Merit Medical Systems, Inc.

Good afternoon, ladies and gentlemen, and welcome to the third quarter 2021 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 and that the recording will be available on the company's website for replay shortly. I would now like to turn the call over to Mr. Fred Lampopoulos, Merit Medical Systems founder, chairman, and chief executive officer. Please go ahead, sir.

Thank you and welcome everyone to Merit Medical System's third quarter 2021 earnings conference call. I am joined on the call today with Raul Parra, 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 statements, 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 on 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 what is currently expected. In addition, any forward-looking statements represent our views only as of today, October 28, 2021, 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 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. 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 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 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 of what we will cover during our prepared remarks. I will start with an overview of our better than expected revenue and financial results for the third quarter. After my opening remarks, Raul will provide you with a more in-depth review of our quarterly financial results and the formal financial guidance for 2021 that we reaffirmed in this afternoon's press release, as well as a summary of our balance sheet and financial condition. We will then discuss some recent corporate developments, before opening the call for your questions. Now, beginning with a review of our third quarter revenue performance. We reported gap revenue of $267 million in the third quarter, up 9.4% year-over-year. Our total gap revenue was driven by a 5.9% growth in U.S. sales and a 14.5% growth in international sales. Excluding the benefit to our GAAP revenues as a result of changes in exchange rates compared to the prior year period, our total revenue increased 8.8% year-over-year in the third quarter on an organic constant currency basis. Our total constant currency growth was driven primarily by a 7% increase in U.S. sales and an 11.4% increase in international sales. Our third quarter revenue results exceeded the guidance we provided on our quarter two call, which called for quarter three constant currency revenues to increase in the range of approximately 5.3 to 7.6% year over year. The strong revenue results in quarter three were driven by strong execution from our team and more favorable sales trends in China versus what our guidance range had assumed. Excluding the benefit to our revenue results this quarter from the lack of tender-related pricing headwinds, our total revenue increased approximately 8% year-over-year on a reported basis and a little more than 7% year-over-year on a constant currency basis. Importantly, these growth rates would have been at the high end of our guidance range, which reflects the strong execution of our team during the third quarter. Now turning to review of our quarter results in quarter three, unless otherwise stated, all growth rates are on a year-over-year and constant currency basis. In terms of our sales performance by our primary reportable product categories, third quarter total revenue growth was driven primarily by a 9% growth in sales of cardiovascular products, offset partially by a 3% decline in sales of endoscopy products compared to the prior year period. Sales of our peripheral interventional products increased 16 percent year-over-year, representing almost two-thirds of the total cardiovascular segment year-over-year. Sales of our scout radar localization products increased 27 percent year-over-year in quarter three and represented the largest contributor to total PI growth in the quarter. Sales of our biopsy products increased 19% year-over-year, and our drainage and embolotherapy products, which together represent roughly one-third of our total PI business, increased 18% year-over-year in quarter three. Sales of our cardiac intervention products increased 15% year-over-year, representing the second largest contributor to local cardiovascular segment growth year-over-year. We saw a balanced contribution to total CI product categories in quarter three from strong sales of our intervention products, angiography products, and sales of our fluid management products, which increased nine, 23, and 34% respectively year over year. On the intervention side, our basics and map lines posted mid-teens growth. On the fluid management side, our medallion products more than doubled as they continued to benefit from higher demand as a result of COVID vaccination programs. On the angiography side, we had strong demand for our diagnostic guide wires, cardiology diagnostic catheters, and control syringe products. Sales of our OEM products increased 22% year-over-year in quarter three, driven by improving demand from larger customers replenishing inventory levels. Our total cardiovascular sales was partially offset by a 13% decrease year-over-year in our CPS products. However, the stable demand trends in this area of our cardiovascular business masked by a nearly $9 million net headwind from sales of our Cultura year-over-year. Excluding Cultura, sales of our CPS product category increased 3% year-over-year in quarter three. Finally, sales in our endoscopy segment decreased 3%, driven primarily by a decline in sales of our Endomax line due to a supply chain interruption, offsetting solid growth in other stent products and sales in our Elation and Aeromini product lines. Now, turning to a brief summary of our sales performance on a geographic basis. As I mentioned, our third quarter sales in the U.S. increased 7% year over year, and our international sales increased 11% year-over-year, both on a constant currency basis. Sales to U.S. customers represented nearly half of our total company growth in quarter three, led by our U.S. direct business, which increased approximately 5% year-over-year. Sales in our three primary global regions, APAC, EMEA, and rest of the world, increased approximately 9%, 12 and 27 percent respectively on a constant currency basis in the third quarter. Similar to OUS trends we outlined on our quarter two earnings column, we experienced overall improvement in trends during the third quarter. However, we continue to see notable variation in the pace of recovery across regions of the world where we do business, including wide variation within certain geographic regions. The EMEA region was choppy in the quarter three as the region continues to see material impacts from COVID-19 and is still in the early stages of recovery. Restrictions and lockdowns are changing constantly across regions, causing limitation to sales contact and lower demand for electric procedures. That said, overall sales growth trends