Merit Medical Systems Inc (MMSI) 2005 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the Merit Medical Systems fourth quarter and year-end earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Mr. Fred Lampropoulos, Chief Executive Officer of Merit Medical. Please go ahead sir.

Thank you and good afternoon, ladies and gentlemen. Fred Lampropoulos here. As you can see from our release, our fourth quarter revenues were 42.7 million, a 9% increase over the previous year. And earnings for the fourth quarter were $3.7 million. Now that was down from 4.3 million a year ago. A couple of things that you need to be aware of. I have discussed this, we're talking about this, of course, publicly. We talk about in the text of this, the start up of new facilities.

One of the cost items is approximately $200,000 a month or about $2.4 million per year for increased depreciation and amortization because of our new facilities, new injection molding equipment and the associated equipment that goes with all of this. We also talked about the increased cost of direct labor. Like most labor markets, we have to be competitive and Salt Lake has one of the lowest or highest cost and lowest unemployment levels in the country, so we, of course, have to deal with that.

We're launching new products and I'm going to spend a few minutes about that in just a minute and talk about that. We also had a 1.3% reduction in gross margins because of the trade business in Richmond. And we had a choice of taking the expense which is for SFAS No. 151, its inventory cost. And we decided we would take it and put it into last year -- that was about a 1.1% reduction as well. Now what it will affect going forward is we'll actually have an increase in gross profits, but we felt it would be appropriate to take it. We had to take it either in the previous year or take it in the first quarter. So we decided we would just get it over with -- again, a requirement under accounting law.

We also, as you all know, have hired the new sales people and we've increased our research and development. Now, all of that sounds like, I don't want to say bad news, but it sounds like we spent money and as you all know, we have been investing in the future, in facilities, in new products, in capability and this is just a part of that. We will continue to see these expenses as we have discussed previously, as we move into next year until we start to absorb these expenses. One of the things that I'll discuss in a minute is -- that you'll see some of the reductions in some of - I'm going to call them the old line products for lack of a better word, legacy products, because of some of the maturation of that market and I think an increased interest in our sales force in new products, and I'll discuss that in a minute.

As we've previously discussed, we came in at the low end of our range. We came in at 166.6 and it was a 10% increase. And to be very candid with you, I'm not happy, I'm glad that the year is over. But I think it also spells out that the actions that we've taken to develop new products, to put the sales force in place and do all the things that we've done, were things that were timely and needed to be done clearly, and we're going to continue to do that and introduce a whole slew of new products, which I'll review in just a moment.

For the year, we had net income of $15.8 million or $0.57 a share. And all of you can, of course, follow that. I do want to point out again a 1.4% decline in gross margins because of the Richmond facility. Now, on the Richmond facility, good news, and that is, it is now producing, going into this year, positive gross margins, and - a little quicker than we actually thought it would. So as we go forward, it's not going to be as big a drag. It still has a long ways to go before it's performing at the level we'd like to but it is -- business is turning up. They're hitting record sales almost every month. And yet we're actually trying to - we're not encouraging those sales, it was a strategic issue, because we have these other sales and new products that we want to have that have higher gross margins for them.

Now, as I mentioned, all the products in the year increased in 2005. Catheters rose 17% and we will continue to see an increase in catheter sales as we introduce a slew of new products. In the fourth quarter, catheter sales rose 27%. For the year, it was up around 17%. With the introduction of the new stiffen dilator micropuncture kit which has just been released this last week and it is a product, a continuation, a broadening of that particular product line. That will add to the product group, which was the fastest growing last year in our catheter sales.

This week, after a long and painful experience we are going to -- excuse me -- next week put the resolved drainage catheter in human beings and go out and do what we call our market preference. We'll look at that for probably two or three weeks and then we'll ready to roll. And that's a significant factor, it's one that we have been waiting for a long time and we're very excited about the opportunities that that will meet.

The stand-alone devices increased 10%. Custom kits were six for the year and inflation devices were five. And as we point out the sales of procedure trays were only 2.4% of total sales. Now you'll notice that the areas historically that we have worked on, custom kits, has slowed and inflation devices, a part of that has to do with the decrease of restenosis and inflation devices would participate because that on the downside in terms of lower growth.

I do believe, however, that as we introduce these new products and have a broader that we'll probably see these products in a more mature -- actually probably click up a little bit because there'll be an across the board, I think, more interest in Merit's products. But what you will see is in the standalone and the catheter sales and some of these areas, those of the areas where you're going to see.

Now, one of the other things that we are going to do and Kent and I are going to be working on this for analyst purposes. And that is that we're going to probably at some point in time take a look and re-categorize these products so that some of the newer products can be better analyzed and we can point them out. So we're probably going to do some reconfiguration of the four or five categories, so that it better spells out some products that get stuck into some of these areas that we think are going to be quite exciting. So we're going to do that.

