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Merit Medical Systems, Inc. (NASDAQ:MMSI)

Q1 2009 Earnings Call

April 28, 2009 5:00 pm ET

Executives

Fred Lampropoulos – Chief Executive Officer

Kent Stanger – Chief Financial Officer

Greg Barnett – Chief Accounting Officer

Analysts

Sean Babic - SIG

Christopher Warren – Caris & Company

Jayson Bedford – Raymond James

James Sidoti – Sidoti & Company

Unidentified Analyst

Operator

Welcome to the Merit Medical Systems’ first quarter 2009 earnings conference call. (Operator Instructions). This conference is being recorded today, Tuesday, April 28, 2009. I would now like to turn the conference over to Mr. Fred Lampropoulos, CEO of Merit Medical.

Fred Lampropoulos

Good afternoon, ladies and gentlemen. This is Fred Lampropoulos with members of our staff in Salt Lake City and our beautiful snow-capped mountains. We have Kent Stanger who is traveling, been on the line in Atlanta and will be home later on this evening, and I’m going to ask Ann Marie Wright if she will read our disclaimer.

Ann Marie Wright

In the course of our discussion today, reference may be made to projections, anticipated events, or other information which is not purely historical. Please be aware that statements made in this call, which are not purely historical, may be considered forward-looking statements. We caution you that all forward-looking statements involve risks, unanticipated events, uncertainties and other factors that could cause our actual results to differ materially from those anticipated in such statements. Many of these risks, events, uncertainties and other factors are discussed in our annual report on Form 10-K and other reports and filings with the Securities and Exchange Commission which are also available on our website. To the extent any forward-looking statements are made in this call, such statements are made only as of today's date, and we do not assume any obligation to update any such statements.

Fred Lampropoulos

Thank you, Ann Marie, and good afternoon ladies and gentlemen. We're delighted to report today the results of our first quarter. As you can all see Merit reported record sales of $58.4 million, up 9%, as compared to $53.6 for the first quarter of 2008. I should mention that in this quarter, we had approximately 3 weeks of the Alveolus sales which accounted for about $485,000, but that was only 3 weeks. The sales were affected by about $700,000 of lower than expected sales from a large OEM customer, and I’ll come back and discuss that a little further on the call as well as about $1.1 million for FX effect, and this is because of strengthening of the US dollar. All in all, I’m very pleased with the quarter. As you can see from the report, our earnings were $0.19 per share versus $0.15, a 28% increase. I think you can also see that our gross margins were up 220 basis points, over the year ago period at 42.5%. We are very pleased with the improvements that we see in gross margins.

In addition you’ll notice that the SG&A costs were 25.4%, approximately 130 basis points of that were expenses that were incurred relating to the acquisition of Alveolus, and as some of you will recall, we discussed previously that under 141R those costs now have to be expensed in the period. That being said, we also took a writedown in the quarter of about another $420,000 pre-tax. This was for some obsolete inventory and equipment, and we impaired that, but the results take all of those things into consideration. I think as you look at all of that, you’ll agree that it was an extraordinary quarter.

Let me talk a little bit about the groups. Catheter sales were up 25%. I think you’re all aware that that has been the fastest growing area of our business for some time now, and we believe that will continue as we develop more vascular access products. Custom kit and tray sales were 10%. You’ll notice that there is one situation there where you saw a reduction in our inflation device sales. Most of that reduction was a result of the lower sales from an OEM customer.

Without that, our sales would have been up 1.2%, so even that area, which is the slowest growing area of the company, still grew, although marginally. We expect to see improvements to that as we go on through the year with the introduction of two new Merit inflation devices, one digital and one a brand new version of our Basics line, and that’s a 60 mL inflation device which is used for peripheral and esophageal procedures, and that will be a Merit product.

Our inventory continues to turn reasonably well. We continue to have no long-term debt, although you’ll notice that we had a substantial reduction in cash from year end as we used that cash to pay for the transactions. We also repurchased $2.5 million worth of stock during the quarter, and at the end of March 31, we had about $16.4 million in cash.

Another thing that I’d like to bring your attention to is our tax status, and that is that our tax rate was 31.4% compared to 36%. That has to do with the large volumes of product and the direction that we’re going in Ireland, and Greg Barnett, our Chief Accounting Officer, would you just shed a little light on that Greg?

Greg Barnett

During the quarter, the strengthening of the dollar helped their cost to be lowered, plus the material cost of their purchasing went down as well, and they had some increased volumes for production, so all those increased their profitability which are taxed at a lower rate at 10% versus at 38.7% in the US, so that helped improve the overall effective rate for the company for the quarter.

