Merit Medical Systems Inc (MMSI) 2007 Q2 法說會逐字稿

Welcome to Merit Medical's second quarter earnings conference call.

(OPERATOR INSTRUCTIONS)

This conference is being recorded today, July 26, 2007.

I would now like to turn the conference over to Mr. Fred Lampropoulos, Chairman and Chief Executive Officer.

Please go ahead, sir.

Good afternoon, ladies and gentlemen. This is Fred Lampropoulos. We're broadcasting from our corporate headquarters in South Jordan, Utah. Present with me today are members of our general staff. We appreciate you being with us today.

I'd like to just turn over a moment of time to Rashelle Perry, who is our Chief Legal Counsel, and have Rashelle read a short legal disclaimer.

Rashelle?

Thank you, Fred. 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 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 obligation to update any such statements.

Thank you, Rashelle, and again, ladies and gentlemen, thank you for joining us.

About an hour ago we reported the results of our second quarter, and as you can all see, our revenues were $51.8 million as compared to $48.1 million, an increase of 8%, and for the six months they were $102.8 million, compared to $93.1 million, a gain of 10%.

Now, clearly, one of the concerns that we have and that I mentioned in our text is this was below our internal expectations for sales results, so it was a relatively soft quarter. However, the other side of that coin is that because of the many cost savings programs and I think hard work of our staff, we came in quite comfortably at $0.13 a share, which I think was essentially the Wall Street consensus.

The sales were affected by what we think are some of the issues regarding the cardiology issues that many of you are aware of, and some of the areas that we saw were in, again, some softness in our interventional products.

Now, that being said, you'll recall that last year our sales in our inflation devices were in the 8 to 9% range. Sales of our inflation devices actually increased in the second quarter over the first quarter, and some of that is attributable to more orders and some of the installation that we have in this market from the spine therapy OEM customers that we have.

And so I think Merit is unique in that, where other companies have seen substantial decreases in interventional procedures and stent sales -- and I've heard numbers of interventions being down 10% and some stent sales being down 30 to 40% -- we're somewhat insulated in that particular area because of the breadth of our product line.

Now, one of the things that we're all aware of that is important to us and to you is how are we coming along on our cost savings programs? And I'm pleased to report to you that many of those programs are now online.

Let me give you an example of one that we looked at, and I had just a discussion about an hour ago. We have a new piece of automated equipment that we've just brought online, and in fact it is producing -- it is a production tool at this particular time that makes a part for us in which we literally use millions of these a year. Today we produce 16,000 of those parts with one person. Two weeks ago we were producing 12,000 with about 10 people. And that piece of equipment is online as we speak, with literally hundreds of thousands of dollars in savings.

I alluded to, in our comments, that three packaging -- automated packaging systems are up, validated and will be running production lots in the next two weeks, hundreds of thousands of dollars in savings.

Now, again, all of these projects have to flow through the earnings and through the model of having higher cost inventory on the shelf -- that has to be sold -- and then these new products at lower cost go on the shelf.

The other thing is that now four of the projects that we've sent to Mexico are online, and starting with the next week, the final product will go from a 50% production rate to 100% in our offshore facility. And that particular project, on an annual basis, will now save the Company about $500,000 a year. That's just one project. And that will be in full production within the next two weeks.

So we've done a lot of things to make sure that all of those automation projects come online. We're sitting with a headcount of approximately 60 or so, 70 people less than we were at our high point, and we would expect that between now and the end of the year that we'll have somewhere between 60 and 80 additional personnel that will be not working at Merit anymore. Most of that will be through attrition. However, I will not hesitate, if necessary, to be able to do a reduction in force if we feel that that's the prudent thing to do. That's the first time I've said that, but we are committed to make sure that we can be more efficient. And there are areas in any business, as you know, that you can take and make adjustments, and we'll continue to do that to make sure that we deliver the numbers.

Now, the other thing we said in our statement is we're not prepared at this particular time to make any changes in our guidance. Let me tell you why. We -- although we saw a soft second quarter, relatively speaking, and we're coming into our summer quarter, we want to make sure that we have time to look at the trends, finish up July, take a look at our statements, take a look at the markets, particularly in light of the numerous amount of new product introductions that we have already announced or that will take place in the next couple of months.

And I'm going to go through a few of those with you in just a moment, but if we find that it's necessary to reduce our sales estimates or our earnings estimates, we'll come back in, we'll announce it and we'll sit down to do that. We are not prepared to do that. I'm not suggesting that we're going to do that. But in light of the second quarter I want you to know that we are at least discussing and analyzing to see where we think we're going to end up at the end of the year.

Now, we've had a lot of positive things also with inventory and with cash flow. These are all, I think, indicators of a business that's getting healthier. So I'm going to just turn over a moment of time to Kent Stanger, and, Kent, have you discuss just briefly about cash flow and the inventory issues that are presented in our balance sheet today.

