Merit Medical Systems, Inc (NASDAQ:MMSI)
Q2 2016 Results Earnings Conference Call
July 27, 2016, 05:00 PM ET
Fred Lampropoulos - Chairman and CEO
Brian Lloyd - General Counsel
Bernard Birkett - CFO
Ron Frost - COO
Brooks West - Piper Jaffray
Jason Mills - Canaccord Genuity
Jayson Bedford - Raymond James
Jim Sidoti - Sidoti & Company
Marcos Rodriguez -
Good day ladies and gentlemen and welcome to the MMSI Second Quarter 2016 Earnings Call. [Operator Instructions]
I would now like to introduce your first speaker for today, Fred Lampropoulos, Chairman and CEO. You have the floor sir.
Good afternoon ladies and gentlemen, and thank you very much for taking the time to join us in Toasties Salt Lake City today where we appreciate you taking the time, we know you're very busy.
We’ll start our meeting today by having Brian Lloyd, our General Counsel, read our Safe Harbor Provision. Brian?
During our discussion today, reference may be made to projections, anticipated events, or other information which is not purely historical. Please be aware that statements made in this call, which are not purely historical maybe considered forward-looking statements. We caution you that all forward-looking statements involve risks, unanticipated events, and uncertainties that could cause our actual results to differ materially from those anticipated in such statements.
Many of these risks are discussed in our Annual Report on Form 10-K and other reports and filings with the Securities and Exchange Commission available on our website. Any forward-looking statements made in this call are made only as of today's date, and we do not assume any obligation to update any such statements.
Our financial statements are prepared in accordance with accounting principles which are generally accepted in the United States, however we believe certain non-GAAP financial measures provide investors with useful information regarding the underlying business trends and performance of our ongoing operations and can be useful for period-over-period comparisons of such operations. The table included in our release and discussed on this call sets forth supplemental financial data and corresponding reconciliations to GAAP financial statements.
Readers should consider these non-GAAP measures in addition to, not as a substitute for, financial reporting measures prepared in accordance with GAAP. These non-GAAP financial measures exclude some items that affect net income. Finally, these calculations may not be comparable with similarly titled measures of other companies.
Thank you, Brian and once again good afternoon ladies and gentlemen. We are pleased to report our second quarter to you. As you can see from our press release our revenues were approximately $151 million and we’re quite pleased with that. It’s up 9.4% and on a constant currency basis about 9.9%.
Our non-GAAP earnings per share were $0.26 per share, GAAP earnings per share were $0.16. Our margins improved for the quarter at 44.3% compared to a year ago period by a couple of basis points and I should point out - or about 20 basis points but I should point out that sequentially from the first quarter our gross margins also improved.
Let me give you some of the highlights because as it was a very, very busy quarter and I would like to go through some of the highlights of the quarter for you. I would like to start out by discussing a business opportunity that merit, I think ceased and has absolutely done a terrific job of moving forward and that’s specifically the Cook situation.
Now let me just temper that somewhat by saying that these are not pleasant things to befall a company like Cook and I hope Cook in the highest regard. That being said, our job is to meet the needs of our customers and to be able to provide products that help to save people's lives.
In the quarter we generated an additional $3.6 million of revenue on this situation and you’ll recall that this started in early April. Think about this for just a moment. We had to ramp up, we had to go and get a lot of things in place to meet this demand. We hired over 50 people and they had to be trained. We had to move up our supply chain so that we had adequate raw goods to build inventory and I am pleased to say that we did all of that and in fact we've done some other things that is that we've added substantial capacity going forward.
It is our belief that this opportunity is one that is going to be larger than I originally anticipated and will last longer. The question always comes up as to well, was this short term or long term. From our point of view and from input from the field and talking to customers personally, I believe that this is more of a long-term situation than short. The reasons simply being is that Merit has great products, Merit has a breadth of products and has a sales force out there and I think many hospitals want to make sure that they don’t get caught in a position like this, where they have been sole sourced in the past.
I also believe that there is a second wave coming and we’re seeing that. We’re seeing orders that are coming in now in increased quantities from China, Japan, Russia, in addition to the business that we’ve generated in the United States. We've put into production approximately six new braiders and we’ve increased as I mentioned our stocks for instance, platinum bands for our marker band catheters and the second wave is being well received by our sales force, our customers are calling us and we’re visiting customers and we expect this to continue.
I am not going to comment on what Cook's plan is and when they'll back in the marketplace. The bottom line is as we believe based on our face-to-face conversations with customers that this is going to continue to be a long-term opportunity for Merit.
Let me move on now and talk a little bit about Australia and Canada because part of what's driving this demand is the fact that we went direct in both of these countries and we made them the priority because we were just starting up and we thought it would be a good opportunity and that has more than paid off.
In fact, we believe by the end of July which is a few days from now, that we will have already met our entire forecast for our business and in Australia. So I think that kind of tells you about how these opportunities are helping the company.
Now that being said, there's also about 20 basis points that would cost us in this lower margin side of the business. And part of that is because of training start out scrap the things that you do and my expectation is as we move forward that we will overcome that, we will have higher yields that - with the training and experience will be in place. And then we’re also going to see improved margins out of this business because of the mix as we expect that we’ll see a substantial increase in our marker band catheters as we move forward.
