Executives
Anthony J. Conway – President and Chief Executive Officer
David Jonas – Chief Financial Officer
Analysts
Ernest Andberg – Feltl & Company
Tyson Bauer – Wealth Monitors
Michael Boulegeris - Boulegeris Investments, Inc.
Beth Lilly – Gabelli
Rochester Medical Corporation (ROCM) F3Q09 Earnings Call July 30, 2009 4:30 PM ET
Operator
Welcome to the Rochester Medical Corporation third quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Anthony Conway, CEO and President.
Anthony J. Conway
Thank you for joining Rochester Medical’s third quarter conference call. I am Anthony Conway, the company’s President and CEO, and with me is David Jonas, Rochester Medical’s Chief Financial Officer. To start, I will go through some of the highlights for the quarter, and then David will present detailed information on the financials and what they signify, and after that we will be happy to take your questions.
As always, before starting let me remind you that we will be making some forward-looking statements today, and I would refer you to the Safe Harbor statement found in today’s press release and also to the Risk Factors section in the company’s annual report on Form 10-K for the year ended September 30, 2008. These statements further clarify the risks and uncertainties that are associated with the forward-looking statements.
First let me review the results as reported in the press release, and then I will talk more about the quarter activities and what we might expect going forward. As stated in the press release, we reported sales of $8,908,000 for the current quarter, compared to $8,241,000 for the third quarter of last year. In constant currency, which we believe fairly represents our progress, that amounts to a very nice overall 18% sales growth rate for the quarter. As planned Rochester Medical’s operating profits are being reinvested to assure long-term strategic success in the key areas of opportunity. The narrow bottomline for the quarter is as expected and reflective of our confidence in gaining future rewards from these investments.
Looking a little closer at the numbers, it is clear that we don’t usually expect a 42% increase in private label sales. As most of you know, private label sales often fluctuate from quarter to quarter due to the timing of the large orders and shipments. For that reason, private label sales for the third quarter of last year were down, thus positively impacting a large percentage growth for the current quarter. While the company is strategically focused on its Rochester Medical brand, our private label business is good for the company, and we’re very pleased with the fact that major device companies are proud to put their brand on our high quality devices.
As stated in the press release, we had good 15% branded growth in the US and Europe on a constant currency basis. As you know, these are the primary areas of our investments. In other parts of the world, we believe the 16% branded decrease was entirely due to timing of orders and shipments to several of the major distributors. We discuss timing issues every quarter, and while they are impactful for the quarter, they self correct as we go forward.
Looking at the key areas of opportunity in our branded business, I believe we are making excellent progress. I’m more confident than ever that we will succeed in our areas of strategic focus. In the US acute care market place, we are now seeing results from our sales and marketing and development efforts. I have been saying from the start that it would take some time before we would gain reward for our efforts in this market. I am very pleased to say we are now seeing those early results confirming the soundness and strength of this strategy. I’m particularly pleased that in this quarter another major nationally known key opinion leading hospital has recognized the very significant benefits of our Foley catheters and converted their institution to them in order to gain those benefit for their patients.
Given the recent progress in Q4, we should start to see more visible growth in acute care sales. We believe these conversions bode very well for the future, especially since we are now introducing the new Strata SI and Strata NF technology which provides significant benefits not previously found in this market.
As stated in the press release, we are also now gaining ReleaseNF Foley Catheter evaluations in the UK, and we’re exploring business opportunities to promote its introduction throughout mainland Europe. We expect this introduction will be further energized by the Strata SI and Strata NF technology which we believe is the most advanced in the world. The Magic 3 intermittent catheters are going over very well in both the US and the UK, and early indicators show this should do extremely well in Europe. This is a very large market and again we believe we definitely have the most advanced offering available.
We are exploring and studying the best way to approach the US consumer directly, for both the Magic catheters and the female FemSoft insert, and we hope to be able to communicate some of those plans to you in the near term.
