Merit Medical Systems, Inc.

Good afternoon, ladies and gentlemen, and welcome to the fourth quarter and fiscal year 2021 earnings conference call for Merit Medical Systems, Inc. At this time, all participants have been placed in a 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 send the call over to Mr. Fred Lampropoulos, Merit Medical Systems founder, chairman, and chief executive officer. Please go ahead, sir.

Thank you, and welcome, everyone, to Merit Medical's fourth quarter and fiscal year 21 earnings conference call. I'm joined today on the call by Raul Parra, our Chief Financial Officer and Treasurer, and Brian Lloyd, our Chief Legal Officer and Corporate Secretary. Brian, would you please take us through the Safe Harbor statements?

Thanks, Fred. Before we start, 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 as of today, February 24, 2022 only, 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 8 . 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 our 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. 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 fourth quarter and 2021 fiscal year. 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 2022 that we introduced in this afternoon's press release, as well as a summary of our balance sheet and financial condition. We will then open the call for your questions. Beginning with a review of our fourth quarter revenue performance, we reported total GAAP revenue of $278.5 million in the fourth quarter, up 7.9% year over year. Our total GAAP revenue growth was driven by 6.4% growth in U.S. sales and a 10% growth in international sales. Excluding the headwind to our GAAP revenue growth as a result of changes in exchange rates, compared to the prior year period, our total revenue increased 8.4% year-over-year in the fourth quarter on an organic constant currency basis. Our total constant currency growth was primarily driven by a 6.6% increase in U.S. sales and a 10.8% increase in international sales. Our fourth quarter revenue exceeded the updated guidance we discussed in our Q3 QUAL, and implied fourth quarter constant currency revenue would increase in the range of approximately 2% to 6% year over year. The strong revenue results in quarter four were driven by solid execution from our team, stronger than anticipated demand from OEM customers, and more favorable sales trends in China versus what our updated guidance range had assumed. Turning to a more detailed review of our revenue results in quarter four, note, 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, fourth quarter total revenue growth was driven primarily by 9 percent growth in sales of cardiovascular products and 4 percent growth in sales of endoscopy products compared to the prior year period. Sales of our peripheral interventional products increased by 11% year-over-year, representing approximately half of the total cardiovascular segment growth year-over-year. Sales of our drainage and embolotherapy products, which together represented roughly one-third of our total PI business, increased 9% year-over-year in Q4, and together were the largest contributor to total PI growth in the quarter. Sales of our Scout Radar localization products increased 14% year-over-year in quarter four, and sales of our biopsy products increased 23% year-over-year in the fourth quarter. Sales of our cardiac intervention products increased 12% year-over-year, representing the second largest contributor to total cardiovascular segment growth year-over-year. Sales of our intervention products were the largest drivers of the CI product growth category, increasing 12% year-over-year, fueled by growth of our basics and map lines, which increased 18% and 16%, respectively, in quarter four. Sales of our angiography products also contributed meaningfully to our total CI product category growth, increasing 18% year-over-year in quarter four, driven by continued strong demand for our diagnostic guide wires and cardiology diagnostic catheters. Sales of our OEM products was much stronger than expected in Q4, increasing 16% year-over-year, driven by improving demand from large customers replenishing inventory levels in multiple categories, including kits, EPCRM, and fluid management products. Our total cardiovascular sales growth was offset partially by a 5% decrease year over year in sales of our CPS products. However, the stable demand trends in this area of our cardiovascular business was masked by a $4 million net headwind from the sale of the Cultura year over year sales. Prior year sales also included $2.5 million of sales from our ITL business, which did not contribute to sales in the fourth quarter of 2021, given the divestiture. Excluding Cultura and ITL, sales of our CPS product category increased 4%, excuse me, 8% in quarter four. Finally, sales in our endoscopy segment increased 4% in quarter four, driven primarily by a 27% increase in sales of our Endomax line as we remedied the supply chain interruption that impacted sales in the third quarter of 2021. Now, turning to a brief summary of sales performance on a geographic basis, as I mentioned, our fourth quarter sales in the U.S. increased 6.6% year-over-year, and our international sales increased 10.8% year-over-year, both on a constant currency basis. Sales to U.S. customers represented 45% of our total growth in quarter four, led by our U.S. direct business, which increased approximately mid-single digits year over year. Elective procedures were steady during quarter four until COVID case counts began to surge during the back half of December as the Omnicon variant took hold in the U.S. At that time, numerous hospital systems began announcing moratoriums on non-urgent procedures that could require an overnight stay, in some cases for up to 30 days. Directly related and