Q2 2023 Merit Medical Systems Inc Earnings Call
Please standby.
Welcome to the second quarter of fiscal year 'twenty to 'twenty three earnings conference call for Merit Medical Systems, Inc.
At this time, all participants have been placed in a listen only mode. Please.
Please note that this conference call is being recorded and that's a recording will be available on the company's website for replay shortly.
I would now like to turn the call over to Mr. Fred Lin Propolis Merit Medical systems, founder Chairman and Chief Executive Officer. Please go ahead Sir.
Thank you and welcome everyone to Merit Medical's second quarter of fiscal year 2023 earnings Conference call.
Brian would you mind, taking us through the safe Harbor statements.
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.
The 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 July 25 2023.
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 sections entitled cautionary statement regarding forward looking statements in today's press release and 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 sections of our press release and 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 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.
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 let me start with a brief agenda of what we will cover during our prepared remarks.
I will start with an overview of our revenue results for the second quarter. After my opening remarks, Rob will provide you with a more in depth review of our quarterly financial results and the formal financial guidance for 2023 that we updated in today's press release as well as a summary of our balance sheet and financial condition.
As of June 32023.
We will then open the call for your questions.
Now beginning with a review of our second quarter revenue performance, we reported total GAAP revenue of $321 million in the second quarter up 9% year over year. Our total GAAP revenue growth was driven by 9% growth in U S sales.
8% growth and international sales are.
Our total revenue increased nine 1% year over year in the second quarter on an organic constant currency basis, excluding the headwind to our GAAP revenue growth related to changes in exchange rates compared to the prior year period.
And contribution from the two acquisitions, we announced on June eight 2023.
Our second quarter revenue results were notably stronger than the growth expectations that we outlined in our quarter. One earnings call specifically, we shared our expectations for organic constant currency revenue growth in the range of 5% to 7% year over year in quarter two.
Let me now provide you with a more detailed review of our revenue results in the second quarter, beginning with our sales performance in each of our primary reportable product categories.
Note that unless otherwise stated all growth rates are approximated and are on a year over year and constant currency basis.
We have included reconciliations from our GAAP reported results to the related non-GAAP item in our press release and presentation are available on our website.
Second quarter total revenue was driven by 9% growth in our cardiovascular segment and 6% growth in our endoscopy segment.
Constant currency growth exceeded the high end of our expectations in our cardiovascular segment, while endoscopy sales were softer than expected in the second quarter.
Sales of our peripheral intervention products increased 14%, representing the largest driver of total cardiovascular segment growth again this quarter.
Within the PDI product category sales of our access radar localization embolic products increased 19%.
And together represented nearly 60% of total pie growth year over year.
And sales of our Green region, and geography products increased 12%.
And together represented roughly one quarter of our total pie growth.
In quarter two.
We are proud of the continued strong performance across a number of key products and RPI category.
So I would be remiss, if I didn't call out the largest contributor to our total pie growth again quarter to our highly differentiated scout radar localization product line.
We have been pleased with the market response to our scout many refractory as well during the first full year post commercial launch.
Continuing on with the discussion of our quarter two revenue growth drivers sales of both our cardiac intervention products and our OEM products were key contributors to our total cardiovascular segment growth this quarter, increasing 6% and 14% year over year, respectively.
Sales of our access and our EP CRM products increased in the mid single digit, which offset low single digit declines of our intervention products.
Sales of our OEM products exceeded the high end of our growth expectations, which we attributed principally to continued improving demand from larger customers in multiple categories, including AP, CRM coatings, and kitchen products, which together increased 50% year over year.
Quarter to.
Importantly, <unk> demonstrated ability to meet this growing demand is a key driver of this track record of growth.
Sales of our custom procedural solutions products increased 1%, which was notably better than the mid to high single digit declines we expected in quarter two.
This upside was driven primarily by stronger than expected demand of our Cps products from U S customers, which offset mid single digit declines in our sales of our Cps products to customers outside the U S.
Finally sales in our endoscopy segment increased 6%.
Is below the growth range, we assumed in our second quarter guidance.
While we are pleased to see the underlying growth trends in our endoscopy business improve in quarter. One as expected endoscopy results continued to experience business disruption as we continue to navigate material shortages supply chain constraints and work on qualifications for a new win new vendor.
As discussed during our quarter one call, we had anticipated improving trends as we move through the year and mid teens growth for our endoscopy business in 2023.
Our updated guidance reflects reflects the softer than expected sales results in quarter, two and we are cautiously optimistic that we will continue to see improving trends and mid teens growth in our endoscopy business in the second half of 2023.
Now turning to a brief summary of our sales performance on a geographic basis, our second quarter sales in the U S increased 9% year over year.
Our U S growth performance reflects continued strong execution and overall improving trends in the U S market during the second quarter, particularly in our direct business during the months of May and June .
International sales increased 10% year over year exceeding the high end of our expectations in the quarter.
APAC was the primary driver of the better than expected results.
Both the EMEA and rest of world regions were at the upper end of our growth expectations in quarter two.
APAC growth was driven by sales in China, which increased 23% year over year as the improving trends in March that we discussed on our quarter one call continued into the second quarter.
