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TMCNet:  MERIT MEDICAL SYSTEMS INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.

[March 12, 2014]

MERIT MEDICAL SYSTEMS INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operation should be read in conjunction with the Consolidated Financial Statements and related Notes thereto, which are included in Item 8 of this report. Although our financial statements are prepared in accordance with accounting principles which are generally accepted in the United States of America ("GAAP"), our management believes that 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. Included in our management's discussion and analysis of our financial condition and results of operation are references to some non-GAAP financial measures. Readers should consider these non-GAAP measures in addition to, not as a substitute for, financial reporting measures prepared in accordance with GAAP. These non-GAAP financial measures exclude some, but not all, items that may affect our net income. Additionally, these financial measures may not be comparable with similarly-titled measures of other companies.


OVERVIEW We design, develop, manufacture and market single-use medical products for interventional and diagnostic procedures. For financial reporting purposes, we report our operations in two operating segments: cardiovascular and endoscopy.

Our cardiovascular segment consists of cardiology and radiology devices, which assist in diagnosing and treating coronary arterial disease, peripheral vascular disease and other non-vascular diseases, and includes the embolotherapeutic products we acquired through our acquisition of BioSphere. Our endoscopy segment consists of gastroenterology and pulmonology devices which assist in the palliative treatment of expanding esophageal, tracheobronchial and biliary strictures caused by malignant tumors.

For the year ended December 31, 2013, we reported record sales of approximately $449.0 million, up approximately $54.8 million or 13.9%, over 2012 sales of approximately $394.3 million. Gross profits as a percentage of sales was 43.3% for the year ended December 31, 2013, compared to 46.2% for the year ended December 31, 2012.

During the year ended December 31, 2013, we reduced the amount of the contingent consideration liability related to the Ostial PRO Stent Positioning System, which we acquired in January 2012, by approximately $3.8 million. Under the terms of the Asset Purchase Agreement we executed with Ostial, we are obligated to make contingent purchase price payments based on a percentage of future sales of products utilizing the Ostial PRO Stent Positioning System. The adjustment to the contingent consideration liability triggered a review of the intangible assets we acquired from Ostial, which resulted in an intangible asset write-down of approximately $8.1 million related to those assets. These adjustments reduced operating income for year ended December 31, 2013 by approximately $4.3 million, or approximately $2.7 million net of tax. The reduction of the Ostial contingent consideration liability and the impairment of the Ostial intangible assets was the result of our assessment that we are not likely to generate the level of revenues from sales of the Ostial PRO Stent Positioning System that we anticipated at the acquisition date.

Net income for the year ended December 31, 2013 was approximately $16.6 million, or $0.39 per share, as compared to $19.7 million, or $0.46 per share, for the year ended December 31, 2012.

Our endoscopy segment made significant progress and generated operating income of approximately $1.2 million for the year ended December 31, 2013, when compared to an operating loss of approximately $770,000 for the year ended December 31, 2012. This increase in operating income for the year ended December 31, 2013 over the prior year was largely driven by higher sales and lower operating expenses associated with the endoscopy segment.

During the year ended December 31, 2013, we completed the construction of two new buildings in the U.S. to expand our production, warehouse and administration offices. The new South Jordan, Utah building of 253,000 square feet was completed in February of 2013 and the new Pearland, Texas facility of 94,000 square was completed in December of 2013. We anticipate that the additional costs associated with the operation of our new Texas facility could increase our selling, general and administrative expenses and could decrease gross profits and earnings for 2014. We believe the total impact of such costs will be approximately $3.0 to $3.5 million. Some of the building costs will be expensed into selling, general and administrative costs as opposed to cost of sales, during a transition period of approximately six months, as we believe it will take this long to complete the movement and qualification of production equipment from the old facility into the new facility. We anticipate that our new U.S. facilities will allow us to expand our manufacturing operations for new and existing products and increase our research and development pilot lab capacity for new product development, given the growth we are experiencing in our international markets.

During the fourth quarter of 2013, we acquired from Datascope the Safeguard Pressure Assisted Device, which assists in obtaining and maintaining hemostasis after a femoral procedure, and the Air-Band Radial Compression Device, which is indicated to assist hemostasis of the radial artery puncture site while maintaining visibility. During the fourth quarter of 2013, we also purchased from Radial Assist, the Rad Board, Rad Board Xtra, Rad Trac, and Rad Rest devices. The Rad Board is designed to 29-------------------------------------------------------------------------------- Table of Contents provide a larger work space for physicians and an area for patients to rest their arms during radial procedures. The Rad Board Xtra is designed to work in conjunction with the Rad Board by extending the usable work space and allowing for a 90-degree perpendicular extension of the arm for physicians who prefer doing procedures at a 90-degree angle. The Rad Trac is also designed to be used with the Rad Board and facilitates easy placement and removal of the Rad Board with the patient still on the table. The Rad Rest is a disposable, single-use product designed to stabilize the arm by ergonomically supporting the elbow, forearm and wrist during radial procedures. With the purchase of these products for radial procedures, along with our existing radial products and those under development, we plan to launch a complete line of radial approach products to a U.S. market which is growing rapidly and to an international market where, in some countries, this procedure accounts for more that 50% of percutaneous coronary interventions.

