Merit Medical Systems - Q2 2024

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by. Welcome to the Merit Medical Systems second quarter 2024 earnings conference call. At this time, all participants have been placed in a listen-only mode. Please note that this conference call is being recorded, and 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.

Fred Lampropoulos (Chairman and CEO)

Thank you, and welcome, everyone. I am joined on today's call by Rahul Parikh, our Chief Financial Officer and Treasurer, Joe Wright, our President, and Brian Lloyd, our Chief Legal Officer and Corporate Secretary. Brian, would you mind reading us through the safe harbor statements, please?

Brian Lloyd (Chief Legal Officer)

Thanks, Fred. I would like to remind everyone that this presentation contains forward-looking statements that receive safe harbor protection under federal securities laws. Although we believe these forward-looking statements are based upon reasonable assumptions, they are subject to risks and uncertainties. The realization of any of these risks or uncertainties, as well as extraordinary events or transactions impacting our company, could cause actual results to differ materially from the expectations and projections expressed or implied by our forward-looking statements. In addition, any forward-looking statements represent our views only as of today, August 1, 2024, 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 sections entitled "Cautionary Statement regarding forward-looking statements" in today's press release and presentation for important information regarding such statements.

For a discussion of factors that could cause actual results to differ from these forward-looking statements, please also refer to our most recent filings with the SEC, which are available on our website. 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. A 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 press release and presentation entitled "Non-GAAP Financial Measures" for important information regarding non-GAAP financial measures discussed on this call.

Readers should consider non-GAAP financial measures in addition to, not as a substitute for, financial reporting measures prepared in accordance with GAAP. Please note that these calculations may not be comparable with similarly titled measures of other companies. Both today's press release and our presentation are available on the Investors page of our website. I will now turn the call back to Fred.

Fred Lampropoulos (Chairman and CEO)

Thanks, Brian. I appreciate it very much. Let me start with a brief agenda of what we will cover during our call and prepared remarks today. I will start with an overview of our financial results and key operating progress areas during the second quarter. After my opening remarks, Joe will provide a summary of our revenue results before turning the call over to Rahul, who will provide a more in-depth review of our quarterly financial results and our financial guidance for 2024, which we updated in today's press release. Then we will open the call for your questions. Our second quarter results exceeded our expectations.

We reported the total revenue of $338 million in the second quarter, up 5.6% year-over-year on a GAAP basis and up 6.6% year-over-year on a constant currency basis. The constant currency revenue growth we delivered in the second quarter was stronger than the high end of the range of growth expectations that we outlined on our Quarter One earnings call. Specifically, we expected constant currency revenue growth for the second quarter in the range of 4.7%-5.8% year-over-year. Importantly, the better-than-expected constant currency revenue growth in the second quarter was primarily driven by strong organic growth and, to a lesser extent, contributions from acquired products, which modestly exceeded the high end of our growth expectations as well.

With respect to our profitability performance in the second quarter, we leveraged the solid revenue results to deliver non-GAAP gross profit and operating profit growth of 6% and 11%, respectively, which resulted in year-over-year margin expansion by approximately 15 basis points and 92 basis points, respectively. We delivered 17% growth in our non-GAAP earnings per share, which exceeded the high end of our expectations as well. Perhaps most notably, we generated nearly $58 million of free cash flow in the quarter, a record for Merit, and have generated more than $82 million of free cash flow over the first half of 2024, representing a more than fivefold increase year-over-year.

We believe our second quarter results reflect continued strong momentum in the business over the first half of 2024, and we are confident in our team's ability to deliver the updated financial guidance that Rahul will review later on the call. While we are proud of the results achieved over the first half of the year, we are not resting on our laurels. We are focused on delivering continued strong execution, stable currency, constant currency growth, improving profitability, and solid free cash flow in 2024, as well as continued progress in our continued growth initiative program related financial targets for the three-year period ending December 31, 2026. I would now like to share a brief update on several areas of operational progress in recent months.

First, with respect to new product introductions, we announced multiple regulatory clearances and commercial introductions in the second quarter, including: in May, we announced FDA 510(k) clearance for our SEEDS Vascular Plug and the commercial launch of our Bearing nsPVA Express prefilled syringe in the United States and Australia. These addition to Merit's Embolics portfolio complement a comprehensive offering of microsphere, particle, and gelatin foam products, supported by a range of microcatheters, guide wires, and other enabling devices. We also announced the US commercial release of the BasixKY inflation device in May. BasixKY is the latest addition to Merit's comprehensive inflation device portfolio, which includes both digital and analog devices. The BasixKY is available as a standalone solution and in kits with Merit angioplasty packs, configured to offer complementary access, plus Honor and PhD hemostasis valves.

Second, with respect to our progress in the area of clinical validation in recent months, we are pleased with the progress achieved in recent months for our Wrapsodyarteriovenous access efficacy or WAVE pivotal study. We completed the clinical study report and filed the final module with the FDA for premarket approval, or PMA, by the end of the second quarter of 2024, as expected. We look forward to engaging with the FDA as they review our PMA application for this innovative technology. The Wrapsodycell-impermeable endoprosthesis is built to combat the challenges dialysis patients can often experience due to stenosis and occlusions in the dialysis outflow circuit. We believe this technology can extend long-term vessel patency rates and reduce the complications associated with existing treatment options on the market today, including the need for repeated interventions, frequent trips to the hospital, and inadequate dialysis treatments.

Importantly, we are excited to announce the clinical results from our Wrapsody studies will be featured in scientific sessions at key medical meetings this fall, including at the Cardiovascular and Interventional Radiology Society of Europe, or CIRSE, Annual Congress on September 14 in Lisbon, Portugal, and at the Controversies in Dialysis Access, or CIDA, meeting in Washington, DC, on October 5. Third, we announced important enhancements, enhancements to both our executive leadership team and our board of directors. In May, we announced the appointment of Joe Wright as President. Joe now oversees Merit's global commercial, marketing, and operations teams. With more than 19 years of experience with Merit, serving a variety of leadership roles and in multiple geographic regions, I believe he is the ideal leader for this important position.