I often get asked if the weak economy is affecting our business. We suspect there is some negative impact, but we think it is very minor and hard to measure. All in all, we’re pleased with our progress and excited about the prospects ahead.
Now, let me turn it over to Dave for some more of the financial detail.
David Jonas
I’m going to spend a few minutes highlighting a few results reflected in our just released third quarter fiscal 2009 earnings release. First, our sales: For ease of discussion, unless otherwise noted, all sales numbers will be shown in constant currency. I’m doing this to exclude the impact of foreign currency exchange which will show a true reflection of our sales growth.
As Anthony has explained, our sales results for the third quarter showed an 18.1% increase from the third quarter of last year. As I have discussed the last few calls, we are keenly focused on and have dramatically increased our investments and activity in our branded sales, especially in the US and Europe and most recently in Japan. This has been done for many reasons, including better market access, changing reimbursement rules, and an increased clinical demand for infection reducing and all-silicone devices. We have called this our investment in growth strategy, and so far the early results are extremely positive.
These investments and focus fuel the growth in our worldwide branded sales, which were $5.8 million this quarter versus $5.3 million last year, an increase of 8% for the third quarter. This 8% increase included 31% growth in worldwide intermittent sales, 22% decrease in Foley sales, and a 4% growth in MEC sales. Foley sales were only down due to timing of shipments and to a lesser extent because of our decision to strategically discontinue selling very low margin Foley products overseas.
Our branded sales accounted for 65% of our total sales so far this year, compared to 66% last year. Let me first discuss our domestic branded sales in more detail and then our international branded sales. In total, our domestic branded sales for the third quarter were $1.8 million versus $1.6 million last year, a 13% increase from last year’s third quarter. Year to date, domestic branded sales are $5.1 million, versus $4.8 million last year, an increase of 6%.
Domestically, our advanced intermittent catheter sales grew 10% in the third quarter dollar-wise. For the year, our domestic branded intermittent sales are up 7% dollar-wise and 22.5% unit wise. The difference in growth between units and dollars came from the April 2008 Medicare change. In the short-term, it discourages kit usage and is driving users towards intermittent strips, which carry a lower average selling price. Our 22.5% unit growth year to date which reflects both new patients and increased usage is very encouraging.
Our domestic branded sales of male external catheters grew 13% for the quarter and are now up 4% for the year. Our domestic branded Foley catheter sales grew 14% for the quarter and are now up 9% year to date. Most of this Foley growth can be attribute to the acute care market. As we’ve discussed previously, we have increased our efforts in the US acute care market to take advantage of our superior silicone anti-infective technology and exciting changes developing in both US reimbursement and state reporting. It’s worth repeating what Anthony just said. This quarter, much progress has been made as we have seen additional trials and a significant increase in interest including a conversion of a major key opinion leading hospital.
For the third quarter internationally, our branded business continued to grow even though the exchange rate drop masked the success we made. Again, to make sure everybody understand our true growth, the following numbers are using a constant currency showing ’08 sales at ’09 exchange rates.
In total, our international banded sales were $4 million this quarter versus $3.7 million last year, an increase of 8%. Year to date our international branded sales are $11.7 million versus $10.4 million, an increase of 13%. The majority of our sales internationally continue to come from male external catheters. This male external catheter business grew 1% in the third quarter and is virtually flat year to date. Our advanced intermittent catheter sales grew 103% in the second quarter and are now up 153% year to date.
Our new triple-core Magic 3 technology launched late in the first quarter has received rave reviews and should help us continue to grow market share in Europe. As we have previously stated, the warnings issued by the EU affect most of our competitions’ product and should boost the demand for our superior all-silicone intermittent catheters.
As previously noted, international branded Foley sales declined 65% for the third quarter and are now up 3% year to date. Our UK operations also include direct-to-the-patient prescription sales under our Rochester Medical Script-easy brand. These sales are for any urological products and drain care, including products not manufactured by Rochester Medical.