Now we put a plan together. We put a plan together, 18 months or two years ago, we looked at our business, we had a capacity problem, our sales were stagnant, our research and development was not producing products at the pace that was necessary to compete and there were some opportunities on the acquisition side. We had put a plan in place, we've discussed that plan. We've asked that you continue to be patient with us as we now roll these out and start a new era.

And I think that's a significant thing for all of us to understand, that we really are at a new era in our company. We are putting out new products at just record paces. We have so many ideas and so many opportunities that - and the guys in the R&D labs and in operations, and they're all in the room, of course, and I don't want - they're not always living up to my expectations, but I can tell you that we're doing much, much better than we were doing two years ago, or even a year ago, but there's still more improvement that we can make.

Now for the year, again, you saw that gross margins were down. This is not anything new. I do want to point out that in the fourth quarter, we had 38.8% and we had 1.1%, which is attributed to the accounting adjustment, so that we moved it up to just about 40%. Sales and administrative expenses, I think they speak for themselves. You can see that research and development expenses were up around 4.5% in the quarter and in the year, and that's about a 35% increase over the previous year.

So we've added the headcount in R&D, I think they're doing as good a job as I've seen them do for years. The sales force is now trained. We told you that it would take six to nine months. We started hiring people last summer, about mid-year, and those nine months are about up. And we're excited about the future of the company.

So right now it may appear to be dark and I'm apologizing for a company that makes money that is a great company, but at the same time, we all believe and I believe and you believe that we can perform better. And now what we have to do is to absorb this overhead, continue to introduce these new products, and as we do that, we're going to see, I think, a substantial increase in our capabilities as a company.

It's not to come overnight. And I want to make sure that that everybody understands that we're talking about two or three quarters where we're going to be making progress before we start to see more cash being generated, more earnings, it could even be a year. But what I'm saying is, we're going to that process, I hope it won't be that long, but the reality is, we're doing the right things and you'll see, I think, progress in terms of the sales side and then as those costs come down, and we get more efficient in producing the newer products, then we'll see those profits start to come into effect. All of those profits -- all of those products have higher gross margins than our overall business, substantially. And we think that over time, of course, that will contribute to our overall business.

Now, one thing that we did say today and we hoped we wouldn't have to do this and that is that we're going to have to delay our guidance. Let me tell you why. As we speak to you, I am calling you from Europe. I had not planned to come here. I've been here almost, now 13 to 14 days over the last 30, working on a number of issues and opportunities that will help enhance our business. And I can't go into any more detail than just to tell you that we are here for a reason. I've had my staff here, part of them are here and part of them home now and we're working on a number of situations that we think will add tremendous capabilities to the company.

The MCTec acquisition I think has met our expectations. There's still, of course, a long ways to go and great opportunity there. I can tell you that in the month of January they were already profitable. We expected them to be and we expect that they'll be a – when I say a substantial contributor -- they will probably bring to the bottomline somewhere between $500,000 and $700,000 net after taxes this year. So it's going along well and what we are doing there is, we are tying it together with other opportunities, new customers and we believe that's going to be a significant opportunity and acquisition which I think we bought at a great price. And if you do the math, of course, you can see just the return on the net investment is substantial and we're excited about that.

We have some other new products that we've not talked -- I've alluded to them a little bit, some of them are product line extensions. One is, I mentioned the S-MAK, which is the stiffened micro access kit. It has a patent on it. We received our first orders today. We are excited about that. I'm calling you and have just flown in from -- where I was today -- I was in Copenhagen and I'm in London now and we received an annual order for over $100,000 on a new product line extension here in London today. So the sales force is out there working. We have a number of new national account agreements that expand existing agreements. We have the new products, we have the sales force, we have the facilities, we're loaded up and I'm excited about the opportunity that we have to -- to do this. You know what Rashelle? I forgot to let you do your introduction, didn't I.

That's okay. We can do that toward the end.

Okay. I forgot, I got so excited about talking and it's very late over here. And again, I had not anticipated being in Europe, but I forgot to let you do that. I apologize. If we were in the room, I would have known because you would have let me know. But anyway, I think that's pretty well what I need to cover. We hope that in the next couple of weeks, probably closer to three weeks, we'll have the new budgets in. We'll have some other opportunities that we can give you a clearer picture. We were concerned -- we don't want to be guessing and there's a number of things that we felt it would be prudent to wait until we could put all of these things together and make sure that we present the appropriate picture. Kent, would you like to comment.

No, I just want to say that even though right now we've loaded up our financial statements with a lot of overhead and expenses and really it's mostly in capacity increases. And so, now we are staged for, I think, for most of three to four years of not having to add a lot of overheads. And so we can go through cycles as we had -- did several years ago of becoming more efficient. And I'm seeing a lot of evidence of it beginning here, of trying to utilize those resources better.

Even though our cash balance has diminished to just under 5 million by year-end, it's starting to grow now and we're starting to build some cash values and cash flows. So I think the long-term future looks good. The products that we have coming out are pretty exciting. One that you didn't mentioned Fred was the Impress and it's one that I think the market is already accepting very well in the initial work we've done in the field and it's ready to go now. I think it's pretty impressive, if you will.