Fred Lampropoulos

Research and development costs were about 3.6% of sales. I would like to remind everybody that Merit still intends to introduce about 15 new internally developed products this year, and we are excited about many of those opportunities. Some of the products that we have released in the first quarter include a 510 clearance for a microcatheter. In the second quarter, we also received and announced recently the clearance for a 55-cm dialysis catheter. A product that we are very excited about that we are starting to ramp up on and one that you’ll hear a lot about during the year is the Merit Miser. This is a patented product that helps hospitals to control the cost. In fact their largest cost in the cath lab is that for contrast media, so it’s a very expensive proposition, and we have a product that helps to save those hospitals money.

One other thing that I didn’t mention in this press release is that we recently received CE Mark approval for our Richmond facility, and that will help us in terms of moving various products to be manufactured, what we think is in a more efficient environment overall. DSOs are 43 days. EBITDA was a record $45 million for the trailing 12 months, so all in all, I believe that we at least met the expectations. In many ways, in our view we exceeded those.

I’m pleased overall with the performance of the company for the first quarter. As you all know, we talked about our performance for the year, and that is $260 to $263 million, and earnings at $0.77 to $0.79 with gross margins at 42.6%. We are not in any position to change or adjust any of those at this point, but if necessary one way or the other, we certainly would do that as we move down through the rest of the year.

We’re excited to have the Alveolus group on line, and we’re I think doing a very nice transaction or at least transition in that business. We’ve renamed the business Merit Endotech, and we’ve hired four new sales people, so we are excited about the opportunities of having those new sales people on board. They’ll be trained over the next few weeks. I’m honored and pleased that today we have a training class of several of our new sales people who are sitting with us from Germany, and I’d like to welcome all of them and thank them for being here. They’re sitting in the room, and this is the first time they have done that. We’ll be here for training over the next few weeks, so we are delighted to have you fine people here today. So, ladies and gentlemen that pretty well tells the story. Again, a 9% improvement in revenues, a 28% improvement in profits, a 220 basis point improvement in gross margins, so overall I’m pleased. I’m delighted to take any questions that you have, and I’ll go ahead and direct amongst Ken or Greg and myself any questions you might have, so we’ll turn time over to the operator, and let’s open it up and start taking questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Sean Babic – SIG.

Sean Babic - SIG

With the tax rate, can we expect that lower rate going forward? The items that you said that went on in the Ireland facility, are those going to be able to be continued?

Fred Lampropoulos

One of the things that we need to do is to make adjustment from time to tome. As you are well aware, each of the taxing entities wants to get their fair share, and there’s this taxing authority and it has to be adjusted. In this quarter, we already adjusted it for several hundred thousand dollars of tax that we paid from where we were a year ago. Greg, do you want to give a little bit further color to that?

Greg Barnett

We’re expecting about a 34% tax rate for the year, so we’ll see. It’ll probably bump back up a little more in the second quarter, and then in the third quarter, we have the FIN48 lapse where it drops down to about 30%, but we’d probably be at 35% to 36% in the second and fourth quarters, but we’re expecting about a 34% tax rate for the year, and if Ireland continues to be more profitable than prior years, we will see a little more improvement in the overall rate.

Fred Lampropoulos

Let me just follow up on that a little bit further. We have several products that are being developed that would be taxed at 10%, so there’s at least an opportunity going forward of several major products that will be major contributors, and so I think we will see a major long-term trend downward on our tax rate because of those high-margin products that are being produced in Ireland. You’ll see some of that yet this year, and you’ll see it continue to progress as more and more of those products are produced there.

Kent Stanger

Yes, I was just going to add basically to what you said that it was part of our basic strategy. It’s part of why we’re in Ireland, not entirely, but I think we have some real opportunities for some of these new proprietary products.

Fred Lampropoulos

We think it’s our patriotic duty to pay a fair tax, but not to pay any more than we need to.

Sean Babic - SIG

On the share buyback, how much of that is left?

Fred Lampropoulos

I think prior to this we had an opportunity to buy up to 1.1 million shares. We bought 250,000 shares, so if you subtract that out of the 1.1 million, there’s your number.

Sean Babic - SIG

I know you basically reiterated your 2009 guidance. Are you still comfortable with the 2010 guidance you gave?

Fred Lampropoulos

Yes. I said that, and I believe that we’re going to grow. We have a lot of exciting products and opportunities, but I’m okay with that.

Sean Babic - SIG

Lastly the 130 basis points of expenses that were related to the Alveolus acquisition, were those like one-time expenses or are those operating expenses contributed from that company?

Greg Barnett

It was $330,000 related to legal and accounting, which are one-time expenses. The SG&A was about $430,000 for ongoing business with their costs for supporting the sales force and the transition.

Fred Lampropoulos

After 90 days, as you’ll recall from our previous call, $100,000 of that will drop off. If you recall, in the transition, we were going to keep all of the employees for a 90-day period. We’re about half the way through that expense this year. After that time, we’re of course keeping the sales force, and then shutting down certain aspects of the company, and we’ll have a reduction of about $100,000 a month in expense.

Operator

Your next question comes from the line of Christopher Warren – Caris & Company.

