Jul 31, 2013
Executives
Fred Lampropoulos - President and CEO Rashelle Perry - Chief Counsel Kent Stanger - CFO
Analysts
Tom Gunderson - Piper Jaffray Jim Sidoti - Sidoti & Company Michael Rich - Raymond James Chris Cooley - Stephens Greg Macosko - Lord Abbett Dale Detile - Boston Company
Operator
Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Merit Medical Systems Incorporated Second Quarter 2013 Earnings Call.
During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions.
(Operator Instructions). I would now like to turn the conference over Chairman and CEO, Fred Lampropoulos.
Please go ahead, sir.
Fred Lampropoulos
Good afternoon, ladies and gentlemen. This is Fred Lampropoulos.
We are assembled in Salt Lake City with our general staff. We appreciate you taking the time to visit with us today.
We have an exciting story to tell you but prior to that, we’re going to let our Chief Counsel read out the statement that you’re all excited to hear. Rashelle?
Rashelle Perry
Thank you, Fred. 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 historical may be 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 such statements.
Although Merit's financial statements are prepared in accordance with accounting principles which are generally accepted in United States, GAAP, Merit's management believes that certain non-GAAP financial measures provide investors with useful information regarding the underlying business trends and performance of Merit's ongoing operations. The table included in our release, which will be discussed on this call, sets forth supplemental financial data and corresponding reconciliations to GAAP financial statements.
Investors 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.
Fred Lampropoulos
Rashelle thank you very much. And again, ladies and gentlemen, thanks for joining us.
We are pleased to be able to report today what I believe to be significant improvements and a further explanation of our profitability plan going forward. One other thing that I will refer to, most of my discussion and comments today will be in relationship with the results of the first quarter.
And although we are required to compare quarter-to-quarter or year ago, I would remind all of you that there have been a lot of changes since that time. We’ve had the introduction of the Affordable Care Act and the tax, the 2.3% tax.
Merit has made the largest acquisition in its history. We have shutdown a facility, and we started up a brand new facility.
And so most of my comments will be made as to the first quarter, comparing those and then moving and talking about where we’re going to go from here. First thing I of course would like to point out is the substantial improvement in gross margins.
What we have discussed in the past is that we believe that Merit has an opportunity with the investments that we’ve made to be able to improve our gross margins approximately 60 basis points per quarter for the next six quarters or year and half. That’s a very, very aggressive prediction, so to speak.
That’s 360 basis points that we should be operating at by the end of 2014. Now, fortunately, this quarter we exceeded that.
I would remind everybody that you shouldn’t assume that we’ll do 140 basis points but that our plan is in place and we believe that we should see those opportunities. It will have to do with increased market share, product mix and just an overall reduction of expenses and new product introductions.
Then we’d like to move down to the SG&A expense line. Once again quarter-to-quarter from the first quarter down 220 basis points.
In just a moment, I’ll have Kent just briefly discuss some of the issues that were made in period oriented, like some of the expenses that were in SG&A that will now move to the gross margin side. But I’ll just make a couple more comments and then have Kent to discuss that.
R&D expense was down 90 basis points compared to the first quarter, and I think we’re able to do this, ladies and gentlemen, while reducing our inventory of $3 million. So let me talk about that just for a second.
While we were moving, shutting down a facility and making sure that we had no disruption to our customers, we still reduced inventory $3 million. We continue to believe that as we get leaner, as our automation goes into place, that there is even more opportunity to reduce these inventories as we grow our company.
So it will be one of the things that in terms of cash management, obsolescence and other issues that we feel comfortable about. The other reason I think it’s an important metric is that as we go back to last year and look that in the third and fourth quarter where Merit was building inventories actually for most of the year up until the third quarter, we disappointed shareholders when we have to slow production down because had much inventory.
And we have those negative variances for the fourth quarter, some of which carried over into the first quarter. Those variances are essentially gone.
So, Kent, what I would like you to do is just briefly comment on variances, where we came from in the first quarter and then maybe talk just briefly about the SG&A expense and any adjustments that we could see as we’ve moved into the new building and where they would be allocated. Would you comment on those please?
Kent Stanger
The first item just following up on what you said about the variances, with the slowdown in production in the fourth quarter and somewhat in this first couple of months of the first quarter, January and February, we were under utilizing our capacity. But as we’ve moved into March and following months up through the day, including this month of July, we’re doing much better at meeting the standard cost of flying overhead and actually exceeding in many places.
So that not only relieves the lag we have had on the negative variances, but we started to actually pick up some positive variances in some of our operations. And that's one of the biggest effects that was dragging us down, now has been relieved.
The other things that are going on has to do with the move. There is some inefficiencies in the lost productivity when you shut down a line, take those personnel and resources and move them into setting up and testing and re-qualifying a production line.
And while that non-productive gets reclassified the SG&A costs is not being used to build products. So for short time we have had some outside costs of a couple of hundred grand or so of actual moving people and the logistics of that.
And secondly we had a reclassification of $400,000 - $500,000 into SG&A, which will now be back into the cost of sales when you see the third quarter numbers.
Fred Lampropoulos
Kent, thank you very much for that explanation. Let's talk a little bit more about some ongoing expenses that we will have.
In shutting down of the facility we have essentially one more month of rent and that will be the month of August. After that point there would be reduction of expense of approximately $90,000 a month going forward, that will of course help to offset the increased cost of our new facility.
Kent you want to comment on that?
Kent Stanger
Yes I think some of those cost reductions not having to do security level, the cleaning, the maintenance; utilities are already dropping further, because we're out.
Fred Lampropoulos
So that will give us more momentum moving forward in terms of cost. We have a number of new systems, as some of you have been here and have seen some of the new automation systems where we don't have to truck materials.