according to data from the Department of Health and Human Services, U.S. hospitals were reporting critical staffing shortages the most since late December of 2020. Additionally, tighter restrictions on sales and clinical access in large part mirrored the surge in case counts and hospitalizations during December. Sales in the three global regions, APAC, EMEA, and the rest of the world increased approximately 7%, 14%, and 14% respectively on a constant currency in the fourth quarter. Similar to the OUS trends we have discussed earnings calls throughout 2021, 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 EMA region was choppy in quarter four as the region continued to see material impacts from COVID-19, specifically in terms of access restrictions, which depending on the country, were limited as much as 60 to 70%. That said, elective procedures continue to ramp back up, although we are not back to pre-COVID levels. We are managing our EMEA business well overall and are leveraging virtual selling strategies as much as possible, which is helping us to drive the business forward despite the challenging operating environment. The EMEA region was the largest contributor to total international revenue growth in quarter four, with the strongest sales results of EMEA business coming from Russia, United Kingdom, other EMEA, Italy, and France. APAC sales increased 7% in Q4, although excluding the impact of the divestiture of the ITL business, sales increased 12% year-over-year. Sales in China increased 13% year-over-year in the fourth quarter. As mentioned earlier, these results were far better than we contemplated in our Q3 call when we foresaw flatter sales year-over-year. The better-than-expected sales results in China in the fourth quarter showed was driven by demand for our inflation devices in advance of the volume-based purchasing tenders that we currently expect to begin in April of this year. In summary, we are proud that we were able to deliver results above the high end of our guidance range despite the tougher-than-anticipated operating environment in quarter four. Now, before turning the call over to Raul, I wanted to comment on a few other noteworthy items in the quarter. We delivered another quarter of impressive profitability improvement, margin expansion, and free cash flow generation in quarter four. Our non-GAAP growth profit and our non-GAAP net income reflect strong leverage in the period, increasing 13% and 33% respectively compared to the prior year. Our non-GAAP gross margin increased 210 basis points year-over-year to 50%, a record for us, and we managed our expenses prudently, which resulted in a non-GAAP operating margin of 17.4%, also a record for us. We also generated more than $37 million worth of free cash flow in the quarter. Finally, I wanted to provide a brief update on our Foundations for Growth program. Specifically, we've made considerable progress in year one of the program and we believe our efforts to date have added a transformative impact on our company. We have launched more than 40 initiatives intended to drive value creation for merit shareholders across many areas, including SKU optimization, network consolidation, compensation and benefits, and of course, product line transfers and manufacturing initiatives we have discussed on prior calls. The FFG program is helping to offset the inflationary cost pressures we're seeing in certain raw materials and in shipping and freight expenses. Our focus on scrap reduction across manufacturing sites is resulting in more than a 20% reduction in scrap as a percent of our total production. We are also seeing the early benefits of improving our manufacturing efficiency, specific in the area of skew rationalization we identified more than 2,000 products that were targeted for obsolescence given low revenue and or low product gross margins. We have already inactivated 95% of these products with customers. In nearly all cases, we've been able to move them to alternative products. The Foundations for Growth program has also formed six new teams, including Control Tower, Pricing, Global Procurement, global HR, EM strategic account management, and an EMA inside sales team. We've also defined and recruited more than 15 new roles, including a chief human resource officer, chief strategy and innovation officer, vice president of global pricing, vice president of global communications, and vice president of global head of talent, and a vice president of global comp and benefits. Overall, we continue to execute on our FFGs initiatives and are excited about the progress in year one and the results we're seeing across our entire business. Finally, we believe our financial results in fiscal 2020 represent clear evidence that we're making progress towards our goal of enhancing Merit's long-term growth and profitability profile. We increased our constant currency revenue more than 10% year-over-year, We expanded our non-GAAP gross margin 220 basis points year-over-year despite considerable headwinds in our cost of goods line compared to last year. We increased our non-GAAP operating margin 230 basis points year-over-year, and most importantly, we have generated more than $119 million of free cash flow in fiscal year 2021. We remain committed to financial targets we outlined in the Foundations for Growth program for the three-year period ending December 31, 2023, which call for our constant currency organic revenue to increase at a checker of at least 5%, non-GAAP operating margins of at least 18%, and cumulative free cash flow generating more than $300 million. Now, with that said, let me turn the time over to Raul We'll take you through a more detailed review of our fourth quarter financial results and our 2022 financial guidance, which we introduce in the press release this afternoon. Raul.

