Merit Medical Systems Inc (MMSI) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Merit Medical Systems Second Quarter 2017 Earnings Report. (Operator Instructions) Now I would like to welcome and turn the call to Mr. Fred Lampropoulos, Chairman and CEO. You may begin.

Thank you, and good afternoon, ladies and gentlemen. Thank you for joining us on a very busy reporting day. Some of you are listening to this live, others will listen to it via recording. We appreciate your interest in the company and taking a few moments to hear the Merit story.

As you can see from our report, we reported record sales and record earnings. We are also here today to talk about a guidance adjustment to the upside and a discussion about our 2018 and 2019 preliminary thoughts.

So what I'll do right now is turn some time over to Brian Lloyd, our General Counsel, for our safe harbor provision. Brian?

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 purely 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 Securities and Exchange Commission available on our website. Any forward-looking statements made in this call are made only as of today's date, and except as required by law or regulation, we do not assume any obligation to update any such statements, whether as a result of new information, future events or otherwise. Please refer to the section of our presentation, entitled Disclosure Regarding Forward-Looking Statements, for important information regarding such statements.

Our financial statements are prepared in accordance with accounting principles, which are generally accepted in the United States. However, we believe certain non-GAAP financial measures provide investors with useful information regarding the underlying business trends and performance of our ongoing operations and can be useful for period-over-period comparisons of such operations.

The tables included in our release and discussed on this call set forth supplemental financial data and corresponding reconciliations to GAAP financial statements. Please refer to the sections of our presentation, entitled Non-GAAP Financial Measures and Notes to Non-GAAP Financial Measures, for important information regarding non-GAAP financial measures discussed on this call. Readers should consider non-GAAP measures in addition to, not as a substitute for, financial reporting measures prepared in accordance with GAAP. These non-GAAP financial measures excludes some items that affect net income. Finally, these calculations may not be comparable with similarly titled measures of other companies.

Thank you, Brian. And again, welcome, ladies and gentlemen. Today's a delight to report what we believe is a reaffirmation of our plan, as we continue to deliver on our 3-year plan, both in terms of areas of sales growth, gross margin and earnings growth.

So I'm going to now ask Bernard Birkett, our Chief Financial Officer, to go over the numbers on the revenues, gross margins and earnings side. And I'll be back again in just a minute. Bernard?

Thank you, Fred. We're pleased to report our Q2 results, which continued to deliver on consistent growth and revenues, where we've seen revenues grow by 24.9% on a constant currency basis to $188.7 million and by 23.5% on a reported basis to $186.5 million. Organic growth was 10.4% on a constant currency basis in the quarter. And we've seen sales growth in all product portfolios and across all our markets in the second quarter.

Gross margin was 8.3% on a non-GAAP basis, up from 46.4% in Q2 2016. Margin improvement has been accomplished by delivering on our objectives, changes in our product mix and improvements in efficiency, cost management and increased utilization of our facilities. And earnings improvement continues on a non-GAAP basis. For the quarter, earnings were $0.36 versus $0.26 in Q2 '16. We just want to highlight that $0.02 of the earnings achieved in the second quarter of '17 relates to a tax credit adjustment for options exercised in the second quarter.

Bernard, thank you. And just a reminder that these earnings are based on a higher number of shares, almost a 10% increase, because of an offering we did in the late first quarter. And they still, I think, exceed essentially what we had talked about and had guided to. Even with that $0.02 adjustment, I think we are still beat on consensus earnings by about $0.05. And so, I mean, I think that, that is an extraordinary effort. I'm very pleased with it -- of the efforts.

The other thing that I think is important to note is the gross margin of 48.3%. Now we had mentioned that, during the first quarter, that we thought we could see a slight adjustment because we would have a full quarter of the Argon acquisition as well as the Catheter Connections. But as it all turned out, it was the same as the first quarter and I'm very pleased with that. It goes to what Bernard talked about and that is the utilization, the mix, which means really that the business is really performing, from our point of view, in a number of areas. So I'm very excited and pleased with our efforts.

Now what I'd like to do is, based on where we are, it's clear to us that we need to do some adjustments. And so, Bernard, you're the star of the show today. I'm going to let you talk about our guidance and some upticks also for '18, '19 on a preliminary basis. Bernard?

Thanks, Fred. So update to guidance for 2017 based on the results that we've achieved through the first half of the year. We're increasing our revenue guidance to a range of $722 million to $727 million, up from $713 million to $723 million. Margin guidance remains the same between 48% and 48.5%. And we increased our non-GAAP EPS guidance to a range of $1.23 to $1.28, up from $1.15 to $1.20. And GAAP guidance remains the same.

For 2018 and 2019, we're giving preliminary guidance based on what we see,and the market trends and how we believe our business can perform. And we're forecasting top line growth of approximately 8% for 2018 and 2019. This will be supported by: an introduction of new products through R&D; the integration of M&A completed in 2017, primarily on Argon and CCI; continued development of our international sales organization; and changes to sales force structure and compensation.

Gross margin, we forecast to expand by 100 to 150 basis points each year. Again, this is supported by: opportunities with mix; focus from our sales force restructure and compensation; new product launches with higher margin profile; improvements in utilization and efficiency in our manufacturing facilities; and focus on discipline in managing our cost base.

And EPS growth is -- we forecast to be in the range of 13% to 15% in 2018 and the same in 2019. Again, this will come through, through a combination of a sustained organic sales growth and margin improvement and, again, disciplined and focused management of OpEx.

And on that particular issue, I think one of the things that you'll see, as you look into the second quarter, is really how we controlled our expenses. And we think that this 3-year plan that we introduced 2.5 years ago, it has really been helpful to the management team. And it helps us to focus in on everything that we do as to whether it meets those objectives. And so it's our view that by adding these additional couple of years that it is helpful for the entire business to keep focused on getting the results that we all want.