Yes, thank you, Fred. I mean, our cash flow from operations improved to $13.4 million for the first six months of '07 compared to $11.5 million a year ago, and also I'd like to point out that inventory in particular, I think, is probably the most important change in that, in that we have seen, rather than inventory increasing as it did last year for the first six months to a little over $3 million increase for use of cash, now we're getting a $1 million reduction in inventory when you net out the acquisition of the Datascope inventory. So the net effect of that is a $4 million -- $4.1 million increase in cash flow, which is helpful.

In case, for the people that remember, we've made an acquisition in this last quarter or so with Datascope for $3 million and a couple of other small transactions, as well as some buyback of stock of a little bit north of $4 million, and so that's where some of that cash has gone is we've invested it, basically.

But it's gratifying to see the strengthening of our systems. We're adjusting our capacity both for the sales numbers Fred is referring to, but as well as that it's for our inventory levels and the capacity we need to produce the proper amount of inventory. So I've really appreciated the improvements that the ops group have been able to make in the last few months in regards to reducing the inventory.

Our turns are going to start improving, and have begun to. Our use of the resources, labor, overhead and (inaudible) and those things are now getting more efficient. So that is going to lead to lower cost as we go forward. And as we're able to do that, cash flow will improve and so will the bottom line.

All right, Kent. Thank you.

One of the other, I think, important parts of understanding Merit's business is the fact that we have a relatively broad product line that has a high amount of focus in interventional cardiology but even more focus in terms of our new product development in the area of interventional radiology. And in many cases radiology procedures aren't elective. If you need a dialysis catheter or a PICC line, or if you have to have a clot removed from your leg or a biopsy of your liver and so on and so forth, you have to have those things done. You can't defer them.

We've introduced a number of products in the last quarter that I think will have an impact on the company. One of them is a very interesting product. You'll recall that in one of our previous conversations we discussed the fact that we had a situation with an OEM customer in which we were producing large numbers, up to 50,000 units a week. And we kind of -- I hate to use the word "trapped", but for lack of a better word right now, we got ourselves into a situation. We were essentially locked into a commitment that finished up in June. In our analysis, that had about a half a point, or about 50 basis points effect on our gross margins. That contract was completed in about mid-June.

Now, subsequent to that, we've developed a CT transfer set that we are now selling that we expect to be a huge winner for us at about a 65% gross margin. So I'm going to be very candid with you. It's one of the products that we've had a little bit of difficulty trying to catch up with the demand. Now, we've now adjusted our orders and our workforce and everything in that one particular area. And this is a product that would not surprise me at all that we would be producing 20,000 units a week, 50,000 to 80,000 units a month, at about a 65% gross margin. We think it could bring -- it's a relatively small dollar product, but what we've done is take a product that was essentially break even and replace it with a product that will produce about a 60 to 65% gross margin.

We introduced a new what we call the fuzzy bag. It's a nice product that gets a premium price. We've Meritized our dialysis catheters and we've announced that we've launched that. And we just received notice this week that that particular product was approved for European sales. And so we will be conducting a sales meeting in Europe to launch our dialysis catheters there the first week of September. So we're about a month away from actually doing the training and launching the product there. That came in a little bit earlier than anticipated.

Another interesting development this last week which I'm very pleased about and took a lot of work from our staff and our regulatory department is that we received approval from the Food and Drug Administration, which we announced, regarding our transradial kits. Now, very briefly, a transradial sheath is one that's placed in the arm. It usually has a two to three X price over a standard femoral sheath. And although it probably has less than 5 or 10% of the market in the United States, in countries like Sweden it's about 60%, in France about 60%, in Brazil 50 to 60%. And in a recent conversation with our Japanese distributor, it's an emerging technology there that is approaching 50%.

Now, the reason some of these countries like to use this product is the product goes in the arm just in the radial artery, and it is much easier to ambulate the patient. Normally they have a pad, but it eliminates some of the costly things that we do in the United States in terms of putting in closure devices, which can cost, as you know, up to $250. So some of these other areas of the world are much more conscientious about cost, and we believe that this is going to be a very exciting product.

I will share this with you, that in a recent trial in London, from a physician that was using the market leader, this physician preferred our product in that trial over the current market leader in that area. So this will be a new entry for Merit. Has, again, a broad international appeal, particularly in South America, Europe and the Pacific Rim. So we'll be going to market with that product in the next couple of weeks, and, again, we're quite excited about its prospects.

Earlier in the week we also announced the acquisition of a technology from Lightek, and it is a laminar radiopaque marker band that allows us to take and to essentially reflow a marker band on a catheter that does not require metal, but is either platinum or tungsten carbide. And we think it's a better technology. And if you look at the various reports that are out in the field about problems with catheters with metal marker bands, there are a tendency for those to fall off and to crack, and we think this technology is something that will be beneficial to Merit in the future. So we will -- have acquired the technology. We'll now transfer that technology. We're already incorporating it into a number of our existing products.

Let's see here. What else did I want to talk about? There's a lot to talk about today.

Kent, is there anything that comes to mind that you'd like to discuss?

