Merit Medical Systems, Inc. (MMSI) Earnings Call Transcript & Summary

Good morning, everybody. I think, we're live now. My name is Matt Miksic. I cover medical devices at Credit Suisse. We're very pleased to have with us again this year at our meeting Merit Medical. Fred Lampropoulos, our Chief Executive Officer; and Raul Parra, Chief Financial Officer. Thanks, gentlemen, for joining us again this year.

You're welcome. We're glad to be with you, Matt. Thank you.

Pleasure is ours. So we're going to pursue a fireside chat discussion of topics on the quarter and in terms of your outlook and the environment and as I've started most of the meetings and the sessions in this conference. I thought it might be good to just get a sense of what you faced in the environment now, how you think your businesses have held up under the recent quarter quarterly surge in the U.S. and various geographic patterns of the pandemic worldwide.

Yes. Thanks, Matt. I'll pick that up and then Raul comment shortly. I think generally, as you can see compared to our peers in the marketplace, we did pretty well. Business was for the third quarter, which is normally historically seasonal and then with the surge, I think all in all, we did really very well. And as we come into this quarter, there are still the supply chain issues that everybody else has. I think the biggest factor for us has been freight and shipping. And we've had to move almost all -- close to 93% of our shipments to our distribution centers have been via air. Last year, it was 30%. And of course, so that's going to affect your expenses. Now some of that will come back to us in terms of pass-throughs and so on and so forth. And we are -- in fact, one of the -- I don't want to call it necessarily blessing, but maybe it is, is that -- this environment has created more elasticity in our pricing. And, so we're able to offset a lot of our increased costs and that sort of thing. And probably -- if you look at our gross margins, you would see that we're doing really quite well in managing all this. That being said, let me give us the color. I'm going to say, am I a play-by-play guy, you're the color guy. It's one of those things, I don't know, go ahead and pick it up, Raul.

No, I think -- I guess, we're seeing what everybody else is seeing, right? I think it's a choppy recovery back to normal. During the quarter, in the U.S., sales were up 7% as year-over-year. OUS, we were up about 11% on a constant currency basis. So generally, I think things are slowly getting back to normal. I think we were 1 of probably the few that didn't expect a V-shaped recovery, and it's kind of played out that way, right? I think we were a little bit more conservative coming out of the second quarter, too. we didn't update guidance out of Q -- coming out of Q1, like a lot of companies did. We waited until the second quarter to see how things were playing out. I think that benefited us because then I think we were able to manage Q3 better than most. And it's really, quite frankly, the back half of the year better. And so the company continues to do really well. And I think the COVID recovery is kind of going as we expected. Again, kind of choppy with hotspots here and there and kind of changing as things progress and get better and the vaccination rate goes up.

And Matt, let me just add 1 more thing. Merit is a company that is very much vertically integrated. So whether it be our molded parts, whether it be extrusions, whether it be [ brading ], whether it be even semiconductor pressure sensor chips that we use for a lot of our products to measure physiological pressures, we do that all in-house. And it's kind of funny to see how the world goes around because I mean, I know for years and years, we've been criticized. Well, why don't you do this? Why don't you outsource that? And why don't you do this and do that. And that's just not what we did. We kind of have it all here. So -- although we're subject to the same things that Raul said, we see the shortages and we see this and that. We have so many internal technologies and capabilities that I think, I can fairly say that we're probably substantially less affected than others in certain areas. Again, we -- I mean early on, it was boxes, and it was this, and it was that. But we pretty well have that under control. And what that means for Merit is that in addition to our organic growth, there's a lot of opportunity to pick up market share from companies that just can't deliver. So we're about -- I mean under the conditions, I think we're probably in about the best shape you can be in very candidly.

Well, this has been going the way you expect it, Raul and Fred, I should make a note to talk to you guys more often because I don't think, I don't think anybody has been able to sort of effectively project how things go quarter-to-quarter. So you did come in pretty well pretty well in line with your expectations for improvements in Q3. How much of that do you think -- you mentioned your supply chain, your vertical integration. We can talk about geography as geographic portfolio is part of that. But how much of that is also, do you think, tied to the resilience of some of your end markets, whether it's peripheral or some of the cardiovascular intervention.

