Merit Medical Systems, Inc.
Q3 2010 Earnings Call Transcript

Published: 5 Nov 2010

[Operator:]

Welcome to the Merit Medical third quarter 2010 earnings conference call. [Operator Instructions.] I will now turn the conference over to Fred Lampropoulos, Chairman and CEO. Please go ahead sir.

[Fred Lampropoulos:]

Good afternoon, ladies and gentlemen. This is Fred Lampropoulos. We are broadcasting from Salt Lake City. Assembled in our office here are members of our staff. We'd like to start our meeting by having Rashelle Perry, our general counsel, read our Safe Harbor provision. Rashelle?

[Rashelle Perry:]

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

[Fred Lampropoulos:]

Rashelle, thank you very much and good afternoon ladies and gentlemen. Our purpose today is to discuss with you the results of our third quarter as well as to give you an update on our acquisitions and our integration plans. Let's start first by talking about the results for the third quarter in terms of revenues. Our revenues were $73.2 million for the quarter, an increase of 10% over the revenues of $66.8 million a year ago. As we take a look at year-to-date, we're up 13.5% If we take a look at the first two quarters, which came in at 16% each, I think you would agree with me that a 10% growth rate is comparatively somewhat anemic for the third quarter. Now, why did we see this sales slowdown? Several reasons. Primarily, I believe it's the first time that we've seen a slowdown because of procedure rates. We just clearly had lower sales in various areas. There are several other reasons, however, that I think are important. With the acquisition of BioSphere, we spent a lot of time during the quarter planning integration. We had a lot of salespeople out in the field. We were doing a lot of training. So we were engaged in doing what was necessary to be done, and that is to integrate this business, and I will discuss that with you in a few moments. If we can move on just briefly to the issues regarding our performance, during the quarter we recorded the acquisition accounting cost of which you are all aware. These are one-time expenses that have to do with issues such as investment banking expenses, legal, accounting, severance, and so on and so forth. In the quarter, we took about a $2.2 million charge of these one-time expenses. It's important to note that we are mostly through with this. We had some of the expense in the second quarter, some in the third. We have about $400,000 of expense that we expect will come through in the fourth quarter, and this is for our carryover expense where we have a transition team on the ground in the Rockland facility in a Boston suburb. And this has to do with accounting and some sales and marketing and customer service and the severance associated with those folks to make sure that we have a smooth transition. I will talk further about that transition in a few moments. Now there's a charge here that I'm sure you're all very interested in, and that is a one-time charge that was taken for our Endotek endoscopy division. Let me explain that to you. Once a year, under accounting rules, we are required to take and value all assets. They could be research and development projects, they could be any expenditures, [molds], and certainly businesses, and they fall under the scrutiny of impairment test. The true test of impairment is cash flow. We have been operating in the endoscopy division, which we call Endotek, as a separate reporting unit. By that I mean they have their own sales force, they have their own marketing department, because they call on a different point of sale. And so consequently, our auditors came in. We looked and we evaluated, as prescribed by GAAP, at those various accounting units, and that unit is not profitable at this point. And so the question was, we sat down and did an entire forecast, took it out, put all the new products, and did some forecasting on that, but the net result was that based on the rules of the game, it was not just suggested but it was required that we take this one-time charge. Now there are a couple of things about that charge that are important for you to know, and many of you already know this. This is a non-cash expense. It is a one-time, it hits the income statement, and we offset it in the goodwill provision in terms of our key accounting. So Kent, I'm going to go ahead and let you comment on that, because I think it's important from an accounting point of view that everybody understands what we were required to do.

[Kent Stanger:]

I think you've covered it pretty well, Fred. It's just a matter of you have to value the present value of the cash flows of the business plus you do some external comparisons. And basically it's an appraisal of the business, and then once you have triggered an issue where you have a valuation that's greater than your carrying value then you have to revalue the whole group of assets and the net change occurred in the goodwill. So we had to then adjust our balance sheet to the carrying value or the current fair market value of this business, and therefore we had to write off the goodwill amount of the lower $8.3 million, which is the entire balance in that account.

[Fred Lampropoulos:]