Yes. Well, and let me just briefly touch on that. We've gone out and trialed the product. We have sales people out there now trialing and we are building the initial inventories which will release about the 23rd of March. I can tell you that I've had physicians tell me that they were able to get into vessels and they were doing cases in which they have said that they could not have done it with other catheters on the market. That's an extraordinary endorsement to hear from physicians who -- this is their business is doing the real tough stuff. And when you have someone say that to you that they could not have done it with our competitors' products that is very exciting. And we've always said that this was a sleeper. So let me review some of the products.

The Impress catheter, it's a line of radiology catheters. The Revolution, like I said, will start rolling out here pretty quickly. We will make an announcement when it actually is for sale and we're maybe two or three weeks away from that. The Multipack +, this is where we're able to combine cardiology catheters and introduce receipts and a guide wire. And incidentally, Merit is the only company that I am aware of that produces all of those products on their own. Some of our competitors have to source that from outside. We have the capability of doing all of that and it's an extraordinary opportunity. The Revolution, the Honor hemostasis value, which we hope to be able to report to you in just a few more days as we finalize the agreement that I'd talked about, which is part of the reason why I'm here in Europe.

New safety products, the new safety needle. I could just go on and on and on about all the products. So --

Fred, do you want to mention the PAL?

Yes, the PAL, that's the one with the labels. People make fun of us. We're going to do a couple of million dollars worth of that product this year at 65%. This is a product we didn't even know about just two months ago. So we're going to ask you to be patient with us just for a little while longer. And we believe that you're going to see the growth increase substantially from where it is today, profitability and cash increase and really a new era for Merit.

And what I'm starting to work on is the kind of ideas, new products, which will take over from here three and four and five years from now and the technologies associated with those needs. And so we'll get this stuff done. But we're already thinking about the future and we're looking towards that -- those magic numbers of 0.5 billion in revenues down the road five, six, seven years from now. And we're also seeing more acquisition opportunities knocking on our door than we have probably for the last two or three years. So there's a lot of opportunities out there, but we want to buy the kinds of companies like MCTec that can contribute immediately and also start to build a long-term technology base that differentiates Merit. So I think that's pretty well it.

Rashelle, do you want to say anything now, since I've already kind of spilled the beans.

Well, I think now it will an appropriate time to read our forward-looking statement disclaimer. In the course of our discussion today, reference may have been 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 in such statements.

Many 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 Securities and Exchange Commission, which are also available on our website. To the extent any forward-looking statements are made in this call, such statements are made only as of today's date and we do not assume any obligations to have update any such statements.

Rashelle, well done. It sounds like you almost had it right in front you. Well, let's go ahead now and turn the time over for questions, and I will go ahead and direct Kent or Lee or others in the room to answer those to the best of their ability or myself.

[OPERATOR INSTRUCTIONS] Our first question is from Matt Duncan with Stephens Incorporated.

Hi, Matt. How are you?

I'm fine. Good afternoon, Fred. Good afternoon, Kent. Quick question here, on the gross margin. Kent, would it be possible for you to quantify just how much the impact was from the new facilities and equipment, and then also from the new product launches on gross margin in the quarter?

Not separately. I mean, there's a lot of factors. We were looking at - I was adding those up by the way, and I don't have that right in front of me. But there's a lot of that -- when you add a facility, you not only have the amortization and depreciation, which are non-cash expenses, but you have higher utilities, you have higher maintenance costs, you have an increased property tax, you have the utilities of various natures, and you also have the maintenance and cleaning of it. So when you combine all those, they were, as I recall, somewhere in the $750,000 range for the quarter. And I can get back to you on that shortly.

And that's an addition to the depreciation Kent, right?

Yes.

So you will be talking about probably, if you take 750 and put that on top of the additional 200,000 a month, it's just short of $1.4 million.

Okay. That's helpful.

Just based on that that analysis there.

Sure.

Another thing that Kent didn't cover, of course, in the R&D area this isn't in the margin, this is below the line, but, again, it's that increase in research and development that I mentioned.

Sure. And then, Kent, as I look to the first quarter then on the gross margin, it sounds like the accounting change cost you 110 basis points in this quarter.

Yes.

So that should get added back in the first quarter, correct? So --

Right. It's a one-time shift where we're moving some costs that were in the standard cost to a direct expense for the month.

Okay.

And it will continue that way, so it will sort of level itself then beyond.

Okay. And then Fred mentioned that in Richmond, you're now positive on the gross margin line, so I assume it would be reasonable to see your gross margin back above 40% again -- in that 40% range here in the first quarter then.

No, I wouldn't assume that. I wanted to stay in a more conservative range. We do have the inventory management issues and volumes we want to be aware of. We've also got the rest of the overheads that have to do with people, increased salaries, some of the other things we mentioned there. So it's not going to turn real quickly and we told you -- we've been saying that for sometime that the first few -- first quarter in particular, but even the second quarter is not going to turn too quickly.

