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Executives

Anthony Conway – Chairman, President, CEO

David Jonas – CFO

Jim Carper – VP, Marketing

Analysts

Ernest Andberg – Feltl & Company

Tyson Bauer – Wealth Monitors

Seth Damergy – Deutsche Bank

Peter Sullivan – Private investor

Rochester Medical Corporation (ROCM) F2Q10 (Qtr End 03/31/10) Earnings Call April 29, 2010 4:30 AM ET

Operator

Good day ladies and gentlemen, and welcome to the second quarter 2010 Rochester Medical Corporation earnings conference call. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference.

(Operator instructions)

I will now turn the presentation over to your host for today's conference, Mr. Anthony Conway, President, and Chief Executive Officer. Please proceed, sir.

Anthony Conway

Thank you for joining Rochester Medical's second 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 briefly review the highlights of 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. Now 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 30th, 2009. These statements further clarify the risks and uncertainties that are associated with the forward-looking statements. Now, let me review the results.

As stated, we reported sales of $9,845,000 for the current quarter compared to $8,445,000 for the second quarter of last year. That’s approximately a 17% increase in sales, 14% on a constant currency basis. Worldwide Rochester Medical branded sales rose 32%, 27% on a constant currency basis. We are very pleased with the strong showing in the combined US and UK market where Rochester Medical fields its own direct sales force. There we had excellent branded sales growth of 35%. Intermittent catheters sales increased 79% in this market, thanks to the continuing warm reception to our Magic3 technology, which in the UK is sold under our HydroSil brand. This layered technology combines softness and easy handling with hydrophilic and antibacterial hydrophilic surfaces.

US Foley catheters sales increased 69% in the second quarter, again this is because our new soft silicone Strata product lines are generating strong interest in the hospital marketplace. As we said before, we truly believe there is no longer a good reason for placing a latex catheter in a patient. The US Foley market is about 90% latex. We still have a tiny market share in acute care but we are now selling goods into several hundred hospitals on a repeat basis, and the number is growing.

Private label sales were down 12% this quarter, and as you know they tend to fluctuate on a quarterly basis. This quarter most of the decline was due to the fact that a European private label customer has now converted to the Rochester Medical brand. This also helped us achieve the strong 32% worldwide branded growth. The willingness of a private-label customer to switch to the Rochester Medical brand speaks highly of the increasing recognition and respect for our brand. We are pleased with the results and we are expecting to have a good year. I will turn it over to Dave now and he will give you further insight into the numbers. And after that I will talk more about our plans and expectations and then we will take your questions. Dave?

David Jonas

Thanks, Anthony. I’m going to spend a few minutes highlighting our second quarter results. First our sales. For ease of discussion unless otherwise noted, all sales information will be discussed in constant currencies. 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 second quarter showed good overall growth especially in our key branded markets in both the US and UK. As we’ve discussed last couple of years, we are focused on and have dramatically increased our investments and activity in our worldwide branded sales. This has been done for many reasons including better market access, changing reimbursement rules and an increased clinical demand for infection reducing in all silicone non-latex and non-PVC devices. We have called this our investment in growth strategy and so far the results have been positive. These investments and focus fuel the growth in our worldwide branded sales, which were a record $7.3 million this quarter versus $5.7 million last year, an increase of 27% for the second quarter. This 27% increase included 76% growth in worldwide intermittent sales and a 17% increase in male external catheter sales. Our branded sales accounted for 74% of our total sales in the second quarter, also an all time high for Rochester Medical.

Let me first discuss our domestic branded sales in a little more detail and then our international branded sales. In total, our domestic branded sales for the second quarter were $2.2 million versus $1.7 million last year, a 28% increase from last year’s second quarter. For the year, our domestic branded sales are up 26%. Domestically, our advanced intermittent catheter sales grew 48% in the second quarter, and are now up 39% year-to-date. This growth reflects both new patients and increased usage, which is very encouraging.

Our domestic branded sales of male external catheters increased 2% in the second quarter, and the year-to-date 3.1% growth is in line with our expectations. Our domestic branded Foley Catheter sales grew 70% in the second quarter, and are now up 71% year-to-date. The majority of this Foley growth can be attributed to the acute care market and recent hospital conversions. The launch of our all silicone Strata technology has been very well received and the interest has never been higher in our advanced Foley products and anti-infection technology.

