Merit Medical Systems Inc (MMSI) 2013 Q3 法說會逐字稿

Welcome to the Merit Medical Systems Inc third quarter 2013 earnings conference call.

(Operator Instructions)

I would now like to turn the conference over to Fred Lampropoulos, Chairman and CEO of Merit Medical Systems. Please go ahead, sir.

Good afternoon, ladies and gentlemen. Thank you for joining us today. We're delighted to be with you, out in beautiful Salt Lake City, with a temperature of about 60 degrees and blue skies. So we thank you for taking the time. We're assembled in our conference area with members of our general staff and a special guest, our Country Manager from Brazil, Christian Tamagnini, who is here with us today. Christian, thank you for joining us from -- all the way from Sao Paulo. So, we're delighted to have you here today. We will turn some time over to our General Counsel, who will pronounce our Safe Harbor Provision, Rashelle Perry.

Thank you, Fred. During 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 historical, may be considered forward-looking statements. We caution you that all forward-looking statements involve risks, unanticipated events and uncertainties that could cause our actual results to differ materially from those anticipated in such statements.

Many of these risks are discussed in our annual report on Form 10-K and other reports and filings with the SEC, available on our website. Any forward-looking statements made in this call are made only as of today's date. We do not assume any obligation to update such statements. Although Merit's financial statements are prepared in accordance with accounting principles, which are generally accepted in the United States, GAAP, Merit's Management believes that certain non-GAAP financial measures provide investors with useful information regarding the underlying business terms and performance of Merit's ongoing operations and can be useful for period-over-period comparisons of such operations.

The table included in our release, which will be discussed on this call, sets forth supplemental financial data and corresponding reconciliation to GAAP financial statements. Investors should consider these non-GAAP measures, in addition to, not as a substitute for, financial reporting measures prepared in accordance with GAAP. These non-GAAP financial measures exclude some items that affect net income. Finally, these calculations may not be comparable with similarly titled measures of other companies.

Thank you very much. Ladies and gentlemen, again, we're thankful for your interest in the Company. What do I say? We have I think, arguably, one of the best quarters in Company history. Our sales were up 20%. Our core business was up around 11.2%. We add in the time that it has taken for our sales force, who are converting some of the OEM business in our Thomas product to direct. If we added those back in, it would add almost another $1 million to core. So, it's even better than it appears there.

Our business segments -- I think -- listen, I don't want to say that -- well, I guess I can say that we're surprised to the extent that every single business segment, every product line improved sequentially. We did this in what is arguably a seasonal quarter. So I think I should give you some explanation to why we think, as we look now back, because we had guided down, as you will recall, between 5% and 7%, which we will traditionally do in this third quarter, because of the breaks in Europe and other locations. People are on vacations. Physicians are gone. Sales people are gone.

That being said, the numbers came in and I think it speaks a lot to our strategies and the attention and focus that we put on the business. We all recall that first quarter. It was one of the most unpleasant calls I've ever had to make. This is one of the most pleasant. But I recognize that, as soon as we finish today, we have to start --we've already started on what we're going to need to do to make sure that we can continue to move the Company forward.

So if we look at our leadership. I think at the first of the year, we had some changes in the responsibility in Europe. I think in our group numbers, in terms of sales both in dealers and direct, they were outstanding numbers. They were all in the 20% plus increase in Europe in direct and dealers in a summer quarter. I think I would argue, I think, very effectively that is an extraordinary effort.

We take a look at our worldwide dealers. We have performed well there. If we take a look at our sensor company, if we take a look at our coatings company, if we take a look at our OEM -- just across the board, every segment performed in all of the various branches and facilities, from Melbourne to Richmond to Galway to Paris and others, Houston, Angleton facility. So, that, I think, is the leadership and the drive of the leadership team.

I think in terms of products and strategy -- I think that's something that is very noteworthy. It wasn't one product that drove this, it was essentially all of the product segments. So I think that is another thing that we hope that you will pay some attention to and consider and that is whether they'd be inflation devices, which are still the slowest group, but improved sequentially to our kits, to our standalone devices, to endo tech, which was close to double-digit growth. It's been slow for most of the year. All of these businesses and segments performed, I think, extraordinarily well.

