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Merit Medical Systems, Inc. (NASDAQ:MMSI)

Q2 2009 Earnings Call

July 28, 2009 5:00 pm ET

Executives

Fred Lampropoulos – Chief Executive Officer

Kent Stanger – Chief Financial Officer

Marty Stephens – Vice President of Business Development

Greg Barnett – Chief Accounting Officer

Analysts

Dave Turkaly - SIG

Christopher Warren – Caris & Company

Jayson Bedford – Raymond James

James Sidoti – Sidoti & Company

Ross Taylor – C.L. King & Associates

James Terwilliger – Duncan Williams Inc.

Operator

Welcome to the Merit Medical second quarter 2009 earnings conference call. (Operator Instructions). This conference is being recorded today, Tuesday, July 28, 2009. I would now like to turn the conference over to Mr. Fred Lampropoulos, Chairman and CEO.

Fred Lampropoulos

Good afternoon, ladies and gentlemen. This is Fred Lampropoulos. We’re broadcasting from Salt Lake City, Utah, today. We’re delighted that you’ve joined us. I’m going to ask Ann Marie Wright if she would please read the safe harbour provision.

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 are discussed in our annual report on Form 10-K and other reports and filings with the Securities and Exchange Commission and 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

Ladies and gentlemen, we're delighted that you’ve joined us. I’m pleased to announce the results of our second quarter. As you can see from the headline, our sales were up 13% over the year-ago quarter, at a record level of $64.8. I think of significance, we should note that our core business was up 9% and change, and we continue to be very strong in our overall business. Our net income was $5.8 million or $0.21. I believe that is ahead of Wall Street consensus of $0.19 as well as I think the revenues themselves were slightly ahead of Wall Street consensus.

Just as a point of interest; they are record earnings, and I think we were able to do that with some headwinds that came from the cost that we have previously discussed with you regarding the acquisition and particularly of the Alveolus acquisition which came with a salesforce and the expense of that as well as more salespeople that we have hired since that time, and we have a full quarter of that expense. Additionally, we have been staffing up in Europe. We staffed other areas in our OEM sales, and so we’re building, we think, for the future and make sure that we have the horses out in the field to be able to take advantage of the opportunities that we see in the future.

All of the areas of the business grew except for the inflation devices. This was anticipated, and most of that decline comes from the issues of Kyphon, which is as you’re all aware an OEM customer, and we expect that pressure will continue to decline, even though that overall sector continues to be very important to us.

We will introduce a couple of a new inflation devices this year, and we’ve a couple of other business issues that we’re considering that we think will actually bring that sales grow back into a growth mode probably by the first of the year. I’m not going to discuss a lot of about that, other than to say that the product is very desirable and has other uses as we all know than just in cardiac and peripheral work, and we’ve had several inquiries and are now having dialogue with a number of potential customers which we think will help to enhance that business.

Overall, I think we’re very pleased with the growth of the various areas of the business. Gross margins were 43.4%. That’s up 70 basis points from the previous quarter, and we’re up 150 basis points year to date. You’ll recall that as Kent and I have had these discussions with many of you in the past, we had promised 150 basis points for the year. We’re there, and depending on how our proceeds the balance of the year, we hope that we’ll have an opportunity to exceed that.

Just as a reminder, we’re entering into what we call our slow season. It’s always a little unpredictable, and we don’t go by quarters, but we always caution at this time of the year. I’ll remind you that last year we cautioned on the revenue side, and I think it was our strongest quarter of the year, but nevertheless, the summer because of shutdowns in Europe and so on and so forth is always an area where we get a little cautious, even though we think that the business will still grow in the range of 13% or more for the overall year. Year to date, I think we’re up at around 11%, but we’ll have the balance of the products for the whole year.

Kent, you had a comment you’d like to make.

Kent Stanger

On the gross margins, the second quarter was our strongest quarter last year, so that comparison is the toughest for us because if you look at the next couple of quarters, it was actually down sequentially, so I think it gives us good hope for the ability to maintain all through that 150 you were talking about.

Fred Lampropoulos

Also, as a point of interest, as you’ll all note from the financial statements, there is the higher SG&A costs, up about 270 basis points, and of course this is the expense associated that we just discussed with really those sales group. Now, over time, we believe that that will normalize down into the 23.5% to 24% range, but it’s going to be into 2010 before we see that, but nevertheless we’re making the investments that we have to make in order for the business and to have people out there selling our products.