For the second quarter internationally, our branded business continued to grow. Again, to make sure everyone understands our true growth, the following numbers are using a constant currency, showing 2009 sales at 2010 exchange rates. In total, our international branded sales were $5.1 million this quarter versus $4 million last year, an increase of 27%. Majority of our sales volume internationally continues to come from male external catheters. This male external catheter business was up 19% in the second quarter, and is now up 12% year-to-date.

Our branded advanced intermittent catheter sales grew at a very strong pace of 131% internationally in the second quarter, paced primarily in the UK where the intermittent growth rate was 178%. For the year, branded intermittent sales internationally are now up 121%. Our new triple-core Magic3 technology launched a year ago has received excellent reviews and should help us continue to grow market share in Europe. 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 (inaudible) including products not manufactured by Rochester Medical. This business grew at a healthy 47% in the second quarter, and is up 41% year-to-date.

Now let’s take a look at our private label business. Rochester Medical continues to have a number of excellent private label partnerships. As previously discussed, their ordering patterns have been erratic quarter-over-quarter really for the last few years. Last year, in 2009 our first quarter private label sales were up 18%, they were down 16% in the second quarter, up 42% in the third quarter and down 20% in the fourth quarter of '09. And as we predicted, and most importantly our 2009 private label business was up 2% for the year. In 2010, we continue that trend with the first quarter being up 22% and the second quarter being down 12%. We still believe the sales of our products out of our private label partners' doors are growing moderately and our sales to them will show moderate growth over longer periods.

Gross margin. Our gross margin was 47.3% in the second quarter of 2010. The primary reason for slightly lower margin this quarter and fiscal year relate to the fact that majority of our sales increases are coming from our advance products, which are still at relatively low production levels. We expect margins to stay close to this level until sales volumes of these advanced products reach higher level resulting in significantly higher efficiencies and lower per unit fixed costs.

Operating expenses. Our operating expenses increased 7.9% or $356,000 in the second quarter to $4.9 million, being very much in line with our expectations. We had increased spending with our increased investment in sales and marketing in both the US and European markets and especially our FemSoft marketing campaign. We spent almost a half million dollars in the second quarter alone this year, and over $600,000 year-to-date.

Sales and marketing costs for the second quarter were up 17% from last year and are up 13% year-to-date. For the year they represent about 28% of sales, which is down a little bit from last year’s 30%.

Research and development costs for the second quarter were down 19%, and they are now up 11% year-to-date. For the year research and development costs represent about 3% of sales, which is down from last year's 4%. The dollar spend increase is directly related to new product development. Again, we continue to cost effectively develop life changing new products and have brought two new breakthrough products, Magic3 and Strata to the market this year.

Administrative costs for the second quarter were down 1% from last year, and are now up 10% year-to-date. For the year, they represent about 17% of sales, which is slightly lower than last year’s 19%. The majority of this increase comes from higher costs in accounting and legal related to year-end.

This quarter we had a net loss after taxes of $351,000 or $0.03 per diluted share, versus net income of $361,000 or $0.03 per diluted share last year. It is important to note that last year's second quarter included a $1 million legal settlement resulting in $637,000 of after-tax income, as noted in our non-GAAP table on Page 5 of our earnings release. But I do believe that non-GAAP disclosures in our press release are very helpful in understanding Rochester Medical's operating results, apples to apples, so to speak.

For the table in the press release, after tax affected adjustments for non-recurring legal settlements, intangible amortization and stock option compensation expense, our second quarter non-GAAP net income was $140,000 or $0.01 per diluted share compared to $207,000 or $0.02 per share last year. This decrease in non-GAAP income is a direct result in our growth strategy and investments in the US and UK branded markets and the new investments in FemSoft, which will continue.

Our balance sheet highlights. Our balance sheet continues to be very healthy with secure liquid cash and very little debt. Our cash position is $35.8 million, and our philosophy of tightly controlled management of working capital has served us well. As most of you know, most of our cash is in highly liquid and secure US government T-Bills and CDs. We have just $7.5 million in short and long-term debt. This consists mostly of debt associated with our June of ’06 asset acquisitions and normal operating payables.

Lastly, I would like to say how excited I continue to be about what lies ahead for Rochester Medical and the customers we are dedicated to serve. We are well positioned for a sustained meaningful growth, which in the end means more people will be using the best technology in the world. I would like to hand it back to Jim – to our CEO, Anthony Conway for some more comments. Thank you very much.