Let me also remind you that Merit is fully integrated in this effort. We extrude, we brayed and we finish all of our catheters in-house and I think that is a huge benefit and opportunity.
Let me move on to the HeRO. As you well know in early February we announced the acquisition from CryoLife of the HeRO product line it has met every one of our expectations. I'm particularly proud of the fact that within about a 90 day period, we were able to send a full team to Atlanta - excuse me - we were able to have our people trained and then we transfer the product back to Salt Lake City.
The original estimate from my engineering staff is that we were going to be able to take an additional $2 million of cost, in other words we're substantially more efficient in our facility in producing this product which will take our original estimate of about 55% gross margin to somewhere around 70% gross margin.
So we’re very excited about this product line. We’re introducing two new products in the HeRO line in the first week and second week of August. So we believe that it will have a niche of more momentum going in this particular area.
In addition, in the end of August, August 25 and 26, we are starting our first Think HeRO program. Now many of that we've been very successful with our Think Radio programs where we're training both cardiologists and interventional radiologists and we're bringing on now this program where we have a full capacity of 12 physicians that are coming into our facilities to be trained. And we're excited about that opportunity, our physicians will be doing the training and they will have an opportunity of course to be in our facilities here in Salt Lake City.
Now in the second quarter, there was a little bit of a drag because of the extra expense of having people in Atlanta, a little bit of expense in terms of the inventory markups. But all of that should wash through here in the very near term or is it some - and a good portion of that already expensed in the second quarter. And we believe this will be a nice contributor to gross margins moving forward. And as I mentioned I think this Think HeRO program is - has a substantial opportunity for Merit.
Let me move on now and talk to you about DFINE and I also want to take a few minutes and make sure that I clarify for the benefit of our analysts and shareholders why we think this fits. So we've had conference calls on this but I just wanted to make sure everybody understands that business.
First of all it is a vertebral spine business. We're dealing in kyphoplasty and vertebralplasty. We believe that we have the best cement in the business. We have the longest part life which allows physicians to complete their procedures without happen to go to another kit or source and expense.
We also have articulating osteotome that allow us to be able to create the space that’s needed and so we continue to believe that this is going to be a great opportunity for Merit. Then there is the oncology side of this where we have the Star product line and that product line is used to ablate vertebral metastases and then if there is a fracture present you can then also follow that up with the use of cement in the kyphoplasty. In most cases this is the very same call point not always the same physician but the same call point that a good portion of our peripheral and now our new interventional and oncology spine sales force is calling on.
And then let me remind about the sale force reconfiguration. We talked briefly about HeRO. If you have just one group of people selling all these products it’s very difficult to get all of that work done. So we pull the defined products our embolic product, our micro catheters and some other products into this IOS group. And that leaves more time for the peripheral guys to sell the HeRO and all of the products that are in that particular product area.
So we think that having additional sales people, having additional bandwidth is going to be very, very beneficial to the entire company not just to define part of the business or the IOS group.
We’ve had our sale meeting, the entire sale force and those who are invited from DFINE. We did training for over a week where we had it was cross functional, we did didactic, we did hands-on and we’re very exciting about this opportunity.
On the business side we’re integrating the business and there is a lot of work to be done there. As you will recall we had a plan in which we say that we’re going to be flat on the earnings side in terms of expenses for the last half of the year and we’re going to ask you to be patient because some events in the third and fourth quarter and how they’ll match up.
So Bernard I am going to ask you now if you just kind of explain this so that we can make sure that everybody understands how we hope to stick to our plan, our three-year plan and yet how this next six months will play out for the benefit of our shareholders and analyst.
What we’re going to see is that we will expenses in Q3 in relation to the transition of DFINE and incorporating that into Merit’s business. So we may see some adjustments on our earnings within that period and if there is any resulted in Q3 we expect to kick that off in Q4 so over the next six months the effect will be neutral on earnings as we’ve already guided but there may be some timing differences within the two quarters. So just for people to be aware of that.
Okay Bernard, and thank you very much. We’ll have you come back in a few minutes and talk about some other things. Again I think all in all we believe it’s a perfect fit. We’re already working and integrating new research and development projects and prioritizing those into the Q if you will and we believe that our sales force and I think it don’t really make any difference what I think. I think it’s the sale force thinks, those are the guys who would have to make the calls and all of my input from that has been positive.
Interestingly just as a point of interest one of the things that we found out at our sales meeting is about 75% of the new DFINE sales who are now Merit sales have had experience in selling embolic and I think that’s a big plus that we didn’t anticipate but there is a lot of experience out there.
And the other thing we found in this group and it’s something that we looked at in our due diligence and that is that this sales group is much more, what’s the word I want to use, clinically trained and they come from that clinical background. We think when you’re talking about Rx and oncology and with our new biopsy product line which is releasing here in the next week into that group we think that it gives us great opportunity. At the same time the other groups are I think going to do as well.