Joe has been central to executing our strategic plan and positioning the company for continued success, including spearheading our commercialization efforts and overseeing significant international expansion, engineering the advanced capabilities of our renal therapies group, including the integration of the business and assets we acquired from AngioDynamics in 2023, and directing the development of our commercial excellence initiatives globally. I look forward to continuing to work closely with Joe going forward. We also enhanced our board of directors with the selection of Sylvia M. Perez as a new director at Merit’s Annual Meeting of Shareholders on May 15th, 2024. Sylvia is President of the Commercial Branding and Transportation Division at 3M Company. Her expertise and proven track record of leadership success will provide valuable industry and organizational perspective to both the board and our management team as we pursue our Continued Growth Initiatives program.

Now, before turning the call over to Joe, I would just like to take a few minutes to discuss the strategic acquisition we announced on July first. We announced the acquisition of assets for EndoGastric Solutions Incorporated for a total cash consideration of approximately $105 million and the assumption of certain liabilities. We believe this acquisition represents multiple strategic and financial positives, and importantly, this acquisition is consistent with and will not distract us from our Continued Growth Initiatives program. Strategically, this acquisition enhances our endoscopy product portfolio in existing clinical specialties while expanding our global footprint in the gastrointestinal market. This acquisition adds an innovative solution for patients suffering from chronic gastroesophageal reflux disease or GERD, which is a significant annual addressable market opportunity, estimated at $2 billion annually.

GERD is a digestive disorder that occurs when the lower esophageal sphincter doesn't tighten correctly, allowing acid from the stomach to enter the esophagus. When this occurs chronically, it can result in serious health conditions such as esophageal damage and cancer. The EsophyX Z+ treats GERD by restoring the body's reflux barrier. By restoring the body's reflux barrier, the EsophyX Z+ device is designed to provide relief of GERD symptoms and reduce acid reflux that can cause long-term complications and risk. Now, this is accomplished under endoscopic visualization during a minimally invasive procedure called transoral incisionless fundoplication or TIF 2.0. Recently, the American Gastroenterological Association released a clinical practice update on the evaluation and management of GERD, and listed TIF 2.0 as an effective endoscopic option in carefully selected patients.

We estimate that there are more than 5 million patients in the U.S. alone, currently using pharma treatment options for refractory GERD that represent potential candidates for TIF 2.0, or the EsophyX Z+ procedure each year. The EsophyX Z+ device is supported by economically favorable reimbursement, level one clinical evidence, and strong advocacy for medical societies. We also believe this device is highly complementary with our existing portfolio and customer base, while expanding access into interventional gastroenterologists and surgeons in the endoscopy unit and the operating room. In addition to the strong strategic rationale, we believe the financial profile of this acquisition is extremely compelling. Now, Rahul will share, you know, give you some additional color on the favorable financial profile of this acquisition later on the call.

In the interim, I will share with you that we expect sales contribution in the range of $13 million-$15 million over the second half of 2024, and we expect this acquisition to be accretive to our multi-year total program, excuse me, total company growth profile on an annualized basis going forward. Now, with that, let me turn the call over to Joe, who will review second quarter revenue performance. Joe?

Joseph Wright (President)

Thank you, Fred. I'll provide a detailed review of our revenue results in the second quarter, beginning with the sales performance in each of our primary reportable product categories. Note, unless otherwise stated, all growth rates are approximated and presented on both a year-over-year and constant currency basis. We have included reconciliations from our GAAP reported results to the related non-GAAP item in our earnings release and presentation available on our website. Second quarter total revenue growth was driven by 6% growth in our cardiovascular segment and 16% growth in our endoscopy segment. Our cardiovascular segment was the primary driver of the better-than-expected total revenue results versus the high end of constant currency growth expectations again this quarter. However, our endoscopy segment sales did exceed the high end of our expectations as well in Q2.

Sales of our peripheral intervention, or PI, products increased 11%, representing nearly 74% of total cardiovascular segment growth in the period. Excluding sales of acquired products, PI sales increased 7.6% on an organic constant currency basis. Organic growth in the PI product category was driven by sales of our access products, and our delivery systems increased 22%, and sales of our radar localization products increased 9%, and together represented nearly three-quarters of our total PI organic sales growth in Q2. Sales of our custom procedural solutions, or CPS products, increased 3%, which was notably better than the low single-digit decline we expected in Q2. This performance was fueled by strong growth in sales of kit products, which more than offset the expected year-over-year declines in sales of trades, resulting from our ongoing SKU rationalization efforts discussed on prior calls.

Cardiac intervention product sales increased 1.5%, slightly above the high end of our growth expectations, driven primarily by strong sales of EP/CRM products and, to a lesser extent, growth in sales of fluid management and intervention products. Sales of our OEM products increased 5% year-over-year in Q2. While sales to OEM customers increased in the mid-teens on a sequential basis, sales of our OEM products were the only area of our cardio business that came in softer than our growth expectations heading into the quarter. We continue to believe the softer-than-expected sales trends of our OEM products are a result of order timing and fluctuations in demand as our customers work through efforts to optimize inventory levels. Demand trends from customers in both the U.S. and OUS regions improved from Q1, as expected.

We saw solid growth in product sales to OEM customers outside the US, while demand from US customers drove product sales growth of just 3% year-over-year in Q2. Importantly, we continue to expect low double-digit growth in OEM sales for the full year, 2024. Lastly, sales in our endoscopy segment increased 16%, which exceeded the high end of our growth expectations. We continued to see a normalization of growth trends in this business as expected, and our updated 2024 guidance now assumes low double-digit organic growth in our endoscopy business this year. Turning to a brief summary of our sales performance on a geographic basis. Our second quarter sales in the US increased 8.5% on a constant currency basis and 6% on an organic constant currency basis.

Similar to what we experienced in Q1, sales to US customers came in roughly a point softer than what our guidance had assumed, driven by the softer than expected OEM sales, as previously mentioned. We continue to expect to deliver approximately 6% organic growth in the US at the midpoint of our 2024 guidance range. International sales increased 4% year-over-year and 3.8% on an organic constant currency basis, exceeding the high end of our growth expectations by more than 470 basis points in the quarter. The stronger than expected organic constant currency growth to customers outside the US was driven primarily by 1% growth in APAC, compared to our guidance range, which had assumed a decline in the range of 10%-11% in Q2.

