10-Q 1 mmsi-6302017x10q.htm 10-Q Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2017.
 OR
 o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM              TO             .
Commission File Number   0-18592
 
a2015mmsilogoaa06.jpg
MERIT MEDICAL SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Utah
 
87-0447695
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Identification No.)
 
1600 West Merit Parkway, South Jordan, UT 84095
(Address of Principal Executive Offices, including Zip Code)
 
(801) 253-1600
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý  No  o
 
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).  Yes  ý  No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. 
Large Accelerated Filer x
Accelerated Filer o
Non-Accelerated Filer o
Smaller Reporting Company o
Emerging Growth Company o
 
 
(Do not check if a smaller reporting company)
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  ý
 
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date.
Common Stock
 
50,129,418
Title or class
 
Number of Shares
Outstanding at August 1, 2017

 



TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2017 AND DECEMBER 31, 2016
(In thousands)

 
June 30, 2017
 
December 31, 2016
ASSETS
(unaudited)
 
 
 
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
37,675

 
$
19,171

Trade receivables — net of allowance for uncollectible accounts — 2017 — $1,514 and 2016 — $1,587
103,689

 
80,521

Employee receivables
148

 
198

Other receivables
5,560

 
5,445

Inventories
136,684

 
120,695

Prepaid expenses and other assets
9,105

 
6,226

Prepaid income taxes
2,656

 
2,525

Deferred income tax assets

 
8,219

Income tax refund receivables
43

 
423

 
 
 
 
Total current assets
295,560

 
243,423

 
 
 
 
PROPERTY AND EQUIPMENT:
 
 
 
Land and land improvements
19,680

 
19,379

Buildings
143,059

 
139,119

Manufacturing equipment
188,329

 
178,110

Furniture and fixtures
46,795

 
43,433

Leasehold improvements
30,778

 
30,413

Construction-in-progress
31,975

 
28,180

 
 
 
 
Total property and equipment
460,616

 
438,634

 
 
 
 
Less accumulated depreciation
(175,413
)
 
(162,061
)
 
 
 
 
Property and equipment — net
285,203

 
276,573

 
 
 
 
OTHER ASSETS:
 
 
 
Intangible assets:
 
 
 
Developed technology — net of accumulated amortization — 2017 — $62,108 and 2016 — $52,843
157,525

 
135,358

Other — net of accumulated amortization — 2017 — $33,111 and 2016 — $30,048
53,681

 
47,339

Goodwill
226,829

 
211,927

Deferred income tax assets
1,997

 
171

Other assets
31,056

 
28,012

 
 
 
 
Total other assets
471,088

 
422,807

 
 
 
 
TOTAL
$
1,051,851

 
$
942,803

 
 
 
 
See condensed notes to consolidated financial statements.
 
 
(continued)


3


MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2017 AND DECEMBER 31, 2016
(In thousands)

 
June 30, 2017
 
December 31, 2016
LIABILITIES AND STOCKHOLDERS’ EQUITY
(unaudited)
 
 
 
 
 
 
CURRENT LIABILITIES:
 
 
 
Trade payables
$
36,671

 
$
30,619

Accrued expenses
59,185

 
44,947

Current portion of long-term debt
16,969

 
10,000

Advances from employees
192

 
572

Income taxes payable
1,910

 
2,193

 
 
 
 
Total current liabilities
114,927

 
88,331

 
 
 
 
LONG-TERM DEBT
224,943

 
314,373

 
 
 
 
DEFERRED INCOME TAX LIABILITIES
23,354

 
25,981

 
 
 
 
LIABILITIES RELATED TO UNRECOGNIZED TAX BENEFITS
438

 
438

 
 
 
 
DEFERRED COMPENSATION PAYABLE
9,725

 
9,211

 
 
 
 
DEFERRED CREDITS
2,474

 
2,550

 
 
 
 
OTHER LONG-TERM OBLIGATIONS
9,508

 
3,730

 
 
 
 
Total liabilities
385,369

 
444,614

 
 
 
 
COMMITMENTS AND CONTINGENCIES (Notes 5, 9, 10 and 13)


 


 
 
 
 
STOCKHOLDERS’ EQUITY:
 
 
 
Preferred stock — 5,000 shares authorized as of June 30, 2017 and December 31, 2016; no shares issued


 


Common stock, no par value; shares authorized — 100,000; issued and outstanding as of June 30, 2017 - 50,092 and December 31, 2016 - 44,645
348,051

 
206,186

Retained earnings
318,171

 
293,885

Accumulated other comprehensive income (loss)
260

 
(1,882
)
 
 
 
 
Total stockholders’ equity
666,482

 
498,189

 
 
 
 
TOTAL
$
1,051,851

 
$
942,803

 
 
 
 
See condensed notes to consolidated financial statements.
 
 
(concluded)



4


MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2017 AND 2016
(In thousands, except per share amounts - unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
NET SALES
$
186,549

 
$
151,071

 
$
357,618

 
$
289,148

 
 
 
 
 
 
 
 
COST OF SALES
102,408

 
84,217

 
197,535

 
162,193

 
 
 
 
 
 
 
 
GROSS PROFIT
84,141

 
66,854

 
160,083

 
126,955

 
 
 
 
 
 
 
 
OPERATING EXPENSES:
 
 
 
 
 
 
 
Selling, general and administrative
57,409

 
43,653

 
115,180

 
85,358

Research and development
13,313

 
11,429

 
25,838

 
22,016

Contingent consideration (benefit) expense
(18
)
 
91

 
19

 
193

Acquired in-process research and development
75

 
100

 
75

 
100

 
 
 
 
 
 
 
 
Total operating expenses
70,779

 
55,273

 
141,112

 
107,667

 
 
 
 
 
 
 
 
INCOME FROM OPERATIONS
13,362

 
11,581

 
18,971

 
19,288

 
 
 
 
 
 
 
 
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
Interest income
89

 
16

 
172

 
25

Interest expense
(1,639
)
 
(1,768
)
 
(4,345
)
 
(3,097
)
Gain on bargain purchase
(669
)
 

 
11,574

 

Other income (expense) — net
170

 
33

 
434

 
(447
)
 
 
 
 
 
 
 
 
Other income (expense) — net
(2,049
)
 
(1,719
)
 
7,835

 
(3,519
)
 
 
 
 
 
 
 
 
INCOME BEFORE INCOME TAXES
11,313

 
9,862

 
26,806

 
15,769

 
 
 
 
 
 
 
 
INCOME TAX EXPENSE
1,830

 
2,572

 
2,520

 
4,128

 
 
 
 
 
 
 
 
NET INCOME
$
9,483

 
$
7,290

 
$
24,286

 
$
11,641

 
 
 
 
 
 
 
 
EARNINGS PER COMMON SHARE:
 
 
 
 
 
 
 
Basic
$
0.19

 
$
0.16

 
$
0.51

 
$
0.26

 
 
 
 
 
 
 
 
Diluted
$
0.19

 
$
0.16

 
$
0.50

 
$
0.26

 
 
 
 
 
 
 
 
AVERAGE COMMON SHARES:
 
 
 
 
 
 
 
Basic
49,957

 
44,308

 
47,406

 
44,297

 
 
 
 
 
 
 
 
Diluted
51,188

 
44,703

 
48,516

 
44,647

 
 
 
 
 
 
 
 
See condensed notes to consolidated financial statements.
 
 
 
 
 
 
 
 

5


MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2017 AND 2016
(In thousands - unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
9,483

 
$
7,290

 
$
24,286

 
$
11,641

Other comprehensive income (loss):
 
 
 
 
 
 
 
Cash flow hedges
(527
)
 
(152
)
 
310

 
(881
)
Less income tax benefit (expense)
205

 
59

 
(121
)
 
343

Foreign currency translation adjustment
1,425

 
(423
)
 
2,205

 
805

Less income tax benefit (expense)

 
(120
)
 
(252
)
 
(209
)
Total other comprehensive income
1,103

 
(636
)
 
2,142

 
58

Total comprehensive income
10,586

 
6,654

 
26,428

 
11,699

 
 
 
 
 
 
 
 
See condensed notes to consolidated financial statements.
 