Right. Yes, I knew the expectation was second half, is when you should really start to see it recover. I guess, I'm just referring more to that 1.1% accounting hit that you took. So that won't all be added back right away.

No. There are other factors that are weighting in there that I just mentioned that will kind of offset that coming back to us on the 1.1%.

Okay.

Yes, Matt, another thing too -- and we've seen this historically in our business, the first quarter for us always has the increases in insurance and all those sorts of things and we do start to see an improvement as we then produce as a percentage of sales more. So this is kind of a historic thing, I think, maybe for most businesses where you have all of those new expenses -- new health insurance, new this and new that and it takes you several months until you start to absorb that out. So -- and that's been pretty historic with us.

Sure. And then last question on the gross margin then. If we look throughout the year and I know you're still in your budgeting process, but how much do you think you can get that gross margin up throughout the year and what would a reasonable expectation before you [you might be able to exit the year].

Matt, I hate to do this to you, but I'll tell you exactly what we think that's going to be in three weeks. Here's why, and I'm not trying to avoid the question but we'd be speculating. And what we want to do, there are some factors for instance even on MCTec where we bought it so well that we even have to take some amortization hits on customer [lists and] that because we bought it so well. It's really an interesting thing. I've never seen this happen before but even some of those things. We want to factor all of those things in in the cost of launching these products.

I think where we got off track last year was for instance in the cost of introducing the introducer fees and some of those start up costs and some of those issues relative to the higher valve cost. So we're essentially operating at a loss in those areas and then we hade the samples on top of that.

With as many products as we're launching and we're trying to be very diplomatic about this where -- I'm watching the samples, I personally am talking to marketing and sales saying make sure we keep an eye on these samples. I'm just saying we want to be careful that we don't stumble and then turn around and have to explain it. I would rather understand it. And again, part of the reason why we're not giving the whole thing now, is we had not anticipated on being gone for two or three weeks this year as we were working on both an acquisition that we had to bring online and then several other opportunities which have pulled us all away and many members of my staff have been gone. So I'm just going to ask you to wait for us for -- until we get all that, and then we'll answer you directly.

Okay.

I just -- I have to do that so we don't speculate now.

Sure. And then last question here on your sales force. How many quota carrying sales people do you have now, and then what are your plans for additions in 2006?

Okay. We have 72 people in the sales force. Out of that we have a couple of technicians and clinical people as well. So we have about 70 full-time people in the United States, all with quotas. And I should mention some other things that Marty Stephens has done, and that is that we're also aligning and incenting this sales force to -- there's certain things they have to do if they want to get certain rewards. And it's not just go out and sell all you can in -- somewhat lowers margin. There are certain products, there are certain strategies, and I think we are doing a better job of that now than we ever have.

So there's 70 there and there's 18 in Europe. I would say, overall, that on the high side, we could probably add maybe as many as five. Now I previously had said we were going to kind of hold it tight here. Let me tell you where some of those would come. We're finding that the clinical specialists are really a tremendous asset to the sales force where they can go in, follow the sales presentation and the initial sampling, and go into the hospital and do the in-service which frees the sales person up. So we're going to look at maybe adding a couple more of those, and we could add one or two more people in Europe. So we're going to be pretty minimal this year.

But I'm not going to say we're not going to add a few. But we're not going to add 20 and we're not going to add 10. Unless the sales start to accelerate, or we can't -- we just can't get to all the places that want to buy our products. We will talk to you in advance should we decide to do that. But I would say right now probably four or five could be in this number this year of which probably half of those would be clinical support people to help the sales force.

Okay. Thanks.

Thank you. Our next question is from David Turkaly with WR Hambrecht & Company.

Great. Thanks a lot. Hey I know you're not ready to do anything for 2006, but just broad stroke -- I mean 10% to 12% is that -- do you think on the revenue growth kind of line -- is that still kind of reasonable or can you even comment at all briefly just on what you think --

Well, we did 166. And if we were going to do 10% that would be what, 16 or 17 million, which would put you at, what, 183. If you add a couple of more -- 200 more basis points for that you would be at another $3 million or $4 million. I don't think we're going to have any problem. I think that our range will be within that. I would be -- I mean everything I've said today if we weren't able to do that would be misdirected.

Now hopefully there will be more on the upside, but we're not going to -- even if there is, I should say right now for the group, even if there is and we have those great expectations, we're not going to -- we are going to stick pretty close to what we absolutely know we can do, and you guys all know the same. But we're excited about this business, but I believe that we're going to -- if it's possible I have a hard time doing this, we're going to kind of low key it. I'm excited about our business you guys, I'm very excited about it. But I don't think we'll have any problem reaching the level that you just talked about.

Excellent. And then, in terms of just taxes going forward, what rates should we be thinking about because it looked like in this quarter it was a little bit --

Yes. This was a weird quarter because we restated some stuff that we were going to move over to Ireland, we've been accounted for, and we pulled it back and it gave us a lower tax rate. But I think, Kent, we were talking about probably the effective tax rate about 36%.