We intend to continue to invest in emerging international markets such as Brazil, Russia, India and China, in an effort to expand our market opportunities.

RESULTS OF OPERATIONS The following table sets forth certain operational data as a percentage of sales for the years indicated: 2013 2012 2011 Net sales 100% 100% 100% Gross profit 43.3 46.2 46.0Selling, general, and administrative expenses 28.6 31.0 29.1 Research and development expenses 7.5 7.0 6.1 Acquired in-process research and development - 0.6 1.6 Intangible asset impairment charge 1.8 - - Contingent consideration benefit (0.9) - - Income from operations 6.2 7.5 9.2 Income before income taxes 4.4 7.0 9.1 Net income 3.7 5.0 6.4 Listed below are the sales by product category within each business segment for the years ended December 31, 2013, 2012 and 2011 (in thousands): % Change 2013 % Change 2012 % Change 2011 Cardiovascular Stand-alone devices 10% $ 125,445 12% $ 114,242 15% $ 101,959 Custom kits and procedure trays 10% 103,700 3% 94,586 11% 91,532 Inflation devices (4)% 66,182 2% 68,979 8% 67,353 Catheters 16% 75,131 17% 64,878 23% 55,357 Embolization devices (1)% 33,395 8% 33,870 247% 31,229 CRM/EP 1,359% 28,271 -% 1,938 -% - Total 14% 432,124 9% 378,493 21% 347,430 Endoscopy Endoscopy devices 7% 16,925 31% 15,795 33% 12,019 Total 14% $ 449,049 10% $ 394,288 21% $ 359,449 Cardiovascular Sales. Our cardiovascular sales for the year ended December 31, 2013 were approximately $432.1 million, up 14.2%, when compared to the corresponding period for 2012 of approximately $378.5 million. Sales for the year ended December 31, 2013 were favorably affected by sales of our cardiac rhythm management ("CRM") and electrophysiology ("EP") products acquired from Thomas Medical of $26.3 million, an increase in sales of our stand-alone devices (particularly our Merit Laureate® 30-------------------------------------------------------------------------------- Table of Contents hydrophilic guide wires, newly-acquired Safeguard product and EN Snare endovascular snare) of approximately $11.2 million, or 9.8%; an increase in sales of catheter devices (particularly our peritoneal dialysis catheter acquired from MediGroup, micro catheter product line, Prelude sheath product line and Maestro microcatheter) of approximately $10.2 million, or 15.8%; and an increase in sales of custom kits and procedure trays of approximately $9.1 million, or 9.6%. Our cardiovascular sales for the year ended December 31, 2012 were approximately $378.5 million, up 8.9%, when compared to the corresponding period for 2011 of approximately $347.4 million. Cardiovascular sales for the year ended December 31, 2012 were favorably affected by an increase in sales of our stand-alone devices (particularly our hemostasis valves, guidewires and Scion Clo-SurPLUS P.A.D.) of approximately $12.3 million, or 12.0%; an increase in sales of catheter devices (particularly our Prelude sheath product line, micro catheter product line, aspiration catheter product line and diagnostic catheters) of approximately $9.5 million, or 17.2%; and an increase in custom kits and procedure trays of approximately $3.1 million, or 3.3%. Our cardiovascular sales for the year ended December 31, 2011 were approximately $347.4 million, up 20.8%, when compared to the corresponding period for 2010 of approximately $287.7 million. Cardiovascular sales for the year ended December 31, 2011 were favorably affected by an increase in sales of our embolization devices of approximately $22.2 million, or 246.9%, compared to $9.0 million for the three and one-half months in 2010, an increase in sales of our stand-alone devices (particularly our Merit Laureate Hydrophilic guide wire, hemostasis valves and manifolds) of approximately $13.4 million, or 15.1%; and increased sales of catheter devices (particularly our Prelude sheath product line, aspiration catheter product line and diagnostic catheter product line) of approximately $10.5 million, or 23.5%.

Our cardiovascular sales increased during 2013, 2012 and 2011, notwithstanding the fact that the markets for many of our products experienced slight pricing declines as our customers tried to reduce their costs. Substantially all of the increases in our revenues during the three years were attributable to increased unit sales. Sales by our European direct sales force are subject to foreign currency exchange rate fluctuations between the natural currency of a foreign country and the U.S. Dollar. Foreign currency exchange rate fluctuations increased sales by 0.2% in 2013 compared to 2012, decreased sales by 0.7% in 2012 compared to 2011, and decreased sales by 0.5% in 2011 compared to 2010. New products and market share gains in our existing product lines were additional sources of revenue growth.

Endoscopy Sales. Our endoscopy sales for the year ended December 31, 2013 were approximately $16.9 million, up 7.2%, when compared to sales in the corresponding period of 2012 of approximately $15.8 million. This increase was primarily the result of sales of our EndoMAXX Fully-Covered Esophageal stent.