 
 
 


6


MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2017 AND 2016
(In thousands - unaudited)

 
Six Months Ended June 30,
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
24,286

 
$
11,641

 
 
 
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
25,709

 
19,705

Gain on bargain purchase
(11,574
)
 

Losses on sales and/or abandonment of property and equipment
234

 
44

Write-off of patents and intangible assets
19

 
90

Acquired in-process research and development
75

 
100

Amortization of deferred credits
(76
)
 
(85
)
Amortization of long-term debt issuance costs
343

 
521

Deferred income taxes
(295
)
 
141

Excess tax benefits from stock-based compensation

 
12

Stock-based compensation expense
1,691

 
1,410

Changes in operating assets and liabilities, net of effects from acquisitions:
 
 
 
Trade receivables
(13,248
)
 
(6,459
)
Employee receivables
54

 
51

Other receivables
(168
)
 
2,126

Inventories
(2,160
)
 
(1,403
)
Prepaid expenses and other assets
(1,230
)
 
(2,226
)
Prepaid income taxes
(92
)
 
(118
)
Income tax refund receivables
294

 
872

Other assets
(1,500
)
 
(762
)
Trade payables
3,664

 
(5,147
)
Accrued expenses
7,833

 
3,039

Advances from employees
(412
)
 
(119
)
Income taxes payable
(301
)
 
1,620

Deferred compensation payable
513

 
603

Other long-term obligations
907

 
(212
)
 
 
 
 
Total adjustments
10,280

 
13,803

 
 
 
 
Net cash provided by operating activities
34,566

 
25,444

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital expenditures for:
 
 
 
Property and equipment
(17,782
)
 
(21,222
)
Intangible assets
(1,082
)
 
(989
)
Proceeds from sale of cost method investment

 
1,089

Proceeds from the sale of property and equipment
3

 

Cash paid in acquisitions, net of cash acquired
(54,809
)
 
(22,800
)
 
 
 
 
Net cash used in investing activities
(73,670
)
 
(43,922
)
 
 
 
 
See condensed notes to consolidated financial statements.
 
 
(continued)


7


MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2017 AND 2016
(In thousands - unaudited)

 
Six Months Ended June 30,
 
2017
 
2016
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of common stock
$
140,989

 
$
791

Payment of offering costs related to issuance of common stock
(815
)
 

Proceeds from issuance of long-term debt
96,859

 
93,812

Payments on long-term debt
(179,359
)
 
(69,687
)
Excess tax benefits from stock-based compensation

 
(12
)
Contingent payments related to acquisitions
(30
)
 
(183
)
 
 
 
 
Net cash provided by financing activities
57,644

 
24,721

 
 
 
 
EFFECT OF EXCHANGE RATES ON CASH
(36
)
 
67

 
 
 
 
NET INCREASE IN CASH AND CASH EQUIVALENTS
18,504

 
6,310

 
 
 
 
CASH AND CASH EQUIVALENTS:
 
 
 
Beginning of period
19,171

 
4,177

 
 
 
 
End of period
$
37,675

 
$
10,487

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
 
 
 
Cash paid during the period for:
 
 
 
Interest (net of capitalized interest of $240 and $194, respectively)
$
4,386

 
$
2,912

 
 
 
 
Income taxes
$
2,678

 
$
1,580

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
 
 
Property and equipment purchases in accounts payable
$
1,560

 
$
1,497

 
 
 
 
Acquisition purchases in accrued expenses and other long-term obligations
$
6,000

 
$

 
 
 
 
Contingent receivable in exchange for sale of cost method investment
$

 
$
681

 
 
 
 
See condensed notes to consolidated financial statements.
 
 
(concluded)



8


MERIT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1. Basis of Presentation. The interim consolidated financial statements of Merit Medical Systems, Inc. ("Merit," "we" or "us") for the three and six-month periods ended June 30, 2017 and 2016 are not audited. Our consolidated financial statements are prepared in accordance with the requirements for unaudited interim periods and, consequently, do not include all disclosures required to be made in conformity with accounting principles generally accepted in the United States of America. In the opinion of our management, the accompanying consolidated financial statements contain all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of our financial position as of June 30, 2017 and December 31, 2016, and our results of operations and cash flows for the three and six-month periods ended June 30, 2017 and 2016. The results of operations for the three and six-month periods ended June 30, 2017 and 2016 are not necessarily indicative of the results for a full-year period. These interim consolidated financial statements should be read in conjunction with the financial statements included in our Annual Report on Form 10-K (the "2016 Form 10-K") for the year ended December 31, 2016, which was filed with the Securities and Exchange Commission (the "SEC") on March 1, 2017.

2. Inventories. Inventories at June 30, 2017 and December 31, 2016 consisted of the following (in thousands):
 
June 30,
 
December 31,
 
2017
 
2016
Finished goods
$
75,971

 
$
63,852

Work-in-process
15,572

 
11,008

Raw materials
45,141

 
45,835

 
 
 
 
Total
$
136,684

 
$
120,695

 
3. Stock-Based Compensation. Stock-based compensation expense before income tax expense for the three and six-month periods ended June 30, 2017 and 2016, consisted of the following (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Cost of goods sold
$
168

 
$
141

 
$
264

 
$
264

Research and development
100

 
54

 
152

 
96

Selling, general, and administrative
846

 
591

 
1,275

 
1,050

Stock-based compensation expense before taxes
$
1,114

 
$
786

 
$
1,691

 
$
1,410


As of June 30, 2017, the total remaining unrecognized compensation cost related to non-vested stock options, net of expected forfeitures, was approximately $17.3 million and is expected to be recognized over a weighted average period of 3.87 years.

During the three and six-month periods ended June 30, 2017, we granted stock-based awards representing approximately 1.28 million shares of our common stock. During the three and six-month periods ended June 30, 2016, we granted stock-based awards representing 220,875 and 784,375 shares of our common stock, respectively. We use the Black-Scholes methodology to value the stock-based compensation expense for options. In applying the Black-Scholes methodology to the options granted during the six-month periods ended June 30, 2017 and 2016, the fair value of our stock-based awards granted was estimated using the following assumptions for the periods indicated below:
 
Six months ended June 30,
 
2017
 
2016
Risk-free interest rate
1.77% - 1.79%
 
1.25% - 1.40%
Expected option life
5.0 years
 
5.0 years
Expected dividend yield
—%
 
—%
Expected price volatility
33.81% - 34.03%
 
36.50% - 37.06%

For the purpose of the foregoing analysis, the average risk-free interest rate is determined using the U.S. Treasury rate in effect as of the date of grant, based on the expected term of the stock option. We determine the expected term of the stock options using the historical exercise behavior of employees. The expected price volatility was determined using a weighted average of daily

9


historical volatility of our stock price over the corresponding expected option life and implied volatility based on recent trends of the daily historical volatility. For options with a vesting period, compensation expense is recognized on a straight-line basis over the service period, which corresponds to the vesting period.