Yes, 36, maybe 35.5. But 36 is probably what I'd model.

All right. Great. Thanks a lot.

Thanks.

Thank you. Our next question is from Arnie Kaufman with Brean Murray.

Hi. Thank you. Good afternoon. Fred, I was just wondering if you can give us any idea on sort of an average or what we can expect on some of those new products that you were talking about launching regarding the gross margins on those products that will be coming out?

Sure. Well, Arnie -- and first of all, let me just again thank you again for inviting us back to your conference. It was a great conference and we enjoyed being in New York with you. So thanks again.

Oh, thanks for saying that.

I've been also to Roth & Company, we just finished being down there just last week. So in between all these trips, we've also attended a couple of these great conferences. And let me thank both you and Roth for those conferences.

We believe that when we reach our target cost - which are within a reasonable period of time and I'm talking about probably 12 months and that's because all these products generally are going to be about 60% or better. Now, of course, as we start up, you're going to have the higher labor cost, the higher material cost. But I believe that within about 12 months on most of these -- now there are going to be some others like, for instance, our catheter line, our Impress Catheters, the market just will not afford a 50% margin.

Although the kind of responses, if we can do what physicians are telling me, then we'll get more volume even though it's at -- maybe at market prices, and we'll get more positive variances. And that's why you're going to see tremendous amount of growth down in the Angleton area. So to answer your question, our goal is within 12 months on the resolve, on the PAL, which is already out on the Revolution, on the Honor hemostasis [files], all of those are -- which one Kent?

Mac will be higher.

Yes, the Mac is about 65%. All of those products are all in that 65% gross margin range. And some - there's a couple that are not, but the bulk of them are on in that level which is going to spell -- if we're right, we're going to be really right. But I don't think we're wrong. So --

Good. Thanks. One other question, I know you can't give much detail, but I was wondering regarding the acquisitions you'd mentioned. Is there any areas that you sort of focused in, that you would prefer that you're actually looking into?

Yes, Arnie, we again continue to take a look at base technologies which allow us to have advantages over the competition. One of the things that's come out of the MCTec deal is that there are some things that we can do and they can do that nobody else can do when we combine them together. And that's the kind of acquisition that makes money and adds a base technology that will have a relatively long life, either through patents or know-how is a pretty significant issue.

So we continue to look at catheter-based type things and products that complement, you know, interventional cardiology and radiology. So that may sound a little broad. We look at a lot of things. I turned one down this week that just didn't fit. I looked at one last week, but we're concentrating on things that we think can have an immediate impact and are complementary to our sales point.

Thanks a lot guys.

Thanks, Arnie.

Thank you. Our net question is from Matthew Scalo with Canaccord Adams.

Hi, guys.

Hi, Mathew. How are you?

Good. The second Matt here. I just had a couple of quick questions in regards to maybe some of the previously newly introduced products such as the Prelude if we can talk a little bit. You gave us some details, I know at the end of '05 in regards to number of accounts -- it's penetrated as of right now. Can you give us some comparison of how that one product per se or any other material product has progressed into 2006 as far as --

Yes. I would be less than candid if I said that we've gotten all that we can out of that particular product. I had indicated in my previous calls that over time I believe that this product is going to add $25 to $50 million in revenues to the company. What I can tell you is this. At the end of this quarter we are introducing a four French model. That's significant because what's happening in a lot of accounts is we haven't had a full line to compete with our competitors.

We also are going to introduce this quarter [Optrada] version. This is for patients that have to stay in overnight. In the second quarter of this year, we are going to introduce radial artery products, and we are going to add also 23-centimeter in micro-band. So there is a whole broadening out of this product line. And it's going to be necessary for us to complete these products, complete them on time to be able to go out and get the kind of numbers we've talked about in the past.

The good news is that almost all of the or a good portion of all of these things will be introduced this year, which are in addition to everything else that we've talked about. So I guess the best way to put it is I don't want to say I'm disappointed because I'm not, but I'll be glad when we have the full line. It's difficult to go out and compete with somebody that has a full line, and the choice we made was to go to the market and -- with what we had.

Now I was talking about this account in London. Having the Introducer fees, having our own Guide Wires, and having the Multipack with the three catheters that are used to do a basic angiogram, are ways that we can take this product and leverage our catheters and our other products. So we'll be doing that as well. So I think, again, to summarize, it hasn't been all that I had thought it would be. Will it be? And the answer is absolutely yes. But we need to broaden this out. And we're only four, five, six months away from having these other additional issues that allows Merit to walk in and have a full arsenal of products.

I will tell you this. There's absolutely no question in my mind that Merit's product has the easiest entry into a vessel and is superior in terms of entry of anybody else's product. There's absolutely no question about that. And I would put that up against any of the competitors in this particular market. We clearly have the best insertion product in the market place in the world. To that there's no doubt.