This is all going on while operationally, we are now just starting to get used to our skin, so to speak, in terms of the new facilities. I think the good news is that in terms of efficiencies in the business, we are focusing a tremendous amount of effort in new automated systems, which will eliminate paperwork. To give you an example of one of those, so that you can see the impact that this effort will have, which will take months and years. This isn't something that will be done next quarter. This is something that will take, as I point out in my comments, all of 2014 and 2015. It is an ongoing effort.

But to give you an example of it in a situation. A work order that will come out of our new automated system can be on the floor, essentially, within 15 to 20 minutes versus, in the past, it could take 4 to 5 hours. Now, that is to assemble all the parts, get the paperwork in place and get it assembled for production. I think you would all agree that when you can do that, we can move inventory faster. We can produce the things to meet our customer needs and that acceleration, also takes a lot of cost out. So, that is just one example of the opportunities that we will have -- we have a lot of work to do on that part of it. So I think operationally, I think we're coming along.

But in terms of where we are -- we're at 15% or so of where we could be. That means there's 85% out there of things that we could do to get our goals. That 85% of additional things that we need to do, literally mean tens of millions of dollars in gross margin opportunities. In terms of gross margins, I think we were up 140 basis points last quarter, 150 basis points this quarter. It's even more significant than that when we take and reallocated the costs that were in SG&A for the facilities. So as we are starting this up, the costs were in SG&A. Now in the third quarter, a good portion of those costs are in the cost of goods. That would have been about another 30 basis points or something like that. So, even though we did 150 basis points, we actually even did better than that. So I think from that point of view, we did a very nice job.

On the SG&A side, I'm going to let Kent explain a few things to you there in just a moment. But I think even there, Merit has cut back in a lot of things. In terms of discretionary expenses, trade shows -- we have downsized, our Managers, across the board, are holding the line. So we are getting some leverage on the SG&A line and R&D line. So, Kent, there are a couple little unique, I think, entries, so to speak, that you might want to address on this area. So if you want to just kind of weigh in.

For SG&A costs, we just did a good job, a combination of higher sales and lower cost. If you look sequentially, they are actually down, which is unusual from the second quarter to third quarter in actual dollars. So when you are able to reduce your total SG&A costs, while your sales grow at 20%, you're obviously going to get leverage there. We got 150 basis points of improvement sequentially.

Then when you move down to R&D, we have got another 160 basis points or so there. That's been helped -- there was a $900,000 adjustment that came -- or benefit, I will call it, from the Irish government that was classified by accounting rules to a reimbursement or reduction of R&D expenses. But even without that, we would have been at 7.2%, which was down 70 bips. So, we were improving in the core, leverages in R&D, as well as benefits from the Irish government helped even more.

Okay. Thank you very much, Kent, for that weigh in there. Some other interesting points, that while we are growing at this level, we were still able to reduce our inventories by the $0.5 million in the quarter.

$3.5 million for the year.

Yes. Over $3 million for the year. Our inventory turns are improving. Just a general comment, in terms of cash flow and things like that. Kent shared with me a couple of days ago that we're about $10 million ahead of where we thought we would be. So, in terms of our expenditures in cash, we are doing much better there. I just want to also -- I think it's important to note, the confidence that Wells Fargo Bank has entrusted us with. They've been very, very helpful in terms of supporting our efforts.

We also have integrated the Safeguard business that we bought from Datascope. I will say that it was absolutely seamless. I think our folks, both in terms of our due diligence, in terms of our taking orders -- we didn't miss a beat. So we're going to be showing that product and introducing as a Merit product down at the TCT next week. We're very excited about the opportunities there. The RAD Board from Radial Assist, we are actually selling these things. We haven't actually officially launched it, but we're selling them faster than we can make them.

When you take a look at this Radial strategy -- I hope I get some questions on it in terms of both the prop, the access, the delivery and the closure, it is I think a strategy that we have put together -- I know some of you were a little nervous about this acquisition. But I think that as you see it, some of you can -- I'll visit with at TCT and you see the results of what happens here as we go forward. It's an extraordinary opportunity to have a platform and a program that really we have very, very distinct advantages over any of our competitors in what is, arguably, the fastest growing segment of the cardiology market in the United States and great opportunities in world markets. So, we're very excited about that opportunity.