Yes, I'll let Raul go ahead and get the front end of that one. Go ahead, Raul.

Yes. I think there's something to that, right? I mean, I think our peripheral products have done really well. That was 1 of the areas that was hit the hardest last year with our Cianna product line our embolic in our drainage products. And so I think those products have recovered nicely with Cianna, which we're really high on even as you compare to 2019, it's over -- growing at over 30%, which is kind of getting to kind of the expectations that we had of it. Europe Is starting to sell the product now. And so, we're getting traction there, too. So overall, I'd say we've got a broad product portfolio. We've got -- regionally, we're spread across a lot of areas, which I think helps us. And then our OEM business is also kind of a good indicator for us is what's going on with our -- some of our customers and competitors and what -- how they're ramping. And so I think we do have [indiscernible] on the market, I would say, on what's going on. And we've been, again, very fortunate and have plans. I don't want to say conservative, but I think we've just been hesitant to say that there was going to be a quick recovery, and I think that benefited us.

Matt, I think we call them as we see them. And I think, we have not gotten over our skis. It's almost ski season here in Salt Lake City. That's an advertisement from the Salt Lake Chamber of Commerce. And we have some thoughts that are hot. And by that, I mean, I don't mean negatively. I mean you have a place like Australia when you have these supply chain shortages and difficulties, it just opens up all these opportunities for us that can overcome some of those issues. And then you've had other players and some of the bigger companies kind of dropping product line because to them, a $10 million or $20 million or $30 million product line doesn't mean much. To us, I mean, we've become ravenous. I mean, I can give you one this -- just this week or a couple of weeks ago where a company decided they would drop a line because they were having problems with the vendor. It has the potential of $30 million of that revenue globally. Now, we're not going to get all of that. But we're going to get 10% to 20% of it and we can make it and we do it all in-house. They're buying it from a third party. So that kind of situation really plays out well for us. And again, just so I can restate this. We do all of the work for that product in-house, coating, grinding, coiling, all of it. But many other people buy them from third parties. And that's fine. I mean, we just don't. And so when they have a problem from 1 source to another source, boom, here we are. And we picked that news up. And then we just found the deal on everybody goes out. And in some ways, it's kind of fun because it's a business that responds to stimulus, if you will, of opportunity and bang the way we go. And that's kind of always been the way we've been in. It's not new for us. I'll get on the problem here in a minute. I'll start banging the drum anytime now.

Yes now, rewind, I think, maybe pre-pandemic and pre-supply global supply chain issues. I think, if we were having a conversation about insourcing or outsourcing manufacturing, it would be one about margins, right, or operating leverage or fixed asset absorption or something like that, right, expertise of 1 company or another running their own manufacturing plant. But in this environment, it really does come down to the advantages of having your own factors of production and manifested in being able to supply these products, right, where others can't. So it is an interesting time for those who can just kind of turn a dial or push the lever or run another shift to push more product out when other folks are struggling or [ point ]. I wanted to ask, there was another factor. You mentioned this idea of picking up share, of folks not being able to supply the market or having to drop of a product. There was a dynamic heading into the pandemic, most refreshing to talk about something that's not 100% pandemic-related. But the MDR process in Europe, and that, to me, for sort of larger-scale global suppliers devices was presented obviously a cost, right, of having to tangle with those rigs, but also an opportunity as folks dropped out. And I'm wondering might not be on the front burner of all the things that you talk about. To what degree is that providing the same kind of share pickup and consolidation opportunity that you're describing?