In summary, we are extremely pleased with the strong execution in the second quarter and throughout the first half of 2023, the overall environment remains challenging but it is improving overall and our team is executing well and remained focused on our multiyear strategic plan.
With respect to our financial performance in the second quarter. We believe the results continue to demonstrate that the team's hard work and commitment to our foundation for growth program are paying off.
non-GAAP gross and operating margins of 51, 4% and 19, 9%, respectively for the quarter and 58 and $18 one for the first half of 'twenty three.
Impressive improvements in our profitability.
While we are not losing focus and we remain confident in our team's ability to deliver our financial guidance for fiscal year 2023, and continued progress in the three year.
Three of our foundation for growth program and the related financial targets for the three year period ended December 31 2023.
Now before turning the time of the call over to Raul I would like to take a few moments discussing the strategic acquisitions, which we announced last month.
On June eight we announced two acquisitions. The first was a portfolio of dialysis catheter products and the bio century biopsy tract sealant system for managing our dynamics for a total cash consideration of $100 million.
Acquiring these assets broadens our therapeutic platforms.
It strengthens our position in the dialysis and biopsy markets and expands the foundations of our growing specialty dialysis device offering which includes the rhapsody selling <unk>.
<unk> prosthesis, the hero graft and the surface here inside out access catheter system.
Many dialysis patients rely on these solutions to receive vital therapies.
We believe that by combining this portfolio of interventional solutions within merit will allow us to leverage our physician relationships, our commercial infrastructure to serve more patients in the multibillion dollar dialysis market.
The acquired dialysis catheter portfolio includes the innovative bile flow duramax dialysis catheter with <unk> technology, a proprietary material more resistant to thrombus accumulation in vitro compared to conventional non coated dialysis catheters.
Rhombus formation can block blood flow through a catheter preventing adequate dialysis treatment.
In addition to the dialysis portfolio. We also acquired Angio dynamics Biocentric biopsy crack sealant system, which again, we believe strengthens our position in the biopsy market.
The <unk> is designed specifically to reduce the incidence of biopsy related pneumothorax newmont.
Pneumothorax as a potentially life threatening complication.
<unk> extended hospitalization occurs in approximately one quarter.
Patients undergoing lung biopsy.
The second acquisition, we announced was an asset purchase agreement completed in may to acquire the surface or inside out access catheter system from bluegrass vascular technologies for total cash consideration of $32 7 million.
Bluegrass vascular is a privately held company that merit knows well, having established an equity investment in the company and serving as the exclusive global distributor.
The system from 2016 through 2022.
The surface here is a unique device designed to obtain right cited central venous access in patients with various obstructions, providing this population with access to life saving therapies, including hemodialysis and chemotherapy.
Importantly, these acquisitions of assets from manager dynamics in bluegrass vascular are consistent with our stated objective to selectively invest to expand our product portfolio in key strategic markets that leverage our existing commercial footprint.
In addition to the strong strategic rationale we believe the financial profile of these acquisitions is compelling.
We expect these acquisitions to add approximately $30 million of revenue on an annualized basis and to be accretive to both our non-GAAP net income and non-GAAP earnings per share in the first full year post closing.
And accretive to our non-GAAP gross and operating margins non-GAAP net income and non-GAAP earnings per share in the second full year post closing.
The integration is underway and we expect to continue these assets to contribute approximately $13 million to $15 million of revenue in fiscal 2023.
With that said, let me turn the call over to Rob who will take you through a detailed review of our second quarter financial result.
And our 2023 financial guidance, which we updated in today's press release.
Sure.
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.
For the avoidance of doubt unless otherwise noted my commentary will focus on the Companys non-GAAP results during the second quarter of fiscal year 2023, we.
We have included reconciliations from our GAAP reported results to the related non-GAAP item in our press release and presentation are available on our website.
Gross profit increased approximately 13% year over year in the second quarter.
Our gross margin for the second quarter was 51, 4% compared to 49, 3% in the prior year period, representing the highest second quarter gross margin in the company's history.
The increase in gross margin year over year was primarily due to favorable changes in product mix improved freight and distribution expenses as well as other <unk> related efficiencies.
As expected our second quarter gross margins were impacted by the inflationary headwinds we are seeing in freight logistics labor and raw materials with respect to freight specifically, we're still seeing the headwinds to gross margin as expense are still higher than pre COVID-19, but freight expenses have significantly improved compared to the prior year period.
The 200 basis point increase in gross margins year over year exceeded the high end of the expectations, we outlined on our Q1 call, which called for gross margins to increase 70 to 130 basis points year over year due primarily to fixed cost leverage on the better than expected sales performance in the period.
Operating expenses increased 13% year over year in the second quarter the year over year increase in operating expenses was driven by a 14% increase in SG&A expense and an 8% increase in R&D expense compared to the prior year period.
The increase in SG&A expenses was primarily due to increased labor related costs associated with head count as well as increased travel and marketing costs to promote sales as restrictions continue to lift post pandemic.
Our operating expense performance in Q2 was better than expected and reflects strong operating leverage principally due to our continued focus on expense management and prioritization of investments to support our future growth initiatives.
