Good afternoon, ladies and gentlemen, and welcome to the Fourth Quarter 2020 Earnings Conference Call for Merit Medical Systems, Inc. Please note that this conference call is being recorded, and that the recording will be available on the company's website for replay shortly. I would now like to turn the call over to Mr. Fred Lampropoulos, Merit Medical Systems Founder, Chairman and Chief Executive Officer. Please go ahead, sir.

Thank you, Liz, and welcome, everyone, to Merit Medical's Fourth Quarter 2020 Earnings Conference Call. I'm joined on the call today by Raul Parra, our Chief Financial Officer and Treasurer; and Brian Lloyd, our Chief Legal Officer and Corporate Secretary. Brian, would you mind taking us through the safe harbor provisions, please?

Thank you, Fred. Before we get started, I would like to remind everyone that this presentation contains forward-looking statements that receive safe harbor protection under federal securities laws. Although we believe these forward-looking statements are based on reasonable assumptions, they are subject to unknown risks and uncertainties. The realization of any of these risks or uncertainties, including the unpredictable effect of the ongoing COVID-19 pandemic as well as extraordinary events or transactions impacting our company could cause actual results to differ materially from those currently anticipated. In addition, any forward-looking statements represent our views only as of today, February 24, 2021, and should not be relied upon as representing our views as of any other date. We specifically disclaim any obligation to update such statements, except as required by applicable law. Please refer to the section entitled disclosure 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-K. Please refer to the sections of our presentation entitled non-GAAP financial measures and notes to non-GAAP financial measures, for important information regarding non-GAAP financial measures discussed on this call. Readers consider non-GAAP financial measures in addition to, not as a substitute for financial reporting measures prepared in accordance with GAAP. Please note that these calculations may not be comparable with similarly titled measures of other companies. Both today's press release and our presentation are available on the investors page of our website. I will now turn the call back to Fred.

Raul, thank you. Given Raul'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 2020. We have included full reconciliations from our GAAP reported results to the related non-GAAP item in our press release this afternoon. Gross profit decreased approximately 1% year-over-year in the fourth quarter. Our gross margin was 47.9% compared to 48.3% in the prior year period. The approximate 40 basis point decline in gross margin year-over-year was driven primarily by changes in product mix, partially offset by improvements in manufacturing efficiencies.

Thank you, Fred. I would like to provide a few considerations and key assumptions for the investment community to bear in mind as they evaluate our 2021 revenue guidance. We have two items to call out as contributors to our 2020 revenue results that represent material headwinds to the growth rates our guidance assumes in 2021. We also have a key assumption impacting our 2021 revenue expectations over the second half of 2021. And let me give you some additional color. Regarding the two areas that represent headwinds to our 2021 revenue expectations, first, as we discussed in prior calls and disclosed in filings during fiscal year 2020, we announced strategic decisions to exit three businesses: the suspension of Merit's distribution agreement with NinePoint Medical in the first quarter of 2020, the closure of the ITL Healthcare procedure pack business in our Australian facility, and the disposition of assets related to the manufacturing of Merit's Hypotube product in August 2020. Together, these businesses contributed revenue of approximately $11.1 million during the fiscal year 2020 and will not contribute to our revenue results in 2021. Second, our 2020 revenue results benefited from the sales of Cultura nasopharyngeal swab and test kits used to collect and transport samples for COVID-19 testing which we developed, manufactured, and distributed beginning in the second quarter of 2020 in response to the critical need as a result of the COVID-19 pandemic. Importantly, Cultura is not a core product line for Merit going forward and we expect to gain approximately $1 million to $2 million in sales from this product line in 2021 compared to more than $19 million in 2020. This represents a material headwind to our year-over-year revenue profile for 2021. Our revenue guidance includes approximately $11 million to $12 million of headwind related to lower pricing as a result of tenders over the second half of 2021. Overall, we expect our total revenue in China to increase in the low single digits year-over-year in 2021, despite the expected pricing headwind as a result of strong unit growth during the year.

That's a lot of information, but that kind of wraps it up. And at this time, we'd like to turn the time over to Liz, and we'd now like to open it up for questions.

And our first question will come from Mike Matson with Needham & Company.