4. Earnings Per Common Share (EPS). The computation of weighted average shares outstanding and the basic and diluted earnings per common share for the following periods consisted of the following (in thousands, except per share amounts):
 
Three Months
 
Six Months
 
Net
Income
 
Shares
 
Per Share
Amount
 
Net
Income
 
Shares
 
Per Share
Amount
Period ended June 30, 2017:
 

 
 

 
 

 
 
 
 
 
 
Basic EPS
$
9,483

 
49,957

 
$
0.19

 
$
24,286

 
47,406

 
$
0.51

Effect of dilutive stock options and warrants
 

 
1,231

 
 

 
 
 
1,110

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted EPS
$
9,483

 
51,188

 
$
0.19

 
$
24,286

 
48,516

 
$
0.50

 
 
 
 
 
 
 
 
 
 
 
 
Stock options excluded from the calculation of common stock equivalents as the impact was anti-dilutive
 
 
1,007

 
 
 
 
 
552

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Period ended June 30, 2016:
 

 
 

 
 

 
 
 
 
 
 
Basic EPS
$
7,290

 
44,308

 
$
0.16

 
$
11,641

 
44,297

 
$
0.26

Effect of dilutive stock options and warrants
 

 
395

 
 

 
 
 
350

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted EPS
$
7,290

 
44,703

 
$
0.16

 
$
11,641

 
44,647

 
$
0.26

 
 
 
 
 
 
 
 
 
 
 
 
Stock options excluded from the calculation of common stock equivalents as the impact was anti-dilutive
 
 
1,207

 
 
 
 
 
1,093

 
 

5. Acquisitions. On May 23, 2017, we paid $2.5 million to acquire 182,000 shares of preferred stock of Fusion Medical, Inc. ("Fusion"), a developer of medical devices designed for clot removal. The shares of preferred stock we acquired, which represent an ownership interest of approximately 19.5%, have been accounted for as an equity method investment of $2.5 million reflected within other assets in the accompanying consolidated balance sheets because we may be deemed to exercise significant influence over the operations of Fusion.

On May 19, 2017, we entered into a business purchase agreement with Sugan Co, Ltd. ("Sugan"), a Japanese medical device distributor. Pursuant to this agreement, we terminated our distributor agreement with Sugan and acquired the customer list Sugan used in the distribution of our products in Japan. The consideration attributed to the customer list was approximately $1.1 million payable on or before December 31, 2017. The customer list is recorded as an other intangible asset and the amount due to Sugan is recorded in accrued expenses within the accompanying consolidated balance sheets. We intend to amortize the customer list on an accelerated basis over five years.

On May 1, 2017, we entered into an asset purchase agreement with Lazarus Medical Technologies, LLC to acquire rights to the patented technology for the Repositionable Chest TubeTM and related devices. As of June 30, 2017, we had paid $570,000 in connection with this agreement. We are obligated to pay an additional $750,000 if certain milestones set forth in the agreement are reached. We are also required to pay royalties equal to 6% of net sales throughout the term of the agreement. We accounted for this transaction as an asset purchase. We recorded the amount paid upon closing as a license agreement intangible asset, which we intend to amortize over 15 years.

On May 1, 2017, we entered into an agreement and plan of merger with Vascular Access Technologies, Inc. ("VAT"), pursuant to which we acquired the SAFECVAD™ device. We accounted for this acquisition as a business combination. The purchase price for the business was $5.0 million. We also recorded $4.9 million of contingent consideration related to royalties payable to VAT pursuant to the agreement. The following table summarizes the preliminary purchase price allocated to the net assets acquired and liabilities assumed (in thousands):


10


Net Assets Acquired
 
Intangibles
 
Developed technology
7,800

In-process technology
850

Goodwill
4,323

Deferred tax liabilities
(3,073
)
 
 
Total net assets acquired
$
9,900


We are amortizing the developed technology intangible asset over fifteen years. The sales and results of operations related to the acquisition have been included in our cardiovascular segment since the acquisition date and were not material. Acquisition-related costs associated with the VAT acquisition, which are included in selling, general and administrative expenses in the accompanying consolidated statements of income, were not material.

On January 31, 2017, we signed a purchase agreement with Argon Medical Devices, Inc. ("Argon") to acquire Argon’s critical care division, including a manufacturing facility in Singapore, the related commercial operations in Europe and Japan, and certain inventories and intellectual property rights within the United States. We made an initial payment of approximately $10.9 million and received a subsequent reduction to the purchase price of approximately $797,000 related to a working capital adjustment according to the terms of the purchase agreement. We accounted for the acquisition as a business combination.

Acquisition-related costs associated with the acquisition of the Argon critical care division during the three and six-month periods ended June 30, 2017, which are included in selling, general and administrative expenses in the accompanying consolidated statements of income, were approximately $1.3 million and $2.4 million, respectively. The results of operations related to this acquisition have been included in our cardiovascular segment since the acquisition date. During the three and six-month periods ended June 30, 2017, our net sales of Argon products were approximately $11.7 million and $19.0 million, respectively. It is not practical to separately report the earnings related to the Argon acquisition, as we cannot split out sales costs related solely to the products we acquired from Argon, principally because our sales representatives sell multiple products (including the products we acquired from Argon) in our cardiovascular business segment.

The assets and liabilities in the initial purchase price allocation for the Argon acquisition are stated at fair value based on estimates of fair value using available information and making assumptions our management believes are reasonable. The following table summarizes the preliminary purchase price allocated to the net tangible and intangible assets acquired and liabilities assumed (in thousands):

11


 
 
Preliminary Allocation
 
Adjustments (2)
 
Revised Preliminary Allocation
 
Assets Acquired
 
 
 
 
 
 
Cash and cash equivalents
$
1,436

 
$

 
$
1,436

 
Trade receivables
8,351

 

 
8,351

 
Inventories
12,217

 
(546
)
 
11,671

 
Prepaid expenses and other current assets
1,275

 

 
1,275

 
Property and equipment
2,667

 
(348
)
 
2,319

 
Deferred tax assets
184

 

 
184

 
Intangibles
 
 
 
 
 
 
Developed technology
2,600

 
(400
)
 
2,200

 
Customer lists
1,300

 
200

 
1,500

 
Trademarks
1,500

 
(600
)
 
900

 
Total assets acquired
31,530

 
(1,694
)
 
29,836

 
 
 
 
 
 
 
 
Liabilities Assumed
 
 
 
 
 
 
Trade payables
(2,306
)
 

 
(2,306
)
 
Accrued expenses
(5,083
)
 

 
(5,083
)
 
Income taxes payable
(2
)
 

 
(2
)
 
Deferred income tax liabilities
(999
)
 
228

 
(771
)
 
Total liabilities assumed
(8,390
)
 
228

 
(8,162
)
 
 
 
 
 
 
 
 
Total net assets acquired
23,140

 
(1,466
)
 
21,674

 
Gain on bargain purchase (1)
(12,243
)
 
669

 
(11,574
)
 
Total purchase price
$
10,897

 
$
(797
)
 
$
10,100

 
 
 
 
 
 
 
(1)
The total fair value of the net assets acquired from Argon exceeded the purchase price, resulting in a gain on bargain purchase which was recorded within other income (expense) in our consolidated statements of income for the three and six-month periods ended June 30, 2017, and includes a negative adjustment of $669,000 in the three-month period ended June 30, 2017. We believe the reason for the provisional gain on bargain purchase was a result of the divestiture of a non-strategic, slow-growth critical care business for Argon. It is our understanding that the divestiture allows Argon to focus on its higher growth interventional portfolio.
(2)
Amounts represent adjustments to the preliminary purchase price allocation first presented in our March 31, 2017 Form 10-Q resulting from our ongoing activities, including reassessment of the assets acquired and liabilities assumed, with respect to finalizing our purchase price allocation for this acquisition.

With respect to the Argon assets, we are amortizing developed technology over seven years and customer lists on an accelerated basis over five years. While U.S. trademarks can be renewed indefinitely, we currently estimate that we will generate cash flow from the acquired trademarks for a period of five years from the acquisition date. The total weighted-average amortization period for these acquired intangible assets is 6.0 years.

Given the timing of this acquisition, which closed during the first quarter of 2017, as well as the complexity of the acquisition, the entire purchase price allocation disclosed herein (as well as the gain on bargain purchase) is considered provisional at this time and is subject to adjustment to reflect information obtained about factors and circumstances that existed as of the acquisition date that if known would have affected the measurement of the amounts recognized as of that date. We are currently reassessing whether we have fully identified all the assets acquired and the liabilities assumed, and the measurement period remains open.

