Merit Medical Systems Inc (MMSI) 2008 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Merit Medical's second quarter earnings conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions).

As a reminder, this conference is being recorded today, July 23, 2008. I would now like to turn the conference over to Mr. Fred Lampropoulos, Chairman and CEO of Merit Medical. Please go ahead, sir.

Good afternoon, ladies and gentlemen. This is Fred Lampropoulos broadcasting from Southern California. The staff is assembled in Salt Lake City and we'd like to thank you for joining us this afternoon. As you saw, we'll be discussing our second quarter results, but to start out I'd like to ask Rochelle Perry, our General Counsel, to read our Safe Harbor provision. Rochelle?

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 SEC which are 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.

Thanks, Rochelle, and again good afternoon ladies and gentlemen. We're delighted to report our second quarter results. As you can all see from our announcement, revenues were at $57.4 million. That compared with $51.8 million. That's an 11% increase and we're pleased to see that into the double-digit range. Revenues for the six months were $111 million compared with a $102.8 million for the same period in 2007, a gain of 8%. And I'd like to point out that that 8% range, which we'll discuss in a few moments, was again our forecast for the year.

We're pleased also to announce that our income was a record $5.8 million. That was up 62% compared to $3.6 million, and I should point out up from $4.3 million our first quarter. And we're just delighted with the results and as we point out this is really an effort from our entire Company, from the Sales effort to the Operation folks, and all of our facilities worldwide. And so, congratulations to the staff and I hope you're as pleased as I am with the results.

Now, there are several things that I think would be of interest to you. One that we're quite pleased with is we are just starting to see an increase in interventional procedures, and we saw inflation devices rise 8% in the quarter. And that's despite the fact that a large OEM customer, Kyphon, actually has slowed down. So what we're seeing is growth in real terms not based on somebody else's efforts, although we appreciate their business. But we're seeing that from our sales force and our distributors worldwide, and so we're very, very pleased with that.

Of course, you're all aware of the increase in gross margins to 42.7%. That's very, very exciting and for the first six months gross margins were 41.5%.

There are a couple of other points that I would like to make and that is, that if you take a look at our effective tax rate it was up approximately 130 basis points from the year-ago period. So, we're playing a little bit more to the government and some of that has to do with various adjustments and the fact that we have to estimate in the quarter. And you're all familiar of the adjustment that I'll let Greg Barnett discuss in a few minutes, or Kent, regarding the adjustment in the third quarter.

Now, simultaneous with our announcement today, we discussed and moved up guidance in terms of Merit's guidance. And just to refresh everybody's memory, we put together a forecast and a guidance in the fall, and then right after the first of the year we come out and we talk about where we're going to be for the year. You recall that we had a goal, a three-year plan that talked about increasing gross margins by 150 basis points per year from the base of 38.4, which would have brought this year our goals to 39.9%. Well clearly, we're above that and if we take a look at our performance in Operations, on the gross margin side we're up a year ahead of plan which is nice. I know that there have been times when we've been a year behind plan, so it's nice to be in front of this.

However, I would like to point out a couple of things that will be of interest to you and why in some ways we're actually below some of the analysts' estimates here, and then as we continue to want to be conservative. We're coming into the summer quarter which historically is slower and normally we will see a 3% to 5% reduction in revenues, as cardiologists and Europe and other factors play into a generally slower, sequential quarter. Also, because you would have lower sales, we would have less applied overhead and consequently we would expect to see lower gross margins.

Now, that being said, some of you will recall that we guided lower last year and we were pleased and surprised that we actually came in, even though the sales were lower, we came in higher on the gross margin side. But historically and our general feelings are -- and most of you have, at least the analysts have, a slowdown in the third quarter which is traditional seasonal adjustments that we see.

So, we're comfortable with the 8% growth for the year. We have hopes that we'll exceed that, but I think based on the first six months we think that our guidance is good. We are going to adjust up our gross margin simply because if we just did what we did in the first half, we'd end up at the same range.