As you know, in the Alveolus transaction, there had about 10 salespeople, and they just simply had geographical areas that were just prohibitive, so we have diced that up, and we think that as we train and get those folks, which usually is a 6- to 9-month period that we’ll start to see the benefits of that product as we go forward. We continue to spend about 4.5% or so on R&D, and we’ll continue to do that.

Just as a point of interest, the EN Snare product that we acquired from Hatch is in pre-production. We expect that at the first of the year we will be delivering that product. That will have great implications relative to gross margins. I believe that it was 90 to 100 basis points that we’ll see going forward, and we think it’s a terrific product. Just about every place and everybody we talk to that we did in our due diligence and continues on is that people love the product, and with the number of salespeople we have and the overall geographic presence, we think that that’s going to be a terrific product for us.

Just as a note, a good portion of the international sales that came from the product are existing Merit distributors, and so the crossover into Japan, into Canada, and other areas if going to be relatively easy in terms of the relationships that we already have.

A couple of interest, also on individual product lines, we saw tremendous growth and continue to see that as we’ve staffed up on our OEM division. Our overall OEM division year to date is up 36% and up 28% quarter over quarter. A couple of highlights of product areas that we’ve very excited about and part of our fluid administration and our valves for the quarter were up 33%, up 40% for year. Our vac-lack syringes, a product that has been around for several years, continues to receive acceptance in markets from numerous OEM customers. That business is up 47% for the quarter and up 63% for the year. Our new product, the short sheath is up 122%, and here’s something else I’d like to share with you because I think it points out and speaks to really Merit’s products and the building of product lines.

Oftentimes when we release a product, these are products that we think have advantages over the competition but they may have been in the market for a number of years. I’ll give you an example of the Prelude. The Prelude sheath has numerous catalogue items and as we started that product line out, we came out with a basic package first and then moved it on to marker bands, we moved it onto radials, we moved it onto 23 cm and so on and so forth. That business which we first introduced almost 5 years ago for the quarter grew at 53% for the quarter and for the year 53.3%.

So, here we are 6 months down the line, and now that we have all the pieces to the puzzle, we’re really enjoying tremendous success, and yet those products may have been written off or not discussed much, but I’m sharing them with you because we believe that this business can grow another 60% or 70%. In fact, it’s our plan to grow this business another 60-70% by the time we get through the year 2010. Tremendous growth, but it takes time. We’ve build this product line out. I think we’ve been very strategic about it and patient; nevertheless, we’re starting to see I think the bounties of the harvest, and this product line continues to grow dramatically.

One last one is the Resolve drainage catheter. For the quarter, the catheters were up 63% and 71% year to date. That is just terrific and I think speaks volume to the efforts of our salesforce, of the innovation that’s involved of these products, and the acceptance of these products by our customers. So all in all, I’m very pleased about how the business is coming. We continue to have no long-term debt. We’ve made these acquisitions, we’ve funded all this, funded all of our capex, and we’ve paid everything in full, so that’s a tremendous position to be in.

We’ve talked about gross margin. Kent, why don’t you go ahead and jump in if there’s anything you’d like to say.

Kent Stanger

I think we’ve done a reasonably good job of managing our cash flow. Our DSOs are at 42 days. Our EBITDA continues to grow. It’s reached $45 million in the trailing 12 months, so we’ve been able to keep growing the business and still fund all of our capital needs and cash flow needs so far.

Fred Lampropoulos

Just a couple of other points, and then the best thing to do would be to turn it over for your questions, but we intend this evening to file our 510(k) for the projects that we’ve discussed previously in Ireland. We’re not going to talk about the product for competitive reasons, but the important point is that we hope that within the 90-day period we’ll receive that 510(k), and as we roll into the first of next year, along the EN Snare product line, we’re going to have some dynamite products as well as others that we expect will roll out by year end.

So all in all, we have a full pipeline, great opportunities, no debt, gross margins are growing, sales are doing terrific particularly in this environment, and all in all I think the company is doing just fine. Kent, any closing comments, and then we’ll turn it over to questions.

Kent Stanger

Also note that our tax rate has improved over last year in part because of the improvement in Ireland in large part. We’re paying lower rate on that.

