Merit Medical Systems Inc (MMSI) 2007 Q4 法說會逐字稿

Welcome to Merit Medical's fourth quarter and year end conference call. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded today, Thursday, February 14, 2008. I would now like to turn the conference over to Mr. Fred Lampropoulos, Chairman and Chief Executive Officer of Merit Medical. Please go ahead, sir.

Good afternoon, ladies and gentleman. This is Fred Lampropoulos along with Kent Stanger and members of our staff broadcasting from Salt Lake City today. Thank you for joining us. We were delighted that you have joined us. I'm going to first ask that Rashelle Perry, our general counsel, read our Safe Harbor provision. 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 good afternoon, again, ladies and gentlemen. As you can all see from the press release that we released just a little over an hour ago, for the fourth quarter the company recorded revenues of 54.3% versus 50.8 for the fourth quarter of last year. Net income was 4.7 million or $0.17 a share. That was up 55% compared to the 3.1 million for the year ago period.

Now just as a point of interest and disclosure, you will recall that I think it was the fourth quarter of last year that we took a one-time writeoff for an impairment charge and I will have Kent Stanger discuss that in a few minutes.

I think more importantly for the year we reported $207.8 million, just 9% increase over the previous year in what we consider relatively difficult market conditions. For the year, we ended up at $0.55 a share and some of you will recall that on that $0.55 that it was on the high side of our range. So even though about mid year we reduced the sales side, we were fortunate to come in on the high side on the earnings side of things.

If we take a look at our business overall for the year, catheter sales rose 18%. Custom kit and tray sales grew 12%. Inflation devices, which I think is an area, of course, that could have been most affected by the slowdown that we saw in DES procedures we're still up 5%. Much of that had to do with the breadth that we have in terms of this market place both in interventional radiology, interventional cardiology and spine therapy. Overall, though, for the year the gross margins only increased, as you are all aware, by 10 basis points from 38.3 to 38.4. But you saw the improvement that we saw quarter over quarter, and particularly I think strong was the fourth quarter gross margins coming in I think it was at 39.8.

Now the good news is is that going forward we would expect that we will see our gross margins in that range of that fourth quarter or better. As we have promised you, we believe that our gross margins will improve by about 150 basis points for the '08 numbers and then we would then see that our earnings growth will be at least 20%. I want to go again over and say that for next year we're looking at 8% growth which will bring this at about 224 million and then we'd expect to see a 20% increase in our earnings per share. Hopefully we will do better than that. Those are our numbers and the numbers that we feel confident with going forward.

Now there are some people talking about the firming up of procedures and we often get asked how things are going and are we seeing that. I have to be candid with you that we have not seen it firm up at this particular point. There are some people saying that it has. I was in some cath labs, in fact scrubbed in to some procedures about a week ago, and in that particular situation they said that they were about flat, maybe slightly down from a year ago and we'll all recall we started to see a decline in procedures as we came into the second quarter.

Our assessment is that although it may have bottomed and we are not seeing necessary declines but we have not seen the increases in procedures at least in cardiology. However, our business, as you know, is well diversified into cardiology, radiology and into the OEM side of things. So there are a couple of cash issues and EBITDA issues that I would like to have Kent Stanger go ahead and just address for a minute. Kent, you want to just jump in the performance issues for the benefit of our listeners.

Thank you. Yes. It's nice to see that our EBITDA calculations are now at $32.8 million, which is a record. So even though our earnings haven't reached a record, the EBITDA numbers are now surpassed any of our prior years. I was also pleased to see our cash flow from operations was 30.7 million, which is also a record. It's up nearly $5 million over our best year previously.

So what we are seeing is the -- we are starting to see the leverage and it's showing up in the gross margins but also in our CapEx expenditures and the non-cash expenses and amortizations that are associated with that. As our income improves and as our inventories -- another big item is we were able to reduce inventories of over $5 million last year net of our acquired or acquisition inventory. That contributed a lot to our cash flow. So as we become more efficient in our use of labor, our use of facilities and fixed costs as well as our inventories, it's really generated a lot of cash and I'm proud of the progress we've made this year.