Anthony Conway

Thank you, Dave. As I said, we are pleased with the quarter and we look forward to a good year. Most of our sales and marketing emphasis this year will be on these three main areas. One, the acute care Foley market; two, the intermittent homecare and rehab market; and three, the FemSoft homecare market. We expect a good year driven by growth in the first two, with Foleys and the intermittent catheter markets.

We believe FemSoft is potentially a great opportunity but it’s too early to make any kind of projection as to its future contribution or impact. Also we continue to discuss potential acquisition opportunity and we continue in other company discussions. At this time, there is nothing new to report on those subjects.

And with that, we’d be happy to take your questions.

Question-and-Answer Session

Operator

(Operator's Instructions). And your first question comes from the line of Ernest Andberg of Feltl & Company.

Ernest Andberg – Feltl & Company

Hello Jim, Dave.

David Jonas

Hi there, Ernest.

Ernest Andberg – Feltl & Company

Dave, congratulations. You have finally hit my number.

David Jonas

Thank you Ernie.

Ernest Andberg – Feltl Company

It's not your problem, it's my problem. Dave, just a little housekeeping thing on the income statement. If I read it right, there's a $125,000 tax accrual in the quarter. Am I looking at it right?

David Jonas

Yes, of course. There is $125,000 tax expense that we had booked this quarter, yes.

Ernest Andberg – Feltl & Company

What caused that?

David Jonas

A bunch of things. But the biggest one is stock options. We have to take a book expense when we grant stock options every quarter and you cannot take the tax deductions for those stock options – that stock option expense until somebody exercise.

Ernest Andberg – Feltl & Company

Until they exercise. Okay.

David Jonas

But for us, because of our numbers, it looks like a lot bigger than it is, but that's why we have tax expense this quarter.

Ernest Andberg – Feltl & Company

Okay. Fair enough. And that is, I recall, is it the March quarter where you normally give new options and that's why it hits it now?

David Jonas

Correct. We – the Board grants options usually after the shareholders' meeting, which is in January or February. So, it is always the second quarter that we get the book expense for stock options. It's going to flip the other way when people exercise stock options. There will be quarters down the road –

Ernest Andberg – Feltl & Company

Where you are going to write off.

David Jonas

--benefit because if people exercise stock options that makes sense compared to the income the other way.

Ernest Andberg – Feltl & Company

Fair enough. Jim, I know that it's very early in this FemSoft marketing thing, and you made some comments about being optimistic about the start and the interest. What does that mean as a practical matter? Are you actually getting usage out of the healthcare system and the distributor at this point?

Jim Carper

Let me try to give you a kind of a little better sense of it Ernie. First of all, we started the direct-to-consumer campaign in February and we've had what I would describe as great consumer and clinician response. What does that mean? We got over a hundred clinicians now that have taken online training in that area and are now registered as certified prescribers, and that's actually well over a hundred right now. Hundreds of individual woman have expressed solid interest and many have pending doctor's appointments, and new prescriptions are being written. So far the numbers are modest. But we will have a good feel for this for several more months. It's kind of the actual prescriptions are kind of the trailing indicators, if you will. First you generate the leads and then you get the leads interested in talking to a clinician and so on.

So, while we like what we are seeing, I mean, what we know for sure is that there is a huge interest, and I think I said this last time and we also know the device works great. And the challenge is to educate potential users and clinicians about the device's comfort and its ease of use. Because you have overcome an initial hesitancy, even concern about performing a urethral insertion. So that's the whole challenge right now with this campaign. The device is great, the numbers are out there. There are just a huge number of women that need a non-surgical solution. Going forward, we are continuing the direct-to-consumer campaign and we now have two full-time trained reps right in Charlotte, working full time with the clinicians and patients, as well. So, lots of activity going on, and we are working very closely with the distributor, as you know also. So, really interesting stuff here and too early to tell.

Ernest Andberg – Feltl & Company

Now, you said that there are significantly more than a hundred clinicians who have been trained to date and I –

Jim Carper

That's just in that area as a result of this –

Ernest Andberg – Feltl & Company

Well, that's what I was just going to ask is, is that associated with the clinic you are working with in Charlotte?

Jim Carper

Yes. This is brand-new ones. Not just from that clinic but from the entire area. We've got an online training, femsofttraining.com, where they can actually learn how to do it, register and become certified prescribers. So, this is all the direct result of this new campaign, right in that area.