There are a lot of other things going on. I think, Bernard mentioned, and I mentioned as well, the business, just about all of its areas is kind of hitting on all cylinders. In the business world that doesn't happen very often. Whether it be our sensors business, our coatings, our OEM, the International market, things have been performing very nicely. And we expect that, that will continue.

There's been a couple of, I think, interesting developments. You're all aware of them. PAE is a very interesting market for us and -- but it's still very early. And you're not seeing any results from PAE at this point and you likely won't until next year. There's a couple of initiatives that Merit's involved in that will help to organize and to grow that business.

First of all, one of the things that we'll be initiating next month is the ThinkPAE. We've been very successful with our HeRO product line, which continues to grow, I think, at about the 20%-plus range, give or take, in our radial programs by bringing skilled physicians in and they train other physicians. So we've, just in the last week or so, opened up a training course for prostatic artery embolization. Those are held here in South Jordan. And also we do them in Europe and the response has been overwhelming.

So what we thought would be 1 course and then maybe 1 later on in the year has now turned into essentially 4 courses that are already planned and they're all fully subscribed. Which means that you're going to have somewhere, by the end of this year, about 100 additional physicians that have been trained and starting to do these procedures. And it's not just the embolics because that's actually a small part of it but it's all of the other parts that go on, the vascular access, products like the SwiftNinja. And just this week, we received approval for our True Form guide wire. And this is a very exciting product that sells for in excess of $200. And this product allows us to have that interventional guide wire but it also helps us with all of our microcatheter products to combine this. So with, for instance, the Maestro, we've been at a disadvantage and we haven't really had a wire that you could package and our competitors did. So now we have that full package. And so we think having that wire, along with the new Amplatz wire and other products, are going to help to fuel our growth.

The pipeline is full with lots of new products like it always is. And so, again, as we look out into the future, we're confident that with the controls that we put into place, with the focus on the objectives that we have, I think, clearly spelled out to you, that we're confident in the growth of the business from this point on. So you want to make any other additional comments, Bernard?

I think it pretty well covers and the guidance is clear. How we're going to achieve that is also clear: supported by PAE, supported by robust R&D. Nothing further to add.

Yes. I think it's -- I'm going to call it the new Merit. The new Merit is like the old Merit with more discipline. And I think that's the key to this, is that the whole company has bought into this and we've structured support to be able to support the line units in understanding their cost and their expense lines and making sure that they're kept in line. So again, I'm very, very pleased with our performance and I hope you are as well.

Let me just move quickly over to M&A for just a few minutes because I'm sure I'll get asked the question but I'll go ahead and see if I can address that now. We think that there are, and continue to be, numerous opportunities for Merit that are consistent with a couple of things that are important to us, and that's the expansion of our existing business platforms. We're not looking for an acquisition for revenues. We're looking is it consistent? Does it fit? Does it give us gross margin expansion? Does it help us introduce other products that we can develop beyond there.

Now there could be a new strategic type of product line but at this point, very candidly, I just don't see that. I see product line extensions, enhancements in our existing 4 legs of the business that we have and I'm comfortable with that. But I also want to be very clear that we're constantly looking and opportunities are being presented. And again I would say at a pace that I've actually, very candidly, have not seen before. So I think this consolidation is something that goes on, and I think that plays very well with disruption for Merit and opportunity as well as opportunity to fit these products in under the kinds of requirements that are complementary, that are -- to our platforms and that we think will add more profits. I mean, it's kind of simple as that.

So I think with that said, Bernard, unless you have anything further, I think, we've spelled it out. We'll try to keep this comment short because of the day and how busy you all are. But thank you for joining with us. And at this time, we'll now turn it back over to our administrator. And we're sitting here and we will also be here after the call to maybe add some additional clarity, if that's necessary. So we'll turn the time back over to our administrator.

(Operator Instructions) And our first question is from the line of James Sidoti.

So seems like the acquisitions are going as planned. Would you say you're through the bulk of the integration at this point? Or do you think you still have some more costs in the back half of the year related to integration?

Now there are some more things to do. For instance, in our Singapore plant, Jim, we are going live with Oracle starting next week so we have a team over there. And there's still work to do. It's only been a few months and there's a lot of training and a lot of just things where we have to become disconnected from the prior host and then integrate and train. So there's still work to be done. But I think, maybe more importantly is, we've been pleased that the revenues have maintained themselves and in fact grown more than we thought they would. And I think we've just been pleased very much. The Catheter Connections, we just had a record month in revenues there. Our tooling is completed. Our costs are going to be coming down. We're opening up new accounts every day. We've gone now and gone off the dealer thing into the direct. So all of those things are like kind of all taking place. There's work to be done. But I mean, I think, the integration risk, I mean just the general business and that sort of thing, all of those things have worked out I think much better than some of our others in the past. They've worked very, very nicely. So I think we're very pleased with it.

And you mentioned Catheter Connections. Would you say the same for DFINE? Is that revenue coming in where you thought it would when you did the deal about 6 or 7 months...

You have to remember, Jim, with DFINE that there are over 100 people let go. We had to shut down distribution, so I said we're okay with it. But let me go to another point that hits all 3 of these and that is one of the things that we always do is to start a research and development project. And we have 3 research and development products -- we have a new product, for instance, the Catheter Connections, Argon and DFINE, all coming some time probably in the first quarter, these things that have been developed. And this is part of that integration where it teaches people the process that we go through to bring a product to market. So I think all of them are moving just fine. We're very excited about the DFINE product and a number of other things going on there. So I think we're fine with all of these, Jim. There's still work to be done, though, but we're fine with them.

Okay. And on the R&D line, with the approval for the PAE, will some of those costs start to come down for that project? And I assume they'll be offset by the projects you just mentioned. Is that right?