improved in the third quarter as compared to what we experienced in the second quarter, and EMEA sales were the largest contributor to total international growth in the third quarter. We experienced improving demand trends in the UK and Italy and continued softer demand trends in emerging markets. APAC sales increased 9 percent in quarter three, although this growth was impacted by two important items of note that masked true normalized performance in the region. The first item is that sales in Australia were down 34% year over year in quarter three on a reported basis, but excluding the impact of the divestiture of our ITL business, sales to Australian customers increased more than 57% on a constant currency basis in quarter three. The second item is that sales in China increased 16% year over year in quarter three, representing more than a third of our total international growth in the period. As mentioned earlier, these results were far better than what was contemplating in our third quarter guidance as a result of a lack of tender-related pricing pressure in the period. The timing of tenders has been delayed in China, which means that our sales were roughly $4 million higher than expected in quarter three. Excluding the benefit from not having the tender-related pricing pressure this quarter, sales in China increased in the low single digits year-over-year in quarter three. Again, we are very pleased with our third quarter results. The operating environment has been challenging in recent months. Everyone is trying to navigate the seemingly ever-changing dynamics surrounded COVID, and the impacts are certainly being felt in all areas of our business. Our customers, hospitals, clinicians, patients, And as Raul will detail to you later in the call, in our supply chain and logistics as well. You'll recall that one of the statements I made during prepared marks last quarter was that based on our performance in the second quarter and first half of 2021, we were confident in our expectations for a return to normalized year-over-year growth trends in the third quarter of 2021. Despite the tougher-than-anticipated operating environment in the quarter, We are proud that we were able to deliver results at the high end of our guidance range, excluding the China tender benefit. Raul will review the details of our full-year guidance, which we reaffirmed in our press release this afternoon in a few moments. For now, I'll just say that we remain confident in our plan for the year and look forward to continued strong execution from the team going forward. Now, before turning the call over to Raul, I wanted to comment on a few other noteworthy items in the quarter. First, we delivered another quarter of impressive profitability improvement, margin expansion, and free cash flow generation in quarter three. Our non-GAAP gross profit and our non-GAAP net income reflect strong leverage in the period, increasing 14% and 26% respectively compared to the year-ago period. Our non-GAAP gross margin increased 210 basis points year over year. As expected, we managed our operating expenses prudently, resulting in only a 1% increase in non-GAAP operating expenses compared to the second quarter. And importantly, we generated $18 million of free cash flow in the quarter. We believe our financial results over the first nine months of 2021 represent early evidence that we're making progress towards our goal of enhancing MERIT's long-term growth and profitability profile. We have expanded our non-GAAP gross margins 220 basis points year-over-year, despite considerable headwinds in our cost of goods line compared to last year. We have increased our non-GAAP operating margins 250 basis points year-over-year. And most importantly, we have generated nearly $82 million of free cash flow over the first nine months of 2021. Second, we are pleased with the progress during quarter three of our clinical study, the WAVE study of the Rapsody Endovascular Stent Graft, an investigational device being studied for the treatment of stenosis or occlusion within dialysis outflow circuits. We have more than 40 clinical sites identified, 28 of which are actively enrolling patients. The study has been designed to evaluate the safety and efficacy of the Rapsody endovascular stent graft for the treatment of venous outflow circuit stenosis or occlusion in hemodialysis patients and represents an important step of our goal of establishing Rapsody as the standard of care for more than 2 million patients suffering from kidney disease around the world. With respect to expanding clinician awareness of the clinical efficacy of Rapsody, We were pleased to announce in September that the results from a prospective, observational, first-in-human study to evaluate the safety and effectiveness of the Merit Rhapsody Endoprosthesis were published in Cardiovascular and Interventional Radiology. The study reported anatomical, clinical, and procedural success in all cases. According to the primary investigator, Mr. James A. Gilbert, transplant and vascular access surgeon, vascular access lead at Oxford University Hospitals, quote, early first in human studies show that the merit rhapsody endoprosthesis can be safely used to treat stenosis at key sites within a dialysis access circuit. Even more encouraging are the very promising primary one-year target legion patency rates of 84.6% and access circuit patency rate of 65.9%. To my knowledge, these are higher than any other published data and suggest that the novel features of the rhapsody endoprosthesis may have a key role in preserving the longevity of precious dialysis access for our patients," end quote. Now, we're very encouraged by the Rhapsody First study, positive results, and we look forward to assessing future study results regarding the Merit Rhapsody Enteroprosthesis and making a positive impact in the life of patients suffering from kidney disease. Finally, I wanted to provide a brief update on our Foundations for Growth programs. Specifically, we've made very nice progress over the first nine months of 2021 including in the areas of skew rationalization, product line transfers, and manufacturing initiatives. The Foundations for Growth program continues to focus on scrap reduction across manufacturing sites, and we're seeing the early benefits of improving our manufacturing efficiency, which is helping to offset the inflationary costs, pressures we're seeing in certain raw materials, and in shipping and freight expenses. Overall, we continue to execute on our FFG initiatives, and we're excited about the progress and the results we're seeing across our business. Well, that's a lot. But with that said, let me turn the time now over to Raul, who will take you through a detailed review of our third quarter financial results and our 2021 financial guidance, which we reaffirmed in this afternoon's press release. Raul, you're on deck, and now you're up to the plate.