Total operating income in the second quarter increased $7 1 million or 13% year over year to $63 6 million.
Our operating margin for Q2 was 19, 9% compared to 19, 1% in the prior year period.
70 basis point increase in operating margin was driven by a 200 basis point increase in our non-GAAP gross margin.
Offset partially by a 130 basis point increase in our non-GAAP opex margin compared to the prior year period.
Second quarter other expense net was $3 4 million compared to $1 $1 million last year. The change in other expense net was primarily related to an increase in interest expense associated with increased borrowings and rising interest rates increased expense associated with realized and unrealized foreign currency losses.
Second quarter net income was $47 6 million or <unk> 81 per share compared to $42 3 million or <unk> 73 per share in the prior year period.
We are pleased with our profitability performance in the second quarter, where we delivered 13% growth year over year, and non-GAAP net income and 11% growth year over year and non-GAAP diluted earnings per share exceeding the high end of our expectations.
Turning to a review of our balance sheet and financial condition.
As of June 32023, we had cash and cash equivalents of $72 1 million total debt obligations of $340 million and available borrowing capacity of approximately $507 million compared to cash and cash equivalents of $58 4 million total debt obligations of $198 2 million in available borrowing capacity of approximately <unk>.
$523 million as of December 31, 2022.
Our net leverage ratio as of June 30 was one two times on an adjusted basis.
We generated $11 5 million of free cash flow in the second quarter cash from operations decreased 55% year over year in the second quarter is a strong improvement in GAAP net income year over year was offset by a material increase year over year and use of cash for working capital.
There were two primary drivers of the increase in working capital year over year, one that we have talked about in recent quarters. The other is nonrecurring in nature.
Specifically the increase in second quarter working capital use was due in part to a decrease in accrued expenses related to payment of the final siano medical milestone payment of $13 3 million.
<unk> 5 million of which impacted operating and free cash flow in the period.
This is a result of an accounting rule that requires treatment of this specific final payment as cash flow from operations versus cash flow from financing.
The other notable driver of working capital use in Q2 was related to the strategy. We have discussed on prior calls to proactively invest in our inventory balances to build a requisite safety stock and ensure high customer service levels.
We continue to expect to generate strong free cash flow generation in 2023, the majority of which we continue to expect will be generated over the second half of the year.
Turning to a review of our fiscal year 2023 financial guidance, which we updated in today's press release. We have included a table in our earnings press release, which details the updated ranges for each of our formal financial guidance items and how those ranges compared to the prior year period.
We continue to expect GAAP net revenue growth of approximately seven two.
Two 8% year over year.
The GAAP net revenue guidance range now assumes net revenue growth of approximately 7% to 8% in our cardiovascular segment.
Net revenue growth of approximately 12% to 13% in our endoscopy segment.
A headwind from changes in foreign currency exchange rates of approximately $4 million.
Excluding the impact of changes in foreign currency exchange rates, we expect total net revenue growth on a constant currency basis in a range of seven 3% to eight 5% year over year in 2023.
Note the midpoint of this range now assumes approximately 9% growth year over year in the U S and approximately 6% growth year over year in international markets compared to 6% and 7% respectively assumed in the guidance provided on our first quarter earnings call.
The higher U S constant currency growth expectation versus prior guidance reflects the stronger than expected second quarter results and the anticipated contributions from the aforementioned acquisitions.
The lower international constant currency growth expectations versus prior guidance is driven by the EMEA and APAC regions, specifically in Russia, and China, we have revised our outlook for sales in Russia over the second half of 2023 in response to department of Commerce's announcement in late May that they are extremely new and existing sanctions under the export <unk>.
Ministration regulations against Russia, and Belarus, the additional rules and approval process defined by the department of Commerce has challenged our ability to meet our revenue expectations. In these countries versus what we had assumed in our original guidance for 2023.
With respect to China sales results have modestly exceeded expectations over the first half of 2023. However, we have moderated our growth expectations in China for the second half of 2023, as we expect headwinds to growth related to recently announce VP programs later this year.
Our total net revenue guidance continues to assume contributions from the acquisition announced on June eight 2023 from their respective closing dates through December 31, 2023 in the range of $13 million to $15 million.
Excluding revenue from these acquisitions our guidance reflects total net revenue growth on a constant currency organic basis in the range of approximately 6% to 7% year over year.
With respect to profitability guidance for 2023.
We have updated our GAAP net income and diluted earnings per share ranges of $2 $76 million to $81 million and $1 30 to $1 39, compared to 87 million to $92 million and $1 49 to $1 57 per diluted share previously.
Our non-GAAP net income and diluted earnings per share ranges remain unchanged.
For modeling purposes, our fiscal year 2023 financial guidance now assumes non-GAAP gross margins in the range of approximately 57% to 59% up 200 to 220 basis points year over year.
non-GAAP operating margin in the range of approximately <unk>.
18% to 18, 2% up 110 to 130 basis points year over year.
GAAP other expense of approximately $13 million compared to $6 million previously and non-GAAP other expense in the range of $11 million to $12 million compared to approximately $6 6 million previously the increase in both ranges is primarily related to higher interest expense on incremental borrowings related to acquisitions.