Well, first of all, it is on the front burner for us. We were the first one know -- we use BSI, British Standards is our notified body. We were the first people to actually file with them, and it is expensive. I don't know that we're picking up any product quite yet, but we are starting to see somebody say, well, we're not going to do this, and we're not going to do that. But it's a couple of years away. But what it's going to ultimately do is we're going to have this upfront cost, but we're going to end up picking up a lot of opportunities in the future. But in the near-term, it's a headwind. And it is because your new products can no longer be sold or filed under the old, what they call MDD. So for the near-term, and it's part of what you'll see in Europe, it will be a little slower because of that because where we can sell products in the U.S. or in Australia or Canada, you won't be able to introduce those new products. Over the long haul, it's going to affect European companies, it's going to affect small companies. They're not going to be able to compete. I mean, all in all, it's like any regulation. It's there to try to do good and to be able to make sure products are safe and efficacious. But as we all know, regulators, I don't care at what level of government have a tendency to kind of swing over here. And that's why I think they are. Now will it come back here? I doubt it. I mean I think -- I mean the dire task, they may extend time frames, and they've done that several times already. But everybody is fully cast. Everybody is moving forward, and the casualties will be the small companies, the start-up companies, and the winners will be those who have the capital and the staying power and an existing presence. And that's another really important thing. We have 3 manufacturing facilities in Europe and we have literally thousands of employees there. So I think all of those are factors. Raul, do you want to add anything to that?

Yes. I think you're starting to even see that in some of the smaller companies that new product launches and how they factor or think about MDR and it's going to be really hard for them when they have a new product to get in line at this point, to get the regulatory approval that they will need. And so it will be interesting to see if that does anything to valuation and how it delays kind of the opportunity in some of those countries, OUS that rely on that CE mark.

Yes. And we've already seen it where smaller things that we look at or companies you can talk about the U.S. market. And then as soon as you switch to -- what are you doing over here? Well, nothing. So what the expectation is, we're going to pick it up, and that's fine. We're happy -- I mean if it's the right product, what I'm really saying is it's going to create opportunity over time. And so -- And even the bigger companies, like I said, will drop things that aren't meaningful to them. And I think all of us are kind of cleaning our closets, looking through and saying, well, if this is only getting this amount of revenue, why are we going to spend this money, the return just isn't there. So it's an interesting dynamic, but one that we are fully engaged in. And we will cross the finish line. There's no doubt about that. We will cross this finish line at or whatever the bigger companies because we've made the investments, and we've spent the time.

Yes. Yes. No, it's a bit of an overhead and overhang for everybody or additional burden for everybody. So it strikes to me it's going to slow everybody down as you pointed out with new products, but then it also -- go ahead.

No, I was going to say what's interesting in 2, 3 years ago, we said we were talking about this. And everybody, all the analysts would say, why are you guys talking about this? Nobody else is. And I say, well, because it's a big deal. And now it's a big deal. It's just interesting how people pick out what they want to talk about, when they want to talk about it. For us, going back to what you said about being able to really gauge things, we look at these things, we pay attention to them. And we think, ultimately, they're going to end up being a competitive advantage.

Yes. And I mean, perhaps you're describing also just cleaning closets. It's an opportunity to sort of pin out some of the SKUs and products that may be customers might have [ ragged ] about you and having to drop, but now a lot of companies are -- they have a perfectly good reason to face something out and focus on a different line, which I can't imagine nobody wishes for this kind of regulatory burden and spend. But when it does clears, it seems like a global provider, who is tackling these challenges in Europe. It's going to just be better positioned per share and for margins and for execution and everything. Even though, again, not something anybody would wish for if you had the choice. So maybe to pivot a little bit into how you're talking about outlook given Q3 and our expectations for Q4, both in terms of growth and margins and what you've talked about so far over year '22 or how all this affects your long-term growth?

Yes. Well, we're very cautious about getting out in front, and we've been very disciplined to talk about where we are in February, we'll do all of this. But I will say this, that in terms of R&D and our pipeline of things that we work on continuous nothing is, I think, deferred our outlook for innovation and that sort of thing. So I'll answer it that way to say that it's business, if you will, as usual, in terms of the number of things that we're working on. We have compressed it a bit and really focused on the things that we think will have an impact going forward. In terms of the other stuff, I always defer this to Mr. Parra.