When we acquired Alveolus, our goal was to build a third leg of our business in the G.I. or endoscopy business. The purpose for that is that we take a look at our business and look at the opportunities. We felt that we needed additional technology and additional sales avenues for growth in the future. But there were a couple of things that didn't go quite the way we expected. Let me share some of those with you. One of the things that we discovered for lack of a better word was that there were sales being made in areas that were questionable, and by that I mean there was a risk to the company that there were sales that were being made in off-brand uses. And Merit plays by the rules, and Merit is not going to go out and promote and do things which are illegal. This represented about $2 million worth of sales revenues, which we said we have to walk away from, because it was in an area that did not have an indication. And we did it. We didn't anticipate some of the fallout of that, but we didn't think it would be - because we didn't know what all those numbers were. I'll also say that since we made the acquisition we have essentially retooled the entire sales force there. If we look at the sales force there today, there's probably two or three of the best sales guys that we've had, but almost everybody else has turned over and we've hired additional people to put back in so they're essentially all Merit people now. And that was one of the issues. Another one was if you take a look at the non-vascular stent business, the largest single area there is biliary. And if you take a look at this business as some of you will recall, we had the esophageal, we had the tracheobronchial, and we had the biliary business. We were told by physicians as they did bench top demonstrations that the product was acceptable. However, when we went out in the field and actually performed procedures we found that it had some limitations and it wasn't competitive. So we have retooled. We have changed, and are moving in a different direction than we had anticipated. So consequently, we simply haven't had the revenues that would have come, and that we expected to come. So those are issues that we didn't anticipate. Now, let me talk to you about the other side of the coin, and that is this. We have done a number of things that we believe will lead to profitability in this division, and will help to build it. We've done several of these, which I note in our press release. One, we are tooling a number of products that we believe will have a significant difference. One of them is the inflation device called the "Big 60". Now, many of you know that Merit is the worldwide leader in inflation devices. We have tooled this device that can be used to inflate esophageal balloons and we believe that we will become the market leader in inflation devices for esophageal balloons in the next few years. We have a great product that's utilizing our core technology, and our capabilities and patented devices that as we've taken it to doctors it is going to be very well-accepted and we will launch that product in just the next few weeks. Interestingly enough, our [competitor's] product has a disposable and a reusable, and so we believe that we have a strategy - in fact in a recent account in talking to a physician they couldn't wait to get their hands on it, because it's so cumbersome for them to go find a reusable piece and a disposable piece. Oftentimes the reusable piece doesn't work. It's misplaced. This way it is one device, it's disposable, and so we're quite excited about it. We also will tell you today that we are going to release Merit's own bipolar probes. As part of the acquisition of our endoscopy division we acquired a small product line from Hydromer. It included a probe, which we're currently producing for OEM customers. That business has more than doubled in the last two years, and we have the major players in endoscopy who will buy that product from us. What we've done is now improve that product substantially, and believe that we have a product that is competitive with the market leader, and we are going to release that product under our own name. These products, both of which I mentioned, carry gross margins in the 65% range. Additionally, we have, and will introduce sometime in the late first, early second quarter, Merit's EnVue esophageal dilatation balloon. This is a three-stage balloon that we're very excited about. It has very reputable margins, again back up in the 65% range. It is used with this inflation device, is used with our guide wires, and so we believe now that we're building the foundation of a business strategy that can be launched worldwide. In addition to that product, we are introducing a new novel plastic biliary stent. Now, not a metal stent, but a plastic stent utilizing a unique technology that allows the endoscopist to be able to [inaudible] this product both endoscopically and fluoroscopically. I'm not going to go into any more detail on that, but as we're out on the road in the next few weeks at several conferences we will show you these products and I think it will become readily apparent to you of the advantages these products have. Additionally, we have some new stent products and maybe the biggest game-changer is that we're moving down the road for the introduction of the anti-reflux valve, which is delivered endoscopically in a stent that is a game-changer. The reason it's a game-changer is there's not any product that can perform like this and what it does for patients is extraordinary. Where they've had their valves that have been destroyed - they literally can't sleep. They have to sleep standing up or sitting up because of this reflux that comes from the stomach back into their throats. So we think this is a big deal. We did a license agreement with Vysera, and we're coming down the road and so we have that portfolio. So that's what we're doing to change the game here, is to introduce new products and to put our strategy together. And again, it's very unfortunate that we have to take this charge. It's not something that I was aware of until after we sat down and we went over it, and pronounced it, and looked at it, and it came to the table just in the last week or so and as we analyzed it, and then just recently met with our board to discuss it. It was necessary for us to take that charge in this quarter. So that's the story with Endotek, and I will field questions to that in a few moments. Let's go to BioSphere now. I think that on our BioSphere transaction it has been very successful. Let me tell you what we've done. In just less than two months, we've been able to negotiate with each of our distribution bodies in Europe. So we had a distributor in Ireland, the United Kingdom, the Netherlands, Germany, Belgium, and so on and so forth. In every case, we were able to go to them and work out a deal in which they would transfer their sales history, their pricing, their customer list. They would introduce us to their customers, and we wouldn't miss a beat. And in fact, I can attest to you that even this very day - most of these have just been finished in the last week - we're receiving orders now that are at retail, directly from those hospitals, and it's probably the most successful transition that I've ever seen, that allows us to build the rapport with physicians and to make sure that there is no discontinuation or loss of sales to our customers. And I've had probably 10 or 15 phone calls from our sales force. There's a new understanding and a new awareness of Merit in the marketplace, particularly in the IR market. And here's why

[Kent Stanger:]

We've had approximately $80 million of NOLs that we were able to carry forward and apply over the next 14 or so years in the U.S. and another little over a million dollars in France we should be able to utilize. So what that will do is benefit us in cash flow, because we'll be able to credit those NOLs against the payments we'd have to make to the government in the form of taxes. If you were to look at those in present value then back to the present and kind of cash value them in the present it would be at 5% about a little over $20 million in value for our cash flow benefit going forward.

[Fred Lampropoulos:]

So you always hope that you're going to get those, but this is over a 14-year period, but it is a huge cash flow item to us, and we think from at least our point of view, when we take a look at the cash that we got at close, and we take a look at this, it moves that value down to about $66 million, which is a couple times sales. Now another important thing to understand this quarter is that we only had the business reportable in the quarter for 20 days, and of course you didn't see much of the effect of that during that 20-day period. But going forward, at least in this quarter now, it will be the entire quarter that will have the benefit of the product. So we're very, very excited about that. A couple of other things relating to the BioSphere transaction. Again, the sales force has been trained. We kept a number of the salespeople from BioSphere. That's been integrated. If we go down and take a look at the office where they were located, we essentially have the office. Reduced the expense there immediately, and we've kept essentially all the people that are operating our facility in Roissy, France, which is a suburb of Paris. Kent and I were having a discussion just earlier today and I think the model that we now believe is that our gross margins, based on the fact that we're going to be able to have these retail and the growth that we expect, are going to be about 80%. I think in our initial model they were around 75%. So we're also seeing higher sales than the $25.7 million, or at least we anticipate that, that we had used in our modeling. And so we believe that we're going to see higher sales from our initial model. Now there is an issue on inventory, and another one of these pronouncements, these little accounting issues, that we have to deal with regarding inventory in that market. Kent, would you explain that to our listeners?

[Kent Stanger:]

The basic concept is when you purchase a business you can't buy profits, so you have to mark all of your assets, including inventories, to their fair market value in their current condition. That mostly affects finished goods. Finished goods, conceptually, are valued not at their cost of production but rather at their wholesale kind of price that a distributor would buy them. And it's a complicated calculation, but in theory that's kind of the application of the idea. So what you're doing is marking up, in our case, the finished goods at about $2.1 million of additional value of our purchase, which have to come through the income statement in the cost of goods sold. So we're estimating five, maybe six months' time it will take to roll those finished goods through the financial statement and therefore impact considerably our gross margins for that time. It's in the range of $450,000 a month we're figuring we're going to have to spend or use up that inventory that were in the finished goods. There's also some value added, only about $300,000 more, to the work in process that was over in France partway through their process.