So I guess I'll start with the tenders you're assuming in China, is this based on tenders that you're aware are actually going to be happening? Are you just kind of putting some cushion in there in case they do happen? And then do you expect this to be kind of an ongoing thing that recurs every year over time and maybe rotate through different product categories? Or is this more of a one-and-done type of thing?

Yes. Thanks, Mike. Well, listen, what we've seen from other players, particularly in PTCA balloons and other types of things are these types of decreases that I think people like Medtronic and other companies have announced. So looking at this and understanding that they've basically focused on cardiovascular products, we thought it prudent to be able to go through and make sure that we're not making excuses. So again, governments and changes in administration can change lots of things. We thought it wise, based on what we're hearing, what we see, but it's not something that we have a tender that's pending or a directive that we've received. But with so much chatter and the local sourcing going on and what they call the single invoice program, we thought we'd be wise to do this.

Okay. Your guidance also reflects some of the divestitures or business exits mentioned from 2020. What about in 2021? Are you planning any more activities like that? I know your long-range plan involves some of that. Should we expect more in 2021, and would that potentially necessitate updates to your guidance, or would its impact be more significant in 2022?

Yes. Mike, we're not talking about that in advance. But it's part of our 3-year plan and our foundations for growth. So as you know, that's a 3-year plan. We're two months into that. We will be moving a number of products to Mexico as part of our foundations for growth this year. But we're not going into all of that at this point. If it was imminent or something like that, we had something on the table, we'd certainly lay it out there. But this is really just part of our 3-year plan. There will be more things to come, but nothing to announce or discuss today.

Our next question comes from Matt O'Brien with Piper Sandler.

This is Gerome on for Matt. I just wanted to start out a little bit on COVID. Appreciate the commentary on both the Q4 trends domestically and outside the U.S. We've heard fairly mixed things across medtech as far as Q1. So maybe you could kind of give us a flavor of whether things have gotten a little bit better, a little bit worse since last quarter. And then you mentioned not assuming any material improvements to the operating environment. I assume you mean from a patient throughput perspective, is that correct? And then just how material of a drag are you assuming in your guidance for that?

Yes. Well, listen, we saw business soften somewhat in December and ahead of expectations through the first two months of the quarter. They're still locked down, and they announced further lockdown in Ireland and some other locations. So I think in part of the COVID issue, we still see these locations, particularly in some of the emerging countries. So I think in looking at this, we do have confidence in the second half of the year. We're seeing lower cases and more people getting vaccinated. But outside the U.S., there's still a lot of this lockdown being imposed. So I think that's kind of the way that we looked at COVID. It's bumpy. There are pockets, but it's still not back to the point where it's totally under control. It's going to be a while.

Yes. I think you kind of see our reaction to it, right? For Q1, we've essentially said 5% down year-over-year. A big portion of that is, obviously, the COVID-related impact.

Yes. Does that answer your question, Steve?

Yes, absolutely. And then on your foundations for growth call a couple of months ago, you were a little hesitant to provide a lot of detail on the margin cadence. But now, I guess, with guidance out there, maybe you could help us understand in detail what you're baking into your 2021 guidance on the gross margin side? And then on the SKU rationalization, have you started that process? And if so, how much more do you have baked in for 2021?

Yes. I'll answer the question in terms of we've started it. The answer is yes. We have initiated a lot of work done in the initial assessment of that program. It's being driven internally by various teams and silo leaders. They've met with me. We've agreed on how we were going to proceed. It's aggressive but necessary and something we've been needing to do.

On the gross margin, there are really two components of revenue mix. We're expecting higher margins as elective procedures come back, and we've seen that quarter-over-quarter since the bottom. In addition, the U.S. is growing faster than OUS in 2021, which contributes to the gross margin improvement.

Our next question comes from Steven Lichtman with Oppenheimer.

So obviously, as you think about the pipeline, and I appreciate, Fred, the update on WAVE that remains a big long-term target. Wondering in the near term, what are some of the product lines that you're looking to in terms of above corporate average growth here over the next 12 to 18 months?