Ernest Andberg – Feltl & Company

What's happening with Liberator down in Florida?

Jim Carper

They are running their own campaign in Southern Florida. They are generating a lot of leads on their own. Most of their leads are phone leads. They are also working to the best of our knowledge. Their current customer base is, well they have got a number of customers around the country that they can cross-sell to now. I don't have a progress report on that, but –

Ernest Andberg – Feltl & Company

Fair enough. Fair enough. Dave, I will make us go over all of the individual numbers by domestic and branded and advanced, but I would like to give you a call off line and pick up those numbers. We can probably avoid it here on the call itself.

David Jonas

Fair enough Ernie.

Ernest Andberg – Feltl & Company

My last question this time is, Jim, I think it was you who said that some of the decrease in the private label and increase in the branded was one significant private label customer switching from private label to the Rochester brand in their selling. I don't remember if you said, gave a sort of a magnitude of that, and is that going to change the way the revenue flows between branded and private label over the course of the rest of the year. I mean we got a good history on the two and you are saying that there is a change going on.

Jim Carper

Yeah. It will a little bit. Let me try to give you a better feel. This is a mainland European private label customer. It doesn't have any impact on all the branded numbers that you have heard for the United States or the UK and all those high numbers. But on the overall worldwide 32% increase, it had an impact of several percentage points there. And since the private label business is much smaller, it's only 25% this quarter, the impact on that was about double or so the percentage points. So, it accounted for most of that 12% decrease in private label. I can't give you the exact figure because –

Ernest Andberg – Feltl & Company

That's fair enough.

Jim Carper

Their competitors would know then exactly how many MECs they are selling.

Ernest Andberg – Feltl & Company

That's fair enough. And I should expect aside from the volatility quarter to quarter, this is a permanent change in what you guys are going to call private label versus branded products sales.

Jim Carper

Yes that's right.

Ernest Andberg – Feltl & Company

Okay. Good. Thanks much.

Jim Carper

Thank you.

Operator

The next question comes from the line of Tyson Bauer of Wealth Monitors Incorporated.

Tyson Bauer – Wealth Monitors

Good afternoon gentlemen.

David Jonas

Hi Tyson

Tyson Bauer – Wealth Monitors

A couple of quick questions. What are you anticipating in regards to additional marketing expenditures on your three primary, the FemSoft those who the $600,000 this past quarter?

David Jonas

Yeah, we spent over $600,000 year-to-date on the FemSoft and our initial estimate is that we are going to spend a million dollar for the year and I would still stick with that, but depending on what we have learned, later on we may change that. But that's the current plan.

Tyson Bauer – Wealth Monitors

Right now, will taper off the next two quarters.

David Jonas

Yeah, that's correct.

Tyson Bauer – Wealth Monitors

Looking at the calendar, we are within about six to seven months of getting the British study out that you have talked about for the last couple of years. What is the status there, expected results, and what could it mean?

Anthony Conway

We have no new news. They don't tell us anything. We expect that when they analyze the data that the Rochester Medical technology will win hands down. That is our expectation. If that's the case, we think it will have a huge impact on our ability to sell not only in the UK but in all of Europe and also in the United States. It will be the first true huge head-to-head data in vivo that has been done.

Tyson Bauer – Wealth Monitors

And awfully difficult for competitors to discredit it.

Anthony Conway

Well, depending on how the data is analyzed and published, we will have a see. It will have to be a peer-reviewed document as you all know and depending on what the results are, I would think it would be very hard to discredit it.

Tyson Bauer – Wealth Monitors

Are you seeing any – as you are starting to gain traction and showing some pretty healthy growth percentages, any competitor actions, to try to tie up users or make it more difficult for acceptance for your products?

Anthony Conway

There is always really tough competitor action. I don't think that has changed at all. But we are breaking through that. And as we gain additional customers, especially certain important ones, we gain credibility, so that it makes somewhat easier for us. But we're working the GPO end of it very hard as well. And I will have more to say on that in the coming months.

Tyson Bauer – Wealth Monitors

Margins, expecting still between 45%, 48%, hopefully with gradual upticks thereafter. Is that still the case, and how are raw materials, what direction they have gone in?

