Merit Medical Systems Inc (MMSI) 2005 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Merit Medical Systems third quarter earnings conference call.

(Operator Instructions).

I would now like to turn the presentation over to Fred Lampropoulos.

Thanks you. Good afternoon ladies and gentlemen. This is Fred Lampropoulos, broadcasting now from South Jordan, Utah. We have with us members of our staff. As a part of a new way to conduct these calls, or at least an additional requirement, we have a responsibility to read a forward-looking statement, so we will do this in this particular meeting and we will do this from this time forward on any of our conference calls.

So I've asked Rashelle Perry, our general counsel, to read that as we open our meeting and then I'll conduct it from that point. Rashelle?

In the course of our discussion today, reference may be made to projections, anticipated events, or other information which is not purely historical. Please be aware that statements made in this call, which are not purely historical, may be considered forward-looking statements.

We caution you that all forward-looking statements involve risks, unanticipated events, uncertainties, and other factors that could cause our actual results to differ materially from those anticipated insight statements.

Any of these risks, events, uncertainties, and other factors are discussed in our annual report on form 10-K and other reports and filings with the SEC which are also available on our website. To the extent any forward-looking statements are made in this call, that statements are made only as of today's date and we do not assume any obligations to have dated any such statement.

Thank you, Rashelle. And as I mentioned, in all of our calls going forward, that will be part of our procedure, going forward.

Earlier, just an hour or so ago, we announced the third quarter earnings and some additional information regarding the quarter. This was a follow-up to an announcement we made on October 19, which in which we announced preliminary third quarter results.

Revenues for the third quarter were $41.2 million. That was up 16% from the year-ago quarter. Our net earnings were $3.3 million, or $0.12 per share. For the comparable 2004 quarter, we had reported $4.2 million or $0.15 per share on revenues of $35.5 million.

For the nine months period, our sales were up 11%. All the categories of our business contributed to growth in the third quarter, with catheter sales rising 21%, stand-alone devices 18%, and the rest of the information is available there for you on our press release to review.

Now the real critical issue here that I know you're all interested in discussing is the issue of gross margin. Gross margins were 40.8% as compared to 44.5% for last year and you'll all recall that gross margins for the first nine months were 42.4%, a decrease from 4.8%.

We spelled out some of the reasons for the decrease in the gross margins. Part of it was due to the acquisition as you're all aware of our custom trade business in Richmond, Virginia. And one particular factor in there we were a little bid delayed in the quarter in terms of moving and shutting down the facilities, so we were operating out of two facilities and continue to do so today.

However, this weekend we will shut down and have all of our facilities moved and we'll be all consolidated as of Tuesday morning, when we open for business. So we will spend the weekend and then we will be in that one facility.

Also, so that you can be aware, and I think this is a positive thing for the Richmond facility, is that we're negotiating a lease that essentially is more than the depreciation costs on the building. And we are well along our way. In fact, I had a conversation today on that particular lease. Let me again state that we have not signed that lease, but are negotiating, for a lease of an office annex which is part of that facility, which of course the purpose is to offset the cost of that facility and operation.

We also mentioned the issue of two start-up facilities. We're all aware that Ireland has been online for some time, but we have plenty of room for capacity there and we have moved into our new facilities in Salt Lake City, what we call the MTL building. That building consists of our injection molding facilities and our new automated warehouse. We have not moved all of our equipment into that. That won't be done until about mid January.

But we have received 12 additional or brand new injection molding machines that are being qualified and approximately nine or so of those 12 are in production or available in starting up production. We will start next week by moving three additional machines over and will have this facility vacated and that full facility up and running in approximately three months.

Now, we had to hire people to run those machines, qualify those machines, and that's part of the cost that hit us in this particular quarter.

Also, some other additional things that you'll be concerned with. We had an increase in R&D. Now this is below, of course, the gross margin line. That issue, well aware from this release, is up 50%. One of the things that we have done is move into the new R&D facility. We've been in there now almost nine months. We're producing introduced receipts out of that facility, but in order to move those products and to increase the new product offerings that are coming forward, we've had a substantial increase in R&D expenses.

Now as you all know, the purpose status for new products in those investments will reap appropriate returns, but the expense has to be generated before you have the results. Now one might ask, why didn't you have that before or do that before? And the answer is we didn't have the capacity in our existing operations to be able to develop the new products.

Well now we have the facility, we have the ideas, and so we've staffed that and again, as we mentioned in our press release, essentially all of the new products: the Resolve, the Honor, the Impress, and the Revolution are all scheduled to be released this year.

In fact, in some of our meeting that we've had earlier this week, we planned to do our first human patients for the drainage catheter starting the week of December 5. So those are not far away and that of course is one of the big issues in terms of gross margins and market opportunity.

Now we hired salespeople and I know some people that I talked to earlier this week were concerned that we had talked about hiring 12 salespeople and there were a couple of issues there. One, that there are some additional new products, one which we announced this week with a new safety needle and some additional products that, I'm going to call them ancillary, but other products that we may or may not make a press release on. But additional new products that will be coming out and released over the next three or four weeks.

And as we were going through the process there were two things that occurred. One, we felt that we needed to hire some clinical personnel to support the products, like the new catheters, that needed to be in the hospitals and we hired two of those. And we've included those in these numbers, so when we talk about sales personnel, some of them are support personnel to support sales effort.