Okay, Fred. So if 25 million is, say, let's just say, a longer term target for Prelude, what could we expect in 2006, I guess, rough numbers?

I'm going to wait until we go through that full forecast, because one of the things that - that is not in there that we haven't put together, I want to talk about this, is this Multipack+ kit. We're talking about a pretty substantial amount of Introducer fees that will go along with. It's a special packaging system in which you include those -- I don't want to call it a kit, because it's not, but they're added on. And that's pretty significant, and I want to make sure that I have the numbers, and I'm over here, and I don't have those numbers in front of me. So again, I do not want to speculate on that.

Okay. Fair enough. Thank you.

You bet.

As far as, just the Richmond facility, are we still looking at profitability in the third quarter of '06?

Kent, do you want to go ahead and discuss that just for a minute, and then I'll jump in.

Well, I would like to defer again the rest of time on that question, because its one of very issues that we are reformulating a little bit. And so I'm not comfortable in speculating on it separately right now at that time because it's not complete.

Okay.

But, we in January as we have said, we are seeing positive gross margins and we'll continue to work on that and then we'll report that. Because that's one of things that's been dragging us. And yet as a strategy, if you talk to our sales force and I think it's been something that has helped to protect some of our other products. But we still think it's sound but it will all be the proof is in the pudding. It has to be profitable or all this is just rhetoric.

Right. And it does sound like there's a little bit of a balancing act in regards to gross margins and focus on these new higher gross margin products?

Yes. There's no question. Let me give you an example, I alluded to it, but we have a situation where we invite certain people to what we call the President's Club. And it's not just about gross sales, it's about profitability of those sales and about hitting the things that align the interest of our sales force with the interest of our shareholders. And I think that's probably the biggest change that we've made this year is that we have really concentrated on getting the performance in the areas that we wanted and we're starting to see that already.

In fact, the sales people, in a recent national sales meeting we had, alluded to the fact that they appreciated having more knowledge about the sales and how they affected the overall company. And why we were talking about -- and why we were incenting these various areas. So I think Marty Stephens has done a tremendous job of doing that.

Okay. Thanks guys. And then, I guess, just one last question. As far as the OEM business is concerned. Can we kind of expect that 15 to 20% historical growth, if you will, going (multiple speakers)?

Yes you can.

Okay. Thank you very much, Fred.

Thank you. Our next question is from Gregory Macosko with Lord Abbett.

Yes. Thank you. Hi, Fred.

Hi, Greg. How are you?

Fine. Just wanted to check on what you said about the area of standalone, you said, plus 10%, was that 7% like was printed in the release, I thought, you said 10, but was it 7 in the quarter?

Well, no. It was -- let me just go back here.

9% for the year.

For the quarter, stand-alone was 7 -- let's see, stand-alone devices were 7 for the quarter. And then for the year, they were 9.

Right. Plus 7% for the quarter and 9% for the year.

Yes. That's correct.

Okay. No difference in that they slowed in the quarter? No issue there?

No. No. Again, one of the things that we want to do is, we want to make sure that some of these newer products and so we're going through and taking a look at how can we better report this. It might be that we just break out the new products that we've talked about and just give those as the sales number as a percentage. We just want to make sure that -- and I think one of the best ways to take a look at all this, is to make sure that we can really track this stuff. This is what we are investing in. And we think that you ought to be able to have some visibility into that.

And then the custom kits, it was down 3% versus up 6 for the year. Was there anything there that made them fall off for the quarter?

No. When I looked at this, one of the things that that does happen -- and is that those custom kits, that have been sitting as a group before, move over into packs. And so some of it moves from one area over to another area, simply because we take it and we bundle it now, and it gets credit over in the other area. That's part of it.

And then, of course, in the year a lot of times what we see is that in the fourth quarter or the third quarter, people start anticipating that we're going to be shut down -- we shut down for a week, during Christmas. And you see some of that roll up into the third quarter so they have all their supply. So, I think most of it is -- has just been, kind of, we are moving from custom kits over to packs. Kent, you want to comment on that?

Yes. There has been some of that. We used to ship a product, say, directly to hospitals as a [K-09] or we'd ship it to another packers as a pack kit and it would still get invoiced as a kit in that category. Now, a little bit invisible because as we transfer it internally between Salt Lake and Richmond, there's no invoice created and there's no value given to kits. Rather it becomes part of, or say, half of the price of a new tray and the tray revenue gets it.

So that tray revenue is increased from -- well a year ago it was just somewhat less than [0.007%], now it's 3.5 for the quarter. So as that increases and accelerates some of that's pulling kits and that's what Fred was talking about. It's pulling some kit revenue down. I don't know if that explains all of it but it's certainly part of it. It's a little bit hard to identify, because we just have a transfer of materials and it isn't the full amount of that, but it is much of it.

And so, the restenosis thing you talked about, how long will that last? And does that hits the kit area that?

No. No that hit inflation devices, I mean, clearly --

I'm sorry.