On January 31, 2017, we acquired substantially all the assets, including intellectual property covered by approximately 40 patents and pending applications, and assumed certain liabilities, of Catheter Connections, Inc. (“Catheter Connections”), in exchange for payment of $38.0 million. Catheter Connections, based in Salt Lake City, Utah, developed and marketed the DualCap® System, an innovative family of disinfecting products designed to protect patients from intravenous infections resulting from infusion therapy. We accounted for this acquisition as a business combination.

Acquisition-related costs associated with the Catheter Connections acquisition, which are included in selling, general and administrative expenses in the accompanying consolidated statements of income, were not material. The results of operations

12


related to this acquisition have been included in our cardiovascular segment since the acquisition date. During the three and six-month periods ended June 30, 2017, our net sales of the products acquired from Catheter Connections were approximately $2.5 million and $4.3 million, respectively. It is not practical to separately report the earnings related to the products acquired from Catheter Connections, as we cannot split out sales costs related solely to those products, principally because our sales representatives sell multiple products (including the DualCap System) in the cardiovascular business segment. The purchase price was preliminarily allocated as follows (in thousands):
 
 
Preliminary Allocation
 
Adjustments (1)
 
Revised Preliminary Allocation
 
Assets Acquired
 
 
 
 
 
 
Trade receivables
$
952

 
$
7

 
$
959

 
Inventories
2,244

 
(87
)
 
2,157

 
Prepaid expenses and other current assets
181

 

 
181

 
Property and equipment
1,472

 

 
1,472

 
Intangibles
 
 
 
 
 
 
Developed technology
22,900

 
(1,800
)
 
21,100

 
Customer lists
100

 
600

 
700

 
Trademarks
2,900

 

 
2,900

 
Goodwill
7,612

 
1,280

 
8,892

 
Total assets acquired
38,361

 

 
38,361

 
 
 
 
 
 
 
 
Liabilities Assumed
 
 
 
 
 
 
Trade payables
(338
)
 

 
(338
)
 
Accrued expenses
(23
)
 

 
(23
)
 
Total liabilities assumed
(361
)
 

 
(361
)
 
 
 
 
 
 
 
 
Net assets acquired
$
38,000

 
$

 
$
38,000

 
 
 
 
 
 
 
(1)
Amounts represent adjustments to the preliminary purchase price first presented in our Quarterly Report on Form 10-Q for the Quarter Ended March 31, 2017, resulting from our ongoing activities with respect to finalizing our purchase price allocation for this acquisition. The larger adjustments primarily relate to the valuation of the acquired intangible assets.

We are amortizing the Catheter Connections developed technology asset over 12 years, the related trademarks over 10 years, and the associated customer list over eight years. We have estimated the weighted average life of the intangible Catheter Connections assets acquired to be approximately 11.7 years.

On July 6, 2016, we acquired all the issued and outstanding shares of DFINE Inc. ("DFINE"). The DFINE acquisition added a line of vertebral augmentation products for the treatment of vertebral compression fractures as well as medical devices used to treat metastatic spine tumors. We made an initial payment of $97.5 million to certain DFINE stockholders on July 6, 2016 and paid approximately $578,000 related to a net working capital adjustment subject to review by Merit and the preferred stockholders of DFINE. We accounted for the acquisition as a business combination. In the three-month period ended December 31, 2016, we negotiated the final net working capital adjustment resulting in a reduction to the purchase price of approximately $1.1 million. As a result, we recorded measurement period adjustments to reduce inventories by approximately $89,000, reduce property and equipment by approximately $109,000, reduce goodwill by approximately $1.2 million, reduce accrued expenses by approximately $407,000 and increase the associated deferred tax liabilities by approximately $113,000. The measurement period for this acquisition is now closed. Under GAAP, measurement period adjustments are recognized on a prospective basis in the period of change, instead of restating prior periods. There was no material impact to reported earnings in connection with these measurement period adjustments.

Acquisition-related costs associated with the DFINE acquisition during the year ended December 31, 2016, which were included in selling, general and administrative expenses in the consolidated statements of income included in the 2016 Form 10-K, were approximately $1.6 million. The results of operations related to this acquisition have been included in our cardiovascular segment since the acquisition date. During the year ended December 31, 2016, our net sales of DFINE products were approximately $13.5 million. It is not practical to separately report the earnings related to the DFINE acquisition, as we cannot split out sales costs

13


related solely to the DFINE products, principally because our sales representatives sell multiple products (including DFINE products) in the cardiovascular business segment.

The purchase price was allocated to the net tangible and intangible assets acquired and liabilities assumed, based on estimated fair values, as follows (in thousands):
Assets Acquired
 
Trade receivables
$
4,054

Other receivables
6

Inventories
8,585

Prepaid expenses
630

Property and equipment
1,630

Other long-term assets
145

Intangibles
 
Developed technology
67,600

Customer lists
2,400

Trademarks
4,400

Goodwill
24,818

Total assets acquired
114,268

 
 
Liabilities Assumed
 
Trade payables
(1,790
)
Accrued expenses
(5,298
)
Deferred income tax liabilities - current
(701
)
Deferred income tax liabilities - noncurrent
(10,844
)
Total liabilities assumed
(18,633
)
 
 
Net assets acquired, net of cash received of $1,327
$
95,635


With respect to the DFINE assets, we are amortizing developed technology over 15 years and customer lists on an accelerated basis over nine years. While U.S. trademarks can be renewed indefinitely, we currently estimate that we will generate cash flow from the acquired trademarks for a period of 15 years from the acquisition date. The total weighted-average amortization period for these acquired intangible assets is 14.8 years.
    
On February 4, 2016, we purchased the HeRO® Graft device and other related assets from CryoLife, Inc., a developer of medical devices based in Kennesaw, Georgia ("CryoLife"). The HeRO Graft is a fully subcutaneous vascular access system intended for use in maintaining long-term vascular access for chronic hemodialysis patients who have failing fistulas, grafts or are catheter dependent due to a central venous blockage. The purchase price was $18.5 million, which was paid in full during 2016. We accounted for this acquisition as a business combination. The purchase price was allocated as follows (in thousands):
Assets Acquired
 
Inventories
$
2,455

Property and equipment
290

Intangibles
 
Developed technology
12,100

Trademarks
700

Customers Lists
400

Goodwill
2,555

 
 
Total assets acquired
$
18,500



14


We are amortizing the developed HeRO Graft technology asset over ten years, the related trademarks over 5.5 years, and the associated customer lists over 12 years. We have estimated the weighted average life of the intangible HeRO Graft assets acquired to be approximately 9.82 years. Acquisition-related costs related to the HeRO Graft device and other related assets during the year ended December 31, 2016, which were included in selling, general and administrative expenses in the consolidated statements of income included in the 2016 Form 10-K, were not material. The results of operations related to this acquisition have been included in our cardiovascular segment since the acquisition date. During the year ended December 31, 2016, our net sales of the products acquired from CryoLife were approximately $7.1 million. It is not practical to separately report the earnings related to the products acquired from CryoLife, as we cannot split out sales costs related solely to those products, principally because our sales representatives sell multiple products (including the HeRO Graft device) in the cardiovascular business segment.

The following table summarizes our consolidated results of operations for the three-month period ended June 30, 2016 and the six-month periods ended June 30, 2017 and 2016, as well as unaudited pro forma consolidated results of operations as though the DFINE acquisition had occurred on January 1, 2015 and the acquisition of the Argon critical care division had occurred on January 1, 2016 (in thousands, except per share amounts):
 
Three Months Ended
 
Six Months Ended
 
Six Months Ended
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
 
As Reported
 
Pro Forma
 
As Reported
 
Pro Forma
 
As Reported
 
Pro Forma
Net Sales
$
151,071

 
$
170,878

 
$
357,618

 
$
360,378

 
$
289,148

 
$
327,268

Net Income
7,290

 
4,528

 
24,286

 
12,516

 
11,641

 
15,974

Earnings per common share:
 
 
 
 
 
 
 
 
 
 
Basic
$
0.16

 
$
0.10

 
$
0.51

 
$
0.26

 
$
0.26

 
$
0.36

Diluted
$
0.16

 
$
0.10

 
$
0.50

 
$
0.26

 
$
0.26

 
$
0.36


* The pro forma results for the three-month period ended June 30, 2017 are not included in the table above because the operating results for the DFINE and Argon critical care division acquisitions were included in our consolidated statements of income for this period.

