one of our other vendors, but we've we've felt that or at least.
We have identified and we're working on it and we should be back in the market by their own solution.
Okay, great. Thanks, and then how much was rolled the impact of obsolescence in the quarter.
Oh, let me just pull that up here.
And while Youre looking for that just is I think I'm going to go back to the FX question. I think you were saying the guide is three to three and a half million dollars in the year based on a 1% hit to the second quarter Youre at three and a half million through the first six months do you expect to benefit as we exit the four in the fourth quarter.
I would expect another negative hit in the third quarter, you would have to have a positive to offset it in the fourth quarter I'm trying to do the math on this.
Yeah I.
I guess I missed that.
You might have answered it travels I'm traveling so I was looking for this number one I missed the first part of the question. Yes. That's correct again, you have to you have to take.
Take into context.
We're certain currencies, where at the end of last year, but yes that is correct yes.
Okay. So the obsolescence.
There's about 100 basis points.
Okay.
And then.
Actually that's all my questions. Thanks, great. Thank you.
Thanks.
Okay.
Thank you and that concludes our Q&A session I would now like to turn the call over to Mr. Fred <unk>.
Propolis for any closing remarks.
Yes, thank you very much ladies and gentlemen, thank you for your time today.
We look forward to reporting back on our results and our progress will be available over the next several hours.
I have to travel to another meeting and solve for those a little bit on that call I will be calling in as well and Raul will be holding down the ship.
On those calls and we look forward to clarifying again. Thank you very much for your interest in the company and I will look forward to talking to you again soon signing off from Salt Lake City.
Good evening. Thank you.
Thank you that does conclude our conference call for today. Thank you for your participation.
[music].
Yes.
Hum.
[music].
Yes.
Hum.
[music].