Fred Lampropoulos

And I think that maybe deserves a little bit more discussion in that this is the strategy—we produce a number of products, we’re very busy in Ireland. It was years and years when it was a drag, and now again we’re enjoying the fruits of the labors of many years. We also have a tremendous amount of work that’s been done here locally in terms of R&D tax credits in the state of Utah, so as you look at all these things, I think that you’ll see that our effective tax rate legitimately is in a place where we get to have the benefits of lower taxes, and particularly in the environment that we face, I think this is good news for our company.

That’s it. A tremendous quarter as far as I’m concerned, improvements across the board. One little blemish on the issue of inflation devices, but that is not a surprise to us. We’ve discussed that, and we’re prepared to continue to grow that business as we move into 2010, and other segments of our business really doing well. One last comment is that we continue to see from our competitors that in many of the areas that we compete in, they seem to lose attention and focus and they don’t develop a lot of new products, and so we believe that with what we have on our plate, new products that are coming forward, that we’re going to be able to grow in double digits for the foreseeable future.

That’s our report. We’ll go ahead turn the time over to you for your questions, and again thank you in advance for your participation.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Dave Turkaly - SIG.

Dave Turkaly - SIG

I know you mentioned in the quarter that you did expand the salesforce. Can you tell us how many people you have now and where that stands versus your goal for the year?

Marty Stephens

In the US, we have about 85 people in the field.

Fred Lampropoulos

In Europe?

Marty Stephens

We have about 25.

Fred Lampropoulos

This is including managers, so about 110, and in the Alveolus salesforce we have 16. So one of the things that we did David as we had thought initially that we might hire a couple of these folks and spread of them over quarters and then as we looked at the training and the time engaging them, we moved them and compressed them a little, particularly on the Endotech division. We talked about maybe 2 in the second, 2 in the third, and 2 in the fourth, and we compressed those because we thought we’d be more effective in training and getting those products out there. So those are the numbers on the salesforce, and we’re pretty well done for the year. There may be a few more, but we’re pretty well wrapped up for the year in terms of those expenses.

Dave Turkaly - SIG

On the charge that was in the SG&A in the quarter, can you tell us how much that was? Typically I would exclude acquisition related charges which would probably mean you beat by instead of $0.02, maybe $0.04.

Kent Stanger

For the quarter, the SG&A involved with our acquisition was $1.9 million.

Dave Turkaly - SIG

That’s the incremental now. Wasn’t there a writeoff in there as well?

Fred Lampropoulos

No. The expenses were incurred in the period. There were no writeoffs. The expense for the six months is about $0.04 and about $0.02 for the quarter.

Kent Stanger

That’s the net. I think he was asking for SG&A increase, and that was about $1.9 million, and there was R&D for another $340,000 and then we had contribution from sales net of cost and you end up with the $0.02 variance.

Dave Turkaly - SIG

You mentioned some of the products that were strong, but standalone division was up a lot. Would you say that the products you highlighted before would be the main drivers of why that was strong this quarter?

Fred Lampropoulos

That’s part of it.

Kent Stanger

Some of those were catheters were though.

Fred Lampropoulos

In fact, if you look at the drains and the Prelude, those go down in the catheter division. MAPs were up. MC Tech, our division that we bought several years ago from Angiotech, was up about 46% for the year, and I failed to mention that. That’s a terrific little business that we bought several years ago for about $3 million and it’s just doing terrific over in Europe, and this one of our businesses, the Coach wire that’s used for tubes and diagnostic catheters, of which Merit is of course the largest user. That business is doing very well for us.

Kent Stanger

MAPs and medallions and needles were strong this quarter as well in that group.

Fred Lampropoulos

I think Dave one of the things that’s really helped is as we’ve staffed out our OEM division, we’ve got the US and Europe staff. We didn’t have this done a year ago, and I think that’s one of the areas as I mentioned that’s up I think 36% or so for the year, and so we’re doing terrific. Business is strong across the board.

Operator

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

Christopher Warren – Caris & Company

What were the revenues for the stent product in the quarter?

Fred Lampropoulos

In the quarter, they were $2.195 million.

Christopher Warren – Caris & Company

Any change at this point to what you think is reasonable for the top and bottomline for the whole year, or are you keeping pretty much the prior comments?