They go directly from the molding area and other players to the replenishment center and right into production. We expect that we're going to see dramatic increases in productivity in our business and we will see substantial returns in the future as we move forward.
It is not going to happen overnight. The third quarter will still have some of the drag of this expense that Kent just discussed, that was in the second quarter for the full quarter.
Some of that will be relieved and be totally gone by the fourth quarter. We're also bringing this new fulfillment center online on or about August 15th.
And so we will have almost a quarter and a half of that expense and not the productivity. And it will take us some time to be able to work out the wrinkles there.
But by the time we get into the fourth quarter, then those should be pretty well worked out and then we'll start to see substantial increases we think in that productivity and the movement and candidly a lower headcount, because we won't need the people that have been doing the things in the past, that part would have been automated. So I think we're enthused about the campus and how we've been able to consolidate and let me just say that is wasn't easy.
We've been trying to move from our 45th facility where we started 25 years ago. But I want to commend the staff for the work that they did.
Literally we came in about $500,000 under budget, we came in five weeks earlier and we had no disruptions from customers. So that's a big deal, and I want to express again my appreciation to the staff.
Now let's move over if we could for a second to the sales side. I suppose if there could be a criticism, it would be on the sales.
If you take a look at our business, we had 9% business overall and we had some uptakes and some down takes, downdrafts so to speak. I am going to have Kent go through some of the ups and some of the downs, and then I will comment on the specifics of those.
Kent do you want to go ahead and discuss that?
Kent Stanger
Yes I mean some of the strong things that we've got; we can look at it as products or as geography.
Fred Lampropoulos
I would like to look at the departments that you looked earlier on that document.
Kent Stanger
So we have seen really strong growth in the international areas, for both the European distributors as well as some of the Pacific Rim and those areas. We are growth rates (inaudible).
So we've got growth rates outside the U.S. for example, the Pacific Rim type dealers, there is 18% growth, Japan is 10%, China, our direct sales is 28% growth, and as well as the European distributors are up and that will be 25%.
So the problem is we have had some downers as far as some of our core OEM business is off. The (Thai Fund) business is down significantly, it's off 84%, so that one we have been telling.
Fred Lampropoulos
That's just something that we expect to go away, but I would also say that we also provide for the project, they are building sensors and other products on that side. So just finish up with couple more Kent.
Kent Stanger
Those kinds of things have reduced and offset our growth, and so we have ended up with a slower than expected growth rate in the core business. Although we have got some new products both acquired and coming on that have been strong and look good in the future.
Fred Lampropoulos
And we have some very hot products. Our Hydrophilic guide wire, Laureate is up substantially 269% and I think in the quarter we're up $1.2 million in new growth are micro catheters.
All of these have relatively good margin products. A number of products are radio access products, as we start to see that shift.
So we're confident that what you are seeing is temporary. We'll see probably the same time of performance on the core business mostly coming out of United States which is the slowest area.
And let me remind you that as we move into this third quarter, it is our slowest quarter of the year, because of the seasonality, particularly the seasonality in these areas that have been the highest performance for us but we will see that typical slowdown that we’ve reported for 25 years and that seasonality and then it will start to accelerate in the fourth quarter and going forward. Let me talk about another point though that I think is very, very significant.
So, part of what we did, many of you will recall that we had a downfall of revenues in the first quarter based on the fact that we did not receive any orders from a large OEM customer out of the Thomas Medical. We had received an order and shipped one in late December and then we didn’t really see anything after that and that was a surprise to us.
However, I am pleased to say that from that customer we actually received an order and although I don’t believe that we’re going to go back to those levels, at least tells me that there is still interest in that product and opportunity. I will also tell you that we are in the final throws of negotiating what we think is a major opportunity for one of our products on OEM basis and which we have forecasted about $4.5 million.
This is coming out of our Thomas Medical. Now, hold on to that $4.5 million for just a second.
In addition to that, during the first six months of the year and on a basis that each month improving sequentially, January, February, March and each number going up, we’ve been able to on an annualized ramp basis through the first six months produce about $3 million of ramp sales that were in our balance sheet that were formally OEM. We believe that that will accelerate on an annual ramp basis to about $6 million by the end of the year.
If we take that $6 million that we believe will now be direct at higher margins and add to it this new opportunity that will be in 2014 for another $4 million, it is my belief that the $10 million that we lost will be made up and on a ramp basis going forward into 2014 we would make that up. In addition, a number of the Thomas products have been private label, Merit labeled.
So our transeptal needles, our coronary sinus guides and we expect sometime in the very near future, next 30 days or so I hope to receive second approval from the FDA. We are having already received one of our steerable sheets but some modifications were made.
We filed a special 510-K and we hope and we believe to some extent that in the next 30 days we’ll have that approved. There is a lot of momentum in the Thomas medical and although we hiccupped and we took some steps back, it’s my absolute belief that as we move into the balance of this year, you’ll see that ramp rate which is right now around $13 million, based on about $2.5 million a month where these other opportunities and it’s continued focus on the direct effort by our U.S.
sales force will see that move back up into the areas that we have previously forecasted. So, it would have been a year off, but I think we’ve made a lot ground.
The reason I’m saying this is we like this business. We think it has great opportunities for Merit and we also like to having a little less exposure and having more control in terms of having some as some of those products go direct and we think that we are on good track for that.
Our sales force, this is the point after all of this stuff that I’m really trying to make. Our domestic sales force spent a substantial amount of time in the second quarter, which I think as evidenced by the month to month increase in orders and working transferring that business directly to Merit and they will continue to do that at higher margins.