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 fourth quarter of fiscal year 2021. We have included reconciliations from our GAAP reported results to the related non-GAAP items in our press release and presentation available on our website. Gross profit increased approximately 13% year over year in the fourth quarter. Our gross margin for the fourth quarter was 50% compared to 47.9% in the prior year period. The approximate 210 basis point increase in gross margin year-over-year was primarily due to changes in product mix, improvements in manufacturing efficiencies on higher volume, offset partially by inflationary headwinds we are seeing in logistics, labor, and to a lesser extent in raw materials. Specifically, we estimate the year-over-year increase in logistics and labor expenses represented a headwind to our non-GAAP gross margins of more than 300 basis points in the fourth quarter. Fourth quarter operating expenses increased 9% compared to the fourth quarter of 2020. The year-over-year increase was driven by a 28% increase in R&D expense and a 5% increase in SG&A expense compared to the prior year period. The increase in R&D expense in Q4 was driven by the combination of the lower spend in the prior year period related to COVID-19. Outside expense for certain R&D projects, in particular related to Rhapsody Clinical Study, and increased compensation expense related to our acquisition of KA Medical and two other new projects. 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, mitigated by our continued focus on managing expenses, which provided effective proved effective again this quarter as we were able to reduce G&A only expenses 4% year over year. Total operating income in the fourth quarter increased 8 million or 19% year over year to 48.4 million. Our operating margin for Q4 was 17.4% compared to 15.7% in the prior year period. Fourth quarter other expense net was 1.6 million compared to 2.6 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 lower average debt balance. Fourth quarter net income was $40.8 million or $0.71 per share compared to $30.8 million or $0.54 per share in the prior year period. We are very pleased with our profitability performance in the fourth quarter where we reported growth in net income and diluted earnings per share of 33% and 31% respectively year over year. Turning to a review of our balance sheet and financial condition of December 31st, 2021. Our strong profitability performance in the fourth quarter of 2021 combined with strong working capital efficiency resulted in strong free cash flow generation of $37.5 million in the fourth quarter. We generated more than $119 million of free cash flow for the 12-month end of December 31st, 2021. We used a portion of this free cash flow to reduce our outstanding borrowings Specifically, we paid down approximately $108.5 million of debt on our line of credit facility during 2021, including $35.9 million, which we paid down in the fourth quarter. As of December 31, 2021, we had approximately cash on hand of $67.1 million, long-term debt obligations of approximately $243 million, and approximately $490 million of available borrowing capacity. compared to cash on hand of $56.9 million, long-term debt obligations of approximately $352 million, and available borrowing capacity of approximately $389 million as of December 31, 2020. Our net leverage ratio as of December 31 was 0.9 times on an adjusted basis. Turning to a review of our fiscal year 2022 financial guidance, which we introduced in this afternoon's press release. For the 12 months ended December 31, 2022, the company expects GAAP net revenue growth of approximately 4% to 6% year over year. The GAAP net revenue range assumes a headwind from the changes in foreign currency exchange rates in the range of approximately 3 million to 3.5 million, representing a headwind of approximately 30 basis points to our forecasted GAAP growth rates this year. The GAAP net revenue guidance range also assumes net revenue from the cardiovascular segment growth of approximately 4% to 6%. Net revenue from endoscopy segment growth of approximately 6% to 8% year-over-year. With respect to profitability guidance for 2022, we expect GAAP net income in the range of $75.4 million to $84 million, or $1.30 to $1.45 per diluted share. Non-GAAP net income in the range of $140 million to $148.7 million, or $2.41 to $2.56 per diluted share. For modeling purposes, our fiscal year 2022 financial guidance assumes non-GAAP gross margins in the range of approximately 50.1 to 50.6 compared to 49.3 in fiscal year 2021. Non-GAAP operating margin in a range of approximately 16.6 to 17.3 compared to 16 percent in fiscal year 2021. Non-GAAP other expenses of approximately 6 million. Non-GAAP tax rate of approximately 22 percent and diluted shares outstanding of approximately 58 million. Lastly, given the COVID-related headwinds that impacted our first quarter of 2021, revenue results where sales increased just 2% year-over-year, our guidance assumes growth in the first quarter of 2022 that is modestly higher than the growth ranges over our full-year guidance assumes. Specifically, we expect our total revenue to increase approximately 5% to 7%, year-over-year on a GAAP basis and increase approximately 6 to 8% year-over-year on a constant currency basis in Q1 2022. Note, our growth expectations for Q1 2022 assume no material improvements in the COVID-related headwinds on the elective procedures we experienced in Q4 2021. We expect our non-GAAP net income and EPS to decline approximately 8 to 16% year-over-year in Q1 driven by inflation-related pressures on our year-over-year gross margin performance and a 10% year-over-year increase in non-GAAP operating expenses against an easier prior year comparison. With that, I'll turn the call back to Fred.