And then last I'd like to point out that we have seen some pressures on the labor side of things that we've pointed out in previous calls, and also in commodity prices. Now, I just had the opportunity to listen to the base report just before the market closed and it talked about the pressures on labor starting to decrease, but commodity prices, even though we've seen an adjustment in the last few weeks in oil prices, down reasonably. And so we're still seeing, however, some of these commodity prices.

And although our gross margins for the first six months reflect those, we want to be cautious about those headwinds. We are seeing some costs come through. They can be negotiated, but we want to just make sure that we don't get too far ahead of ourselves. Now, the analysts can do what they want, but we feel comfortable in that guidance.

All in all, I'm very, very pleased with the work that the staff has completed; the ongoing projects, the automation. Cost savings are actually coming in ahead of our projected numbers in terms of coming on-line or at least being implemented. Let me restate that, being implemented, which means we'll see some of these opportunities going forward.

Also I should say this; I was disappointed in some of the newer products. There were just a couple of new products that were really not consequential in the second quarter, but we do have just a full load of new products; some of which are in being reviewed by the FDA and have been submitted and others that Merit is now doing their testing, particularly in our Irish project where we are now up and operational and producing and qualifying equipment. That's been a long haul. We're still not ready to discuss that project, but I'll go on the record as saying that we're very satisfied and pleased with the new products that we think will have a substantial impact on the growth of the Company going forward.

Now, that's about it. There are some other issues that you'll be able to see in the numbers that we sent out, but as you all know we have no debt. Our cash position was close to $27 million, and SG&A expenses, all of these things were all in line with your models; DSOs, EBITDA by the way I think is very important was $40.2 million at quarter end for the trailing 12 months. So I think the business is moving forward very nicely and we're pleased with it, but we also know that the real proof in the pudding is not just one quarter or two quarters. But I think Merit's efforts over the last year and a half to deliver what we said we were going to do, we think there is more left to do, more opportunities and more growth for our Company. And we appreciate those who have had faith in us and continue to be shareholders in our Company.

With that said, let me turn a little time over for Kent, some general comments that you might have. And then we'll turn the time over in just a few minutes to those who are in queue. So Kent, you want to comment please?

Thank you, Fred. Yes, I was really encouraged by the growth in our revenues that helped drive everything. And so seeing the PCIs come up a little bit, the procedure count, and some of the new products that we've introduced even last year starting to really kick in, I think the sales force has been well focused this year. We're seeing growth in the U.S. market as well as in the international markets from currency that really helped. And they're growing in real terms, but their currencies are amplifying that growth, so that really helps and drives a lot of things.

I also think that -- I'm excited about the operational gains we've had over the last year. It's been a long time coming. It's come from just the volume increases on fixed costs from the capacities that we invested in starting in '04 through '06. And that was planned and expected, but we've actually been able to accelerate that through some lean manufacturing. We were able to reduce our headcounts. We've moved some; some of those headcount reductions are due to Mexico contract manufacturing and automation.

All of these pieces are falling in line. We've been telling this story and it's nice to see it coming in, and like Fred has already mentioned, ahead of schedule and that leverage is accelerating and it's pretty interesting to watch what can happen when you can execute on that kind of level. We see some leverage also occurring in our SG&A right now, which is nice, as that revenue line picks up.

Our taxes they're a little bit high, partly because Congress hasn't seen fit to reinstate R&D credits which are important to us as a medical device R&D company. You probably noticed R&D expenses up a little bit this quarter as a percentage of sales, so we continue to invest in that. I expect that will come back, but we can't count on it yet. So anyway, it's a great quarter.

Thanks, Kent. And I think kudos go out again, as Kent mentioned, to all of our sales organizations; to Marty Stevens, Joe Wright, Matt Lyons to Lana [Buello] over in Europe, to our auxiliary companies, our Sensor systems and MC Tech. They all did a really good job. And then to [Arla Nelson], Ron Frost and [Neal Peterson] and the whole operational group; (inaudible) in Molding. I could just go on and on. There's plenty of credit to be handed out and they all worked very, very hard to accomplish these results. And again, we're looking forward to the opportunity as we move forward to finishing this year up.