And while we have the staff here, I think it would be appropriate to congratulate them on a job well done. And they know me pretty well. We will say this now and as soon as this meeting is over it's what have you done for me lately, and that is where are we going from here?

One of the advantages I think that we have going forward is as we add those 150 basis points going forward that we're already seeing, we did not have the benefit of a lot of the programs even in the fourth quarter that we will see going forward next year.

Now we have set some goals, in terms of cost savings, of going offshore, in terms of reductions of inventory and I will share a few of those with you. We believe that even though we can grow our business at 8% that we will still reduce our inventories this year by a couple of million dollars. We believe that in our ability for cost savings, I think the number that we settled on for cost savings was $5 million. So we believe that 4 or 5. I'm going to give a little room here. We still have $4 or $5 million worth of cost savings that will come in in different increments during the year so we won't get the full benefit but those cost savings will be implemented during the year and we think that's significant. We have additional offshore capacity that we'll bring up in the late first and early second quarters. Then we have a number of new products that we are quite excited about and new platforms. And for just a moment I would like to address those for a second.

We made a press release earlier in the week that we had concluded the Micrus transaction that we announced back in November. And essentially what that calls for is that Merit has acquired three technology platforms. Those platforms or at least one of them now is in the process. We believe the largest opportunity is in process of being transferred. However, the Micrus will continue to produce the product for us which will Meritize for at least one year and we hope by the time we roll around until November, so it's actually less than a year, then we will be producing that product our self in our own facility. That's well on its way.

We also talked about a acquisition of a hemostasis product from Dr. Tim Clark. We worked with Dr. Clark before on the Sea Dragon. This particular product is one that is going to have about a 75% gross margin. It's a product that is used for declots and other areas where we have tracks that are draining or other areas where we go into the body and where we would use a purse string suture and essentially closes down and tightens that suture up so we can close off any of the oozing or drainage that comes out of those wounds. Again, used in interventional procedures both in cardiology and radiology.

So we are quite excited about that. And we should be on the market, by the way, with that patented product some time in the second quarter. So we aren't very far away from it. Part of the reason is because of our relationship with Dr. Clark and the work we had done prior to closing the deal on other products that had some crossover. We are excited about what that means and it's something really totally unique and we will be about a $15 product, but we think it's something that will be entree into a lot of opportunities for us.

We also have -- we believe we will introduce somewhere around 15 additional products this year. One of our goals is to continue to look for technology that upgrades our capabilities in terms of platforms for the future and higher margin products. So we've worked a lot this year on those types of transactions. We are looking at others as well as looking at other opportunities where we think acquisitions that fit into the company which may go beyond just product line extensions. So we have a couple of ideas there. We are looking at them and talking there. We are in a very good position, as you all know. We have no debt. We have the capability to leverage our balance sheet. And so we will be looking at those. And we think the current market conditions are probably going to lend themselves to some type of transaction this year as the cost of smaller single product or companies that just cannot spread the cost over the requirements that are necessary worldwide. As those become more and more apparent, we think there are going to be more opportunities for us.

In the mean time, we have our competitors who continue to be focused in other areas as well as some spin-offs and some other types of transactions that are going to kind of change the landscape. We think that as we move later into this year, particularly in probably the late second, early third quarter that we will start to see the benefit of some of those and some momentum in the third and fourth quarter and then a lot of momentum as those projects and things then move over to Merit in '09.

So all in all, we are in good shape. I think the staff has done, again as I mentioned, a great job. We've staffed the areas that we think are necessary to be able to sustain our growth. And we think we have our financial models in place to be able to deliver improvements in margins and earnings for several years to come. So we are in a great position. Our capacity is probably somewhere around 50%. So each sales dollar that goes on top there starts to reduce unit costs and we are not operating in a false economy. We have plenty of capacity.