With respect to China specifically, sales decreased 5% year-over-year, better than the low 20% decline our guidance had assumed. We continue to see quarter-to-quarter variability in growth trends related to volume-based purchasing tenders as expected. By way of reminder, while we are not providing country-specific growth assumptions in our guidance messaging, the midpoint of our 2024 constant currency growth guidance range now assumes our total international sales will increase 4.3% year-over-year, driven by 7%-8% growth in EMEA, and 11%-12% growth in the rest of world region, partially offset by a 0% growth in the APAC region versus the 4% decline assumed in our prior guidance range. The lower headwind from APAC, assumed in our updated guidance, is driven by better than expected results in China over the first half of 2024.

Note, regarding our China business in 2024, our guidance continues to assume that we will be able to increase sales of units on a year-over-year basis, but we expect total revenue to decline due to continued pricing headwinds related to volume-based purchasing. With that, let me turn the call over to Rahul, who will take you through a detailed review of our second quarter financial results, balance sheet, and financial condition at June thirtieth.

Raul Parra (CFO)

Thank you, Joe. Beginning with a review of our P&L performance, for the avoidance of doubt, unless otherwise noted, my commentary will focus on the company's non-GAAP results during the second quarter of fiscal year 2024. We have included reconciliations from our GAAP reported results to the related non-GAAP item in our press release and presentation available on our website. Gross profit increased approximately 6% year-over-year in the second quarter. Our gross margin was 51.5%, fifteen basis points year-over-year. The increase in gross margin year-over-year was driven by pricing uplift, favorable product and geographic revenue mix, and improvements in freight and distribution costs, offset partially by manufacturing variances compared to the prior year period. Operating expenses increased 3% from the second quarter of 2023.

The year-over-year increase in operating expenses was driven by a 2% increase in SG&A expense and a 7% increase in R&D expense compared to the prior year period. Total operating income in the second quarter increased $6.5 million, or 11% from the second quarter of 2023, to $67.8 million. Our operating margin was 20.1%, compared to 19.1% in the prior year period. The 92 basis point increase in operating margin was driven by a 15 basis point increase in our non-GAAP gross margin, and by a 76 basis point decrease in our non-GAAP OpEx margin compared to the prior year period. Second quarter other expense net was a benefit of $1.4 million compared to expense of $3.4 million last year.

The change in other expense net was driven by an increase in interest income associated with our higher cash balances, partially offset by an increase in net interest expense associated with increased borrowings. Second quarter net income was $53.8 million or $0.92 per share, compared to $45.9 million or $0.78 per share in the prior year period. We are pleased with our profitability performance in the second quarter, where we leveraged stronger than expected revenue results to drive both expansion and operating margins and non-GAAP diluted earnings per share that exceeded the high end of our expectations. Turning to a review of our balance sheet and financial condition. As of June 30, 2024, we had cash and cash equivalents of $636.7 million, total debt obligations of $822.5 million,...

available borrowing capacity of approximately $680 million, compared to cash and cash equivalents of $587 million, total debt obligations of $846.6 million, and available borrowing capacity of approximately $626 million as of December 31st, 2023. Our net leverage ratio as of June 30th was 2.4 times on an adjusted basis. We generated $57.9 million of free cash flow in the second quarter, compared to $11.5 million in the prior year period. The year-over-year improvement in free cash flow generation was primarily a result of significant improvements in cash used in working capital compared to the prior year period.

We have generated more than $82 million of free cash flow over the first half of 2024, expect strong free cash flow generation in 2024, and continue to believe our CGI program will generate more than $400 million free cash flow in the three-year period ending December 31, 2026. For reference, we have included a table in our earnings press release, which details each of our updated formal financial guidance items and how those ranges compare to prior ranges as of July 1, 2024, when we updated our guidance to reflect the projected impact of our acquisition of the assets of Endogastric Solutions.

Our updated guidance ranges now assumes the following: GAAP net revenue growth of 6%-7% year-over-year, net revenue growth of approximately 5%-6% in our cardiovascular segment, and net revenue growth of approximately 45%-52% in our endoscopy segment, and a headwind from changes in foreign currency exchange rates of approximately $9.1 million, or approximately 70 basis points to growth year-over-year. Excluding the impact of changes in foreign currency exchange rates, we expect total net revenue growth on a constant currency basis in a range of 6.9%-7.7% in 2024.

Finally, our total net revenue guidance for fiscal year 2024 now assumes inorganic revenue contributions from the acquisitions announced on June 8, 2023, and July 1, 2024, in the range of $24.6 million-$26.6 million in the aggregate. For avoidance of doubt, this aggregate range consists of approximately $11.6 million of inorganic revenue related to our acquisitions of assets from AngioDynamics in Q1 and Q2, plus the contributions from our acquisition of assets from Endogastric Solutions in Q3 and Q4. Excluding inorganic revenue, our updated guidance reflects total net revenue growth on a constant currency organic basis in the range of approximately 4.9%-5.6% year-over-year.

With respect to our updated profitability guidance for 2024, we now expect non-GAAP diluted earnings per share in the range of $3.27-$3.35, representing an increase of 15%-17% year-over-year. Note, this range includes the expected dilution related to our acquisition of assets from Endogastric Solutions, which, as disclosed on July first, is expected to be in the range of $0.04-$0.06. As Fred discussed earlier, we believe this acquisition offers a very attractive financial profile.

While we believe this acquisition will be modestly dilutive to our full year 2024 Non-GAAP profitability, given the partial year contribution and the impact of approximately $2.7 million of lower interest income on cash balances used for the total purchase consideration, we expect the acquisition to be accretive to our Non-GAAP gross and operating margins, Non-GAAP net income, and Non-GAAP EPS in the first full year post-closing. For modeling purposes, our updated fiscal year 2024 financial guidance now assumes Non-GAAP operating margins in the range of approximately 18.4%-18.7%, up 120-150 basis points year-over-year. Non-GAAP interest and other expense net of approximately $1.5 million compared to $10.6 million last year. Non-GAAP tax rate of approximately 21.5%.