So we’ve talked about, now the Cook situation we’ve talked about DFINE. One of the things that I have to mention is just how much work everybody has put in. Now I know that’s what we get paid to do but during this last quarter we were dealing with the Cook opportunity, we were doing due diligence and with the DFINE situation we were ramping up in Australia and in Canada and we were transferring the HeRO and when you really think about how monumental that was and the effect that will have on the business going forward in terms of gross margins, in terms of profits.
Now I just want to makes sure that how appreciative I am of my staff. You get a few pats on the back and well done and all that sort of thing but I really need to acknowledge the efforts by our engineers and people who traveled out town and stayed out of town in some cases for up to five weeks to get this product transferred and so again I wanted make sure that make comments about one.
I want to go a little bit up to the mix for a second. One of the things that you’ll notice on our charts when it breakdown the sales categories you’ll notice that custom kits and procedure trays are flat. I think this is exactly what we had hoped. I think this is what we’ve been driving for that although we think it’s an important part of the business and particularly after we get the install bases on our kyphoplasty and oncology product other things that we can sell the lab the focus has been on the these other product areas that have higher margins.
And so we’ve not abandoned the business. We still think it’s an important part of the business in the long run but I think it’s important that you see that we had essentially flat which is exactly what we were planning and what we were driving to do.
If you look at our catheter market you can see that is just doing terrific and I just have a point that I want to bring out to you. You’ll notice in the endoscopy division that was only about 5%. We still expect for the year that this division is going to produce 20% to 25% growth. What happened in this particular quarter as there were some large OEM orders last year for some of our bipolar probes and we just didn’t have those orders this year but we’re running substantially harder at moving forward with our new products and have launched a couple of new products in the endoscopy line.
We have our 510k in, we’ve received comments and we hope that very soon that we will have our approval for our pulmonary balloons. I will tell you the Elation Balloons as part of Endotek we’re literally making as fast as we can and that’s I am very pleased with the efforts of that product and what it means going forward as well.
So those are my comments. On inflation devices just another point of interest, Merit launched this day our new basic TOUCH 40 and so we’ve had a competitive product that came out from Bard and it hasn’t been out there very long but it did take some business away but we now have that product that is on line and it’s now in the hands of our sale force so we’re very excited about that.
I think what I’ll do now is Bernard maybe just turn a little time over to you to talk about some of the highlights and some of your thoughts on some of the financial issues. Bernard?
Thank you, Fred. Just a quick recap on gross margins. On a non-GAAP basis gross margin for the quarter was 46.4% compared to 46.1% for Q2 2015 and we see margin improvements of 30 basis points when we compare the two periods and there are areas that we should note that affected gross margin.
One as we’ve already mentioned is on the mix of our products and the increased catheter sales has affected us by about 20 basis points and also we’ve seen a FX impact and particularly coming from our Chinese operation which was about 30 basis points in the period.
On SG&A and R&D the SG&A was 26.8% of revenues in Q2 and 27.5% on year-to-date basis and R&D which includes regulatory and clinical were 7.6% both for the quarter and year-to-date.
And just also to note on our CapEx expenditure that again we’ve seen a reduction in that amount in Q2 2016 so we’ve seen our CapEx reduce quarter-on-quarter since Q2 2015 and so again we’re really paying a lot of attention to that level of expenditure and controlling our expenses and at the same time striving higher revenue.
And again we understand the focus on margins and that gets a lot of more attention. We believe we will see that margin improving through Q3 and Q4 as we have already talked about.
And I think Bernard that’s five consecutive quarters of lower CapEx expense and I think as you all know we put a lot of capacity in place and we don’t have to spend that money and we should be able to continue to grow the money but just generally and there will be some expenses but just basically with maintenance and new projects and that sort of thing and that I think was exactly our plan.
Let me just briefly if I could move to Mexico for a moment. So Mexico continues to operate in positive variances. They are still of course absorbing a lot of growth down there, we have about 500 employees in Mexico today. We are now going through and looking at various facilities and products and taking a look as to what our next moves will be. We have a lot of capacity down there and we will continue to evaluate and I think we will probably move a few more product lines before the end of the year.
So that’s what's going on in Mexico and I want to again, and not to offend anybody but you look at numbers and you have words and so on so forth, it’s the effort. You think about the efforts of the new facilities in Canada and Australia and acquisition and moving up a product. I couldn’t be proud of, but I think at the end of the day you can have all of these advance but they have to be meaningful. And the meaning is growth, improving the margins and profits.
And so I think we are online for meeting that three year plan, this will be incremental. Our sales and as Bernard pointed out, we’re going to be flat for the next 6-months as we integrate the fine business. And incidentally there is a lot of work to be done there still. We’ve moved now customer service and inventory to Salt Lake City. We’ve paired the business down in a number of ways, I don’t want to go into a lot of detail on that and there is more pairing to do and we will do the job that we committed to do and I think it will have great benefit to Merit shareholders and the intermediate term once we get through this restricting part of the business.