Yes. Thank you. One of the things that we've continued to do during this process is to keep our R&D going. And we have about ten products right now related to inflation devices, electrophysiology products, vascular access, among others. The good news is these products have regulatory approvals. However, it's hard to get into hospitals due to many restrictions.

I think our next announcement will be when we start enrolling. We will issue a press release as soon as the first patient is treated, which will happen very soon.

We'll give you more detail on that as we treat the first patient. So it's an exciting time for the business.

Yes, I think for Capex, we announced maybe a 3-year plan, roughly about $50 million per year, maintaining $35 million and $15 million for FfG related items.

And then, Fred, I think you guys mentioned strong demand in China, sort of offsetting the otherwise negative APAC region. Can you quantify that? I mean, was it up 10%? Or can you just talk about what you saw in China specifically?

Yes. I don't have the exact number in front of me.

China was up 7% year-over-year on a constant currency basis for the fourth quarter.

And yes, that would be safe to assume that it's well above the corporate average.

And just to be clear, for this year, you had about $30 million of discontinued products or products that have been phased out. So without that, your top line rate would have been closer to 6% or 7%?

That's correct.

Yes, 6.5% to 8.5%.

Next question comes from Jayson Bedford with Raymond James.

I guess just to follow-up on a few of the growth comments. First, what's the assumption for FX in '21 on the top line?

It's approximately $4 million, representing 40 to 50 basis points.

Yes. These situations really have to do with PTCA, as I mentioned. And one of the things we're concerned about is that we're a major player in inflation devices. Now nothing's come down, nothing's been pronounced, but if you're going to see it on this side, you may see it on the other side.

Yes. Roughly $11 million to $12 million.

Yes, we've been being transparent so you can glean these things.

It's Wei calling in for Larry. I want to start by asking you, I think you mentioned in response to an earlier question that the first couple of months of the year have been ahead of expectations. Can you give a little more color on that in terms of is that relative to December or your expectations for Q1? And if there's any color on which business segments have been outperforming?

Yes, I'm going to go ahead and let Raul answer that one.

We are seeing softness in our business and have accounted for it. In addition to the item we mentioned on the weather impact in February.

Okay. And then my second question is just looking at the revenue cadence for the year. So you talked about COVID headwind in the first half, normalized growth in the second half, but there's the potential for the China tender impact in the second half. In that context, can we see sequential revenue growth through the year?

Yes. I think if you look at our growth, it implies sequential growth in Q2. We do expect that growth to kind of get back to normal as we head out of Q1 and into Q2.

That's correct.

I may have missed this earlier, but Raul, did you give a D&A expense for the quarter and stock comp for the quarter by any chance?

Yes, on D&A, we've got $23.5 million and $4.1 million in stock compensation.

Okay. And did I hear free cash was $26 million in the quarter, correct?

Yes. Thank you, Mike.

Yes, for the fourth quarter, it was up 7% year-over-year.

And I just need to ask this because I want to clarify that guidance for 2021 is coming in at approximately 15% EPS growth on about 3% to 5% top line growth with most of that coming from gross margin improvement?

Yes. I think you hit the nail on the head.

Just wanted to get that out there, obviously 18% to 21% operating margins.

And just to clarify, for this year, you had about $30 million of discontinued products that have been phased out then you have the issue in China. So without that, your top line rate would have been closer to 6% or 7%?

That's correct.

Yes, 6.5% to 8.5%.

Our next question comes from Doug Free with World Capital Group.

So regarding China, you mentioned the single invoice program and more local sourcing. To what extent have you explored increased partnerships or joint ventures with local market participants to be viewed more as a local solution through a Chinese partner?

Yes. It's a good question, Doug. Listen, I mean, listen, we could spend a lot of time talking about China. The way we've chosen to approach in the past is to make sure that our registered products had strong IP, and they were innovative. We've always been concerned about partnerships and our IP. I think, however, we may need to reexamine that now and look for opportunities moving forward.

I'm showing no further questions in queue at this time. I'd like to turn the call back for closing remarks.

Liz, thank you very much. Well, listen, thank you for your time. There's a lot going on, and we appreciate your engagement. We will continue to provide updates as appropriate, and we're looking forward to another year of improvement. Thank you for your support, and good night.

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