Diluted shares outstanding of approximately 58.8 million, and we now expect CapEx in the range of $55 million-$60 million, and free cash flow of at least $130 million, compared to at least $115 million previously. We would also like to provide additional transparency related to our growth and profitability expectations for the third quarter of 2024. Specifically, we expect our total revenue to increase in the range of approximately 5.7%-7.1% year-over-year on a GAAP basis, and approximately 6.4%-7.8% year-over-year on a constant currency basis. The midpoint of our third quarter constant currency sales growth expectations assumes approximately 9% growth year-over-year in the U.S., and 5% growth year-over-year in international markets.

Note, the midpoint of our third quarter constant currency sales growth expectations also includes approximately $6.4 million of inorganic revenue. Excluding these inorganic contributions, our third quarter total revenue is expected to increase approximately 5% year-over-year on an organic constant currency basis. With respect to our profitability expectations for the third quarter of 2024, we expect non-GAAP operating margins in a range of approximately 18%-18.7%, and we expect non-GAAP EPS in the range of $0.77-$0.82.

Finally, I wanted to call out one item for consideration when comparing our updated non-GAAP operating margin assumptions versus our original guidance for 2024 we introduced on our Q4 call, and subsequently reaffirmed on our Q1 earnings call on April 30, and again, in our Endogastric Solutions press release of July 1. As detailed in our earnings press release this afternoon, beginning in the second quarter of 2024, consulting expenses associated with initiatives conducted under our Foundations for Growth program are no longer adjusted as part of our non-GAAP measures. Non-GAAP financial measures detailed in the reconciliation tables in our earnings press release reflect the removal of these FFG consulting fees for the 3- and 6-month periods ended June 30, 2023 and 2024. Specifically, $4.2 million in the first half of 2023, and $1 million in the first half of 2024.

FFG consulting fees totaled approximately $12.3 million pre-tax for the 12 months ended December 31, 2023, representing an approximately 100 basis point impact to the previously non-GAAP operating margin for that period. Accordingly, our updated non-GAAP operating margin assumptions for fiscal year 2024, excluding FFG consulting fees, now reflect expected year-over-year expansion in the range of 120 basis points to 150 basis points, compared to expected year-over-year expansion in the range of 45 basis points to 70 basis points previously. Importantly, when applying this new treatment for FFG consulting fees throughout the 3-year FFG program, our non-GAAP operating margin expansion performance is still extremely strong.

Our efforts to improve profitability over this period resulted in a non-GAAP operating margin of 17.2% in fiscal year 2023, compared to 13.2% in fiscal year 2020, an increase of approximately 400 basis points. Further, this new treatment does not impact the cumulative free cash flow we generated over the three years ending December 31, 2023, which totaled nearly $300 million. And by way of reminder, we generated nearly $419 million of free cash flow since the beginning of 2020. Finally, this new treatment does not impact our 2024 guidance, nor our CGI financial targets for the three-year end, period ending December 31, 2026. That wraps up our prepared remarks. Operator, we would now like to turn, open the line up for questions.

Operator (participant)

Thank you, sir. Ladies and gentlemen, if you'd like to ask a question, please signal by pressing star one one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We do ask that you limit yourself to one question and one follow-up. If you would like to ask additional questions, we invite you to add yourself to the queue again. One moment for our first question. Our first question will come from the line of Jason Bednar from Piper Sandler. Your line is open.

Jason Bednar (Analyst)

Hey, good afternoon, guys. Congrats on another solid quarter here. Wanted to start first with guidance. Looks like you're flowing through mostly that 2Q overage here. Not much changing here with the implied outlook for the second half of the year. I think this is within how you typically manage your guide or your outlook, but I wanted to check to see if there's any incremental caution you have with respect to pieces of your business that just has you think of the momentum from the first half of the year doesn't continue into the back half. It doesn't sound like that, but really wanted to check in on that. And then, you know, within that conversation, maybe discuss, you know, a little more specifically, your China assumptions within your overall guidance range.

It doesn't look as onerous, but I don't think I heard exactly what you're assuming now for China this year.

Raul Parra (CFO)

Yeah, so yeah, you're right, Jason. This is how we typically do it, right? So we're flowing through that first half, you know, increase. As you know, we beat by about, you know, $7 million on the high end of our guidance, and so we're flowing that through. Obviously, you have the dynamics of EGS that we're also, that we've also included in that, which we did that, you know, earlier this month when we did the acquisition. So, I think, you know, generally speaking, we're super optimistic about how the business is doing. You know, the US growth was outstanding again. International growth was great. So we're feeling pretty optimistic and, you know, I think, I'm sure we'll get some questions on China.

You know, China, you know, did better than anticipated, and we continue to see that. So, generally speaking, I think we're pretty excited about how the first half went and how the back half is looking. And I think ultimately, we're putting in a pretty strong year together.

Jason Bednar (Analyst)

Okay, thanks. And, you know, one follow-up there and a separate question, just if you could specify just what China is within your updated guide versus where it was previously. Again, it seems like it's not as onerous. But and then I did want to ask as a follow-up, you know, I bring it up often here, but, you know, the gross margin line was pretty solid again this quarter, and considering this was the toughest year-over-year comp on the margin, gross margin line. So those margin comps get easier over the balance of the year. I'm just wondering how you're thinking about, you know, the gross margin trend line from here.

Maybe if we're thinking about a seasonal step down in the third quarter, but, you know, just, you know, going forward, is this 51% or so range more or less defendable as we look ahead?

Raul Parra (CFO)

Yeah, I'll let Joe kind of hit on the international piece here first in China, and then I'll answer the gross margin.