Our endoscopy sales for the year ended December 31, 2012 were approximately $15.8 million, up 31.4%, when compared to sales in the corresponding period of 2011 of approximately $12.0 million. This increase was primarily related to the increase sales related to our new EndoMAXX Fully-Covered Esophageal Stent. Our endoscopy sales for 2011 were approximately $12.0 million, compared to 2010 sales of approximately $9.0 million. This increase was due primarily to an increase in sales of approximately $2.4 million of our Aero® Tracheobronchial stent, in large part accelerated by a competitor's withdrawal from the airway stent market.

International Sales. International sales for the year ended December 31, 2013 were approximately $165.8 million, or 37% of total sales, up 13.3% from the same period in 2012; international sales for the year ended December 31, 2012 were approximately $146.3 million, or 37% of total sales, up 16.2% from the same period in 2011; and international sales for the year ended December 31, 2011 were approximately $125.9 million, or 35% of total sales, up 32.2% from the same period in 2010. The increase in our international sales during 2013 was primarily related to year-over-year sales increases in China of approximately $5.4 million, up 20%; Europe Direct of approximately $5.3 million, up 13% (would have been up 11% in constant currency); and Russia of approximately $2.4 million, up 54%. The increase in our international sales during 2012 was primarily related to year-over-year sales increases in China of approximately $5.9 million, up 29%; Europe Direct of approximately $2.7 million, up 7% (would have been up 16% in constant currency); United Arab Emirates ("UAE") of approximately $2.0 million, up 55%; Russia of approximately $1.8 million, up 67%; Japan of approximately $1.8 million, up 14%; and Brazil of approximately $1.7 million, up 50%. The increase in our international sales during 2011 was primarily related to year-over-year sales increases in Europe Direct of approximately $9.7 million, up 31%; China of approximately $8.1 million, up 66%; Europe, the Middle East, and Africa ("EMEA") distributor of approximately $5.6 million, up 46%; and Pacific Rim (excluding China) of approximately $4.8 million, up 21%. Our total European direct sales were approximately $46.2 million, $42.6 million, and $39.9 million in 2013, 2012, and 2011, respectively.

Gross Profit. Our gross profit as a percentage of sales was 43.3%, 46.2%, and 46.0% in 2013, 2012 and 2011, respectively. The decrease in gross profit in 2013 was primarily related to amortization of developed technology costs of 1.3% associated with the Thomas Medical and Datascope acquisitions, implementation of the Medical Device Excise Tax of 1.0% which was part of the Affordable Care Act, and higher standard costs of 0.9% resulting from lower production volumes at the beginning of 2013. Gross profit for 2012, compared to the corresponding period of 2011, remained relatively unchanged. The increase in gross profit in 2011 was attributable primarily to an increase in sales of higher-margin BioSphere products of approximately 1.9% of sales and higher prices and unit sales through our distribution system in China of approximately 0.6% of sales.

31-------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Expenses. Our selling, general and administrative expenses increased approximately $6.5 million, or 5.4%, in 2013 compared to 2012; approximately $17.6 million, or 17%, in 2012 compared to 2011; and approximately $16.9 million, or 19%, in 2011 compared to 2010. The decrease in selling, general and administrative as a percentage of sales of 28.6% for 2013, when compared to 2012 of 31.0%, was primarily related to the implementation of cost-cutting initiatives in expenses such as trade shows and conventions, 401(k) employer match and bonuses. The increase in selling, general and administrative expenses in 2012, compared to 2011, was primarily due to the hiring of additional domestic and international sales and marketing representatives, in an effort to expand our sales distribution and increase market share for new and existing products. In connection with the Thomas Medical acquisition, we incurred approximately $2.7 million, or 0.7% of total sales, in non-recurring severance costs and acquisition costs included in selling, general and administrative costs for 2012. The increase in selling, general and administrative expenses in 2011 was primarily related to the addition of sales and marketing employees, trade show expenses, commission payments and amortization of intangibles relating to the BioSphere acquisition and commencement of our Chinese distribution system. Selling, general and administrative expenses as a percentage of sales were 28.6% (28.0% if not for approximately $489,000 and approximately $2.4 million, respectively, of non-recurring transaction costs attributable to acquisitions and severance expenses), 31.0% (30.3 % without non-recurring Thomas Medical acquisition costs), and 29.1% in 2013, 2012 and 2011, respectively.

Research and Development Expenses. Research and development expenses increased by 21.9% to approximately $33.9 million in 2013, compared to approximately $27.8 million in 2012. The increase in research and development expenses for the year ended December 31, 2013 was primarily due to research and development costs associated with the acquisition of the products we acquired from Thomas Medical, headcount additions for research and development to support new product development, and personnel increases in Merit's regulatory department to support registrations in foreign countries to expand international product offerings.

Research and development expenses increased by 26.7% to approximately $27.8 million in 2012, compared to approximately $21.9 million in 2011. The increase was primarily due to headcount additions for our research and development group to support new products and personnel increases in our regulatory department to support product registrations in foreign countries as we expanded our international sales distribution. Research and development expenses increased 43.1% to approximately $21.9 million in 2011, compared to approximately $15.3 million in 2010. The increase was primarily related to headcount additions to support various new product launches, regulatory costs for seeking product approvals from the FDA and international regulatory agencies, additional regulatory costs incurred for the start-up of our Hi-Quality clinical trial and the development of several new products for our endoscopy product line. Our research and development expenses as a percentage of sales were 7.5% for 2013, 7.0% for 2012, and 6.1% for 2011. We have a pipeline of new products and we believe that we have an effective level of capabilities and expertise to continue the flow of new internally-developed products into the future with average gross margins that are higher than our historical gross margins.