Now, let’s take a look at our private label business. Rochester Medical continues to have many excellent private label partnerships. As Anthony stated, their ordering patterns have been particularly erratic the last few quarters. In 2009 first quarter, private label sales were up 18%, they were down 16% in the second quarter, and now they’re up 42% in the third quarter. Most importantly, year to date our private label business is up 10%.
We still believe the sales of our products at our private label partners’ doors are growing moderately and our sales to them will show moderate growth over a period of time.
Our gross margin was 47% in the third quarter and now sits at 49% for the year. I’m very happy with this considering our COGS is still under pressure from exchange rate fluctuations, raw material prices, and advanced product mix changes. We’re dedicated to continuously improving our efficiencies and material costs, and that effort is paying off. We also continue to dedicate resources and focus to increase the margins on our advanced products, which is a key element in our future growth. In the long term, as sales of these advanced products grow, we will see corresponding improvements in our margins.
Our operating expense increased $215,000 in the third quarter to $4.3 million and now sits virtually flat with last year at $13.1 million. We have increased spending with both our increased investment in sales and marketing in both the US and UK markets and invested in R&D related to new intermittent and Foley products. This is offset by a planned reduction in our administration costs.
Our sales and marketing costs for the third quarter were up 8% from last year and are now up 9% year to date. For the year, they represent 29% of sales, which is up a little bit from last year’s 27%. The majority of this increase is from the previously mentioned increased efforts in both the US and UK.
Research and development costs for the third quarter are up 74% versus last year and are now up 32% year to date. For the year, research and development costs represent 4% of sales, which is up slightly from last year’s 3%. This increase is directly related to new product development. We continue to cost effectively develop life-changing new products and brought two new breakthrough products, Magic 3, our exciting new triple core intermittent technology, and Strata, our exciting new Foley technology, that will change the way people think about silicone Foleys to the market this year.
Administrative costs for the third quarter were down 8% versus last year and are now down 12% year to date. For the year, administration costs represent 18% of sales, which is lower than last year’s 20%. The majority of this decrease year to date comes directly from lower costs in legal, SOX compliance, and insurance costs, partially offset by increases in fees paid during our ongoing IRS audit.
This quarter, we had net income after taxes of $77,000 or $0.01 per diluted share versus a net income of $312,000 or $0.02 per diluted share last year. I believe the non-GAAP disclosures in our press release are very helpful in understanding Rochester Medical’s operating results apples to apples, so to speak.
Per the table in the press release, after adjustments for settlement income, deferred revenue, intangible amortization, and stock option compensation expense, our third quarter non-GAAP net income was $245,000 or $0.02 per diluted share compared to $636,000 or $0.05 per diluted share last year. This decrease in non-GAAP net income is a direct result of our growth strategy and investments in the US and UK branded markets and a strong tax benefit last year related to tax credits.
Our balance sheet continues to be very healthy. Our cash position is $35 million in cash. Our philosophy of tightly controlled management of working capital has served us well. As most of you know, most of our cash is invested in highly liquid and secure US government T-bills. Our total assets are $75.1 million, down slightly from the $77 million at the beginning of the year, and this decrease is directly tied to fluctuation in exchange rates. With $7.2 million in short and long-term debt, this consists mostly of debt associated with our June ’06 asset acquisition and normal operating payables
I would like to hand it back to our CEO, Anthony Conway, for some more comments.
Anthony J. Conway
Let me just again that I think Rochester Medical is very well situated for growth, and with that, we’d be happy to answer any questions you might have.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from Ernest Andberg – Feltl & Company.
Ernest Andberg – Feltl & Company
Dave, you through a lot of statistics fast at us on the markets. I’m not going to make you go over them again right here, but in trying to tie it into Jim’s comments on the acute care market and the signing of a significant new thought leader in the business, can you give us a feel for what the acute care sales of Foleys might have been up in the quarter and is it getting material to the overall results?
David Jonas
For the quarter, the one product that goes mostly into acute care is Foleys, and domestically our Foley catheter sales were 14% in the quarter. The sales to the one hospital, that conversion really happened at the end of the third quarter, so we’re going to see that starting in the fourth quarter.