Look, Matt, we left our guidance essentially untouched after Q3. It's kind a wide range, both on the revenue side and the earnings side. And quite frankly, I think what we wanted to do is, again, let's not get out ahead of ourselves. And with all the dynamics that you're -- with COVID and the freight issues and the timing of when freight gets there and whatnot. We thought it was just -- the prudent thing to do is just say, hey, let's just leave it. We're confident in it and then that will set us up for our 2022 discussion in late February when we have our earnings call. So again, I think we're feeling pretty confident in the guidance that we have. And I think it's -- when you look at the year-over-year improvements that we've had so far through Q3, I think they're pretty impressive. Fred and I were talking about this yesterday. I know, I think we get caught up in looking at the quarter-over-quarter. And those are impressive, too. But I think when you look at the year-to-date results, they're even better. I think it really shows the hard work that the group is -- the executive team and the rest of the company is doing.

And you make a good point, Raul, because I got a note from one of our directors the other day. And he said, Fred, I was looking overall in the numbers and looking at the quarter and the transcripts and all this kind of stuff. What I really did. I went back and I looked at really the progress you guys have made not for 1 quarter, but what you've been doing. And it just gave us a shout out, which is always great when you hear that from a director. So I think, we are comfortable with what we're doing with our strategy. At the same time, the reason -- and again, this is -- may sound like we're boasting and maybe it is. But the reason we've been right -- And not -- I mean, everybody -- a year ago, if we were sitting here, everybody was talking about the V, a year before that, that we're talking about V. What V? I mean, we've never seen any Vs. I mean all we saw was a gradual improvement and the ability for the planet to adapt. But COVID is not over. It is not -- and it's not going to be. I mean oral pills and boosters and this and that, it's not over. And it won't be, it may never be over. So I think people, at least Merit just needs to be prudent, move down the track, keep our eyes open. And I think that's what we've been doing. And it's kind of funny. We had an analyst kind of say what you said the other day, he said kind of we look at -- I mean, this is shocking. He said, we look at you guys as the bellwether and I'm just quoting what he said because you're the only guys that have been right. Well, I'm sure that's not the case. But sure sounded nice to hear because you often hear about how often you're wrong and so anyway, not on that but.

You have to tell me about -- you don't have to tell analysts about being wrong. So you do have to hold on to the things that you get right. So just on outlook role, 1 of the things that you've put out there is this 18% to 21%, 2023 goal. And obviously, you're going to end the year at 15% to 16%, something like that. The natural question is you've got sort of 2 years to get into that range of 300 to 500 basis points or something. What is that. Is it reasonable for folks to think that you just split that in half and you'll do half in '22 and the rest to '23? Or better in '22 and slower in '23? How should we think about it at this point, just a best guess from an investor or analyst perspective.

Yes, yes. It's a great question, and it's a good way to try and get to the 2022 guidance, right? So what I'll say is -- I'll say a couple of things. I think you hit on 1 item, which is kind of what's the base coming out of 2021. And again, our guidance calls for 15% to 16%. We feel comfortable with that. And I think, what we'll do is -- and I guess, maybe the second piece to that and how I typically answer it is that we still feel confident in the 18% to 21%. And I think when we come out with our guidance in February, it will give some color to how we think this will play out. But again, really strong start this year. I would say that we actually did a lot of work last year that got us a good head start, and we continue to do that work. And we're still very confident in that 18% to 21%. And the other pieces to that, the 5% to 7%. Obviously, we feel good about that. And then there's a minimum of $300 million in free cash flow associated with that long-term plan, too, and we're well on our way to achieving that, too. So again, we feel pretty comfortable with the Foundations for Growth program, and I can tell that I can say that everybody is engaged in that and there's a lot of work that, quite frankly, is being done and still needs to be done.

Well, that was an excellent answer without exactly giving us your 2022. But I mean, I guess, I would say -- I can imagine what it's like trying to guide given some of the variables as right as you've been or is stable and steady as the business has been, there's a lot of variables, right, which obviously widens the bill curve and all kinds of considerations to how you decide to break up that progress or whatever it's going to be, 300 to 500 basis points in a few years?