And also as a point of interest we, as I mentioned in one of my previous calls, the sensor operation is up now and fully transferred and running. Everything is shut down in California. That's going to be about an $800,000 swing from last year to this year and that's significant. We were profitable in all of the divisions of the company moving forward. In fact, we just got our January numbers and, save some intercompany issues, we are profitable in our MC tech division, we're profitable our sensor division. Again, this is moving into January and one month that's not a quarter made but we made 140,000 net after tax down in our Richmond facility in January. So I think all of the -- I think all of the wheels are greased and the organization seems to be moving forward quite nicely.

All in all, I'm pleased, at least for today. As we start tomorrow morning, it's looking at each and every opportunity and trying to deal with the various challenges of what we can still see as a somewhat challenging market. Kent?

I just wanted to comment on the gross margin improvement. There were some nice trends, not only through the entire year but when you look at the fourth quarter in particular, the things we have been talking about with head count reductions and automation and other ways we became more productive and able to reduce our manufacturing head count by 13%. The other thing that was interesting was that we saw mix changes that were helping our margins. We saw increases in some of our higher margin products and some of the lower margin ones were less weighted and that was also helping our margins. Those I think are nice trends that we should be able to continue.

So, again, we had preannounced because of the gross margins and a little bit better sales than we had anticipated as we moved into that fourth quarter. These are the cold hard facts now which are pretty straight up with what we had discussed before with a little bit more spice thrown in, in terms of kind of what our strategy is and some of these new opportunities. But I think that pretty well does it. I think it would be probably appropriate now to open it up for questions and we will do our best to answer those if you care to ask. We will go ahead and turn the time now over to our operator, and we will open the lines up for calls.

Thank you, sir. (OPERATOR INSTRUCTIONS) Our first question is from Dave Turkaly with FIG. Please go ahead.

Hi guys, this is Sean [Bevick] in for Dave. I just wanted to know if you could explain a little bit more detail any of the 15 new products that you have coming out in 2008?

We will talk about a few of them. One of them, of course, is the slip knot which we talked about is a hemostatic valve. Another one is our new digital inflation device that we are very, very excited about. That will be later on in the year.

We have the biliary product which we announced we have received approval for, but we will launch that product in the next 30 days. We have a couple of new Prelude products, one is a product we call the Short Sheath. And that will be coming out. We have -- help me here. Give me a couple more. Yes, we have the new market tip sheaths. They released the last couple of weeks. We got FDA approval so we are just rolling those out now.

I'm sorry, go ahead, speak up -- Relaunching the ReSolve. That's both the biliary and the standard one will be relaunching that so there is some products there and improvements we made there. And then, of course, we hope to launch this year our Irish project. We have not talked about that. We hope that by the time we get to our next call we will be able to do that. And then there are several products that will be launched out of these acquisitions we talked about. But for competitive reasons we aren't going to talk about the specific product or the timing.

There are a lot of those and there is another hemostasis valve, that's the short hemostasis valve. So there is a whole bunch of stuff, Sean. And then the new one -- yes, thanks, Joe. The MAK NV. A great product that we expect to introduce I think in the second quarter. And the MAK NV is a product that's an $85 product that has about a 75%, 65-75% gross margin. And I think if I were going to pick one product that I think will have an impact this year it's probably that particular product. The MAK NV is a nonvascular vascular access product that is very exciting.

And one other thing, Sean, I'm sorry just to throw this, but I just thought about it. Looking down at our national accounts manager and I think one of the other things we saw this year that I did mention on the call, is that the fact we signed three or four contracts in the third and fourth quarter that I think will have a huge impact on us going forward. That's a long answer to your question.

Okay. Thank you very much.

Thank you. Our next question is from Christopher Warren with Friedman, Billings, Ramsey. Please go ahead, sir.

Couple of questions, guys. First of all on kits and trays, noticed sales were about flat in the quarter. Is this a concerted effort to sort of minimize growth there in order to get the sort of mix shift benefits you mentioned?

Yes. I don't think there is any secret that that's our lowest margin area. So we have been trying to incentivize overall other areas that will give us more profitability. However, as I mentioned on our call, we had a very nice performance in January and I think our business down in Richmond is doing quite well. But in that fourth quarter a lot of that has to do with packers get their orders in early so that they can get their stuff into the third quarter. They can build it in the fourth. I think that was part of it. And just the slowdown of procedures that we have seen. That would be on that cardiology side. And I think that's one of the things that I alluded to that tends for us to believe that things haven't necessarily turned up. They probably flattened out. Kent you want to comment?