And one thing that hadn't happened in the past is that many times when we opened requisitions, they took a lot longer to fill. And in this particular case, Marty Stephens sold it much faster than we anticipated, but we felt with the Magnificent Seven, the overall growth of the business, and then several new products, including the trays, the new secure lock, and a couple of others that will be coming out as early as next week.

As an example, one of them that we thought about making a press release, but we were concerned that it might be misconstrued is a new torque device that's used on hydrophilic guide wires. And that we will release next Tuesday. It carries an 80% gross margin and we actually have sold almost 1,000 units already. But it was not something that we felt necessarily that we would make a press release on, but we knew that those products, or hoped that those products would come into play and they have and it will release next week.

And so we felt going forward that we needed to have those requisitions open and they got filled. I think in the intermediated term, that those decisions will pay off, we'll have people in place, and hired. And I again want to come back to say that we saw a 16% increase in the third quarter over the year-ago period and still are operating at a little bit more than 11% for the year.

One of the other issues that candidly caught us by surprise, was the amount of costs associated with samples. Our (inaudible) sheet is receiving a substantial amount of interest, we continue to open up new accounts everyday, and the samples are running somewhere about one-third of the units we produce are being used and being sampled all over the country. And as you will recall from our previous conversations, those particular samples were at a very, very high price.

You may recall that I shared with you that there were some parts of that that ran $2 each. Now that we have the multi-cavity tooling, those costs are down to $0.08. So it was like $2.20 to $0.08, while all these units that have gone out have gone out at that higher price and now that cost is coming down and coming down dramatically.

So those are other issues, and that was pretty substantial. In fact, our sample budget was twice what it was a year ago. So it was a lot more than we'd anticipated and I think that of course is not good for the quarter, but spells well for the future because there's a lot of interest in our new product.

I'm going to go ahead and turn some time over to Kent and let him go ahead and, oh, one more thing. We alluded to this in a press release, and that is that we had to manually shut down our facility in Texas. It cost us probably a full week of costs and another week of momentum and start-up.

We closed the facility down on a Wednesday, opened it up the following Wednesday. We paid all of our employees during that same period of time, plus we had a cost associated with going down and looking at the facilities, and we had to move inventory. And then we lost some momentum, of course, when you have to start up. It's like coming back from a vacation. And candidly our employees.

It was a very stressful situation, as all of you will recall as you watched television. So we had those particular costs that hit us in the quarter, plus Katrina. We have at least 6 to 10 hospitals down in the Louisiana area that aren't buying product from us now and haven't reopened. We figure that those costs for the year were going to be somewhere between $0.5-$0.75 million in sales and consequently the profits for those particular products.

I've kind of seen this across the board with other device companies in some of their releases and some of their challenges in the third quarter. So we got hit with those things and it was all of these things converging together.

Kent, I'm going to turn some time over to you and have you go through a few of the issues and then we'll turn the time over and we'll answer questions.

Thank you, Fred. I just wanted to point out that I was pleased with the revenue growth, that it was strengthened again, in a quarter that's been traditionally difficult from the standpoint of procedural growth rate. We are hearing from many of our analysts, and I'm sure some of them are on board today for this call, that it was a slow quarter, they thought more so than any they'd ever seen in many of the people reporting their earnings in this period.

And so we were grateful that even though the procedure growth rate seemed to be slow, that our growth rate still laws strong. And we had some exciting growth in some of our newer products like the mack (ph), I would say I would highlight, and some of the other catheter products that we've talked about that made that growth accelerate.

I think another thing that I wanted to point out was the gross margins. We've made a lot of investments and they're long term in nature and won't turn around quickly, but we think that they bode well for the long-term investment, that gives us the capability to bring in not only these new products on and ramp them up, but to expand the volume in really all of our stuff. Particularly to look at the molding operation that was at full capacity running 24/7 and it was important and imperative that we expand that. And there is a price to pay for that and it will take some time to absorb that up, but we're beginning on that path with a higher top-line growth rate and more products to sell every day.

I think in the SG&A costs I wanted to point out that there were some somewhat one-time costs in regards to severance. We have $325,000 of severance costs that were due to terminations of some key employees that were curved this quarter that we won't see at that level or at least didn't see that level last year. That's the difference from last year's quarter. So if you took that out, our SG&A costs are actually lower as a percentage of sales than last year.

And then of course the R&D Fred just talked about. I think it's already seeing the fruits of it. Not just the products we talked about, but the schedule. We're on schedule better than I've seen in the past and I think that bodes well that the capabilities and accountability for the product development cycle has improved.

So our other issues are pretty well factored in there as far as we're pretty confident. And I'll turn at this time back to Fred.

Going over a few more issues and then we'll turn it over.

First of all, our sales range that we gave earlier in the year, we still believe that we can be on the low end of that. We're going to have to hustle to do that, but we believe that it can be done. Secondly, the new products, as I mentioned, are on schedule. We lost a little bit of momentum, but according to the project leaders, we're still scheduled to release these products as we had previously announced.

In fact, the reality is that we will announce a few more, or at least we'll have three more additional products, in our bag to sell by the first week of January. These are safety-related products, one of which is the needle and two other safety products that will be coming down the road before year end.

Next, we are already, and as I tried to allude to in our press release, we're aware of some of these costs, we are doing some reductions and some non-replacements. We've had a couple of people leave the company, a couple of them are in this room. Unfortunately, one of our lawyers is leaving by his own choice and we're going to miss him, but we're not going to replace him for the time being.