In June 2023.
non-GAAP tax rate in the range of 21% to 22% compared to 21, 5% to 22, 5% previously and diluted shares outstanding of approximately $58 5 million.
Lastly, we would like to provide additional transparency related to our growth and profitability expectations for the third quarter of 2023, specifically.
Specifically, we expect our total revenue to increase in the range of approximately $5 five to seven 5% year over year on a GAAP basis, and up approximately 5% to 7% year over year on a constant currency basis.
The midpoint of our third quarter constant currency sales growth expectations assumes approximately eight 5% growth year over year in the U S.
With respect to our profitability expectations for the third quarter, we expect non-GAAP gross margins in the range of approximately 53% to 56% up 190 to 220 basis points year over year non-GAAP operating margins in a range of approximately 16, 6% to 17, 1% up 50 to 100 basis points year over year.
Are these.
These margin expectations combined with the higher interest expense year over year are expected to drive a year over year change in non-GAAP EPS in the range of down 5% year over year on the low end to up 3% year over year on the high end of the range.
That wraps up our prepared remarks, operator, we would now like to open up the lines for questions.
Thank you Sir if you would like to ask a question. Please signal by pressing star one 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 <unk>.
And one follow up.
I would like to ask additional questions. We invite you to add yourself into the queue again again by pressing star one one.
Okay.
Please standby for your first question.
Which comes from the line of.
Steve Lichtman of Oppenheimer <unk> company.
Thank you evening guys.
Hey, I guess first question on the on the Andrew dynamics product acquisition.
Wondering if you could talk about sort of the early feedback from the field and what you see as the key opportunities to accelerate key sort of underlying growth of those products now under the Marriott umbrella.
Steve This is Fred and thanks for the question first of all the strategy has always been debatable to strengthen and get ready for the Rhapsody.
Which will be around here.
In the near future and to take a look at the surface, where the hero and then how all of those products and then to align our sales force.
Along with that and be prepared for it so that is the basic.
Our thinking.
And we think it sound.
We wouldn't have done the deal. We also are of course transferring the product to Mexico, and we have the guy that did our becton Dickinson deal, Greg <unk>, who is sitting in the room with us.
He is running that program. So I think that it's an area that we know our customers.
Our I think 99% or 98% were existing customers.
So we feel strongly I think the program is coming along as planned.
And going to the question of growth.
And without criticizing anybody else essentially on the biopsy side, there was one product sold in Europe .
From the company, we bought it from from NGL Merit has a broad direct sales force all of it is all distribution.
And very candidly.
It's something that we felt like we now have that full portfolio, which I had to say by the way.
That nobody else has.
To be able to have the peritoneal.
The acute the chronic.
Surface here the hero the Rhapsody, I mean, who wouldn't want to have that so the positive thing I think from customers is we love having all these pieces and all of the access part of it and and we appreciate it we've reached at palace customers, we weren't order to cash almost immediately and where the.
Process.
Now transitioning over to our facility in Mexico. So I think we continue to be optimistic about the opportunity and the ability to use this product to get growth out of it because youre right. It was something that unfortunately for them. They didn't do it they just didn't focus for us.
It's an exciting opportunity one of the best I've seen in and we will look forward to reporting I think thats in the success of this in the future I hope that answers. Your question, yes. Thanks spread and then just secondly, following up on your comments on the end markets. Fred you talked about improving end markets.
So talk to another point about so some challenges out there having having come in better than expected here in the first half as.
As you look back what are the biggest improvements you've seen in the end markets here over the last six months plus.
What are still some of the challenges that you think you need to navigate.
Yeah, I'll hit a couple of days in Alaska role too to weigh in on this.
Listen I think the U S market.
As.
Doing fine there we continue to be challenges in other areas, but we still see growth across the entire gamut of our product lines you can see the numbers on OEM, where again reliability.
It becomes such an important factor people buy from us because they are reliable where reliable and and that goes a long ways. Other people have had shortages now we're not without headwinds and that sort of thing Rod. Let me give you a few minutes or seconds or whatever you want to just you want to comment on that yeah. No look I think we continue to be excited about the.
Our business, Steve Obviously had great results for Q2, I think when you look at the back half of the year.
The implied organic.
Constant currency revenue growth is 6% to 7%. We did I think it is important to call out that we did.
Let some of that beat flowed through into the U S market. So that growth is going to grow 7% to 8% versus the 6% to 7%. We previously had.
When you look at the international market there is still some some kind of noise out there.
We've accounted for it there which is why we didn't raise revenue guidance, but when you look at the international organic constant currency growth.
Approximately 5% to 7% versus a 7% to 8% and Thats really due to two specific issues. One was the EMEA kind of the Russia issue right there is different.
Requirements now to sell into Russia, which we've accounted for as part of our guide and then the APAC region. We got additional volume based purchasing out of China that will hit us in the fourth quarter of this year or could we haven't been very good at guessing this stuff, but it's accounted for in our forecast and so.
Those are really the two things we're excited about how the business is doing quite frankly, great.
Thanks, Fred enroll.
Thank you Sir.
Thank you.
Okay.
Our next question.
Comes from the line of Jayson Bedford of Raymond James.