Fred Lampropoulos

I think we’re going to just stay where we are. There were some issues in the startup and the transfer of the stents and kind of gathering some of the trunk stock and stuff like this, and we’re also improving the biliary part of that business. We really haven’t launched part of that, but I can’t say that these things were unexpected. These are a few little bumps along the road, but all in all I think we’re fine. If you take a look at the six months, we’re at $0.40 per share, and I think we said that we were going to do $0.77 to $0.79. It looks like that’s quite doable, and if we have reasonable at these levels, then we’re going to be just fine, and hopefully we’ll be able to exceed that, but I don’t think it’s appropriate for us to go ahead and comments on it now. Now, if we have a gangbuster third quarter like we did last year, we could up the numbers. So I think we’re okay for now.

Christopher Warren – Caris & Company

I have a question for you on the hospital pricing environment. I understand a lot of these guys are becoming more sensitive to the cost of devices and to some extent that may play competitively in your favor. Are you seeing any benefits to an increase in price sensitivity there?

Fred Lampropoulos

We always have those issues to deal with, with the buying groups and those sort of things, but I don’t hear a lot about it, Chris. I just don’t see a lot of pressure, other than what I have seen traditionally, so there’s nothing extraordinary or unique in any way even though there is a lot of discussion and everybody is talking about cost. We think we bring value to hospitals. We bring safety to hospitals. We bring the ability to bundle and customize and offer convenience, so we continue to sell that. As an example, last month in Great Britain, it was an all-time record sales month. So we’re doing the things and delivering the products that people want to buy. Even in spite of what some people say are lower, we see these number of lower admissions and lower procedures, we hear all of that stuff, but the way we have our business structured with OEM, with industrial types of products like our wires and our sensors, the mix, the geography, we’re doing pretty well. I’m always knocking on good, but compared to what everybody else and what the world looks like, I think we’re doing terrific.

Christopher Warren – Caris & Company

Typically as you go into the seasonally slow third quarter, operating margins decline sequentially. Are there any factors associated with the recent acquisition and integrations that might be an incremental sequential positive from a margin perspective?

Fred Lampropoulos

Not yet. I think as we move into the first quarter of next year with the EN Snare, we’ll move into essentially a fixed cost environment. I think we’ll see quite a bit of positive there both on the gross margin side that we’ve discussed, but I don’t think we see anything else at this particular point that would give us much of an advantage.

Kent Stanger

The stents will help a little bit, 30 basis points. There was some help there on it, and on the other side, we’ve seen a lot of growth in some of our lower margin stuff, like some of our kits and stuff, so that helped balance that out I think.

Operator

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

Jayson Bedford – Raymond James

The growth in the custom kit and trade business accelerated quite a bit, and I am just wondering what accounted for that strength. Is it in either custom kits or the trade business or was there a new product there that helped boost that growth rate?

Marty Stephens

It’s not a focused product, Jayson. That’s an interesting thing for us. It’s something that we’re not really pushing, but as we get more and more penetration into the labs with all of these other core products that we have, that becomes a natural byproduct of the sales process, and so I would say that, and other function is that there is considerable disruption in that market place right now, and there are other players that are having some difficulties and I think that’s helping us right now.

Fred Lampropoulos

Jayson, we have the new Miser which is rolling out now that has a cost savings of about $700,000 a year on our existing sales, and I believe that you’re going to continue to see for really quite sometime continued momentum in this particular area. Now, we like to sell those higher margin products, but all of these contribute, and although it’s a lower margin in general discussion, when you start to apply that across the board, and as Marty pointed out you get pull of a lot of other products in both directions. We think that these areas across the board will continue to grow. We have at least 4 new products rolling out that are in these kits and trays that have significant advantages over our competitors, and we believe that will continue to pull substantial business from these guys, and when I say substantial business, I have said that the Miser itself in my view could pull $15 million worth of additional business in both kits and packs over the next couple of years, so there’s a lot of momentum, and it just isn’t coming from the weakness of others, although I agree with Marty that that’s part of it, but the other part of it is that we’ve been able when we develop newer products particularly with our competitors who haven’t developed any new products in some 10-15 years, you come out with something that actually improves, you get to see their soft underbelly, and we’re seeing some of that as well. All in all, the point is and I’ve said it many times, our competitors in some of our areas just aren’t paying much attention and are satisfied with their businesses as they are. Merit isn’t. Merit is constantly improving products. So you’re going to see continued growth and momentum in all of these areas.

Jayson Bedford – Raymond James

On the competitive landscape for this product category, with the disruption you’re seeing, have you seen competitors exit the market or is it just the de-emphasis happening?