Well, I mean, I think you've mentioned the improvements I think we're trying to make in our efficiencies in cost programs. And the products that we've taken so far to Mexico I've been pleased with that we haven't had a lot of quality problems, that the projects are flowing well and on time, and that those cost savings are, if not started, will very soon begin to flow into our income statement.

And, with that, I think it frees up some of our resources to move into these new products and production of things that are coming out. That will free up space and resources for that as we move these offshore. So I think it's a double bonus in that we can reduce costs and free up resources.

Now, just another reminder that Merit has announced previously that we're in a stock repurchase program mode. We have purchased some shares, but a relatively small amount. We've been in a blackout period for about the last three weeks. Merit will come out of that blackout period following the first trade on Monday morning, and at the price that the stock is currently trading at, Merit will be a buyer at these particular levels, so -- or below or -- and, candidly, slightly above. So it's within our range where we have purchased, so we still have almost 1.3 million shares or more to repurchase. This is in addition to the shares that we've previously announced that we've brought back into the treasury from an individual investor.

So I think that pretty well does it, except for one final thing. And these are important issues.

We've talked about the products that we introduced during the quarter. There are some new products that I'd like to just briefly talk to you about, and then we'll finish up and go to the Q&A.

We will introduce a new product in the late third quarter, early fourth quarter, called the All-Star. This is a product that has a 90% gross margin. It is a hemostasis valve in which Merit is the world leader. We believe that this product goes head to head with other products that are in the marketplace, but I don't believe that there's any product like this. We will do a broad advertising campaign, including the Cath Lab Digest, starting in September or October. And we believe that this product is going to pull along not only on its own and standalone basis, but also sales of our inflation devices into interventional radiology and cardiology.

So we're very excited about this product. It already has issued patents. And I can tell you that in talking to a number of our salespeople last night who have been trained, have seen the product, that they can't wait to get out there into the field. This is a product that will sell about $35, and, again, with approximately a 90% gross margin, with patented features and patented -- issued patent technology.

We're introducing a new patented product called the Sea Dragon. It's a device that's used with interventional guide wires. The 4 French, which is the smaller sized Impress catheters, which will be the sister and the companions to the 5 French will be released. And then, as I mentioned, both the transradial sheath, which we've previously announced.

One additional thing that I did not have in here and may have to be covered by an 8-K, we will also introduce before the end of the year the Prelude marker band sheath. And this is a product that, again, is an extension and will complete the initial stages of our Prelude sheath. This is a product that also gets a 3X price over a standard sheath. It has a tip which is highly recognizable under a fluoroscope and is a product that is -- does over $10 million in the U.S. and we think has a worldwide market of about $25 million. So that's another product.

So when you take a look at Merit's products, you take a look at the cost structure, the automation, the lower headcounts, the lower inventories and the additional items that are coming online, in terms of our overall plan and profitability and gross margins, I really have little doubt of continued improvement, assuming that we have reasonable volumes to cover those overheads with, and I believe that we will.

So we have an awful lot to do and to finish up, but I think we are setting the stage for a year of improvement over last year, and a significant improvement and a resumption of things that we've seen in the past at the Company as we move out through the next several years. So everything is on plan.

And, Kent, do you have a closing comment?

Yes, just that I also wanted to point that the SG&A I think is getting much more productive. We had 100 basis points improvement as a percentage of sales for our sales force in the G&A group as a whole, and I think that leverage is starting to show up, that the sales force is maturing and the revenues are growing on a relatively fixed [basis] cost.

That's a very good observation. I appreciate it.

I think that pretty well does it from this side.

Let's go ahead and turn the time over now for questions and answers.

So let's go back to our facilitator and we'll go ahead and take questions, please.

Thank you.

(OPERATOR INSTRUCTIONS)

Our first question comes from the line of Mr. Scott Gleason, with Stephens. Please go ahead.

Hey, Kent, Fred, how are you guys doing today?

Good.

Hi, Scott, how are you?

Real good. First question, I think the top line was maybe a little softer than people had anticipated, but on the bottom line you guys showed some pretty nice margin improvement, about 70 basis points, it looks like.

From the first quarter.

Yes.

Yes, from the first quarter. Can you kind of quantify that in terms of what the biggest contributors were there? Was it new products or was it mostly the cost saving initiatives that you guys have been working on?

I think a lot of it was reduction in cost of materials that we buy, because we've had a lot of those types of things. We've had reductions in cost regarding some of the automated, and but mostly efficiency.

I think the biggest issue that we've done here over the last three or four months, we have a new administration in operations, headed by Arlin Nelson and Ron Frost, and the morale at Merit is much higher. The workers are getting more rest. We don't have as much money in overtime and yet we can fill all of our orders. And we're building the things that we need to build. So we're not wasting time and money on things that we shouldn't build.

So it's a combination of materials, a little bit of automation, but most of the automation, most of the Mexico stuff won't really be seen until we get into this quarter and the fourth quarter and then on into next year. So most of it I think, candidly, is probably the efficiency and the great job that Arlin and Ron and the staff have done. And consequently what it means is that we've been able to bring down the headcount, and that's been through attrition. So I think that's where most of it's come from.