Anthony J. Conway
We have increasing business in the acute care market apart from that. We’re just noting the particular major because it has a major impact on influencing others, so the 14% as Dave said really didn’t include that. It included other, in most cases, smaller conversions.
Ernest Andberg – Feltl & Company
Can you give us a rough feel for how significant this is in the overall stream of revenue, Jim? Is it as much as 5% yet?
Anthony J. Conway
I’m not going to put a dollar figure on it. One institutional certainly does not make a major impact. It’s visible. It’s more important for the key opinion leading aspects of it because it will help us going forward in many other hospitals. That’s what we believe, but you’ll see an impact, but it’s not like one hospital just overwhelms it in anyway.
Ernest Andberg – Feltl & Company
Where do you think the UK study is, and has there been any progress on that, or is it still being pushed out, Jim?
Anthony J. Conway
They say that it’s all well underway and that all of the institutions are in full swing. We’ve not gotten any feedback or intermediate data or data points on it. We had originally been told it may be done as early as the end of this year. The last we heard it sounded like it had slipped a full year and maybe more. It certainly doesn’t sound like there’s going to be any imminent data coming out of it, and that’s all we know. They don’t share anything with us. They keep it very close to the vest.
Ernest Andberg – Feltl & Company
Is there any way that you could sponsor your own smaller study here in the US to make your case?
Anthony J. Conway
We could. We looked at that. The truth of the matter is even on a smaller study by the time you get through it and sign up all the patients, you’re talking several years, just like we did originally. We’ve got a lot of good US data. We just don’t have the exact head-on in vivo data. We’ve got some very good head-on in vitro data as I think you know.
Ernest Andberg – Feltl & Company
I know you don’t like to give guidance, and it’s been particularly difficult to gauge from the outside where you’re going. Do you think that the trends in the third quarter can persist into Q4, or was the jump in the private label side so significant that you don’t think that it would persist this quarter?
Anthony J. Conway
I think there are a couple of things. In private label, basically the guidance we’ve given of modest growth year over year we would still give. Dave explained that you’ve got these erratic quarters, and I think that translates into 10% year to date, and we always end up trying to explain each individual quarter. This one we’re trying to explain that the percentage growth is too high because a year ago it was a down quarter, but if you look at year over year of moderate growth, we still think that that’s very accurate.
Ernest Andberg – Feltl & Company
I ought to look at where you might get in single digit or modest or the 10% year to date and that’s how it might impact fourth quarter by taking year from nine months?
Anthony J. Conway
Ernie, I am going to say again that in any given quarter, it just goes up and down. I know that makes your job extremely difficult because you try to lay out a quarter, but even we can only map it on a yearly basis until we get into a quarter, so the best guidance I can give you is what I did on the private label, but what I can say is that two-thirds of our business is the branded business. We’re very confident about the growth of our branded business going forward. Even the rest of the world, what we call ROW, where we don’t have a salesforce, you saw a downward aberration in this quarter, but we’re confident that again in that we’re going to see good solid growth. Certainly in the areas where we’ve launched our sales and marketing activity, which is the US and the UK and now mainland Europe, we’re confident of the type of double digit growth, and we’re hoping that we’re going to accelerate that growth, and we think we’ve laid the groundwork to accelerate that growth.
Ernest Andberg – Feltl & Company
In the UK, you’ve still got some pretty significant headwinds on currency in the September quarter. Didn’t you, Dave?
David Jonas
Yes.
Ernest Andberg – Feltl & Company
So, even if we see continued strong progress in local currency, it will translate into fewer dollars of revenue?
David Jonas
If the exchange rates stay where they are at right now, that’s correct, but it’s hard to predict what’s going to happen in the next 2-1/2 months, but yes.
Operator
Your next question comes from the line of Tyson Bauer – Wealth Monitors, Inc.
Tyson Bauer – Wealth Monitors, Inc.