So, I think we feel comfortable with our business in terms of the new products that are coming. We have got a full pipeline. I think that spells great news going forward, whether it be the new hydrophilic sheath that goes right along with these other two acquisitions and existing Merit products to finish that or the new ASAP LP, the ConcierGE, the PHD, some of the products now that came out of Thomas, the [worry] systems, we have now Merit-ized and those are going into our direct bag. Before, those products were only being sold on a limited basis. So as we look at all of the products, including the basixTOUCH, the new [sure cross] catheter -- we're just loaded. Then we have, again, a lot of other products come down. So I think we have the right products. They have the right margins. We're in the right place to take market share.

Now, someone mentioned to me the other day that PCI levels in the US were down about 5% and over in the international markets down 1% or 2%. This came from one of the larger companies and an analyst shared that with me. If that's true, then we're taking market share. Then you get these other growth markets like the Radial products, it adds I think a lot of excitement to our sales force and a lot of opportunity for the Company. So, we, of course, never change guidance. We just don't do it as a matter of policy.

I think some people were concerned as we came through and approached the third quarter, where we had guided down, whether we were going to be able to hit those revenue numbers. I think, clearly, as we look at those numbers that we will be well within the range. We're already at $0.49 through this quarter, on the non-GAAP side. So we only have to make $0.01 more to be able to get on the bottom side of the range. Clearly, we'll do better than that. So, we will have a forecast for you early next year.

But there is a lot of momentum both on the operational side of the business -- I think we're controlling our expenses, and our sales operations and our leadership. All of our facilities in our business segments worldwide are doing a good job. I'm pleased with the work that my staff are doing. They're all sitting here, so I complemented them before the meeting. Again, as I mentioned earlier, if you looked at that first quarter, it was a terrible quarter. But we did the things we needed to do. We have given it the focus -- I want to make sure everybody understands, it's all about the focus.

It's all about -- I don't ever want to have a quarter like that. I don't ever want to be in a position like that. I'm going to pay this debt down. We're going to all work to increase gross margins, get better leverage in the business and deliver the results that all of you have so patiently worked for. So, please understand the resolve and the commitment and the focus that we all have in this room, to be able to deliver these results. This is just the first of what we hope for many reports that will be pleasing to you. We'll do the things that we've committed to do and things we've said that we would do, as we embark on this -- these initiatives and this focus. Kent, I'm going to let you add some things in here.

Thank you. Yes, a couple of highlights I'd like to focus on. One is, that I was pleased to evaluate that our non-GAAP income exceeded $10.5 million, which is a record for us, all-time. Another highlight was the tax rate. It's unusually low. I wanted to explain a little bit of that. First of all, we're seeing a shift of income ratios where our international businesses, particularly in Ireland, are making a bigger percentage of our total income. So that weights the -- that's part of our strategy, long-term, we've been building that opportunity there.

In addition to that, we had some unusual or advantageous tax advantages in Ireland. I explained some of those already. We had -- also some catch-ups this year in our R&D credits in the US. All of that has led to an almost -- just under 13% tax rate for the quarter and 14% for the year-to-date. Some of those are unusual for this quarter, particularly when you look at the FIN 48 adjustments that normally come this time of our year, as in the third quarter. They're loaded in there too. So you'll see the fourth quarter bounce up a little bit. But it is nice to not have to pay so much tax, particularly when we have to pay Obama's tax.

Another interesting thing is just how we've been able to adjust our debt structure, so that we have capacity. We have an estimated $22 million of room right now in our line. We added $40 million to do this deal. Now, we're able to march forward, work our balance down and our EBITDA ratios are going to come. I've got capacity in them and they are going to march down as we make more money with both these acquisitions, as well as our operational.

Another thing is, our CapEx, of course, with our facilities and that sort of thing will be reducing in some terms of our EBITDA. As we move forward, it will help to reduce this debt rather dramatically as we move forward. That is important to us out here. I just have one other thing, maybe a few other comments. But I'm looking in the room and I've noticed that I have -- Kent Stanger here; Darla Gill; and I have, Bill Padilla. These are my three partners -- Darla Nelson -- these were the folks that started this business with me 26 years ago. I just want to thank all of you guys for your years of service. It's always nice to have you all in the same room together. So thank you for being here.

Guys, there it is. There's a lot of stuff here. One final comment on the tax strategy. Oftentimes, I think taxes and tax strategies are dismissed as being something that just kind of floats through and is subject to the ebbs and flows. The reality of it is, we developed a tax strategy and a business strategy that allowed us to be in international markets. Part of these tax strategies are coming because of the facilities and the businesses that we have there. So these things are not coming by accident.