Well I think ladies and gentleman that pretty well covers it. I think a quarter that I am pleased with, there is always more that we can do but we have been very busy here and I think we accomplished a lot. We are looking forward because as we look into this third quarter, I will be able to talk to you about the integration plan, we will be able to talk to you further about and the accomplishments of that, we will able to talk to you about a number of new products that will be coming on and driving growth in the future but I think I have said enough for today to give you kind of an overview of both our earnings, our sales momentum and all the things that are going on here at Merit.
So I think at that point, back to our administrative. We will go back now and we will take questions regarding our results and aspects of the business. So we will turn the tide back over to our administrator.
[Operator Instructions] Our first question comes from the line of Brooks West from Piper Jaffray. Your line is open.
Thanks. Fred, can you hear me?
I can sir, thank you.
Great, good to hear your voice and congratulations on a nice quarter. I wanted to start with guidance, you didn’t say anything about guidance, I'm looking at I guess its Slide 9 in the webcast and it looks like you did take revenue guidance up a bit it for the year but looks like margins and EPS are unchanged, am I reading that correctly?
Yes, I knew that Bernard just speak that for a second but further to that, that's something we hope to clarify and clear. We need to give a little more details, so Bernard.
We adjusted the revenue guidance based on the condition of the defined products for the remainder of the year, and as we had already guided on earnings that would remain flat for the year.
So this is going to be about I think 16.5 of additional revenues, of course we will have increased gross margin to go along with that, we discussed that, I think we said about 80 basis points, could be higher than that.
Yes, that’s still within the range.
Yes, that's still within the range but what we want to make clear is that there are these restructuring charges that are going to be part of what we’ll have to finish out to the balance of the year and that’s why we’ve said all along that there would be, earnings would be flat. When I say flat, they’ll be above, they’ll be our original numbers until we get this through this six months and then from that time forth we’ll have the restructuring completed.
Let me take with that restructuring as so I am perfectly clear. We have facilities to shut down, we’ve to trend the work force. We have been moving customer service and inventory and shipping all those sorts of things and so there is a lot of work and I would say that right now we have completed as our discussion this moment about a third of that.
So we’ve already in a very short period of time accomplished about a third of what needs to be done and then over the next the balance of the year, we’ll finish the other two-thirds and by the time we get to 1 January, everything will be square and then everything will flow down and then of course we will guide both earnings and revenues going forward from there for next year.
Got it, okay. And when did the DFINE transaction close?
It closed on July 6. We tried to get it as - put to the end of the quarter so we would have stuff periods but because of the holiday and everything it got pretty complicated but I think we finished up on July 6 and by the say I should say that there are always issues with integration but I think what was really pleasing was when you see the revenues, you see the customers, you see the sale force and we’re starting to already see that the former DFINE now Merit sales people are selling the Merit products and the Merit people are selling their DFINE products.
So it's already starting to come together but it will take some time and additional training to get this thing all into sync.
But I think it's moving exactly as planned.
Okay. So I think Fred I am little surprised, the business has been performing above expectations in the first half, you got this Cook opportunity, it sounds like HeRO is trending a little bit better than plan. I am little bit surprise you aren't taking up numbers for the base business. Can you just speak to that?
Well yes, one of the things that you have is that when you have all of the effort, you think about the amount of business that we picked up on the Cook situation that takes away from a lot of other things that we could be selling.
So I just think with all that’s going on we just felt it would be better to especially going into the summer, we just thought we’d just stay pat. We’re going to see a continued growth and I guess mentioned in the third quarter over the summer with all the things that are going on in Europe, we just felt we'd like to stay conservative and we will bring in this capacity on as well.
So I think Brooks more than anything it was just not to get expectations ahead of where they ought to be and just trying to manage these things properly and then as the old saying goes, you've taught it to me, under promise and over perform.
So I know that we’re necessarily under promising as much as we’re saying there is a lot of work to do, lot of things to be accomplished but I think that what we’ve done for instance is I mentioned on the catheter situation, we’re going to have a huge opportunity here but I still got the six [writers] [ph] to bring online, and some of them are already online.
So I think that’s part of it. I think whenever you have a transition and you are training people and you’ve got people – even though I think we feel pretty comfortable about this, we’ve only been into this three weeks and I think rather than trying to get the best outcome, I think we said let’s stick with this and then let’s pool what we can do instead of going out and here you go, this is all excited because we are, we’re very excited but I don’t want to be a apologizing for anything either.
So I think it’s just trying to stay conservative and not get things in front of us, that’s all.
Okay, okay. And then I guess last question from me, you said that the Cook situation was about $3.6 million in the quarter. If we annualize that number, call it $14 million, $15 million of an annual asset, is that about the right way to think about it or are you still ramping there, is the opportunity actually bigger than that? Thanks.
I think going with what I just said in terms of trying to keep things, I think that's a fair comment. What I feel strongly about is that I don’t know what others were doing but as we made an assessment of the situation, we immediately made decisions to add capacity because we have a new facility in Texas, we had to add some machinery.
We also made plans with vendors that more than tripled our marker band capacity and availability. That’s a high margin product as well as some Vascular Access. That capacity is now coming online, in fact it is online not fully but over the next 30 days, we will more than double or triple. That double or triple was not in this quarter and so I am going to stick with kind of the ramp that you indicated. Is there upside to that, yes, but we have to come online and get that product sold.