Joseph Wright (President)

Yeah. Hi, Jason, this is Joe. Our international sales were up 4%, year-on-year and 3.8% on an organic constant currency basis. So this exceeded the high end of our growth expectations by approximately 470 basis points in the quarter. So that, those better than expected OUS results were driven primarily by only a 1% constant currency growth in, or decline in APAC in Q2. Our previous guidance range had assumed a decline in the range of 10%-11% in Q2. So, regarding the APAC sales, so China sales decreased 5% year-over-year, so that was better than the low 20% decline our guidance had assumed.

you know, we continue to see quarter-to-quarter variability in the growth trends related to volume-based purchasing tenders, which is as we expected.

Raul Parra (CFO)

Yeah, so, just, you know, on the gross margin, you know, Jason, as you know, we don't comment on the gross margin. I, you know, generally speaking, we, we did say at the beginning of the year, and I think this still holds true, that, you know, as far as the operating margin improvement, it, you know, it would mostly come from gross margin. And to the extent that, you know, we would also, you know, on the high end, we would also leverage OpEx. So I, I'd say, generally speaking, we're really happy with the way gross margin is, is, is performing. We, we've been happy the last three years, the way it's, you know, what it's done, and, and, and again, continue to be excited about what it's doing this year.

I'd say it's kind of where we want it to be.

Jason Bednar (Analyst)

Okay, fair enough. I'll let others hop in here. Thanks.

Operator (participant)

Thank you. Our next question coming from the line of Mike Matson from Needham & Company.

Mike Matson (Analyst)

Yeah, thanks. Thanks for taking my questions. I guess just one on the EndoGastric deal. So, I imagine this is going into the endoscopy business. So, you know, are you going to be combining the sales teams and having kind of both groups of people selling all the endoscopy products? Or will you maintain kind of a specialist sales force to sell the EsophyX Z+ product?

Fred Lampropoulos (Chairman and CEO)

Yeah, Mike, hey, thanks. This is Fred. Thanks for the question. Listen, we've been looking for assets in this GI business for a long time, and it's been very difficult. What we did with this product is we found something that we thought would be able to cross over, that we could have the combined sales forces. So for the balance of this year, there's training and, you know, there'll be the... We did keep that sales team and some of the, you know, the technical and clinical people. We'll combine those together with the existing products we have in Endotek. And then, as other pros- you know, other products come out, because we have a very nice pipeline, we won't discuss it specifically, but we think that that's gonna serve well and will be more efficient.

You know, we've had a good sales force, but—and I mean, they're still doing a good job, but the utilization wasn't what we needed it to be. This way, there was a single product company that fit into our business very nicely, and we're gonna combine those two. We've had them here, by the way, I should mention, all of those sales forces have been here to Salt Lake, all getting together. We've all spent time together, and I'm actually very pleased with how that's coming along, as well as the integration. Joe, you wanna add something to that?

Joseph Wright (President)

Yeah. As you mentioned, Fred, we've been looking for something in this space for a long time. The great thing about this opportunity was just the financial profile. It's very rare that you find something that's going to be accretive to not just our growth profile, but also our gross margin and overall profitability in the first full year. So that was very attractive, and it's our existing call point. So we're basically able to increase our footprint in a very attractive market here. So yeah, we're excited about the combination, and we expect to train, cross-train all of the EGS salespeople that we hired and also our current Endotek sales force, so both will be able to sell both product lines. So we do expect some cross-selling opportunities as we move forward.

Fred Lampropoulos (Chairman and CEO)

Joe, if I could just add one more thing. Mike, the other thing is the territories and our ability to focus more instead of having people traveling so far with these, you know, additional folks. We think we can get deeper into the accounts. And incidentally, just as a point of interest, every single account that Merit has, happens to be exactly the same footprint as they have. So it's not like these are new customers. You know, they're, they're our existing customers, and they're all their existing customers, so they know who we are. You know, we're not having, you know, new people show up in the lab. This is something that has a lot of features that Joe mentioned and that I have alluded to, that we think helps to make it a pretty dynamic team.

I guess the other part that goes with that is when you get... I don't know, I'd probably get 10 notes from the sales force, after we were here and spent a couple of days together, just how excited they were to have this opportunity. Every person that we made that offer to in that sales force accepted. I think those are really interesting facts, you know, that they all came together, and that group will come together under the leadership of Nikki Kennedy, who's the leader of that Endotek division. So we're quite excited about this opportunity. A lot of work to be done, but nevertheless, we're very excited about it.

Mike Matson (Analyst)

Yeah, it sounds great. And then just on the cardiac business, have you seen any kind of impact there, positive or negative, from the rapid uptake we're seeing of PFA ablation?

Fred Lampropoulos (Chairman and CEO)

No, we have not seen that at all. We haven't seen anything that's taken away. Joe, anything that you've seen?

Joseph Wright (President)

No, we have devices that enable ablation procedures, so regardless, if it's RF ablation or PFA, our tools are generally applicable to both procedures, so it hasn't been an impact for us.

Fred Lampropoulos (Chairman and CEO)

In fact, it's access to get them there so they can deliver those products.

Mike Matson (Analyst)

Yeah.

Fred Lampropoulos (Chairman and CEO)

You know, it would be our heart span, our stable sheaths... our splittable, you know, it's those products that complement that they don't take away.

Raul Parra (CFO)

Yeah, got it. Thanks.

Fred Lampropoulos (Chairman and CEO)

Okay. Thanks, Mike.

Operator (participant)

Thank you. Now, our next question coming from the line of Larry Biegelsen from Wells Fargo. Your line is open.

Larry Biegelsen (Analyst)

Hey, guys. It's Larry. Thanks for taking the question. Hey, Fred, I wanted to ask you two on Rhapsody. First, a big picture one, and then a little bit more detailed one. And by the way, congrats on the nice quarter here, especially on the margins. You know, Fred, how do you expect to compete, you know, with Gore and BD in the stent graft space? We've heard that price is a key component when physicians choose a stent graft. What's your view? And I had one follow-up.

Fred Lampropoulos (Chairman and CEO)

Yeah, I think that first of all, as you know, Larry, we made a press release early to talk about the data being, you know, presented at the CIRSE meeting on, I think it's August fourteenth or September, whatever. It's coming up in the next couple of weeks. So we just, my general take is that we have superior technology, period. That's always been why we developed it. We think it's a great product. I think, you know, we've been out there selling it for a while, and the uptake on the product has been positive. So we're very excited about the long term. We continue to track well in those markets. The clinicians continue to be positive, and we're really looking forward in the future to discuss more of the addressable market opportunities.