We've had Brian Lampropoulos, who is my son, who is no longer associated with the company. We have Diana Upp who was been with the company for many years and was the head of sensor systems and she has taken a job for a start-up company in Connecticut. Some of those positions, which were all senior positions, will not be replaced.

The net of it is, this: we had a quarter that all of you are disappointed in and we are as well. But the long-term plan of new products, development of the sales force, capacity, and a change and turn up in margins, we still believe is going to take place some time in the third quarter as we launch these other products and start to absorb some of these costs of the new plans and those sorts of things.

We're well aware of our deficiencies and we will work and we have a plan. We're not oblivious to this. I think everybody that's sitting in the room, and there's about 20 people here, all of the staff, are aware of the task that stands before us.

But we've never been in a better position to move forward and to build this company at higher growth rates or higher dollar volumes than we ever had in the past. We just are in a good position to do that and it was an unfortunate situation. And we'll have some of these costs still with us in the fourth quarter and we'll have some of the costs in the first and second as we launch these additional products.

But once we move beyond that, we believe that we'll have several years of high double-digit growth and sustained growth and higher levels of profits. That's what our belief is and that hasn't changed from when we discussed it with many of you before.

So I think that pretty well covers, Kent unless you have anything else, I think that -- Greg, do you have anything? Our accounting officer. Okay. Well I think with that said, we all have our hard hats on and we're ready to take questions and answer them to the best of our ability.

Thank you, sir.

(Operator Instructions).

Our first question comes from Matt Duncan with Stephens Inc. Please go ahead.

Good afternoon, Fred and Kent.

Hi Matt, how you doing?

Doing fine, thank you. Fred, I want to try and delve a little bit deeper into this gross margin issue and try and see if I can't understand a little bit better where all the pressure is coming from. Is there any way that you can kind of quantify maybe, of the issues you've listed, which ones are putting the most pressure on gross margin, for example how much pressure are you having from the two facilities in Richmond running concurrently?

It's not necessarily the two, that's probably $15,000-$20,000 a month or some other number associated with the inefficiency there. But the other part is the overall gross margin, some of the inherited business when we bought the business and the hiring of new personnel that were not part of the other facility.

The $15,000-$20,000 I'm talking about is just the rent issue when you're running two facilities, but now we've got a facilities manager there, we have to put a finance guy in place there and I don't know if he's in place but he will be. So we have those kinds of issues, including putting the systems in place with (inaudible) and all that kind of stuff.

Now, not all of that cost is there yet, but a good portion of it. So I will tell you this. I believe it was last month and I think I can say this, but we have a $100,000 loss last month in Richmond and that is higher than we anticipated. That is a pretty significant situation right there. And as we pointed out, the overall effect on gross margins is about 2%. About 2%. So, Kent, do you want to answer that?

Yes, I mean that's the largest factor if you want to weight them and the effect on the margins without it, we would have been almost 2% higher in gross margin percentage. And there's other factors that I think are heavy. We put in there that we had a labor increase this quarter which began the first of the quarter.

We've been struggling a little bit with retaining and maintaining our labor force here in regards to direct labor or entry-level assembly labor. And so we made a decision, which wasn't in our original forecast when we made it last year, and we felt it was the right thing to do at this time, was to increase that and try to maintain our employee base and be able to grow it which we need to do.

So we expanded somewhere around $150,000 plus the benefit costs of that are closer to $200,000 for the quarter.

It's a good point, Matt, and that is that one of the things that we have in Utah is a very, very tight labor market. Whereas in Richmond, Virginia, for about 50 jobs we had almost 1,100 applicants. In Salt Lake City, we've been having some turnover problems and a lot of pressure on wages here. I think with the slowdown I anticipate that we'll start to see that alleviate a little bit, but the bottom line is that we've had an annualized cost of almost $875,000 of wages that we will put in over the next 12 months, that take in place and we thought necessary to be competitive in the medical device area and the local market.

We don't have that labor issue necessarily in Richmond, so I don't want to get off the Richmond issue, but I think the number of $100,000 loss or about a $1 million a year, $1.2 million pretaxed, which is going to be somewhere around $0.02 a year, is a factor and we have our eyeballs on that. And I'll tell you how we're going to solve it.

We have some tax business that we're building here, that we're not as efficient and will have to offset some costs down there and we can sterilize in Richmond, Virginia for half the cost we can in Salt Lake City, half. So over the next 90 days, we're going to transfer about $5 million worth of tax-type business that we have here and transfer that down to Richmond, which we'll have to offset some of the overhead issues there and allow us for more capacity of higher margin products here in Salt Lake City.

And I guess another thing that we really need to try and get our hands around here is when can this gross margin start to recover? Are we talking about a 41% gross margin through the middle of 2006, as you seem to be alluding do? Or will there be some gross margin increases, even in the fourth quarter?

I do not anticipate increases in gross margins in the fourth quarter. In fact, I don't anticipate that we will see increases until the third quarter of next year. The reason I say that, we're going to continue to sample heavily for those institutions that want to consider our products and a sampling, for instance, of an introducer sheet, has to go through sometimes as many as 20 or 30 physicians in a hospital. Like I said, right now the samples are running about for every three that we sell, we have one as a sample. Actually a little bit more than that.