Christopher Warren – Caris & Company

Just wanted to touch base on the inflation devices. Could you give us a hard number or a hard growth rate for what was reported in the quarter, and then touch base on what you expect here in the second quarter?

Fred Lampropoulos

We don’t talk out in front in terms of forecast, Chris, as you’re well aware into the other quarters. In the first quarter, we did about $14.3 million in revenues off the inflation device business, so that’s what we did in that area. One of the things that we have to look at here is we don’t have very much visibility as to where that large OEM customer is coming from, but I would like to point something that I think is very important, and I’m glad you refreshed my memory.

If you take the large OEM customer out and look at the rest of that division, which you’ll recall that we re-staffed and we’ve been very aggressive in our OEM business, we’re up 41% quarter over quarter, year over year in our OEM business when you back that out. It’s extraordinary, and it’s one of the fastest growing areas of our business, and I pointed out a little bit in our note here that the reason it’s so strong is that a lot of the larger companies are really looking for companies that are reliable in this economic environment and companies that they can get good value, and so Merit has opened up more new accounts and more opportunities in the history of the company, so although we could focus on this one OEM customer, it won’t be very long, and they’ll be a small portion of it, and I don’t mean to diminish the impact that they have now, but clearly it’s declining, and I expect it will continue to do so.

The offsetting entry to that is that that OEM business is growing. In fact I think that the OEM growth in the quarter was about 2-1/2 times what the differential was, so there was about a $700,000 difference in inflation devices from that one customer, but the growth in the OEM for the quarter was about $1.6 million over last year, so more than overcoming that particular part of the business.

Christopher Warren – Caris & Company

Other companies have talked about a little bit of weakness and inventory destocking from the distributors. Are you seeing that in either the cardiology portion of your business or the radiology portion?

Fred Lampropoulos

We’re seeing some areas, like for instance we’re seeing more geographical areas. For instance, we’re talking about Central and South America. We’re seeing some weakness there, but we’re not seeing any weakness in the Pacific Rim. We’re seeing some weakness in Europe, but that’s basically because of the dollar. So all in all, if we take a look at our OEM business and our businesses overall, I think the 9% speaks for itself. There was very little of that that was Alveolus, and we still believe that we’re going to be in double digit growth for the year. I’ve looked at some other companies, Chris, like you have, and I’m not seeing too many of them are doing double digit growth. Merit it. We did 9%, and we expect for the year that we’ll be in those double digits that we talked about.

Christopher Warren – Caris & Company

On Alveolus, you added 4 reps in the quarter. Does that put you pretty close to the total where you want to be for ’09?

Fred Lampropoulos

When we talked about the quarter, we’ve added 4 to this point, so some of them were in the second quarter, so it’s not just in the first quarter. They’re spread out between the first and second, and then remember we only owned for the last three weeks of the first quarter. With respect to your question, we have at least two more that we expect to add, and we’ve moved that up a little bit. Rather than spreading them out over the year, we’ve felt like the opportunity to get them on line a little sooner, so we’ll probably add those other two, probably in this quarter, maybe in the early third quarter, so we’ve probably moved that up a quarter.

Operator

Your next question comes from the line of Jayson Bedford – Raymond James.

Jayson Bedford – Raymond James

Question on the gross margin. I’m just trying to figure this out, meaning the last couple of quarters, it was about 40.5%, and you just put up 42.5% on essentially the same revenue number, and I’m just wondering what really contributed to the turnaround in gross margin, and then is this level that you can build on going forward?

Fred Lampropoulos

To go right to your question, the overhead variance due to higher production was about $700,000, and so from our cost that’s in the system, we’re more efficient. The Ireland and the favourable euro-dollar exchange, now when we talk about that, remember that the dollar is getting stronger, but our costs in the system in Ireland are at the higher cost. That was about 80 basis points, and then if we take a look at the price variances, and this is something we’ve talked about in the past where we’ve seen the cost of raw materials come down. That was about 80 basis points.

I’ll answer your question by saying we continue to invest heavily in automation. We continue to have our programs in place on cost savings. We continue to look at efficiency, so it’s how we get paid. It’s how my staff gets paid. It certainly has our attention, and we think that we’re in the kind of environment that will lead us to be able to meet hopefully and exceed what we’ve talked about, so did 250 for the year. We did the 220 in the first quarter. That’s extraordinary, but if you look at it for the year, I think we’re about 10 basis points behind, so I believe that there is an opportunity when more of the Alveolus products come on. Those were by the way for the quarter, and in that short period of time, we’re about 61%, and as more of that spreads in, we feel that that can help us going forward.