I would say this in closing that the new products and the new technologies that Merit has been working on for some time are going to come into play and they're going to have a big impact and move Merit back into double-digit growth as we move into '09 and we're excited about that; double-digit growth on a bigger number. So we're looking forward to again seeing the fruits of our labors not just on the Operational side, but on the Research & Development side. We're spending a lot of money and a lot of time really focused on a couple of what we think are at least doubles and maybe homeruns. So we're excited about that.

I think that pretty well does it. The numbers speak for themselves. Again, congratulations to my staff, and why don't we go ahead and turn the time over and we'll go ahead and take some questions.

Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions). Our first question comes from the line of James Sidoti from Sidoti & Company. Please go ahead.

Good afternoon, Kent, can you hear me?

Yes, we all can hear you.

All right, okay. You mentioned, briefly on your comments about R&D, can you give us an idea on how long you think, or what level you think R&D will remain at for the rest of year?

Well, I believe it's going to stay between 4% and 5%. That's kind of our objective and it's more driven by the projects we have and the resources we're applying to complete the projects on a timely basis. So, that could vary a little bit, but our objectives are somewhere between 4% and 5%.

So with it ramping up now, should we assume we're getting close to the end of the project development cycle?

Oh no, no, it'll be continuous. We have a new pipeline and other projects that roll off and so the resources will be similar. They'll just be reapplied to new projects.

Okay, and then on the commodity pricing, how long does it take you to pass that cost along? Is that something you can do in one or two quarters?

Jim, I'm going to answer that question. It depends on the customer. I'll give you an example of one product and, that is, let's talk about Microban catheters that use platinum. We've seen a pretty substantial rise in that. Those are hospital and international accounts. Some of those are on national accounts and so they have to wait until those are up. Other ones that go out to distributors and those that are not under contract we can go ahead and, in fact, we'll be meeting in the next two or three weeks to discuss which price increases are justified based on those increases.

So, it's kind of a mixed bag. Some of them you can pass on pretty quickly; others of them have to work through the cycle and national accounts. But I think one of the valuable things that we've learned through what's been going on the last couple of years is to make sure that we have the correct language and the correct ways to be able to pass through the expenses of let's say shipping and some of these other types of issues. So, but we've been doing that and getting these types of results while we've been seeing that.

So we did raise prices last year on a lot of our OEM customers because of higher resin costs and utilities' costs, and we'll be meeting again and it's likely that we'll go ahead and raise prices again. We do have some pricing flexibility and pricing power in the market in the conditions that we're in. It's not 100% for everybody, so it kind of cycles through. I would say if I were going to guess this year that somewhere around 50% of our products would be able to get priced through the balance of this year, and then I would say the other 15% over 12- to 18-month period.

Right and then the last question on the revenue breakout, catheter sales again a very good quarter there. Is there any particular line that's driving that, or was it across the board?

You know there are a lot of them across the board. I mean some of our safety and [Centesis] products -- and then to be very candid with you, Jim, as much as I'd like to discuss it I don't want to rub my competitor's nose in it, but there's a couple of areas that we're kind of taking names and doing a little damage out there to our competitors. And I'd actually prefer not to go and talk about it publicly because it would kind of hurt their feelings. I just don't want to do that. But I'm just telling you that across the board we're seeing in the catheter areas that our competitors, because of disruptions, companies being sold and the lack of focus in some of the areas that Merit plays in, we continue to see substantial opportunities going forward.

All right and I did actually have one more question. On the Mexican manufacturing, what are the plans for the rest of the year? Are there anymore lines to move down there?

No, I think we're pretty well done for this year. There could possibly be one or two more, but the other thing we have to do is we have to let that organization kind of absorb it. We put a lot down there pretty quickly and like anything we had a few problems, so we think that we're going to just kind of stand pat; maybe one or two more. I think one other thing that we are planning on though and starting to look at seriously, is the opportunity of rather having a contract manufacturer, that somewhere down the road Merit would have their own facility that we would control, which would make it even more profitable.

All right, thank you.

(Operator Instructions).