And at the right time, in the very near future, we'll be talking about all of these things so that we can lay it out. And on this call, it's, we're not intending to do that today, but we don't have... I can just tell you that I don't have, and I don't think the people in this room have any doubt about the viability of this technology and its performance capabilities. We'll talk more specifically in the very near future.

Larry Biegelsen (Analyst)

Well, I wanted to push my luck and ask you one follow-up. How are you thinking about the likelihood you can obtain a transitional pass-through payment or TPT payment? And if you believe you can get a TPT because you have breakthrough status, does this mean you're going to have to price it at a significant premium, you know, when you come out, you know, of the gate, so you can meet the TPT criteria? Thanks.

Fred Lampropoulos (Chairman and CEO)

Yeah. Larry, we do have breakthrough status on this product that speaks to that. At the appropriate time, as we talked about, all of this will be revealed. In the very near future, we'll lay all of this out. Our primary focus today is the PMA has been filed, it's been accepted. Let's get that done, and then we'll start hitting all these other things once we know and we get closer and understand them better. So it'll be there. Just gonna have to be a little bit more patient, and I sure appreciate you pressing your luck.

Larry Biegelsen (Analyst)

No, I'm not, we're not good at being patient here, Fred, but thank you.

Fred Lampropoulos (Chairman and CEO)

Oh, I know. I know that. It's okay. You're just. I'm going to teach you a lot of things like you've taught me. You have. I mean that as a compliment, Larry. You have.

Larry Biegelsen (Analyst)

I know that.

Fred Lampropoulos (Chairman and CEO)

Over the years, you have, and I appreciate it. Thank you, sir.

Operator (participant)

Thank you. And our next question coming from the line of Steve Lichtman from Oppenheimer. Your line is open.

Steven Lichtman (Analyst)

Thank you. Evening, gentlemen, and congrats on the quarter. Wanted to ask again about the EndoGastric Solutions. Can you talk a little bit more about what the revenue growth profile is of the products? Appreciate the base of revenue that's being built in here, and sort of, you know, do you see opportunities in the near term to accelerate that, you know, with some potential cross-sell from your current business?

Raul Parra (CFO)

Yeah, a great, great question, Steve. You know, as you're aware, we disclosed that, you know, for this year, we're going to be in the $13 million-$15 million range for the back half of the year. And we also announced, you know, that it would be, you know, accretive to revenue, gross margin and operating margin, in the first full year of integration. So other than that, I don't think we're going to get into the details of, you know, of it. You know, we'll give you obviously our guidance for 2025, you know, in February. But I can tell you that, you know, the endoscopy team, and the, you know, both teams are excited about the products and...

That we have and the scale that we think we can get there with the cross-selling. So, we'll leave it at that, but you know, continue to be excited about that asset.

Steven Lichtman (Analyst)

Got it. Okay. And then, now, obviously, you were acquisitive, you know, this quarter. Free cash flow coming in stronger, though. How should we be thinking about, you know, sort of where your head's at in terms of use of free cash, looking forward here in the near term?

Raul Parra (CFO)

Yeah, and look, first of all, I just want to, you know, I'll give a little shout-out to our operations group, you know, on managing the inventory growth. I mean, it's been a huge benefit to our free cash flow this year. We're growing, you know, ahead of plan. So they've been able to manage keeping up with our customer demands while also essentially keeping, you know, inventory flat, you know, to down. So, you know, we continue to expect strong free cash flow generation, you know, for the back half of the year.

We continue to believe that, we'll, you know, we're in a good position to hit our CGI, you know, program of a minimum of $400 million in free cash flow. And lastly, and more importantly, you know, we took our, a minimum of $115 million in free cash flow target for 2024, and we bumped that up to $130 million. So, you know, super strong generation for the quarter. Couldn't be more excited about that.

Steven Lichtman (Analyst)

Great. Thanks, guys.

Fred Lampropoulos (Chairman and CEO)

Good to be with you, Steve. Thank you.

Operator (participant)

Thank you. Our next question coming from the line of David Rescott from Baird. Your line is open.

David Rescott (Analyst)

Oh, great. Thanks for taking the questions, and congrats on the strong quarter here. My first question is, you know, more around the wave results. Looking forward to seeing that. I don't think I've. I definitely haven't attended the CIDA or the CIRSE conference in the past. So I'm just wondering if you could give us a sense for maybe what to look for there, and then, at least in your view, maybe how data that's presented at these two conferences, you know, tends to kind of flow into some of the clinical practice.

Fred Lampropoulos (Chairman and CEO)

Yeah. Well, first of all, this is gonna be presented by physicians as part of the scientific sessions, you know, not by Merit. This is the six-month follow-up results on patients from the randomized arm of the study. What we call the AVF cohort, which includes target lesion primary patency, access circuit primary patency, and safety events. So this is the randomized part of the study, and that's will be presented, it'll be presented from the podium in the scientific sessions. In terms of the specific data, you know, come to Lisbon or tune in because, you know, we can't speak to it until that date, and then we'll be happy to have the physicians, not Merit, the doctors, talk about the results and how they view it.

So I think we're, you know, excited to... We'll all be there. I can just tell you the people in this room will be at that meeting in Lisbon, Portugal.

David Rescott (Analyst)

Okay, thanks. I don't think I'll make it out to Lisbon this year. But my second question, you know, is more on China, APAC. Obviously, that was a stronger growth driver than you expected from the comments there. I'm just wondering if you can help us think about some of the components of the way in which your business model operates in that market, and the level of visibility at least you have into, you know, the next several quarters of growth. I mean, it seems like in med tech, it's a weaker kind of macro market in general. Seems like you've held in there a little bit better than maybe expected.

Just wondering if your business or the visibility you have into those markets is maybe any different than what some other kind of med tech competitors out there have? Thank you.