So one might look and say well, you would have been at this number core, most of which was taking down because of OEM and slow domestic sales and Typhoon (ph). But if you look at the other markets that don’t have the device techs we are doing substantially better in the Middle East, Russia, China, Central and South America and unfortunately we have that those going up and these other ones have been attracting but we think that there is opportunity to move this forward.
The point is U.S. sales force spent substantial amount of time promoting that product under our direct sales until I don’t and I hope you will not just separate the core and the overall growth of 9% because it’s probably somewhere in the middle, if you have that extra ramp basis, they come with and that’s how we’ve instructed because we thought those were the sales that we wanted to kind of being home and make sure would we could make up that difference from the short fall.
Kent, you want to comment?
Kent Stanger
I will just comment on the strength of the international businesses moving now to 37%. In fact for the month of June, 45% of our revenues were international.
.Part of that is quarter end shipments but it’s interesting that you have strong.
Fred Lampropoulos
Well, I didn’t realize that Kent, that it was 45. I was thinking it was 39% or 40% but that is extraordinary.
I think that gives us an advantage going forward and we’re doing better and better in these locations. We’re also over the next few quarters we will be opening up for the modified model in Turkey also probably for early next year in Switzerland and some of these models that that we have used in China, Brazil, in Russia, India and the UAE had worked out very well and those decisions, which did have a cost to them are now paying what we think very, very handsome dividends.
Let me move on to some of the new products and discuss those because I think those are also important in terms of the momentum that we see coming. One of the products that you let me talk about is our Basics Touch and there is no doubt in my mind and I think in minds of a number of new customers that it is the best inflation device in the world.
Now why is one device something that we talk so much about? Well the fact of the matter is Merit is the world leader.
Merit has well over $125 million in various forms or another coming out of this product line, whether it be for a socket (geohabilitation), whether it be for coronaries or peripherals with several different product platforms. We've spent a good 18 months and substantial resources to develop the Basics Touch.
Because of the success that we have seen in Europe and the distribution, we are seeing substantial take up of this product, to the extent that we are essentially selling everything we can build. Everything we can build in this product line is being sold in Europe in the Middle East and Eastern Europe today.
We have even received orders from Japan. We have received orders from Mexico.
It’s just getting started. Now what are we doing about it?
We have a second production line that will be up and running I think in the next 60 days guys is that about right? 60 days okay.
And then we have the ability at that point to go to a night shift and we will be able to produce about 40,000 a month when we are fully staffed up on this. That would generate somewhere around $15 million in revenues.
This is a hot ticket, it’s a great product, there is nothing better, and when we combine that product along with our hemostatic valves and in fact a new hemostatic valve called the PHD, we expect that we are going to see substantial growth. I will also say it’s kind of just in time, and that is we have seen kind of a flattening of our inflation device business and this is the perfect time to regain the momentum, particularly where our competitors would be introducing any new products that we are aware of.
So that is one product that you will be hearing a lot of along with some of the others. Additionally, we expect to introduce sometime late this year possibly early next year a PreludeEASE Hydrophilic Radial Sheath.
Now as many of you know, years ago there was very little discussion about radio procedures. If you go to Europe Japan Scandinavia any of these areas, the procedural rate will run anywhere from 40% to 80%.
There is I think ample data to support there is better mobility, no more morbidity and certainly no more mortality. It is a device a product whose time has come.
Merit has grown that business. It’s well over 100% growth this year.
It was over 100% last year in terms of our current product line but this is a hydrophilic product and we are very excited about its introduction, particularly when the United States has gone from that 3% that we discussed to somewhere around 16%. There are some who say that it will be 40% to 50% in the next five years.
Think about that. Think about essentially half of the thermal procedures approaches in the United States going to these products.
In addition to the Sheath there are all of the other products like the wires, catheters, guide catheters another products Merit makes that will I think also see substantial opportunity. And of course along with that, once you have that presence with inflation devices and sheaths and guide catheters then you also see the kits, the trays and all the rest of the business come along with it.
So we think that’s a great opportunity. We also will introduce hopefully later on this year and in the fourth quarter our ASAP LP Catheter, which is an Aspiration Catheter.
We are very excited about this we are doing very well with our ASAP. We think the LP will have to enhance.
In fact we would expect a substantial, almost doubling of revenues in that whole product line in the first based on this new product and so we are very excited about ASAP. Kent?
Kent Stanger
Yes in the first quarter I mean this is the second quarter it was up 121% added $645,000 in new revenue.
Fred Lampropoulos
Yes so we are excited about that I am telling you this stuff folks because although it’s slow, I believe that once we come to this third quarter which will be the slowest time of the year you are going to see growth resume at very high levels. When I say higher levels (inaudible) that as well as resumption of sales that we will see.
So although you might look at these things and see something differently, I think that as we look at the staff we take a look at the products the distribution and there are many others. There is another five to six products that will be coming out and we can build to a lot of those but we have a full pipeline that we have talked about.
Well I think we have hit the highlights of the ones that we think that will have the biggest opportunity. In summary, we are doing better.
We are just getting started. We have realized that we have been lagers in terms of operating profits and creating shareholder value.
We have restructured the company in many ways so that our attention is on efficiency, reducing costs, introducing new products and really getting our operating margins well above 10%. You saw the substantial improvement just between the first and second and although I know one month does not a trend make, in the month of June our operating margin was around 9.2%.
So as we think of these expenses come up, we absorb more, we introduce these products and move through this third quarter that we're going to start to see the kinds of returns that I think all of you are interested in and certainly we are in terms of establishing shareholder value. So I think that's pretty well it for me.