I believe that we talked about the effect of that would be about 90 basis points for the year, so we didn’t even get to see that in here. So you ask the question can we do that; we believe that we’re going to have the opportunity as the business moves forward to be able to, I don’t want to say improve beyond this, but we’re able to at least meet what we said we’re going to, and I think you can read the writing on the wall, although it’s still only the first quarter and we have to execute, but our focus is on materials, on efficiency, on transportation costs, on higher margin new products, and mix, and that’s were Merit’s future is—not looking at the past. I don’t mean to offend anybody talking about inflation devices. It’s a big part of our business, but it’s clearly not the growth part of our business. Vascular access and other types of therapeutic devices are where the future of the company is. It’s where we’re concentrating, and we’ll get the future value of the company while still maintaining some of these areas and some of our legacy products.

Jayson Bedford – Raymond James

Lastly on the gross margin, the $420,000 writedown that was in the number, are we going to see anymore writedowns going forward?

Fred Lampropoulos

Jayson, one of the things you can always count on from Merit is that we’re going to look at each quarter and look at are there any impairments. We do it all the time, but we did so well in the quarter that we thought it would be good time to take those, and there were some assets that you might get hit at the end of the year, and so if there are that are suspect or some inventory or we think something might sit there, we’re going to impair it. We have done it throughout the history of this company, and that’s why you don’t see adjustments at the end of the year, and Greg, do you want to comment on that?

Greg Barnett

Jayson, the $220,000 is in the margin; the other $200 would be in SG&A, so the full amount is not in the gross margin, just so that you’re aware of that split.

Fred Lampropoulos

Nevertheless, we do it all the time. If something can’t be sold and we have to scrap it, we have to impair it, that’s what we do.

Jayson Bedford – Raymond James

So this wasn’t Alveolus specific?

Fred Lampropoulos

None of this was Alveolus. It could’ve been a launch, could have been mix of some products we didn’t have or something where we made an improved process, and of course sales guys don’t want to see the old stuff and you have stuff sitting there, and you can leave it sitting there for several years, and that’s when companies get into trouble when they pull those kinds of stunts. Merit doesn’t do that, and Merit’s never done that.

Kent Stanger

Jayson, one other thing on Alveolus. We make estimates in our purchase accounting 141R, and try to book everything including inventory, and we do get a year’s period in which to really have a chance to adjust those things, but one thing that does affect it, it was only about 10 basis points in this quarter. It is higher margin, so it was only three weeks for it to fail, so it helped us about 10 basis points. As Fred mentioned, in coming quarters, that’s going to be worth maybe 50 or something.

Jayson Bedford – Raymond James

Historically, I think from an EPS standpoint and customer revenue as well, the first quarter has been the softest quarter of the year. I’m just looking at your annual guidance, and the strength of the first quarter. Is it safe to assume that you kind of endorse the higher end of that EPS guidance for the year?

Fred Lampropoulos

First of all, it’s interesting when you talk about the soft quarter. There usually is some slowness that’s associated with a startup. People work out their inventory. Third quarter is generally our softest here in the summer, but last year we saw the biggest improvement quarter over quarter in the third quarter which was surprising to us, so I don’t anymore if we can really predict how these things work out because we’ve been surprised on a couple of occasions, so we’re just going to stick with what we have. We’ve got a lot of work to do and some great opportunities, and I should point something out while I have the thought, and that is there are a lot of other great opportunities out here. This market has created a lot of turmoil, and there are a lot of tuck-ins and opportunities, and as I have said on every call for the last 20 years, Merit continues to look at that and is engaged actively in dialogue for the opportunities that we think we’ll grow our company, so there are great opportunities out there. This market is still in a lot of turmoil.

Jayson Bedford – Raymond James

On R&D, how much of that was Alveolus?

Kent Stanger

$50,000.

Jayson Bedford – Raymond James

I guess the only weak spot in the quarter was the topline growth, and I’m just looking at it. The comps get a little tougher. Your guidance is double digits. What are the big drivers in the remaining three quarters in the topline?

Fred Lampropoulos

Well, we’ve got the new M.A.K.-NV. We’ve got the short sheath. Radial arteries are a big player. The Miser is going to drive a lot of business. I think I mentioned on our last call, it’s probably the sleeper and the biggest opportunity in this company that I’ve seen in a long time because of all of the business that it bring along with it. We did well over 200 market preference trial, and we’re gearing up for that business, and I can tell you that it’s going to drive tons of business. I am excited about it. The Miser is going to be a big product. The sheath line, we’ve got some hydrophilic catheters that will be new to Merit, and a whole bunch of new product extensions.

Jayson, I’ll be happy to go over with you offline, and I’ll be presenting them. We’re doing a presentation in New York, I think, on the 14th of next month, and we’ll have all that information that we can make available because we’ll be showing it there, and we’ll put in online, so that you can see that stuff. Our trays, our kits, just across the board. If you look at the catheter line, that area, short sheaths, M.A.K.s, SMAKs, the Prelude. Radial is continuing to be a big improvement. We have another radial compression device that goes right along with that sheath that’s a new product that will be coming out this year, so just kind of across the board, a lot of good products and just an expansion of our business. It’s just about everything.