Here you go. Thank you, Fred. Given Fred's detailed review 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 company's non-GAAP results during the third quarter and first nine months of 2021. We have included reconciliations from our GAAP reported results to the related non-GAAP items in our press release this afternoon. Gross profit increased approximately 14% year-over-year in the third quarter. Our gross margin was 49.1 percent compared to 47 percent in the prior year period. The approximate 210 basis point increase in gross margin year over year was primarily due to change in product mix, improvements in manufacturing efficiencies on higher volume, offset partially by inflationary headwinds we are seeing in raw materials, logistics, and labor. Third quarter operating expenses increased 18 percent year over year. The year-over-year increase was driven by a 16% increase in SG&A expense and a 24% increase 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, and lower OPEX in Q3 of 2020 from cost-cutting initiatives, lower headcount, and lower discretionary spending as a result of reduced travel, training, and shows and conventions during the COVID-19 pandemic. Our continued focus on managing expenses proved effective again this quarter as we were able to limit the growth in G&A only expenses to just 6% increase year over year. The increase in R&D expenses in Q3 was driven by the combination of lower spend in the prior year period related to COVID and outside expenses for certain R&D projects, in particular related to the Rhapsody Clinical Study and increased compensation expense related to our acquisition of KA Medical and to other new projects. Total operating income increased 2.8 million or 8% year over year to 39.5 million. Our operating margin was 14.8% compared to 15% in the prior year period. Third quarter other expense net was 1.6 million compared to 2.7 million last year. The change in other expense net was driven by lower interest expense as a result of a lower effective interest rate and a lower average debt balance. Third quarter net income was $30.2 million, or $0.52 per share, compared to $24 million, or $0.42 per share in the prior year period. We are very pleased with our profitability performance in the third quarter, where we reported growth in net income and diluted earnings per share of 26%, and 24% respectively year-over-year. Turning to a brief review of our financial results over the first nine months of 2021. Total revenue for the nine months ended September 30th was $796.3 million, up $90.4 million, or 13% year-over-year. Total revenue for the first nine months of 2021 increased 11% year-over-year on a constant currency basis. Gross profit increased 18% year-over-year to approximately 390 million, representing 49% of sales compared to 46.8% of sales in the prior year period, a 220 basis point increase year-over-year. Operating profit increased 35% year-over-year to 124 million, representing 15.6% of sales compared to 13% of sales in the prior year period, a 250 basis point increase year-over-year. Net income increased 53% year-over-year to $95.4 million, or $1.67 per share, compared to $62.5 million, or $1.11 per share, in the prior year period. Turning to a review of our balance sheet and financial condition as of September 30, 2021. Our strong profitability performance in the third quarter of 2021, combined with a strong working capital efficiency, resulted in strong free cash flow generation of 18 million in the third quarter. We have generated 81.8 million of free cash flow for the first nine months of 2021. Our free cash flow generation over the first nine months of 2021 is a result of great execution from the team, and importantly, continued evidence that we are clearly focused on enhancing the profitability and cash flow profile of our company going forward. We continue to expect to generate approximately 100 million of free cash flow for the full year of 2021 period. driven by continued improvements in our profitability and strong working capital efficiency, offset partially by investments in capital expenditures of approximately $35 million this year. We have used a portion of our strong free cash flow to reduce our outstanding debt obligations over the first nine months of 2021. Specifically, we paid down approximately $72.6 million of debt on our line of credit facility, including $13.7 million, which we paid down in the third quarter. As of September 30th, 2021, we had cash on hand of approximately $68.9 million, long-term debt obligations of approximately $279 million, and $456 million of available borrowing capacity. Compared to cash on hand of approximately $56.9 million, long-term debt obligations of approximately $352 million, and available borrowing capacity of $389 million as of December 31st, 2020. Our net leverage ratio as of September 30th was one times on an adjusted basis. Turning to a review of our fiscal year 2021 financial guidance, which we reaffirmed in this afternoon's earnings release, for the 12 months ended December 31st, 2021, the company continues to expect GAAP net revenue in the range of $1.06 billion and $1.07 billion, representing an increase of approximately 10% to 11% year over year. The GAAP net revenue range now assumes a benefit from changes in foreign currency exchange rates in the range of approximately $10.5 million to $11.5 million, representing a tailwind of approximately 110 to 120 basis points to our GAAP growth rate this year. The GAAP net revenue guidance range also assumes net revenue from the cardiovascular segment of between $1.028 billion and $1.038 billion, representing an increase of approximately 10% to 11% year-over-year. Net revenue from the endoscopy segment of between $32.5 million and $32.7 million represented an increase of approximately 9.6% to 10.2% year-over-year. With respect to profitability, guidance for 2021, we continue to expect gap net income in the range of $38.1 million to $46.4 million, or $0.66 to $0.81 per diluted share. non-GAAP net income in the range of $118.8 million to $127.1 million, or $2.07 to $2.22 per diluted share. For modeling purposes, our fiscal year 2021 financial guidance assumes non-GAAP gross margins in the range of approximately 48.8 to 49.1 percent, non-GAAP operating margins in the range of approximately 15 to 16 percent, compared to 13.7% in fiscal year 2020, other expense in a range of approximately $7 million to $7.5 million, a non-GAAP tax rate in the range of approximately 21% compared to prior guidance, which assumed a non-GAAP tax rate for full year 2021 in the range of 22% to 23%, and diluted shares outstanding in the range of $57.5 to $58 million compared to prior guidance, which assumed approximately 57 to 57.5 million shares for full year 2021. With that, I'll turn the call back to Fred.