Kent, would you want to --

I agree. I mean, we've just seen more efficiencies, and we've seen our variances decline that we -- (inaudible) overhead that we were seeing at the end of the year and beginning. So that's now -- that expensive inventory is getting out and the stuff's starting to come through that's (inaudible).

Yes, and I think it's fair to say, Scott, that we're on plan to do all the things that we've said that we were going to do. I can't think of a single thing that we had talked about in terms of automation, efficiencies, transfers. Everything that we said we were going to do we have executed on.

Now, we were a little bit surprised at the softness of the second quarter, too. But as we look out amongst some of our peers and those that are in the industry, you know, sometimes things can get caught up into acquisitions and adding revenues that way, but this is a pure play. I looked at one company today in a growth area, and they only did 7%. I've looked at others in this area. So --

That were down 5.

That were down 5%. We looked at another competitor. They were down 5%. So we were up 8 and up 10 overall for the year. So I'm not going to apologize for it. I wish it would've been more. But it is what it is.

And on that tone, Ken and Fred, if you look at the major cardiology companies, I think Boston Sci indicated that stent volumes were down 30% year over year, J&J 20%, can you quantify how much that probably impacted, or estimate how much that impacted you guys in the quarter?

I think it probably, if we look at the growth from last year, and that's probably the biggest determinant, and say that we were, let's say for the first six months we were up about 1% or something like that over last year, and we were running at a run rate last year of about 8 to 9%. On a 50 -- that's --

He's talking inflation devices.

I'm talking about inflation devices, yes. So we're talking about that growth rate moderating about 600 basis points, and you're talking about a $50 million business. So it was probably, on an annual basis, it would probably be somewhere around $4 million or $5 million over the year. So for the quarter I'm going to say it was probably about maybe half --

Yes.

-- maybe as much as three-quarters of the differential that we would've seen. We were down from our internal projections a couple of million dollars, 2.3 for the quarter, Kent, was that it? 2.4? So it probably accounted for a good half to three-quarters was probably in that area. Now --

And I might add the other half has probably been in K09s and fluid administration kits that are in those same procedures, used in those same procedures. So one's a high-margin product that we miss and another one's a lower-margin one. But it's still -- it's those areas that we see are a little soft.

Yes, and so those were the areas, which would be consistent with what we saw in these other areas. However, despite that, the overall business, because of our --

Diversification --

-- diversification, interventional radiology and -- yes. In fact, OEM set records. Our international business did well. It was basically our domestic business and in the cardiology side that was soft. Everything else really did really quite well.

Okay. And then just one last question, with the move of the six products to Mexico, can you guys give us a little more granularity on how we should think about gross margin as we trend towards the end of the year?

Well, I think we're going to -- I think we're going to stick with what we said that we would do, and that is, our plan is to improve our gross margins at 100 to 150 basis points per year over the next several years. Now, depending on -- and everything's in place to do that. So we're not missing anything that's gone to Mexico, or the automation project. So everything is on to be able to do that, and hopefully we'll be able to do better in that particular way.

The one thing I think is a pleasant -- I don't want to call it a surprise, but whenever you're launching new products, there's always this or that. But I think probably the thing that is most positive is the fact that we have a lot of new products, and they are coming out and they are going to have a significant impact going forward. That's the thing I think I'm the most pleased with. These are all high-impact products going out down the road, whether it be the dialysis or the sheath itself at two or three times the standard cost of a sheath, with probably less than $0.50 or $1.00 of additional cost, looking at the All-Star.

I mean, the All-Star is going to be talked about for a long time, because it is an interventional cardiology product. But it is going to -- while everybody else is laying off sales forces and consolidating and do this and that or selling divisions, Merit's going to be there with a new, exciting product and we're going to be able to pick up a lot of business.

I was talking to an account yesterday up in Buffalo and we have an opportunity to pick up on a $100,000 a year account when we introduce this product. The account's seen the product. They're just waiting for it to get there and fortunately, for us, we're going to replace a competitor and it's just based off this one new product. That, I think, speaks volumes.

So I think the big plus is that the staff is executing across the board on all the programs and all the new R&D projects, which I think are going to do well for us. They're all high margin products going forward.

Okay, great. Fred, Kent, thanks for taking my questions.

Bye-bye.

Ben Alexander, Alexander Capital.

Hi. I'm new to the stock and I kind of wanted to ask you, would you be able to detail the expense savings that you're working and how many millions of dollars from each of these initiatives?

Ben, I can give you a little bit. I'm going to give you kind of a thumbnail version of it. We've essentially said that we would have about $10 million worth of annualized cost-savings, some of which will -- for instance, we're bringing on this new machine that I was talking about today that costs us about $750,000. It will save us $600,000 or $700,000 for the year.

There's a couple of million dollars down in Mexico. Each of the three packaging machines will bring $600,000 a year of savings. I've got a list. Kent, do you want to read some of those, of just projects but without giving too much detail?

Yes. I mean, we've got the Ireland Multivac machine. That's a packaging (inaudible) --.