Yes, the interesting thing about PAE is we really didn't have any R&D expenses. What we had was approval of an existing embolic product and an indication. And since it's not been here there was no product and device, the de novo route was the route that we had to take. But I think the important thing is, Jim, is that we have -- we're the only company that has approval for embolic for that procedure in the United States. And as I tried to mention in my initial comments, it's the SwiftNinja, it's the vascular access, it's the radial pro, it's closure, it's all those other things that go on that are all high-margin products supporting PAE and really, very candidly, Merit's presence, our -- we're having people call us, physicians, we're the only game in town right now in that area. We expect to be for some time. But the money to be made, from a shareholder's point of view, and building the business really comes from those other products where we have very high margins. But there's no R&D expense. We did that a long time ago.

Okay. And then last one on the legal expense. It seems like it came down a little bit from the first quarter. Will that trend continue? And then I noticed one of your competitors took a reserve. It sounds like they're going to settle a situation they had with the DOJ. Do you anticipate anything like that happening with you in the next 12 months?

Well, as you know, I can't comment other than to say that it goes on and on. It's slow, the wheels of justice move slowly and they're expensive. But I don't -- I can't comment on it, Jim, other than we're engaged in the process. We're providing the information that was asked of us. That's the essence of it. That's all I can say about it.

And do you think costs will remain at about this level for the rest of the year?

We think it will decline.

And our next question comes from the line of Jason Mills with Canaccord Genuity.

I wanted to start where you left off in your prepared remarks, Fred, with respect to M&A and get your take on the med-tech sphere, I guess, more generally. You mentioned the M&A activity. I presume in some respects you were referring to a lot of the M&A we've seen in the public domain. Could you comment a little bit further with respect to how that M&A, that we are seeing publicly, affects your ability to find, and the competition around the assets that you think may be attractive to add going forward?

Yes. The thing that's so interesting about this is you see these consolidations. And it means that they're so busy doing that, that it creates opportunity because some of those companies have products that we compete against. They don't know who they're buying from. They have all of the issues but they may not have the same salesperson. So just from that point of view, one of the things that's always been kind of a hallmark of Merit's growth and opportunity is we're Steady Eddie. We show up, we have new products, they know who we are and that's helped us. So from a consolidation point of view, most of the time people comment, "So why aren't you nervous about this?" and, "Aren't you nervous about that " and, "Aren't you worried about this?" And the answer is no. They create opportunities. They're not distractions to us. They create opportunities. Now in terms of the situations out there, as I mentioned in my comments, you've got all of these things coming. It goes back to 2008, 9 or 10 years ago, when private equity dried up and this and that, there are only so many people that people can go to with products that fit, that have a global distribution. It's part of the reason why the SwiftNinja came our way, why other products come to Merit because we have that footprint globally. And then there's a lot of really good ideas out there where people have done work here in the U.S., they have approvals but they don't have a sales force. They don't have the national accounts. They don't have the ability to go to a trade show and have a presence. All of those things play in. I don't think we could be better positioned nor have I seen better deals than I've seen now and that are presented to us almost on a daily basis.

That's very helpful color, Fred. That's what I was looking for. So your gross margins continue to track up, I think this is 6 straight quarters, something you've been focused on and something the Street has been focused on. And you've delivered. And now you've given guidance to deliver for the next 2.5 years. Talk about what are the key drivers to achieving those sort of goalposts you've set out for yourself, I guess, generally. And then specific to some of the assets you've acquired recently, how is CCI and Argon contributing at this point in time, and DFINE and SwiftNinja, et cetera? What kind of confidence does it...

A little bit of time here because that's a big question. Let me go to -- and I was hoping someone would ask this question. 3 or 4, 5 years ago, someone wanted to have some suggestion we change the name of the company to Merit Construction Company. We had projects going here in Salt Lake. We had projects in Texas. We have projects in Ireland. We had projects in Hong Kong. We had projects in France. We brought on -- and in the Netherlands. I was in the Netherlands last week at our distribution and corporate headquarters for Europe. And the warehouse that we built there 2 or 3 years ago and opened and added 30,000 or 40,000 square feet, is now 85% utilized. And ahead of -- usually we look at these things for 5 years. We put into place these facilities because of the growth that we anticipated. Had we not done that, and let's also throw Mexico in that, by the way, we built that. So we built and put a lot of capacity in place. But if you look at 24% growth, pick your number, that means that under the rule of 72 is you double your business in 3 years. And I think what we did is we put those in place now. You have that expense that comes with that, the depreciation, you've got to clean it, you've got to heat it, you've got to cool it. But as you bring product through and those costs now get absorbed. Then all of a sudden you see the kinds of performance and opportunities for gross margin improvement through absorption. In terms of our business, and I said this on our last call, a lot of people in this room that are sitting with me, and I've got 30 of our staff sitting here now, but I think, Ron Frost and Neil Peterson, the guys, I said this on the last call -- Charlie Wright. The things that we're doing to lower cost, negotiating with our vendors, the efficiencies, new automation, streamlining, all of those things are bringing millions of dollars a year into that gross profit line. And it's one of -- it's the primary reason I think this quarter where we had actually, if you go back to transcript, you'll talk -- you'll hear me say in the previous quarter that as we were coming through this quarter in the last, really, we only had 1 month of the Argon deal. Well, we were able to, because of our efficiencies, to be able to keep that at that 48.3% non-GAAP. And that was -- I mean, I don't want to say it was a surprise to me, it was certainly a hope, it's a reality. And I think that when all these things start clicking and you get positive variances, you get all the businesses is growing. I mean, even if you look at the line items, you'll see inflation devices are growing. Those were pretty flat for a while. But that's growing. So the business is growing. The folks on the operations side are working a lot on efficiency and then remember, back to the Argon, because I know people look at these things and say, "Well, why did you do this? And why did you do that?" Remember the Japan connection, and that is we've now gone direct in Japan with our OEM sales. And on the first of next year, we'll go direct on our products over there other than our fluid administration. So -- but part of the Argon deal was the strategy of being able to maintain the discipline in our SG&A and to be able to have enough coverage and enough volume to cover that expense of going direct for the SG&A in Japan is going to be higher. And I think we -- I think this proves that even though we haven't started that higher product sales that, that absorption is there. And again the other thing I mentioned in my previous comments is that we've seen, I don't want to say surprising, but certainly pleasingly that we've seen that we didn't lose any business. We didn't lose any business in this transition. In fact, if anything, we gained business. And you don't get to see that very often in a transaction. You usually have something drop off. So efficiency, absorptions, mix, higher gross margins on the new products that come in to market, you all add that up and that gives us the confidence of being able to step up to the plate and saying, "Okay, we can continue this down the road for the next 2.5 years."