A lot of numbers, Raul. Thank you very much. I appreciate your efforts. Well, first I wanted to discuss the development subsequent to quarter end. Specifically, the company made an announcement via Form 8K, filed on October 22nd, that pursuant to an action taken by the independent members of our board of directors, Justin Lampropoulos is employment as our president of EMEA was terminated effective October 19th. Now change at this level of leadership is a sensitive issue for any company to manage. And in this particular case, as you can well imagine, given that Justin is my son. Of course, many of you would appreciate that has been an especially difficult situation for me. For the avoidance of doubt, the decision to terminate Justin's employment was made by our independent directors in a meeting which I did not participate in accordance with our governance policy. The action was taken in connection with an ongoing inquiry being conducted by an independent party. Because that inquiry is ongoing, it would not be appropriate for me to discuss that work at this point. I would also like to note that other than our public disclosure obligations, which were satisfied with the filing of the Form 8 last week, we do not publicly discuss personnel matters regarding current or former employees. Now, I began immediately the process of engaging with our team in the EMEA region to execute a plan to minimize potential risk disruption as a result of determination. Importantly, I have appointed as interim president of EMEA Dr. Richard Speck. Richard is a vascular surgeon who transitioned from practicing medicine to a number of sales and marketing roles at Covidien and Stryker over a span of more than 20 years before joining Merit in 2015. He has taken on roles of increasing responsibility on our sales and marketing team in EMEA over the last six years, most certainly serving in a leadership role as the vice president of strategy initiatives in EMEA. Dr. Svek and our team in EMEA have been focused on engaging with customers and clinicians in the region, and we believe we are well-positioned to continue to deliver the growth objectives we established in the region coming into the year. Last point on this subject. We appreciate the fact that initial messaging for the street was less than optimal. And frustratingly, we believe that we missed an opportunity to be more transparent despite the sensitivity of the issue at hand. While we are not able to share additional color on the circumstances that led to the Board's decision, the street may have found the announcement easier to digest if we had included the additional detail on the transition plan we are already executing. The strong interim leadership we have named and overall confidence in our ability to avoid material disruption in the region. Lesson learned. In closing, despite the tougher than anticipated operating environment in quarter three, we are proud that we were able to deliver revenue results that exceeded our guidance. Quarter three also represents another quarter of impressive profitability improvement margin expansion, and free cash flow generation. We are confident in our 2021 guidance, which calls for total revenue growth on a constant currency basis of 9% to 10% year over year, and importantly, excluding the impact of investors and product sales that uniquely benefit from pandemic-related demand trends in 2020. Our constant currency revenue guidance reflects growth of 12% to 13%, year-over-year in 2021. We also expect to report improving non-GAAP growth operating margins and strong free cash flow in 2021 driven by strong execution and contributions from our multi-year strategic initiatives related to our Foundations for Growth program. Now, this wraps up our prepared remarks, and operator, we would like to now turn the time back to you and open up the line for questions.

Thank you, sir. If you'd like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, 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 by pressing star 1. And our first question will come from Mike Madsen with Needham & Company. Your line is open.

Yeah, thanks for taking my questions. I guess I'll start with the peripheral and cardiac businesses, cardiac intervention businesses. They had really strong kind of mid-teens growth. That seems to be better than what we've seen from some other companies in that space. Just wondering if you could maybe talk about what some of the growth drivers were there and whether or not you think you're taking share maybe in some categories

Yeah, so a good pickup there. Our Scout radar localization products increased 27% on a constant currency basis. That was the largest contributor to our total PI growth. In addition, biopsy products increased approximately 19%. And then drainage and embolotherapy products increased 18%. So together, those represent about a third of our total PI business. Those three products, you know, they've been performing really well this year and continue that progress into Q3.

Okay, thanks. And then I wanted to ask one on China. So it sounds like the tenders haven't happened like you thought, but I just wonder what the outlook there was for potential tenders. Do you still expect them at some point? Do you think that they're off the table for now or just have they just been delayed? And, uh, you know, do you still expect it to be in the same kind of categories that you were expecting before? Which I think was the balloon inflators primarily.