I think you're probably tired of listening to me, but we do have a plan. We don’t want to just be in here just jabbing and just talking about how wonderful we are.
We're not performing at the level that we’re capable. We have a plan in place.
We’re focused to those efforts. We have the investments in place, we have the products in place and we want to make you money, we want to make money, we want everybody to do better and we're committed to doing that.
I know the staff is and we have a plan and place to do it. So talk is cheap.
The real issue is I think we've done exactly what we said we would do between the first and the second, and even though we were little disappointed on sales side, going forward we have the products, the distribution system and the capability to manufacture. So with that said we will go ahead and Kent you want to comment at all on anything?
Kent Stanger
Just summarizing the high points, I was pleased with the inventory dropping $3 million since the beginning of the year. You've improved the gross margin improvement.
The SG&A drop is ahead of schedule of now as far as we move forward and we've seen a drop in R&D we didn't mention. So there's 90 bits there that we’ve also accomplished and all that comes into this operating margin you've been talking about.
So those are the things are really good accomplishments for this quarter.
Fred Lampropoulos
All right then, I think it's Chad, Chad if you're out there lets go ahead and turn it over and line them up.
Operator
Thank you, sir, and we will now begin the question and answer session, (Operator Instructions). And our first question comes from the line of Tom Gunderson with Piper Jaffray.
Please go ahead.
Tom Gunderson - Piper Jaffray
So just, Kent maybe you could just to start off, maybe we could, you said it or had it in the news release, I missed it, could you just break out overall revenues for Q2 between U.S. and OUS and the organic growth rate for the U.S.
and the growth rate for OUS?
Kent Stanger
The overall revenues for domestic is $69 million and the international is $40.8 million and that percentage, I'll calculate, I just don't have it handy, I know what the split is. It's 37% international.
Let me get the growth rate for it for a second. You can ask another question if you want.
I’ll come back to you.
Tom Gunderson - Piper Jaffray
And then Fred last quarter was, Q1 was I believe the first quarter that Endotech was profitable. I noted in your press release that the sales weren't up nearly as much but I'm wondering how the profitability for that was in Q2?
Fred Lampropoulos
Tom, thanks for the question and I'm happy to answer it because just prior to this call we had the discussion. If we were looking for the six months and we’ll just talk to the six and we'll talk for the quarter, I am going to do the quarter in the sixth, the profitability on lower than expected sales, I will say that was one of the areas that was a little bit slower.
For the three months it was about a $129,000 versus a loss of $250,000 last year. For the six month period the profits were approximately $255,000 versus a loss of $592,000.
Now one of the other things Tom that you'll see, we are just now are starting to utilize those lower cost stents. As you recall from our conversation previously, we changed vendors, and it was the savings of somewhere between $1 and $2 million depending on the mix and since the sales had been a little bit slower, we didn’t use it as quickly as possible.
But as we move from this point out by the time we get in I think to the fourth quarter which is not very far away, we will have utilized essentially all of those stents through the end of the year and then the lower costs. So the margins will kick up pretty substantially and the profits will continue to improve in this division.
We are also just as a point of interest have filed for our IDE on our Endomax EBT. This is our valve, esophageal stent.
This is a significant product. We expect to have the CE mark on the product by September, October and will start selling that product in Europe at that time.
It's going to require a small study and a 510K with a study in the U.S. We also will be launching later on this year our pulmonary dilation balloons that go along with our big 60 and then we'll be ramping up other balloon products in that product line through 2014.
So we do have a product pipeline and we have made, I think, substantial improvement. On the growth rate, for international business was 12.2% for the quarter and domestic was 7.6%.
That includes Malvern, of course in that, in the demands.
Tom Gunderson - Piper Jaffray
And then not much on internationally, right, for Malvern?
Fred Lampropoulos
Very little.
Tom Gunderson - Piper Jaffray
Last question, I know what some others get in here, and that is; can you give us an update on headcount Q1, there were some reductions, I don’t know of that. You did it all at once or whether it’s going to continue through the year?
Can you give us an update where you are at the halfway point?
Fred Lampropoulos
Yes. We have not reduced headcounts.
In fact just the opposite; as we build some of these production lines and we improved the automation, remember we have been in the new building about, I will see here, maybe less than 45 or 60 days. Now with the new automation coming online, on or about August 15, that’s when we will start to see a trimming of the sales, have to be in the balance of the year.
So that’s when you will start to see. At this point we had people moving, extra people setting things up.
Staffing these production lines that we have set, and then now would they stop coming, and now comes what I would say is most difficult part. But it is less than 30 days away as we have started to trim.
Operator
And our next question comes from the line of Jim Sidoti with Sidoti & Company, please go ahead.
Jim Sidoti - Sidoti & Company
Can you break out any onetime cost in the quarters, show startup cost provided to the new facility, and if, I guess there was no severance to fit into any reductions. And what the inventory step-up charges were?
Fred Lampropoulos
Yes, that is very little in the inventory step-up charges. We have had some moving cost.
Let me go over few of those, for it will be less severance in the quarter of about 266,000 and a little bit of an acquisition cost for 27. And we have had –
Jim Sidoti - Sidoti & Company
What about $700,000 moving cost.
Kent Stanger
Those fortified or reallocated within our onetime charge that I think he is referring to. And then we had a little bit of debt issuance charges that were long term that we, (inaudible)
Fred Lampropoulos
It’s not a lot Jim.
Jim Sidoti - Sidoti & Company
So maybe about half a million?
Kent Stanger
Yes, but those were adjustments in our non-GAAP, yes.
Jim Sidoti - Sidoti & Company
And I just want to be clear now. It sounds like, you are going to continue to have some of these transitional costs in the third quarter as you shut down one plant and start off the other.