Fred Lampropoulos

I haven’t seen anybody exit the market. It’s mostly that everybody doesn’t have R&D projects. They don’t have R&D expenses and new products, and when you walk in with a new product that makes it safer to do a procedure, it helps to reduce the amount of time for a procedure, and the convenience that’s involved, all of us know that when you have a salesforce that’s motivated and encouraged and has that attitude, that’s a great formula, and that’s what we’ve build this business on.

Marty Stephens

I think it’s quality and delivery as well. That’s another key component.

Fred Lampropoulos

I appreciate that. We’ve invested a lot of money in delivery systems and automated warehouses, and we really are quite relentless on quality. We’re not perfect, but the little things bother us, and we stay after them and try to improve them, and that’s we’ve seen recently that some of these other things just wear down, and they don’t improve them, and they’re just right for the picking. One of the things that’s very important is I think our national accounts guys, they’re kind of like the unsung heroes, they’re sitting here in the back of the room over here and they just sit there quietly, but what they do is give us access to all these accounts, so for all intents and purposes, we’re not restricted from going anywhere. We have some exclusives. We never announce those contracts because you just don’t know when they’re all going to kick in, but I think what your seeing here is the results of that.

Jayson Bedford – Raymond James

On the Alveolus business or the Endotech, you mentioned that you haven’t launched the biliary stent. When will you launch that?

Fred Lampropoulos

Let me clarify that. We’re actually selling that product as is to some existing customers, but there were a couple of areas that were important to us, and that was that we’d be able to deliver it both percutaneously, and there were some improvements that we needed to make, and we felt that it was important to do those things. So by year end, all of those improvements will be completed. They are minor little things, but in the practice of medicine, little things are a big deal, and we thought rather than just go out there and be mediocre, let’s go out there and make these few little improvements that unfortunately at Alveolus they were sales time and wrapping it up, and they didn’t make those things. We decided to make them, so we will essentially reintroduce the products by year end. That’s the commitment that we have. I just reviewed those products this week. Darla will be out this week some more customers verifying those, but these is kind of a big deal for us, and we just want to make sure we do it right, and we have 4 or 5 GI docs as advisors, and we’ve really tried and we’re very committed to building this division over time, and we wanted to make sure we did it right. So year end is the answer. We think the improvements are significant for us to go out and capture both endoscopically and percutaneously a substantial portion of this, and remember that this segment of the business is bigger than all of those other parts combined. So when you take esophageal, colonic, duodenal, and tracheobronchial, this stuff is twice the size of all those markets combined, so this is a big part of it, and some of it on the percutaneous side is at the existing IR locations, which are the customers where you’re seeing the growth of, you’ve seen the growth of these drainage catheters and so on and so forth. So we want to do it right. We think we are doing it right. Jayson, as you know, I’m just thrilled with this business, and that’s why I’m pleased to stand behind the statement that we believe we’ll continue to see double digit growth for the foreseeable future because it’s what we believe here.

Jayson Bedford – Raymond James

You came in a little lighter than my number just on that segment of the business. Is it fair to assume that it was because of this biliary stent push-out?

Fred Lampropoulos

Yes. It is, and yet we are not upset, and we haven’t lost our enthusiasm. These are the things that we are doing because they are the right things to do, so we are committed to that business, we think it’s going to be a terrific business for us, and we are starting to see, Jayson, some other little areas that are coming out of this for opportunities too. It’s amazing all the opportunities that are out there even in the environment that we’re in. There’s terrific stuff out there.

Jayson Bedford – Raymond James

What was the FX impact in the quarter? Do you have that Kent, and last question for me, you kind of teased us a little bit with the 510(k) filing tonight. Can you maybe just talk about the size of the end market you’re addressing with that product?

Fred Lampropoulos

I have discussed it before, but I’ll go ahead and refresh it. It’s about $150 million, we believe, and we have worked long and hard on this, and I recently returned from a trip overseas where I presented the product in form to who I considered to be the master of this product, and he said to me that this product is better than the product that he had or he had built or others had built, and that to me confirmed that we had developed the product to the extent and improved it to the extent that we had hoped to, so we’re gearing up for production, and we’re doing our quality runs. We filed the 510(k), but again for competitive reasons, we’re going to wait just a little bit longer, and I hate to do that, but the good news is because I did say at one time I’d let everyone know, but it is so significant that we don’t want to tip off anybody on this product.