During 2012, we incurred in-process research and development charges of approximately $2.5 million related to the purchase of several new product technologies. These technologies included the purchase of four patents for the development of future products, primarily a new cross-support catheter and an exclusive license for certain nanotechnology. During 2011, we incurred in-process research and development charges of approximately $5.8 million related to the purchase of several new product technologies. These technologies included the acquisition of intellectual property for a vena cava filter for $1.0 million, flexible sheath technology for approximately $1.9 million, and support guide catheter technology for $2.0 million. In addition to these acquisitions, we abandoned the development of certain biomaterial technology and our covered biliary in-process research and development, resulting in charges of $500,000 and $400,000, respectively, during the year ended December 31, 2011.

Our operating profits by business segment for the years ended December 31, 2013, 2012 and 2011 were as follows (in thousands): 2013 2012 2011 Operating Income (Loss) Cardiovascular $ 26,597 $ 30,411 $ 38,010 Endoscopy 1,247 (770 ) (4,820 ) Total operating income $ 27,844 $ 29,641 $ 33,190 Cardiovascular Operating Income. Our cardiovascular operating income for the year ended December 31, 2013 was approximately $26.6 million, compared to operating income of approximately $30.4 million for the year ended December 31, 2012. The decrease was due primarily to lower gross profits during the year ended December 31, 2013. Our cardiovascular operating income for the year ended December 31, 2012 was approximately $30.4 million, compared to operating income of approximately $38.0 million for the year ended December 31, 2011. The decrease was due primarily to higher selling, general and administrative expenses and higher research and development expenses during the year ended December 31, 2012. Our cardiovascular operating 32-------------------------------------------------------------------------------- Table of Contents income for the year ended December 31, 2011 was approximately $38.0 million, compared to operating income of approximately $30.2 million for the year ended December 31, 2010. The increase was favorably affected by higher sales and gross margins, and was negatively affected by higher selling, general and administrative expenses, research and development expenses and acquired in-process research and development expenses.

Endoscopy Net Operating Income (Loss). Our endoscopy net operating income from operations for the year ended December 31, 2013 was approximately $1.2 million, compared to a net operating loss of approximately $770,000 for the year ended December 31, 2012. The generation of net operating income for 2013, compared to a net operating loss for 2012, was largely driven by higher sales and lower operating expenses. Our endoscopy net operating loss from operations for the year ended December 31, 2012 was approximately $770,000, compared to an operating loss of approximately $4.8 million for the year ended December 31, 2011. The decrease in net operating loss from operations for 2012, compared to 2011, was favorably affected by higher sales and gross margins, lower research and development expenses and was negatively affected by higher selling, general and administrative expenses as we added some additional sales representatives to this segment. Our endoscopy net operating loss from operations for the year ended December 31, 2011 was approximately $4.8 million, compared to an operating loss of approximately $13.0 million for the year ended December 31, 2010.

Excluding the abandonment of certain biomaterial technology and our covered biliary in-process research and development, which resulted in charges of $500,000 and $400,000, respectively, our net operating loss for the year ended December 31, 2011 would have been $3.9 million. Excluding a goodwill impairment charge of approximately $8.3 million that we recognized during 2010, our net operating loss for 2010 would have been approximately $4.6 million. Excluding these non-recurring charges, the decrease in our 2011 operating loss was favorably affected by higher sales and gross margins, which were partially offset by higher research and development expenses and selling, general and administrative expenses.

Our effective income tax rates for 2013, 2012 and 2011 were 16%, 29% and 30%, respectively. During 2013, our effective tax rate was lower as a result of a higher mix of earnings from our foreign operations, which are taxed at lower rates than our U.S. operations. In addition, the 2013 effective tax rate was lower than the 2012 rate, due primarily to the reinstatement in 2013 of the federal research and development credit for the 2012 tax year. The credit was reinstated by the American Taxpayer Relief Act of 2012, which was signed on January 2, 2013. We recognized the federal research and development credit as a discrete benefit in 2013, the period in which the reinstatement was enacted.

During 2012, our effective tax rate was negatively impacted by a valuation allowance related to a capital loss carryforward. Excluding the effect of this discrete item, our 2012 effective tax rate would have been approximately 25%.

The decrease in the effective income tax rate for the year ended December 31, 2012, when compared to 2011, was the result of a higher mix of foreign income, which is primarily due to our income in Ireland being taxed at a lower rate than our U.S. income. The increase in the effective income tax rate for 2011 compared to 2010 was primarily related to the increased profit of our U.S. operations, which are taxed at a higher rate than our foreign (primarily Ireland) income.