Thank you, Raul. In closing, despite the challenging operating environment in Quarter 4, we are proud that we were able to deliver revenue results that exceeded our guidance. We also note that this was a consistent theme in our quarterly results throughout fiscal year 2021. Quarter four also represented another quarter of impressive profitability improvement, margin expansion, and free cash flow generation. Again, consistent themes on our quarterly results throughout the fiscal year 2021. We're confident in our 2022 guidance, which calls for total revenue growth on a constant currency basis of 4% to 6% year-over-year, and we expect to see progressive improvement in the operating environment, specifically access to patients and elective procedures over the first half of 2022. We also continue to expect to report improving non-GAAP gross operating margins and strong free cash flow in 2022, driven by strong execution and contributions from our multi-year strategic initiatives related to the Foundations for Growth program. The benefits from our FFG program are helping us to navigate the inflationary environment well, and while we have avoided material business impacts related to global supply chain disruptions to date, this is something we are watching closely as more and more companies are struggling in this area. We are executing well and delivering strong performance despite the challenges. 2021's achievements reflect our team's ability to remain focused on our strategic initiatives while standing ready to adapt quickly to changes in our markets. We would like to thank all of you and all of our team members around the world who made this possible. Now that wraps up our prepared remarks, and we would now like to turn the time back over to our administrator and open up the line for questions.

Thank you, sir. Ladies and gentlemen, if you'd like to ask a question, please signal by pressing 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 again by pressing star 1. Now, first question coming from the line of Jason Bednar with Piper Sandler. Your line is open.

Hi, guys. This is Drew on for Jason, and thank you for taking the questions, and congrats on a nice end to the year here. Thanks, Jason.

Drew, Drew, I said Jason anyway. Sorry.

Not a problem. You know, I wanted to start off on the guidance a little bit here. You know, just given the macro environment, we've had You know, some MedTech companies, you know, willing to quantify the level of headwinds that they're assuming into their guidance from supply chain, insulation. I think you've made some comments on FX. So just wondering if, you know, that's something you'd be willing to do. And then, you know, what is your guidance assuming as far as when you might return to a more normalized operating environment?

I'm going to let Raul answer that, Raul.

Yeah, so I think we're, you know, from getting back to normal, I think we've been very consistent in our messaging, right? I think, you know, we kind of have all along been just talking about a kind of a choppy recovery to normal, you know, for a longer period of time than most, right? No V-shaped recovery. But I think, you know, we're obviously, you know, well into this. We really think we start to get back to a normalized level, you know, kind of the back half of this year. As far as the inflationary... you know, expenses that we see in our 2022 guidance, you know, we expect, you know, somewhere around 120, you know, basis points in our gross margin that's impacting the, you know, the, you know, basically headwind for 2022 that's built into our guidance.

Does that help you, Drew?

Yep, that's very helpful. Thank you. And then just, you know, your comments on China being better than expected, you know, can you maybe flesh out a little bit, you know, how sustainable is that higher than expected demand? And, you know, what's the right way to think about, you know, the incremental gains you might get from new product registrations there and then, you know, the offset being the anticipated headwinds from pricing? And can you just remind us on the peripheral side of that? you know, are those products already cleared to sell in China or is, you know, the cadence of new launch activity going to pick up throughout the year? Thank you.

Well, yeah, we have a kind of a constant effort in terms of new products that get approved, whether they be wires, they be splittable sheets and so on and so forth. So, you know, when they get approved and how they get approved is really up to the government and whether it be in the U.S. or in China, it's in many, many ways unpredictable. But last year we got the Swift Ninja approved, and then they have to get on the pricing councils, so to speak. So we just keep moving along with those products, and it's kind of just a constant cadence. We know we currently expect that – well, we know that some of this pricing is coming on – for the volume pricing in April. Now, all of that being said, as you know, last year we spent a lot of time with much ado about nothing. We talked and people would ask questions about China. As it all turned out, it was a non-event. We do know that these events are coming on, but how they peel in, what the competitors do, supply chain issues, there's so many things that can affect And it's really only for a couple of products. Our strategy has been to move, as we've said in previous calls, to move inward to 30 cities that have over 5 million people and continue to invest and grow in China.