[Fred Lampropoulos:]

So again, those were the rules of the game that we have to live by. So Kent, in terms of gross margins, once that inventory flows through, that $450,000, what would you expect it would do to our gross margins in the aggregate? Just on that one part. And the second part to that question is, over this four, five, six months, what affect will it have on us. So before and after. Could you just discuss that in your best guesstimate?

[Kent Stanger:]

The margins are going to be down in the 55% to 60% range I believe for the interim period. Now, carrying on beyond that, we also have to amortize the intangibles that are involved with the manufacturing, so even though our cost standards will be 82%, we're going to have a varying amount. It's $3.5 million down slightly, declining. But in addition it isn't in the cost standards because it's an amortization.

[Fred Lampropoulos:]

And again these are things that are just required that we have to do.

[Kent Stanger:]

There are fixed costs that will set that overall margin, and vary year to year.

[Fred Lampropoulos:]

So just a few more things on BioSphere. We were able to reach an agreement with the FDA in terms of some issues that we had on appeal for the study that we hope to do. This study, that has been proposed to the FDA, would be one that would, if we are successful, and if the outcome is successful, allow us to have the only indication for HCC on the planet. This is the use of taking our hepaspheres, quadraspheres, and loading them with doxorubicin. We expect that we will hear from the FDA on their conclusion of this issue by the 23rd or so of this month. So we have done all of the things that are necessary. The FDA did acquiesce on a number of issues, but we have to wait. There's no guarantee that they will approve this, and we will let you know how this all turns out sometime in the next couple of weeks. I think it's a big opportunity for us, and I am pleased with the steps we have taken and where we've brought it to at this point. Let me move on to another really important issue that we've been talking about for a long time, and that's China. We believe, and if you take a look at the data that's available in the marketplace - I'm looking at a recent study by Hewitt, and the source here is the International Business Observation, which currently ranks the United States as essentially the number-one marketplace in the world. But as we look down into 2020, ten years out, China will have come from tenth place worldwide, on the pharma and device side, to the number-two marketplace, passing Japan, Germany, France, Italy, Britain, Spain, Canada, Mexico, passing all those countries up and moving just behind the United States. This is a big deal, and Merit has spent a lot of money to set up our operation in Beijing. I'm pleased to report to you that in our first month of operation, the business was break-even while still providing profit for the products that were sold to Merit. So let me explain this to you. There's a price at which we transfer it over. We make a manufacturing profit, and then we have an expense over there for offices and personnel, and we make the sales. And with that differential, after we've taken a manufacturing profit, it's essentially at break-even the very first month. And in fact, in the second month, our sales went up by almost 50%, just short of 50% on a direct basis. Now I don't have the numbers in terms of what the second month would do, but I believe that we will see that that is going to be profitable in its second month of business. And that's an extraordinary effort. We also believe that as we look forward to next year that we could see our business grow in the 40% to 50% range going forward into 2011 in China. So it's going to provide higher gross margins, closer to our customers. We're making money there. And maybe something that's more important than all of this is that we now control the regulatory process. And by that I mean we have at least ten, maybe twenty products that are currently submitted. Right now we're only selling 20% of our portfolio of products in China. We believe that as we move through 2011 and 2012 that we'll have a much higher percent, probably closer to 70% of our products, or 75%, will be available for sale there. The fact that we control that, the fact that we can compete on bids, and as I mentioned to you before, in some cases the products that we're now just starting to sell, we're getting more than double the price than we were when we were going through the wholesale method. All the people who worked here in our warehousing and facilities, and particularly Joe Wright, in overseeing this and managing this, did a terrific job. But it includes accounting, ops, facilities, transportation, all the guys that did this, just did a tremendous job. And we believe that China has huge opportunities. Let me remind you that China is also the largest market in the world for HCC. The largest market in the world. Over 50% of the new cases reported are from China. Markets like Japan and particularly Korea are also exciting. So Merit has a foothold in Asia, and we are looking West to that opportunity because we think it's huge. It's going to have a big effect on our operations, profits, and certainly on sales as we go forward. So those are the things that we want to share with you. Just a few more things on the sales side. One of the things that we've thought, and you can see in the base of the information that we've provided to you, is that our kits and trays were very, very strong. This is really an issue relative to some missteps by a competitor. And clearly that, as you all know, is a lower margin business. So we didn't see an improvement in our gross margins. Part of that has to do with mix. You'll also notice that if we take out that OEM customer, then our inflation devices grew at 9%. So there were areas of opportunity and hope and performance that we're very pleased about going forward. Also, as we mentioned in our release here, we have released the ASAP catheter in Europe. We've already received orders from it. After doing our trials in Europe I can say to you that in every single trial every physician that used our products said that it was equal to, or better than, the competition. And so we're very excited about that product. It is currently in the FDA, and we're awaiting approval there. Of course, when we receive that we will go ahead and let you know. So Kent, I think that pretty well wraps it up. We talked about the quarter, the sales, which again were a little bit soft, but by the way I should mention that we had guided to and said "guys, we're coming into the summer quarter." We did see, and I'm happy to share this with you, that in October we had the second largest month in the company's history. And we were essentially at forecast. So I think that portends that even though we saw that slower third quarter, we're seeing - I guess I could call it a rebound - that we're hitting the numbers that we had projected in our overall forecast. So I'm pleased with that. So I think with that said, that's about a half an hour, that's the best way that we can explain it. Now what we'll do is turn the time over to you to ask questions. And so to our operator we'll go ahead and turn the time over and we'll go ahead and let you field the calls for us and put them forward.

[Operator:]

Thank you sir. And ladies and gentlemen, at this time we will begin our question and answer session. [Operator Instructions.] Our first question is from the line of Larry Solow – CJS Securities. Please go ahead.

[Larry Solow:]

You talked about the customized kits market, and without mentioning the competitor's name but I know you brought it up last quarter as well, I think you had mentioned that you thought there was like $15 million to $20 million in potential sales that were up for grabs. Any update on that and the dynamics in the market? And has this competitor now seemed to right the ship a little bit?