Jayson Bedford – Raymond James

And you don’t sell this product internationally?

Fred Lampropoulos

We do not sell this product for all intents and purposes today international, but we will sell this internationally. We will both the CE Mark and the 510(k) on it.

Operator

The next question comes from the line of James Sidoti with Sidoti & Company.

James Sidoti – Sidoti & Company

Can you tell me is there any opportunity to begin selling the EN Snare ahead of 2010 or do you think we should wait till 2010 start to add that to our model?

Fred Lampropoulos

2010 is the date. The company that previously handled this product has the rights to sell it through the end of the year. Now, the other side of that coin is that we receive a substantial royalty for everyone that they sell. We’re already starting to amortize the intangibles, but for the quarter, and remember we only close this thing I think on June 2nd, net of the intangibles I believe was $40,000 of income that we got. We’ll get a full quarter of that royalty income for the third quarter and the fourth quarter, and so that would be somewhere around $120,000 or $150,000, somewhere in that range, and then we will be out on the street with the entire salesforce worldwide with this product on the first of the year.

James Sidoti – Sidoti & Company

If we look at Merit longer term, Fred, you already said you think you can keep the topline growth in the double digit range for the foreseeable future, what should we think about for margins Kent? You said 150 basis points this year. Do you think you’re getting to the end of the road there, or do you think you will be able to continue to improve margins over the next couple of years?

Fred Lampropoulos

I wish this was a webcast or a camcast because I always love it when Kent is nodding his head or shaking his head no. I always do that. Kent seldom does it. The answer is no. We believe that with the product strategies that we have, with the automation that we have, with the applications of overhead, the mix and so on and so forth that we are going to continue to be able to deliver improvements in gross margins, both from efficiency, from lower unit cost, from higher margin products and then of course with the mix itself, but we are not going to promise anymore than 150, which is what we promised this year. The good news is we’ve kind of met that already instead of trying to catch up at the end of the year, so we think that a significant. If I could Jim just to jump in, if I could, to Jayson’s question, the effect of FX for the quarter was about $1.2 million.

Greg Barnett

In reduced sales at the lower exchange rate.

Fred Lampropoulos

So, that’s another factor. There is a little bit of a headwind there, but again we are still doing I think quite well even with those breezes.

James Sidoti – Sidoti & Company

Looking out into 2010, you would expect the operating margin to expand faster than the gross margin just because some of these integration expenses should start to roll off?

Kent Stanger

That’s correct.

Fred Lampropoulos

One other thing to just as a point of interest, you’ll recall that we talked when we made this acquisition that we were going to have those monthly expenses that would run through, I think, it was June or so, so through most of the quarter. We have now dropped off that $100,000 a month of SG&A cost that was in there before going forward now that the quarter is now off the books. That goes to your question of rolling this stuff off, and there will be others that will be absorbed up and others that will be rolled off as well going forward.

Operator

The next question comes from the line of Ross Taylor with C.L. King & Associates.

Ross Taylor – C.L. King & Associates

I’ll start with some of the expenses related to Alveolus that you just finished up with, but going back to one of the earlier questions, I’d thought there was a few hundred thousand dollars in attorney fees or banking fees that might carry over into this quarter. Is that correct or not?

Fred Lampropoulos

No. There was very little that carried over to this quarter, most of it we took as a onetime charge when closed the deal, I think it was in the first quarter.

Kent Stanger

That happened in January and February and March, and so there wasn’t much overhang for us fortunately. There is a little bit of the accounting fees and stuff, but it was less than $100,000, I’m sure.

Ross Taylor – C.L. King & Associates

Next question relate to the inflation device business, but can you give any rough projections as to how long before you think the Kyphon business might stabilize for you all?

Fred Lampropoulos

I don’t know that it’s going to stabilize. I don’t believe that we think it’s going to stabilize. We think it’s going to continue to decline, and just simply because I think that’s what’s in the cards. There is also some new products they are coming out with and that sort of thing, so although it has been a very important business to us in the past and we continue to make all the deliveries and commitments that we have made, I think it’s just a matter of time before that fades away. It many ways though I think, Ross, that it’s actually better for us because we don’t necessarily like having such a large portion of that OEM. In fact, as we have restructured the OEM department, we’re getting bits and pieces. We have one deal out there that we might bring on that could bring about $2.5 million worth of business in this area in inflation devices, but that’s not $15 million, so I believe that it will continue to decline. What I also believe is that we bring on products that go to the GI division. We’re talking about specifically esophageal balloons and inflation in that area. As we talk about new digital inflation devices, we talk about the potential of some OEM customers and that sort of thing, that the business overall minus that will stabilize and grow, and that’s my expectation, that we will see the inflation device business grow and eventually both the OEM and inflation device will just absorb out that business, and although we appreciate it, they will just fade into history.