Now, starting, as we get into the fourth quarter, those costs should be gone, will there be any new cost that will enter the equation now once that plant is started up?
Kent Stanger
So let me come back to the first one. The reason there are cost in this quarter even though we’ve moved, we had a notice of six months, and we gave that as we are engaging the time.
We now are moving this, I mention we’re a five weeks early. And we are in the building, and so those cost will come up starting the first of September, the majority of the cost of the other building.
The only other thing I can think of, that we will have to think about is, we do have this new fulfillment that the medic system in our facility, as that comes into play, that’s going to go on the depreciation schedule. So we will go from the development to depreciation which will be some cost associated with that.
But that is to amortize over 15 to 20 years. I don’t want to sing in the noise.
But there is about $6 or $8 million of that. We are having more specific cost that will edge in, that will be some expense; probably almost over 20 years and we build the book, of course another tax issue on that.
But that will be one cost, right. I think all of the other costs are in place.
And I think if anything, we should see of those headcounts and there is efficiency that’s where the biggest opportunity is for us to reduce cost, now that everybody is here. And I don’t, Jim I just want to say that again, maybe I am overstating this but, it’s like playing baseball without making an error.
We made lot of mistakes and we have done various things in our business career. But we executed with almost perfection, the movement of that facility.
Remember this is automation equipment, 85,000 square feet and 150 employees and again we did extraordinarily well, can in fact see more than that because we moved on, lost everything from this selling over, that will be taken down reset out. So it was the big operation.
.
Fred Lampropoulos
We had to make deal and we did all that in this quarter and so we are pleased with that.
Kent Stanger
Other part then, Jim?
Jim Sidoti - Sidoti & Company
So, but you say that cost, you know all that cost is about half a million dollars, rolling.
Kent Stanger
Yes, and it’s for the quarter. We would rather cut cost associated with moving and breaking in the first quarter, and stuff like that as we are bringing it over and setting things up and qualifying.
Remember these things all have to go through the whole process of certification once you move them. So breaking them up, so those costs, I think in the first and second quarter we were probably talking about one.
Fred Lampropoulos
About 800,000 total.
Kent Stanger
About 800,000 in the first and second quarter we’re probably talking about one.
Fred Lampropoulos
About 800,000 in total.
Fred Lampropoulos
About $800,000 in the first six months that won’t be there going forward.
Jim Sidoti - Sidoti & Company
Okay.
Kent Stanger
Plus the additional offset of the rents which were about 100,000 so that’s another thing that we drop off and help the offset some of the higher cost deprecation of the building that occur already in the results that you see.
Jim Sidoti - Sidoti & Company
Okay so the third quarter will probably still be a little messy because its sound like that when you’ll start you’ll have some more seven expense and you’ll finish with transition and then in the fourth quarter I guess will be our first look at what the new Merit is going to look like with just as one facility running, is that sound right?
Fred Lampropoulos
Yes, if you want to call that the New Merit, I think it’s time but I think Jim Leash (ph) I hope you give us some credit for this quarter and where we came from the first quarter and these improvements in the margins, they don’t happen magically they happen because we focused on the expenses and those sort of things, but if you’re talking about that fourth quarter you’ll rise all of this stuff will be off also things will be through the summer slowdown, the system will be up and running and then you’ll start to see reinvigorated a leaner a tremor Merit as we move through with these new product introductions and with these new facilities, so yes, this is probably a fair statement I just like to way a said it there.
Jim Sidoti - Sidoti & Company
All right so then we look in the fourth quarter and that’s typically your best revenue quarter, do you think you get back to a double digit operating margin?
Fred Lampropoulos
That’s our goal.
Jim Sidoti - Sidoti & Company
Okay.
Kent Stanger
That’s our goal, like I said in June we did 9.2 that’s our goal, that’s a very stiff goal to go from 5.7% to 5.6 this quarter double that but I won’t say that we’ll see sequential improvements in our operating profits and we believe that we have the capability to do double digit whether it all happened in the fourth quarter as we’re launching these new products and those sorts of things and they’re launching in a big way, I don’t know that I want to stick my neck out but it will be better in my view to what we saw this quarter and the next quarter will be better than, so we will continue to make improvement quarter by quarter, gross margins, operating profits, and the things that effect those profit SG&A, R&D and so on so forth into that one thing you did say that I want to correct you, we’re going to do as much as we can in terms of attrition and other types of things rather than having large amounts of expenses with trimming, so we had some pretty big expenses in the first quarter and then in the fourth quarter some of those were more management changes that will be substantially more modest going forward.
Jim Sidoti - Sidoti & Company
Okay, how is the size of the sale force been affected from the recent challenges that you had in the first and second quarter, have you maintain the same size sale force that you had at the end of the last year?
Fred Lampropoulos
Yes, we’re down one.
Jim Sidoti - Sidoti & Company
Olay, so, if that includes the Thomas- the additional people with Thomas?
Fred Lampropoulos
Yes, I mean they only had one sale guy so that doesn’t remember – they only had one sale guy and that was all over, but we’re down one sales person and that almost and that’s just transitional stuff that’s, the essences of it is didn’t have affect.
Jim Sidoti - Sidoti & Company
Do you think that the readiness start adding again by the fourth quarter or do you think you going to stay at this level for awhile?
Fred Lampropoulos
I think, it would be just ingenious to say that we’re going to go out and grow the business in substantially higher levels without adding some sales force, but I can’t say that we can do that and still maintain a low rest SG&A expense as a percentage of sales, so I can’t say that but I would say that we would start adding some, if we do not have a plan that goes out and add substantial amounts of sales force or anything like that other than one or two here or there with three or four but it’s a percentage of sales we’ll still be able to get that leverage, yes we get those sales going up in these new products, it becomes harder and harder and more and more opportunity, if don’t do it we lose opportunity, so we just have to manage that.