[Fred Lampropoulos:]

We still believe that that opportunity was available and that we in fact captured on a ramp basis going forward, some of which by the way is just starting delivery. So some of those deliveries are just being made, where we were supplying small amounts, or they were scrambling, and we believe that that's the annual income that came out of that going forward. So that hasn't changed, and we've kept most of that business. I'm not aware that we've lost that business. So we have kept that. I think things have stabilized there however, where we're not seeing all the opportunities. I'm looking at one of my ops guys. Ron are they still showing up? Or has it settled down?

[Ron:]

Settled down quite a bit, but they're still showing up.

[Fred Lampropoulos:]

Okay, so we get them from time to time, but it's not like - remember now if you take a look at our inventory you'll see that there were some jumps in our inventory because we had to make sure we had the supplies to build this stuff going forward. So it's settled down. There's still a few opportunities that popped up, and I think we've been able to maintain and retain the business and the opportunities that we captured here in the second quarter - late first and early second.

[Larry Solow:]

And then I know you had a number of recent new product introductions, a couple of highlighted products. Any update, maybe perhaps on specifically how the Laureate guide wire is doing? I know it's sort of early in the game, but maybe anecdotal evidence?

[Fred Lampropoulos:]

I still absolutely feel that the Laureate guide wire is best in class. I can tell you that we have a pretty substantial competitor, actually the market leader. And at a recent trade show we were surrounded, and by that I mean they had every one of their engineers over there watching and looking and it was actually quite flattering. There's a reason why nobody's been able to compete for 25 years, and that is this is not easy stuff to do. And so we've had some struggles ramping up. We are in fact more than doubling our manufacturing space in the wire capacity in Ireland as we speak. That will be online by the end of the year. And we're trying to set up the entire portfolio, because there are 150s, 180s, 260s, and then there are .018s, .025s, .035s, and .038s. But here is the most, I think, revealing, and that is the reorder rate. Once those people buy the products, the orders just keep coming. In all candor, what we need to do to take full advantage of this is to make sure that we can offer the entire product line. And I don't have that all on the shelf yet. I'm still opening up new accounts every day. I still believe that it represents a $50 million to $70 million opportunity for the company. That has not changed, but I would also say that we've had a few struggles in terms of trying to meet the capacity. In fact the essence of it is that we're selling everything that we can make, and I think that's the best evidence that’s possible.

[Larry Solow:]

And would you see the opportunity as sort of a three- to five-year type of horizon, or -

[Fred Lampropoulos:]

You'll see this business grow at 35%, 50%, 60% per year for the next several years. When we dig in, though, just like we did on this manifold business, stuff that you talked about earlier. We've been in the business for 23 years. It took us 23 years to become an equal player in terms of volume in that one segment. So just like this wire business, and I'm an old infantry officer, if we're going to fight the war we're going to fight it for 100 years. So three to five years we will see the steady growth, so I think we'll have $70 million in five years, no. Do I think we'll have $70 million in 10 years? The answer is yes.

[Larry Solow:]

And lastly, on BioSphere, you've had a few months to digest it, and I realize there are several moving parts, and I'm not sure if you care to comment, but I know initially you had thought it would be about $0.05 accretive in year one. Is that still sort of in the ballpark?

[Fred Lampropoulos:]

I think there were a couple of things that came out of that that are always interesting. You know, you put forth a plan, then you go out and you test that plan. There were a couple of things that I think that have adjusted. For instance, we ended up keeping more salespeople than we had anticipated. And the reason we kept them is we talked to their customers. Physicians calling us, saying, "We love our relationship with these guys. Please do whatever you can to keep them." And I think what we did is we - and I think we discussed this previously but let me share it again - we had eight salespeople that were in the Merit new hires this year. What we did is rather than hire those eight, we simply substituted keeping those people, and we didn't hire those other eight. But in terms of our expectation that I started with earlier, we expect that our sales will be larger than the base that we had anticipated. And we said that we would start at $25.7 million and that we would grow that by 10%. Although I can't give you the numbers today, when we come out with our 2011 forecast I will tell you that those numbers will be substantially higher than that base going forward. And then we had this other adjustment, where we had these retail issues, or these wholesale distributors, and we had talked about that. It's just that it was very, very successful. I think that we approached it correctly with those guys. We paid money to have that successful transition, but every single one of those guys was in agreement. And the reason was that it was going to terminate in six months and we gave them notice. Or we said "We can do this deal. We will help pay a certain amount of those sales if you will help us with this transition and share this. We can do it A, or we can do it B." And everybody chose B. Kent?

[Kent Stanger:]

We also eliminated a risk that was there for collecting the receivables. So we were able to offset our receivables against that money we would pay for the sales information, and not have that debt writeoff problem.

[Fred Lampropoulos:]

I think in terms of BioSphere to this point, it has met every one of my expectations, but it's not without challenge. There's a lot of work to be done there. But there's one other important thing. We've also started a new research and development project for a new embolic that we can do with our existing personnel and our existing facility, that we think is going to create a substantial surprise for many of our competitors. I won't go into what that embolic is, but I will simply just tell you that the project has been initiated and other than some manufacturing equipment and that sort of thing we can do it within the confines of our present facility. So we're excited about the fact that for the first time in many years we've started a new research and development project that we think can have an impact on this whole business as it pertains to embolic materials.

[Operator:]

Our next question is from the line of Drew Jones with Stephens Inc. Please go ahead.

[Drew Jones:]

A couple of questions on BioSphere. First, what was the revenue run rate for the full quarter for BioSphere, July, August, September. And then secondly, as we think about the sales force, the existing Merit sales force and the guys you brought over from BioSphere, can you quantify the sales days lost in training the Merit reps on the BioSphere product and vice versa, training the BioSphere reps on the Merit products?