And our next question comes from the line of Larry Biegelsen with Wells Fargo.

It's Adam in for Larry. I wanted to start with the long-range plan into 2018 and 2019 goals of 8% organic growth. You talked a little bit about different drivers on the call, including new product introductions. I was hoping you could just highlight a couple of those products that will help drive growth in the coming years.

Yes. Some of these are interesting. When we talk about new products, they're not just new introduction but products we may have actually introduced last year. Let me give you a prime example of one of those is our Elation balloons. Our Endotek business, and a product we just introduced just a few months ago with our Elation Pulmonary Balloons, is driving that entire business. That business is growing dramatically. It'll grow even faster as we go forward. I just got a report from Darla Gill, who runs that division for us, one of the founders of Merit by the way, and that would be one. The True Form guide wire, I mentioned that in my comments, does a couple of things. It is a re-shapeable guide wire. And it also goes along as packaged -- we've been at a disadvantage because our Maestro microcatheter, which is a great product, didn't have that kind of wire and our competitors had a wire packaged with theirs. So that's online. You've got the SYNC, the radial procedures continue to grow. You've got the TWISTER. You've got the new Amplatz guide wire. We didn't really talk much about the Amplatz guide wire. We have -- and this is a guide wire that sells in the $30 to $50 range versus a diagnostic wire at $6 or $7. So if you take those products. We also have -- let's see, I'm trying to think. What am I missing here, Justin, other new products coming out?

I think you pretty much hit it.

Okay. So those are just some but I think between now and the end of the year with our new [Izod] syringe -- which one? What, I'm sorry?

(inaudible)

Our new vascular access product, there's a whole bunch of it. One of the things that's always interesting about Merit, and kind of difficult for analysts, is we have a lot of products. I mean, I've always said this, if we were a baseball player, I mean, we would have the highest batting average in history because we hit a lot of singles and we hit -- a double from time-to-time. So there's a full basket of that. And then remember I'm going to say this to you now because it's not -- it's coming around the corner, Merit has a new CVO, this is a central venous obstruction stent, fully covered that's going to start showing up in Europe in about 18 months from now. So that, overall down the road, could generate $100 million a year for Merit. So the pipeline is full, vascular access. And then you've got these just these initiatives that we talked about. Radial, PAE, all of these sorts of things and all the accessory products that go with them. So they're all -- I don't want to say singles. Some of this might be long singles. We might make it to second base on these but there are several of them.

Got it. That's helpful. And then I guess I just wanted to ask a follow-up on PAE specifically. How do you think about the size of that opportunity? I think you've previously said you anticipate doing roughly $30 million to $50 million, let's call it a 3- to 5-year window. Is that still the way you're thinking about things? And then obviously the long-term opportunity is quite large but requires a lot of market development activity. So wanted to ask you how you plan on building out the market, driving adoption and what the rollout will look like.

It's a very good point and something that we've discussed -- but we talked about a little bit in the previous comments about these PAE classes. Again, we went out -- even today I was told after I made that comment that we had more people sign up today. Interventional radiologists are signing up for this program as fast as they can and very candidly, faster than we can accommodate them all. We expect that if we take a look at what I am seeing today, that we will probably train 100 physicians between now and the end of the year in the United States alone. And that's an enormous number, and particularly with the excitement for interventional radiologists. So you can talk to me and I'll tell you about why I think it's a great opportunity. But if you really want to get fired up, go call an IR doc and talk to him about his skill set, imaging, why they're the best at doing this job and what it means to their practice. So that's what's going to drive this. And another thing that we did is there were 5 or 6 men sitting in this room yesterday having a conversation and we were talking about this very same issue. And we started saying, "Okay, guys, what are you going to do? Any in for TURP? Anybody in for laser? How many want to be in for an outpatient procedure with a BAND-AID on your wrist if you did a radial approach?" And every hand went up. I think as the awareness becomes available, as more and more people get the procedure done, as the press starts to pick it up, as we present it at trade shows and it gets picked up there, it's simply going to be, and I've said this for a long time, it's going to be the procedure of choice. And Merit is there, not only with the only improved embolic but with all the accessories. And it's really the accessories that drive the value here: SwiftNinja, the vascular access, the catheters, the procedure pack, the closure devices. That's where Merit's going to make the money is, in all those other products, the embolic is the small part of that. The procedure is the big part of that.

And then if I could squeeze in one more on M&A. You've mentioned in the past you've had an interest in building out the interventional oncology and spine business, I think particularly within spine. So I wanted to ask, is that still the case? And then are you still considering -- or would you consider more traditional spine assets, with call it, an orthopedic surgeon call point or assets that would go through your interventional radiology call point?

No, we're going to stay focused. We're going to -- we're not looking for traditional spine and orthopedic guys. That's not our market. We would look for things that might fit into the IR. We have to stay focused. We have limited resources to do all of these sorts of things. And to be very candid, we have a couple of other products on the embolic side that will be coming into the IOS and a couple of other products in that area. So we're comfortable in that space. We think we can grow that business nicely. But we want to be -- we don't want to be distracted by having these more orthopedic types of issues. And with traditional spine, that's not our cup of tea. So we're going to stick to the knitting.

And our next question is from the line of Jayson Bedford with Raymond James.

I don't want to be ungrateful with this question, and I appreciate the '18 and '19 goals, but the EPS guide of 13% to 15% implies, I think, that OpEx kind of stays at similar level as a percent of sales. And I'm just wondering if you see opportunities over the next few years to create a bit more leverage below the gross margin line.