Good morning, guys can you hear me.
Afternoon, guys can you hear me Okay. Yes, we can hear Jason is good to hear your voice. Thank you.
Two.
Just just picking up maybe on the on the China comment.
Strong <unk> imagine there was probably a bit of a catch up there, but I'm just more interested in the GBP commentary.
So the guide assumes an impact in the fourth quarter I guess I'm just curious.
Are these GBP programs in place now or is the guide reflects what you think may happen to announced GBP programs.
So.
They are announced VIP programs that debt.
The Chinese government has announced that will happen in the second half of 2023, Jason.
So.
As you know we did have an impact that we had already included in our guidance.
Okay.
Okay.
This is incremental to that so.
So again given that we had strong results we didn't really have to change our guidance just given that we had such strong beat that.
We're able to kind of maintain our guidance and it's reflected in our APAC number exactly well so in our model.
Okay and to be clear the expectation it starts in <unk>.
In the second half look I mean with China. It will change tomorrow, Jason I mean, I will just say the second half and I think that will account for any.
Any changes there.
Okay, and then just on the third quarter gross margin.
Very strong <unk> and I realize that I always I think trends down sequentially, but is there an impact from the acquired assets. It's weighing on the on the third quarter or fourth quarter GM for that model.
For the third quarter look it's all it's all in right. What we think is going to happen most of what Youre seeing is the impact from just reduced revenue we've got fixed.
Fixed costs that we have to cover.
And really that's what's driving it we always see a decrease in revenue in the third quarter. We always typically see a decline in the gross margin also and also in an operating margin and earnings for that matter. So.
As you know that Jason, but that's really what's driving those that impact.
Okay, and then just maybe last one for me in terms of endoscopy that was probably the only wrinkle I'd say <unk>.
Yes, I'll call it sounds like it's more of a supply issue than a demand issue.
Just the level of confidence here that you kind of have this fixed under control over the next quarter or two.
Jason We finished I think 80% I mean, we've got all the other things done and one of the units.
There is more work to be done and we just want to make sure. They are right. Yes. So the vendor we have absolute confidence in <unk>.
They have done extraordinary work.
And transferring this over I think we handle it as well as we could.
So and I think what last quarter was what 12 13, 14%, yes, I mean, I think really it's really just these final qualifications that were kind of waiting on Jason I think we have we have a pretty good robust plan.
And just this is one of the issues that Fred was talking about a little bit earlier with Steves question. We just kind of there is still this kind of noise out there with supply chain and just.
Availability of product and so as this is just one of US one of the areas that kind of hit US a lot of these little pick up there.
I hope that helps share by application.
It does thank you you bet.
Okay.
Thank you.
Our next question.
Comes from the line of Larry Nicholson of.
Wells Fargo.
Good afternoon. Thanks for taking my question and congrats on a nice quarter here.
Robert.
I have to admit I'm a little confused on the numbers I thought I heard you say the second half implied organic growth is six to seven.
Six to seven still organic for the full year.
Yes.
Okay, and so if it's six to seven for the full year and you did I think about $9 five in the first.
First half.
Tell me, if I'm wrong, but.
The second half implies about 4% is that right.
That's correct Larry It does it does go down sequentially, yes, okay.
So on the China, and Russia headwinds so Russia.
What percent of sales are from Russia for Merit and what is the implied impact.
In the second half guidance and on China could you tell us the same thing what which areas last time, you had a <unk> impact you told us how much it was and in what area. So can you tell us what you're assuming.
For China.
Amount and in what areas.
Yes, we're not going to give that detail Larry I think the last time, we did this was.
A year ago, and we spent.
The better part of that year, explaining $10 million I think you can just.
It.
It's implied in our guidance and it's 1% of the APAC growth change reflected in our in our guidance if that helps.
Okay, and Russia have you disclosed the percent of sales for Merit I cant remember again, yes, we won't disclose that.
It's baked into our guidance.
Okay got it.
Okay.
Fair enough Fred.
Brad I'm just curious what's your view.
Catch up of deferred procedures.
Some areas Youre seeing that does married have any areas that you think would benefit from procedures that were deferred during the pandemic.
And what are you assuming in the guidance. Thanks, Larry I think you stated it properly that is there are some areas I think I stated last time, we visited that.
Theyre, having problem staffing obl's, let's say in Texas.
In other areas.
<unk> been able to solve it so it's spotty, but higher but we do believe there is a lot of pent up demand out there.
Fair enough. Thanks for taking my questions you bet. Thank you. Thanks, Jason Thanks, Larry.
I'm looking at Jason.
Thank you.
Our next question.
Comes from the line of Jason Bednar Piper Sandler.
Hey, good afternoon, thanks for taking the questions and I'll Echo the congrats here on a strong result here.
Wanted to maybe follow up on one item of strength that we are just really stood out to us in the quarter and it's really for the first half of the year, but we'll focus on <unk> and.
And that was the gross margins and these arent just moving higher on a sequential basis, but you are hitting new record highs in gross margin, which is just really extremely impressive in this environment not a lot of companies can say that just given inflationary pressures.
I understand the guidance here for third quarter, but could you elaborate.