[Fred Lampropoulos:]

Let me do the best I can. As you'll recall, I said that we had about 20 days, and in that 20 days I believe that we did $1.5 million, in that first 20 days. So that's the best information I can give you. That would put you, if you took that at two thirds, you'd be at about $2.25 million, something like that. About $7 million. So if you took $7 million, that would start it out at $28 million versus the $25.7 million that we had indicated we had used as the starting number. We'll do better than the $28 million. We'll do substantially better than that number in my view, and that can be as much as $30 million or more. And I expect - again, we're going through the forecasting, but if you take a look at that, let's just use $30 million, that's going to be almost 20% higher than the base number that we had originally used as our starting number. And I think it's going to be even better than that. I'll give you an example of the situation. We recently received an order from Russia, and I think that order was for $300,000. The exciting part about it was it was our existing American distributor. They had won a tender, knowing that we were going to bring this product on, and our sales at this point have already tripled from what we were doing in Russia, just simply because of the presence we have there and that relationship. So those types of things are happening. There's places like South Africa, lots of places where we see great opportunity for the growth of our embolic materials, our BioSphere products. Now to the question of the days lost, this week I've got half of my sales force being trained on the East Coast. I have another group being trained here in Salt Lake City, half of it next week. And we've probably gone through three or four of these types of trainings. So I would say we've probably lost, to the best of my ability to quantify it, a month of time over the last four months training everybody. So they've been out of the field substantially, but listen, this is complicated stuff. You know, understanding the anatomy, understanding the chemistry, understanding the mixing, understanding all the parts of this. This is not easy stuff. But, I think they've been invigorated, I think that they're well-trained. But it took time and it took money to do that. That's a third of the quarter, plus on top of that you have summer, plus all the problems we had in Europe with - we're all familiar with all the issues going on and the disruptions that took place in Europe over the last several months. So those are some of the things that affected, I think, overall, and that's my best guesstimate of the amount of time that our people were out of the field.

[Drew Jones:]

Okay, and then just a quick one for Kent. Can you quantify what the mark-up of the BioSphere inventory - how much that impacted you in the third quarter? And then secondly, how much was amortization of intangibles total for the third quarter?

[Kent Stanger:]

I know the September mark-up inventory that came through was $117,000. And the amortization - we had about $80,000 in SG&A and we would have about $220,000 for the cost of sales.

[Operator:]

And our next question is from the line of Jayson Bedford with Raymond James. Please go ahead.

[Jayson Bedford:]

I can't do the math quick enough here on the $220,000 cost of goods sold. Can you give us the gross margin on the base business in the quarter?

[Fred Lampropoulos:]

On the overall business, taking out the BioSphere?

[Jayson Bedford:]

Right, breaking out the mark-up in inventory, taking out the amortization, the $220,000 that you mentioned. I'm just trying to get a -

[Fred Lampropoulos:]

Here's what I think is best to do. We're sitting here and people are scribbling stuff. As soon as this call is over we'll call you. We'll have the number for you, because I don't want to just speculate. We'll work it out and we'll call you, just as soon as this is over.

[Jayson Bedford:]

Okay, but the point I guess is the gross margin on the base business was higher than the 42 7.

[Fred Lampropoulos:]

That's correct.

[Jayson Bedford:]

Just in terms of the top line - you saw some weakness or deceleration in catheter sales, and it seems like it's been a great grower for a long time. I'm just wondering what was the dynamic you saw on the quarter. Any comment on either competition or pricing in any way?

[Fred Lampropoulos:]

I don't think it was on pricing. I think some of it had to do with the transfers, where we have distributors that we sell a lot of product to. Like for instance in China? So they buy it in a bolus and we deliver it. In this case it's going to our warehouse and we're selling a number of products, so that's part of it. You see what I'm saying? In other words we have ABC Distributor. They order 100,000 catheters. You deliver those catheters. If we send it to our warehouse and they go out to different hospitals, you're not going to have the volume number because they're going out individually versus that large single sale. And there's still a transition between what we had sold the previous quarter that some of our distributors, knowing we were going to direct bought, and the part that - so there's still a mix between some of the distributors that we're holding over in China and are direct. And I would say that the first month it was 50-50, and it's probably 75-25. And we'll still continue to provide some of these products until we get it fully turned over in the next several months. But here are some things that I think are important that go to your question. Because I think most of those are not pricing. Look in the catheter section [inaudible] and we look for the quarter and look at things like, for instance, our pericardial centesis, up 30%. If we take look at our impress catheters, up 64%. If you take a look at our centesis, up 22%. So most of this if we look at the decline in catheters, for instance there's a multi-pack in which - that was down. It's a relatively small number. But there are some subtracts that came out of this but the base, core business of the new product, the sheath business grew at 37%. So many of these things are still growing, but I think it was really that transition between wholesale and direct in a bolus versus dribbling them out to individual customers.

[Jayson Bedford:]

And it sounds like from your comments there it's more international than domestic.

[Fred Lampropoulos:]

I think that's absolutely true. There were some issues, for instance - I'll give you another one. I won't mention the names, but we had one customer, they were on credit hold, and we had a whole bunch of catheters. We didn't ship them until they paid us. We're not going to book a sale, and then create a liability or an expense on the other side of it. They have to pay for them. And so there's been some of those issues that continue to dribble through. Some from Europe and some from South America.

[Jayson Bedford:]

Any way you can comment just on U.S. growth versus international growth in the quarter?

[Fred Lampropoulos:]

You know, I can tell you this, anecdotally. The U.S. sales group, I think overall was up about 16% or 18%, so even though they had this time off, they're sitting kind of high on the hog, and the domestic market has done very well. Where we've seen a slowdown this year is in a couple of areas, and one I want to mention, and I'm glad you raised this. One of them is of course with the dealers and distributors in Europe. That is essentially the - there's two groups that have been lower in sales this year. That's one of them. The second one is in our MCTec division, and this is our [coating] division that's over in the Netherlands. And in the third quarter versus last year it was down $700,000. That's pretty significant. And part of that has to do with a number of issues that I won't go into right now. We think we have straightened that ship and we understand it was more of a competitive issue and a new player coming into the market. That being said, that's a pretty significant decline in that one little business segment, about $700,000 in the quarter.

[Jayson Bedford:]

MCTec is in the standalone bucket? Is that right?

[Fred Lampropoulos:]

Yep.

[Jayson Bedford:]

And that contributed to the deceleration?

[Fred Lampropoulos:]

That's in the standalone bucket.

[Jayson Bedford:]

Okay, and just can you comment maybe on snare sales in the quarter?