Raul Parra (CFO)

Yeah, Joe's gonna take the China question, but David, just as a, you know, a point here, I believe that the CIRSE will be able to webcast that information.

David Rescott (Analyst)

Yeah.

Raul Parra (CFO)

So if you can't make it there, I think a pass will get you a webcast. I don't know all the details yet. We're trying to find that out, but our understanding is that there is a webcast available for that, so for those of you that can't make it.

Operator (participant)

Yeah. Thanks, Rahul.

Joseph Wright (President)

On China, just as a way of reminder, we don't provide country-specific growth assumptions, but you know, we did have better than expected results from China in the first half of 2024. We, like all the other med tech companies, are affected by volume-based purchasing, and there is some variability to that, but we still look at China as a very strong demographic strong growth market for us. The key for us is just getting through this year and perhaps next year, and then we reset our growth based on a new baseline, and we still expect great things from China in the future.

Raul Parra (CFO)

Yeah, I think, you know, one thing to highlight too that we're excited about is that, you know, even though we did have a total revenue, you know, decline, we did see sales, you know, of volume growth, you know, year over year. So I think that's important, 'cause as Joe mentioned, once we reset that, then I think we can get back to normalized levels of growth in China.

Operator (participant)

Thank you. Our next question coming from the line of Jason Bedford from Raymond James. Your line is open.

Jason Bedford (Analyst)

Good afternoon, guys. Can you hear me okay?

Fred Lampropoulos (Chairman and CEO)

Yeah, we got you, Jase.

Jason Bedford (Analyst)

All right. A few questions. Following up on Rhapsody, I apologize if I missed this, but did you provide an update on expected timing around FDA approval?

Fred Lampropoulos (Chairman and CEO)

No. It's in there, it's in their hands. We'll go through all the steps. We're prepared for it. We're prepared for the various aspects of a PMA, but it's in their hands now. We've completed the submission as we said we would on time, and now we just sit back, and we respond, and when they're done, they're done. So, we haven't spoken to it because it's in their hands, Jason.

Jason Bedford (Analyst)

Got it. Okay, that's fair. OEM, flat year to date, but I think I heard you say that you're still expecting double digit growth for the year. One, if you could just kind of confirm that, and I, I don't mean to be overly obvious with the question, but do you have strong visibility? 'Cause it, it does imply a pretty big ramp in the second half to get to double digit, if, if indeed that's the guide.

Raul Parra (CFO)

Yeah, yeah. You know, Jason, I mean, you know, first of all, I'd like to highlight, you know, our U.S. sales growth was just, you know, tremendous, and it continues to be so. And OEM did contribute, you know, in the second quarter, so they grew at about 5% on a constant currency basis. That's, you know, compared to Q1, where they were down, you know, approximately 5%. So we've seen a good rebound. We haven't changed the guidance for OEM because we do feel like we have the visibility to a better second half, and it does, obviously, the math would imply that it's a pretty strong back half of the year, and we feel good about what we've guided there.

So, again, I think we're really happy how things bounced back, and we're seeing some pretty strong demand there. As you know, there was also, you know, a deal announced, which we included, was in our guidance, but nevertheless, I'll highlight it with Medtronic on our spine business, that our OEM division is, you know, helping with. So, strong demand for sure.

Fred Lampropoulos (Chairman and CEO)

Yeah, that, that pipeline's filling back up, Jason.

Raul Parra (CFO)

Yeah.

Fred Lampropoulos (Chairman and CEO)

So we do have probably more visibility there of the stuff that's coming. As, you know, those orders are coming in, behaviors are going back to what we would see has been kind of the general after the ups and downs and the workouts of COVID are starting to come back to normalization.

Joseph Wright (President)

Yeah, and we have seen in the past 20%+ growth quarters from OEM. So while we're not necessarily saying when that will happen, it's not out of the ordinary for this sales division.

Jason Bedford (Analyst)

Okay. Yeah, the business obviously lends itself to some pretty good visibility. Just, and last one, I guess, for me, just on the EGS deal, and the improving growth profile there. Is there an international angle to the strategy, or is it mostly US-driven?

Fred Lampropoulos (Chairman and CEO)

Well, it is mostly U.S. driven. However, they do have, and I think they, they just didn't have the bandwidth. We think that's one of the things we're exploring is they have sales coming out of Europe and the Middle East, and we think we can add to that, and we'll be pursuing those growth opportunities wisely and very methodically.

Jason Bedford (Analyst)

Okay, thank you.

Fred Lampropoulos (Chairman and CEO)

You bet. Thank you.

Operator (participant)

Thank you. Our next question coming from the line of Craig Bijou from Bank of America Securities. Your line is open.

Craig Bijou (Analyst)

Thanks, guys, for taking the questions, and congrats on a strong quarter. Just had a couple quick follow-ups on, on China and the better than expected results in Q2. Just wanted to know, was that VBP's maybe not coming through on certain products you were expecting, or the impact, the pricing impact from the VBP wasn't as big as you expected, or maybe the underlying markets, you know, got a little bit better there? And then similar question for, you know, the rest of the year, and, you know, how conservative you guys think you are on the VBP side. And I think this was alluded to in a couple of other questions, but with the growth of the underlying, you know, China medical device market, just, you know, any thoughts there?

It sounds like you still expect volumes to grow, so that's positive. But any broader thoughts on, you know, the underlying market there? Thanks, guys.

Raul Parra (CFO)

Yeah. And so, you know, I'll let Joe kind of tackle the market, you know, and what, you know, what he sees there. But, you know, first of all, we, you know, we haven't changed, you know, our second half VBP headwind assumptions, you know, those kind of stay. I will say that, you know, during the first half of the year, obviously, we, we've done better than expected, you know, clearly, as we, as we talked about. And I think the one thing that I do want to highlight, which I think is really important, is that we continue to grow sales of units on a year-over-year basis, which I think is really important because we, we're able to overcome some of that volume-based purchasing impact. So we're definitely seeing it in our, you know, in our P&L.

We're definitely getting hit with VBP, but our team is doing an excellent job of continuing to growing, you know, units, which is giving us a little bit of upside. So, I'm optimistic about China. Joe, what do you think?