Our other expense for the years ended December 2013, 2012, and 2011 was approximately $8.0 million, $2.0 million, and $315,000, respectively. The increase in other expenses for 2013 over 2012 was principally the result of higher average outstanding debt balances and the corresponding increase in interest expense. The increase in other expenses for 2012 over 2011 related primarily to the write-off of approximately $2.4 million of a cost-method investment, which was partially offset by a gain on marketable securities of approximately $745,000. The decrease in other expenses for 2011 over 2010 was primarily the result of cash balances maintained in China, which resulted in increased interest income and foreign exchange gains recognized with the appreciation in the Chinese Yuan, all of which was partially offset by higher interest expenses.

Our net income for 2013, 2012, and 2011 was approximately $16.6 million, $19.7 million, and $23.0 million, respectively. The decrease in net income for 2013, when compared to 2012, was primarily related to lower gross profits, partially offset by lower selling, general and administrative expenses as a percent of sales. Our 2013 net income included intangible asset impairment charges, net of fair value reductions to the related contingent consideration liability, of approximately $4.3 million or approximately $2.7 million net of tax, severance expense of approximately $1.8 million or approximately $1.1 million net of tax, and Thomas Medical's mark-up on finished goods of approximately $744,000 or approximately $461,000 net of tax. Excluding these charges, our 2013 net income would have been $20.9 million, compared to $24.0 million of net income in 2012, excluding the extraordinary items discussed below. The decrease in net income for 2012, when compared to 2011, was unfavorably affected by higher selling, general and administrative expenses and higher research and development expenses. Our 2012 net income included charges related to Thomas Medical acquisition costs including legal, accounting, investment banking, and severance of approximately $2.7 million, or approximately $1.6 million net of tax, an increase in cost of sales related to Thomas Medical's mark-up on finished goods of approximately $831,000, or approximately $508,000 net of tax, charges related to acquired in-process research and development of approximately $2.5 million, or approximately $1.5 million net of tax, and approximately $631,000 related to a deferred income tax valuation allowance related to a certain capital loss carry forwards. Excluding these charges, our 2012 net income would have been approximately $24.0 million, compared to $27.0 million of net income in 2011, excluding the extraordinary items discussed below. The increase in net income in 2011 as compared to 2010 was primarily related to increased sales volumes, higher gross margins and a lower effective income tax rate, all of which offset higher selling, general and administrative expenses and research and development expenses and acquired in-process research and development expenses. Our 2011 net income included charges 33-------------------------------------------------------------------------------- Table of Contents related to acquired in-process research and development of approximately $5.8 million, or approximately $3.6 million net of tax, and an increase in the cost of goods sold related to BioSphere's mark-up on finished goods of approximately $724,000, or approximately $442,000 net of tax. Excluding these charges, our 2011 net income would have been approximately $27.0 million, compared to net income for 2010 of approximately $22.0 million, adjusted for non-recurring charges related to goodwill impairment of approximately $5.2 million, net of tax, and BioSphere acquisition costs, including legal, accounting, investment banking, severance and stepped-up inventory costs, of approximately $4.3 million, net of tax.

LIQUIDITY AND CAPITAL RESOURCES Capital Commitments and Contractual Obligations The following table summarizes our capital commitments and contractual obligations as of December 31, 2013, as well as the future periods in which such payments are currently anticipated to become due: Payment due by period (in thousands) Contractual Obligations Total Less than 1 Year 1-3 Years 4-5 Years After 5 Years Long-term debt $ 248,854 $ 10,000 $ 20,000 $ 218,854 $ - Interest on long-term debt (1) 39,952 9,585 19,818 10,549 - Operating leases 61,761 6,569 10,930 8,195 36,067 Royalty obligations 483 50 100 100 233 Total contractual cash $ 351,050 $ 26,204 $ 50,848 $ 237,698 $ 36,300 (1) Interest payments on our variable long-term debt were forecasted using the LIBOR forward curves plus a base of 3.25%. Interest payments on a portion of our long-term debt were forecasted using a fixed rate of 4.23% as a result of an interest rate swap (see Note 8 to our consolidated financial statements set forth in Item 8 of this report).

As of December 31, 2013, we had approximately $2.5 million of contingent consideration liability, $2.0 million of unrecognized tax positions, and $7.8 million of deferred compensation payable that have been recognized as liabilities that have not been included in the contractual obligations table due to uncertainty as to when such amounts may be settled.

Additional information regarding our capital commitments and contractual obligations, including royalty payments, is contained in Notes 7, 9 and 13 to our consolidated financial statements set forth in Item 8 below.

34-------------------------------------------------------------------------------- Table of Contents Cash Flows At December 31, 2013 and 2012, we had cash and cash equivalents of approximately $7.5 million and $9.7 million respectively, of which $6.9 million and $8.1 million, respectively, were held by foreign subsidiaries. For each of our foreign subsidiaries, we make an evaluation as to whether the earnings are intended to be repatriated to the United States or held by the foreign subsidiary for permanent reinvestment. The cash held by our foreign subsidiaries for permanent reinvestment is used to fund the operating activities of our foreign subsidiaries and for further investment in foreign operations. A deferred tax liability has been accrued for the earnings that are available to be repatriated to the United States.

In addition, cash held by our subsidiary in China is subject to local laws and regulations that require government approval for the transfer of such funds to entities located outside of China. As of December 31, 2013 and 2012, we had cash and cash equivalents of approximately $6.0 million and $6.4 million, respectively, held by our subsidiary in China.