[Fred Lampropoulos:]

Now, I want to preface that by a couple of things. You'll recall that in the first quarter and second quarter we made deliveries to an OEM customer. In the third quarter our sales were about $1.7 million or $1.8 million versus a couple of million dollars in each of the first two quarters. But if you back out that OEM customer, it's about flat. Now, one thing I will say, and we'll talk about this at our conferences, but I will disclose to you that Merit is also developing a new snare. Not a replacement snare, but a new snare that we hope to introduce sometime in mid-2011 that is going to be a very, very exciting opportunity that we believe is going to propel Merit as the market leader. So we're about even right now with one other player that was recently acquired by Covidien, but we have a great new product that is an adjunct to what we have, addressing a different part of the market, and that product will be introduced. And so if we were sitting here a year from now, we're going to be the market leader in snares.

[Jayson Bedford:]

Fair enough. I'll just ask a last couple, and then I'll get back in queue. In the $0.19 in adjusted EPS, was there any dilution from BioSphere and then also what was the assumed tax rate in that $0.19 number?

[Fred Lampropoulos:]

I'm going to let you, Greg, talk about the tax, and then I'm going to try to understand what you mean by dilution. So Greg do you want to talk about -

[Greg:]

Just use the 38% tax rate for the non-GAAP disclosure stuff that we did.

[Jayson Bedford:]

And then Fred, just in terms of my question, it's more was BioSphere unprofitable in the quarter, and did that drag down on that $0.19 number?

[Fred Lampropoulos:]

You know, again, we only had that 20 days, and I don't have the numbers in front of me, but Jayson I will look at that. But I think we did have some discussion about this. I don't think it was - we thought it was break-even, guys, is that correct?

[Kent Stanger:]

Well, it's speculation in the sense that we don't have separate financial statements for this product. We've integrated it fully into our same sales force and so to allocate what the sales costs were by product and stuff, unlike the Endotek division, for example, that has it separated, this isn't. So it's not easy to just say what it was. It doesn't have separate financial statements.

[Fred Lampropoulos:]

So we've integrated. We've integrated with the sales force, we've got the manufacturing facility. Again, operating at those gross margins. That was clearly profitable, because it's operating at 65% gross margins, and that's just that standalone part. So we'll do some work on that Jayson, and be able to address it, but it is a difficult thing because we don't have separate financial statements for it anymore.

[Operator:]

Our next question is from the line of James Sidoti with Sidoti & Co. Please go ahead.

[James Sidoti:]

Now Fred, I think that the big question is you're taking a charge tonight, a $5 million charge, it's about 40% of what you paid for Alveolus back in February of 2009. But you sound very confident about this BioSphere deal. What gives you that confidence that we won't be here a year and a half from now taking a charge on BioSphere?

[Fred Lampropoulos:]

It's a good question. First of all, it's immediately rolled up into Merit and it will never be considered a standalone operation. It doesn't fall under the same scrutiny as the Alveolus or the Endotek division. So from an accounting point of view, it's rolled up into Merit and you won't see that. There could be specific assets, but it's just treated differently because it's part of the mother Merit versus a standalone division. Let me also talk about the revenues. If we take a look at the difference between the two, as you'll recall in looking at BioSphere, in 2009 they had revenues of about $30 million. These are products that are the gold standard. These are products that have been in the marketplace with an existing customer base. On the other side of the coin, on the Alveolus side, remember we had the biliary stent that had not been introduced, which was if you take a look at the markets the larger part of that. So Jim, I can sit here and tell you that my sales guys are excited about BioSphere products, what it means to guide wires, microcatheters, kits, trays, needles, all of those sorts of things. We have the gold standard on that side of the business, and we're already exceeding the revenue base that we had used - at least our belief is that we'll exceed substantially the revenue base that we used our modeling. That was not the case where we did not do that because of the reasons I spelled out, of not selling into bariatric markets, and the difficulty introducing on the other side over at the Alveolus or the Endotek division. So they really are two different beasts. Kent, do you want to comment on that?

[Kent Stanger:]

There's another major difference, Jim, and that is that we integrated this into our business, meaning that we have synergies where we can eliminate SG&A expenses. So those guys weren't far from being profitable. They were losing a little bit, but we're able to eliminate a lot of the costs and it's easier to integrate and financially less risky than a whole new enterprise with its own separate sales force that we knew would lose money in the first part of it and that's been delayed some. So it's not at all the same in many respects.

[Fred Lampropoulos:]

That's a great point, Kent, and again, just to amplify that, again this has been integrated. They weren't making money, but most of that was below the line because of their SG&A costs, and the publically held company costs. Where on the other side, you have a distinct sales force that you have to have because it's calling on a whole different point of sale. So they're just two different beasts.

[James Sidoti:]

So unlike Alveolus, with this one, point of sale is similar to the point of sale you have for your current products?

[Fred Lampropoulos:]

That's correct. And that's why when Jayson asked the question, that's why we said that it's just integrated. We can look at the sales, but remember that salesperson that's carrying that bag, that's carrying that product, is carrying all of our other stuff too.

[James Sidoti:]

Okay. Now the $450,000 charge per month for the markup on the inventory, is that a tax number, or pre-tax number?

[Kent Stanger:]

Pre-tax. The gross margin effect.

[James Sidoti:]

Okay. So about $0.03 a share for the next two quarters?

[Kent Stanger:]

It will be one quarter mostly, and then it will have partial in the first quarter.

[James Sidoti:]

Okay. And then the fact that you are taking the charge now to write down the $5.2 million, will that be a positive on your GAAP number going forward, because you won't be depreciating that over time?

[Fred Lampropoulos:]

No. It was in goodwill. We don't depreciate goodwill.

[James Sidoti:]

Okay, so you wouldn't have depreciated -

[Fred Lampropoulos:]

But I like your idea, Jim. I like your idea a lot. [Laughter.]

[Kent Stanger:]

The old rules it used to amortize, but now it doesn't. It sits there until you do this kind of a review and then it adjusts.