We also had a decline in the (general) health of the mix but we had a low margin OEM product that was a kit product to another company that had been discontinued and then the comparable thing was one of the big things that went down.

And that was a couple -- how many millions?

1.3 almost.

In the fourth quarter?

Yes.

That was another issue. Compared to a year ago, there was an OEM customer that dropped out. We are selling, by the way, selling that product direct now under Merit's label at a 65% gross margin. So it's much better for us even though the sales dollars are lower we are making more money on less sales because of the margin and the fact we are direct. That's a little confusing and we will be happy to maybe clarify that on a follow-up call.

Great. And a question on the market in general. I know you said sort of flat, maybe declining year-over-year. Could you describe a little bit sequentially from the third quarter and then into fourth quarter what those trends were?

In the third quarter that's, as you know, historically the slowest quarter for us because of the summer shutdown and slowdowns. And we see that both in the United States and Europe. It is historically our slowest quarter. In terms of the trends, and I don't have those in front of me to go from one to the other, -- what we -- can we call you back on that one? I don't have the numbers in front of me sequentially third to fourth. I just don't have them here.

And then last question. I know you had a couple great GPO contract wins and [Namek] is going through a little bit of a distracting time. Can you comment on at least the chatter about there, request for proposals? New business rolling in?

Yes. It's a tough one because I never like to underestimate our competition nor do I wish them any misfortune. On the other hand, we are already getting calls that we may not have gotten before because they were under group purchasing agreements with Boston. So we are getting a lot of calls saying, okay, listen, we always -- in fact I had one of these today - we've always wanted to buy stuff from you but we always had this contract that was tied up under the umbrella. Make sure your guy gets out here because now is the time when we want to talk to you. Then there is going to be quite a bit of disruption, we think, in Europe as there are some manufacturing plants, we have to move production and I've heard, this is just chatter, that some of it might come back to the U.S. but they're still going to try to service Europe and all this sort of thing.

The bottom line is this. We're going to be competing with a division that's about $180 to $190 million, so just slightly smaller than Merit with about two-thirds of the sales force we have and about one-tenth of the products. I think that bodes well for Merit. I don't want to get puffed up. I don't want to overstate it. But I just have to believe it -- and candidly we are going to target those accounts. We are going to go in and target those accounts because we believe we can offer more value, broader range of products and better service. That being said, I'm sure that they have a different answer and a different strategy. But we are pretty -- we are excited that the playing field has been leveled out a little bit.

Okay. Thank you so much. Appreciate it.

Thanks, Chris.

Our next question is from Jason Bedford with Raymond James. Please go ahead.

Hi. This is his associate, Stephanie, filling in for him.

Hi, Stephanie.

Hi. The first question is could you talk about the percent of your revenue that is currently being manufactured in Mexico and maybe what that looks like in 2008?

Yes. We are generating somewhere around 5% of our sales are being produced there right now. And we believe that that percentage will probably double this year. We have additional products that are right now being transferred there and being qualified there. And we think that will all be finished up no later than the mid second quarter. So I think -- Neal, am I right on that? Okay. So that will about double that capacity going down there.

Again, most of these products are products that have high labor content and low engineering requirements. We have a full time Merit engineer there. They have engineers at our contract manufacturer. But it's essentially going to double. In terms of benefit to the company, we will probably only see about four months of benefit because by the time we get transferred, move the existing inventory off the shelf and then replace it with the lower-cost inventory, you are going to see it in the last third of the year.

Okay, great. And then are there any other cost savings initiatives that you are planning to implement in 2008?