Ro, do you want to add anything to that? The only thing I would add is that, you know, we remain confident in our long-term growth expectations for China. And just, you know, I mean, we did, you know, for 2021, we grew at 15% on a constant currency basis. So nothing more to add.

Yep. I hope that helps.

It does. Thank you.

Our next question coming from the lineup, Larry Biggison with Wells Fargo. Your line is open.

Good afternoon, guys. Thanks for taking the question, and congrats on a nice quarter, Brad. Thanks, Larry. I hope you're feeling better.

I am. Yeah, a lot better. That was like a couple months ago, Larry. Come on now.

I know, I know. Fred, you know, the net debt to EBITDA, you know, 0.9 times. It's pretty low for you guys. You've been pretty quiet on the M&A front. Valuations have come down. Could you just kind of update us on your thoughts on kind of M&A? Do you think it'll be more active this year? You know, what are your criteria for deals? And I have one follow-up.

Yep. Well, first thing I'll say, Larry, is how pleased we are with the free cash flow that we've generated over the last couple of years on our Foundations for Growth plan. I think that evaluations are coming down, and we're out there looking, and we're in a very, very good position, as you pointed out. But at the same time, I think we showed substantial discipline in last year in looking at making sure that we didn't make mistakes. I mean, the real issue and the best way for me to answer the last part of your question is we're committed, as you have seen, and as we will continue to show in our foundations for growth. So anything we do is going to be consistent or exceed those expectations, or we're just not going to do it. So We think this works well. It's got everybody enthused here. We've been able to put a lot of plans in place for our employees and pay for them. So, Larry, we're out looking. There are some opportunities. And when they meet the right criteria, then we'll hopefully participate in those. But we're not going to chase and we're not going to depart from our program. That all being said, you're right. We've never been in a better position. We've been able to pay for all the things in the past. We'll be out of debt here, and this thing will continue. In the meantime, we'll pay down debt, but we're out here looking for the right things that help the strategy, not just anything. Raul?

Yeah, I can't add anything else to that. I think we've been very focused, Larry, and, you know, obviously we're committed to FFG, and I guess that's really what, you know, when we look at acquisitions and M&A targets, that's the focus, right? It's definitely a discussion point, and it's one of the hurdles that that target has to kind of overcome.

Yeah. I hope that helps, Larry, because Very much. And one for Raul. When you talked about the foundations for growth targets, you only mentioned, Raul, the low end, so like 18% for operating margin. Was that deliberate? Obviously, there's a range of 18 to 21. Are you pointing people more to the low end? I didn't hear the gross margin target. Is that because inflation has just made that more challenging? Thanks for taking the questions.

Yeah, well, first, look, I think we've been very consistent in our messaging, right? I think we reaffirmed our FFG goals on the call. And we've been very consistent from day one, right, that we are committed to delivering at least 18% on a non-GAAP operating margin, Larry. And I would say that that, you know, based on what we've done this year, Based on the guidance that we have this year, I think people can kind of look at where we're at and feel good about those targets. And we feel confident. I guess I would just say that we've consistently said, look, we've talked a lot about the 18. The target is 18 to 21. We're fully aware of that. And we're committed to the FFT target.

And I'll just reiterate what he said. And for everybody here, Larry, We are committed to that 18%. We are committed to the foundations for growth. It's working. There's a lot of work to be done, and we're going to stay on this track because we think it's the right track to be able to provide and increase shareholder value. So that's where it rolls. Anything finally?

No, I would just say, look, I think if you look at the performance that we had, this last year, and you look at our guidance for 2022, I think, you know, we'll talk about what 23 brings and, you know, how we finish off that year when we get there. But, again, we're feeling confident in what we've done and what we're going to do this year. Still a lot of wood to chop, too.

Got it. Thanks so much, guys. You bet. Thank you, Larry. Good to hear from you.

Our next question coming from the line of Mike Madsen with Nehem, your line is open.

Yeah, thanks. So if I heard you correctly in the comments on China and the tenders, I think you said something along the lines of you saw more demand for the balloon inflators ahead of the tenders. I mean, it seems a little bit opposite from what we've heard from some of the other companies where they've actually seen people kind of deferring orders because the prices are going to typically go down with the tender. So I just wanted to ask about that.

Yeah, it's a good question. You know, was it pent-up demand? We've been there a long time. We're the quality player. We're the market leader. There are all those things that play into this, Mike. You know, as we were talking about this, we thought you might see exactly what you stated and what others have seen. We simply did not. Okay.

I mean, the numbers, you know, it's... Yeah, I mean, we expected it, right? I mean, we had talked about it and kind of expected what everybody else saw. It just didn't happen.