Well, Jayson, Jayson, Jayson. Those are our numbers. Our goal is to meet those and those are essentially the minimums. Our goal and our compensation is based on us beating those numbers. But we'll stick -- I'm going to -- those are the numbers. We're comfortable. As I mentioned, if we do that, the business will do just fine. And then we will do everything we can to exceed those. But Bernard, you're just itching to take that. I can just see you over there going, "Let me have him. Let me have him." Go ahead.

I think, Jason, it goes back. Our primary focus on where we get the greatest leverage right now is on expanding gross margin. And I think the -- what we've outlined is fairly -- the positive outlook for the next 2 years. There's still a lot of work to be done. We've got some of the low-hanging fruit already and capitalized on that. That is a big area that we're focusing on. But we also commit to managing the OpEx line and making sure that, that stays under control. And I think if you look over the last 3 to 4 quarters, you can see that our OpEx is growing slower than revenues, and that's being -- hasn't always been the case in the past. And that's where we're focusing on that as well. So I think the guidance is -- it's aggressive. In some ways 13% to 15% growth on earnings is aggressive. But we're confident we can deliver on that. That's -- as I said the focus is on managing costs and improving gross margin.

And let me add just a little bit on that. I mean, I mentioned earlier in a question about market development and the cost, I said that we originally thought we might do maybe 2 of these PAE courses this year. And then it looks like it's going to be 4 or 5, just in the U.S. alone. That costs money to do that. So the reason we've kind of stuck with these numbers is because it would give us that top line and those higher margins which give us, as Bernard pointed out, as we all know, the biggest bank. What we don't want to do is say, oh yes, we can get you to 20% to 30% and then we stick with this and we miss it. So that's just not what we feel comfortable with. And we want to have a little bit of room particularly when we see the demand and the opportunities to spend the money that will give is the best returns, Jayson. So Bernard, can you comment?

It's just as well on R&D. To grow at the rates that we forecast, we've got to continue to invest in R&D. And that's a big part of our business, making sure that we have that pipeline of new products coming out. So we want to control the expenditure in those areas but we still need to invest for growth.

This has been the same story we've been telling and the same story that we've been performing on and the same story that, I think, has garnered attention to our company and our stock. So we're going to stick with the story and we're going to stick with those efforts. Jayson, I think, they've served the company well. Like as Bernard pointed out, in this quarter we've got a little bit better on that OpEx side. Good for us, isn't that nice? But if I miss it, you guys are going to kill me. And I'm not going to miss it. So our plan is as advertised.

Okay. That's fair. I appreciate that answer. In terms of the organic revenue growth, which, again, was solid, can you maybe just talk about some of the contribution from some of the newer products launched earlier this year? And then just geographically, I know you break it out in the slide deck but sometimes it's a little tough to tell from an organic and an inorganic standpoint, so if you can just comment where you're seeing the organic strength geographically.

Yes. I think, geographically, I think Joe Wright and his team in Southeast Asia have done a really good job over there. We're seeing it there. We're seeing good growth over in Europe. One of the other things that's been very exciting is our growth in the OEM area, which tells me, by the way, because I think it's a barometer. I think what we're seeing is other medical device companies are growing and growing well. And consequently on the OEM side, we're seeing double-digit growth, which we haven't seen -- and we see that trend continuing. And we're also seeing our sensor, our coatings, so I alluded a little bit that there are a lot of these bits and pieces. And as you know, Jayson, probably as well as anybody, it's a complicated and multifaceted business. So as I mentioned, it's not very often that you get to see everything in sync, where everything is kind of growing and that you get all of these bits and pieces: Europe, Asia, Australia, Canada, where we went direct, you're going to see more in Japan in the future. So it's coming from everywhere. But Bernard, you want to maybe expound on that a little bit?

Yes. Our OUS markets, it is obviously growing faster and that's what we've indicated would happen as that market develops. So the split right now is U.S., 58%; OUS, 42% of the business. We're seeing strong growth in our endoscopy business up close on 23% in the quarter. And again, it's coming from like products like inflation devices, up 11%. So it's not just on new business, there's a very -- there's strong growth in all areas, as I've said earlier, across all markets and across all product portfolios.

And something else that Justin just mentioned to me is one of the other things we're seeing as the business gets larger, we spent a lot of time developing, Jayson, our national accounts. So our inflation device in the United States business in the United States is up 5% to 6%. And that's coming from some additions of some national account contracts that we've brought online. So these are existing products. But Merit seems to be a topic of discussion where people want to do more business with Merit as some of the other players consolidate and fall out. So it's coming from legacy products as well. We talked about the new products. They take time. They roll out, you've got to get through the back committees, you've got to get them on national accounts, you're going to have sales meeting, you've got to launch, you've got to build out -- I mean, it's a long, arduous process on these things. But that's been kind of Merit's history. The biggest advantage we have is that we're a 30-year-old at the prime of our life as a company and getting stronger. So I mean we don't just look at something for a year or 2. We look at it 5 to 10. And here we are -- and by the way, Jayson, just so I can throw this one in, because you're going to like this one, we have a new inflation device coming out at the end of the year. "Oh, boring. Inflation device. They've been doing this." I believe this new inflation device that we're coming out, which was competitively priced, is going to add 10 percentage points to our market. We're a 50% player and I'd say we're going to be a 60% player within 2.5 years after we launch this, so. But I always say those things because I believe in the products and a lot of things. It's coming from everywhere. It's coming geographically. It's coming from legacy. It's coming because of national accounts. It's coming from the new products and particularly we're just talking about Endotek. It's a small part of our business but it's becoming a bigger part of our business every day because it's growing faster overall than our business in general. So very excited about endoscopy.

And our next question comes from the line of Matthew O'Brien with Piper Jaffray.

I happen to think early '40s is kind of the prime of your life.

Okay. I'll accept that. We've got 10 more years as a company, so.