The unaudited pro forma information set forth above is for informational purposes only and includes adjustments related to the step-up of acquired inventories, amortization expense of acquired intangible assets, interest expense on long-term debt and changes in the timing of the recognition of the gain on bargain purchase. The pro forma information should not be considered indicative of actual results that would have been achieved if the DFINE acquisition had occurred on January 1, 2015 and the acquisition of the Argon critical care division had occurred on January 1, 2016, or results that may be obtained in any future period. The pro forma consolidated results of operations do not include the VAT, Catheter Connections or HeRO Graft acquisitions as we do not deem the pro forma effect of these transactions to be material.

6. Segment Reporting. We report our operations in two operating segments: cardiovascular and endoscopy. Our cardiovascular segment consists of cardiology and radiology medical device products which assist in diagnosing and treating coronary artery disease, peripheral vascular disease and other non-vascular diseases and includes embolotherapeutic, cardiac rhythm management ("CRM"), electrophysiology ("EP"), and interventional oncology and spine devices. Our endoscopy segment consists of gastroenterology and pulmonology medical device products which assist in the palliative treatment of expanding esophageal, tracheobronchial and biliary strictures caused by malignant tumors. We evaluate the performance of our operating segments based on operating income. 

Financial information relating to our reportable operating segments and reconciliations to the consolidated totals for the three and six-month periods ended June 30, 2017 and 2016, are as follows (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Net Sales
 

 
 

 
 
 
 
Cardiovascular
$
179,734

 
$
145,525

 
$
344,521

 
$
278,069

Endoscopy
6,815

 
5,546

 
13,097

 
11,079

Total net sales
186,549

 
151,071

 
357,618

 
289,148

 
 
 
 
 
 
 
 
Operating income
 

 
 

 
 
 
 
Cardiovascular
11,545

 
10,880

 
15,549

 
17,529

Endoscopy
1,817

 
701

 
3,422

 
1,759

Total operating income
13,362

 
11,581

 
18,971

 
19,288


15



7. New Financial Accounting Standards. 
Recently Adopted
In January 2017, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which eliminates the requirement to determine the fair value of individual assets and liabilities of a reporting unit to measure goodwill impairment. Under these amendments, goodwill impairment testing will be performed by comparing the fair value of the reporting unit with its carrying amount and recognizing an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. We adopted ASU 2017-04 effective January 1, 2017 on a prospective basis, and it did not have a material impact on our consolidated financial statements for the six months ended June 30, 2017.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which provides guidance to entities to assist with evaluating when a set of transferred assets and activities is a business and provides a screen to determine when a set is not a business. Under the new guidance, when substantially all the fair value of gross assets acquired (or disposed of) is concentrated in a single identifiable asset, or group of similar assets, the assets acquired would not represent a business. Also, to be considered a business, an acquisition would have to include an input and a substantive process that together significantly contribute to the ability to produce outputs. We adopted ASU 2017-01 effective January 1, 2017 on a prospective basis. The implementation of ASU 2017-01 did not have a material impact on our consolidated financial statements for the six months ended June 30, 2017.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which requires companies to record excess tax benefits and deficiencies in income rather than the current requirement to record them through equity. ASU 2016-09 also allows companies the option to recognize forfeitures of share-based awards when they occur rather than the previous requirement to make an estimate upon the grant of the awards. We adopted ASU 2016-09 effective January 1, 2017 on a prospective basis and, as such, no prior periods were adjusted. In accordance with the new standard and prospectively since the date we adopted ASU 2016-09, excess tax benefits from stock-based compensation are reported as an income tax benefit in our consolidated statements of income (see Note 8).

In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, which requires all deferred tax assets and deferred tax liabilities to be presented as noncurrent within a classified balance sheet. We adopted ASU 2015-17 effective January 1, 2017 on a prospective basis and did not reclassify presentation of prior year balances. The adoption of this standard did not have a material impact on our consolidated financial statements for the six months ended June 30, 2017.

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory. ASU 2015-11 requires that inventory be measured at the lower of cost or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Inventory measured using last-in, first-out or the retail inventory method are excluded from the scope of ASU 2015-11, which is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The implementation of ASU 2015-11 did not have a material impact on our consolidated financial statements for the six months ended June 30, 2017.

Not Yet Adopted

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory, which requires the recognition of the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. ASU 2016-16 will be effective for us on January 1, 2018. We are currently evaluating the anticipated impact of adopting ASU 2016-16 on our consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 will be effective for us on January 1, 2018 with early adoption permitted. We do not presently anticipate that the adoption of ASU 2016-15 will have a material impact on our consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases, which eliminates the current tests for lease classification under U.S. GAAP and requires lessees to recognize the right-of-use assets and related lease liabilities on the balance sheet for all leases greater than one year in duration. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption of ASU 2016-02 is permitted. ASU 2016-02 provides that lessees (for capital and

16


operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. We are assessing the impact that ASU 2016-02 is anticipated to have on our consolidated financial statements. We currently expect that most of our operating lease commitments will be subject to the new standard and recognized as lease liabilities and right-of-use assets upon our adoption of ASU 2016-02.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, which amends the guidance regarding the classification and measurement of financial instruments. Changes to the current guidance primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, ASU 2016-01 clarifies guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. ASU 2016-01 will be effective for us on January 1, 2018. Early adoption is not permitted except for the provision to record fair value changes for financial liabilities under the fair value option resulting from instrument-specific credit risk in other comprehensive income. Upon adoption of ASU 2016-01, an entity should apply the amendments by means of a cumulative-effect adjustment to the balance sheet at the beginning of the first reporting period in which the guidance is effective. We do not presently anticipate that the adoption of ASU 2016-01 will have a material impact on our financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), to update the financial reporting requirements for revenue recognition. Topic 606 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The guidance is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. This guidance is effective for us beginning on January 1, 2018, and entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. We have not yet reached a conclusion on whether we will adopt this new standard on a prospective or retrospective basis.

We are concluding the assessment phase of implementing this guidance. We have evaluated each of the five steps in Topic 606, which are as follows: 1) Identify the contract with the customer; 2) Identify the performance obligations in the contract; 3) Determine the transaction price; 4) Allocate the transaction price to the performance obligations; and 5) Recognize revenue when (or as) performance obligations are satisfied. Our preliminary conclusion is that we expect to identify similar performance obligations under ASC Topic 606 as compared with deliverables and separate units of account previously identified. As a result, we expect the timing of our revenue to remain largely the same in comparison to the current revenue recognition guidance. There are also certain considerations related to internal control over financial reporting that are associated with implementing Topic 606. We are currently evaluating our control framework for revenue recognition and identifying any changes that may need to be made in response to the new guidance. Disclosure requirements under the new guidance in Topic 606 have been significantly expanded in comparison to the disclosure requirements under the current guidance. Designing and implementing the appropriate controls over gathering and reporting the information required under Topic 606 is currently in process.

8. Income Taxes. Our overall effective tax rate for the three months ended June 30, 2017 and 2016 was 16.2% and 26.1%, respectively, which resulted in a provision for income taxes of approximately $1.8 million and $2.6 million, respectively. Our overall effective tax rate for the six months ended June 30, 2017 and 2016 was 9.4% and 26.2%, respectively, which resulted in a provision for income taxes of approximately $2.5 million and $4.1 million, respectively. A higher mix of earnings from our foreign operations, primarily in Ireland, which are taxed at lower rates than our U.S. operations and a discrete tax benefit related to share-based payment awards due to the application of ASU No. 2016-09 decreased our effective income tax rates for both periods, when compared to the prior year periods. A nontaxable gain on the bargain purchase relating to the acquisition of the critical care division of Argon also decreased the effective income tax rate for the six-month period ended June 30, 2017, when compared to the corresponding period of 2016.