Operator

Your next question comes from the line of James Sidoti - Sidoti & Company.

James Sidoti - Sidoti & Company

Following up on the R&D, even though your sales were up 9% in the quarter, the R&D number basically was just a little north of last year. It was down from the last three quarters. Is there timing going on, timing of projects ending there in this quarter, or should we look to that number to tick back up again going forward?

Fred Lampropoulos

We have a number of products that are in R&D that are going to be switching over to manufacturing, and then we’ll replace those with new start-up products. So to go on a quarter to quarter, I think the best I can do is just talk about what we think that expenditure is going to be for the year, and we guided I think that at about 4% to 5%, so from this 3.6%, I think you’ll see it tick up a little bit, yes.

James Sidoti - Sidoti & Company

Can you help us on how to think about adding these salespeople and what effect that will have on operating margins over the next couple of quarters? Do you think that will put a little pressure on the margins in the second and third quarters as you start to train these folks?

Fred Lampropoulos

There’s going to be some, but they’re in our numbers. They’re in our budget. There’s going to be that expense, but it’s all included in what we’ve talked to you about, although we’ve shifted them a little bit. One of the great things is I’ve looked at all the resumes. I haven’t interviewed these guys. We’ve got staff that does that, but they’re all people who have experience in this area. They’ve worked for some of our competitors or they’ve worked in associated markets, so although they’ll need some training, it’s fair to say that they’ll take usually about 6 months before they’re at full steam. I don’t know that these guys are any different from any of the other sales guys. It does take some time. I think the other factor though that we’ll see is the guys that are out there, the other 10 or so guys that are out there, I think we’re going to see higher performance levels from them, and the reason that we’ll see that is because now they’re at peace. They’re all signed on. They’re all moving forward. They don’t have to worry about their careers and all that sort of stuff. It’s in place, and so when you get people like that, they’re going to be more productive. They’re going to have more confidence, and they’re going to be out on the street, and they’re going to be managed, not that they weren’t, but you have expectations and we look them, and so I think it’s more of the 11 that I expect that will pick up the slack for the other ones while they’re being trained, and then I think we’ll get full steam ahead as we come through the second half of this year.

James Sidoti - Sidoti & Company

Just a general comment—if I look at your numbers, unlike almost every other company I’ve seen report so far, if I was just looking at your numbers and not reading the newspapers, I wouldn’t know we were in the middle of this economic turmoil. Are you feeling any effect from the economy, and if not, why do you think your numbers are holding up so strong?

Fred Lampropoulos

Jim, I love you deeply. Well, I looked at one company the other day that’s kind of in the same area that we are, and their sales were down 20%, and I’ve looked at others. I think it has to do with our broad range of products, our geographical presence. I think it has to do with the spread of the kinds of products that people have to use. This isn’t something that you can say I’ll schedule later on. These are things that have to be taken care of. I think another part of it is our OEM business where again we’ve seen even on our side from some of our vendors where they’re getting weaker, and we’ve had some expenses and costs of replacing some existing vendors because they’ve gone out of business and we’ve seen all kinds of things. I don’t think other medical device companies want to have to deal with that, so that’s another important and why we saw that business quarter over quarter, year over year up 41%.

So I think if you add all of that up, products that are complementary, our sales effort, our national accounts—you know we’ve got Todd Oldroyd sitting here, we’ve been able to go out and land national accounts. I’m aware at least of one situation just in the last couple of days where we picked up $100,000 worth of business at a hospital with Virginia with good margins simply because of the work that our national accounts guys have done, and as I have said to you Jim, there really essentially is not a hospital in this country that we cannot get into. Now, we’re also starting to work on those national accounts and buying groups in Europe. So I just think it’s because we’re just executing. I saw a bumper sticker years ago; “I heard there’s a recession. I’ve just decided to ignore it.”

Kent Stanger

If I may what I’d like to add is that I think this is a recession for us, and you talked about the topline. It is really helping us in many of our costs, and we talked about some of those inputs in our gross margin where we’ve relatively fixed costs, so as we’ve been able to increase volume and save on freight and things that we’re able to pass those overhead applications into the gross profit area, and then the material cost has been dropping. We talked about them having a lag from last year. Well, that’s coming through now, and you can see that in the margins, and when you see the fact that even though we’ve been talking about the topline being a little weak, it looks almost entirely attributed to the strong dollar, and the exchange rate disadvantages on the sales is the same thing as an advantage in Ireland, and when you tax it less, it’s causing us to actually make more money I think almost with the stronger dollar, so those things are all contributing.