It still represents $10 million to us, but as this thing gets bigger and new products come out and in fact some other competitors of that product who are buying their products s they ramp up, now what we don’t want to do is to prognosticate big numbers from our competitors in new products because we just don’t know what they are going to do, but we have confidence in the inflation device area that Merit continues to be the world leader in inflation devices across the board both for cardiology, peripheral, and for spinal.

Ross Taylor – C.L. King & Associates

Related to that new inflation device you mentioned that you might have available year end, is that designed specifically for an application outside of vascular disease or is it applicable to vascular disease and something outside of that?

Fred Lampropoulos

This new one that we are talking about for year end is specifically for vascular disease. One that we would hope to see by midyear and no later than midyear is more in the GI tract, and we’re talking more about dilatation of esophageal balloons and in those areas. But we are seeing, again, a number of interests in working with two or three customers, on the basis of other spinal products that are coming, and we are looking at and considering the possibility of maybe some partners in some other areas that we don’t have a strong presence in which we may consider some exclusive deal, so there is a lot of things going on in this area. We are paying a lot of attention to it. Our expectation is by the end of the year we’ll swing this product line in the other direction even with Kyphon leaving or declining. That’s our goal. It just simply looks it has run its course, and that’s unfortunate everybody, but it’s a high margin product, but we have other customers and other opportunities in a lot of other segments of our business. It’s an important part but it’s not the only part.

Ross Taylor – C.L. King & Associates

You guys had another strong quarter, and you talked about the guidance a little bit earlier. What are some of the primary risks or areas of caution that you might have that are maybe keeping you from taking up the guidance?

Fred Lampropoulos

I think whenever you come into the summer, traditionally, over the years, we have seen sometimes when things just slow down. Again, last year, it didn’t, but traditionally some are by definition. Europe shuts down, Germany shuts down, France shuts down; then you have weather to start thinking about. Last year, we got hit in the third quarter, and fourth quarter we had expenses associated with Hurricane Ike. I get up and watch what’s going on on the Weather Channel every night, usually about 4 o’clock, so there is all those kinds of factors, just general summer, the weather issues and that sort of thing, and people go on vacations, our salesforce does, physicians do. Those are always the factors. Then around Labor Day, people come back to work and way we go, and we have a strong finish to the year, and then of course the weather sets in and then these various maladies starts to present themselves for opportunities, and our business gets very strong, so that’s why I think it’s just too early both with this acquisition, with the weather, with the summer, and I don’t see any value in doing anything at this point, and maybe that’s the unfortunate part. When it becomes apparent, you guys will know it, and you’ll see it long before we say anything about it. We think that’s the best way to do it.

Operator

The next question comes from the line of James Terwilliger with Duncan Williams Inc.

James Terwilliger – Duncan Williams Inc.

Could you comment on inventories? I know you’ve got a lot of new products, but the inventory level has been increasing on a sequential basis here in the last two quarters, and the second question on inventories is could you provide some color and visibility into how you’re going to handle the inventories when you transition with the EN Snare product at the end of the year?

Fred Lampropoulos

Let me go to your first question on the EN Snare. We don’t have any inventory. Some of the inventory levels is because we are starting to build inventories because essentially on day one, we have to at full steam, so we didn’t acquire any product. We acquired the intellectual property, we acquired the know-how and that sort of thing but no inventory, so we’re building inventory in preparation for that launch in January. Another issue that we have seen and have discussed to some extent is that we have a number of vendors that made us a little bit nervous in as we saw some of these economic difficulties, and so we have built inventories to make sure that we had plenty of ropes so to speak to make sure that we didn’t get ourselves in a bind. We have the inventory associated with the acquisition, and that was Alveolus, that was about $2 million, so that’s a good portion of it, but I think your comments are the same ones that we had in our audit committee meeting, and that is those inventories and building too much inventory and just explaining it off as we’re doing the best we can is not adequate. The other thing that’s really important is when you start seeing this double digit demand in four or five new products and that sort of thing, you are going to have inventories for that, so I don’t want to talk out of both sides of my mouth. It’s important. It’s important for us to be able to have that cash rather than that inventory that has the risk of being obsolescent. At the same time, we have to make sure that we have plenty of this product for the risk levels, the new products they are launching, and particularly with things like Alveolus and EN Snare. That’s my answer. Kent, do you want to weigh in on that?