17


9. Revolving Credit Facility and Long-term Debt. Our outstanding debt obligations as of June 30, 2017 and December 31, 2016, consisted of the following (in thousands):
 
June 30, 2017
 
December 31, 2016
2016 Term loan
$
90,000

 
$
145,000

2016 Revolving credit loans
145,500

 
180,000

2017 Debt facility
6,969

 

Less debt issuance costs
(557
)
 
(627
)
Total debt
241,912

 
324,373

Less current portion
16,969

 
10,000

Long-term portion
$
224,943

 
$
314,373


2017 Debt Facility

On February 23, 2017, we entered into a loan agreement with HSBC Bank USA, National Association ("HSBC Bank") whereby HSBC Bank agreed to provide us with a loan in the amount of approximately $7.0 million. The loan matures on February 1, 2018, with an extension available at our option, subject to certain conditions. The loan agreement bears interest at the three-month London Inter-Bank Offered Rate (“LIBOR”) plus 1.0%, which resets quarterly. The loan is secured by assets equal to the currently outstanding loan balance. The loan contains covenants, representations and warranties and other terms customary for loans of this nature. As of June 30, 2017, our interest rate on the loan was a variable rate of 2.12%.

2016 Term Loan and Revolving Credit Loans

On July 6, 2016, we entered into a Second Amended and Restated Credit Agreement (as amended to date, the “Second Amended Credit Agreement”), with Wells Fargo Bank, National Association, as administrative agent, swingline lender and a lender, and Wells Fargo Securities, LLC, as sole lead arranger and sole bookrunner. In addition to Wells Fargo Bank, National Association, Bank of America, N.A., U.S. Bank, National Association, and HSBC Bank, are parties to the Second Amended Credit Agreement as lenders. The Second Amended Credit Agreement amends and restates in its entirety our previously outstanding Amended and Restated Credit Agreement and all amendments thereto. The Second Amended Credit Agreement was amended on September 28, 2016 to allow for a new revolving credit loan to our wholly-owned subsidiary and on March 20, 2017 to allow flexibility in how we apply net proceeds received from equity issuances to prepay outstanding indebtedness.

The Second Amended Credit Agreement provides for a term loan of $150 million and a revolving credit commitment up to an aggregate amount of $275 million, which includes a reserve of $25 million to make swingline loans from time to time. The term loan is payable in quarterly installments in the amounts provided in the Second Amended Credit Agreement until the maturity date of July 6, 2021, at which time the term and revolving credit loans, together with accrued interest thereon, will be due and payable. At any time prior to the maturity date, we may repay any amounts owing under all revolving credit loans, term loans, and all swingline loans in whole or in part, subject to certain minimum thresholds, without premium or penalty, other than breakage costs.

Revolving credit loans denominated in dollars and term loans made under the Second Amended Credit Agreement bear interest, at our election, at either a Base Rate or Eurocurrency Base Rate (as such terms are defined in the Second Amended Credit Agreement) plus the applicable margin, which increases as our Consolidated Total Leverage Ratio (as defined in the Second Amended Credit Agreement) increases. Revolving credit loans denominated in an Alternative Currency (as defined in the Second Amended Credit Agreement) bear interest at the Eurocurrency rate plus the applicable margin. Swingline loans bear interest at the base rate plus the applicable margin. Upon an event of default, the interest rate may be increased by 2.0%. The revolving credit commitment will also carry a commitment fee of 0.15% to 0.40% per annum on the unused portion.

The Second Amended Credit Agreement is collateralized by substantially all our assets. The Second Amended Credit Agreement contains covenants, representations and warranties and other terms customary for loans of this nature. The Second Amended Credit Agreement requires that we maintain certain financial covenants, as follows:

18


 
 
 
Covenant Requirement
Consolidated Total Leverage Ratio (1)
 
 
 
As of June 30, 2017
 
4.0 to 1.0
 
July 1, 2017 through December 31, 2017
 
3.75 to 1.0
 
January 1, 2018 through March 31, 2018
 
3.5 to 1.0
 
April 1, 2018 and thereafter
 
3.25 to 1.0
Consolidated EBITDA (2)
 
1.25 to 1.0
Consolidated Net Income (3)
 
$0
Facility Capital Expenditures (4)
 
$30 million
 
 
 
 
(1)
Maximum Consolidated Total Leverage Ratio (as defined in the Second Amended Credit Agreement) as of any fiscal quarter end.
(2)
Minimum ratio of Consolidated EBITDA (as defined in the Second Amended Credit Agreement and adjusted for certain expenditures) to Consolidated Fixed Charges (as defined in the Second Amended Credit Agreement) for any period of four consecutive fiscal quarters.
(3)
Minimum level of Consolidated Net Income (as defined in the Second Amended Credit Agreement) for certain periods, and subject to certain adjustments.
(4)
Maximum level of the aggregate amount of all Facility Capital Expenditures (as defined in the Second Amended Credit Agreement) in any fiscal year.
Additionally, the Second Amended Credit Agreement contains customary events of default and affirmative and negative covenants for transactions of this type. As of June 30, 2017, we believe we were in compliance with all covenants set forth in the Second Amended Credit Agreement.

As of June 30, 2017, we had outstanding borrowings of approximately $235.5 million under the Second Amended Credit Agreement, with available borrowings of approximately $129.5 million, based on the leverage ratio required pursuant to the Second Amended Credit Agreement. Our interest rate as of June 30, 2017 was a fixed rate of 2.23% on $127.5 million and a fixed rate of 2.37% on $47.5 million as a result of interest rate swaps (see Note 10), and a variable floating rate of 2.48% on $60.5 million. Our interest rate as of December 31, 2016 was a fixed rate of 2.98% on $130.0 million and 3.12% on $45.0 million as a result of interest rate swaps and a variable floating rate of 2.77% on approximately $150.0 million.

Future Payments

Future minimum principal payments on our long-term debt as of June 30, 2017, are as follows (in thousands):
Years Ending 
 
Future Minimum
December 31
 
Principal Payments
Remaining 2017
 
5,000

2018
 
19,469

2019
 
15,000

2020
 
17,500

2021
 
185,500

Total future minimum principal payments
 
$
242,469


10. Derivatives
 
General. Our earnings and cash flows are subject to fluctuations due to changes in interest rates and foreign currency exchange rates, and we seek to mitigate a portion of these risks by entering into derivative contracts. The derivatives we use are interest rate swaps and foreign currency forward contracts. We recognize derivatives as either assets or liabilities at fair value in the accompanying consolidated balance sheets, regardless of whether or not hedge accounting is applied. We report cash flows arising from our hedging instruments consistent with the classification of cash flows from the underlying hedged items. Accordingly, cash flows associated with our derivative programs are classified as operating activities in the accompanying consolidated statements of cash flows.

We formally document, designate and assess the effectiveness of transactions that receive hedge accounting initially and on an ongoing basis. Changes in the fair value of derivatives that qualify for hedge accounting treatment are recorded, net of applicable

19


taxes, in accumulated other comprehensive income (loss), a component of stockholders’ equity in the accompanying consolidated balance sheets. For the ineffective portions of qualifying hedges, the change in fair value is recorded through earnings in the period of change. Changes in the fair value of derivatives not designated as hedging instruments are recorded in earnings throughout the term of the derivative.

Interest Rate Risk. A portion of our debt bears interest at variable interest rates and, therefore, we are subject to variability in the cash paid for interest expense. In order to mitigate a portion of this risk, we use a hedging strategy to reduce the variability of cash flows in the interest payments associated with a portion of the variable-rate debt outstanding under our Second Amended Credit Agreement that is solely due to changes in the benchmark interest rate.