Yeah. Listen, uh, Michael, you know, we believe that the longterm growth opportunity in China, despite all of these, um, situations that, that, that, uh, may or may not be developing, um, remain. So we are continuing to invest, uh, you know, with new, you know, customers. And as I think I mentioned in previous calls, that we know we're moving into the Midlands. We will discuss, you know, what we learned. We don't expect any impact on this year. But we will discuss all of this as we gather more information during this quarter. And then we'll be prepared to discuss this as we forecast in 2022. Raul?

Yeah, no, I think, you know, maybe stepping back a little bit, you know, China, we were expecting low single digits, you know, at the beginning of the year. We now expect, you know, kind of a 10% constant currency growth for the full 2021. While the pricing headwinds aren't going to impact us, you know, we think, you know, this year, as we had originally thought, we are going to – we are, I guess, experiencing – some buying patterns, you know, some small changes in buying patterns from some customers as they anticipate those price reductions. So, as of now, we now expect the tenders and the pricing-related headwinds to really impact us in the first half of 2022. But, you know, I guess, you know, the best way to say it is you know, in light of the delayed postponed tenders, we really kind of expect, you know, China for the fourth quarter to kind of be flattish.

Okay, got it. Thank you. Yep.

Our next question comes from Jason Bedford with Raymond James. Your line is open.

Hi. Good afternoon. I guess just maybe to follow on the last line of commentary Are you still investing in products into China? And I'm just wondering, is that still an opportunity for growth, is just expanding the bag in China?

Yeah, we believe that there's a lot of opportunity in China. I mean, we're not backing away. We've received approvals this year of the ASAP. We have Embolics. We have a lot of new products that have been approved, including the Ninja. We recently were approved for the SNAP. So we're continuing to invest in China. Our ground strategy has changed. And again, I won't go into a lot. I mean, I think we addressed that we're moving inland. We're moving into, you know, I think I mentioned the last time we called, we have, you know, 30 cities with over 5 million people. So there's plenty of market there. And I think our strategy is to move towards our peripheral products. where there's not much, let's say, attention is the best way for me to answer it, Jason.

Yeah, I think we remain pretty confident in the long-term growth expectations for China overall, to be honest.

Okay. And then you mentioned a supply chain dynamic with Endomax, I believe, that weighed on endoscopy growth. Where are you with cleaning up that supply chain dynamic, and is that going to be a drag here in the fourth quarter or into 22?

So the answer is that we have, I'm not going to say solved it because solved means a conclusion, but we expect that by the end of the year that we will have that resolved and back on track. So we're managing it. I think we're doing a very good job. It wasn't us, but as you know, Jason, a lot of people, a lot of companies that you've talked to today and during the week have had supply chain. This is one of them. I would just say overall, though, that we've been affected. We've seen more of it in the last six months than we did in the previous 18 months. But the good thing about being vertically integrating and being agile and nimble is Many of those things we've been able to solve internally or then tapping our second source. So I think this one will be fine. But, you know, it was also offset by solid growth in the other stent products. And, of course, as we continue our elation dilatation balloon and our aero mini, which is really the pulmonary product line. So I think we'll have it solved. Um, and, um, and our guys have done it. I mean, I've got my COO sitting here, um, and they've done a nice job, but it, it did affect us in that quarter and, uh, it will be taken care of and we'll be back on track, um, by the end of the year. And it'll, again, it'll improve monthly as we go along.

Okay. Thanks Fred. I'll keep it at, uh, at those two.

Okay. All right. Thanks, Jason. Good to hear your voice.

Our next question comes from William Plavnik with Canaccord. Your line is open.

Hey, great. Thanks. Good evening, and thanks for taking my question. You know, your revenue was down 4% sequentially, 4.7% from Q3, from Q2, and that's more in line with the historical trends. I'm just trying to understand, what are you seeing in the field relative to hospital staffing and procedure trends And more importantly, kind of what is contemplated in your guidance for the fourth quarter of this year, and then how do you see that playing out in 2021?

Yeah, you know, it's a good question. It's the question that everybody's been asking. I mean, you know, we have followed all of the other companies and, you know, the different challenges that the industry is seeing. In our product lines generally, we have not – better yet, let me restate that. we continue to see better access and more interest. And maybe more importantly than that, and I almost reluctant to say this, but a lot of our ability to be able to deliver products that our competitors can't. So one of the things that, you know, I think that we'll continue to see is, you know, gaining of market share. So anyway, now, if you're referring to fatigue and staff and those sorts of things, You know, we can read the headlines. It's going on every day, and everybody's concerned about it. Intermountain Healthcare here in Salt Lake, you know, everybody's – I think everybody's tired. I mean, all of that's going on, but, you know, the beat goes on, and patients have to be treated. So it is a problem. It is a challenge. But generally, I would say that our business has been – Well, I don't want to say we're doing better than others, because that would be disingenuous, but I think we've been doing just fine, and I think our product mix is very, very broad, and that helps. Raul, you wanted to comment?