It just didn't happen, which is good for us. Yep.

Okay, so it was less of an issue of actually benefiting than just not having a negative impact from that.

Can you repeat that? Yeah, just say that.

I'm trying to... I'm sorry, but... I don't don't worry about it. I'll just okay. I'm sorry. No, no worries. So and then the endoscopy business, you know, it's very small relative to your other categories. You know, is that you know, what's the plan there? I mean, is that something that you know, where you plan to get bigger, you know, maybe acquire things or, you know, grow it organically with new new products or something that you're developed internally or you know, is that something you could potentially divest? Um, you know, it just, it just seems to be, you know, very small, um, you know, separate category, I guess. And, and is there any kind of synergies with that business and the, you know, the other categories that you're in?

Well, um, okay. So you're correct. Uh, it is one of the areas that we're really focusing on for scale. Um, so, you know, we're, we've been looking for some time, um, The other part of it is that we are, we do our inflation devices. They're larger, they're used for, there is something that is in our core business, but it's a unique product and a very successful one for us. And we do have ongoing research and development of new products that are complementary and new areas of stenting this, that, and the other. in that area in our wheelhouse and our technology base. So you're right, we need more scale there. In terms of divesting it, we don't see any reason to consider that. We're concentrating on how to build that business.

Okay, got it. Thank you.

Thank you, Mike.

And our next question coming from the line of Jason Bedford with Rem and James. Your line is open.

Good afternoon, and thanks for taking the questions, and congrats on the progress. You guys showed some nice improvement this year.

Thank you, sir.

I have a few questions here, and I don't really want to go down this rabbit hole, but just with the China tenders, first, I guess, do we know for sure that the tender will occur in April? And then kind of second, can we assume that this is factored into the 4% to 6% cost and currency guide?

Well, I mean, our expectation is that they're going to happen, and it is built into our guidance. You know, we expect it to start in April, but again, as you know, you know, It comes and goes, right? I mean, I guess it's just not consistent, right? We understand it's coming. We're seeing it happen. You've seen it happen with stents. You've seen it happen, you know, with the large joints. You know, you're seeing, you know, some of the, you know, I guess, you know, regional trauma tenders, you know, are happening. So it's definitely happening. It's just a temptation. We're up to, you know, we're at the mercy of the Chinese government, to be honest with you. And the provinces, right?

Yeah, the provinces have their own, and it has to get on the price list. That's what we were told. Again, I want to go back to what I said previously, and that is you have to remember the range of products, the fact that we have hemostasis valves and other things that go along with this, and that we're at the market leader. So we've seen these programs. But I think going back to inconsistent, it's not merit that's inconsistent. It may sound like it. It's just that there's information that we get from the field about what they think is going to happen. And, you know, we went down, as you said, the rabbit hole. We spent a lot of time last year on nothing at all. But in terms of the 2022 guidance, it assumes that the China growth will be a material driver for of growth that we expect, but it's the whole APAC region. So what we're starting to see is places come back to life. Last year, you recall that it was the slower part of it. So we improved this into that whole area, and we're really quite excited about the whole APAC region. So I just wanted to throw that in as well.

Okay, that's helpful. I apologize if I missed this earlier, but What's left in terms of kind of big lists tied to the Foundations for Growth program?

Well, listen, these are programs that start out with three years. You know, you implement, and I will just say, like any program, we made considerable progress. We think it's been transformative. I mean, just look at it last year, you know, what we did with gross margin. We've launched more than 40 initiatives. SKU optimization, network consolidation, compensation and benefits to make sure we can keep the people we have and incentivize them in addition to the product lines and manufacturing issues that we've done to Mexico. So it's an ongoing process. There's more transfers. There's more SKU optimization. But like anything, when you start digging a hole, the first part of the dirt is relatively easy. When you start getting to the other stuff, it's a little bit tougher. But we're just committed to it. And Jason, as I think we've talked many times, we're believers. More importantly, all of our employees are believers because they've all been rewarded or hit their bonuses or hit their goals this year, and success breeds success. So we've said it a lot today, and we'll continue to say it of our commitment to finishing what we said we were going to do. Let me go through it again, 5% to 7%. operating margins from 18% to 21%, and over $300 million in free cash flow over that three-year period. And that's another important issue. Just to clarify for everybody that it's not a one-year program. It's a three-year program. And we're doing everything we can to meet or exceed those goals. Roll over.