[Fred Lampropoulos:]

And by the way, we did just a little bit of research. About a third of all publically traded companies take an impairment charge or have taken them. So we don't like it. I don't like it at all, Jim, but it's just one of those things that these are the rules of the game. It's like marking up of inventory cost. I don't like the fact that we can't take those profits, but you can't buy profit. So these are the rules that the guys spell out. We're just trying to live by them. And I think on this subject, you may not like these things. I don't like them, but I will tell you this, that if you take a look at Merit's balance sheet, you take a look at the things that we've done, we have a clean balance sheet. When I say clean, everything's straight up. I'll tell you another thing we did. I'll just be straight up with you. In this quarter I also took another $250,000 charge. [inaudible] We had developed a bunch of products and we hoped to go out there and we hoped to be able to compete with AngioDynamics and with DiaMed and these guys. We had a great products. Unfortunately there were these legal issues that jumped up [inaudible]. All that stuff jumped up. And so we have a product that we can't sell until those patents expire. And so the same impairment test came up, and we looked at it and said okay, this asset is impaired. And we did what you should do. It hit the quarter. So we do these things all the time to look at any tooling, any capital equipment and things that aren't being utilized shouldn't be held on the balance sheet and not written off. And so we do the right things.

[James Sidoti:]

Okay, and then as far as the NOLs go, Kent. How will that work? Will you still be reporting fully taxed earnings and then you just won't pay it?

[Kent Stanger:]

So those are earnings that have already been expensed on the income statements previously, but they have a cash value. When you go to pay your taxes you can offset your tax payments with it. So it becomes an asset on our balance sheet that we sort of amortize or apply to as we can through the limitations over those years. And so when we go to pay the taxes we can pay less than what our expense was on the income statement for our current earnings.

[Fred Lampropoulos:]

But it doesn't flow through the income statement. It's a balance sheet item, and we just take it, but it's $20 million real dollars.

[James Sidoti:]

But you'll still be reporting your tax rate in the mid-30s.

[Kent Stanger:]

That's right.

[Operator:]

And our next question is from the line of Ross Taylor with CL King. Please go ahead.

[Ross Taylor:]

I had a couple of questions left. First of all, if you look at inflation devices, if you exclude the impact from that big OEM customer, where are you getting the growth in inflation devices from? I know you're partnered with [inaudible] if you could talk about where the growth might be coming from.

[Fred Lampropoulos:]

There's some coming there, although that's still in its early stages, and there will be more growth coming there. I think another part of it is that we talked about earlier today the fact that we had a customer, or a competitor that couldn't deliver, with the kits and trays? They also make an inflation device for a large medical device company located in the Boston area. And they couldn't deliver and Merit picked that business up. You will continue to see, by the way, growth in this market on the top line because now we're getting twice the price, or a premium price, from where our inflation device was sold before because of China. So it will show up as revenue. It will show up as gross margins, but there won't be any - and you will see unit growth. So you will start to see - and you'll also see the Big 60 - so you will start to see - and it wouldn't surprise me if we weren't back in the double-digit range of growth in that because of the reasons I just spelled out. Where it's been 2-3% or 5%, you may well see it back in double digits.

[Kent Stanger:]

Before, what Fred's was saying, the kits were up 14%, and that would be whether it sold to an OEM or whether it sold with a combination of other stuff that we have that we put in with it. So that and our Basix were particularly strong this quarter.

[Fred Lampropoulos:]

And that's - you know, we're the best on the planet on that stuff, so it's nice to have this new Big 60. That's going to be a big opportunity. We have lots of big opportunities. We just have to deliver. We've got a bunch of work to do out here.

[Ross Taylor:]

And what's the timing of the Big 60 launch again?

[Fred Lampropoulos:]

We're actually going to have product out of the sterilizer in about 2.5 to 3 weeks, and we will try to get out - I'm going to just say January 1, just because as we get close to Christmas it's difficult. But it's imminent.

[Ross Taylor:]

Okay, and next question. You talked about some rebound in your business in October, and can you talk at all about what you think the catalyst for that might be? Is it because of the integration and training are over, people are more focused? Has the market gotten a little better?

[Fred Lampropoulos:]

We're still doing training, but I think people are going back to work. One of the thing again that everybody just has to remember, and we see this every year, and that is doctors go on vacation and patients you're going to see a lot of volume as you get into the winter months, just simply because you'll see higher usage then. So people go on vacations, you had disruptions in France, you had disruptions in Greece. We saw all those things going on and that affects the sales of some of these products. But it's more of a seasonal issue than anything else. People are back to work, kids are back to school, and there are more procedures being done.

[Ross Taylor:]

And last question, it's probably too early to really tell, but are you seeing any benefit from BioSphere pulling through sales of some of your other Merit products?

[Fred Lampropoulos:]

I actually commented on that earlier, but let me come back because it's really an important thing. I think the biggest intangible of this whole thing, this transaction, which I'm still very, very positive about. Again, I think Kent pointed out that when we talked about the Alveolus we were right up front and said that we were going to have a dilution of $0.05 to $0.08 in the first year. We hoped to be cash flow positive in the second year, which is this year, and we haven't made that. But as we take a look at this particular situation we said we would be cash flow positive in the very first year and I think we'll exceed that. My personal view is what that will add to Merit will be better than we thought, simply because the base of sales, what we've been able to maintain. And I mentioned this issue in Russia, and all the things that are going on with Europe, we'll see higher sales there. But what the real issue is - listen I was at the show in Valencia, Spain, the CIRCE, which is the large European radiology meeting. For the first time in the history of our company, our booth was swamped, busy, and they're all physicians. I'll give you an example of one. I'm sitting there with a guy that I've met that's one of our big customers for spheres in Sao Paolo. And the guy was sitting there looking at this and saying "I didn't know you guys had all this stuff. Why isn't somebody calling on me?" So the relationship that I have, even me personally, with some of the largest and most influential opinion leaders in the world are relationships I haven't had before. So we will see a lot of fruit but that's anecdotal at this point. But I'm hearing it from my sales force. I mentioned earlier that I've had at least 15 calls. I had one this morning. I had one yesterday, where my sales guys are telling me "when I go in the lab, we're viewed as guys that are helping these guys, where many of our competitors are actually looked at as 'well, they're in here selling me one thing, but the patients are going over to the vascular surgeons.'" IR docs, which is where our primary emphasis is in these products, are thrilled that we're there because we're helping them build their business. We're attending community health talks. We are sponsoring symposia. We are going to trade shows. We're advertising to them. We're doing things that bring them patients. And like any of us, we love the farmer because he brings us food, and that's who we are in this transaction. So we're building that relationship and that rapport and I think it's going to have tremendous benefits going forward. Just terrific, because these are the guys who buy Laureates, the guys that buy vascular access, the guys that buy catheters. They're the guys that buy microcatheters and aspiration catheters. The doctors buy those things, not their staff. Doctors buy them, and those relationships are going to have a big effect on us going forward. They buy snares as well. You don't sell those to the technicians. Doctors buy these products. And that's a big shift in the way things were done in the past. I don't apologize for the past, but we are in this transition and it's going to affect us positively.