I think as Kent pointed out, when you're talking about -- rates in the US had very high rates. When you take a look at the growth opportunities in international markets, which Merit is well-positioned, which is one of the reasons why I'm delighted to have Christian here. We spent several hours today and yesterday talking about our strategies in Brazil, a country with 200 million people and a market that we should be doing tens of millions of dollars of business -- maybe up to $100 million in five years. These are strategies. These are investments that we have made a long time ago. Now, the opportunities and the fruits of those labors will come forward.

So, some people, like I said -- I get sensitive to the dismissal of the strategies as one-time deals. We would expect that our tax rates, although, they may not always be at these low of a rate, because of these one-time things. That we will have a tax rate that is part of our strategy, which gives us an overall return in earnings per share and returns to our shareholders. So, those are things that we work on and we think about. We've been thinking about them for 26 years. So they go back a long way.

In summary, business is good. Business, I believe, will get better. If we continue to focus on the issues at hand -- most of that is consolidation, most of that is of work that needs to do to improve our efficiency and our operations, expenses will come out. We'll approach that long, sought after goal that I have of 50% gross margins. It's not here this year or next, but it's there. It's attainable, even with the tax. So it has to do with mix and the products and training and all the things, but it is there. That is really -- not -- the numbers are important on the top line, but that gross margin is the one that I am the most focused on while maintaining the expenses below. I think I have got my guys taking good care of that. So Kent, you had one last comment. Then we'll turn it over for questions.

I'm just excited about the growth in all of the segments of our business really and the leverage we're getting out of it. That is going to really help also in the cash flow as we look forward.

Okay. Well, I think that wraps it up. I'm going to be getting on an airplane here in just a few minutes following this call. But Kent will be here available for calls. We'd be delighted now to open it up to questions that you have. We'll do our best to go ahead and answer those for you. Operator -- Chad?

(Operator Instructions)

Tom Gunderson, Piper Jaffray.

It feels pretty good, doesn't it?

Yes, it does, thank you.

So, Fred, one of your closing remarks was gross margin remains one of your number one focus going forward. You've said in the past, 60 basis points improvement per quarter for the next six quarters. You kind of blew by that in the first two quarters. Should we still assume that's a reasonable goal sequentially? Or did you race ahead so far that you've got to the destination earlier than expected?

Well, it is a very, very good question. One I was hoping you wouldn't ask. (laughter) But, I think we have to look at some other things here that we'll be facing. We're going to be looking at a health insurance increase, additional $500,000 worth of an employer's contribution to Obamacare in addition to the tax and our renewal there. As you all know, we took off our 401K match. We're going to put that back. So there are going to be some things there that we think are fair and equitable to our employees.

So, Tom, we've said that we'd do 60 basis points over the next six quarters. That's 360. We have delivered 290, but we will have some of those additional expenses that hit us here. (multiple speakers) Then we have the Pearland building that will be up and running in the first of the year. So we have some of those things coming. They're going to offset some of the gain. That being said, we expect substantial efficiencies in our Pearland building. Remember, we're in a building that is almost 60 years old and kind of very inefficient.

We have these high margin products. We have these efficiencies. I hope you can get out here sometime, Tom, to see these things that we're working on. That literally, as I pointed out, will take up tens of millions of dollars of costs and some other opportunities for consolidation. Moving and consolidating saves us -- has saved us and will save us a lot of money. So that's a lot of talk -- so what I'm saying, there are expenses and there are opportunities.

But I think just as a matter of policy, we are working on our forecast and our budgets for next year. It would be, really, candidly, irresponsible for me to up these things. But we're well aware that we've done very well here. Yes, we'll also get some contributions from these new products that would be almost 60 basis points, plus everything else that we have coming is all sitting there at 60% and 70% gross margins. So, our ability to have that mix change and be able to affect gross margins, those are the winds to our back with some, I would call them, breezes in the face. That is the best way I can answer your question.

Okay. Thanks. Good color. Kent, you said on the tax rate for Q4, at least a bounce up a little bit. Can you hone in on that a little for us to give us a sense. Is it 15%? 20%? Where would you put this all in --

No, closer -- it'll be closer to 20%, low 20%, somewhere in there, without the one-time -- or the annual issues that happen in the third quarter for us, both in Ireland and here in the US. Somewhere in the low 20% are likely.

Okay. Should we look at that same kind of low 20% or maybe a little higher for 2014?