So it's about 30% of the product that we've produced and unfortunately in the last quarter, most of that was done at a very, very high price since it was some of the start-up costs. And by the way, I'll let you know that that cost has essentially halved itself as we go forward into next year already because of these reductions in the automation issues that we talked about.

So, we're going to see that phenomena, however, with a new drainage catheter and with new angiographic catheters, and with some of these other products, we're launching high-margin products, but they have to be sampled. So we don't anticipate that we'll see increase in gross margins until the third quarter of next year. But we will continue to see higher sales that will start and of course contribute gross margin dollars.

Kent do you want to comment on that?

No. I think you've covered it already. There's going to be a longer-term situation. And we have to also remember that with what's going to happen with Richmond, and how much volume we're going to put through that and how that will effect the modeling of it. I think we've discussed this in every occasion in the past. And so as that grows, that will dilute a little bit of our margin percentage, as well.

But it also will bring that along towards a break even in the profitability of that volume.

And we're anticipating that's going to be somewhere in the third quarter of next year. And very candidly, we stopped and asked ourselves and continue to do so, is a wise decision? I'm going to defend it by saying that we believe that to offer an overall service, you have a competitive advantage that it was the wise thing to do.

We had originally mentioned to you that we thought we could open up 50 accounts. The fact of the matter is we've opened up some 200 different accounts that we think help to maintain our business and give us a competitive advantage.

But what we have to do is we have to be able to get those costs down and we have to be able to offset the cost of that new facility which is over 100,000 square feet as you guys are well aware of.

To the sales force, you added, you said 17 people in the quarter. Was that a net addition or a growth addition of people?

I think we lost one and so I think the net is 16, because we lost one. We have four open territories as we speak.

Do you plan to add more people then in the fourth quarter? And I guess the next question that I'm getting to is how many more people do you plan to add to that sales force between now and the end of the year and then in 2006?

Okay, we have four open areas right now that we will look at and if we don't hire them in the next, I'm going to say, two weeks, it will probably sit idle until after the first of the year. Simply because they're not very productive and you have the holidays and Christmas shutdowns and things like that.

Right now we do not have anything in our budget to hire additional salespeople. We have to absorb what we have and get the products launched and get them all trained. We have a training class. We've had two during the quarter, we have a third starting next week.

So your answer is, I think 16 net, four open territories. We'll look to fill a couple of those in the next couple of weeks. If not, that could go into next year and then we're going to just sit pat with what we have until we can absorb it and get the products launched and try to get the kind of results that we want.

Okay, last question and I'll jump back in the cue. Can you give us an update on the role out of prelude. How many accounts do you have ordering the product at this point? Does your entire sales force have it? And I know previously you said you would be a little bit manufacturing constrained there until January, does that still hold true?

I don't have the exact number. I'm going to estimate that we have somewhere about 60 or 70 accounts that we've added in the third quarter and early fourth quarter. We are still capacity constrained. In fact, I was looking yesterday at a project meeting and we can only produce right now about 16,000-18,000 units a month.

It will go up to 44,000 units a month in January and then by October or November of next year it will go up to 110,000 units a month that we can produce. So we're still under that same plan, we haven't slipped off that plan. It's the same exact plan.

We may have moved out a little bit in terms of some of the bumps in the beginning, but essentially we're on the same plan. The good news is that we are anticipating that we're going to be able to capture substantial market share in other countries that we had not put in this forecast before. And in terms of its availability, it is available to the entire U.S. sales force and is available to the European sales force.

But it is not available to all distributors, but as we move into January, we will release it essentially to all players worldwide once we know that we can produce and work up towards 100,000 units per month. So it is not under full release, but most of that are distributors and Europe, Asia, and that sort of thing.

Thanks.

And I ought to mention one other thing too. Over the next, and this goes to the R&D expense, we're going to add over 100 new catalogue numbers in new products, which are the ACT, the radio artery, they are the 23 cm, they are the marker band, they are the four (inaudible) which we'll introduce in the late first quarter. So we'll continue to have a full offering and be working on introductions of new products for the introductory sheet for the next two years or longer, that will be one or two or ten every quarter. And we'll continue to keep everybody briefed on that.

I am told by our users and the one that -- I value all of them -- but our Japanese distributor tells us that their assessment and the market's assessment in Japan is that we have the best device in the world and which we believe we have. However, we won't be able to enter the Japanese market for approximately one year, because of the registration requirements.

But we'll be entering Europe, Central and South America. We're already selling in Mexico, we're selling in Brazil. We have a long ways to go on this product.

Thank you. Our next question will come from Chip Crute (ph) at Springfield Capital. Please go ahead.

Yes, hi Fred and Kent. I had a question. This may be a little more of an observation, then two questions. I sense as you go through there and you have all these little spending needs that you come across, it reminds me a little bit of my 20-year-old daughter who didn't see an item that she didn't like in a store and I think you need to temper some of that a little bit as you go along.

Now, my questions are specifically, with the Texas cost, when it was down. And secondly, with Richmond, you said it's going to come up gradually towards a break even. Wouldn't that imply that the gross margin should gradually improve, that it won't be just like a switch going on and off in the third quarter?

Let me address the question of gross margins coming up. The gross margins in Richmond will come up. However, we'll have the samples and we have to do the absorption of the new facilities that are here that are not being fully utilized. In fact, very utilized at this particular point in terms of the molding, and that sort of thing.