Jim Sidoti - Sidoti & Company
(Inaudible) most of increases in the headcount like number or actually internationally unfortunately in many of those markets, India and Brazil and some places its less costly per copy to in China as well, so those where we added some more I think international more than anything this year and probably next?
Kent Stanger
And this in the international markets the Merit products is hot and whether it would be U.A.E, Russia, China, India, I mean we’re up 150% when we put this new model in and that will continue to grow so I think with we position very nicely and what I think most people would say it’s a pretty tough markets, so I think this basis touch I think some of these products that we’re talking about looking at these radio procedures which is one of those areas and international cardiology is going very-very nicely. I think we’re in the right areas and I think and EP, EP is still growing in the low double digit and with our products it’s part of what’s driving this order for this transseptal needle and some of these other products, so I think we’re in the right place Jim in terms of the product mix that we have.
Jim Sidoti - Sidoti & Company
Okay then the last question specifically in China, can you just give some updates on how your sales are doing there and how many products you’ve approved at this point and where that what direction that’s going?
Fred Lampropoulos
I am going to comment just a bit then I will ask Joe Wright who has responsibility, I will say that our direct sales force, direct sales in China rep around 28% give or take. We have seen --when we went through this transition, we did have some OEM customers or large distributors, those are dropped dramatically Merit’s business has, direct business has improved.
There are two significant things and I am glad you mentioned this Jim because I fail to mention to them in the press release. We did set it out at a separate press release a couple of weeks ago, we have approval for Embosphere and QuadraSphere in Japan that significant, we have received our first order of $1.6 million for that account, we just received approval for the Embosphere in China and we have received in Columbia and number of other places, but that kind of the embolic business has been a little bit slow and some of these procedure rates are fallen out.
We have also introduced PVA, so we have a new embolic on the market and we expect that by early next year or mid next year, will have at least one and may be two new embolic products on the market. So, that’s the best way but I haven’t mentioned out in this press release and I think those are important to know that with these two areas which are the two largest areas for usage of this type of product are pretty significant, Joe do you add anything to Bangalore, India, China?
Joe Wright.
Joe Wright
We have about 250 distributors now in China, so we continue to add sell people to support that business. We have grown in the tier one cities, Beijing, Shanghai etc.
We are now expanding into the tier two cities and will continue to do that over the next couple of years.
Fred Lampropoulos
In terms of new products, regulatory, in terms of approval products, John Knorpp our Chief Regulatory Officer, how many products, ballpark john, do we have approved, you can give me a quick answer, I know that’s kind asking you to shoot from the hip but it’s pretty substantial, John you are going to speak or I will speak for you?
John Knorpp
For this year, we made several submission in China with that three that currently trending we had in terms of the approvals to tier one, seven approvals.
Fred Lampropoulos
Okay, so year-to-date, we have seven new approvals, we have three more that are pending and a number that are being prepared. We are probably selling 20-25 product lines there, give or take versus -- three or four years ago as we are starting to ramp this, we are selling five or six.
One of the other things that I think that’s important Jim is that cardiology has been a big part of that, we have been (inaudible) emerging opportunity in interventional radiology there, peripheral embolic, drainage a number of other products that we are starting to focus and we are hopeful to be able to get -- I get another group of distributor and that’s the beauty of our model there as we can pick and chose the cities and the specialties and again we have been very successful. I think I would put up our model and our success in China with anybody, at least relative to size then we have done a great job there.
Operator
And our next question comes from the line of Jayson Bedford with Raymond James. Please go ahead.
Michael Rich - Raymond James
Hi guys, this is Mike calling on for Jason. Can you hear me?
Fred Lampropoulos
Yes, Mike go ahead.
Michael Rich - Raymond James
Thanks for taking the question. First, when you look at the Thomas Medical business, you talked about going direct more in the quarter, what’s the current mix, where do you expect that go over the time and how confident are you that you can increase that mix without deemphasizing the organic business.
Fred Lampropoulos
As I mentioned in my previous comments, we are at a ramp rate right now through the quarter of about $3 million of selling our classic sheath, that was essentially zero at the end of the year, we think by the end of the year our goal would be to be about $6 million. Now we are developing a new product that we think will be best in class and that will be out in about may be a year to 18 months.
We have also introduced the coronary sinus guide product, we are now introducing, these are things that are coming as we are speaking, our Transseptal Needle under the Merit label, previously these of all are sold to other players and remember that whenever we sale any of these products that there is $2,000 to $3,000 of additional products that are used in these EP procedures and these implant procedures. So, there is a lot of pull through and also we will provide the needs for our customers.
We will meet the needs that they have but at the same time Merit’s goal, a long term has always been that they will be able to have and control the point of sale, I mean that’s what we have always done and yet we have a almost an $80 million of gave or take OEM business and lot of that stuff does not compete with us but I would say that we have a new Steerable Sheath, we are going to go out and sell that exclusively under the Merit name. And now that’s sort of a $1200 or $1500 catheter used in the EP procedures.
We could go along the OEM basis that’s not going to be the way that we are going to do or we are going to sell it along with our sheaths, our Transseptal Needles, our coronary sinus guides and then we have other products that we are now developing to build that portfolio in electrophysiology and CRM.
Michael Rich - Raymond James
Okay, you have talked about in the past expanding Thomas Medical internationally, I know said it wasn’t much in the quarter but any time frame for getting that business outside of the U.S.