David Jonas

I think this quarter is pretty representative of where we are right now with margins that will be for the short-term, Tyson, and as we keep growing, that is going to uptick, and we, as I've stated before, as we start ramping the volume up and reducing the fixed cost and become more efficient that will go up. Raw materials have been pretty good probably the last six months. They haven't moved up, which is a good thing. They haven't really – actually went down either, but stable sometimes is good. So I think what we did this quarter is a pretty good (inaudible) at what we are going to probably do the next couple of quarters.

Tyson Bauer – Wealth Monitors

Are you still encouraged that we will be recording, as reported, profitable numbers (inaudible)?

David Jonas

Certainly, those stay in the black on a non-GAAP basis. What we have been trying to do and we have been trying to communicate this right along, is to say alright, we are going to protect our cash and maybe grow it a little bit, but take the gross profit that we generate and reinvest it. And I think this FemSoft project is a tremendous example. Now clearly we spent about half a million dollars this quarter alone on FemSoft. We could choose to be into the black tomorrow, if we wanted to. We don't think that's the right thing right now. We just want to stay head above water in the black non-GAAP and grow the company.

Tyson Bauer – Wealth Monitors

That was good. Thanks a lot, gentlemen.

Operator

Your next question comes from the line of Seth Damergy of Deutsche Bank.

Seth Damergy – Deutsche Bank

Hi guys. Thank you for taking my question.

Anthony Conway

Yes. Hi Seth.

Seth Damergy – Deutsche Bank

How’re you doing? Just, first, and I know this is small, but in your accounts, so that you have a good track record, have you seen any increase in volumes or would you say that your acute care volumes are – just in general acute care volumes are up a bit?

Jim Carper

Our acute care volumes are up significantly and we know that to a certain extent the acute care business and procedures is down somewhat. But that really does not affect us. We have such a tiny, tiny percentage of that business that we are all about gaining market share actually.

Seth Damergy – Deutsche Bank

I know. I totally understand that I was just meaning in the parts that you are in, but I guess just a couple of that – the accounts that you have displaced, what strategy would you say you are using the displace your competition? Is it your value proposition or is it your product offering of maybe a bit of both?

Jim Carper

Basically we try to go pretty much head on in pricing the competitors' comparables. But we emphasize the superiority of our technology, whether it be the anti-infective technology which is effective against 80% of the pathogens that are out there versus a lot of in vitro data that shows silver is effective against only a tiny handful. We emphasize the fact that we are 100% silicon. As I said, 90% of the market is latex, a lot of downsize as we know to latex, and lot of hospitals want to get away from latex. With Strata, now that we have made the silicone soft and comfortable, they have every reason to move away from latex. So, that's kind of our overall strategy. Now in some hospitals we get a fairly broad conversion. As I said, we are in several hundred hospitals now, and in some of those we may have a particular unit such as a burn unit that is very concerned about infection. We also sell our other products into the acute care on a much smaller basis than Foleys, so we get some of that business as well. So it's kind of a – you don't have to pay any more and you get a way better product for your patient is the overriding strategy.

Seth Damergy – Deutsche Bank

That makes sense. Just one last one and this is just dealing with your coated catheters which you just mentioned. While you are I guess displacing or growing your share, have you seen a little reluctance for hospitals to spend the extra money to pick up coated catheters right now? I mean, are they focusing more on hygiene to prevent these hospital acquired or these catheter-based infections or are they willing to spend the money? Thank you.

Jim Carper

That really varies from institution to institution. We see some that say they think pure silicone catheters by themselves may have enough protective effect. They're considered to be superior to latex because they don't cause inflammation and so on. So some of them are looking to have a good silicone catheter without the coating and save some of the money. There's a big market right now in the other anti-infectives that you were just talking about, the hand cleansers, the surgical site dressings, and all these kinds of stuff, which we are not in that market, of course. So I would say it varies from institution to institution.

Seth Damergy – Deutsche Bank

Thank you.

Operator

(Operator's Instructions) Your next question comes from the line of Peter Sullivan, a private investor.

Peter Sullivan – Private Investor

Hello Dave, I wonder if you could give me the sales numbers for the domestic branded advanced products only this time.

David Jonas

Domestic branded advanced products for the quarter were $973,000.

Peter Sullivan – Private Investor

973,000. Okay, thank you, that's it for today.

David Jonas

Thank you Pete.

Operator

And you have no questions at this time. I would now like to turn the call back over to management for closing remarks.

Anthony Conway

Alright, well thanks very much everybody and we will see you next time. Thanks again.

Operator

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect.

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