I'm going to take advantage and just highlight some of the things that we did in 2021. I mean, we're really proud of it. our employees and the company for really kind of what we've been able to do. You're seeing it in our P&L. The FFT program is helping us offset some of the inflationary cost for shipping and freight. Our focus on scrap reduction across manufacturing sites has resulted in even more than 20% scrap. We're also seeing some of the early benefits of improving our manufacturing expertise. Specifically, the skew rationalization, we got rid of almost 2,000 products, low gross margin or no revenue, and about 95% of those have been inactivated, but we've, in nearly all cases, moving to alternative products. In addition, we've got new programs that we're doing with investments that we've made, I'll say from an organizational standpoint, We've got the control tower. We've got pricing. We've got global procurement, global HR, EMEA, strategic account, all sorts of things.

And to come back to the original question, there's a lot of work that needs to be done. But we've proved to ourselves and I think to our shareholders, to our analysts, to everybody that's involved in the company about what it can mean. There's a lot of work to be done. I think the language that we all use is, all we'll use is there's still a lot of wood to chop. But we'll chop it and we'll get the trees down and chop it up and we'll be ready to go and we'll continue on this pathway.

Okay. Fair enough. Just last one for me. You mentioned that logistics and labor were, I think, a 300 basis point impact on what was a very strong gross margin number in the fourth quarter. My guess is that the labor costs are here to stay, but What about the logistics headwinds? When do you think they start to abate?

Yeah, well, if I could really answer that with any accuracy, I think the thing that we've looked, I'll answer it this way. We've never been in a rush to set dates and do things because they're always wrong. We think that they will. We'll adjust them and adapt them as they start to come along or find other methods, which we've been doing all the time. So let me just say we have full-time logistic people with a lot of experience here that have worked for other big companies. And I have no idea. We have hopes and that sort of thing. But, you know, I mean, who thought we would be where we were last night? And the things that happened, how does that affect, what does it do? So it's hard. I can't give you a date. I'll just say that we're working for it and we're aware it's out there. and we're doing everything we can to be aware of the circumstances and adapt to the marketplace and what's out there all the time, Jason. It's a tough question, but that's the best way I can answer it, and that is we don't know. but we'll work to adapt to whatever the conditions are in the best way we can. Raul?

Yes. Specifically around freight, we think we can control some things. One of the things that we've done is we're going to allow our ops groups to build more inventory to allow for additional capacity and time during the shipping lanes. So we've got things that we can control that we're going to try and control to help mitigate some of that some of that expense. But yeah, I think Fred hit on mostly.

And at the end of the day on that is to meet customer needs and do it better than anybody else. And that's part of our FFG. And we're there to be the best in the business. And I think we've, I'm proud of what we accomplished last year. And the, you know, you all know about the big mole. Well, big mole has to start. And I think it started. We just have got to finish We have two more years to go, and then we'll start talking about where we go from there. We're already thinking about that now. But I'm just saying we're on it, Jason, as best as we can be.

Okay, great. Thank you, guys.

All right. It's good to hear from you, Jason. Thank you.

Our next question coming from the line of Jim Sidori of Sidorian Company. Your line is open.

Hey, Jim. Good day. Hey, good afternoon. Thanks for taking the questions. You called out Rhapsody as one of the reasons why R&D went up in the quarter. So can you just give us an update on how that trial is going, and should we expect R&D to be around this level in the next few quarters?

I would say generally, yes. We want to spend as much as we can and still be within the parameters that we have dedicated. We've made a lot of progress in the fourth quarter. There were 40 sites that were activated. The pace of enrollment has increased year to date, and we're targeting the completement of the trial by the end of 2023. So I think we've made a lot of progress. It was a little slow to start out with because of sites and clinical people that have to be there. Not our people, but their people. the staff to be able to record the results. But Jim, I think we've made a lot of progress in this, particularly recently. We're starting to see acceleration now.

Okay, and then as far as the expense level, is this about right for the next couple quarters?

Well, I think we've called out our guidance. We did get some color around Q1, Jim, and I think we'll leave it at that.

In other words, it's in our numbers.

Yeah. Got it. And anything you can say about what's going on with Russia right now? I know that that was an area that you had some growth in 2021. Can you give us some sense on what's going on there?

Yeah, so it's really interesting to just watch what's been going on in the market today. But first of all, our business in Russia and Ukraine is, was not material to our 2021 revenue. Importantly, Russia and Ukraine does not represent a key growth driver in our plan for 2022. I don't want to say it's not important, but it is not material.

We're obviously watching the developments in the region as things unfold in real time.

We're keeping an eye on things. You know, just not material.

All right. And then, you know, $120 million of free cash flow, I mean, another great year there. Would you ever consider a share buyback?