Our cash flow from operations was approximately $51.4 million in 2013, an increase of approximately $4.4 million over 2012. This increase in cash flow from operations in 2013, compared to 2012, was primarily affected by changes in cash provided by a decrease in inventory of $11.3 million which was partially offset by a decrease in trade payables of $7.7 million. Our cash flow from operations was approximately $46.9 million in 2012, an increase of approximately $12.9 million over 2011. This increase in cash flow from operations in 2012, compared to 2011, was primarily affected by changes in cash provided by increases in accounts payable of $9.9 million and accrued expenses of $3.1 million. Our working capital for the years ended December 31, 2013, 2012 and 2011 was approximately $100.3 million, $89.0 million, and $89.9 million, respectively. The increase in working capital for 2013 from 2012 was primarily related to an increase in accounts receivable of approximately $6.8 million and a decrease in trade payables of approximately $8.1 million. Working capital remained relatively unchanged when comparing 2012 to 2011.

During the year ended December 31, 2013, our inventory balance decreased approximately $2.2 million, from approximately $84.6 million at December 31, 2012 to approximately $82.4 million at December 31, 2013. The decrease in inventory was primarily the result of an effort to improve inventory turns throughout our company. During the year ended December 31, 2012, our inventory balance increased approximately $14.7 million, from approximately $69.9 million at December 31, 2011 to approximately $84.6 million at December 31, 2012. The increase in inventory primarily related to higher inventory levels of approximately $6.4 million attributable to a 9.2% increase in our base business, and our acquisition of Thomas Medical's inventory of approximately $5.5 million.

During the year ended December 31, 2011, our inventory balance increased approximately $9.3 million, from approximately $60.6 million at December 31, 2010 to approximately $69.9 million at December 31, 2011. The increase in inventory was largely the result of higher inventory levels of approximately $8.2 million attributable to a 13.5% increase in our base business and an increase in raw materials related to maintaining a one year supply of resins.

Pursuant to the terms of the Credit Agreement, the Lenders have agreed to make revolving credit loans up to an aggregate amount of $215 million. The Lenders also made a term loan in the amount of $100 million, repayable in quarterly installments in the amounts provided in the Credit Agreement until the maturity date of December 19, 2017, at which time the term and revolving credit loans, together with accrued interest thereon, will be due and payable. In addition, certain mandatory prepayments are required to be made upon the occurrence of certain events described in the Credit Agreement. Wells Fargo has agreed, upon satisfaction of certain conditions, to make swingline loans from time to time through the maturity date in amounts equal to the difference between the amounts actually loaned by the Lenders and the aggregate revolving credit commitment.

The Credit Agreement is collateralized by substantially all of our assets. 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.

The term loan and any revolving credit loans made under the Credit Agreement bear interest, at our election, at either (i) the base rate (described below) plus 0.25% (subject to adjustment if the Consolidated Total Leverage Ratio, as defined in the Credit Agreement, is at or greater than 2.25 to 1), (ii) the London Inter-Bank Offered Rate ("LIBOR") Market Index Rate (as defined in the Credit Agreement) plus 1.25% (subject to adjustment if the Consolidated Total Leverage Ratio, as defined in the Credit Agreement, is at or greater than 2.25 to 1), or (iii) the LIBOR Rate (as defined in the Credit Agreement) plus 1.25% (subject to adjustment if the Consolidated Total Leverage Ratio, as defined in the Credit Agreement, is at or greater than 2.25 to 1). Initially, the term loan and revolving credit loans under the Credit Agreement bear interest, at our election, at either (x) the base rate plus 1.00%, (y) the LIBOR Market Index Rate, plus 2.00%, or (z) the LIBOR Rate plus 2.00%. Swingline loans bear interest at the LIBOR Market Index Rate plus 1.25% (subject to adjustment if the Consolidated Total Leverage Ratio, as defined in the Credit Agreement, is at or greater than 2.25 to 1). Initially, swingline loans bear interest at the LIBOR Market Index Rate plus 2.00%. Interest on each loan featuring the base rate or the LIBOR Market Index Rate is due and payable on the last business day of each calendar month; interest on each loan featuring the LIBOR Rate is due and payable on the last day of each interest period selected by us when selecting the LIBOR Rate as the benchmark for interest calculation. For purposes of the Credit Agreement, the base 35-------------------------------------------------------------------------------- Table of Contents rate means the highest of (i) the prime rate (as announced by Wells Fargo), (ii) the federal funds rate plus 0.50%, and (iii) LIBOR for an interest period of one month plus 1.00%. Our obligations under the Credit Agreement and all loans made thereunder are fully secured by a security interest in our assets pursuant to a separate collateral agreement entered into in conjunction with the Credit Agreement.

The Credit Agreement contains customary covenants, representations and warranties and other terms customary for revolving credit loans of this nature.