Let me make a comment while their fingers are a little jittery, and that is one of the other things that we accomplished during the quarter that we did not discuss today is the fact that we opened our new distribution center in Maastricht in The Netherlands. The exciting part about that is it's essentially break even in its first month and we believe it will be a contributor. It's a beautiful 30,000 square foot facility in which we have our customer service, our sales and marketing and our distribution of all of our products. And we've been in a contract distribution center that really was lacking in a lot of the creature comforts with simple things like air conditioning. But we're in this beautiful facility and we think that it's going to enhance both our image and our profitability going forward. Hopefully, we have another caller?

Our next question comes from the line of Edward Han-Burgess from Raymond James. Please go head.

Hi, this is Eddie Han-Burgess filling in for Jayson Bedford.

Hi, Eddie, how are you?

Good, how are you?

Good.

Congratulations. We have a few questions on gross margin line.

Go ahead, please.

Where did the strength come from? Was it volume increases, manufacturing efficiency, sales force incentives? Where did it come from?

Well, it's all of the above. First of all on the top line on the mix, we have several products that we have focused on that become requirements of the sales force if they want to make various levels in their compensation in what we call the President's Club. For instance, our Impress catheter is a catheter line that for the first six months is up 100% over last year. There are several other products like that. Our ReSolve drainage catheters are up 48% from the year-ago period. So, a lot of it is in the mix on those higher-margin products.

Another part of it is, of course, the absorption. As Kent mentioned earlier, about four years ago Merit opened up 250,000-350,000 square feet of new facilities; some in Richmond, some in Galway, Ireland, and of course the majority of that in Salt Lake City. And we had to operate those facilities. With better sales and better mix and those incentives we get better absorption.

But I think probably the biggest issue of all is the reduction in headcount in automation. We're still down even at this point somewhere around 150 employees from where we were about I'm going to say 18 months ago. And we're doing that because of automation, because of offshore, and more importantly the simple things like just streamlining and lean manufacturing. So it's coming from all of those areas, Eddie. It's just across the board in just about everything we're doing.

We're trying to figure out if the gross margin is sustainable? I think your guidance implies that gross margin at about low to mid 41% for the second half.

Well, let me answer it like this. You know, gross margins are again as you pointed out a function of volume, a function of mix, a function of material costs and labor. All of those things are what drive that. And we believe that with our new products; we believe with the lack of focus from competitors; we believe that the areas that we have concentrated on will allow us to take and to continue to build this company, and I also will say some discipline. There are some products that we're going to discontinue. That might sound like it might affect the revenue line, but I'll give you an example. We have a couple of areas where we have two or three needles and we only need one needle, and so we'll become more efficient with less inventory by starting to lean out our product offering. We have a lot of products and there's another area.

When we put our plan together and started talking about it a couple of years ago, we felt that we could 150 basis points per year. We're a year ahead of that. But if you're asking me can we add another 150 basis points next year from this, the answer is yes, and the following year the answer is yes. So, we think that there's at least another -- from what we can see today at least another 300 basis points we can add on to this over the next 30 months. So, that's what we hope to be able to deliver. I hope that answers your question as to sustainability?

Great, one more. Is there a limiting factor in the portfolio that would prevent the gross margin from getting back to its usual 40% at the employee level?

Could you repeat the question?

Is there a limiting factor in your portfolio, a particular product or a franchise that would keep you from meeting this 40s' level?

I don't think so. You know, we do have some lower-margin product areas. For instance, our custom kits and our trays and some of those areas and even some of our catheters have lower margins. Ed, I don't want to call them a drag, but for lack of a better word I guess that's what they are. Some of those are in the 20% to 30% range, and obviously those are going to have a drag on your gross margins. But again, it's a function of volume and once you get those fixed costs covered, then you're really just dealing with some of those variables. And as we continue to grow as long as we keep our CapEx and our capacities in line and those sorts of things, we feel like we can add over the next 30 months another 300 basis points and then would put us based on our guidance today at about, what, 44.5 or something like that which would move us right up into that mid area that we just discussed.