Yes. And I'm glad you asked. We had mentioned in kind of the front end of this discussion that we believe there is another $5 million worth of annualized savings. And these are projects that have to do with automation. They have to do with just simple things like flow and layout and that sort of thing. So there is a lot of money there and a ton of money in cost savings on purchase parts. We had a meeting earlier today where there was $60,000 or $70,000 that was put on the table today. That was at 10 o'clock this morning. We looked at one here two days ago that had $100,000 in savings. Another one that has $2.7 million in savings. And these are materials on an annual basis. So there is a lot of stuff out there that we think we can do a better job of that have to do with increased volumes, that have to do with candidly competition and those sorts of things. Packaging.

I will give you another one, and I have to mention this. We were talking just before this meeting started. We have a package in which we do a lot of printing that is not necessary. It can be put in an instruction for use. It reduces the cost of a package that we sell millions of by 20%. So there is a lot of those sort of things, Stephanie, that we really have our eye on because there is so much opportunity for cost savings and, of course, that's all going to flow right through the model. Going to give us higher gross margins and of course higher profits. There is a lot of stuff in that area and everybody's compensation. This is another important part, not just rhetoric, everybody's compensation is going to be tied to these goals that the company has set in terms of the cost reduction. So everybody has their eye on the ball.

Okay. That's great. And just one last one. On the last call you talked about seeing some strength in the Japanese market. Have you seen that continue into the first quarter?

Yes, I think that might have been -- let me clarify. What we've said is that there had been some disruption because of some products that were being reused in Japan. And that those products had actually caused some serious illness and I think in some cases death. We were not one of the companies whose product was being used, although we've been in the Japanese market for 20 years. What that did was create a lot of opportunity for us to replace those competitive products and we do see that those particular aspects of the business are continuing to improve.

Okay. That's all. Thanks.

Thanks so much, Stephanie.

Thank you. Our next question is from Shawn Fitz with Stephens Incorporated. Please go ahead.

Fred and Kent, thanks for taking my question.

You're welcome, Shawn.

Fred, as we think about all of the various initiatives you all have to continue to reduce your cost and expand gross margins, it sounds like you continue to move things to Mexico. You've got some strong automation initiatives as well as a focus on the purchasing side. Which of those things as we think about the next 12 to 18 months has the potential to be the most meaningful contributor to your gross margin expansion?

It's a good question. As I mentioned, the Mexico issue and some of that we are going to get the benefit in the last third of the year. If we take a look at the cost savings initiatives, it seems to me that in most of those areas we can affect those the most efficiently as well as with the -- just the streamlining. The lean manufacturing is an example. I'm aware of one cell which there will be a reduction of 12 or 13 head count in that one area alone. That's a significant amount of money. So it's a tough question, Sean, but I think the best way to answer is to say, we have our focus on all of them. I would have to go through and really look and see when they all kick in. I will temperate by saying all of them are important to us. That's why we've identified them. But I think it's the streamlining and the purchase parts that is probably going to give us the best bang for the buck this year.

And then, Fred, just as we kind of think about all those opportunities that you are pursuing aggressively, could you just kind of talk about what you think, give us some guideposts in terms of what kind of underlying gross margin profile could look like for Merit Medical?

Again, what we said, this is our story and we are sticking to it. That is we believe we can add 150 basis points year to year which will put us at about where we are, where we finished the fourth quarter, just at around 40%. Now, you guys are pretty astute. If you take $5 million in savings and you take that over a couple hundred million dollars, that's 250 basis points. But now what we have to factor back in there is when they come into play, whether they be half a year or three months or nine months, and then we also have price and cost increases.

One of the other things I think that is favorable and something that I have been keeping a very close tab on is that we have seen the labor market in terms of the pressure on the labor market because of the slowdown of the U.S. economy start to take hold in Utah. And I think one of the areas over the last -- I would say two or three years that has been the most difficult is the pressure that we had the upside pressure we've had on wages. So that's part of the reason we have gone to Mexico.

But what we are starting to see in our own area is that's starting to slow down. In fact, where they've talked about growth in the state of Utah of jobs of 3.2% just a month ago, now we're talking about 2.5% and I believe before the year is out what we will really see as we approach the third or fourth quarter in our state that you will probably see that at 0% growth. I think we will be in for a big slowdown in this state as we move to the end of year which is going to take the pressure off wages. So we have not raised wages in this facility because of what I see as a softening in the market. I think that will continue and I think the data supports that.