Yes, Matt, I think it's a great point. And I think, look, we set -- obviously, I think we expected some headwinds, probably not all the headwinds we're seeing, but we think some are temporary and some are here to stay. I think the ones that we think are here to stay are of the labor, right? I mean nobody is going to -- you're not going to take that back. And I think, again, but we've got lines that are moving to lower cost areas as part of some of these initiatives, we got automation that we're looking at. We've got just lean manufacturing generally that we're also looking at. So all these things kind of help from that aspect. And then, we'll kind of wait to see what happens with material costs and freight. But again, hopefully, sometime next year, those kind of go away and then we're kind of back to normal. The other piece is -- we sat down as an executive team and we went back and looked at the goal that we had set, just given all the headwinds and we still came to the same conclusion that we felt comfortable with that 18% to 21%. And when we made the announcement, we spent a lot of time kind of describing how we get to the 18%, right? And so I think again, I think there's obviously some things that have to happen, they hit kind of the higher end of that, and we're aware of those. But we're focused on that 18% to 21%, and we're still confident in it.

But you said something, Matt, and I know we're going to -- how much time do we have? We have -- oh, we have plenty of time. Okay. Well, it was interesting, we had an investor come here yesterday. And we were giving them a tour. And we took them down to our automation center. And then first thing he said, well, is how long have you guys been doing this? And I said, well, 30 years. I mean we have a football field of automation. And he said, oh, well, I think it was kind of a new thing. I said, no, we've been doing this other than Mexico, which has been up for 5 or 6 years, we haven't had to go overseas, generally speaking, because we did a lot of automation. And now what we're doing is we're continuing to do what we've been doing for a long time and is looking at where those investments should be made and some of the newer ones that won't really come online for 2 to 3 years. I mean, you got to design it, you got to build it, that sort of thing. And most of that automation for the bigger equipment is done out of house, but they're from our designs. But if you ever get time, I invite you out to come and take a look at 1 of the really -- I mean, it's really kind of amazing to see the amount of automation we have here and the amount we'll have in the future. So I'm not saying we have total offsets to these issues. But as Raul pointed out, even with the [ buffering ] even with all of these issues. Our plan is one that we feel comfortable with because we have the tailwinds of things that are coming on. We have the market share, we have the fallouts, we have the vertical integration. So fortunately, we have enough presently. Now is there a black swan out there, he or she's out there flying around someplace. And hopefully, they go stop someplace out. So I'm just saying, I think that we have done a pretty good job, and we had 1 other advantage. We stubbed our toe in the summer, the second and third quarter of '19. And we put a plan together. This is before we brought on Boston Consulting, and we executed that plan. And then on top of that, we added to take it even further and from a longer view with BCG. So we had a head start. So while everybody is trying to figure out what to do, it's kind of being in the passing lane. Now a lot of people have caught up, and I don't -- I'm not saying that we're a perfect company, but we've had our heads down for a long time. It isn't new for us. And this team -- this management team and all of the employees in this company have done a hell of a good job. So it makes it a lot easier to predict things when you have that kind of team behind you. You know you can move the ball down the field. So hoorah for football this weekend. There you go. Here's my pitch.

Yes. I guess last question on margin expectations is just to point out, as you pointed out, there's sort of like this V-shape. There have been like, I'd say, V-shaped quarters, for sure, in some of the more elective sort of on and off procedure categories, but looking at '22, I think there's a sense that, well, coming out of the pandemic, there should be this [ pop ] on leverage, right? There should be the pop in margins because we're recovering the top line and maybe OpEx isn't growing as fast or something like that across companies that have had that dip running on 4 or 5 cylinders instead of 6 cylinders this year or next year. But I guess the other way of thinking about spending the margins is if you're growing, first of all, more in line and steady state and sort of capturing share and doing better this year, right, then that pop might not be there next year. Wanted to get your through thoughts on that. And the other is, if you're taking share and you have opportunities, you kind of get after revenues, then there's this question of do we invest after this? Or do we drop this margin to the bottom line? And and sort of give investors what they always love to see, which is a big pocket in margin. What are your thoughts on those different.