I also think as we mentioned the higher gross margins, it will absorb and I think this business is going to stick. I have a lot of reasons to believe and listen our customers are telling us they like our product, they don't want to get caught by any vendor without having availability and very candidly some of our competitors that are also doing this are starting to go into back order and Merit is now with that increased capacity is going to have the advantage.
So we’re very aggressive on this and again in the long term we’ve been through these before Brooks and it comes and it goes. This isn’t going to go in my view. I think this is going stick and of course as we build that particularly with this oncology business remember it’s the same call point.
So we think that this bodes well. Listen, we’ve what it’s done for us in our Australia, in Canada, in Europe and it’s still coming. That’s the thing I tried to get across was that orders from India, Japan, Russia, Turkey, some of this stuff is still percolating and you take that along with now reorders and more capacity it’s going to be a very big deal, I mean it just is. I am sorry that somebody’s to somewhat disadvantage but it’s a very, very big deal.
Great, thanks Fred, I appreciate the color.
Our next question comes from the line of Jason Mills from Canaccord Genuity. Your line is open.
Great, thanks Fred, can you hear me okay.
I can Jason, good to hear your voice.
Thank you. You too Fred. Congrats on a solid quarter. I wanted to start with the gross margin. It was nicely up sequentially. Obviously you have a lot of things going on in the second half of the year. It seems like most of them favorable. So could you talk a little bit about gross margin trends quarter-to-quarter as you look into Q3 and Q4 and where in your range you sort of feel most comfortable?
Yes, I think the way I’d handle this is to say that we talked about at the beginning of the year 100 to 150 basis points would be our goal and I think that we’re on line with that and we believe that will be the case and then of course you’ll have that incremental gross margin that will pick up from the DFINE business. We indicated that would be 80. There is some upside potential there but that’s kind of what our numbers are for planning.
Will there be a - is there additional opportunity for gross margin, the answer is yes. But it all comes down to execution. It all comes down to training and how quickly the sales force. So I would rather hold and see what we do in the summer quarter before we have any further - before I just don’t want to get too far in front of myself Jason, I want to hit my numbers and again my goal is to exceed it all the time but I get pretty excited about this stuff and I am going to try to damper my enthusiasm.
So the answer is 100 to 150 on the base business for the year plus the incremental improvement that we’ll get from the DFINE and all the other things that we can do. We’re also starting up some projects new things for instance our Corvocet, we’ve done about 75 cases with the Corvocet all approved in Canada, in U.S. and in Europe. It has the opportunity to be an extraordinary product and it’s right in this IOS area that we’ve talked about.
But anytime you start a new product it’s not as efficient as we’re going to be six months from now. And so that has very nice gross margins along with other products that we’re releasing. So again I am sorry to – I am not trying to avoid your question in any way. I am going to say it’s the 100 to 150 plus as DFINE and hopefully we can deliver more.
So that's helpful Fred. Just a follow-up on the gross margin side. So the baseline that you're coming up from 100 to 150 plus C, the 80 in DFINE the potential for more although that's not something you're coming out right now would be sort of in that 45.5 range last year. So that implies to the second half of the year sort of run rate in the mid-47?
The answer is yes.
Yes. So we guided 46.5 to 47.5 and currently we are at 46.1 for the year. And so yes, there is some room for upside I mean the second half of the year and that's all we had spoken with people about that as we transfer more products to Mexico and actually the variance is reduced from that facility. We need to choose cost-saving projects within our operations and introduce higher-margin products that we would see and not taking gross margin at the second half of the year.
Perfect. That’s helpful. And I think important. Secondly, Fred I just want to make sure I understood your commentary with respect to the quarter-to-quarter variances on the earnings on given the expenses that you talked about and the timing of those expenses here in the second half of the year.
So I know you don't give quarterly guidance but just to make sure that we're all calibrated consistent with how the business should try given those expenses and the timing of them. Could you talk about maybe this time around a little bit more granularity with respect to your pro forma earnings expectations for the third and fourth?
Well let me answer it this way. Jayson that the -- what we commented on was that we know what our expenses and what our plan is on the defined business. And our goal is to have a good portion of that, if not all of it completed by the end of the year. And I think what Bernard was eluding to was the issue of timing and could you have a little bit even though we’re getting that higher gross margin will you have more of it fall in this quarter than you will in the fourth quarter. And what we were trying to say is there could be that.
So I’m going to let maybe have Bernard to give a little bit more of a granular clarification.
So there's a couple of things that taken into consideration and cost that we will see in Q3 so we had a sales meeting expense, the sales meeting that took place in July so that was an additional expense. We will have it in Q3 we will not have it in Q4, timing of synergy.
So we’re working through the synergies and again we will realize some of them in Q3,there’s going to be more of them in Q4 as we kind of we restructure that business.
And then as we're transitioning the business to Merit, we have DFINE people there helping us to do that within the next three months and then again as part of the synergies they will not be there in Q4. So there will be a level of extent and in Q3 that it will just be for that period. So, it's about 1 million to 1.5.
Okay, got it.
That's the kind of figure we're talking about.