And this is in talking to physicians, both members of our Board and other physicians, the whole sales point of a coated stent is that it reduces restenosis from what used to be as high as 30% down into the 1 to 3% range. And so, just by definition, if you had the same population and they're not going to go back in to have a procedure done again, they're going to see that slowdown.

And I think that's what we have seen. And again, for us the good thing is that we have taken our business and over several years, Greg, we've taken and diversified out of, not out of, but we've focused also on interventional radiology rather than just banking on cardiology. I think that was a wise thing to do and I think we'll start to see. That's another thing that we'll do maybe going forward and see if we can try to somehow put some numb -- we're going to try and do some things that will give you a better picture of the business and the investments we've made.

But the restenosis, the benefit you had, you had it for, what, a few quarters in '05 then kind of?

Now, it's not a benefit. I'm not understanding your question. Let me go back and restate what I said. In essence what we're saying is that we've seen inflation devices and not -- pretty well flatten out, I mean, we've seen the 5% growth there.

And for the year, I think it was up, let's just see here, it was up 5% for the year and for the quarter it was up 5. So it was about 5% across the board and that's just simply that there's, again, not as many patients going in to have these procedures done that have to go back. They're not having to go back, remember you can almost take a third of those patients and within six months they were back in the hospital. So they're not -- we're not seeing that anymore.

Okay. Good. And then, Kent just, so I understand the tax rate that 28% that accounted for about, what $0.015, I would -- was that make sense in the quarter, where the 28% versus --

Yes, it was probably be about $0.01.

Okay.

So the benefit from the taxes was that we were able to expense here in the U.S. instead of a low tax environment in Ireland.

Okay.

So that was a long-term strategic decision.

Sure. And then, the cash flow negative that you talked about that will -- that should last for probably until third quarter or something like that. Was that --

I don't think it will be that long -- go ahead Kent.

No. I mean, what we've said is this year we've spent nearly 40 million in fixed assets is just [down] the balance sheet.

Right.

And that's in the equipment, and that's what I'm saying is going to slow considerably. So that the net cash balances it's already started to increase and we'll (multiple speakers).

I see.

Yes. So our inventory growth is going to slow this year too. So we won't be putting out as much cash in that area.

Okay. All right. Thanks very much.

Thanks, Greg.

Our next question is from Sean McMahon with Kennedy Capital.

Hi guys. I just had two questions here. One, on plastic prices has that -- has that severely affected your gross margins in the quarter?

Sean, first of all, it was nice to see you last week.

Thanks .

And the -- there is no question that resin prices have an affect. I don't know -- I don't have the number to say that it affected last quarter. But we saw a lot of that. You know, last year we just saw it kind of come along. The advantage we have is we're a pretty big player in plastics. And we get a lot of barking and that sort of thing. And then, we just said well we can -- there is some competition out there?

So I don't know that it was a big factor in the quarter. But it would also be fair to say that we did see some increases in our materials cost last year because of the increased prices of plastics when everybody was kind of panicking. And what's also interesting to note that while those prices were going up, some of the producers were making record profits. So I don't know if their cost went up. They simply tried to use whatever pricing power they had and take advantage of it.

Okay. And then --

Fred, can I [get on for] a little information on that. I did a check on that because I have been asked that question, and I figured about 4% of the cost of our products were involved in the raw material resins. So even though we have had some price pressures there, they're not too significant, because it doesn't make up a large part of the cost of the product. The raw material there is not the big added value. It's the molding process -- that labor and overhead to create our parts, then and all the assemblies and everything that goes beyond that where the real value added is.

If I understand you correct, did you say 4% of COGS is related to resin prices or 4% of the increase is related to --?

No 4% of the cost is the resin.

Okay.

It's a relatively small component of our total cost.

And then my second question was, you kind of gave a real range maybe next year where you guys are looking at the revenue line. Could you maybe drill down just a touch and say what might be organic and what might be new products you're expecting?

Well that will be part of what we'll talk about Sean in our call a couple of weeks. And again what's going to happen there is you're going to see a huge increase in the second half of the year. Let me give you an example. We're just now, as I mentioned, launching the new Impress catheter. We will not have full inventories to release it for full market release until about the end of the first quarter.

And so even though we've launched the product, we've gone out and sold the product in terms of having all of the catalog numbers. And it will be like some other products where we'll be adding new things to it. But we'll see a big part of that on the back-end of the year. We'll see the same thing with the Resolve. We'll see the same thing with the Revolution. We'll see the same thing with the Honor hemostasis valve.

A lot of this stuff is out being used, being trialed, being -- with customers. And so there's going to be a good portion of it. Not that I'm trying to load up the back-end of the year, but it's just the reality of it.

Well, maybe a better way to ask it is what is the company's organic growth rate?

In terms of new products?

No, no, no, just the products that you're selling right now, what is kind of the organic growth rate?

Without acquisitions, you mean -- organic is both our existing base business growth as well as new stuff?