Great.

So just a little economic report for you.

And just quickly back on the new product side of things. One of the products that I think you all have expressed a lot of optimism about was the new dialysis catheter that Merit acquired from Datascope. Is that product kind of fully developed and ready for prime time and are you still excited about the opportunity there? Maybe give us an update on what you're thinking about 2008 for that product.

There are several positive things in that particular area. One is that we were seeing a lot of traction, much more than I expected over in Europe. We are starting to see more and more in that particular area. We are still bringing out different models that they didn't have. For instance, they didn't have a femoral approach catheter. They didn't have some other links. They weren't offering them trays. They didn't do custom stuff. With the margins that this particular product line affords, we think those are opportunities to take some of Merit's skills and then add them into that market.

Additionally, I'm aware that the upcoming SIR meeting there at least two physicians that I'm aware of that will be talking about why they like to use this catheter over the competitors. So I still think it was a great acquisition. I think what we paid for it, you recall we paid $3 million and we got $3.8 million in sellable inventory as well as the intellectual property and equipment and all that sort of thing. So it was a great acquisition. I'm still excited about it. I still think it's a great opportunity and, one of the big problems we have, Shawn, is that we have a lot of products for people to sell. And what we tried to do this year with our sales force is we have -- and I won't tell you what they are on this call, but we have eight focused product groups. These are eight product groups that we think are products that we believe will give the company the highest margin and give us the best opportunity against our competitors.

As you also know, we have thousands of products. And one of the things we will have to look at and if we do better than expected we will start to expand our sales force with any additional funds that we get; we have to earn the money but we will start to expand it. And I think we need more forces out in the field. But we will only do that based on the monies that are available based on the sales dollars that come in that will allow us to do that. So there's a lot of opportunity out there and still many of our competitors are still have their heads down or they are heading for the hills and we think that's a good sign for Merit who is very stable and has a good portfolio of innovative new products coming out.

Great. Fred, final question, as we think about your guidance for 2008, is it safe to assume that you all are not expecting any significant changes in the macro fundamental environment?

Yes, I think -- what we've said is that we look going backwards looking at the third quarter and the fourth quarter and candidly part of the second quarter. So if we look at the last three quarters of last year and then look forward into next year, we kind of just said everything is going to kind of stay the same. Now as we all know, a number of things have changed both with our competitors, some of the spin-offs, some of the other issues, but we think it's better for us to have those things change and tell you rather than predict them and then come up short. We don't want to do that. But I would say that they are based on the lay of the land that we've seen looking backwards and as we start the year out. The upside potential could be in any of the products, the market improving or any weakness and fundamental change in our competitive situations.

Fred, thank you for your time and congratulations on a strong finish for the year.

Thank you.

(OPERATOR INSTRUCTIONS) Mr. Lampropoulos, there are no further questions at this time. Please continue with any additional remarks you may have.

Again, we'd like to thank you for your continued support. We have a number of investor conferences coming up starting next week. We have three or four over the next 60 to 90 days. In addition, we intend to get out on the road with the various research groups that are following the company to get out and tell our story. We think it's a compelling story. We think that we have the cost structure. We have the products. We have the momentum and we have the capability, both in terms of capacity and capital. And so the business is in the best shape I've ever seen it. I still think Merit is on sale. And we intend to make sure that our strong fundamentals and our strong performance are understood by the street and is exposed to as many interested new investors as well as firming up our investor base as possible. So we are going to be very active out there telling the story, which we think is compelling.

We appreciate your support. I think in closing that what I would like to say is we did what I said we would do. We continue to believe that we have great opportunities going forward and we look forward to reporting to you in the future. But we wish you all a very good evening. We thank you for your participation and we will be available if there are additional clarifications. Kent will be available, myself for the next hour or so. And with that said, we will go ahead and sign off wishing you well from Salt Lake City. Good night.

Thank you, sir. Ladies and gentlemen, this concludes Merit Medical's fourth quarter and year end conference call. ECT would like to thank you for your participation and we wish you a pleasant day. You may now disconnect.