Kent Stanger

I think you said it pretty well. We did have a lot of increase for the acquisitions, mostly in the stent area. We have some in the probes and plastic stents and things, and the raw materials to bring those in to production and prep it, so you are sort of loaded up on both sides as you’re trying to make this transition, but we can’t escape the point that we had some increase in inventories. In our Richmond facility, for example, we added quite a bit and it’s to try and relieve backorders, customer service levels, so I think there is some improvement we can make in that area that you probably noticed which is why you’re asking, but we aren’t oblivious to it. We understand that.

Fred Lampropoulos

Just to another point that Kent somewhat touched on, we bought this little business, the Hydromer business that is the probes that are used in the GI market, and one of the things that we have seen in that area is the demand for that product under Merit’s ownership has doubled, and so it was doing about $1.5 million a year or in that area, and the demand has doubled, so we had to build inventories and try to meet customer demand back in the transition plant back at Hydromer while building the inventories and getting up, and the report I had today is that we are up into production here. We are producing the product here and still producing the product back there which we will be able to do only for a couple more months, so that’s another thing. You’ve got that Hydromer, and that’s doubled, and I think the reason that’s doubled is the fact that we will be able to without trying to slight anybody, we’ve worked hard to make sure that we can meet the needs of our customers, and previously those weren’t being met, and so we’re building product in two locations, and it will all be here under one roof in 60 days, so please understand we’re building the product today, but we’re still building it at the other factory just to keep up with demand. What a problem. I love these kinds of problems.

James Terwilliger – Duncan Williams Inc.

Good problem to have—a growing topline and a lot of new products whether in house or through acquisition. The only question I have got though is as you’re building inventories on the EN Snare, is there a risk that there could be distributor stocking on the EN Snare product as we get towards the end of the year?

Fred Lampropoulos

I think there is always that risk, but I don’t know if you were on the front end of this call, but one of the good things is that I think the largest distributors that were with Angiotech are Merit distributors that we have worked with for long periods of time, so there would be no need for them to do that because they are not going to lose that value. Is there some pipeline filling and is there the risk that there are some people that are taking that inventory and loading up with it or other salespeople motivated to sell it. I suppose that’s always true, but I don’t see very candidly that that’s going to be disruptive. There are other reasons why I believe that. I won’t go into all of them, but one thing I should mention is that one of the components that goes into the EN Snare product is Merit manufacturers, so we have our thumb on this thing pretty closely plus we get substantial royalty on every one of those, so we are going to get it one way or the other.

Operator

(Operator Instructions). There are no further questions in the queue. I’d like to turn the call back over to management for closing remarks.

Fred Lampropoulos

Ladies and gentlemen, as you can see, the business continues to move forward. We have great new products. Again, for competitive reasons, we haven’t discussed all of those, but there are some great things on the horizon. We have the momentum, we have the salesforce, we have great new technologies that will propel this company forward for years to come. We have a terrific staff, and I want to commend everybody here who are asked not only to run the business but to incorporate these other acquisitions and opportunities, and they’ve done a terrific job.

I’m excited about the opportunities. I’m excited about the markets, and I think maybe the more important thing in all of this is I think we’ve structured a business that has sound principles, has no debt, has the ability to take and to spread the risk both on the industrial side, on the direct hospital side, and on the OEM side. Merit is the place you go if you want to buy something OEM. Merit is who you call when you want convenience and safety. Merit is the company that’s known for innovation in these areas where the technicians and physicians work every day. This is a terrific company, and we hope that rather than just use the words, we will continue to be able to deliver the results that we expect and we know that you expect. We thank you for your interest. We look forward to reporting to you in the future, and we’ll now sign off from Salt Lake City, wishing you a good a good evening and all the best.

Operator

Ladies and gentlemen, this concludes the Merit Medical second quarter earnings conference call.

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Source: Merit Medical Systems, Inc. Q2 2009 Earnings Call Transcript
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