Yes. It is likely to be a little higher because some of the unusual events this year. We will come out -- as Fred just said, we'll come out and give you a better guidance when we have it formulated. Because what really matters to that is the mix of profit between what's in the US and what's in Ireland, for example. So, once those budgets come in, we can -- you can have quite a swing depending on what those ratios are.

Tom, we do have some products that are in the 80% gross margin range that are unique to Europe that we will be selling -- that we'll be introducing in February. Some of those products, along with the basixTOUCH and those sorts of things can have a pretty dramatic effect on gross margins and profitability over there, which are taxed, in fact, at those lower rates. So, again, we are going to go ahead and massage this as -- in terms of revenues and expenses and this sort of thing.

But the tax strategy is one that is not something that is passive. It is very active here, in our thinking and our planning. There are some other opportunities for us there. I will stick with Kent's comments and just simply hope that we'll do better than what we think right now through the deployment of various strategies and sales in Europe and our focus there. We're expanding in Turkey -- going direct there. There's a lot of other opportunities that will help us, so.

Good. Thanks. Then, one last question. That is, for Q4, I understand you're not changing the annual guidance. I can do that math, since we've got three quarters under our belt. But you also had an unusual Q3. You started out by saying that. Summer is not supposed to be where you shine. Summer is supposed to be where everybody goes on vacation and we adjust for that. You blew right by that. So, congratulations on that, but now that you've upset the norm, I still have to believe that Q4 will be your strongest quarter, both on the top and bottom line. Is there anything wrong with that assumption?

I would say, if you look at the business historically, that's been the case. We hope you're right. But, again, I didn't expect the third quarter -- but I will say that there is a wind to our back and just slight breezes on the nose. So, that is the best way for me to answer it. We have a lot of momentum.

Okay. Thanks. I will get back in queue, guys.

Thanks.

Chris Cooley, Stephens Inc.

Congratulations on a great quarter. Let me just follow up on Tom's last line of questioning there. A phenomenal third quarter. I guess a two-pronged question, first, Bard was out last night with pretty strong results as well. Can you tell us if you saw anything in the quarter, in general, in terms of a pickup either from volumes, ordering patterns, just anything that was different towards the latter part, that gives you confidence not only in what happened in the 3Q being able to accelerated into the 4Q?

The second aspect of that question, as we think about guidance, I understand that historically you maintain that. But you guys also made a very nice little acquisition there, both with Safeguard and Radial Assist. I have to assume that contributes now here in the fourth quarter. You mentioned it was fully integrated. Can you maybe just give us some additional color there about the puts and takes on what that adds to both the top line and through the cost structure, as we think about our model for the fourth quarter? Thanks.

Let me go back to the question about any trends or things. As I opened the call, the thing that I discussed is that we saw all product groups that we report and all business segments. I think that is a -- really an extraordinary event. Again, I have to put it back to the leadership and the efforts that everybody gave and the efforts of our sales force. We saw it from sensors to our coating company, to all the various product lines across the board, worldwide. Candidly, I suppose the surprising part of it was the really strong growth in the international markets, both from worldwide dealers, which for us is central South America and the Pacific Rim -- was up at almost 20%. We did even better when we take a look at Europe, where both our direct and our dealers did very, very well.

So, I think it is the product mix. I think it is a lot of things that we have done in our strategy. I think one of the things, Chris, that we are doing a better job of here and something we are thinking of is more than a product. We're looking at platforms and programs. I am not talking about bundling necessarily. I am talking about something where we have groups of products that go in and is a program, which will lead and segue right into the next issue. I know some folks were concerned about this acquisition. It wasn't one that we were looking for. But when it came to me, I immediately recognized it. I saw what it could mean, particularly with the work that we were already doing and the momentum that we were already seeing in the Radial market.

If we looked at the Radial market in the United States, we have seen now for several years that our Radial sheaths have been growing at 60% or 70%. As you know, Radial procedures have come from 3% to 16% and some will say that it's at 20%. But the reality of it, it's going to 50% or 60% over the next 5 or 6 years. So we already had products in that area. Then, both on the prep side, I am talking about the Board, which we have an 80% gross margin. We have a disposable that goes with it and other products that were being developed in that area. You take that and then you take the closure part. Now, the interesting thing about the closure business -- as you know, there was about $7 million worth of revenue in this product in the existing Safeguard.