So I'll take -- to follow up a little bit on Jayson's question because the SG&A or OpEx kind of staying flat implies some pretty meaningful investments in SG&A, in R&D. You've talked a little bit about that, the pipeline on the product side seems great. I'm just curious as far as where some of those investments might be coming from on the SG&A line. Are they domestic? Are they International? Will we see some leverage even beyond the 2019 time frame from some of those investments?

One of the areas is more salespeople. And now we don't ever want to do a bolus but what we want to do is we want to stay within the parameters that we've guided to, but yet you're growing and you have to have people. Our products are more complex. So where in the past Merit has been essentially an accessory company, that started changing 5 or 6 years ago as we've moved into more therapeutics. So it requires more clinical support. It requires -- on the R&D side, our products -- in order to get a product that's going to be that double, triple or home run. These are now 5-year projects. They're not 18 months, they take more time and more money. And so we just believe -- and by the way, this is not a change in what we've been saying for 2 years. I find these questions very interesting. We've said we're going to keep that SG&A line and that R&D because those were the investments have to be made, whether it be in going direct in Canada, Australia, building out those infrastructures now in Japan, and with those kinds of things that allow us then to get the higher margins of growth, they have to be made. And so to -- I am not going to -- and please don't take this personally, I am steadfast and sturdy that we will grow it at those numbers we said. We'll get those gross margins and then we will go ahead and manage those expenses but it's really difficult to do all of these things and make everybody happy and make more and more money and then you find out that you're Shallow Hal. You just don't have enough legs to hold up the building. So we've got to invest in these sales forces, clinical training, national accounts and in these countries that require us, in order to go direct, you've got to put infrastructure in place. They all fall in those categories, Matt. And so again, I'm not offended by the questions but I'm surprised that what we've been telling everybody we're going to do and we've done is now being questioned, why don't you do it differently? We're sticking with our model of success. We're extending out what we think we can do in the expansion of gross margins. And if we're lucky, maybe we'll get a break and we'll be able to reduce those expenses and get more of the bottom line. But as Bernard points out and as we all know, it's upstairs that you make your money, in mix and gross margins. And that's where you're going to get the big bang. And that's where we've been concentrating and that's where we've been getting the results while maintaining -- in this particular quarter by the way, it was lower. So I mean I thought we did a pretty good job on the expense line for the second quarter. But that being said, that's my best answer. Bernard, do you want to add any salt and pepper to that?

No, I think you covered it pretty well.

You thought I did okay?

Yes. As we -- we're developing markets, we're developing products to feed into that revenue growth and gross margin expansion. And then it's to let that gross margin expansion fall through to the bottom line and that's what we've been focused on. And that's where our focus continues to make sure that earnings are growing faster than revenues and we're starting to leverage the P&L.

Got it. And then another, well, 2 questions I'll package them here real quick, one for Fred and one for Bernard. But Fred, on the central venous obstruction product, that sounds quite interesting. Can you talk a little bit more about the differentiation of that versus other technologies in the market, and how that rollout should look? Is it going to be PAE-like? And then for Bernard, just, I didn't see anything in the press release on cash flow outlook for the business and I know that's an area that you've been focusing on more and more. Should we expect any kind of inflection point in cash flow or just more steady improvements?

On the cash flow, it will be more steady improvements. We have a lot of focus on working capital management. And again, I think it'll be steady.

Let me go to your question. So I answered that question initially based on what do we see for the future and our confidence in our growth and so on and so forth. On the CVO stent, we think we're about 18 months, I think, maybe it might be 16 months now before we introduce this product in Europe. And it's going to be a couple of years, maybe as many as 3 after that before it hits the U.S. market. That's just the regulatory requirement. But I'm not going to talk really anymore about that until we get -- when we're prepared to launch it because I don't want to tip off my competitors there to our features and benefits and advantages. But I will say that we have a full capability in-house of making the stent doing the PTFE, the delivery system that Merit is fully self-contained in this particular area and we're excited about it, phenomenally this product, but several others that are in the queue behind it. So that's the best -- again, not to offend you, Matt, but I don't want to be talking too much about things because I've got competitors on the phone here listening in. And I can give you your names, if you want me to. I could call them out but I called one out and they sent me a note. And I decided I won't call them out anymore. But I can see their names on my call sheet. So we're not going to talk about it until we get a little bit closer to launch in Europe. And then we'll go ahead and we'll start talking about why we think that there's $100 million market out there available to Merit alone. So that's the best I can do today.

And our next question is from the line of Matt Keeler with SunTrust.

I had just one. First, on the 2018/'19 commentary. I know those are organic targets but is your expectation you'll be able to grow EPS in that 13% to 15% even with M&A? In other words, should we expect the deals are not dilutive to EPS?

Yes. The answer is yes. I think when we look at deals and look at these opportunities, they have to be accretive. They have to be accretive to gross margins and earnings per share. On a non-GAAP basis you have deal expenses and you have some of those startups but that's kind of what our general thinking is. And we look at these things careful to make sure that we don't blow up our plan. So I mean, we're very, very mindful -- and listen, Matt, this plan that we put together 2.5 years ago has worked. And I think we've executed well and our goal is, is to continue that. And that's why we're willing to take -- add these other years, plus we'll be able to do that and those things will be accretive and over and above. And I think that if you look back at our history the last couple of years, that's what we've done. So I'm comfortable with that '18 and '19. And hopefully there'll be some deals there as well. I mean, we're working on deals as we speak. We're always working on something. So I hope that answers your question.

Yes, it does. And if I could just -- 2 more quickly. On PAE, are there any reimbursement hurdles that you need to clear before adoption takes place? Or is that -- is reimbursement already established?

Reimbursement is established.

And then just lastly on the quarter, you gave some color around inflation devices and the reason why that growth picked up, custom kits were also better than we expected. I mean, was there anything in those lines that seemed onetime-ish in nature? Or do you think that uptick in growth is sustainable moving forward?

It's a good question. I'm going to let Justin Lampropoulos answer that question. Justin?