And maybe what's quantifying some of the contributors here that youre seeing in the second quarter on gross margins.
And also talk about your level of confidence in sustainability.
Those gross margin levels beyond this year.
Anything there and to what extent might go to consider additional upside that could materialize through additional pricing actions or benefits from this product line transfers to Mexico or anything like that.
Yes, Thanks look.
Great question, we expect strong gross margin expansion in 'twenty three.
Despite all the headwinds that are out there I think we were very vocal when we gave our initial guidance and we continue to be.
Happy with the way, it's progressing a lot of the contribution is really coming from our <unk> initiatives, which include pricing. It also includes.
Covering some of our fixed cost leverage.
And then tailwind to gross margin that we're really getting us.
The freight and logistics, which we've really focused on have been very vocal about making sure that we can get things back on the ocean.
As far as.
Beyond 2023.
We're not going to talk about that but as you can imagine things are.
We will continue to do work in those transfers and things continue to happen. So I'll leave it at that and you know I don't want to rehash. What you just said because I agree with it all but I think <unk> made a comment.
On our opening comments and that is it's working <unk> has worked and we're now just starting to see some of the benefits of that it's not you make a decision on overnight. It changes. It takes time for these things to work towards system and through our business and it's working and it will continue to work and then Jason The reason we've been so confident.
And the gross margin is because we've been working on some of these programs for not not a month or two years.
Certain cases.
<unk>.
Again, we still got another six months to go but the plan does call for for gross margin expansion.
Okay perfect that's really helpful guys.
Prehensile too.
And maybe to shift gears, a little bit the recent transaction, we executed with angio.
Looks like a fairly low risk move one that probably has some nice operating margin upside and also even revenue growth upside and you talked about earlier in the call.
On the deal glad to see Youre able to find an asset to your liking can you talk about me.
Maybe philosophically.
How you are approaching the potential for additional M&A from here is there still an appetite do you need to get through a certain portion of the digestion period with NGL before taking that next M&A step.
You identified procedural gaps that you'd like to fill externally as you did with angio dialysis and biopsy.
Well. Thank you I think we did a lot of work to sort this out and find it and then to execute it I am very confident in our ability.
The transition agreements and things like that of the people that are engaged in as I mentioned, Greg earlier.
And the history, we've had in the past and very candidly.
Our associates in Mexico very.
These guys know what to do I think.
That there are opportunities out there.
I think that being patient and being wise and not frustrating what we're doing.
Has been the key to it.
You can do it there is a lot of stuff out there a lot of people looking for money.
But it has to fit the things in the criteria that we've set and if it doesn't do that it might be a great technology.
But it's just not going to work for us we like what has worked.
But I think it's.
To do the things that we want I think is may be more difficult.
I think our shareholders are going to have to be patient I think you hit the nail on the head I think the risk factor.
For this transaction was one that we felt that we could digest.
But I've also learned from the past and that is when you try to do two or three big deals or product transfers. It really really things out your resources and capabilities I think we've learned from that.
And we all know about that period of time and aligning the sales forces and having a chief commercial officer and doing this changes that we've made over the last several years will be very very helpful. So patients and that patients will be rewarded.
From I think just good and wise choices role.
I'll add that we're well capitalized with sizable borrowing capacity and we're only at $1 2 million on the net leverage standpoint so.
Yes.
Alright, I appreciate that.
Helpful perspective, if I can just squeeze in one more just how much pricing might have added in the quarter and then any any views you have on what pricing might be within the second half of the year in your guidance. Thanks again, yes.
We're not going to disclose that.
We don't want to get into the volume versus pricing discussion, but I. Appreciate the question, but just know that it is having an impact.
And it is one of our foundations for growth pillars. So yes.
Alright understood. Thanks.
Thank you Sir.
Thank you.
Our next question.
Comes from the line of Mike Matson of Needham and company.
Yes.
Yes, good afternoon.
I guess I'll start with the acquisitions as well so looking at the products that you acquired the dialysis products specifically.
In the slides it didn't look like there was a little bit of overlap maybe between some of the acquired products and some of the catheter.
Catheters that merit was already selling so.
Is that the case is there any risk of any kind of cannibalization or dis synergies or anything there.
Yes, Mike Thank you.
Listen.
They have a number of catheter it but let me point out a couple of things that are very very important.
One as part of one of those catheters, we ended up with an acute catheter remember.
<unk> products are all chronic these are the ones that have a cough oftentimes in different types of.
Accidents, where someone has renal failure. This isn't that youll do these other products merit didn't have that so that is really in addition, a smaller part of the revenues, but Nevertheless. In addition, I think what we'll do is to go through and look at all this stuff and just like any of our other product lines and the things that we've talked about we will do.
That as well.
I will say this but I think that one of the things that I'm very excited about and have been for a long time is this index.
<unk>.
Okay.
I'll call it a component.
Of the bio flow the bile flow is a big deal. We just don't think that it has been.
So I think that is something and we will look at this like anything else.
And try to come up with the right mix over time, but I think for right now it's getting this transferred going through that transition getting in place meeting customer needs getting our biopsy work done and by the way, it's very complementary as we've talked about to biopsy because they didn't they didn't have biopsy products Merit does have biopsy products. So.