I've talked about all of those, yes.

And we've got the -- patient labs (inaudible), I'm that's --.

I'll give you an example of another one.

Rotator family (inaudible).

Yes, I've already talked about those. We had another one with a vendor that was $100,000 for that. In shipping there was $225,000 for an issue there; in another vendor purchase, $250,000. Headcount reduction, we're down 80 employees from -- where is it, about 70 now? Is it 70 or 80 -- 70?

So you take a look at $30,000 to $35,000. There's a couple of million dollars in reduction to our costs and we'll be down an additional amount. There were things like insurance. We were able to save a couple of hundred thousand dollars on our insurance costs, over what we paid. So, as a percentage of sales, that's dropping.

I could go through a huge list of changes and cost structures, but they essentially all add up to about $10 million of annualized savings that we'll have, which would be about 500 BPs. But some of those are going to get to the end of this year.

Let's say, for instance this packaging machines, these automated systems are going to start up in two weeks. They're here, paid for, and that sort of thing and one of the things you can see for this equipment, if you go to our balance sheet, you'll see that our construction and progress has grown dramatically, because those machines have all now arrived here and they'll have to be depreciated.

But there are huge amounts of cost savings in all of those areas and sometime, if you want to give us a call, I'll go through each one of them in much more detail to the best of my ability and still meet the requirements of FD. But I can't tell you how many. There must be a list of 50 of these things. Neal Peterson in the engineering group, the quality group. It's just all over the place.

We're really battening down the hatches, really getting much more efficient and then you see less inventory. You see less turnover. I mean, our turnover has gone in this tight labor market. We were talking about a 2.25% unemployment rate in Utah. We were turning the bottom, people coming and going after 90 days or 120 days.

We had a 60% turnover rate just in production and so people who've been here for over three years we wouldn't lose very many, hardly any of them, but you have this amount of them. Our turnover rate has essentially gone to nothing. I mean, it's not zero, but I'll bet it's down to 5.0 or 10%. So it's dropped dramatically from where we were and of course, when you do that, you're going to get people who are better trained. You're going to get more efficient. You're going to get better quality.

So there's a lot of those projects, I guess, is a long answer to a long question.

May I ask just one follow-up? And you don't have to spend a lot of time on it, if you don't -- I know that a lot of people are I'm sure waiting in queue. But what is your goal in like three years from now in terms of you're business model, gross margins, operating expenses, operating margin kind of thing?

I'd like to be able to operate this business in the mid-40%'s in terms of gross margins. We've been there before. We know that territory. I believe that in terms of our SG&A that we can probably be down around 21.5 maybe 22%, R&D at about 4.0% and operating profits in the 15 to 18% range.

That's where I think we can get. We've been there before. We've had to put a lot of infrastructure in place and we've built a lot of automation and facilities and I want, too, if I can, this is a longer answer, but I get beat up about this and I want to just quickly address it.

Sometimes people say, well, if you're moving stuff offshore then why did you build these buildings and let me just briefly address that. One, we're shutting down our facility, a semiconductor company in California. It's moving into these facilities that are here and in the next 60 days that will be finalized. That has been long haul.

We took and better than doubled our molding capability. We have an automated warehouse and we started up a new business in Richmond. Those decisions -- and we added 40,000 square feet in Ireland, in which those clean rooms in that space are being utilized.

So I don't know that we would have changed anything at all and yet, as we grow, we want to take things that are low engineering, high labor costs and takes them to lower costs. But we're not apologizing for the decisions that we've made for our facilities, because over time we'll absorb them up and they're exactly.

So we don't have hundreds of thousands of suite feet vacant. We have zero vacant. We're using all of our facilities, so sometimes I think people ask the question, well why are they going offshore and why did they build the buildings? And we've built them to anticipate future growth. It takes two to thee years to put up a building.

But those aren't the things that are going to Mexico.

Yes and those are the things that aren't going to Mexico. Anyway, I just wanted to just throw that in there. So go ahead. Are there any more questions, sir?

Hello, Fred?

Yes sir?

This is Nick. I work with Ben.

Yes, Nick, how are you?

I'm okay. Thank you. I'm somewhat new to your company as well and my question is I'm looking at an analyst model here that has revenue expectation of nearly $240 million for next year and I'm trying to get a handle on what your expectation is for new products. Like what are your expectations for how much they're going to be part of the revenue? Yes, what's the goal?

First of all, I think that my goal would still be to grow the business from $12 to $15%. I believe that we're capable growing that, even as we go forward. So those goals haven't changed.

We have a higher amount of larger margin, higher margin, more product than we've ever had, many of them patented. And our goal has always been to try to be able to get, going forward, a contribution of 10 or 15% per year from new products. So, for instance, if we were able to do, let's say -- pick a number. I'll use $200 million, because it's round. We would like to get $10, $15, $20 million a year contribution from new products, plus growth, either procedure.