So and I appreciate the question because we were concerned, we want to make sure everybody understands it, it doesn't change our plan at all it’s about the issue of timing. I mean at the end of the day Jason we’ll have this business, we have our business development leaders and those folks and their compensation and everything that we’re working on is to get this thing aligned properly and will have that work done.
And then as we get so we’ll make our goals this year, we will improve gross margins and then it really sets the stage for 2017 as well. We will have a good year, we will do the things we said we’re going to do but it helps us to complete the business.
And then as we look at it and get that work done as we give our forecast out into 2017 so I think we had talked about 8% growth before. But we will update all of these things as we come down the road. And if we get to a point in this third quarter where we have I don’t want to say surprise but if we are up on the higher end of things then we will keep in the fourth quarter if necessary.
But we’ve got to get the work done first. And its summer quarter and I always – I just -- you think slowdown in Europe and parts of the US as well. So but I think again the bottom line is we will do the plan we said we would do and we have a - we do have a lawful lot of wind at our back. And that's nice.
Got it. Last question for me, I’ll get back in queue. I heard you talked about the endoscopy division you're still fairly bullish, did you say growth there over 20% obviously that would require a pretty big step up here in the second half of the year, maybe comment on what gives you confidence there?
Well, because I’m already seeing it. I mean, I'm commenting on it because we've already seen that improvement as we’re going forward. And I alluded to clarify Merit is the leader in the pulmonary stent market and our line of pulmonary balloons we’re received comments from the FDA, I believe at least it's my hope that within 30 days we’ll have that approval our 510(k) there.
So if we see that along with the acceleration that we're saying in the elation balloons for the esophageal balloons and the stents go right along with it. So all of that is in place that’s a 75% gross margin business and we’re seeing those indicators in places we're speaking.
So and in fact interestingly enough even though we did not see some of those orders on those five quarter prongs that I talked those orders have returned now and those will be delivered in the third and fourth quarter as well. If you take all of things and add them up and it’s going to bring us back to those growth levels that we talked about.
Perfect. Thanks Fred and Bernard. I’ll get back in queue.
Thank you. Our next question comes from line of Jayson Bedford from Raymond James. Your line is open.
Good afternoon and thanks for taking the questions. I just have a couple, somewhere in the commentary you mentioned that the 20 basis impact on -- 20 basis point impact on gross margin and I thought it was related to kind of the Cook related recall meaning the additional 50 folks. So first I guess is that correct?
Yeah. So what we said is that that really affected us by 20 basis points in the quarter but generally on those almost catheters they have lower margin. But on top of that we hired people, you trained people, you had higher scrap and just because think about I mean, we quadrupled our business in 90 days and so all of that had some expense to it. Now those people are trained we have the supplies we are becoming more efficient and it's our expectation that that will be erased and then on the mix part of that.
So most of this was the diagnostic catheters but the other part that comes with this Jayson is a hydrophilic catheters, the vascular access the nonvascular access projects. In fact we call the MAK‐NV and then on top of that the big push that I think is coming in this third and fourth quarter is on our marker band catheters.
And so we had -- we had a big improvement there, but the problem was I mean over last year just to give you an idea on vessels sizing catheters we were up about 58% it can’t work at the diagnostics catheters we were up 200% over the year ago period while this is a big disparity there. And that was nobody have the supply of the marker bands.
Well Merit stepped in very quickly and we more than tripled and I will tell you the market availability is there the production is now actually coming online. When I say coming online there’s product on our shelf there is an increase amount from what we had just three weeks ago. And that will continue to ramp over the next month and a half to two months. And so we’re going to a lot of this business and this is the highest margin part of itself. This is still ramping up, we did it early, we did it aggressively and it was the right decision.
So the 20 basis points was the more lower margin and kind of the startup cost of getting all this work done. I mean we are working 60 hours a week and overtime. Now we've hired and trained and so we’re going to become more profitable and we're certainly more efficient today than we were two months ago.
Okay, thanks, Fred. In terms of Mexico is that adding or detracting to gross margin?
It is now adding. We were $138,000 positive I think just last month -- just last month and you remember we said that we would be at that breakeven point by the end of the first quarter. So now that is incrementally adding to gross margin going forward.
Okay. And then in terms of - you mentioned a second wave and I was just a little unclear as to what that meant, is that just you’re seeing new orders from new countries, is that when you mean by that.
That's part of it, thank you again for allowing me to clarify that. So there was this initial way that came out of this unfortunate situation and I mean there were orders coming from a lot of places and there were 5s and there were 10s and they have lot of customers and we were able to fill a portion of that.
But in some cases you just can’t turn on and go up 200% overnight, but we feel that as well as we could and had - a little bit of a backorder at one time at about $1 million. That’s dropped dramatically but what we are seeing now is that our competitors, those other companies who are also participating in this we're starting to have customers start thinking, get supplies from them at the same time I now have that increased capacity, I hire the people, I made the investments better yet, we made those investments.
And so we're seeing orders coming from large hospitals and we had one the other day, were over 200 catheters and it wasn’t part of the first wave, that first group. We had another one, there was 170. We had an order from Russia for over 100 catheters.