When we look at all the little tactical.
Issues and how they fit into the strategy overall, we think that it's going to be a great opportunity for all you wanted to add something just I mean, if theres any overlap whatsoever really it's already on the numbers, but we would call it minimal.
Just to that point, whatever overlaps will be replaced with something and so we don't look at as a candidate or a loss of revenue.
Recall, the slides, having any kind of estimate of like the market opportunity for that look I mean is this something that could ultimately be.
Tens of millions of dollars of revenue and that is that.
Is it also kind of all I mean.
Whereas the gross margin.
Significantly higher than your overall margins are in line there.
Yes, Mike Let me add let me answer that by saying that we think it is a contributor it is a contributor to gross margin we have been selling this product for four or five years, but it was right in the middle of Covid.
And it was approved in Europe , and then we had to get some work done in the U S. So it was a difficult difficult time to intra.
Introduce a product like this all of that being said I want to go back to the strategy. It's what it fits into what it leads to how it's complementary to the hero.
And very candidly a lot of input from physicians on how they liked one group representing and.
So we listen to what they said over the years and when our distribution rights went away we looked at it and said this fits in their strategy and particularly as we moved in and looked at the chronic and acute dialysis products in biopsy and put all this together. There's there was a lot of thought that went into looked how these will work and how will we.
Market this and how does it differentiate the company. So I won't go into all of the specific products other than to say it is.
That we think will do very well and complement the strategy of the hope that this whole process, which were that I think is what we want to focus on is not one product, but the whole lot because theres a lot of subtle things like I said acute versus chronic things that generally might not be understood by the investing public but the strategy.
<unk>.
Is one that's worth talking about because it's.
So much work went into it so I'm very pleased with the work and the thought that we did to come to that conclusion, and then how we approached it.
Relatively unique transaction.
Yeah, Okay, alright, thanks, guys.
You bet. Thank you.
Thank you.
Our next question.
It comes from the line of Jim Sidoti of Sidoti <unk> Company.
Good afternoon, and thanks for taking the questions.
Yes, good to hear your voice Jim.
So again I guess everybody is focused on the transaction because it has been a while since you did one.
When.
You completed the deal about six weeks ago, you thought you'd see about $15.
$2 million in transaction costs about $2 5 million of interest expense.
Six weeks later.
Good numbers or what are you thinking there.
Yes interesting the interest.
That's expected or implied is about.
$6 million or about four to five.
For the year, Jim and then you would've had some amortization, which I think youre capturing in that $15 million because the transaction costs won't be that significant but a big portion of it will be amortization that obviously comes on as you fair value all the assets.
Okay, so of that $15 million.
It sounds like.
The majority of that will be in the second half of the year.
Yes, the number I have is roughly about $11 million just as a heads up.
Thats the amortization.
Yes, just all in for the expenses.
Alright.
Yes.
Okay.
Alright might I gave at the last time, we talked to Jim.
But yes, we show $11 million.
Loading amortization amortization yet.
And so how much was in the first quarter second.
Second quarter sorry.
Oh, it would have been probably about $6 million somewhere around there $506 million.
Okay. It would've been amortization and then we would have for banking fees.
Right, Okay alright.
Alright.
Yeah.
In terms of pricing I know you don't want to get too specific but is it fair to say that the price increases that you've put in place are sticking.
Yes, yes.
Okay.
I think you said earlier that continued price increases as part of the foundations for growth plan. So you don't expect them to continue to.
To.
Putting in price increases in 'twenty three 'twenty four.
Well the 2020, we have a program of pricing there.
Certain ongoing programming or some of these.
Various issues, where contracts that will come down, but it is a pillar of foundations for growth and it will be a pillar.
Consideration and growth going forward, it's not going to go away, yes, I think when I think of these foundations for growth I always think of the foundational theres a lot of things that we've changed how we what we do or how we do it at Merit and this is just one of those pillars that Fred just talked about obviously additional things those things don't end on December of this year.
Are they will obviously help us in subsequent years.
Alright, and then last one for me on China.
I recall correctly at the beginning of 2022, you were expecting some pretty significant.
It's in China, because of the volume pricing as we went through the year they they didn't materialize.
So.
You are expecting him again.
How confident are you that they will actually happen is there a chance that.
The same thing could happen and they don't materialize in the back of this year.
Well look I mean first of all we are feeling the impacts of volume based purchasing it is within our P&L.
P&L and obviously, it's kind of hitting a little bit because we just continue to execute at such a high level in the gross margin expansion continue so.
I just want to make clear up that we are seeing the impacts.
No.
Very good at kind of you know.
Estimating the exact start of these things, but we do know that they're impacting us in China changes from day to day by the way about the same as everybody else on the Atlanta exactly has never been able to figure it out I think what we have been trying to do and I think we've done a pretty good job of is just making sure that we are transparent with our investors.
You guys know that look theres additional impacts that we had and accounted for and we're just letting you know about those.
Yes, I guess the reason I'm confused is you just had a very good.
Second quarter, you are guiding to revenue for the third quarter.
Pretty good as well.
So.
It implies that the fourth quarter will be significantly slower growth.