Now when you have some things slowing down, there are many other procedures that are accelerating. So we think that the new products that we have now and those which will be in the market place between now and the end of year, and I think this staff would all agree, are the best products, the most profitable products, the most complex products and the most unique products that the Company has ever had. And we've had a history of innovation for many, many, many years. So we're doing better now than we've ever done in our ability to bring those products to market.

Thank you very much.

You're welcome, sir.

Craig [Yeshin], Accipiter Capital Management.

Hi Craig.

Hi Fred.

How are you?

Good, how are you?

Good, sir.

A couple of quick housekeeping questions. On your last quarter call, you had referenced that there was about $600 to 700,000 in royalty expenses that was going to drop out of the P&L in the near future. Was that impacted this quarter or is that something we can look forward to over the next quarter or so?

No. In the fourth quarter, we're going to drop off about $150,000 a year that will affect us in the fourth quarter, but effectively it will be off the books next year. Early next year, sometime next year we have $450,000 that's going to come off, but that's next year about midyear. So that's about $600,000 there.

There's another thing that I think I also alluded to and that is next year we'll have a lower tax rate because we'll have a tax credit in the State of Utah, which Merit fostered and moved through the legislative, for profitable companies that make money.

And that should be somewhere between $600 and $800,000 in a lower tax rate, because of work that was done by [Greg Freedy] and our Governor Affairs department here for a lower -- it's a higher R&D tax credit. So that takes effect the first of January. So I think those are the two things I alluded to in the last call.

Okay and that tax benefit, is that a one-year phenomena or is that something --?

No, no, it's an ongoing, permanent, already passed by the legislature.

Great, okay and then one other question. I'm just trying to reconcile some of the comments you made about the share repurchase. You had noted that you spent roughly $4.0 million, which would be roughly 3.5 million shares, if I just assume the average price was around $11.50 a share. Yet you say there's 1.3 million shares still remaining on the repurchase authorization, but that was only for $1.4 million, so I'm just trying to understand those numbers.

I think you left a zero out. We repurchased in April about 344,088 shares from a private investor. That's already back in and been retired.

Oh, okay.

We announced that we were going to buy back 5.0% of the shares. We bought some shares back this quarter. We have about 1.3 million to 1.350 million. We didn't buy any more than I think 40 or 50,000 shares. But we will be in the market place when we come out of the back price, because it is within our area in which we, our Board, has authorized the purchase of shares.

Okay.

So under the various rules that we have to live with, we will be participants, but we cannot do anything until Monday.

No, that's great. I appreciate that. So the shares that were repurchased from the investor in April were before the new authorization took effect in May?

That's correct.

Okay. That explains that. And then, lastly, just in terms of the expenses this quarter, was there anything sort of one-timer that's not likely to recur in the future or is this pretty much status quo on your SG&A and R&D side?

I think there were a few things that we alluded to just a little bit, but in the text. I think one of the things that we're still doing is we're still cleaning up some of the effects of over inventory looking back.

You'll recall that we -- again, as we've grown, we've actually reduced our inventory. And by the way, I would expect, even with these new products going forward, that our inventory numbers will still come down, which will, of course, enhance our cash flow and help us to have less obsolescence and less scrap going forward.

But we're still picking up in the statement some of I'll call them sins of the past of some things that are obsolete. Now, to the tune, I would say, probably of a couple $100,000, $240,000 of additional expense this quarter that I had not anticipated, or we would have added that to the pretax line. So we did have some of that, but I think the thing is, is we're cleaning all of that out and yet we still made our numbers on a lower sales number. So I'm pleased with that.

Great.

And I think everybody that's sitting there that's going -- I got 25 people, Craig, sitting in this room. They're acutely aware of all the things that we need to do here to be able to give the performance that we've said we would be able to do as we bring this Company forward.

That's great. Thanks so much.

Thanks, Craig.

(Operator Instructions) One moment for our next question. Excuse me, Mr. Lampropoulos, we have no further questions. Excuse me, one question did queue up. Our next question comes from the line of [Ann McCormick] with SunTrust Robinson Humphrey. Please go ahead.

Hey, it's actually Chris. How are you guys?

Good, Chris, how are you?

Very well, thanks, nice job of expense management in a pretty difficult environment during the quarter. I wanted to ask, specifically, I guess, just on mix, did you have anything incrementally positive in terms of the product mix that maybe contributed a little bit to the gross margin?

Oh yes, we had many things that were positive. Ken, you've got the sheet. I remember going through them with you, but go ahead and -- yes.

I mean, there were some increases. Some of our biggest increases are -- well, I'll go down the list. I mean, trays were the biggest increase and then next after that was actually inflation devices. Our basic inflation device was a big grower. And then we had some nice growth out of our packs, our hemostasis valves (inaudible) --.

Don't misunderstand that for packs. Those are hemostasis valves, which are much higher volume.

Yes, (inaudible).

Our drainage catheters were growing substantially over last year.

MAP, which is a new introducer.

Yes. Another vascular access product. So, one of the things that I think we're seeing is that our interventional radiology business, in a number of those areas, continues to grow quite smartly in a number of areas to offset some of the areas where we've seen those, a kind of softness that you would see in inflation devices and kits.