Fred Lampropoulos

Jim, let me just weigh in on one more thing too, again because as I am looking around the room and my staff, I look at my engineering and my operations, we take a look at freight, and one of the things that the high freight costs did to us last year was of course put a lot of pressure in terms of our momentum. With $1.8 million in savings this year just in freight costs because we’re now sending them over on the water, and so some of that shock that came to all of us in this country is something that we responded, and we’ve a good portion of that cost now and that space, because many of those things are going over 50% full, so we’re going to have that space at those lower rates, and that’s $1.8 million worth of savings, so we’re kind of hitting on all cylinders in our business. Our sensor business, our technology companies, our domestic sales, and I think with the re-staffing of Europe and these folks that are in the room today, there’s a lot of optimism as we look not just 3 or 6 months, but as we look at our business. We look at Merit over the next several years, we’re going to continue to perform and build this company, and we’ve targets for earnings like $1 and $1.50 and those sorts of things, and I think we’re going to represent tremendous opportunity for investors.

Operator

Your next question comes from the line of James (inaudible).

Unidentified Analyst

The quarter looks great! I have got a couple of questions. Some of these have been answered, but I’m going to go back and hit them again. Very briefly, on the gross margin, it was much stronger than I was looking for. Is this a function of volume efficiencies, bringing down costs, product mix, or price increases? If you would break up what’s driving the better-than-expected gross margins, how would you define that?

Fred Lampropoulos

We’re not raises, so we’re holding prices, but not raising prices. We did a little selectively, but I don’t think that’s an issue at all. It’s the higher production volume that’s a key factor in it, and the efficiency and automation and those things. The Ireland is so interesting. For years and years, we have worked very hard to build this Irish operation for 15 years, and now that investment is paying off. The products they’re building that they’re supporting, the catheter group, which is growing the fastest, and Ireland builds a good portion of those wires and some of those products that support those products. That’s part of it. We got a little bit of a help from the higher margins and mix from the 61% off the stent business, and then the lower material cost. That, again, as we’ve discussed several times was about 80 basis points, and we continue to hammer on those opportunities. For instance, on the $1.8 million that we’re talking about on freight costs that directly affect those gross margins, that’s just starting. It’s in full effect. We’ve got shipments going out of here every week now, and that pipeline is full, and so we get the savings, and Ron, tell me the difference in that cost per week.

Ron Frost

About $24000 air and about maybe $5000 ocean per shipment for a 40-foot container, per week.

Fred Lampropoulos

That’s a lot of money.

Ron Frost

It’s twice as much products.

Fred Lampropoulos

Yes, and twice as much product, so it’s a significant thing, so it’s all of those factors that we discussed James.

Unidentified Analyst

It sounds like you’re hitting on all cylinders. I’m jump to the R&D, and like other people who’ve said on this call, the number in actual dollars was much lower than I think a lot of us had modelled in, but I know that in your in-house product development, you’ve got a very full product pipeline, and you’ve picked up some acquired products. First of all, I want to clarify, I believe that you said approximately $50,000 of R&D from you Alveolus acquisition?

Fred Lampropoulos

That was about $58,000 that was all that we covered, but remember that that’s only for three weeks of the quarter.

Unidentified Analyst

Fred, we’ve talked about the stents and margins and the growth rates there and the attractive valuation that you got on that acquisition, but can you talk a little bit on this call about what you acquired in the R&D pipeline in that deal?

Fred Lampropoulos

No. Thanks for asking. I don’t mean to smug about it. I will say this that we are actively engaged in a covered biliary stent and doing trial work in Europe on that, and we have several other stents that we’ve had dialogue that had not been started but that we’re starting development of now, so some of that was that ongoing work. There are a number of new products now that they’re under our wing that we’re starting to define and work forward, so we expect that as we move down the road, we’ll have more and more stents that come to market, but they’ll take a few years to do. These are not thing that are going to pop us this year or next, although the covered biliary we think is very important. That’s the largest non-vascular market, and we believe that’s an area that we want to focus on, so I will tell you just this week in a hospital in the US we deployed a couple of biliary stents that were bare-metal stents, and the physician sent me an email telling me that they were extraordinary. He loved the delivery system, and he actually preferred it over their existing product that he was using that’s from a large company up in the Boston area, so that’s encouraging to me that as physicians, it doesn’t make any difference what I think, it’s what they think, and I love getting those mails when a physician takes the time to write me and tell me that he believes that this product is a superior product.

Unidentified Analyst

I’m very excited about the acquisition. Is it safe to assume though that Alveolus during these difficult economic times maybe de-accelerated some of their R&D?

Fred Lampropoulos

I don’t think so, and the reason I say that is because we still have this whole demographic area that’s working for us. We still have very little penetration or anything going on in Europe. We have several of our distributors including our Japanese distributors and others that are excited to get this product. It’s a great product, so both geographically, demographically, and just coverage, remember we have only 10 guys covering the entire US, and we don’t have anybody covering Europe right now, so just that alone and just getting our market share is going to drive growth. Now, another thing that’s exciting about this whole issue is the other products that we’ll be developing or acquiring that will fit perfectly, and they’ve never had any of those products before.