So we're seeing strong performance on the inflation device plan in the United States where we have a pretty significant market share predominantly because of the strategic and national account work that we've done over the last couple of years. And that's just starting to come to fruition. We had some key contracts kick in, in I think, the early first quarter. And those are just starting to materialize now. So I would expect continued performance of that base business on the inflation products to continue. So no onetime transaction.

But I will point one thing out, Matt, just for you to write down. It's a codename. It's called basics Tau, T-A-U. The 19th letter in the Greek alphabet. Write it down.

And our next question is from the line of Charles Haff with Craig-Hallum.

Bernard, I had a couple of questions here on the cash flow statement. Do you have the operating cash flow and the CapEx in the quarter?

The CapEx was $6 million in the quarter and operating cash flow, $17.8 million.

Great. And then, Fred, on the catheter line, that was very strong. And I wondered if there was a material contribution from SwiftNinja and continued benefit from Cook's recall of their angiographic catheter that benefited that or if that's kind of an ongoing rate we should be thinking about.

I think I'm going to take the word material out because that's a big -- and it has a lot of legal implications. Let me just say that the SwiftNinja is contributing and is accelerating. And so -- and we're excited about that because of its margin contribution and the uniqueness of the product. So it's doing well and we're pleased with it. Let me go to the Cook issue. When that deal took place on April 5, I think when we first became aware of it, 2016, early in that second quarter of last year, there was an awful lot of pipeline filling. I mean everybody would do anything they could to get a catheter. Remember people walking in, taking everything off the shelf and walking out the door. And so everybody would order and everything we had was going out the door. We were working weekends, holidays to meet that need because our customers needed it. So we are seeing a drop-off in that catheter area. But remember there's a couple of other things, too, that it costs us 30 basis points to be in that business because our approach was not to gouge but to match their prices and meet their needs in a time of need. We did exactly that. I think that it built huge amounts of goodwill. And I also said that I thought we'd do $10 million to $12 million. We did that, I think, in that full 12-month period. We had some you'd seen -- some of that fall off but it's not because we're losing customers as much as it is that bolus that went through. So if you look at our MAK-NV, if you look at our marker band catheters, if you look at our diagnostic catheters, our Impress catheters, all of those have done very, very well. But they're -- you're not getting that bolus again, so on a percentage basis, starting to fall off a little bit. But we kept a lot of that business.

The catheter business is still growing. It was 10.8% growth in the quarter. So overall, our catheter business is still growing. So Cook is only a small part of it.

Yes, Cook is a very, very small part. But again, I think, we gained more by the goodwill that we created by helping customers, so. But the Ninja is, and will continue to be, a big deal.

Okay, great. And then one more question for me on the long-term guidance. We're not used to hearing such long-term guidance this early but I understand it's part of your culture and that makes a lot of sense to me. One of the factors that we haven't heard from you about is competitive responses to your new products. And if we think that the market growth rate for the markets that you're currently in today may be 5% to 6% and you're growing well in excess of that right now. I'm just wondering, are you anticipating further lack of competitive response? Or do you feel like you just have so many internal programs going? I've heard you talk a lot about the internal programs. But it's just a, I don't want to say disbelief but it's -- given this long-term guidance, I'm just trying to understand what kind of competitive response that you're baking into to giving those numbers.

Yes. I love it when you ask me these kinds of questions. I'm an Army officer. You never underestimate the enemy. You never underestimate anything. That's a fool's game. Now we take into account, we look at what they're doing but one of the advantages, Charlie, we have -- you've been here, you've seen this. Our ability to respond, our ability to bring a product to market, our regulatory, our national accounts, we do things faster than other people, in my opinion. And so -- but I've never underestimate. In fact, if anything, I overestimate their capabilities. But bigger as a competitor isn't always better. So I mean I get questions all the time about, "Well what about this acquisition? What about this rollout? What about this and that?" As I said earlier, I don't see that at all as a disadvantage. I see it as an advantage. And I think history has proven that. It's proven it in so many ways and in so many markets where -- we saw it in investment banking, in commercial banks. We see all of these things that roll up. Did they become more efficient? Did they become more effective? Did they meet customer needs? I would argue that, in fact, in many cases, they don't. So all of this stuff that's going on is not something that frightens me or concerns me. What it does is tell me that there's continued opportunity for Merit in the things that we do, and I think we do as well, if better, than anybody. So I hope that answers your question. I like it, though. I like it when you start talking about -- my guys here, they're sitting in this room. Everybody here, and I'm speaking metaphorically, has a go-bag. And I mean, these guys are the best of the best. They're rangers in this room. We don't underestimate the enemy. And I don't need mean to call my competitors the enemy but metaphorically speaking.

I hear you. Okay. And one last one for me on Japan. One last one on Japan. So I heard you answer somebody else's question. January 1 for 2018 for going direct outside of the kit business. I'm wondering, Bernard, if you could kind of quantify for that -- for us. What percentage of your revenues is in Japan right now? And when you go direct, what type of impact do you think that may have in your 2018 forecast?

While he's calculating that, let me go through a few things to give him a little bit of time. I'll stall for him. First of all, as I mentioned, the OEM started in July. Starting in September, just, what, 30 days away, a little longer than that, but we will be in a consolidated warehouse. We would have consolidated all of the Argon business and all of the Merit business and that will be ready so that when those products come over at the end of the year, the space, the customer service, all of those things are in place a full 90 to 120 days before it's required. It will all be in place and all exercised. So that's what's going on structurally. We have the question about what about SG&A? Well, we've got to go -- we've put that warehouse in place. We've done that but we still have to maintain that SG&A line. So that would generally be an extra expense but because of the absorption, the products that we can ship there from Argon, OEM and the Merit products that will be in place to meet those orders, that costs a little extra money. But you won't see it. Because we already had planned that it will be within those SG&A parameters that we've set forth. Are you ready, Bernie?

Yes. So right now it's about 4%, potentially can move to 5%. So the overall effect on our growth, you're probably looking at 50 to 100 basis points for Japan. And just on the CapEx and the OpEx. CapEx are $7.6 million and the operating cash flow is $19.4 million. I just wanted to correct those numbers I gave you a second ago.