So, I think if you don't manage this; on me it comes down to management and focus. If your focus is to sell kits and trays and that's all, then you're going to see lower gross margins. But if your focus is to sell ReSolve catheters and to sell other products at higher margins, which is what the sales team is doing and I think doing a very good job of, then I think what that helps to do is put their focus in those areas which allow us to see a higher gross margin across the board.

So, I guess we're limited by the way we think and the way we manage the Company and I think that we've proven that we will actually go past what we did, I think, in 2003 and 2004 when we flattened out. In fact, our intermediate term goal is to get to 50%. Well, that's a very, very aggressive goal, but we think over the next five or six years that's what we can get to. So, we're just going to work towards that.

Great. I think you had planned about 8% growth in top line for '08. Do you think '09 will be factored into this year?

Yes, I do. I believe that we can return on -- of course, higher numbers, I believe that in '09 that our growth can be double digit. I think that's going to take -- in order to do that, we have to finish up the projects that we've discussed and have not identified, but they're well on their way. We need to get those products in the market to be able to do that. But I believe that those are coming along a little slower than we expected. They always are, but we believe in that.

We're pleased to see this up-tick in procedures. I heard someone say today that for the first time in many, many quarters they saw 3% up-tick in interventional procedures. That's the first time that's happened in a long time. We're seeing that in our inflation devices. So you take some improvement in procedure growth rates, the competitive factors out there in some of our competitors not focusing, some of the newer products, and candidly some things that Merit is doing to be able to sell many of the products by the way that we're managing and constructing our sales force.

So we believe, in summary, that we can get up to those mid digits. We believe that we can grow with double digits and you know you can do the numbers. That means that Merit's earnings' capability going forward is going to offer shareholders a lot of opportunity. Again though, for this year, we sticking by just the upgrades that we have this year and we're starting to work; in fact, starting here in just two weeks we'll start working on our planning and forecasting for next year.

Just to make sure I have it correct, did you say double digit in 2009?

That's correct.

Thank you.

Our next question comes from the line of Dave Turkaly from SIG. Please go ahead.

Hi guys, this is [Sean Bevick] actually in for Dave today.

Hi, Sean, how are you?

I'm doing good. The R&D tax credit, if that gets reinstated will that be retroactive or just --.

Boy, you'd have to make a call to Washington on that one. You know, I don't know. I will tell you historically that's what they've done. Historically, they've gone back to the first of the year, but we're not really counting on that. The only thing we do have though, Sean, that I think is worth mentioning is that we passed a law in the State of Utah; in fact, some people call it the Merit Law and it really was to the credit of numerous people but particularly Greg [Freedy] who is head of Government Affairs. And we worked out what we think is the most aggressive and exciting Research & Development tax credit in the State of Utah. So we are going to have the full benefit of that tax credit this year that we didn't have last year.

Okay, and then on the tax credit, I remember in the last quarter you mentioned it was going to be bouncing around at 31% in the third quarter and then going back up to 38% in the fourth quarter?

Yes, and the reason for that is the pronouncements from FASB that --

FIN48.

I'm sorry, Kent?

FIN48.

I'm sorry, FIN48 that requires that we go through and we estimate -- I don't think -- why don't you explain the FIN48, Kent?

Greg has it.

We have a - in the FIN48 we have what we call some discreet items that will happen in the third quarter relating to the lapse of statutes on state and federal tax returns. So we're able to flush those benefits back in on that quarter and we can't use an effective rate throughout the year. We have to do it in the quarter that the statutes lapse and that will happen in the third quarter.

Now, let me just kind of take and I'll translate that. You have a tax liability for three years. If you go unaudited and unchallenged, then you can take that year and crop that off and then you can flush it through your system. So that's essentially what it is, the statute of limitations expires on that year that's out there.

But in conjunction with that, you can't level it out like we used to try and do to make sense of it. We have to do it in a herky-jerky method that they are prescribing.

Which I think is unfortunate. Now, did I hear that that's going to go away in the first of the year next year, though?

No.

It'll still be there.

Okay. Yes, we don't want anything to be too smooth or too reasonable.

So those two rates that you gave before will hold true for the rest of year?