So some of those were filled by the other companies but at least appear to us and anecdotally the evidence that I’m receiving is, that they can’t meet those orders. Now I don’t know what they did Jayson, I don’t know – it's selective or they didn’t ramp up, they didn’t reach their capacity, I simply know I’m seeing new orders, I’m seeing old orders and I now have the capacity and we are calling it the second wave here and we are seeing water levels above where this thing originally started and brought.
So it's I believe based on what we are seeing that this is going to continue. We believe it’s going to stick, we’re talking to customers and you can hear the opposite from others. The fact of the matter as we have as good or better part, my belief it is better; customer's don’t want to be held at risk. They want to make sure and this creates a lot of other opportunities from other products.
So, that’s one I’m talking about the second way, that’s added on top of the initial business that we have seen.
Okay, thanks. I will jump back in queue and let others jump in.
Thank you. Our next question comes from the line of Jim Sidoti from Sidoti & Company. Your line is open.
Good morning, Fred. Can you hear me?
A – Fred Lampropoulos
Hi, Jim I can. Good to hear your voice.
Great. First question is what you are doing to keep this business so that when Cook comes back online that you can keep someone in this business.
Yes, the answer is this Jim, is first of all I heard various stories about they’ll be on in six months, they'll be on one year, they’re replacing with other catheters. I hear all those stories and that's a thing but here is what our customers are telling us.
First of all we have probably the broadest line. If you take a look at our catalogue and there is two lines, we have the first line radiology catheters, and we have the pro forma line of radiology catheters that was part of our original acquisition when we bought the catheter line.
Merit then developed its own catheters called the impress and so it's the broadness of the product offering, it’s a fact that unfortunately I think customers like anybody if you don't meet those needs or these things go on too long or they have more than once, they’re just going to lose faith and you have a good product, you have a presence, you have a broad line of other products to sell and it's not like we are new with this, we've been around here for a long time.
So, I think it’s the mix, I think it’s the quality, and I think it’s the ability simply, I mean at the end of the day to provide the product. So, I don’t want to comment, I have a lot of things but I don’t want to comment on somebody’s miss fortune, it’s just very unfortunate but if you are prepared, if you have the capacity and you have the breadth upon it, and you can deliver that to your customer, you are going to win.
And I just believe this is unlike other ones we’ve seen - listen, I've seen my sales guys sit in the room the overall within the arms length at me, so I can - don’t sell something but we all believe that. I mean I’ve got Justin, and I've got Don, and I've got Munro, and I have got others in here, Jesse all the guys are responsible that’s you are saying we are all on the same page, we’re not making it up, we are seeing it and our customers are telling us this. And we are not just coming up when it's not a hope, it’s what we are seeing in the field every day.
And my second question is regarding your R&D spend in the quarter, it's up about $2 million year-over-year, is that people or trials or can you just give us some color what that is?
Yes, I am going to let Bernard comment on that. Bernard?
And that it is – it's following on from the additions that we made through our R&D group in Q3 and Q4 of 2016, sorry 2015 and the spend is actually in line with what we had guide us at the start of the year. We have a number of projects that are – that we need to complete, those new products to be launched in the back half of 2016.
So there is a big effort on there and we felt that we needed to make that investment in headcount and at the backend of last year to deliver on those projects.
I think there is some additional expenses in there for the trials too, there is some expense for that as well. And there can we - as we put the some of the regulatory expenses that are in the R&D budget and with prices the things we have been doing in Canada and in Australia. So there are several places, but I think the key takeaway is essentially on our budget lines, is that correct, Bernard.
Yes, it’s in line with where we would have forecast for the full year 2015, we were about 7.5% from a tracking 7.6% of revenues right now.
Okay. Thank you.
Thank you. Our next question comes from the line of Marcos Rodriguez from [Merit] [ph]. Your line is open.
Good afternoon, guys. Thank you for taking my questions. One real quick a clarification on a prior question with the kind of the volatility you might backed in the second half of the year, based on the integration aspect. You still on a number 1 million to 1.5 million, I just wanted to make sure that number is actually going to be stripped out of your pro forma EPS numbers, is that correct, or is that going to be part of it?
It's part of it. Now we had forecast this on our model that actually got us to neutral on a earning basis when we actually spoke about to find initially, but it's just the timing of those expenses. So again as I said it sales meeting expenses, it having people help us transition the business firm to find in to Merit. So you’re going to see slightly higher level of expense in Q3 for that, rather than in Q4 but overall it will be neutral on the earnings basis for 2016.
And so that I could also make it clear, so no one misunderstands. We are restructuring this business. We are repairing employees, services. We’re consolidating the duplication in the Salt Lake City and all of those sorts of things. We figure and our plan as we put together that would take us about six months, probably some of that will fall out, some of its little early, some of them will be little late, but all in all we should have all of that taking care of over the next six months.
And then as we start the next year, we will have that essentially that business in line with what Merit expenses are and then we’ll have the benefit of the gross margins and by that time we’ll also see acceleration on the revenue side, because of the more sales people, a broader international footprint and the back looks there is complementary products in, going back to the DFINE guidance.