To follow up on Ernie’s last question, do you have the Q4 ’08 average currency rates handy?
David Jonas
I do not have that handy, Tyson, but it’s pretty close to $2. It was in the $1.90 range for sure still.
Tyson Bauer – Wealth Monitors, Inc.
So we don’t get out of this basically pound arbitration investment until we get to your fiscal Q1 at the end of this year?
David Jonas
That’s correct. It started dropping in the early winter of last year’s first quarter.
Tyson Bauer – Wealth Monitors, Inc.
Gross margin was down sequentially due to the private label becoming a bigger product mix?
David Jonas
That was definitely a piece of it. Exchange rates were a piece of it, even though they started to come back up at the end of the quarter, and a piece of it is what we sold. It’s that advanced product that we talked about, where today that margin is a little less than the other business until we get the volume.
Anthony J. Conway
We’re set up, Tyson, for example on, let’s just pick one of the advanced products—the Magic intermittent catheter. We believe that that’s going to be a super high volume product for us, very high volume, and we’re set up to make high volumes. While relative to what we’re set up to make, those volumes are still extremely low, so ultimately we’ll have efficiencies and we’ll be spreading costs over very high volumes. As of right now, that’s not the case, and that will improve, as David said, over the long term as that volume improves.
Tyson Bauer – Wealth Monitors, Inc.
You’ve always kind of benchmarked 50% as a psychological level that you’ve targeted to try to stay above. When do we start achieving volumes that you are comfortably at or above that level?
Anthony J. Conway
It’s hard to say, but I think that independent of those volumes, we’ll be at that level as the currency situation corrects itself. Our intent is to move from the 50 to the 60, as you know, and that requires significant growth, which we believe we’re going to get.
Tyson Bauer – Wealth Monitors, Inc.
What’s the next important date or decision date in regards to your CMS code for FemSoft?
Anthony J. Conway
I believe we’ll get the official result in the beginning of November. We’re hoping to be informed of the progress of that official result prior to that. Even if we know prior to that what that’s going to be, it’s still not official until the beginning of November.
Tyson Bauer – Wealth Monitors, Inc.
Does that impede some of your options in regards to that distribution of that product, as you mentioned you hoped to have announcements here in regards to your intermittent and FemSoft?
Anthony J. Conway
We’re operating under the 100% assumption that we get that file in approval. If that turned out not to be the case, we’d be surprised, but we think it’s a better business decision to operate under that assumption, and we’re full steam ahead working on exploring our options, what we intend to do, what our action plan is going to be in the new year when that final approval is activated.
Tyson Bauer – Wealth Monitors, Inc.
Would that entail a contingent type agreement if you go that route that won’t actually start until that code is available?
Anthony J. Conway
I don’t want to go into details of contract negotiations, but clearly in any agreement with any direct to consumer type of operation, the major activity is dependent on getting that code, so you could deduce that those considerations are looked at carefully.
Tyson Bauer – Wealth Monitors, Inc.
In regards to the Foley product, you mentioned 14% growth thus far this year with that expected to accelerate going forward. What have you targeted as a growth rate or believe you can achieve going forward? Is this a type of product line that can achieve 20 plus percent growth, 25%, 30%? What are your expectations or targets that you are trying to achieve there?
Anthony J. Conway
Let me try to phrase it where I’m not going to give you an expectation, but I will give you a possibility. That market is so big, and we have a such a small fraction of it, and given the introduction of technology that we believe is dynamite, if you will, we certainly hope to improve that growth rate, and I’m not making that as a projection, but that would certainly be our intent.
Tyson Bauer – Wealth Monitors, Inc.
I think investors would be disappointed if that wasn’t improved upon, as would yourselves.
Anthony J. Conway
I think you’re right.
Tyson Bauer – Wealth Monitors, Inc.
Are you at all frustrated at the pace of your new salesforce in the US in getting penetration, in getting development? Have things economically slowed that or retarded the progress that you thought maybe initially you could have had by this point, and what are some of those visible benchmarks that we can be watching on the outside to really gauge success of that salesforce?