And by the way, I think what you'll see go forward, Chris, is this. With this new hemostatic valve that we have, I think what that'll do is that will help with our inflation devices and I should mentioned, incidentally, and I didn't say this, that we are seeing increased demand for one of our OEM customers. They get mad when I mention their name, but we have a large OEM customers that buys our inflation devices and we're seeing increased demand for that particular product in this quarter, up about 10 or 15%. So we're seeing strength there.

So if it get soft on the kit side, I don't mind that, because we'll make, going forward, more on the interventional inflation devices, which is the business where we make better profits anyway. So, if it goes soft in one area and we strengthen up another area and then continue to grow the interventional radiology business, our mix and our profits will be just fine.

Awesome and just zeroing in on the hemostasis valve from the new product you launched, you're probably aware of Vascular Solutions' partnership with Zerusa for the Guardian. Could you comment on how your new hemostasis valve will compete in terms of the price point versus the stuff you currently offer, as well as how you think the competitive landscape may be changing or not?

Yes, I'm happy to do that. We looked at that when we were first approached with that product over a year-and-a-half ago and we chose not to sell it and I think I'll just end the statement right there. We chose not to sell that product.

(Inaudible)

I wish them the very best. I have absolutely no doubt the product that we have and because of our presence with cardiologists is going to be --may be -- I said this to my staff earlier today - may be one of the biggest winners we've had in a long time. It's a great product, with great margins.

I'm not going to talk about price points and that sort of thing. I think I've said enough in terms of gross margins and the fact that this is patented. And we're the primary manufacture. We designed it, we mold it, we build it. We're not buying it from another party where you have to get another margin in the way. So I wish them the very best and I look forward to doing battle with them.

And safe to assume, then, since you've got more proprietary technology in the new one that it's likely to carry a premium price to the old one?

There's no question that it'll carry a premium price of any -- remember this, Chris. Merit is the worldwide leader in hemostasis valves. We're the market leader. And so we're coming in as the market leader with inflation devices, the market leader with hemostasis valves and now with this new product that already has issued patents on it.

So I don't want to sound puffed up, but I'm pretty confident about this product and the affect it's going to have on our business and we did look at the other product and we just simply didn't believe that it was to our standard. I know that may sound harsh, but that's the facts.

We're also targeting a high priced product out there that hasn't [taken our market share from one of] these big players and we think we're going to do some real damage there.

Yes.

It is higher priced, to confirm your point.

There's some confusion out there. I mean, I'll be more specific than Kent. There's a product called the COPILOT. It's a great product. It was owned by Guidant, which went to Boston and it's now over at Abbott. It's kind of bounced around. It's a nice product with nice margins. We have a product that we think is better than that product and we'll go out and prove that here very soon.

Perfect, fellows. Thank you very much for taking the question.

You're welcome. Thank you, sir.

Scott Gleason, Stephens Inc.

Hey Kent and Fred, just one quick follow-up. Kent, Fred?

Yes, we're here. We're not going anywhere.

Okay. Just when we look at the two years and in the third quarter you guys have typically seen a seasonal decline of 3.0 to 5.0%. Would you expect that same seasonality this year?

Yes we would. What you see is simply that people go on vacations. Doctors are going with their families to the beach. Europe shuts down, Germany, France, those places, for parts of July and August. It's just a phenomenon that exists in our particular business. It always has and so yes. I mean, we'll see that again this year.

And then just kind of a caveat on that, if you guys were to see that kind of 3.0 to 5% seasonal decline, it looks like the fourth quarter would have to be exceptionally strong to kind of hit your annual guidance?

Yes. I think that's a fair statement and that's part of what we're looking at and analyzing. I mean, to support that, though, is you have all these projects now that are coming online and you've got that inventory moving through. So we have a lot of these things that are going to hit our P&L and reductions in headcounts, offshore stuff that now gets to flow through the model.

But you're right. I mean, you can go through and look at the model, look at the sales, and you can see that we've got a lot of work to do to be able to come in where we think we can do, even if you see a softer market and that's -- we have a lot of work to do.

But here's the advantage we have. We're not trying to start these projects and get caught up in a hurry, because these things take time to turn. We've been doing these for a long time and we would do them well in advance of any of these slowdowns and so the advantage that Merit has, as a Company, is that we started a lot earlier than most. And some of these things go back 18 months to two years where we were designing some of this automation that's now coming online.

So that -- we're fortunate that we were doing that and that at the time, prior to these slowdowns, we were already slowing down our business and slowing down the inventory bills and we were doing those things before this took place. So we were fortunate that we were in front of the wave.

Fred and Kent, is there anything from a product standpoint or distribution standpoint that kind of gives you confidence that we'll see that boost toward in the fourth quarter or later in the year?

From a distribution point of view, I don't know that I understand your question.

You said that you got a lot work to do. Is there anything that kind of gives you confidence as we look to the second half -- or the fourth quarter of this year?