In this regard, the Credit Agreement requires us to not, among other things, (a) permit the Consolidated Total Leverage Ratio (as defined in the Credit Agreement) to be greater than 4.75 to 1 through the end of 2013, no more than 4.00 to 1 as of the fiscal quarter ending March 31, 2014, no more than 3.75 to 1 as of the fiscal quarter ending June 30, 2014, no more than 3.50 to 1 as of the fiscal quarter ending September 30, 2014, no more than 3.25 to 1 as of the fiscal quarter ending December 31, 2014, no more than 3.00 to 1 as of any fiscal quarter ending during 2015, no more than 2.75 to 1 as of any fiscal quarter ending during 2016, and no more than 2.50 to 1 as of any fiscal quarter ending thereafter; (b) for any period of four consecutive fiscal quarters, permit the ratio of Consolidated EBITDA (as defined in the Credit Agreement and subject to certain adjustments) to Consolidated Fixed Charges (as defined in the Credit Agreement) to be less than 1.75 to 1; (c) subject to certain adjustments, permit Consolidated Net Income (as defined in the Credit Agreement) for certain periods to be less than $0; or (d) subject to certain conditions and adjustments, permit the aggregate amount of all Facility Capital Expenditures (as defined in the Credit Agreement) in any fiscal year beginning in 2013 to exceed $30 million.

Additionally, the Credit Agreement contains various negative covenants with which we must comply, including, but not limited to, limitations respecting: the incurrence of indebtedness, the creation of liens or pledges on our assets, mergers or similar combinations or liquidations, asset dispositions, the repurchase or redemption of equity interests and debt, the issuance of equity, the payment of dividends and certain distributions, the entrance into related party transactions and other provisions customary in similar types of agreements. As of December 31, 2013, we were in compliance with all covenants set forth in the Credit Agreement.

As of December 31, 2013, we had outstanding borrowings of approximately $248.9 million under the Credit Agreement, with available borrowings of approximately $34.6 million, based on the leverage ratio in the terms of the Credit Agreement.

Our interest rate as of December 31, 2013 was a fixed rate of 4.23% on $145.0 million as a result of an interest rate swap (see Note 8), a variable floating rate of 3.42% on $101.5 million and a variable floating rate of 3.50% on approximately $2.4 million. Our interest rate as of December 31, 2012 was a fixed rate of 2.98% on $150.0 million as a result of an interest rate swap, variable floating rate of 2.22% on $87.0 million and a variable floating rate of 2.31% on approximately $566,000.

Capital expenditures for property and equipment were approximately $59.5 million, $64.6 million, and $59.2 million, for the years ended December 31, 2013, 2012 and 2011, respectively. During 2013, 2012 and 2011, we spent approximately $29.9 million, $31.9 million and $36.9 million, respectively, for the construction of buildings and a parking lot as discussed below. We anticipate that we will spend approximately $35 million in 2014 for property and equipment, of which we anticipate that approximately $7.0 million will be spent on building construction.

On June 22, 2011, we completed a registered public equity offering of 5,520,000 shares of Common Stock and received proceeds of approximately $87.7 million, which is net of approximately $4.6 million in underwriting discounts and commissions (the "Equity Offering"). We primarily used the proceeds of the Equity Offering to pay down amounts owing under our Credit Agreement and reduce interest costs. In addition to the proceeds of the Equity Offering, we received approximately $7.2 million in cash related to the exercise of options to acquire approximately 1.1 million shares of common stock and approximately $3.1 million in tax benefits attributable to appreciation of the options exercised during the year ended December 31, 2011.

Historically, we have incurred significant expenses in connection with facility construction, production automation, product development and the introduction of new products. Over the last five years, we spent a substantial amount of cash in connection with our acquisition of certain assets and businesses (including approximately $30.0 million to acquire assets of Datascope and Radial Assist, among other transactions during 2013; $165.6 million (net of cash acquired) to acquire Thomas Medical and $16.5 million to acquire the assets of Ostial, among other transactions, during 2012; and $5 million to acquire the assets of Ash Access Technology, Inc. and AAT Catheter Technologies, LLC, among other transactions, during 2011). In 2013 we completed construction of new production facilities in South Jordan, Utah and Pearland, Texas. In 2012 we completed our 74,680 square-foot manufacturing facility in Galway, Ireland. As of December 31, 2013, we had incurred total costs of approximately $98.7 million with respect to those construction projects. In the event we pursue and complete significant transactions or acquisitions in the future, additional funds will likely be required to meet our strategic needs, which may require us to raise additional funds in the debt or equity markets.

We currently believe that our existing cash balances, anticipated future cash flows from operations and borrowings under the Credit Agreement, as amended, will be adequate to fund our current and currently planned future operations for the next twelve months and the foreseeable future.

36-------------------------------------------------------------------------------- Table of Contents CRITICAL ACCOUNTING POLICIES AND ESTIMATES The SEC has requested that all registrants address their most critical accounting policies. The SEC has indicated that a "critical accounting policy" is one which is both important to the representation of the registrant's financial condition and results and requires management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We base our estimates on past experience and on various other assumptions our management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results will differ, and may differ materially from these estimates under different assumptions or conditions.