Fred Lampropoulos
We have just started selling the sheets in the overseas markets, many of the customers that are of there on OEM but because of the sale force has been so busy with the basics touch in these other products, our focus has not been the Thomas Medical products, overtime we will do the same thing there that we’ve done in the United States, as you can see from the growth whether be from the low EF which is very hot to our micro-capitals to our basics touch to PVH, other things that we’re doing in Europe, we’ growing there with our dealers that are rate somewhere around 15% with our dealers, 20% and our direct sales force is about 9%. So, we’re focusing on that area as we fill out this product lining with steerable sheet, I think once we have that broader portfolio of products which we will have hopefully by the end of the year then we’ll start looking at that opportunity but the basics touch is so hot and we have a new product called PhD was a haemostatic valve, these are very high margin products, there is a lot pull through, I don’t think that’s and immediate issue to focus until probably sometime, I’m going to stay early next year, mid next year.
We have a lot of other (inaudible) and we’re going to go fishing with the stuff that we have right now but the good news is we have new products and we have these things I don’t to say waiting in the wings but we have plenty to sell, that’s good news. And they’re proved.
So, these are sensory, everything we have is CE marked and approved to ready to go so that’s a good news. We don’t have regulatory confinement general.
Michael Rich - Raymond James
It may be too early to answer this but you mentioned that the large customer that you lost in the first quarter has come back to some extent, is there visibility there for recovering orders or is it too early to tell.
Fred Lampropoulos
I think it’s too early to tell and it was a relatively modest couple of hundred, thousand dollar order but I will say this and you’re going to kind of read between lines here, it interesting to know that this large other order that we talked about is with that very same customer. So, interestingly, we ware I think hopefully back in the good graces and again part of the reason that that situation fell out had nothing to do with Merit, it had to deal with some history and some brewing and a whole bunch of things that we would responsible for it.
So we believe overtime, there is an opportunity to bring all of that home and in mean time we’re not counting on it, we’re going to go out and we’re going to develop our markets and our products if it comes fine, if it doesn’t very candidly and without sounding arrogant, we don’t need it. What we do need is control of the point of sale and that’s how we’ve been similar at this mode and other stop is more ancillary and supportive rather than our primary goal.
Operator
And our next question comes from the line of Chris Cooley with Stephens. Please go ahead.
Unidentified Analyst
Just had one quick question. Fred I think you talked about the third quarter being the weakest quarter being you’ve talked about kind of sales being adverse effect of this quarter.
Are we still looking for sequential decline for 2Q in the third quarter.
Fred Lampropoulos
I would just say generally if you look historically and you’re aware of the issues in Europe that started this week, the races around in Ireland, people are heading to the beaches and we have sequentially – we’ve seen historically and sequential required about 2% to 3% in revenues during the quarter historically. Now, on the positive side, some of these new products are going to get lot of take up and we believe that as we move into the fourth quarter, there is going to be substantial take up in both and I think possibly getting the double digits in our direct sales force and certainly it’s already in double digits, distributors and in Europe.
I mean this is phenomenon that we see every year, so I don’t see any reason why would be any difference this year.
Operator
And our next question comes from the line of Greg Macosko with Lord Abbett. Please go ahead.
Greg Macosko - Lord Abbett
What’s in the growth margin? I just want to understand that 360 increase, I’m assuming that 360 through the six quarters is some kind of the low point of what 44, 45.
Kent Stanger
Point of 41, if you’re looking on a GAAP basis to clarify the first quarter.
Greg Macosko - Lord Abbett
Okay. So that was – so the point is we’re going to go from about 45 to 48.5 or something like that, is that the idea, when we get normalized.
What are the numbers we’re looking at for that? Fourth quarter, first quarter next year the normalized level.
Fred Lampropoulos
I’ve said, I’ve got the 41.4 on a GAAP basis so you would be looking at…
Kent Stanger
360 in entire.
Fred Lampropoulos
45.
Kent Stanger
Yes 45.
Greg Macosko - Lord Abbett
Okay 45 alright sorry. Alright look at pieces of that some of that is obviously from is depressed because of the slowdown and all the things there.
It sounds like you are adding maybe sort of on a normalized basis you expect to add maybe 150 to 200 in total?
Kent Stanger
I don’t understand the question really 150 and 200 of what?
Greg Macosko - Lord Abbett
Basis points in other words the increase in the gross margin from a historic normalized level to future normalized level what will that level be I guess on a GAAP basis or on an adjusted basis how were you going to look at it?
Kent Stanger
Yes I haven’t broken that down to analyze that Greg the only thing that we have looked at and say we hit this bottom point there is going to be some take up time and absorption of the building up. We have some vacant space here for growth so we are not operating at capacity but as we move down the road we can see and believe that we should be able to just over this 18 month period and very candidly we should do better than that and continue to do that beyond there.
But at this point that’s as far as I want to kind of talk about what our goals are I can’t have goals now so far that people misspoke of what we need to do today. But there will be more opportunities beyond 18 months.
Fred Lampropoulos
And we will continue to do that.
Greg Macosko - Lord Abbett
Substantially okay would you just help me with the BioSphere there you mentioned that was down 12% in the quarter how what is driving it what are the changes there and what are your expectations around BioSphere there?
Fred Lampropoulos
Yes it is interesting that as we look at the BioSphere business and look at our top 50 customers we haven’t watched any of them what we’re seeing is lower procedural growth. And, so part of it is just kind of the phenomenon we’re seeing in the United States on the various procedures and so on, so forth.
Now, we think that with these new approvals in Asia that will help enhance that we have a number of new and what we’ll call them embolics that will help to support and enhance those sales. And of course we’re continuing on with the sale or the trial that we’re involved in, which we think is going to give us an opportunity in the future.