Yes. I think that confidence comes from just sitting down and talking to my salespeople. For instance, I was talking to the guy, as I told you last night, in Buffalo, our sales guy up there and he was telling me -- in fact, he said something. He said in the eight years he's worked for us, this has been the best time that he's had because of the products and because of all of the disruption from our competitors. Now I'm just giving you essentially verbatim what he said to me.

I also talked to our sales guy out in Nebraska and he said something that I scolded him about. He said, "You know one of the new products we have is almost too easy" and boy, I kind of put him right at attention and said, "Don't ever tell me something is too easy when you're on the sales side, because that means your competitor is just around the corner". But it was a new product that he walked in and he was able to nail the product down on his first call and that sort of thing.

So we have a lot of momentum in the new product area. Now we'll work through this issue on the interventional cardiology side with some of these new products that we're talking about and we'll continue to focus on that interventional radiology, where we think there's still a lot of room and a lot of opportunity for us.

Okay. Thanks a lot, Kent and Fred.

Thank you, sir.

Craig Yeshin, Accipiter Capital Management.

Hey guys, just wanted to follow-up on a comment you just made regarding a competitive disruption. Boston Scientific officially put their NAMIC division up for sale this week. I just wanted to get your thoughts. What are you seeing in terms of lack of focus on the part of your competitors, Boston Scientific in particular and how do you sort of see this over the next three, six, nine months as the sale potentially goes through? How much focus or lack thereof will there be on the competitive front?

Well, I think first of all, NAMIC is a great company. It's the company, when we first started in this business that we set out to emulate. The difficulty has been, I think, is that when you have a company that doesn't get the attention that it needs -- Merit has introduced some 90 new products over the last eight or nine years and that division has introduced one.

I think the advantage will be, for Merit, on this disruption issue, is that if it's out there, then it's going to be sold and so that's two things happened from that. One, the customers out there know it's going to be sold and so they're looking for stability and secondly, even though it's still sitting in the mother company the sales guys aren't going to bother going selling something that they're not going to get any credit for.

So our guys know that. We have the products. We have the breadth of the product line and that's got to just almost by definition play to our hand.

Okay. All right, great, thanks guys.

Okay, great, thank you sir.

Ben Alexander, Alexander Capital.

Yes, thank you. Can you give me an approximation of what percentage of revenue is exposed to procedures that are under pressure or declining?

Well, again, I want to be careful. Our business is split somewhere around 50-50 between cardiology and radiology. It might be 45-55, but we use a number of about 50-50. If you take that particular area into interventional cardiology, about $50 million or 25% of our revenues come from inflation devices. It's the most mature product we have.

It's also the product in which we're the market leader and despite the fact that you're seeing some softness in interventional cardiology. Ben, one of the things that we have that kind of separates us is we have some insulation because of the fact that we sell this product not only to interventional cardiology, but it's also used for a number of spine therapy types of procedures, such as kiphoplasty and discography. Those markets continue to grow outside and those are areas that Merit participates in.

Additionally, there's a new emerging technology and one I think you'll be hearing about in the future where they're using balloon technology for rhinoplasty. So we have some emerging technologies with the use of balloons that are helping us.

So I would say about $50 million of our business on the cardiology side, but even that $50 million is probably two-thirds cardiology and a third interventional radiology, which is not under pressure.

Plus we have the international business at 27% or even more with inflation prices and that hasn't been under pressure.

Yes and we're not seeing the same pressure overseas. So I don't want to say that there's not a slowdown there, but it's in that particular area and as you'll know, we report in four different areas -- inflation devices, kits and trays, standalones, and in catheters. And if you look at our numbers, you'll see where the slowness came down is in those two areas we just discussed.

Thank you very much.

So it's maybe 20-25%, to try to get you in the ballpark.

Yes. That's probably about fair.

It's probably about what it is (inaudible) --.

About 25% of our business is probably that area that's soft. But the other side of that is that is 75% isn't.

Thank you very much.

You're welcome.

(Operator Instructions) Mr. Lampropoulos, we have no further questions. Please continue.

Ladies and gentlemen, we'll go ahead and finish this up. We, again, appreciate your interest in our Company. The things that we've said we were going to do internally, in terms of cost-savings, more efficiency --

Product development.

-- product development, we're doing all of those things. Now there are some things outside on some of these market areas, but again, we also have the ability to adjust our markets in our sales into new and emerging areas, both in terms of the OEM side and in terms of the markets in which we're focusing, such as interventional radiology.

So we're still confident that over the intermediate term for this Company, that our prospects will continue to improve as we go forward. There may be a few bumps, but that's not unusual. But our plan is solid, it's in effect and we'll continue to drive the costs down and improve gross margins. That's our goal. It's working. We're on schedule to do all the things we said that we could do and so if there are any changes, we'll be in touch and we appreciate, again, your interest in the Company and we'll look forward to talking to you in our next release.

Thank you very much and we'll bid you a good evening from Salt Lake City and good night.

Ladies and gentlemen, this concludes your Merit Medical's Second Quarter Earnings Conference Call. ACT would like to thank you for your participation and (audio drop).