Derivatives Designated as Cash Flow Hedges

On December 19, 2012, we entered into a pay-fixed, receive-variable interest rate swap having an initial notional amount of $150 million with Wells Fargo to fix the one-month LIBOR rate at 0.98%. The variable portion of the interest rate swap is tied to the one-month LIBOR rate (the benchmark interest rate). The interest rates under both the interest rate swap and the underlying debt reset, the swap is settled with the counterparty, and interest is paid on a monthly basis. The notional amount of the interest rate swap is reduced quarterly by 50% of the minimum principal payment due under the terms of our Second Amended Credit Agreement. The interest rate swap is scheduled to expire on December 19, 2017.

On August 5, 2016, we entered into a pay-fixed, receive-variable interest rate swap having an initial notional amount of $42.5 million with Wells Fargo to fix the one-month LIBOR rate at 1.12%. The variable portion of the interest rate swap is tied to the one-month LIBOR rate (the benchmark interest rate). On a monthly basis, the interest rates under both the interest rate swap and the underlying debt reset, the swap is settled with the counterparty, and interest is paid. The notional amount of the interest rate swap increases quarterly by an amount equal to the decrease of the hedge entered into on December 19, 2012, up to the amount of $175.0 million. The interest rate swap is scheduled to expire on July 6, 2021.

At June 30, 2017 and December 31, 2016, our interest rate swaps qualified as cash flow hedges. The fair value of our interest rate swaps at June 30, 2017 was an asset of approximately $4.5 million, which was partially offset by approximately $1.7 million in deferred taxes. The fair value of our interest rate swaps at December 31, 2016 was an asset of approximately $5.0 million, which was partially offset by approximately $1.9 million in deferred taxes.

Foreign Currency Risk. We operate on a global basis and are exposed to the risk that our financial condition, results of operations, and cash flows could be adversely affected by changes in foreign currency exchange rates. To reduce the potential effects of foreign currency exchange rate movements on net earnings, we enter into derivative financial instruments in the form of foreign currency exchange forward contracts with major financial institutions. Our policy is to enter into foreign currency derivative contracts with maturities of up to two years. We are primarily exposed to foreign currency exchange rate risk with respect to transactions and balances denominated in Euros, British Pounds, Chinese Yuan Renminbi, Mexican Pesos, Brazilian Reals, Australian Dollars, Hong Kong Dollars, Swiss Francs, Swedish Krona, Canadian Dollars, Singapore Dollars, Japanese Yen, Korean Won, and Danish Krone. Our consolidated financial statements are denominated in, and our principal currency is, the U.S. Dollar. We do not use derivative financial instruments for trading or speculative purposes. We are not subject to any credit risk contingent features related to our derivative contracts, and counterparty risk is managed by allocating derivative contracts among several major financial institutions.

Derivatives Designated as Cash Flow Hedges

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income (loss) and reclassified into earnings in the same line item associated with the forecasted transaction and in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any (i.e., the ineffective portion) or hedge components excluded from the assessment of effectiveness, are recognized in earnings during the current period. We enter into forward contracts on various foreign currencies to manage the risk associated with forecasted exchange rates which impact revenues, cost of sales, and operating expenses in various international markets. The objective of the hedges is to reduce the variability of cash flows associated with the forecasted purchase or sale of the associated foreign currencies.

We enter into approximately 100 cash flow foreign currency hedges every month. As of June 30, 2017, we had entered into foreign currency forward contracts, which qualified as cash flow hedges, with the following notional amounts (in thousands and in local currencies):

20


Currency
Symbol
Forward Notional Amount

Euro
EUR
8,375

Swiss Franc
CHF
1,448

Danish Krone
DKK
9,955

British Pound
GBP
3,355

Mexican Peso
MXN
83,325

Swedish Krona
SEK
13,930


Derivatives Not Designated as Cash Flow Hedges

We forecast our net exposure in various receivables and payables to fluctuations in the value of various currencies, and we enter into foreign currency forward contracts to mitigate that exposure. We enter into approximately 20 foreign currency fair value hedges every month. As of June 30, 2017, we had entered into foreign currency forward contracts related to those balance sheet accounts with the following notional amounts (in thousands and in local currencies):

Currency
Symbol
Forward Notional Amount

Euro
EUR
22,779

British Pound
GBP
811

Chinese Yuan Renminbi
CNY
53,310

Mexican Peso
MXN
12,663

Brazilian Real
BRL
7,400

Australian Dollar
AUD
5,270

Hong Kong Dollar
HKD
11,000

Swiss Franc
CHF
215

Swedish Krona
SEK
3,552

Canadian Dollar
CAD
2,100

Singapore Dollar
SGD
4,902

Japanese Yen
JPY
120,000

South Korean Won
KRW
1,800,000


Balance Sheet Presentation of Derivatives. As of June 30, 2017 and December 31, 2016, all derivatives, both those designated as hedging instruments and those that were not designated as hedging instruments, were recorded gross at fair value on our consolidated balance sheets. We are not subject to any master netting agreements.

The fair value of derivative instruments on a gross basis is as follows (in thousands):

21


 
 
 
Fair Value
 
 
Balance Sheet Location
June 30, 2017
 
December 31, 2016
Derivatives designated as hedging instruments
 
 
 
Assets
 
 
 
 
 
Interest rate swaps
 
Prepaid expenses and other assets (current)
$
174

 
$

Interest rate swaps
 
Other assets (long-term)
4,309

 
4,991

Foreign currency forward contracts
 
Prepaid expenses and other assets (current)
673

 
116

Foreign currency forward contracts
 
Other assets (long-term)
191

 
18

 
 
 
 
 
 
(Liabilities)
 
 
 
 
 
Foreign currency forward contracts
 
Accrued Expenses (current)
$
(214
)
 
$
(275
)
Foreign currency forward contracts
 
Other long-term obligations
(89
)
 
(18
)
 
 
 
 
 
 
Derivatives not designated as hedging instruments
 
 
 
Assets
 
 
 
 
 
Foreign currency forward contracts
 
Prepaid expenses and other assets (current)
$
200

 
$
220

(Liabilities)
 
 
 
 
 
Foreign currency forward contracts
 
Accrued Expenses (current)
(910
)
 
(171
)

Income Statement Presentation of Derivatives

Derivatives Designated as Cash Flow Hedges

Derivative instruments designated as cash flow hedges had the following effects, before income taxes, on other comprehensive income and net earnings in our consolidated statements of income, consolidated statements of comprehensive income and consolidated balance sheets (in thousands):
 
Amount of Gain/(Loss) recognized in OCI
 
 
Amount of Gain/(Loss) reclassified from AOCI
 
Three Months Ended June 30,
 
 
Three Months Ended June 30,
 
2017
2016
 
 
2017
2016
Derivative instrument
 
 
Location in Statements of Income
Interest rate swaps
$
(893
)
$
(152
)
 
Interest expense
$

$
(124
)
 
 
 
 
 
 
 
Foreign currency forward contracts
353


 
Revenue
(41
)

 
 
 
 
Cost of goods sold
28



 
Amount of Gain/(Loss) recognized in OCI
 
 
Amount of Gain/(Loss) reclassified from AOCI
 
Six Months Ended June 30,
 
 
Six Months Ended June 30,
 
2017
2016
 
 
2017
2016
Derivative instrument
 
 
Location in Statements of Income
Interest rate swaps
$
(507
)
$
(881
)
 
Interest expense
$
(104
)
$
(310
)
 
 
 
 
 
 
 
Foreign currency forward contracts
741


 
Revenue
(40
)

 
 
 
 
Cost of goods sold
(37
)


The net amount recognized in earnings during the three and six-month periods ended June 30, 2017 and 2016 due to ineffectiveness and amounts excluded from the assessment of hedge effectiveness were not significant.


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As of June 30, 2017, approximately $483,000, or $295,000 after taxes, was expected to be reclassified from accumulated other comprehensive income to earnings in revenue and cost of sales over the succeeding twelve months. As of June 30, 2017, approximately $512,000, or $313,000 after taxes, was expected to be reclassified from accumulated other comprehensive income to earnings in interest expense over the succeeding twelve months.