Yeah, no, I think if you look at the updated guidance that we gave after the second quarter, we had the benefit. We waited to update our guidance, unlike other companies where they came out at Q1, and so we had better visibility, I think, to what we saw. And quite frankly, you know, when we looked at the back half of the year, you know, it was in line with our expectations of a choppy recovery, you know, COVID flare-ups in certain areas and geographies. I think that's still in play, but now you've also got kind of, you know, the logistics issues you've got to, you know, worry about. You've got the employee shortfalls, as, you know, somebody mentioned in the previous question. So, you know, we're seeing all those dynamics. I think... you know, when you look at our, you know, the low end of our guidance, you know, for the year, we're at a billion 60, which is a 10%, you know, increase year over year. And as you do the math for the fourth quarter, you know, we're really, you know, we essentially kind of, you know, feel like we've covered all the kind of the, we've got, I guess I'll say, a wide gap of the fourth quarter, right? So our our guidance for the fourth quarter is pretty wide. And it's really trying to cover everything that we're seeing, you know, the choppiness and the recovery. And really what I want you guys to kind of focus on is, you know, the drivers in our Q4, you know, expectations. First of all, I think the U.S. is probably the most stable. And our growth, I think, you know, as we modeled, you know, the Q4 is very consistent with Q3. Our OUS assumptions, you know, now reflect, you know, some essentially, you know, prolonged COVID recovery, softer trends, you know, related to spikes in the Delta-related cases in recent months. Also, the China tendering, you know, tenders, although we're not expecting the tender impact, we are seeing some delayed purchases by some distributors as they anticipate, you know, some of those price reductions. So I think, you know, overall, if you look at kind of, you know, you plug in the numbers of what's left for the fourth quarter, I think our Q4 represents constant currency growth of 3% to 5% excluding the divestitures, 5% to 9% excluding divestitures and Cultura. So, again, I think it's in line with what Fred and I have been saying, you know, most of the year, which is kind of getting back to normal growth rates on the back half.

Well, and, you know, Raul, I think we've called this pretty well. I mean, you know, we haven't been overly aggressive. We've kind of called them as we sees them. And I think it has served us well, you know, the way we've structured and the way we look at the business. You know, some people criticize us. Others say, keep doing what you're doing. You know, we're just looking at the numbers and just want to make sure that we can fairly represent what we see. And if we have upside, that would be wonderful. But I think we've been, I think what we have tried to do has worked for us and worked for our shareholders. So we're just going to continue what we've been doing.

Yep. Okay, if I could ask a second question. Thank you very much, and congratulations on a really good year. You know, you're generating a lot of free cash flow. I think you're well ahead of plan at this point, if I go back and look. And just curious how you're thinking about the cap structure today, more in terms of, you know, is continued pay down of debt the best use of cash? Is it acquisitions? Is it stock buybacks? You know, how How do you think about that today versus it was a little while ago you laid out foundations for growth. There's been a lot of changes, especially since you're generating cash faster.

First of all, I think the team has done a very good job. This really came from input from shareholders. You guys were concerned about this. You ought to look at it. It was one of the things that was very important in foundations for growth. One of the things that we've talked about, the logistical issues and and freight and all those sorts of things, supply chain. But labor is going to continue to be a problem. And even though supply issues in the marketplace may take care of those disruptions and eventually equivocate some, we don't see that in labor. So one of the things that we'll be looking at is automation projects and spending our money on those projects that help to reduce the reliance and just become more efficient that way. So, you know, that's a big focus now to select those that will give us the best returns and be able to support the growth that we see going forward. Roland, do you want to add to that?

No, I mean, I think, you know, I think for now we continue to pay down debt. Obviously acquisitions, you know, you never know when those are going to come along. I don't know that we're, you know, avoiding those. You know, I think we're just you know, the hurdle rate, I think, you know, internally is just much higher. It can't frustrate our Foundations for Growth program, which we're really focused on. So, again, it's not that we haven't been looking, but, you know, as Fred mentioned, things are expensive, and, you know, again, we're really focused on Foundations for Growth, and we don't want to frustrate that program.

So we are looking, and anyway, I think, again, just to make a point that we are not avoiding things. We've looked at several things, but they are expensive and they have to fit into our plan. And if they don't, then we just have to move on or just be patient. In the meantime, run our business and spend our capital where it will give us the best returns.

And just as a reminder, just as a point of clarification, we're still targeting $100 million in free cash flow for the year. And CapEx, approximately $35 million It's a big ramp from where we're at right now, but again, we want to make sure that we have the flexibility to make some of the investments for foundations for growth and product line transfers for our operation group, along with automation if they need it. So that's why we've left the budget as is.

And I wish we could see the grin on our COO's face right now.

So anyway. Thanks for taking my questions.

You bet. Thank you, sir.

Our next question comes from Steven Litchman. With Oppenheimer & Company, your line is open.