Yes, the fourth quarter may be a little lower than that 38%. It may be, you know depending on if we get the R&D credit back from the federal side, it may came down another percent or two.

That is when we true-up for the year, usually, and so we can and will do that depending on whether -- we'll try to be conservative but sometimes they have a little adjustment there sometimes.

Okay thanks, guys.

Thanks.

Our next question is a follow-up question from the line of Edward Han-Burgess from Raymond James. Please go ahead.

Go ahead, Edward.

Can you kindly review some upcoming products?

You know we have several projects that are coming out. We have a short sheath that we filed with the FDA and that's going to be an exciting opportunity for Merit. This is used for fistulas. The reason that that's exciting we have been purchasing it from an outside vendor for many, many years as part of a Mallinckrodt acquisition and we can reduce the cost almost in half. We'll be producing this in-house. It's actually being produced as we speak and it's been filed with the FDA.

The other thing is, is that we were unable to get that product released in Europe, but we'll be able to sell this worldwide now, now that's Merit's manufacturing. A new product, again, that's an exciting opportunity with we think some advantages that our competitors don't have. A new product called a Slip Knot that is a closure device for, again in the same market when we're talking about fistulas; a couple of vascular products; and a new MAK NV which is a non-vascular access product. And then a couple more that I'm going to kind of keep under the hood here until they're actually released. We have a new homeostasis valve that will be out probably in about a month.

That's the highest gross margin product that Merit sells in its bag, and we have a new product there that's going to be rolling out. So, we have plenty to do there, and then again this does not include the ability for Merit on the Micrus transaction we'll be producing those products in-house probably some time late this year, as well as again as I mentioned, the most important one is the Iris project. Again, our commitment has been to announce that project when we file with the Food and Drug Administration. So as soon as we file, which again I hope will be in this quarter, then we will go ahead and announce it because it will become public knowledge. So we have a full portfolio of products to go out there and sell, and a couple of more products again as I mentioned, Ed, that we're not speaking about right now.

Do you want to mention the placing device, Fred?

No, but thanks for asking, Kent.

Fred, how many products have you lost this quarter?

Not very many. Ed, I think you missed this early on, but one of the things that I indicated that in this quarter we really only introduced a couple of new products; a couple of sheath products and a homeostasis product this quarter. So I'm a little disappointed very candidly in the stuff, but the reason is because we have all these teams working on these new products; that we have in one case we probably have 25 people working on.

So in defense of Research & Development, you can see it from the expenditures, they're actively engaged and we are going to see, like I said, at least five or six new products in the third quarter, and then hopefully several more in the fourth quarter. So, we're still very busy, have plenty of new products; and as I look at all of these products that are coming in the third quarter, none of them are products that Merit is currently selling at all. So they're all brand new. They're not products that are updated. These are all brand new products that we're introducing that are new to Merit's bag. So we're looking forward to those opportunities.

Okay, thank you very much.

(Operator Instructions)

Well, it sounds like we are finished then unless -- anybody pop up there?

There are no further questions.

Well, let me just close, ladies and gentlemen, by again thanking you for your interest in the Company and your patience. We are, again, excited about the future. I'm pleased and I want to congratulate the staff and all of those who have done so much to make this all happen. We've seen that reward for our shareholders. We believe that we have a lot more to go. We're, I think, holding the line in terms of our headcounts. We're spending our money wisely and in projects that are going to have a big impact on the Company going forward.

We have plenty of capacity so there are no large needs for CapEx. We have plenty of molding capacity, manufacturing capacity; there are areas of course that we have to spend money. But all in all I think the Company is doing very well. I'm pleased with it and again I thank all of you.

Just in closing, a reminder that I think we are going to somewhere around six or eight conferences that we've been invited to between now and the end of the year. So we're going to be out telling our story and visiting with investors and speaking with a lot of enthusiasm about the opportunities that we think exist. So again, we'll go ahead and sign out from Southern California and from Salt Lake City thanking you and wishing you all a very nice evening. Goodbye.

Ladies and gentlemen, this concludes the Merit Medical second quarter earnings conference call. You may now disconnect. Thank you for using AT&T Teleconferencing.