They are having a great product line. I think by the way that's been confirmed over and over too many as I topped the position and some of the best treasury care centers in this country use this product. The problem is that, those guys didn’t have enough products to sell. We had a couple of product lines and so what we have done out put these group of products and that are all complementary to each other and we think that - with that and with core of a set, which is to buy, obviously profit going to the same point of sale we think this is going to be fastest growing division in the company for quite some time.
Got you, very helpful. Then last one question I have here on the inventory side on your balance sheet, have you guys been building any inventory to kind of capitalize on this Cook situation or there are other drivers there?
Well, a lot of it is been the raw materials that you have to build for the Cook situation. We have also launched the basic Touch 40, we’ve got the inventories that we're building for the core of set, the pulmonary balloons, I mean we have been building a stuff to launch these products and some we’ve launched in others, we’re building.
But Ron do you want to add anything - Ron Frost is our Chief Operating Officer, Ron do you want anything to that?
Sure, Fred. We do have inventory in Canada and Australia that we have stocked up as well as Russia. So that is on the books. So we can meet the increasing sales in those territories.
A – Fred Lampropoulos
Yes, and that's a very good point Ron, thanks for mentioning that. So in the past when we worked with a distributor, we would just fill those orders. Intended out by the way just as a point of interest, some of those orders were delivered in three weeks, and that was the standard.
So we have warehouses and customer service in both of those areas and we deliver on demand, and that's what you need to do, and that's why I mentioned that in our - at least in our Australian business that we've already hit the forecast for this year and in the - both of these businesses by the way are profitable and making money and that's kind of an interesting thing when you can start up and we're getting higher prices.
So if that business comes down the road, it offsets those additional expenses of distribution we have, we're going to see pretty very nice comparisons in terms of gross margins and contribution there. But what we have to do is, we've got a warehouse there, and it’s not kind of getting it there when they order it. We've started out and we have to send a long ways and I think one of the reasons why we're already at that point, just because we have the product. It's on the shelf customers can order it.
So yes the Cook was part of that, but the other thing is just having availability and I’d say that in Toronto or in Melbourne we have our own warehouses product down there, and it's more than it would have been if it was been distributed. So that's part of it.
Our inventory churns are also consistent. We're not seeing any spike in inventory churns and month-over-month when we compare it to 2015. So there's - it something that is managed very closely as we said there is inventory sitting in other warehouses, but we’re trying this at the same rate that we've been trying it for the last probably six to nine months.
I appreciate it guys.
Just one thing I would like to comment on before we finish. As we said, the DFINE acquisition will be neutral on a non-GAAP basis from an earnings perspective. From a GAAP perspective there will be an effect there based on all of the reorganization costs. And that's approximately $0.24 and that's not reflect us in the document that we issued. So I just want to make sure that people are clear on that.
And so we’ll have those expenses that you have to spend - the GAAP expense - onetime expense, those are added back in for non-GAAP and then we're done with them. So okay, I appreciate that clarification.
Well it looks like that's the end of the questions. We’ve kept you on here for an hour and we - one of the commitments we made is to try to keep it short and we haven't been able to do that, lot to talk about. I think if we look again in summary at what we've accomplished in this quarter and at the stage it sets for continued growth improvement in margins and profitability, clearly we're engaged, we're focused and we haven't lost sight of that three year plan, as we look at it, everything we look at and everything we talk about is this consistent with the ability to deliver that for your plan and how these other incremental things there to help improve the performance of the company.
So we've got a lot to do, there is a lot of exciting new products and that sort of thing coming forward I think we're going to see a lot of good things coming out of this restructuring, as I mentioned the guys in the different divisions can focus on the various products. I have a broader bag and I think a net-net of about 25 to 30 sales people.
So that's another thing I want to make clear is that that sales number has gone up. And that was we take this into the international markets and that was the thing I think very interesting to us is that was a very, very narrow footprint that DFINE had in terms of Europe essentially just being in - a little bit in United Kingdom and Austria and the bulk of their business.
But there are all of those other footprints that Merit has and the DFINE stability products are also approved in Canada. So as part of our salesman, we brought the Canadians down there as well.
So listen, there's a lot of work to do, there's a lot of momentum in the business and then you get these things like you have the situation that cost us certainly - is going to be a bigger opportunity here we would very I think conservative in this comments at the end of the first quarter. And we said we'd see how it would go, and we would come back and tell you after we've been out on the battlefield for a while and the report is, we’re winning the battle and that there is great opportunity going forward and we are going to retain the ground we captured.
So, ladies and gentlemen that's my report. Bernard and I will be here for a couple of hours if there is clarification and things that we can help with, we will be happy to answer questions. We appreciate you interest. We appreciate you taking your time, I know it’s a busy earning season.
So at 105 degrees in Salt Lake City, we're going to sign off but we will be here to answer questions for you. Thank you again for taking the time. We’ll sign off now. Wishing you all good evening from Salt Lake City. Good bye.
Ladies and gentlemen, thank you again for your participation in today’s conference. This now concludes the program and you may all disconnect this time. Everyone have a great day.
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