They’ve had a few, but they’re going to have inflation devices. They’re going to have other GI products and syringes and other types of things and kits that they’ve never had before. Those are products that we already have, so we think we can generate sales, profitable sales, high-margin sales, but we don’t have to spend a lot of money on R&D. They are existing technologies that we’ve paid for for years, so we’re excited about the growth of that business, and equally important is the core, the base technology, and what those things can do for other endovascular types of products, and again I just had my R&D guy hand me 4 new stent products, which I’m not going to tell them about Jim, so I’m gong to head it back to you.

Unidentified Analyst

When you did the Alveolus and the Biosearch deals, I was under the impression that you had CE Mark approval, but you really weren’t doing much or they weren’t doing much with those products over there in Europe, and I thought that would be a big opportunity for you going out in the second half of ’09 into 2010. Is that a correct assessment?

Fred Lampropoulos

That is absolutely correct.

Unidentified Analyst

When you broke out the R&D number from Alveolus, can you tell me how much of the SG&A number it came in through Biosearch and Alveolus?

Kent Stanger

It’s about $434,000 for Alveolus. There’s really no cost that we’re showing for Hydromer and Biosearch because it’s relatively small, because we’re basically just integrating those into our sales force.

Fred Lampropoulos

There’s not much there. As I mentioned in my earlier comments, we have this extra cost that we have for the first 90 days because of the staffing and the facilities. After 90 days from the closing, about $100,000 a month drops off, but I want to point something else just in fairness, so that we don’t get our enthusiasm here beyond where it should be. The Alveolus division is losing money. That doesn’t sit well. We’ll build it. We’ll structure it, and we’ll do like we did in our business down in Richmond. We lost money on that, but we’ll focus on these areas. We’ll bring these new products out. We’ll get more sales people. We’ll do cross-selling of our other products that go into that area, and we’ll build a profitable division.

Unidentified Analyst

I’m going to switch to the balance sheet very quickly. On the inventories, we had kind of a $5 million sequential increase. I know you’ve got some companies coming in, some acquisitions closed, you’ve got a new product pipeline. Where should that number peak at? Is that about a $45 million inventory number going into 2009?

Greg Barnett

We had about $2.2 million in that number from the acquisitions. We’ll probably see that still trend up some throughout the year as we build that Alveolus business there with the stent, but we’re trying to improve our turns from where they were last year, and so you’ll probably still see some growth in that throughout the year, but we’re trying to keep the turns down as best we can or improve our turns so we can keep that inventory balanced.

Kent Stanger

We’ve got a little extra in some areas that needs to be sold. I know we can keep it pretty flat as far as the total dollar, and then we shouldn’t forget we’ve got the Hydromer business that is going to need to be in inventory because they’ve been in back orders, so we have a little bit more of that I hope as we get that production going here on our own, so Hydromer should help too.

Fred Lampropoulos

Let me also point out one other thing. Because of the turmoil that we’re seeing in the market place, there are some situations where we’ve bought larger safety stocks, where someone has either gone out of business or where there was this or that. There’s still a lot of turmoil. In fact, you’ll recall from my last call that I thought that the largest single risk in the company were the effects and risk of outside vendors. Now, most of those are backed up, but they still take time, and sometimes you have to buy enough inventory to cross you over, so I think some of this is coming from that ongoing turmoil that still exists.

Ron Frost

Some of the increase in inventory as well is building these ocean shipments. We’re going to have inventory on the ocean now, and those are about 5 weeks of inventory, so that causes some increase as well.

Fred Lampropoulos

Again, it takes about 30 days versus about 7 days to take it and fly it over and drive it where it needs to go, and so you have to fill that pipeline, and that’s going to cost a little bit more, and that’s part of what’s in those numbers as well.

Unidentified Analyst

On the other assets, the increase in the intangibles and the goodwill, is that all deal related? Is there anything else in there we should know?

Fred Lampropoulos

It’s pretty well deal-related.

Unidentified Analyst

Fred, you’ve hit this before, and I’m going to ask it again though. In terms of the market place, I mean I’m looking at different companies, I’m hearing from hospitals, I’m hearing from different vendors, the procedure volumes have declined. I’m looking at you guys, and you’re single use. You’re non-CapEx, you’re cardiac focused, you’re non-elective. You’re relatively immune to the economic slowdown as one could be. What are you hearing out there with hospitals and clinicians? You’re in front of a lot f them, and what are you hearing in terms of the US and the EU? I know you’ve talked about it previously in this call. I don’t want to beat a dead horse, but that’s a million dollar question for a lot of investors at this time. Congratulations on a good quarter, and thanks for the time, but talk a little bit, Fred, you just mentioned turmoil. Talk a little bit more about the turmoil, if you don’t mind please.