Well, listen, it's an interesting question and one we've talked about. But I think we have this debt. interest rates are increasing. We want to pay that off, and we want to take a look at opportunities, and we have a very strong balance sheet. So I think rather than committing ourselves to we'll do this or do that, it's just stay on the program we're on, look for the opportunities that we've discussed on this call today. We are looking. We were very disciplined last year. We didn't chase anything. We didn't get crazy, and we don't intend to. On the other hand, There are a lot of things that start to play into better values, different valuations, and then I think that's the kind of thing that we've been waiting for, and we're seeing opportunities pop up. Go ahead, Raul.

Yeah, look, I think we expect to generate strong free cash flow again in 2022. You know, I think about $75 million is a good target to think about for modeling purposes. It's important to consider that we have some planned investments related to FFG and that are going to drive our capex to the $55 to $60 million range for the full year of 2022. Additionally, our free cash flow guidance assumes kind of an uptick in working capital. And that's really two things that I want everybody to kind of think about. We'll have a kind of a higher cash payment related to taxes that we've accounted for. And additionally, one of the key items that we talked about earlier is the continued and proactive investments in our inventory balances. as part of our strategy to build the required safety stock, just to make sure that we can meet our customer demands and needs. I think our supply chain has been a big factor for us, and its vertical integration has really helped us out, and we want to make sure that we have the right inventory levels to be able to take advantage of any customer needs.

All right. Thank you.

All right, Jim. Thank you. Good to hear from you.

And as a reminder, ladies and gentlemen, to ask a question, please press star 1. Our next question coming from the lineup, Bill Plovenik with Canaccord. Your line is now open.

Hey, Bill. Thanks, Mike. Hey, how are you doing? My questions have been answered. Thanks. Okay. Thank you, Bill.

And our next question coming from the lineup, Steve Lichtman with Oppenheimer. Your line is open.

Hi, Dave. Thank you. Hi, guys. Hi. Hi, Fred. Just a couple of quick modeling questions. One, Raul, does the tax rate guidance assume any stock-based compensation? And how much did that benefit you guys in 21 on the tax rate? Yeah.

Our tax rate, just to kind of, thank you for the question, because I wanted to kind of address this, because we did have a pretty low tax rate last year, you know, at 18% on a non-GAAP basis. So the higher tax rate is assumed in our guidance, as you mentioned, at 22%. I will call out that, you know, kind of our base rate on a non-GAAP base is around 23.5, just to make sure, you know, people understand. And so we've built in some benefits for exercise of stock options this year. And we usually weigh that, you know, towards the back half of the year just as a, you know, for modeling purposes. And that's really kind of, I guess, the color behind it is, you know, we've assumed kind of our base rate and some benefit to stock options. And, you know, obviously we hope for those to come in the back half of the year.

Got it. Okay. Thanks for all. And then just secondly on the cadence for the year, just trying to – to map that out, think that through. So the first quarter on the top line you're saying will be above average because of the comp, but what drives the, I guess, the greater pressure on the bottom line in the first quarter versus the rest of the year? Can you walk through that a little bit?

Yeah. So we did call out an 8% to 16% decline in the quarter. A lot of it is around the the COGS inflation pressures that we're seeing. In addition to, if you remember, we shut down during the December holiday period, and then it takes us time to ramp back up in the first quarter. So there's a combination of those two with the inflationary pressures that we're seeing, plus just the normal cadence in our manufacturing process.

Got it. So it's really on the COGS side that will be a little bit elevated early on and then

And a little bit of operating expense, too, right?

Well, there's more and more access from our people getting out. And, of course, hopefully what comes from that, we hope will be increased revenue down the road. So there's a little bit more expense than we had last year. Okay.

Got it. All right. Thanks, guys. Great. Thank you.

I'm not showing any further questions at this time. I would like to turn the conference back to Mr. Fred Lampropoulos for any closing remarks.

Well, again, thank you very much for joining us. Again, I wanted to let you know how pleased we are with our performance last year. We think that creates great momentum for the business. Our commitment to Foundations for Growth and the track that we've been on is something we're going to stick to as why we're looking at other opportunities and continuing to stick with our research and development and our core products. So those are important issues. I think that pretty well covers it. We appreciate you being there. Raul and I will be around for the next two hours, three hours, and we'll pick up questions and try to clarify things that you may have. Thank you for joining us. Thank you for your interest in the company and all best wishes. Signing off now from Salt Lake City. Good night.

Ladies and gentlemen, that's the conference for today. Thank you for your participation. You may now disconnect.