No, I'm not talking about new products out there because those aren't out, correct? So I'm just talking about what you guys are selling right now. What's kind of growth rate of that business?

About 10%.

10%. Okay. Great, guys. Thank you very much.

Yes.

Thank you. Our next question is from Ross Taylor with CL King.

Hi. Just two or three quick questions, if I could. First of all, I noticed inventories have been increasing every quarter over the past year. And I just wondered, you know, what was behind that? And my second question is, you were able to get SG&A down by about $500,000 from the third quarter level. And I just wondered what were some of the initiatives or factors that might have been behind that?

Let me talk about the inventory levels. There were several things that we did this year that we had not done previously. One of the problems that we had as a company is when we would shut down, which we felt has been the right thing to do, because employees between Christmas and New Years just aren't motivated to work.

In past years, we've had a problem in terms of a back order building up in January, where we didn't have enough inventory. One of the things we did last year knowingly is that we decided we would build enough inventory to make sure that as we started back up in January that we would have the sufficient raw components to be able to meet the growth and not deplete products that need to go out the door.

The fact of the matter was -- is it was absolutely successful this year. We had the lowest back-order coming into January and February that we have had over several years. And so we built inventory for that. The other part is, of course, with all of these -- give you an example with catheters. We're talking about something like 54 or 64 different catalog numbers. We're talking about 8 or 10 or 12 for the new Multipack+.

So there's a lot of this stuff that's in there. And another part of it is we probably haven't managed it, because I don't want to make all excuses for it, but there are some areas and clearly, I think, Kent pointed this out where we can do a better job as well in terms of working with our vendors, just in time, we need to do that too. So some of it is explainable. Some of it is we simply need to do a better job.

Yes. I guess, part of my question is looks like, you probably invested about $8 million into inventory this year. And I just wondered if that -- maybe you can touch on some of that back in 2006 or if inventory's is going to stay--

Yes. We think we can. Do you know what's great about these calls. Again, I'm not trying to patronize you, but it's important for our staff to hear this. They're in the room. They'll all listen to this. We're talking to them, and we're looking at the stuff. Well, we've spent time with our Board. We've spent time talking about these particular issues, but it's good for you guys to raise these issues, because it's good for the staff to say, yes, these are real legitimate questions. So we appreciate it.

Okay. And then the second question was, I just looked at the SG&A numbers and the fourth quarter, you did about 9.5 million and then just back in the third quarter in September you did 10.0 million. And I just wondered what you did to get costs down by about $500,000?

Kent, you want to comment on that? I don't have --

I know we had some unusual -- we had some severance costs and things in the third quarter that made that one go a little higher than the baseline. And then what I'd like to do on that is get back to you, Ross, later today or even tomorrow morning and go through some detail. But there was some extra costs in the third quarter that were a little higher that normalized, I would say, in the fourth quarter. And then we had a few adjustments that we made where our bad-debt expense and some of those things were a little lower than we had hoped. But those are not very material.

Okay. Yes, I had forgotten about those severance costs. Maybe I will just ask one other question. I looked at the inflation device growth of about 5% and I figure 1 or 2 percentage points of that growth must be coming from your [Kyphon] business. And I just wondered if you look at just inflation devices that are used in your cardiology procedures, if you have a rough idea to what the year-over-year growth might have been?

I'd have to go to pull those out for you. I don't have it on the top of my head.

Ross, what I will say is this, we have a new product that's coming out, we have hospital - we were in a hospital in Germany in Munich just this last week, and one of the newer products that we are going to bring to the market is going to, I think helped substantially. It's part of the reason why I'm over here right now, as there's an opportunity for us. And so I think that if we are looking beyond probably the first quarter, but all things being equal and then adding this on top, I think we're going to see that that's going to start to improve simply because we have an additional product that helps to pull that -- pull the inflation devices along with it.

So you may see flat for the first, maybe even the second quarter, but then I think that as we get this other product out there that goes right along hand-in-hand with that Inflation device, we're going to start to see that that business is going to grow a little bit higher than where it's been.

Okay, all right. Great, thank you.

[OPERATOR INSTRUCTIONS]

Well, it sounds like we're about done. It's just about approaching 11 o'clock here in London. We appreciate your interest. We'll look forward to getting back with you. We will also, as I mentioned, be introducing some new products and hope we have some additional announcements over the next couple of weeks. We'll look forward to -- we appreciate your questions today, your support. And as I mentioned, I believe that Merit's entering -- has already entered a new era of increased growth in our company, better market presence with products that bring us superior margins.

We just need to get over the hump here. We're climbing up this hill, we're not to the top of it yet, but we're approaching it. And then I think we're go to be able to get back to where we'd all like to be. So, thank you very much for joining us today. I'm going to sign off on behalf of my colleagues in Salt Lake City, and I'll sign off now from London, England. Good night and thank you.

Thank you sir. Ladies and gentlemen, this concludes the Merit Medical Systems fourth quarter and year-end earnings conference call. Thank you so much for your participation today, and you may now disconnect.