Anthony J. Conway
I would say I’m not disappointed or surprised, and we’ve been the ones from the start, and I know the investment community gets very eager and believes that if you have the better mousetrap that the world beats the pathway to your door, but we’ve been saying from the very start that this is a long-term sell. It’s going to take some time. The competition is well entrenched, and we believe that as we started getting a toehold and started converting some major institutions that then we could expect to see it accelerate. I think this is the classic type of product that at some point we hope for the classic tipping point that has been written about many times, but to date, I’m really pleased, and we’re really excited, and I would say our salesforce is more geared up right now than they ever have been and are extremely eager, so we’re very happy about what’s going on right now.
Tyson Bauer – Wealth Monitors, Inc.
But do you believe you can achieve hockey stick type growth, that kind of chart, or is this more of a ramp that…
Anthony J. Conway
I’m just saying this is the type of product, the type of market, the type of situation where that’s a possibility. I’m pretty much a conservative skeptic myself, and while I’m hopeful for very significant improvements, we’ll see how it goes. What I’m confident in saying is that we’re going to have excellent year over year growth in our branded products. I’m very confident of that and will stick to that.
Tyson Bauer – Wealth Monitors, Inc.
You’ve mentioned in the past calls regarding M&A interest, especially overseas. Has that peaked at all, or are we still in a holding pattern and waiting for an opportunity to come by?
Anthony J. Conway
We’ve looked at opportunities in the past, and I would say as far as us acquiring someone else that there is nothing significant on our radar screen, although we continue to look.
Tyson Bauer – Wealth Monitors, Inc.
How about in reverse?
Anthony J. Conway
That’s something that I wouldn’t comment on either way.
Tyson Bauer – Wealth Monitors, Inc.
But you’ve drawn interest, I would assume.
Anthony J. Conway
I can’t comment on that.
Operator
Your next question comes from the line of Michael Boulegeris - Boulegeris Investments, Inc.
Michael Boulegeris - Boulegeris Investments, Inc.
My first question is regarding the balance sheet. It looks like the long-term debt is down to about $1 million or so. Is it correct to assume there is one more payment related to the acquisition?
David Jonas
We had a loan with US Bank that had $2 million left on it that we paid off, and we went with UBS and got a line of credit, so that all moved into current, and then we still have two payments left.
Michael Boulegeris - Boulegeris Investments, Inc.
The bulk of the $29 million, those are in short-term US treasury notes?
David Jonas
Yes. Almost all of them are in short-term 3-month or less US government T-bills.
Michael Boulegeris - Boulegeris Investments, Inc.
It’s so encouraging to see the stewardship of the board and management to preserve the balance sheet during this deleveraging period. One question on FemSoft. Jim, I know you mentioned DTC. Have you looked at any other commercial pathways for FemSoft?
Anthony J. Conway
We’ve looked kind of across the board, and let me explain when I say DTC, Michael. What I’m talking about is a DTC effort in combination with a very strong clinical effort. It’s a prescription device, and you cannot just sell to the consumer and consummate any sales actually, so what you have to do in the DTC arena is similar to what’s done with other prescription devices. You have to educate, train, and have commissions on board in the consumer area so you can couple the two together. This is actually the main difficulty. It’s very easy to run consumer ads and get tremendous response. We already now that. It’s very easy to do. The difficult part is the next step of marrying that consumer with a clinician, getting them in to get sized and fitted and trained on how to use the device, so it’s very much a clinical sell at the same time.
Michael Boulegeris - Boulegeris Investments, Inc.
With regard to the market penetration in mainland Europe, could you expand on your earlier comments? I think last quarter you mentioned being able to recruit a very strong individual with a reservoir experience in sales that proved very well. Could you expand on how we’re penetrating that market place?