Hi, everyone. Thanks for taking my question. This is Amir in for Steve. And I guess you guys did sort of touch upon it earlier, but I guess is there any other thoughts you guys would have in terms or comments, I guess, on just the overall inflationary pressure, you know, within your business and any other plans that you guys may have in terms of mitigating that pressure going forward? Thank you.

Yeah, listen, it's a big part of our daily conversations. You know, we're seeing, you know, price increases coming from vendors. Fortunately for us, you know, we had a head start on all of us, whether it be COVID or these inflationary things, marriage started our procurement, our freight, our negotiations, um, corrugate. I mean, you name it. And we've been involved in these negotiations, not for six months or three or whatever this year we've been involved in for a year or two. as part of our program going clear back to the summer of 2019. I think we are looking and continue to pass on increases with a number of products and a number of areas and a number of divisions. So I won't go into the specifics because someone might take that and say, oh, that was on the call and they said this, so guess what? But I will just tell you that it has our attention. and we are exercising it as we speak in a lot of areas. So, Raul?

No, I would say we are facing the same things everybody else is facing, right? I mean, labor, freight, raw materials. Despite those headwinds and inflationary pressures, our full-year low-end guidance still represents a 48.8% gross margin, so up about 180 basis points. So we're able to absorb, as Fred mentioned just a second ago, some of those expenses because we had our foundations for growth program in place. And again, as we look forward, you know, into our 2023 plan, you know, we continue to, you know, feel that we're confident that our, you know, FFG initiatives will drive us to our continued operating margin expansion that, you know, that we set in that goal, which a big portion of it is gross margin.

Yeah, and I think that's really important, Merle, because again... This is what we're focused on. This is what we've been working on. This is what's giving us the results. And, yeah, we're being hit, as Raul said, like everybody else is. But, you know, there are a couple other internal things that we've been able to do, and that's part of what I think is one of the things that Merit does well, and that is the vertical integration. I'll give you an example of one. Silicon, you know, we have our own foundry, but we're able to raise prices to our customers and offset those costs. And we have control of the supply chain. So, you know, I just have to think with our molding, extrusion, our braiding, our wafer fab, the things that we do and have been doing for a long time have been things that are helping us because we can control those expenses a lot better than just taking and getting the full brunt of what someone might pass on to you. So, you know, there's a lot of things that we're doing. I'll give one last thing, and I'm going on longer than I should, but... We had a couple of shortages from people, and we looked at our own capabilities, and we were able to deliver the products that we needed to meet product demands in-house while saving a quarter of a million dollars. A quarter of a million in the big picture doesn't seem like a lot, but it seems like a lot to me. I'm just saying we are as well prepared as anybody, in my view, to meet the challenges that we see in the marketplace. Period.

Thank you. Thank you, Dad.

Thank you, sir.

Our next question comes from Jim Sidoti with Sidoti and Company. Your line is open.

Hi, good afternoon, and thank you for taking the question. So, you know, just to keep on the cost side, Fred, do you think because of the steps you've taken to vertically integrate, you'll be able to continue to grow margins even as costs increase over the next few quarters?

You know, Jim, I'm not going to move beyond what we've talked about. I think one of the things that you have hopefully, I think you understand this, we've really stick to the knitting and say we're going to talk about the periods and then we'll prognosticate and forecast when it's time to do so. You know, vertical integration is not something new. It's been something we've done from the beginning. So I'll leave it with that statement. It'll continue to be a benefit to merit. But we'll leave the other stuff until we get into February, and then we'll talk more about where we're going from there.

Yeah, I mean, I think we're still confident in our FFG goals.

And I think that's the important thing. I think if you listen to what we put out on FFG, on cash flow, on operating margins, and on earnings per share, if you look at all that stuff, those are the things that we're committed to. And that's what you should pay attention to in our view.

And do you have any pricing power if it gets to the point where you're not going to be able to absorb these cost increases?

Yeah, I think we do have some pricing power. And as again, we're very conscientious about how we do things. We don't gouge. We don't take advantage. We look at cost. We look at markets. We look at those sorts of things. So I do think we have some pricing power. Maybe that we haven't had in the past, to be very honest with you. So, yeah, I think there is some. Rowell? Okay. All right. All right. Thank you. All right. Good to hear your voice, Jimmy. Thank you.

Our next question comes from Jason Bedner with Piper Sandler. Your line is open.

Hey, good afternoon. Thanks for taking the questions here. Just a couple from our side. You know, first, not to hammer here on the cost questions, but just one more follow-up, just related to the inflationary pressures you called out. Would you be able to quantify what those headwinds were that you were able to offset in the quarter?

Well, I'll tell you, there are things that we all – that everybody has, but we'll go through them. There's labor. There's freight. There's –

Every line item on cost.

Yeah, every line item. I mean, raw materials. Yeah, I mean, everything everybody else is doing.