Joseph Wright (President)

Yeah, I think the overall unit growth highlights the fact that procedural growth in China is still strong. So while we're dealing with the VBP headwinds, the first half VBP was largely in line with our expectations, so there's no real change even in our second half guidance. We still expect... It, it's in our plan right now.

Craig Bijou (Analyst)

Great. Thanks, guys.

Operator (participant)

Thank you. Now, next question coming from the line of John Young from Canaccord. Your line is open.

John Young (Analyst)

Hey, good afternoon, and thanks for squeezing me in here. You know, first, I just wanna touch on Rhapsody, too. A lot of questions have been asked on it, but maybe just going back to, you know, what is the commercial infrastructure for the product today, Fred? And how are you thinking about building it up to the PMA approval, so you're ready at launch?

Fred Lampropoulos (Chairman and CEO)

Well, you know, we put together a renal therapy group that we put together last year that had a number of products that are in there that that product will fall into. They include things like the Surfacer and our hemodialysis product, 'cause they call on the same physician and the same point of sale. So part of that has been under development, getting ready for this for some time. So Joe, do you want to comment any further on that?

Joseph Wright (President)

Yeah. As Fred mentioned, we established a renal therapy sales group, and we've been adding to that this year in preparation for Rhapsody. The good thing for us is, as Fred mentioned, we have other renal therapies products that were, frankly, under focused, previously. So when we broke out this team, they've been able to focus on these products that we already have, grow that business, while at the same time, we've been spending a lot of time training them up on Rhapsody, letting them hear, physician experiences in, other approved markets outside of the United States. So we feel like we're doing all we can. We expect to add to that team over time, but we're gonna be judicious in how we do that.

Raul Parra (CFO)

The other thing to add, you know, too, John, is that, you know, you can clearly see that that team is performing well, right? They have the angio products, which, you know, are slightly ahead of where we anticipated they would be. And so, you know, clearly, they're doing a good job and, you know, in the integration part of things.

Fred Lampropoulos (Chairman and CEO)

Let me just maybe add the last thing to that. And that is, I think the ability for these guys to focus on six to eight products, all at the point of sale, is really significant. Again, as Joe pointed out, we've seen that performance, and we're being, I think, very cognizant of making sure we stay within our budgets, at the same time, making sure that people are trained, so when it comes in, we can go to the market without having either too much inventory, 'cause that's another important part of this, the training and the focus. Focus is a key 'cause of Merit's broad product bag, and you can't... It's hard to do. So with this, we think that it was the right call.

It was developed some 18 months ago, and we're just working through it, and when we're, you know, when we get approval, we'll be all set with people that know the product and have complementary products to sell with it, so.

John Young (Analyst)

Great. And maybe just a follow-up on that approval. On the submission, I heard you that it's, you know, in the FDA hands. Have you gotten any deficiency letters yet back, or has the 180-day clock stopped for questions at this point yet?

Fred Lampropoulos (Chairman and CEO)

We generally don't comment, but I will on you know, the stuff that comes in because it could be misunderstood, misconstrued, and whatever. They have it, the clock is ticking. That's where I'll leave it at that.

John Young (Analyst)

Great. Thank you.

Operator (participant)

Thank you. Now, our next question coming from the line of Jim Sidoti from Sidoti & Company.Your line is open.

Yolanda Sullivan (Analyst)

Hi, good afternoon, and thanks for taking the question. On Rhapsody, do you think that presenting the data in Spain will have any impact on your international sales of the product? And, you know, do you think that there is an international market for the product?

Fred Lampropoulos (Chairman and CEO)

Well, first of all, Jim, we're already selling it international, and, you know, data is the name of the game to physicians. That is the name of the game. You hear it—we hear it over and over every day. Where's the data? Where's this? Where's that? On a lot of products. And if you don't have it, how do you prove that it's efficacious? So data's important. It will have an impact, and we're very excited to be able to deliver this at CIRSE.

Yolanda Sullivan (Analyst)

Okay. And then, can you just give us some sense on the impact of the acquisition on the sales team? How big was the EndoGastric sales team that you brought in compared to what you had with your existing sales force?

Joseph Wright (President)

Yeah, so it was about 50% of the size of our Endotek sales force. So we could have taken more, but we decided to selectively hire those we thought were in strategic areas and where we had the opportunity. So it will grow that overall force by about 50%.

Yolanda Sullivan (Analyst)

I'm sorry, was that 15 or 50?

Joseph Wright (President)

Five-oh.

Yolanda Sullivan (Analyst)

50. Okay. And then also, you know, I'm sure that there was a lot of customer overlap, but are there new customers that you'll be calling on now for your core products?

Fred Lampropoulos (Chairman and CEO)

Well, I'll keep... The bottom line is every customer of theirs is a customer of ours already.

Raul Parra (CFO)

There's maybe two new customers.

Fred Lampropoulos (Chairman and CEO)

Yeah. So there, you know, so, you know, that was one of the beauties of all this, Jim, is that they're not new people that, you know, that we don't know or that they don't. So when we're calling on a lab, they know who we are, and we know who they are. So it, it... I've never seen anything quite like this, where every account that we have, they have as well, and they have something in there. So but let me go the other way around. Every account that they have is an account that we're already calling on. Okay? To make-

Yolanda Sullivan (Analyst)

All right. Thank you.

Fred Lampropoulos (Chairman and CEO)

Yeah. Thanks, Jimmy.

Operator (participant)

Thank you. I'm showing no further questions in the queue at this time. I will now turn the call back over to Mr. Fred Lampropoulos for any closing remarks.

Fred Lampropoulos (Chairman and CEO)

Ladies and gentlemen, it's a long call, so we appreciate your patience. There was a lot of things to talk about. Rahul and I and Joe will be around for the next couple of hours to answer specific questions. We wanna thank you for your interest and for the... I thought the questions were great, so thank you very much for your interest, and all best wishes from 100 degrees of heat in the mountain land of Salt Lake City, Utah. Good evening. Best wishes.

Operator (participant)

This concludes our conference call for today. Thank you all for your participation. You may now disconnect.