So yes, the margins will be improving and one of the reasons to move some of the Salt Lake business down there is that we think we can do it for less money down there, which will increase our gross margins on existing business that's being produced in Salt Lake City, less efficient than we believe it can be produced down in Richmond.

So yes, those margins will be going up down there as time goes on, but we're going to have these other costs, the start-up cost and the capacity and utilization costs that are just starting to hit. For instance, with the new building, that's just coming online essentially last quarter and this quarter.

So I didn't understand the question as it pertains to Texas.

In costs. You said the plant was shut down.

You know, it's an estimated. We lost a full week's worth of production. We lost the efficiency because we had to start up. We actually moved all of our inventories, finished goods, and moved them out and at least had a plan to send them to Salt Lake City. It's a little humorous, that we're all loaded up in trucks, but they never left Houston.

Even though we thought they were here, because they essentially were abandoned. It's a long story and I had to fly down and the staff down and stuff like that. But you know it was a pretty substantial cost and I think the productivity. Most of the people that you saw that were on those roads were some of our employees. They were pretty frazzled.

One was held at gunpoint. One was robbed. A number took a two-hour trip that took 18 hours. I could go on and on. We went down there and were on the ground the day after the hurricane passed to give support to those people.

So, I'm going to estimate that that cost during the quarter was somewhere around $0.25 million.

Okay. Last question, then, this one for whoever wants it. Jump ball it. And that is, do you think you can get your gross margins back to where they fit in before? Or will Richmond preclude that?

It's a good question. You know what I'm going to do? I'm going to let Kent answer the question. I already have an answer, but I'm going to let him get first shot at it and then I'll tell you what I think.

Well, with Richmond in there and -- and the confusing thing, Chip, for all of us to model, is weighting it. In other words, the more we sell of that product, which is going to be at a lower margin, it will cause the percentage to come down. That will be the math of it. And if it grows rapidly and we decide that that strategically is what we want to do, the percentage will grow.

That doesn't mean the bottom line's going to go down, because of the growth. But it will cause that modeling or percentage to grow. So that's what gets interesting about it. Right now, it's sort of a double drag because it's not even at break even and yet it hasn't turned. When it turns it will help in its own right start to bring contribution to the bottom line, but it could still dilute the margin percentage and it could still cause it, if it grows to 50-60 million, it could cause us to not get back to those same margin percentages.

But is that the wrong thing to do? I don't think so.

Let me answer it Chip, by saying this. Kent's assessment, I think for the near-term, is correct. There are some things that we can do. Remember, part of the reason that we did this, there were several reasons.

One was a defensive issue in terms of people were stealing parts of our business. Another part was to be able to add services that some of our competitors don't have. I've hardly heard, by the way, for months and months and months, I'm going to say six months, that we're being affected by Boston Scientific.

I just don't hear it. Whereas a year ago I was hearing about bundling and this and that. But as other competitors have come in or other entries, that's kind of gone away. Part of that is because we have services that our competitors don't have.

It was also a transition product that on a long-term basis strategically helped us, but we didn't have any of these products rolling out to the third quarter or fourth quarter of this year, which effectively means that they weren't really going to see a lot of benefit from this until 2006 for our sales force.

And so a lot of people spent a lot of time on this and as we met with various regional meetings in the last couple of weeks, the sales force has been excited and has appreciated and has used this as a tool to grow our business.

However, we believe that there are things that we can do to control that business and for instance, it has a lesser commission than our overall product line. By an adjustment of that, we can insent or disinsent that product line and get the required mix that we want, particularly as we see -- for instance this new little product, and it's not a big product, but it's an 80% gross margin.

The drainage catheters are going to be 65% as they start to roll out after the initial start-up cost and we get some efficiency. So I believe that if we were to look down into 2007 and 2008, that we could move back, if we're right. If the products that we're introducing have the novelty and the benefits and innovation that I believe and members of this staff believe, including our sales force and marketers. Whether it be the Revolutions, the Honor hemostasis valve.

I was on a call yesterday with a sales force with one region and one of the guys just came out and said, "Fred, we're waiting for the Honor hemostasis valve," which is an 80% gross margin product. And he said, "I can sell all you can make." That was the comment he made, right on the phone and people in this room heard that. "I can't wait to get my hands on it."

So, I think on the intermediate term, we're going to deal with the gross margins. I think we'll see a turn in the third quarter of next year. I think we can see gradual improvements and we can adjust it, but what's really going to drive is going to be the acceptance of those products and the ability launch them and launch them effectively.

Now, another thing I want to talk about briefly, is on sampling policy. One of the things that we've learned from introducing this introducer sheet is it has required a lot of sampling and it's probably necessary, on an introducer sheet that's used on every diagnostic and interventional procedure done on the planet.

However, when we launched our drainage catheter, which has a $75 retail cost and a substantial amount of cost. You know the margin number, so you can figure out the cost from that, then we are going to limit, and I think that's a valuable lesson we've learned from this, is we're going to limit the number of samples and the salesperson's going to have to manage what they get.

So we may say you get 10 samples, and until the sales are delivered you have to manage them, it's not a free-for-all. I don't want to suggest that it's a free-for-all, it's just that requires more and the lesson that we've learned, in order to keep the costs down and get the performance is that we have to manage it. And I think we've learned that from this particular experience with the introducer sheet.