Yeah, I think if you do the math and you get to the kind of, you know, as you start to kind of calculate the fourth quarter range, right? I mean, we have a pretty broad range for the fourth quarter. It's about 110 basis points, you know, from low end to high end. Obviously, one of the largest drivers is we also have a wide range on the revenue side. And again, I think what we're trying to do is You know, we don't want to be in a situation where we, one, get ahead on our skis, and two, we're having to, you know, revise guidance. So, we're trying to account for everything. And if you look at the kind of the fourth quarter gross margin, you know, part of that is the revenue, kind of the wider range on the revenue, and that's how it flows through. You know, obviously, whether it's U.S. or O.U.S. mix or which product category. So, you'll have a mix component there. The law end of the fourth quarter gross margin also does reflect a 70 basis point decline quarter over quarter driven by incremental inflationary pressures compared to Q3, as Fred mentioned, labor, freight, and raw materials. But again, however, despite those pressures, I want to point you to our full year low end guidance, which is 48.8 on the gross margin, 180 basis point improvement, And then, again, I want to kind of reaffirm our Foundations for Growth targets and our confidence in that 2023 target.

And, again, if there may be one message that came out today is our focus on our initiatives. It's a three-year plan. We're 10 months into a 36-month plan. And despite all of the other things, we have a plan to execute, and that's what we are focused on. across the board. So there's a lot of factors that go into that. We talked about, you know, automation. We've talked about this, that, and the other. But we're focused on delivering what we said we would deliver. That's the message of the day.

Yeah, I mean, I think to be clear, and I've said this over and over again, but I'll repeat it just to make it clear. You know, we have a wide range of revenue in EPS in the fourth quarter and to hit our fiscal year 21 guidance. But it reflects that we are confident in our ability to deliver the low end of our guidance range, but also remain cautiously optimistic given the level of COVID-related uncertainties and all the other noise that you're hearing out there with the wide range of outcomes in Q4. So I think we've tried to anticipate everything that could, you know, that could hit us, I guess, is the best way to say it.

Yep, absolutely. And you've all been executing very well against that plan. So you deserve a congrats on that. Thank you. Raul, just maybe to follow up on one other earlier question, I think it was Mike's question on China. Is your point on China that customers are running more lean on inventory? I think you mentioned maybe distributors buying less. I guess for maybe any additional color you can add on just that altered buying pattern that you alluded to. I guess just really trying to figure out if we end up having maybe a some inventory normalization within your customer base in 2022. Thanks.

Yeah, I mean, I don't want to get into 2022, you know, guidance or any color around there. Obviously, we did mention that we now expect that pricing component to hit us in, you know, in the first half of 2022. But again, I think what we're seeing, you know, at least for the fourth quarter, what we've kind of planned on is just a lower ordering from our customers. You know, just I guess in light of the delayed or postponed tenders. So they're anticipating a little bit of that. But again, we've tried to include it in our guidance. And once we get to 2022, I think we'll give you more color there. And I'd say dial in February 2022.

But again, despite all of those issues, I hope you didn't miss that we're expanding into other areas with products that we have that are not in focus on very pricing issues. We have a strategy is what I'm trying to say. It's not that we're just having it come at us. We're flanking, so to speak, and delivering our products and new opportunities there as well. And our long-term forecast continues to be positive in China. So I don't want you to forget that. I mean, what I heard was just one side. You've got to hear the other side and why we remain competent. Great.

Very helpful. Thanks so much.

You bet.

Thank you.

Our next question comes from Ron Kempis. Your line is open.

Hi, Fred and Raoul. Great quarter. Thank you, sir. That's really great.

We should have put you up first. I mean, I don't know why we waited, but thank you for your patience with us.

That's all right. It was a great quarter. You know, the only question I have is I was thinking about this tax increase that Biden is proposing, which, of course, is off the wall, but in any event, Have you done any modeling to see what effect that might have on 2022?

Yeah, so as you've heard us in this entire call, we're not commenting on that. I would say this. If we were doing that, we would all have to take medications and other things because it changes every day. Who knows this? It's exercise and futility. So I think we'll wait and see what happens, and then we'll report that on our forecasting. I mean, we're as frustrated as you are in terms of just trying to understand where anything is going. Who knows? But as we gather that information, we'll put it into our models, we'll deliver it in our forecast and our views for next year.

Very good. Continued success, guys. Appreciate it.

Thank you, sir. Appreciate the call. I hope you'll call next time. We'll put you right up on top.

Okay. Bye-bye.

All right. Thank you, sir.

There are no further questions at this time. Please proceed with any closing remarks.

Thank you, Michelle. And listen, we appreciate all of you at a very, very busy earnings season. We took a full hour here. I hope we were able to answer your questions. Raul and I will be around for the next two and a half, three hours, and we will speak further. Now, not anything that we haven't talked about, but Just try to give maybe detail on certain things should you ask. We don't know what your questions are, but we're here. Thank you very much. Listen, there were no questions regarding the 8K, and that's fine. We'll look forward to taking your questions in our private meetings that are coming up in the next hour. Thanks, everybody, and best wishes for now and for... holiday season. We have the holidays upon us. Enjoy the fall. God bless you all, and thank you. Good night.

That does conclude our conference call for today. Thank you for your participation.