Anthony J. Conway
That particular individual is extremely active right now in Europe and is operating at two levels basically. We already have a number of distributors in all the European countries. Some of them are exclusive, and some of them are not. He has been visiting and working with all of them to expand what they carry for Rochester Medical. Some of them had been one product distributors only. Many of them are now very excited about the new Magic technology, and he is working with them about getting that Magic technology in their bag, so that’s all branded business, and the second thing he is doing, and I mentioned this a little bit earlier, we’re exploring significant opportunities to introduce the new Foley technology and the anti-infection technology throughout Europe, and there are companies that are very strong in Europe in these market places which of course we are not, and the interest is very high, and we hope to be able to get something consummated in that arena, and we intend to get it consummated with the Rochester Medical brand. He is very active.
Michael Boulegeris - Boulegeris Investments, Inc.
I came on the call late. Did you mention at all any progress in Japan and in Asia? I think you mentioned last quarter that that was another area of the world that you were interested in.
Anthony J. Conway
We didn’t talk about it. That gentleman is also very active. He is at the point where we’ve developed a very basic initial overall business plan and business analysis of all the distribution mechanisms in Japan, who our competitors are, how we get to market, and who the potential partners may be for us. We’ve done significant investigation of the regulatory flow throughout Japan. He will be visiting for extended periods of time in Japan in the very near future, meeting with these identified potential partners. Just to be clear, we do not expect any immediate revenue from this Japanese initiative, but it’s a great market for us, and we believe that we’ll do very well there.
Michael Boulegeris - Boulegeris Investments, Inc.
You mentioned the warning. I assume that was latex warning in Europe. Can you refresh on me that, or has there been an additional warning?
Anthony J. Conway
Actually this is a new one related to PVCs and the plasticizers, mainly the family of phthalates which is a plasticizer that’s used in the PVCs, and France came out about two months ago and issued a very early warning ahead of the rest of the EU. The entire EU will be coming with its formal position, I believe, the first of March; it might be the first of April, and basically their position is similar to what was done with latex where they’re not banning the PVCs or the use of the plasticizer, but they’re making people identify it on any literature or packages and put warnings on it, and then the health organizations recommending where alternative materials are available that clinicians should consider strongly using those alternatives. So it’s very similar to the latex situation, but it’s PVC, and the reason it’s important for us is essentially the entire market place for intermittent catheters for Europe which is about $400 million is almost entirely PVC.
Operator
Your next question comes from the line of Beth Lilly – Gabelli.
Beth Lilly – Gabelli
I have a couple of questions. Can you just say a little bit more about the acute care market and you are starting to see the early results of all your hard work, and obviously you’re not going to name this key hospital, but can you help a neophyte like myself understand what that means in terms of your business and how that affects sales in the industry, and is this a word of mouth type situation?
Anthony J. Conway
It’s word of mouth to some extent, but this type of institution communicates very effectively not only with other major institutions, but with smaller ones, especially on a broad regional basis. I can tell you that in gaining a customer like this, they communicate with other major institutions that we’ve already converted. They consider comparing data with other major institutions and smaller institutions regarding how much the infection rates were reduced, and how important that is. They consider the possibility of making public some of that information which we certainly hope they do. We can’t do that for them and wouldn’t, and we don’t name them, but we certainly know that these types of institutions have public platforms where they come and announce these types of things and announce the progress, and obviously we hope for that, but it’s a long hard course to land a customer like this. They do very detailed, very long and extensive evaluations. It’s a tremendous victory for our salesforce and our company. It builds their morale tremendously. The competitors are in there at the same time with many more resources than we have, of course, trying to make sure that their product is used instead of ours, so it speaks very highly to the effectiveness of our technology once we’re up against some of the giants and we win. It’s a big deal going forward in accelerating towards what we hope will become a tipping point.
Beth Lilly – Gabelli
When did you win this customer?