The thing that we were excited about and some people were concerned about the price we paid -- but I don't think what was understood and we've tried -- and it gives me an opportunity to restate this. But, what we'll call the AIR-BAND or the Safeguard Radial product, that is the closure device used for Radial procedures, was a product that had FDA approval and the CE Mark. We personally went out and conducted 30 cases, live cases and became convinced that this was a product that was better than the competitors. We are talking about -- when we talk about competitors, we're really talking about Terumo, which is a terrific company. But our customers are telling us -- potential customers, they liked our product better.

We take that product, which essentially was not launched. But it's ready to go. We have inventory. We will introduce this product down at the TCT meeting. More importantly however is, remember, we've owned this now for 10 days, not 10 months -- 10 days. But we have already done a lot of work. It was seamless in terms of the transition, inventory, customer service and customers ordering. That was absolutely done to perfection. But now we are training, this week, our clinical staff. We will then start training our sales staff. We will release this product and put the strategy together. I think you will see momentum on this side. This will become probably a reporting unit, because the revenues and the opportunity is so significant as we go forward and not just in the US. But, remember, places like Scandinavia, France, Japan and other places, some of these areas are as much as 60% or 70% Radial.

But then there's all the other stuff that goes with it. There's the guide catheters. There's a whole bunch of products. We have physicians clamoring for someone to listen to them to develop products that are essentially shapes and different types of things to deliver. We're also seeing things like the liver embolization and other types of procedures, which are being done through the Radial artery. So, this is a tremendous area of growth. One that now, Merit is well-positioned and is focusing new product ideas and development to support that.

As I mentioned initially, this could mean up to $100 million in revenue to Merit, over the next five years or so, annually. That is the best way I can hand it -- in terms of gross margin, it will add about 60 bips, that is on a non-GAAP basis. Is that correct? And about $0.03 on a non-GAAP basis. However, it wouldn't surprise me a bit, if we outdid that. I will say that I have absolute optimism on that product. When you sell more inflation devices, you sell more fluid administration, you sell more kits, more trays -- these are just some of the tools for the procedure but everything else goes with it. I think that gives us a tremendous advantage across the board to drive growth. Kent, do you want to comment?

Just to support and clarify that the 310 basis points estimate is basically for 2014. It's an annual number. But it also includes -- I've taken out or reduced that number by loading up all the interest expense added for the new deal on the loan.

So it is essentially fully burdened --

Fully burdened with all the interest of the entire loan balance, not just the $27 million.

Yes. Isn't he a wonderful guy? (laughter) He takes it and piles it one -- like one little kid and wants -- the kid is kind of a bully.

You have got to watch him, Fred.

Yes. I like it when you say that, Chris, because most people say he has to watch me. So, I appreciate you turning the tables.

If I could squeeze one more in here just very quickly, just from a housekeeping standpoint. I apologize, I missed this. Did you give us the US and the international split just in terms of total revenue growth earlier? Then I will get back in queue. Thanks.

Yes, I have a right here. Go ahead, Kent. I'll let you --

The split is 37% to 53% as far as the split. It's 63%, 37%. But if you're talking about growth rates, the domestic was actually -- which includes, of course, the Melbourne business, which is mostly, it's 21% on the -- it's part of OEM and everything. The international is up 18% overall. Is that what you want?

That's great. Thank you so much Kent.

Jayson Bedford, Raymond James.

Just a couple, on the spending rates going forward, just on R&D, the first half of the year seemed abnormally high. 3Q at, let's call it, 7% was similar to 2012 levels. What is the right target or range going forward? Have you reprioritized R&D now with an acquisition, which I would assume lessens the pressure on R&D?

I don't think it lessens the pressure on R&D at all. In fact, if anything, I think what it does is, we may redirect those, as I pointed out, to additional products, a higher margin to support the acquisition. But I don't think it lessens it. I think our goal, Jayson -- I appreciate you asking this question is still to have that SG&A in the 27% range and the R&D in about 7%. Then when our gross margins up -- continuing to improve, I think that is where our goal is. We have not change those goals. Then again, I think the real key to driving the business is, we will get some leverage. But the big one is that -- those gross margins on the top line. I think with these acquisitions and the new products that we have, they all have well above -- I mean well above, some of them in the 70%, 80% gross margin range of the new products that Merit has developed.