A couple of thoughts on that. First of all, I think that there's not enough discussion about how hospitals have adapted, how they've come to view elective procedures and manage their COVID caseload. I think they've done -- I mean if we look at Intermountain Healthcare here in Salt Lake City, they've done a great job. And the hospitals like businesses, just like manufacturers, they've got to adapt. And the only thing we've ever seen to hear is, all of these critical care beds are full or there's this, there's that. But you never hear about the fact that the other places, whether it be the cath lab or specials or the oncology to think that breast surgery for cancer is elective is kind of full hardy. I mean it just doesn't make any sense. And I think as everybody kind of came to their senses and we're able to deal with the realities of COVID and the vaccines and things that have come on and have eliminated or not eliminated, but have reduced the hospitalization issues, I think that's part of the reason why we've seen a very, very nice response back, for instance, with our Cianna Scout product, which is our breast localizer. So I mean -- so first of all, I think that a lot of credit has to be given to the really good places in hospitals and institutions who have adapted to that technology. The other thing that I think -- and that I will address, I mean, is that we have not stopped our R&D. We have a pipeline of products, some of which we introduced are completed might be a better word last year. Some of those things have never had fair play. And so -- and then we have new coming this year. So I think from an organic point of view for our revenues going forward, we don't have a void. We don't have a hole. But what we have to do is systematically introduce and these products are time-saving, life-saving, protective, safe, there are all the factors that go with it as Merit moves up the so-called food chain into more therapeutic products. And I think that's another thing that we talked about for the last several years. We've been 1 of those fortunate companies because there aren't very many that are in this range, this $1 billion range. They're either very big or very small. There's a few companies in the middle here. But we've been gradually moving towards with our reps. We haven't talked about that, but we have a product that is approved in Europe, in Canada and in a number of countries. We're conducting a U.S. trial and we have other products coming in. So from a momentum or pipeline and with MDR and all these other things we've talked about, merits in really good shape in terms of what's coming. We have a bunch of -- if I can use the term, a bunch of movies in the can. And it's just a matter of making sure that they get the proper attention, our sales force gets the training and as the hospitals open up, the back committees and this and that. I was in New York last week, and I was visiting a hospital uptown. And I couldn't believe how excited they were to see me. I had one of my engineers there. We were working on a product, and we went to talk to some docs there. And they said, man, it's so good to see you guys. It was like [ kumbaya ]. They just haven't -- they want to have things to improve their work skills and their outcomes. So without going into '22, but if you want to talk about '22 to '30. Let's talk about those things. Merit, I think, has continued to do the things that will allow us to have the organic growth that helps to drive the programs that we've talked about.

Yes. I think on the operating expense side, Matt, I think we're getting back to a normalized level. Now I think you're kind of seeing that in our income statement. I think the 1 caveat that I would throw out there is travel and trade shows and making sure that we allow the flexibility for our sales force to match or exceed what our competitors are doing. And so I think that's the 1 caveat that I would say that is still kind of at COVID levels, I'd say, the travel and trade show piece. As you know, we're doing this virtual. And so, I think that's the one, I think, headwind that I would add to operating expenses. But again, we've got new procedures in place and new travel policies. And so we'll manage that the best we can. But at the same time, we don't want to put our sales team at a disadvantage. And so we'll have to kind of monitor that and see how much rope we give them from that aspect.

Well, in fact, one other thing on that note, Matt, is that we'll be attending in person, which is like shocking, the [indiscernible] meeting, which is generally in New York, but it will be in Orlando in 2 weeks. And some of it is virtual, but we'll be there for a couple of days, and we have to talk about hemodialysis outflow circuits and some products that we have at that meeting. So I'll be there. And it's like the first time we've gone to a trade show in 2.5 years.

Excellent. Well, it is nice to see things kind of getting back to sort of in-person interaction, which I'm sure were missed. Well, with that, we are at time, and we should probably call it. I know there's a lot of things we didn't get to, but certainly enjoyed catching up with you and thanks, everyone, for joining us. And Fred and Raul, really appreciate you joining again this year.

Thanks, Matt. And come on out, and I'll show you our automation center coming up at Salt Lake and bring your skis with you.

That is a great idea. All right, thank you. Bye.

Thank you.