So, the answer to your question is Kent believes they can go up, but it will be affected by the tax business, I believe the same thing. And I believe overall that we have tools and incentives and adjustments that we can make than can drive it.

But at the end of the day, we want to do what's right for the long-term growth of the business and our market position and it could be that we may have to settle for a lower gross margin, but we may have higher profits. That's going to be a judgment that we're going to have to look at as we go down the road. What's in the best long-term interest of our shareholders and our overall business, and we'll have to look and see how these products are accepted and what changes happen in the marketplace.

A long answer.

Still here. Thank you.

Thank you. Our next question comes from Emily Johnson with WR Hambrick. Please go ahead.

Hi, thanks for taking my question. With all of the new products coming out by the end of this year, they're all within the 60%-80% gross margin?

No. The Honor hemostasis valve is. The Revolution is. The Resolve will be, and is. The Impress catheter is more like a 30%, because it's an existing type of product. Our safety needle is in the better than 50%. Our new torque device for our hydrophilic guide wire is in the 80% and a new safety product that will be released in the first week of December and talking about that in another week or so is in a 50% profit range.

So not all of them are 60%-80%, but a good portion of the "Gee whiz" products, the Resolve, the Honor, and the Revolution are all 80%.

And it will take some time to get those kinds of margins.

And with the sampling cost, what would you say? That cuts it back generally 20%? Or how does that work? Is it a 50% cutback when you factor in the sampling?

You know, if we were to look at the introducer sheet and take a look at the cost and take a look at the sampling, overall I think this is fair. What I'm trying to say if we took in all that we sold and took at what they cost us to produce it and the sampling cost of it, it's operating at a loss during the quarter.

It's clearly a loss. The samples are below the line because they're in the sales thing, but we're selling these things to meet the market price or a slight premium for that. By the way, we're getting substantially higher prices in Europe. But as you launch these things out as I mentioned, one particular part of it was costing us $2.20. That cost is now $0.08.

And so almost all of that business segment was sold essentially at a loss during the quarter and at a substantial expense because of samples. Now as we go into this quarter, those costs have dropped almost in half and they will drop by probably another 30% over the next six months.

So that's a 70% reduction in costs over the nine months. But when you go out and you have a universe of 15 or 20 million devices that were sold worldwide and you have to compete head-to-head with people that have been in the marketplace for some time, it's the cost of entry into the marketplace. Did I anticipate that it would take that type of sampling? No.

Did I anticipate that we would have the start-up costs and the volumes and those issues, that it would probably take that expense? Yes. We knew in that production plan and those things what our costs would be, how fast to drive those down, and candidly, we were in one month period I think about two months late in doing the turnover from the valve from the $2.20, maybe two or three months later than we had hoped for.

And that was costing us somewhere around, that we were producing 10,000-12,000 a month, $25,000-$30,000 a month on that one part. That was $75,000-$80,000 on that one part for the quarter. Now that's pretty substantial cost. So that's just the cost of the (inaudible).

Did we anticipate all those? No.

Okay. And my last question is with going forward with your growth rate on the top line, is it reasonable to say with the new product introductions you guys can stay in the 10% area going on?

No question.

Okay, good.

We're 11% this year with really no new products and just the Richmond issue. We were 16% for the quarter above last year. But last year, in fairness, was a slow quarter, we had a whole bunch of, there were issues last year that for whatever reason, we were like $6-$6.5 million higher than the year-ago quarter.

There's absolutely no questions at all that Merit will be well above the 10%-11% range that we'll be at this year. I think we'll end up at 11% costs for the year. But absolutely no question, with all of this other stuff coming out, even on a bigger base, that we'll be substantially higher than that.

And on the bottom line, it still remains (inaudible - phone line connection)?

Well we're going to have the reduction, of course, for the year based on the differential of the $0.04 for the quarter as we pointed out. We'll have some of these ongoing costs that will hopefully be offset by some higher sales costs that we expect in the quarter, but also some of these other things coming online.

So we're going to have some of these costs going to the fourth quarter and then we're going to have to launch the products in December. Some of those costs will be this year. A good portion of those will be in the first quarter of next year. But, as those things start to launch and our business starts to solidify, much like we said before, we're not any different than we said before.

We said before that we thought that the margins would increase in the third quarter of this next year. That hasn't changed. What has changed is that we had higher expenses than we had anticipated and we'll continue to see that.

But if we look down the road 18 months to 2 years and look back at this, it will have been this blip. A couple of years of flat earnings performance and lower gross margins in this blip. In the corporate history, it's going to be a blip.

I know that's not a blip to shareholders. It's certainly not a blip to me or anybody else. But I think, as Kent pointed out, and as I believe, we've made the investments, we're spending the money. And I know the comment was made about, you never saw an expanse you didn't like.

Okay. Thanks.

Yes. But I just want to comment to that. You know, there wasn't something where you have to tell your 20-year-old daughter not to buy everything she likes. We're not buying everything we'd like to do and I don't like to see that perception out there.

Have we made investments in the future of this company? Sure. Could we not have made the investments and have slower growth and higher earnings? Yes.

In the long run, the decisions we made or do I regret buying Richmond? Do I regret hiring the sales force? Do I regret building the facilities and giving capacity or developing any of these products, which will enhance Merit's long-term worth and value? Absolutely not.

There are a couple of things maybe, a person here a person there, probably I wish I hadn't have or I could have held back on. But all in all, I think we've done the things that will add long-term value to this company.