Fred Lampropoulos

Let me go to part of your comments when you said we’re in the cardiac area. Remember that half of our business is in the interventional radiology business. It’s also where we’re focusing and have focused our R&D for sometime, so that’s another important factor. We’re in the critical areas where people have to have these procedures. You can’t delay them, you can’t say I’ll do it later it or after this or that. You have to have these things done. Again it goes back to the geographical issues and opportunities. We’re still going direct in one new country or two each year, so we’re going from wholesale to retail. That’s relatively small, but as you start to add that up year over year, it starts to move that in that business. Remember, there’s always a bull market someplace, and if you take a look at Japan, you’re seeing that with the strength of the yen, they are purchasing more products because it costs them less, so there’s another factor there, and we’re blessed to have all of these various factors working.

Now, I’m a little bit concerned about Europe. We’re doing great in manufacturing. A lot of that’s coming back, and I’m saying that because I have 5 new German reps sitting here and they’re going to take care of my concerns. They hear you saying that, and I hear me saying it, and we think that this is a great opportunity when other companies are downsizing and when they’re not doing so well to really pick some really wonderful folks. These are tremendous folks, and I expect a lot of them. So we’re spending a lot of time, the folks that work on our staff there of really taking advantage of what we think is weakness of our competitors and of the environment to strengthen ourselves and to move forward with these opportunities, with these products in those markets.

So where’s the Euro going to go? I don’t know, but one of the great opportunities that we have is that we have that natural hedge in place. It’s not going to be too much one way or the other, but we’re protected. We’re getting some tax benefit. It cost us $1 million in the quarter for FX effect. Okay, well, we pick it up on the other side with lower costs on the production side in Ireland. So, I don’t know if the concern on the call is somehow that this is fluke or a one-time deal. To be very candid with you, the sales number was below our expectation internally. I can share that with you. I thought we’d do a little bit better, but I’m not unhappy with 9%, and we also spent an awful lot of time over the last 4 or 5 months putting these deals together. It took a lot of time and a lot of focus for us to get those deals done, and we couldn’t spend our time in all these things. We also had some restructuring in our sales and marketing. Marty Stevens took over some other deals. We brought some other folks up and changed those, so this is a dynamic company, but all in all, I don’t see my competitors developing new products. They’re still ignoring the areas that Merit recognized 20 years ago that there were opportunities to bring new technologies.

Another important thing, in the first quarter, I think between the fourth and first quarter, more new patents issued than any other time in Merit’s history, so we continue to create technology, intellectual property, our technology is growing, and I want to point out one other thing. This is a long answer to your question, but another area that’s working really well, and going back to our technology companies. You know we have our sensor company here. They’re kind of quiet. You don’t hear a lot about them, but we have two or three major contracts with companies on sensors, and that helps our business. We were over in China recently at a trade show, where our coated wires that are coming out of our MC Tech business over in the Netherlands. We are in fact today in the process of coating a large Japanese company that’s looking at buying out coated wire, so there’s been a lot of opportunities created. I think we have a solid business plan, and we’re just driving that plan, and there are still these great opportunities. That’s the other thing. I’ve never seen more opportunities that tuck in very nicely that fit right at point of sale. My staff is looking at and they’re all giving me googly eyes right now. They’re going will you please stop. They all want me to go on vacation. I’m thinking about taking a day off in July, so that’s life for us by the way, so all the kidding aside, there’s this much to do. So thanks for the question, and I hope I answered it appropriately.

Operator

There are no further questions. I’ll turn the call back over to you for any closing comments you might have.

Fred Lampropoulos

I appreciate the questions. They were good questions. We appreciate your interest in the business. Despite all this discussion that we’ve had, we have a stock that’s come from a high of $21 or $22, and we’re sitting down here at $13 and change, and that’s disappointing to me. What’s not disappointing to me are our plans, our balance sheet, and the people that are sitting in this room that worked so hard. We believe that this is maybe the greatest time and the greatest opportunities I’ve ever seen in the 30 years that I’ve been in the medical device industry.

Despite the turmoil, the political uncertainties, all of these things that are going on, it fits right in our sweet spot because we planned for it, we worked for it, we prepared for it, so we believe that there’s a great future for the company. I’m not talking about quarter to quarter. I’m just telling you that as I look at our growth rates in our business, I can look down 5 years and see a company that’s twice this size than it is today with improved gross margins and profits that will more than double as the size of these things, which means that some day we are going to look back and say I remember when I had a chance to buy this stock at this price and I didn’t or I didn’t buy enough and all this kind of stuff. That’s fine. We’re in markets, they go up and down, but Merit has a solid plan and a great opportunity, so thank you all for you interest. We have several investment conferences coming up, 5 or 6 of them coming up over the next few months, and we’re going to be out there telling our story, and we have other things that we hope to be talking about in the very near future, so thank you very much. We’ll sign off from Atlanta and from Salt Lake City, bidding you a good evening.

Operator

Ladies and gentlemen, that will conclude today’s teleconference. We do thank you again for your participation.

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Source: Merit Medical Systems, Inc. Q1 2009 Earnings Call Transcript
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