I think those will continue as they roll out. One of those by the way, is this new Prelude Ease. It is a hydrophilic sheath that is preferred by many physicians doing Radial procedures. Again, you add that to an already existing sheath business that we have and I think we are looking at $5 million plus its first 12 months and probably $10 million in that one product line in the second year. So when you add those kinds of products on here with this strategy and these platforms and programs that we're talking about, Jayson. I think it gives us a reason to be quite optimistic about some of these business segments.

Okay. The new facility, was it a drag on gross margin as production ramps there? Or, I guess the question more is, do you still expect to get additional leverage on that facility going forward?

It is a good question. As I mentioned in my previous -- earlier comments, the first two quarters basically had the cost of the building in the SG&A as we were bringing it online. In the third quarter, that particular expense is now in the gross margin line and still allowed us to be able to deliver the 150 basis points. The answer to your question is, there is substantial capacity here that is going to allow us to leverage the business going forward and get more gross margin dollars out of the facilities that we have in place. That is -- I think, by the way, some people were kind of scolding me about buildings and this and that.

But I think, everybody in this room that looks at some of the performance -- some of the things we're doing are things because we have some space and things that we can do that we didn't have before. We were literally loading things up in the truck just to get them out of the areas because we had no room and driving them -- it was so inefficient. So, I think there is a lot of leverage left. It's not just in the facilities and their space, although that is a big part of it. We have, for instance, in clean room one here and two, where we first started in the main building, we're probably only at 25% or so capacity right now.

That means that we can bring a lot in. That means that we will have better absorption going forward, essentially lower unit costs and higher gross margins. So there is a lot of opportunity there. As we have tried to do, as we have built the business, we try to think out five years. So, we really don't have a need, as we see it today, for any facilities or additional cost in that area for at least five years. So, that gives us a lot of opportunity and I think adds to the discussion I had about moving that gross margin up towards that 50% as we get better absorption over time.

Okay. That's helpful. Maybe just, the last one for me. You mentioned the international growth, I think you said, up 18%. Can you just comment on growth in China? Maybe some other emerging markets?

Yes, we can. Kent?

China direct was particularly -- is our star. The whole group is up 55% for this quarter over year ago quarter and 37% year-to-date. When you combine it with the distributors, it's still 24% for the quarter.

Let me add some color to that Jayson. As you will recall from some earlier comments that we had made, one of the great surprises in China has been the uptake of our embolics. We expect to get clearance on our HepaSphere product in China in the next 30 days or so. So I think one of the great opportunities are these embolics, particularly in a market where it's the highest incidence of HCC in the world. If it's anything like the Embosphere product, these things carry 80% and 90% gross margins. So, that's another thing. Then what -- it drives the micro catheters. It drives Access products. So we are very excited about those opportunities. Radial is also an emerging opportunity. Now, we're a little ways out on that because there are some registrations, but we are selling our existing Radial sheathes and catheters already in China. So, we expect China to continue to be a star for us for some time to come.

Okay. Thanks. I will get back in queue. Nice quarter.

Thank you so much, Jayson. Jayson, I know you're back in queue, but I guess you will be watching the television tonight. It's 7.30 PM Eastern, Fenway Park. Just -- I don't want to rub it in or anything. (laughter) I hope that's in your comments. I like it when they can't talk back. (laughter) It is a perfect thing. We will go ahead and take the next caller, please.

(Operator Instructions)

Jim Sidoti, Sidoti & Company.

I heard it is pretty chilly in Boston, so you better wear a coat.

I have got one in the car.

(laughter) Can you give us some color on the one-time charges? I assume the goodwill is related to Thomas. What was the contingent income?

Yes. We bought a product -- I am going to let Kent handle that. Guys, I hate to leave, but I'm going to Kent talk about the impairment. I have got a plane to catch. So I hope you all forgive me for that. Kent will handle you well. So Kent will be in the chair. Best wishes to everybody. Thanks to the staff for everything.

Yes Jim, I'm glad you asked the question because I think it would be nice to clarify. One -- what we have isn't actually goodwill, just to clarify. It's other intangibles. So, we have two issues. It is on -- it's the Ostial PRO, not Thomas. So, the Ostial PRO is an acquisition we made some months ago. The forecast has been -- the uptake has been slower. So we needed to adjust the contingent liability, which there is an offsetting thing. This is going to get more complicated than maybe some of you want. But that you have a liability, which is the present value of the royalties you're going to be paid as part of the deal. So, the good news is you don't have to pay -- it is not worth as much as we had it at the liability on the books, so we get to reduce it. But that triggers an evaluation of the asset that the intangible -- you're talking about know how, customer lists and those kinds of things.