Thank you. Our next question comes from Ross Taylor with CL King. Please go ahead.

Hi. I have two topics I wanted to ask about. Number one, if you could address pricing at all on whether you saw any change in trends on pricing during the quarter?

And second area, is I just wanted to try and figure out the economics of Richmond a little bit more. I think you mentioned a figure of a $1.2 million loss and for that were you referring to all of calendar 2005? And I guess the final question on Richmond would be, you thought you'd get the profitability in the third quarter of 2006 and would that just be at the gross margin level or do you think you'd be profitable after SG&A costs also?

The loss for YTD for Richmond is about $560,000. The loss that we talked about being $1.2 million would be if you were taking annualized stats, $100,000 loss that we had last month. Part of that was because of the hiring of new people and duplication of costs with multiple facilities.

I don't believe that we're going to have that kind of loss going forward, but I was just talking about it to annualize that cost.

In terms of cost pressures, we're always in a marketplace where there always is a lot of competition and where we're seeing pricing issues all the time. We had a lot of issues, guys, in the quarter, candidly as you know across the board in this country, where we had surcharges hit us for transportation. Where we had higher costs than we did maybe last year because we had contracts with national accounts that require that we send that at our cots.

I don't have that number in front of me right now, but I can just tell you that that was another reason that you'd see lower gross margins and higher costs in those areas. So we had some of those particular areas and pricing is always an issue.

And you know what's surprising about this business that we're in, is that we can come out with a particular product that costs us about $1 and people are falling all over themselves to pay us $5 to buy it. I wish we could find everything that we had to do that, and yet you find stuff like that and that's the great contradiction of our business, is our customers will pay for certain products that have their needs and meet their needs, 80% gross margins. And some of the things that are the most complex required, they pay a 23% gross margin.

It's just the complexity of the business and it of course all revolves around the mix and the strategy and it changes because of our competition. So cost issues are always out there. We don't have a lot of pricing power and yet, I'm holding this product in my hand that sells for $5 and it cost me $0.97 to make.

Let me answer that a little bit, too. I spent the time to go through really all of our product lines through September and look at the ASPs and the trends of those. They're not down very much as a general rule. They're generally pretty flat. There's some slight, I would guess, 1%-2% over the year, I've seen the decline in pricing.

If I go through all of these, like 40 products that I reviewed. So, there's some pressure there. We see it in kips in some places, but we keep adding to the kips. We make them bigger so the price tends to go up because there's more in them. So it's hidden somewhat, that way.

But the general statement on my review is that it didn't drop much. It was pretty stable.

Another factor that's in here. I spent a couple of hours today with our new production manager who came to us from Ballard Medical, Kimberly-Clark. And the other thing that's not weighed here is the inefficiency that we've faced almost all year long because of hitting up against the wall of capacity.

And that's another thing that is hard to measure, but the reality is that there's no question that that's been a factor. We've been fighting that now for 18 months.

Now, we have the new facilities. We have a new lunch room. We have a place where people can sit down and have lunch. They were sitting on the floor and in corners and in small, make-shift rooms for the last 60 days as we're finishing off our new cafeteria.

I think we're going to see increases in productivity. I think we're going to have more productivity now that we have the space and the investment that we've made. I think we've been hitting that for quite some time. We know it's limited our ability to sell product.

In many cases, we were telling some of our salespeople, and our OEM and other people, not to accept the business because we couldn't make it. I think those particulars, capacities and efficiencies will increase as we now utilize and bring these new facilities online.

And then just on Richmond, to follow-up. You mentioned you thought you'd probably be at a profitability in the third quarter next year and there were you referring just gross profit, or would that be after SG&S expenses associated with that facility, too?

I think that goal is that it would be profitable as a stand-alone unit, it would be profitable on its own. All those expenses incurred.

Okay. Alright, good. Thanks.

Okay, our next question comes from Paul Solencia (ph) with Vanguard (ph) Securities Group. Please go ahead.

Yes, thank you. Fred, in your last conference call, I believe it was in April. You talked about a company in Utah that was looking, I guess they were going to be going out of business, could you comment on that?

Also, I think you had a goal at that point in time to accomplish 5 million trades for the year, at least that's what I had in my notes here. Could you comment on that as to whether or not you expect to meet that goal?

And also, I was wondering, as an original equipment manufacturer for other medical device companies, how is that business going as well?

Let me go back to the issues. We had talked about Kimberly-Clark, formerly known as Ballard Medical, and at the time an announcement that Abbott Medical, which was bought by ICU, would be shutting down their facilities and moving to Mexico.

One of the other things that occurred is, there was a lot of talent at these companies. One that we hired that we felt was essential was our new production manager, who came from Kimberly-Clark. That might not have been available had we waited or we might have gone out of state. So as those facilities and those announcements were made, there were some very, very good people that became available and when we saw some slots, or some opportunities that we'd have to hire, we hired those people.

And again, going back to the comment about doing everything and buying everything, there are some times when you're sitting at the control panel and something pops up and it's not what you planned, but it's a good opportunity.

In the case of that situation, we hired a number of engineers that came from Kimberly-Clark and Abbott, that are helping in the R&D. Part of that is that increased R&D expense. Those engineers came from those companies. They may not have been available if we had waited another three, or four, or five months.

On the issue, the second part of it Kent?

The OEM sales.