[Operator:]

[Operator Instructions.] And our next question is from the line of Gregory Macosko with Lord Abbett. Please go ahead.

[Gregory Macosko:]

Just with regard to the Endotek and the Alveolus, you've put in some new products. What is left from Alveolus in terms of products, etc. Is there anything left there?

[Fred Lampropoulos:]

Yeah, of course. It's a good question. They have the esophageal stent. They have what is considered to be the best airway stent in the world. We were at the CHEST meeting this last week in Vancouver, where the AERO stents are considered to be the best in the world, and they still have the basic design and delivery system for the biliary stents. So those are the things that we bought. We bought three stent platforms

[Gregory Macosko:]

And then with regard to October, it sounds as if you said you're back to plan, or it's a bit of a rebound. It doesn't sound like it's necessarily procedure-related. You basically are saying, and we've heard it from others, that the procedure growth has slowed across the board in a lot of companies. And so I guess what you're saying with regard to October from that standpoint it hasn't changed that much?

[Fred Lampropoulos:]

We are at plan, essentially with our base business. This is when we take the other stuff out. So I'm just talking about Merit's base business ex the BioSphere. We're essentially at plan for October.

[Kent Stanger:]

But I will say, Greg, that we're not immune to this change in procedure rate, because that's how our products are used and have to be replaced at that rate. So we felt like there was probably some of that effect in the summer that's made this quarter a little slow that we're reporting on.

[Gregory Macosko:]

And then finally, just so I understand, and I'm sure it's very simple, but the goodwill charge on the P&L is $8.3 million, and you took $5.2 million. What is the difference?

[Fred Lampropoulos:]

One is pre- and one is after tax.

[Gregory Macosko:]

Oh, so the $5.2 million is after tax.

[Kent Stanger:]

When you figure EPS you use the after tax.

[Fred Lampropoulos:]

So I think we've talked about how we've tried to take it down to the after-tax effect.

[Operator:]

And Mr. Lampropoulos, there are no further questions at this time. Please continue with any closing remarks you may have.

[Fred Lampropoulos:]

Well, ladies and gentlemen, we appreciate the questions. They're difficult questions, in a complex business environment. When you have these transactions they raise a lot of these issues, whether they be the markup of inventory, the associated one-time costs. All these things are relatively new things for Merit. But fundamentally, if we go back and take a look at the BioSphere, which is the largest transaction we've ever made, I'm absolutely confident in our ability to become not just the gold standard we are on the Embosphere, but on the HCC side and other embolic materials going forward sold at our same point of sale I'm as confident as I ever have been, in fact more so, that we have integrated, and again I want to close by saying look, we've done the facility. We've started research and development. We've closed down or we have modified the issues relative to size. We have taken out all the publically held costs and accounting and all those things have all been concluded, and we've been doing the training. And we've done this essentially over the last couple of months. And whether it be IT, customer service - fully transferred. Listen, the day we closed the transfer, this transaction, which was I think on a Thursday or Friday, Monday morning we were shipping product from Salt Lake City to customers. We didn't miss a beat.

[Kent Stanger:]

We just did that in Europe too.

[Fred Lampropoulos:]

And we just did that and moved it from the Paris manufacturing facility to our customer service facility where we're now shipping our product in [inaudible]. So I think that we have done - and people in this room, and I said this before we broadcasted today, have worked extraordinarily hard. They've done a great job of I think a very difficult transaction. And we've done that. Now, have we made mistakes? Has everything worked out the way that it should have? No. Or I wanted it to? No. Do we give up? No. I remember just a few years ago I was criticized because we made a business decision to start up in Richmond, and I don't want to sound like sour grapes, but gee, we're making $600,000 a month down there now. I never hear a word about it. Why was it successful? Because we didn't give up. And we're not going to give up. We're going to make our businesses profitable. We're going to work on them. We're going to integrate them, and these products are going to be sold worldwide. So we're a bunch of tough cookies out here. At the same time, we understand that we can be criticized. We understand that we are fallible, that we are going to make errors. But on the fundamental issues of our business, the embolic materials is a great strategy in my view, and I believe that it's bearing fruit already. If we take a look at the endoscopy area, it hasn't turned out exactly the way I wanted it to, but I can look at three business segments in this room and think about, for instance, Ireland, when it wasn't successful. Richmond, when it wasn't successful. MCTec, when it wasn't successful, and sensors, when they weren't successful, and they are all successful businesses today, even MCTec, who's had a little bit of a pullback, is profitable, despite their sales being down $700,000. They're still profitable and making money. And we have a plan and we'll be back on course there. So I'm proud of the people in this room. Their hard work, their loyalty, and candidly, their brilliance. These are smart folks out here. So I know you probably get tired of listening to me and being the optimist and saying it's onward and upward, charge and all that kind of stuff. So this is what I have to say in closing, and we will do all the things we said, given the appropriate time, and we'll do even more. Now, I know, I'm going to get a call, the next time around, Fred, are we onward, are we upward and you still charge? And the answer is as long as I'm standing tall that's exactly what I'm going to do. So we've got a great business, great opportunities, great new pipelines, and I'm excited about our business, as excited as I ever have been. So thank you to everybody here. Thank you for your questions and your support as shareholders. We look forward to talking to you soon. Kent and I have four or five conferences in the next several weeks, so we'll see you in New York. Thanks everybody and good night. Copyright policy