It is -- we grew it very nicely over the last couple of years but we’ve just seen this slowdown. With Asia, with the PVA and other products and others that we are coming with, we expect that we’ve kind of seen at least my expectation is, we’ve kind of seen the bottom of that will probably be in this quarter again because this is the slowest quarter of the year and we’ll start to see that move forward.
We do have some initiatives. We do have some plans.
But I also would like to point out because I think it’s that there is some correlation here. But one thing we’ve been able to do and one of the arguments that we made for the BioSphere transaction was the pull through.
And one of the things that we’re starting to do is we saw in terms of our micro catheters growth this quarter I think it was about $600,000 of incremental growth in the quarter, Kent?
Kent Stanger
Yeah, $560,000, 114%
Fred Lampropoulos
So about $600,000. Now, here is the good news Greg.
We are going to start to produce that product at about half the price we’re currently paying for and produce that in-house starting in the middle of October. And that is a very-very hot product for us.
What that tells me is that we’re able to glove and use that product not only with our existing embolics but we’re taking market share from our competitors and it gives us a tremendous tool to take in bundle our micro catheters, which were about 350 bucks a pop along with these embolics. So we’re not… we’re disappointed that it slowed down, that we’ve seen a slowdown this year over last year but we haven’t given up by any means in fact we’re developing strategies to reignite those opportunities.
Greg Macosko - Lord Abbett
And then the last question you mentioned the study you’re doing there for the trial stuff that you’re doing in BioSphere. How is that going and has that I assume that a good piece of the R&D budget went up because of that.
Have we kind of stabilized here or is there more increase coming from particularly from the BioSphere or anything else, give me some color on the R&D?
Fred Lampropoulos
Yes we are going to spend this year probably $2.5 million on our study, give or take. We have, I think, $125 or 100s and so patients enrolled.
We still have a long ways to go. But there is a lot more that goes with the study than just the cost and that is the opportunities to sell other products like these micro catheters.
So, we are trucking on down the road. The pay date for this is still three to four years away, but at that point we believe that we’ll be the only company with an improved indication for these products.
So we believe that gives us a lot of credibility with the customers and we believe there is good science. And I know a number of people said why don’t you just stop doing this and the answer is that we’ve sat an surveyed that and talked about that in circles, we just don’t think it’s the right thing to do and the longer term opportunity here would more than pay for the expenses of the study.
So that continues to be our position.
Greg Macosko - Lord Abbett
Thank you, Fred.
Operator
(Operator instructions), our next question comes from the line of Dale Detile with the Boston Company, please go ahead.
Dale Detile - Boston Company
My question was answered but while I am here I’ll just ask, the 10% goal you set Fred I'm assuming that's GAAP not the adjusted way.
Fred Lampropoulos
And then again that's not the end game, that's something I think that given over the next 18-24 months we will see that we can operate at that level, I think that's the first train stop we want and we're giving a lot to climb to that and it's a big climb but when start to see things like 9.2% in June, without these efficiencies and some of these additional expenses and so on and so forth it gives us reason to believe that it's an attainable goal and there's more beyond that. We're totally (inaudible) utilizing a portion of these new facilities.
Dale Detile - Boston Company
Without trying to pin things down too precisely, I can look back at your margins, I believe it’s on a GAAP basis, '07, or '08 or '09. Is there something structurally different outside of the medical device (inaudible) is there something structurally different that would make those historical margin levels, either unattainable or irrelevant to the current state of the business.
Fred Lampropoulos
Well you know there are a lot of things going on, the business as you know there's price pressure, there's all kinds of issues, it's a tough business, listen you got Repcheck you've got buying groups, you've got the government you know listen it's tough for everybody I think it’s one of the reasons why the investments that we made outside the US are ones that will pay handsomely you can see it in our growth you can see it in our profitability, so I think we hit a low point a number of years ago at about 43.3%, or 43.1, no actually it was 38.3 and we talked about moving up a 150 basis points per year, we were able to do that and then we took a step back and we’ve added some of this overhead, but again as we absorb this we've higher margin products and I will tell you that we are spending a tremendous amount of time both in term of lean manufacturing, efficiencies, automation and I will exceed even with the device tax the previous levels that we hit with markets, we will absolutely do that, it won't happen overnight but over the next two-three years we will meet and exceed and we will approach that 50% and we'll have our operating profit sitting in the double digits, so we'll get there. We've got the plan and we got people committed to it and we'll get there, it won't happen overnight but it's moving in that direction as you can see from this quarter and you'll see it sequentially quarter by quarter.
Operator
And I'm showing no further questions at this time, sir, please continue.
Fred Lampropoulos
Okay, well listen, I think we've tried to explain to the best of our abilities the opportunities, the challenges, at the same time I am reasonably pleased with what we've accomplished but I am very optimistic about where we can go from here, we built these facilities, we needed more capacity. We're out of the building business, we have a few things to wrap up and finish up but we're out of the building business, we're into the manufacturing business, the lean business, the efficiency business and the profit business and as I've said to all of you guys I want to make some money I don't want stock and I want to make some money and I want you to make some money and I think we can make some money together, we appreciate your interest, Kent and I will be available for the next couple of hours to answer questions and drill down to whatever we can do under the requirements of the FD, we appreciate again and look forward to reporting to you in the future, and we'll go ahead at this moment now and sign off in Salt Lake City, wishing you and the Boston Red Sox great success this evening, good night.
Operator
Ladies and gentlemen that concludes the Merit Medical Systems Inc, second quarter 2013 earnings call, thank you for your patience, you may now disconnect.