Additionally, changes in accounting estimates could occur in the future from period to period. Our management has discussed the development and selection of our most critical financial estimates with the audit committee of our Board of Directors. The following paragraphs identify our most critical accounting policies: Inventory Obsolescence. Our management reviews on a quarterly basis inventory quantities on hand for unmarketable and/or slow-moving products that may expire prior to being sold. This review includes quantities on hand for both raw materials and finished goods. Based on this review, we provide adjustments for any slow-moving finished good products or raw materials that we believe will expire prior to being sold or used to produce a finished good and any products that are unmarketable. This review of inventory quantities for unmarketable and/or slow moving products is based on forecasted product demand prior to expiration lives.

Forecasted unit demand is derived from our historical experience of product sales and production raw material usage. If market conditions become less favorable than those projected by our management, additional inventory write-downs may be required. During the years ended December 31, 2013, 2012 and 2011, we recorded obsolescence expense of approximately $2.7 million, $2.3 million, and $1.5 million, respectively, and wrote off approximately $2.8 million, $1.5 million, and $1.1 million, respectively. Based on this historical trend, we believe that our inventory balances as of December 31, 2013 have been accurately adjusted for any unmarketable and/or slow moving products that may expire prior to being sold.

Allowance for Doubtful Accounts. A majority of our receivables are with hospitals which, over our history, have demonstrated favorable collection rates.

Therefore, we have experienced relatively minimal bad debts from hospital customers. In limited circumstances, we have written off bad debts as the result of the termination of our business relationships with foreign distributors. The most significant write-offs over our history have come from U.S. custom procedure tray manufacturers who bundle our products in surgical trays.

We maintain allowances for doubtful accounts relating to estimated losses resulting from the inability of our customers to make required payments. These allowances are based upon historical experience and a review of individual customer balances. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Stock-Based Compensation. We measure stock-based compensation cost at the grant date based on the value of the award and recognize the cost as an expense over the term of the vesting period. Judgment is required in estimating the fair value of share-based awards granted and their expected forfeiture rate. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.

Income Taxes. Under our accounting policies, we initially recognize a tax position in our financial statements when it becomes more likely than not that the position will be sustained upon examination by the tax authorities. Such tax positions are initially and subsequently measured as the largest amount of tax positions that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authorities assuming full knowledge of the position and all relevant facts. Although we believe our provisions for unrecognized tax positions are reasonable, we can make no assurance that the final tax outcome of these matters will not be different from that which we have reflected in our income tax provisions and accruals. The tax law is subject to varied interpretations, and we have taken positions related to certain matters where the law is subject to interpretation. Such differences could have a material impact on our income tax provisions and operating results in the period(s) in which we make such determination.

Goodwill and Intangible Assets Impairment and Contingent Consideration. We test our goodwill balances for impairment as of July 1 of each year, or whenever impairment indicators arise. We utilize several reporting units in evaluating goodwill for impairment. We assess the estimated fair value of reporting units based on discounted future cash flows. If the carrying amount of a reporting unit exceeds the fair value of the reporting unit, an impairment charge is recognized in an amount equal to the excess of the carrying amount of the reporting unit goodwill over implied fair value of that goodwill. This analysis requires 37-------------------------------------------------------------------------------- Table of Contents significant judgment, including estimation of future cash flows and the length of time they will occur, which is based on internal forecasts, and a determination of a discount rate based on our weighted average cost of capital.

During our annual test of goodwill balances in 2013, which was completed during the third quarter of 2013, we determined that the fair value of each reporting unit with goodwill exceeded the carrying amount by a significant amount.

We evaluate the recoverability of intangible assets whenever events or changes in circumstances indicate that an asset's carrying amount may not be recoverable. This analysis requires similar significant judgments as those discussed above regarding goodwill, except that undiscounted cash flows are compared to the carrying amount of intangible assets to determine if impairment exists. All of our intangible assets are subject to amortization.

Contingent consideration is an obligation by the buyer to transfer additional assets or equity interests to the former owner upon reaching certain performance targets. 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. In connection with a business combination, any contingent consideration is recorded on the acquisition date based upon the consideration expected to be transferred in the future. We utilize a discounted cash flow method, which includes a probability factor for milestone payments, in valuing the contingent consideration liability. We re-measure the estimated liability each quarter and record changes in the estimated fair value through operating expense in our consolidated statements of income. Significant increases or decreases in our estimates could result in the estimated fair value of our contingent consideration liability, as the result of changes in the timing and amount of revenue estimates, as well as changes in the discount rate or periods.

During the year ended December 31, 2013, we reduced the amount of the contingent consideration liability related to the Ostial PRO Stent Positioning System, which we acquired in January 2012, by approximately $3.8 million. Under the terms of the Asset Purchase Agreement we executed with Ostial, we are obligated to make contingent purchase price payments based on a percentage of future sales of products utilizing the Ostial PRO Stent Positioning System. The adjustment to the contingent consideration liability triggered a review of the intangible assets we acquired from Ostial, which resulted in an intangible asset write-down of approximately $8.1 million related to those assets. These adjustments reduced operating income for the year ended December 31, 2013 by approximately $4.3 million, or approximately $2.7 million net of tax. The reduction of the Ostial contingent consideration liability and the impairment of the Ostial intangible assets was the result of our assessment that we are not likely to generate the level of revenues from sales of the Ostial PRO Stent Positioning System that we anticipated at the acquisition date.

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