So, you have to reduce those down to what their fair market value is today, as well, in the process. The net of that was around a $4 million adjustment. That is what you see there, as the one-time. You see the two netted together. So, those are part of operating expenses by GAAP. But they are non-cash. They are a one-time adjustment. I will add one thing to that, if you take those out and look at a normal GAAP number without that one-time thing, you're at $0.19 -- you're over $8 million and $0.19 a share. So, I think that's a kind of an interesting adjusted GAAP. It's not non-GAAP, but it is a more of normalized GAAP without that one-time or non re-occurring expense.

All right. So basically what you're saying is, since it didn't hit the target, you are not going to pay as much royalty. But you are writing down the goodwill. So, net-net it's a $2.3 million non-cash charge (multiple speakers) in P&L.

Yes. After tax, it is $2.7 million.

$2.7 million, okay. Now, can you just remind me -- now, what is going on with the facilities in the third quarter? You finished the new one and you started to move into it. But were you still running the older facility in Utah?

No, we have moved out. So, essentially all of the one across town that is five, six miles away, we had 70,000 square feet. We just had six or seven units. We kept two and they're operating at a minimal level for storage and for some aging ovens and so forth. So the overheads are much lower. So, yes -- we, really through August. So we've seen one month where we've been able to shed the majority of those overheads. Going forward, we'll have a much smaller amount there. That will help offset some of the increases that we see from carrying the full facility in the cost of sales that we were referring to earlier.

Okay. That older facility, is that something you own? Or was that something you were leasing?

No, those were leased. We were on month-to-month at the time we were finishing up. Those are not on our expense list or our balance sheet. They never were.

All right. Then just -- I'm not asking for 2014 numbers. But looking at longer-term, Fred has mentioned a goal of 50% gross margins and 20% SG&A, 7% R&D. So, you think you can be a 15%, 16% operating margin Company at some point in the next five years? Is that what he's saying?

Yes, that is what we're saying. We believe we can work our way up to that mid double-digits in that timeframe.

Okay. All right. Thank you.

Gregory Macosko, Montrose Advisors.

Just one question, Kent. Just with following up on the R&D, with regard to the changes there. There were some factors there. You are continuing to add people, is that correct?

We've added some in R&D this year. Is that what you're saying? There's some headcount increases. With Melbourne, right at the end of the year, we added a whole group of people. So when you look at this year compared to last year, you have that team, as well as some adds through the organization in different locations. It is not dramatic anymore. It's been kind of leveled off a little bit recently, but there has been some, yes.

So sequentially, we were basically stable at this point now?

More stable, I think you might see some growth. We are talking about -- one thing that we didn't talk much about here is the ongoing trials for both BPH, as well as the liver high-quality trials. Those are ramping up a little bit. They are still not dramatically increasing, but we expect to see some increased expenses of those. Then we are going to continue to invest strategically in some of these product developments. So, what we've been saying is, we want to keep in the 7% for at least that core. That is pretty stable as a percentage of sales, I would agree with that part.

Okay. Very good. Thanks, very much.

Thank you. There are no further questions at this time. Please continue with any closing remarks.

Thank you very much. Well, I am just excited again to reiterate what we have already said. That we have really seen in -- significant gains. Not -- first on the top line, it was a great quarter for a third quarter, for a summer quarter to see the growth as broad-based as it was. There were so many products through all of our -- really every geography, if you will, improved sequentially and gained momentum except for one. That is gratifying. I don't want to over emphasize or get too far ahead of ourselves as far as what we expect. I don't think we're going to see 20% growth again, necessarily.

But the fundamentals are strong, the top line is and every step down through the statement, whether you look at gross margin improvements, sales and administrative expenses as a percentage of sales, research and development -- we are seeing leverage there -- even in the tax rates. The only negative I suppose in that entire story is the higher interest costs that we have. But we are going to work those down too. In a very few quarters, both by covenant and by plan, we are going to lower our interest rates as we lower the risk rate or the EBITDA ratios.

So, overall I think it was a great quarter. I think it was, in many respects, a record quarter for us. I think we are set up to continue the progress in the future. So I thank you very much. We'll sign off at this point.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.