Anthony J. Conway
In the third quarter. I want to make clear that’s not the only good activities we have going on in acute care. It’s just such a major thing that it’s just worth highlighting, but we have a lot of activity going on in other institutions. Maybe the most important thing that happened in the quarter is the tremendous response to our Strata technology. People are saying they’re just grabbing it and feeling it, and the anti-infection cell is very complex and abstract. You’re comparing data from one company with data to another. You’re calculating savings. You’re calculating lower infection rates and all that, and it’s all great stuff, but it may be more immediately impactful when you can put a catheter in a nurse’s hand and she can feel it and say wow because she has not seen anything like that before. That’s what the Strata technology brings.
Beth Lilly – Gabelli
Let’s then take this qualitative discussion to a quantitative discussion, and that is as you look at your model going out into 2010, your gross margin should increase because of this higher margin advanced branded product, correct?
Anthony J. Conway
It should increase for other reasons. In the near term, even though we expect to sell much more of our advanced products, they’re still a very low number versus our capacity and our investment to product them, so let me kind of clarify again. Ultimately, from our Magic catheters we expect margins very similar to our very high volume male external catheter, but right now if we sell a Magic catheter, its margins are lower simply because the volumes relative to those other ones are very low.
Beth Lilly – Gabelli
So we don’t see substantial margin improvement then until 2011?
Anthony J. Conway
I’d say you will see margin improvement, but what you’re defining as substantial probably not.
Beth Lilly – Gabelli
You talk about 60%, correct?
Anthony J. Conway
Yes, we do. That is our goal, and the wording I’ve used is when we’re a bigger company, when we’re double the size we’re, we’ll be close to that, and we hope to get to double the size we are in a very reasonable amount of time.
Beth Lilly – Gabelli
Will you continue to reinvest as you have been doing in marketing and selling and R&D over the coming year at the same rate that you have?
Anthony J. Conway
We hope to stay at a plateau. A year ago, I know I said these exact same words, and then we saw new opportunities like the Japanese thing where we could invest in a great opportunity, so we thought it was a smart thing to do, so we made a new decision to invest in Japan, which we hadn’t figured on doing over a year ago. We had planned a year, as you know, to kind of plateau out, and let the topline increases flow to the bottomline, but then we made the Japanese decision. Then we also had a great opportunity for further investment in mainland Europe which we had talked about prior to that, so we increased that investment, and while going forward our intent was to plateau out, if you will, temporarily and let that flow down, now the new FemSoft is of such significance given that we get that approval, but it’s very likely that we have new and further investment in FemSoft. I can tell you that this whole time while doing that we intent to keep essentially our head above the water, and on a non-GAAP basis to stay in the black just because we think that makes a lot more disciplined and healthy company. So we’re going to make investments. We’ve got such great opportunities. It would be the wrong thing to do not to do them, but we’re going to do them judiciously.
Beth Lilly – Gabelli
So gross margins over time are going to expand up to that 60% level, but to the extent that you keep having opportunities that’ll keep the operating margins or the EBIT margins depressed?
Anthony J. Conway
That’s correct.
Beth Lilly – Gabelli
You have plenty of capacity, so there’s no capacity issue in terms of producing the product, correct?
Anthony J. Conway
We have plenty of capacity, and we hope to run into capacity issues, but we can fix them in a hurry.
Operator
Your next question comes from the line of Ernest Andberg – Feltl & Company.
Ernest Andberg – Feltl & Company
Did this new institution evaluate the existing Foley or did they make their decision on the new Strata gem?
Anthony J. Conway
The existing Foley. The existing Foley is a great product, but Strata leapfrogs that technology.
Ernest Andberg – Feltl & Company
Was it made on the basis of anti-infective?
Anthony J. Conway
Very much on anti-infective.
Ernest Andberg – Feltl & Company
Dave, I don’t want to do it online here, but I’d like to talk about all of the pieces of branded and private label and advanced products. I’ll talk to you about that, okay?
David Jonas
Alright, Ernie.
Operator
There are no further questions at this time. I would now like to turn the call back over to Anthony Conway for closing remarks.
Anthony Conway
Once again, thank you very much for your interest and support of us, and we hope to talk to all of you again next time, and if you have further individual questions whenever, as always, feel free to call us.
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