And I want to come back and make one last comment about Japan. We have a great reputation in Japan. A lot of these products that you know, like the SwiftNinja, are things that we distribute on a long-term, global basis. But I think as a market, aside from essentially going from wholesale to retail, I think what this opportunity is in restructuring of that marketplace is it gives us a great opportunity for growth going forward in Japan. There are products that Merit's been making for many years that we haven't been able to compete with because we had a distributor who had -- and who is a great distributor and we have a long-term relationship with, who were essentially locked out of those markets. There are many, many, many products that Merit hasn't been selling in Japan and many new products that we will be able to sell in Japan. So I would like to think, and I know I'm looking at Joe Wright at the end of the table here, (foreign language) that I would like to see those growth rates approximate what we've been doing over in China and Southeast Asia. So that's 20%. That's -- I'm asking Joe, he's looking at me, he hasn't responded yet. But my point is, it gives us a lot more opportunity for growth in that marketplace with products that have been well accepted all over the world but was not consistent with the distribution system we have in place. So we're, I think, very excited about the opportunity there.

And our last question is from the line of Mike Petusky with Barrington Research.

So I guess -- and I may have missed this early on but any update on the Tijuana facility capacity kind of near-term intermediate plans as far as that facility is concerned?

Yes. Mike, thank you. It's a great question. I don't know how we'd run our business very candidly without our Tijuana plant. The unemployment rate in Utah is just slightly above 3%. With the growth that we've been showing, we've been taking products and moving. We're moving products, more products this week to Mexico and there will be more -- we're only at about 15% capacity down there. So we still have plenty of room for growth. The business is operating and creating positive variances even with that much capacity. And by the way, another really interesting thing, and I've said this many times, but if I -- if you haven't heard this, Mexico for us isn't about the cost of labor, it's about the availability of labor. And we have less than 1% turnover in Mexico. And like any business, that -- whenever you have turnover, it costs you money. You've got to train people. You've got to recruit people and you're going to lose those even in Utah because of this tight labor market. And I would say we've seen this in Houston, we've seen it in Melbourne, wherever you go, these markets are tight and they're expensive. But in this, we've got capacity, we've got a great staff down there. It will be one of the big contributors to gross margins. And we've been able to move what I'll call legacy products or products that are being built here in Salt Lake City. We've been able to move those into that facility. It's an ongoing and constant plan to do so while we're bringing these new R&D projects, these 10 new products that we'll bring online over the next 12-month period. And we're able to produce these here and go through them, work the bugs out while we move the legacy products there and they pick them up and they execute them perfectly. And one more thing. We have people that come here from Mexico. They come here to be trained. They'll come here for, sometimes, as much as 3 or 4 weeks. Their behavior -- we've never had a single problem with one. They comply with the law, they're hardworking and (foreign language) Mexico. I love Mexico. There you go.

So I guess, maybe it's a question for Bernard, I'm not sure. But the assumptions around the gross margin expansion, which really I'll just say, I think, are pretty impressive. How much of that -- I guess, how much greater utilization of the Tijuana facility is included in that? Or is there a way to essentially say, "Hey, of the 300 basis -- 200 to 300 basis points we expect of improvement there, 50 basis points is associated with greater utilization of Tijuana." Is there a way to kind of break out how much you're assuming in terms of the gross margin from Tijuana?

Yes, there's a number of them. From our operations point of view, we're not solely reliant on Tijuana to deliver on that gross margin improvement. So I will be looking probably for 10 to 20 basis points from Mexico. And -- but we're seeing improvements across all our facilities. And so our focus just isn't in one area. It's kind of spread across -- it's spread across all of our facilities but we're looking at improvements. So Mexico is a part of this. But I -- it's not -- we're not fully reliant on that.

Okay. So out of the 100 to 150, 10 to 20 is Mexico.

Yes, yes.

Okay, great. Then just a couple other quick ones. On the SwiftNinja, I think you guys actually gave sort of a revenue number in the first quarter. I know that's a tiny part of your business but I'm just curious. You said it was accelerating, I think it was around $1 million in the first quarter. I mean was it much beyond $1 million? Or was it roughly in that ballpark?

I don't think we gave $1 million for the first quarter because we just launched it. But I can just simply say without revealing -- because I mean -- some of those things I don't want to talk about. It is accelerating. This PAE approval will continue to do that. But it's not just in the U.S. We're seeing it in Europe. We're seeing it in Australia. I'm seeing stuff in Hong Kong, I'm seeing it in China. So we have it approved in a number of places and it's growing in all of those areas. I think that's the best way for me to answer that question.

Okay. And then just the last question. Were revenues associated with DFINE -- were they actually sequentially down in the second quarter?

No, they were actually fairly close to what we achieved in the first quarter. And as we progressed through the second quarter, we actually saw those revenues improve.

Okay. So it's still decent momentum there.

Yes.

Thank you. And ladies and gentlemen, with that, we will close our Q&A session for today. I would like to turn the call back to Fred Lampropoulos for his final remarks.

Well, ladies and gentlemen, thank you for the questions. Thank you for -- I know it's a busy day, a lot of other companies out there reporting today, and I thank you for taking the time. We're excited. We like laying these plans out. We have found, as I mentioned, that they've helped us. They've helped us to stay focused. And there's a marker out there that everybody can measure us against and we're committed to making this work and doing our best to exceed. So let me just again thank you for your support. I know that we have a number of conferences coming up. I will tell you that those conferences are filled. Every slot from 7 in the morning till 6 at night is filled. So we're looking forward to meeting with the investors that are on the phone. And we thank those who have invited us. And at this time, there's still work to be done here this evening. Bernie and I will be here for the next hour or 2. Thank you again for your interest in the company. And signing off from Salt Lake City and wishing you all a very pleasant evening. Good night.

And with that, ladies and gentlemen, we conclude our program. You may all disconnect and have a wonderful day.