Oh. OEM sales continue to be strong. We had a little bit of disruption because of one of the employees, but there's been a lot of chatter that somehow that that business is not a good business or that it's not going to be successful now that Brian has left and all that kind of stuff. And that's just nonsense.

I signed some new business requests today at good margins. Merit continues to be respected as a quality OEM. We're going to do almost $30 million. We're $25 million this year and we think that particular segment next year is going to grow better than 20% and above our overall average. So it will actually add to the overall growth percentage of the company, because it will grow us a segment higher than the other areas.

The other part of the question I think he asked was about Richmond. And we had talked about a $4-$5 million number early in the year that we expected to get for that. We're on pace to make at least the $4 million number. I don't know, the $5 million's a little high for us at this point.

And there's been more of a lag in converting those accounts over and shipping out that inventory than we expected. Instead of the two to three month lag, we're seeing four and five month lags.

In some of those cases it's a good point, Kent. I give the one large institution, maybe the largest one in Massachusetts, that signed a contract and it took us almost four months before we delivered the first tray and yet we dolt it, we had the inventory and it sat in inventory. Because the previous vendor had to move all their stuff out and it went a little bit longer than we thought it would. We thought we'd get that revenue.

The bottom line is we have the account, but it took them a little bit longer to do the conversion.

Just a follow-up, you had mentioned on your last conference call also that one of the positive things that Merit Medical has going for it is the introduction to a lot of the more, (inaudible) hospitals across the board nationwide. The new product lines that are going to be coming out, is it going to be that easy to infiltrate, to be able to penetrate that market out there, with that kind of introductional rate that you guys have?

Let me go to the issue of all of the accounts. We essentially have a contract or a negotiating contracts with almost all of the buying groups and hospital groups in the company. There's another one right now that we're selling to, but we hadn't had a contract to, and we're getting very close to finalizing that deal. And that will give us more access.

With Merit's innovation, it's hard to keep Merit out of the hospital because the physicians ask for Merit products. Our products are for advance centers of interventional cardiology and radiology. I do not anticipate that we will have any difficulty with these new produces. They are essentially the same points of sale that we've already been calling on, but now with advanced and broader product offerings.

We have people, like I said, on this one little new device we just introduced, we've sold 1,000 of them and the product's not even on the shelf ready to sell until next week.

So I don't think the problem is Merit's access to the accounts or anything like that. If anything, I think what happens is the new products and the broader range of products, calling on the same point will help to pull other products along with it.

Thank you.

(Operator Instructions).

Ladies and gentlemen at this time we appear to have no additional questions in the cue. If you would like to make any further comments at this time, please do so at this time.

We appreciate -- I know this is a frustrating situation, I can assure you that everybody in this room has a very sober face. We understand the task and the credibility that we have to rebuild. I am disappointed in this quarter.

However, I am convinced of our strategy, our products, the capacity we have, the sales force we have, the people that we have operating the business, the enthusiasm that's in this room, and the changes that we've made over the last 12 months in terms of new product introduction, selection of those products, TAI, our molding and other areas -- I believe that we have the right groups, the right people, the right products, and the right market.

While other companies were only showing 2% increases for the quarter, Merit showed a 16% increase in the quarter. And I pointed that out to my staff, that some of the larger players that are involved in coated stents and that thing, were essentially flat.

So I believe that you are going to see we'll work through these issues. That business is fundamentally sound. We have no debt. Everything is paid for. We have cash. We have energy. We have idea. And I believe we're in the right market, with the right products, at the right time.

We'll work through the issues. We'll continue to report to you. We will announce to you new product introductions. We're working on several acquisitions and other opportunities that we will think will enhance the business. Also some distribution agreements.

We continue to work on those things, but we have the people in place to sell the products. We have the leadership in place, and I believe the innovation and the energy.

I am dismayed at the quarter. However, we're up to the task. It's a good business. We've made the investments for the future and we're not going to go away. Yes, we stubbed our toe, but I think we understand where we are. I'm enthusiastic about the business. I won't pack off about our strategy, not out of pride. Not out of just trying to defend, but in order to say that I believe the new products, the people, the energy, the strategy is here and in place.

And we've made the investments. Essentially the things that we've talked to you about, although some of them are going to come in the future, in terms of product introduction, those things, are things that we think we should invest in and we'll continue to invest in. And you'll see this company grow at levels both in dollars and in market share and we'll have our competition on the run.

So it's a short-term setback, but the bottom line is that I believe that Merit's strategy is sound. We'll manage it. We'll eliminate the unnecessary expenses. We won't spend the money in every place. It's a wake-up call for all of us in this room and we will deliver the returns and we will regain the confidence of our shareholders. And we'll bring new shareholders in.

We hope our existing shareholders will stay with us. We understand that there are various pressures of Wall Street returns. But this is a sound financial company with a good business plan and the risk spread over many, many, many product lines.

So that's how we all feel. There's not anybody in this room that feels any different from that. There may be some of you that do, and yet I sense that you're on this phone call because you want to believe that we really do have the enthusiasm and the energy and the vision and we do.

So we'll look forward in future months to deliver results to you, to talk to you about these increases and the introductions of the new products. And we will report them as we release them.

We appreciate you being on the line today. I appreciate the staff being here and we wish you our very best and we'll look forward to talking to you in the near future.

We'll sign off now from South Jordan, Utah and wish you the very best, particularly as we approach the holiday season.

Thanks, everyone. And goodnight.