Derivatives Not Designated as Hedging Instruments

The following gains/(losses) from these derivative instruments were recognized in our consolidated statements of income for the periods presented (in thousands):
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
 
 
2017
2016
 
2017
2016
Derivative Instrument
 
Location in Statements of Income
 
 
 
 
 
 
Foreign currency forward contracts
 
Other (expense)
 
$
(1,834
)
$
198

 
$
(2,692
)
$
(145
)

See Note 11 for more information about our derivatives.

11. Fair Value Measurements. Our financial assets and (liabilities) carried at fair value measured on a recurring basis as of June 30, 2017 and December 31, 2016, consisted of the following (in thousands):
 
 
 
 
Fair Value Measurements Using
 
 
Total Fair
 
Quoted prices in
 
Significant other
 
Significant
 
 
Value at
 
active markets
 
observable inputs
 
unobservable inputs
Description
 
June 30, 2017
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
 
 
 
 
 
 
 
 
Interest rate contracts (1)
 
$
4,483

 
$

 
$
4,483

 
$

Foreign currency contract assets, current and long-term (2)
 
$
1,064

 
$

 
$
1,064

 
$

Foreign currency contract liabilities, current and long-term (3)
 
$
(1,213
)
 
$

 
$
(1,213
)
 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
Fair Value Measurements Using
 
 
Total Fair
 
Quoted prices in
 
Significant other
 
Significant
 
 
Value at
 
active markets
 
observable inputs
 
unobservable inputs
Description
 
December 31, 2016
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
 
 
 
 
 
 
 
 
Interest rate contracts (1)
 
$
4,991

 
$

 
$
4,991

 
$

Foreign currency contract assets, current and long-term (2)
 
$
354

 
$

 
$
354

 
$

Foreign currency contract liabilities, current and long-term (3)
 
$
(464
)
 
$

 
$
(464
)
 
$


(1)    The fair value of the interest rate contracts is determined using Level 2 fair value inputs and is recorded as prepaid expenses and other assets (current) and other assets (long-term) in the consolidated balance sheets.
(2)    The fair value of the foreign currency contract assets (including those designated as hedging instruments and those not designated as hedging instruments) is determined using Level 2 fair value inputs and is recorded as prepaid expenses and other assets (current) and other assets (long-term) in the consolidated balance sheets.
(3)    The fair value of the foreign currency contract liabilities (including those designated as hedging instruments and those not designated as hedging instruments) is determined using Level 2 fair value inputs and is recorded as accrued expenses (current) and other long-term obligations in the consolidated balance sheets.

Certain of our business combinations involve the potential for the payment of future contingent consideration, generally based on a percentage of future product sales or upon attaining specified future revenue milestones. See Note 5 for further information regarding these acquisitions. The contingent consideration liability is re-measured at the estimated fair value each reporting period with the change in fair value recognized within operating expenses in the accompanying consolidated statements of income. We measure the initial liability and re-measure the liability on a recurring basis using Level 3 inputs as defined under authoritative

23


guidance for fair value measurements. Changes in the fair value of our contingent consideration liability during the three and six-month periods ended June 30, 2017 and 2016, consisted of the following (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Beginning balance
$
705

 
$
928

 
$
683

 
$
1,024

Contingent consideration liability recorded as the result of acquisitions (see Note 5)
4,900

 

 
4,900

 

Fair value adjustments recorded to income during the period
(18
)
 
(14
)
 
19

 
57

Contingent payments made
(15
)
 
(16
)
 
(30
)
 
(183
)
Ending balance
$
5,572

 
$
898

 
$
5,572

 
$
898


The recurring Level 3 measurement of our contingent consideration liabilities and contingent receivable includes the following significant unobservable inputs at June 30, 2017 and December 31, 2016 (amounts in thousands):
Contingent consideration asset or liability
 
Fair value at June 30, 2017
 
Valuation technique
 
Unobservable inputs
 
Range
Revenue-based payments
 
$
5,572

 
Discounted cash flow

 
Discount rate
 
9.9% - 15%
contingent liability
 
 
 
 
Probability of milestone payment
 
100%
 
 
 
 
 
 
Projected year of payments
 
2017-2033
 
 
 
 
 
 
 
 
 
Contingent receivable
 
$
528

 
Discounted cash flow

 
Discount rate
 
10%
asset
 
 
 
 
Probability of milestone payment
 
57%
 
 
 
 
 
 
Projected year of payments
 
2017-2019
 
 
 
 
 
 
 
 
 
Contingent consideration asset or liability
 
Fair value at December 31, 2016
 
Valuation technique
 
Unobservable inputs
 
Range
Revenue-based payments
 
$
683

 
Discounted cash flow

 
Discount rate
 
9.9% - 15%
contingent liability
 
 
 
 
Probability of milestone payment
 
100%
 
 
 
 
 
 
Projected year of payments
 
2017-2028
 
 
 
 
 
 
 
 
 
Contingent receivable
 
$
528

 
Discounted cash flow

 
Discount rate
 
10%
asset
 
 
 
 
Probability of milestone payment
 
57%
 
 
 
 
 
 
Projected year of payments
 
2017-2019
 
The contingent consideration liabilities and contingent receivable are re-measured to fair value each reporting period using projected revenues, discount rates, probabilities of payment, and projected payment dates. Projected contingent payment amounts are discounted back to the current period using a discounted cash flow model. Projected revenues are based on our most recent internal operational budgets and long-range strategic plans. An increase (decrease) in either the discount rate or the time to payment, in isolation, may result in a significantly lower (higher) fair value measurement. A decrease in the probability of any milestone payment may result in lower fair value measurements.

Our determination of the fair value of the contingent consideration liabilities and contingent receivable could change in future periods based upon our ongoing evaluation of these significant unobservable inputs. We record any such change in fair value to operating expenses in our consolidated statements of income. As of June 30, 2017, approximately $5.5 million was included in other long-term obligations and $69,000 was included in accrued expenses in our consolidated balance sheet. As of December 31, 2016, approximately $595,000 was included in other long-term obligations and $88,000 was included in accrued expenses in our consolidated balance sheet. The cash paid to settle the contingent consideration liability recognized at fair value as of the acquisition date (including measurement-period adjustments) has been reflected as a cash outflow from financing activities in the accompanying consolidated statements of cash flows.

During the three and six-month periods ended June 30, 2017, we had losses of approximately $1,000, and $19,000, respectively, compared to losses of approximately $90,000 and $90,000 for the three and six-month periods ended June 30, 2016, respectively, related to the measurement of non-financial assets at fair value on a nonrecurring basis subsequent to their initial recognition.

24



The carrying amount of cash and cash equivalents, trade receivables, and trade payables approximate fair value because of the immediate, short-term maturity of these financial instruments. The carrying amount of long-term debt approximates fair value, as determined by borrowing rates estimated to be available to us for debt with similar terms and conditions. The fair value of assets and liabilities whose carrying value approximates fair value is determined using Level 2 inputs, with the exception of cash and cash equivalents, which are Level 1 inputs.

12. Goodwill and Intangible Assets. The changes in the carrying amount of goodwill for the six-month period ended June 30, 2017 were as follows (in thousands):
 
2017
Goodwill balance at January 1
$
211,927

Effect of foreign exchange
1,686

Additions as the result of acquisitions
13,216

Goodwill balance at June 30
$
226,829


As of June 30, 2017, we had recorded $8.3 million of accumulated goodwill impairment charges. The goodwill balances as of June 30, 2017 and December 31, 2016, were related to our cardiovascular segment.

Other intangible assets at June 30, 2017 and December 31, 2016, consisted of the following (in thousands):
 
June 30, 2017
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Amount
Patents
$
15,192

 
$
(3,444
)
 
$
11,748

Distribution agreements
6,626

 
(4,013
)
 
2,613

License agreements
21,284

 
(4,067
)
 
17,217

Trademarks
16,208

 
(3,992
)
 
12,216

Covenants not to compete
1,029

 
(953
)
 
76

Customer lists
25,603

 
(16,642
)