China get my head, so is that because of China or Russia or.
I'm, just you being conservative just trying to understand whats going on.
Again, I think we'll just kind of stick to our guidance that we feel.
Pretty good about our guidance that we've given and the growth rate that we expect.
For the year, which is 6% to 7%.
The growth expectations in the U S have not changed.
Versus what are.
What are what our prior guidance had assumed it's really kind of those those impacts that we're feeling from EMEA and APAC.
Okay.
Alright, thank you.
Thank you.
Thank you.
Our next.
<unk>.
Comes from the line of Michael, but Husky Ah Barrington research.
Hey, good evening, guys nice quarter.
So I guess I wanted to ask.
Raul on the expectations for cap ex in the second half I mean, I was up at $55 million for the full year and it certainly seems like that.
Unlikely to come in that high can you just comment on what your thoughts are on Capex for the full year.
Yes, we obviously have seen an increase in working capital in it we're very focused on our free cash flow target for the year, we have slowed down some of the capex.
And that will that will feed through the rest of the year Mike.
But our expectation is still too.
We're still shooting for that $300 million of free cash flow.
Okay, Okay, but I mean in terms of Capex.
I think at one point in fragrance forgive me I mean, I may begin it's wrong, but hadn't you said that capex would probably be somewhere around $55 million or Mike maybe misremembering that or.
Yes, Youre right, we havent, we havent changed that I guess, I'm, saying that we did slow down in the second quarter, and so that'll kind of feed through right, but we haven't changed the guidance, we haven't changed any guidance for free cash flow for that matter or capex or capex slow down for the quarter, but year to year, we haven't changed any so theres a lot of timing based things that happen with capital expenditures and just free cash.
In general to be honest.
Okay.
Alright.
Okay. So in terms of in terms of the the earnings guide for Q3 sort of the possibility that maybe you have a couple of pennies.
Negative comp or a couple of pennies positive comp essentially.
Is it a meaningful part of that around whether endoscopy sort of really continues to.
Lag or what what what essentially is sort of the delta between the two.
It's really just the revenue right.
That will drive it and the gross margin right I mean, I think we've got that we've got the operating expenses that we've increased incrementally from quarter to quarter. We've got the incremental interest expense that's going up.
So it's really really what impacts our third quarter every year from an earnings perspective, an op margin perspective is really that revenue and how much we can.
Where we end up on that between the high and the low of the guidance of the commentary we gave.
Okay.
Then just one housekeeping and I, probably should be able to figure this out but I just wanted.
What the extra sort of hand, holding in terms of interest expense that you expect in the second half.
Is that roughly right.
$7 5 million for the second half from something something like that or or or is it. Yes. I mean, it's four to five Mike is the best way to kind of put it in obviously.
Big portion of that is going to happen in the back half of the year.
Okay, Alright, very good. Thank you guys appreciate it alright, thanks, Mike.
Thank you.
Our final question.
Comes from the line of Bill <unk> of Canaccord Genuity.
Yes.
Hi, This is zachary owned from Bill. Thank you for taking the question again, just on the free cash flow you sort of touched on it there, but given you're at just over $13 million in the first half and the goal for the year and was $300 million can you provide a little more color on how youre looking to specifically get there is it really just the capex or is there anything else.
Thank you.
Yes, there's also some work being done on inventory.
As you know we've tried to move.
Are we haven't tried we've actually done a pretty good job of moving our freight from ocean or from air to Ocean. So that obviously creates more inventory we do have a plan in the back half just to start to eat into that inventory.
Inventory. So it becomes you know in addition to free cash flow as opposed to taking away.
In addition.
We're just.
I'll call out that one of the things that happened in the second quarter and it's not an excuse but there is a kind of an accounting.
Issue that happens when you when you originally fair value your contingent payments anything that exceed that fair value is actually moves from financing and into operating cash flow. So that impact was $12 $5 million or so so really in my eyes, we hit about $25 million.
And free cash flow I want to call that out because it's kind of a unique thing.
As you can imagine we fair valued this this contingent payment five years ago.
Before COVID-19 and everything else that happened and so.
It's a good thing that we're paying the contingent payment above what we thought we would pay because that means that <unk> is doing much better than we anticipated which is good for us.
But I did want to call that out.
And just as a highlight I guess, we've generated over $200 million in free cash flow in the first two and a half years of FFG. Despite all the headwinds in the global macro environment supply chain raw material costs freight and distribution expenses et cetera. So overall.
I'm pretty excited and we're still focused on that $300 million.
Cumulative free cash flow.
And so we will continue to work towards that.
I think we've demonstrated though that.
This business is really capable of generating strong free cash flow.
We continue to expect this not only for this year, but into the future.
Great. Thank you very much.
Thank you I would now like to turn the conference back to Fred's when properly for closing remarks, Sir.
Yes, well, okay, everybody. Thank you very much for the staff. Thank you for your preparation Raul and I will be around for the next couple of hours to do our one on ones. We appreciate you taking the time on a busy earnings.
Season, and all best wishes from Salt Lake City Goodnight.
That does conclude our conference call for today.
You for your participation you may now disconnect.
Okay.
[music].
Okay.
Yes.