It has been more than two years since anyone wrote about LeMaitre Vascular (LMAT) here on Seeking Alpha and that’s a pity as the company has made major steps in the right direction since the most recent article. Its revenue continues to increase as it continues to penetrate its core markets, while the balance sheet looks better than ever before with a substantial net cash position and in excess of $20M in ‘marketable securities’. Time to have another look at LeMaitre to see if the recent weak performance in the past few weeks creates opportunities.

Data by YCharts

The revenue and cash flows continue to increase

LeMaitre’s team of salespeople continues to do an excellent job by ‘creating’ a market for its products (LMAT produces medical devices that are used in veins and arteries outside of the heart) as almost 80% of LeMaitre’s revenue is generated through sales that are directly made to hospitals thanks to a specific focus on targeting the vascular surgeons.

Source: company presentation, Q4 results

What I specifically like about LeMaitre’s product offering is the fact the company searches for a specific niche in the vascular medical sector, which means there is some sort of natural barrier to entry as a new entrant could very well decide against making the investments in R&D and marketing if there’s only a small pie to share.

The revenue continues to increase and after generating $89M and $101M in sales in 2016 and 2017, 2018 was another year of revenue growth as LMAT saw its revenue increase by almost 5% to almost $106M. What’s also very interesting is the fact the additional $4.7M in revenue only caused the cost of sales to increase by less than $1.5M which means the gross margin remains relatively stable at 70%.

Source: SEC filings, annual report 2018

The total income from operations increased by in excess of $7M to $28.2M, but this also includes a one-time $7.5M benefit from a non-recurring gain. Excluding this one-time event, the operating income would have been slightly lower than in 2017, but this seems to have been caused by a 24% increase in R&D spending. If the R&D expenses would have remained unchanged, the operating income would have increased by approximately 10%.

Thanks to the one-time gain and despite the higher R&D expenses, the net income increased to almost $23M or $1.18/share. Unfortunately, LeMaitre’s share count continues to increase as it now has almost 1 million additional shares compared to two years ago. That’s a pity, and one of the reasons why I think LeMaitre should consider a share repurchase program (see later).

LMAT reported an operating cash flow of $19.5M, but this includes a $1.7M investment in the working capital position as well as a $2.2M payment to settle deferred taxes (so these taxes were due on historic profits and should be excluded from the FY 2018 cash flows as this one-time tax payment does skew the results).

Source: SEC filings, 2018 results

This means that on an adjusted basis, LeMaitre generated an operating cash flow of $23.4M, and after paying the $3.1M in capital expenditures, LMAT’s adjusted free cash flow result was roughly $20.3M or $1.03 per share. Note: this result is lower than the net income because it excludes the $7.4M non-recurring gain on divestitures.

Source: company presentation, Q4 Results

The balance sheet contains a net cash position – what’s the plan?

While I agree an EPS of $1.18 and an FCF per share of $1.03 don’t look too attractive for a stock trading at approximately $30 per share, there’s more to this than meets the eye here.

Not only does LeMaitre deserve to trade at a premium based on its strong balance sheet but I think it’s also only fair to take the net cash and the net investment in marketable securities into consideration. LMAT has no long-term debt but has $26.3M in cash and almost $22M in marketable securities on the balance sheet; which equates to almost $2.5/share.

On February 14, the LMAT board approved a $10M stock buyback and I think this is a good move considering the share count continuously increases through the vesting of Restricted Stock Units and that’s the main reason why the share count increased by approximately 1 million shares in just one year. And this trend won’t end as LeMaitre disclosed it will have to record an additional $9.7M in share-based expenses over the next 3.8 years while it also granted options with an average fair value of in excess of $8/option.

ChartData by YCharts

It’s great to reward important staff, but it does bother me a bit to see the share count increase by approximately 3% per year as this does slow down the growth per share. Buying back stock could be a valid way to counter the effect of this dilution, but repurchasing half a million shares per year at $30/share would cost LeMaitre $15M per year and this, combined with the quarterly dividend would absorb pretty much the entire free cash flow.

Investment thesis

I like what LeMaitre is doing, and I like the company’s balance sheet. However, most of its efforts to grow will be useless as the continuously increasing share count substantially reduces the impact of the earnings and free cash flow per share. When comparing the 2017 results with 2018, the net income increased by 33%, but the EPS increased by less than 30% exactly due to the higher share count.

As long as LeMaitre’s net income continues to grow at an accelerated pace, this will go unnoticed, but the continuous dilution due to RSU’s and stock options is actually hurting the company and this will become very noticeable when the growth slows down. If I would use the normalized net income of $16.9M after excluding the non-recurring gain, the net income would have decreased by 1.5%, but the EPS would have decreased by 5.6% due to the dilution.

Should LeMaitre find a solution for the RSU’s and stock options that are slowly killing the benefits for increased profits, I will give the company a very good look, but for now, I stand on the sidelines as it looks like the entire free cash flow would be needed for the share buybacks to neutralize the dilution.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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