ICU Medical Inc (ICUI) 2004 Q3 法說會逐字稿

Good day everyone and welcome to this ICU Medical third quarter 2004 earnings results conference call. Today's conference is being recorded. I would like to turn the call over now to Dr. George Lopez, CEO. Please go ahead sir.

Good morning and thank you for joining us on our review of ICU Medical's results for third quarter, and nine months ended September 30th, 2004. I am Dr. George Lopez, Chairman and President of ICU Medical. With me today is Frank O'Brien, our CFO. On today's call I will provide an overview of our operational results, then Frank will provide detailed financial information for the third quarter, and nine months ended September 30th, 2004. I will wrap up our prepared remarks with an update on guidance for the remainder of the year, and a discussion of current business trends before we go to Q and A. As always we will limit the length of the call to about 45 minutes.

Before we begin, in the event that we touch on forward-looking statements on this call, please be aware that they are based on the best information currently available to management, and assumptions that management believes are reasonable but such statements are not intended to be representation as to future results and are subject to risks and uncertainties. Future results may differ materially from management's current expectations. We refer all of you to our filings with the SEC for a more detailed discussion of the risks that may have a direct bearing on our operating results, performance, and financial condition.

Our results for the third quarter were bad. We reported a loss for the quarter and expect to report a loss for the fourth quarter as well. The basic problem is temporary. It has not changed from our second quarter call.

Hospira is aggressively reducing their inventory, and this reduction has become more aggressive with our help since we spoke at the end of the second quarter. This has caused us to systematically scale back production resulting in a large amount of unabsorbed overhead, as much of the costs in the affected production areas are fixed. The good news is that Hospira's customers continue to buy our products, and growth is strong. We have been working increasingly closer with Hospira on inventory level management over the past six months.

Our objective is to get control of this issue and not let them control us. We need information and cooperation and we are getting it. It will take the rest of the fourth quarter, and maybe several weeks longer to work through this, but we will make sure that what we ship them is only what they really need.

The other aspect of our business with sales rapport in the last quarter was our Punctur-Guard blood collection needle product line. We've been dropping prices to achieve broader distribution, and moving our distribution emphasis to general line distributors and laboratory contracts. We have made a lot of progress there, but it is slow and the progress does not show in our numbers. We still believe strongly in our product. Remember, we bought the product for the wing set, and wing set units are recently turning up.

Frank will give you numbers for the impact of Hospira and other items on the third quarter and prospects for the fourth quarter. Let me circle back to say something more on Hospira. Hospira's sell-through of our products is up very nicely over last year. We have an excellent relationship with them at all levels, and our business partnership with them has been extremely beneficial for both product companies in the past, and will even be more beneficial in the future. Their decision to reduce inventory is a good one for their business. They are taking a page out of our play book. Our excellent on-time delivery record with them has enabled Hospira to be very aggressive in inventory management, and carry inventory levels below our previous expectations, but this situation is temporary. Once they reach the desired level, their buying patterns will be back to normal.

We continue to build for the future on new product front. Tego, our new connector, is ready to launch for the first quarter of 2005. We have a 5-10 K approval from the FDA. The Y connector with the integral check valve, is going into production very soon and the Orbit diabetes set, for which we have the 5-10 K approval should be ready in the first quarter 2005. In August we invested in a start-up company developing a new medical device. Sales releases are several years away, and we cannot talk about this and the technology prospects to us seem very exciting. We also will seek FDA approval in 2005 for a new product for custom sets in Europe.

Before I get into greater detail about the current business trends and our outlook for the remainder of the year, I would like to turn the call over to Frank to discuss our third quarter and first nine months financial results.

Thank you, Dr. Lopez. Revenue for the third quarter was 16.5 million versus the 25.5 million last year. Let me give you a perspective on why we had a loss. Just follow along the numbers here carefully. Third quarter 2003 showed income from operations of 6.5 million. The lower sales of 9.1 million in the quarter reduced our standard gross margin by about 4.9 million. So take the 4.9 off the 6.5.

We cut back production because we did not need to make as much product, so we had unabsorbed overhead of 2.9 million, which was more than the underabsorption in the third quarter of '03 by 0.9 million. Then operating expenses increased by 2.8 million which gets to us the loss of 2.1, that increase in operating expenses included $1.2 million of expenses for purchased in-process R&D, which has to be expensed immediately.

Let me repeat the numbers. Q3 '03, 6.5 million profit. Lower sales reduced the gross margin by 4.9 million. Lower overhead absorption versus last year, 0.9 million reduction, and operating expenses increased by 2.8 million, another reduction getting down to the operating loss of 2.1 million.

Taking this to the bottom line after investment income and income taxes, we showed a net loss of 1 million, or 8 cents a share, as compared to net earnings of $4.1 million, or 28 cents per diluted share for third quarter 2003. For the first nine months of 2004, the Company reported net income of 6.5 million, or 43 cents per diluted share on revenues of 60.4 million, as compared to net income of 15.1 million, or $1 per diluted share on revenues of 77.6 million for the same period in 2003.

In the third quarter, we invested $2.5 million in a start-up company developing a new medical device. Under the accounting rules, about 1.2 million was allocated to purchased in-process R&D, and we are required to charge this to expense immediately, so the 1.2 million is included in increased operating expenses.

During the third quarter our product line breakdown was as follows. Clave products, excluding customs sets, 47%, custom sets, 39% of revenue, Punctur-Guard products 3% of revenues, , CLC 3%, other products 5%, and non product revenue 3%. In the same period last year, Clave products excluding customs sets were 55%, custom sets 26%, Punctur-Guard 6%, CLC 4%, other products 7% and non product revenue 2%.

Doc referred to the poor performance of our Punctur-Guard line. Puncture-Guard product sales for the quarter to domestic and international distribution decreased from 1.7 million in 2003, to 0.5 million in 2004. This was the largest single factor in causing sales in the quarter to domestic distributors to decrease from 6.5 million to 5.1 million. Total sales to international distributors were flat at 1.6 million, but would have shown improvement without Punctur-Guard.

In the first nine months of 2004 sales to domestic distributors was 17.4 million, off about 4%. However if you look at it without Punctur-Guard, they were 14.1 million, up 7%, led by strong growth in custom IV systems. Similarly for the nine months, international sales were 6.4 million up 85%, without Punctur-Guard the increase was over 100%. Custom IV systems sales decreased from 6.7 million in third quarter '03 to 6.4 million in the third quarter of '04, principally because of a drop in sales to domestic distributors. Sales under the set source program to Hospira customers were 3.1 million in both years.

Hospira sales people have been focusing on pump sales, which in the near term is having and adverse effect on custom IV system sales. Longer term, The IV pump business is a foundation for expanded Clave and custom IV set business, so the slowdown in growth is only temporary. Looking as custom IV systems, the first nine months which takes the edge off the slow summer months, sales were up from 16.9 million in '03 to 20 million for the first nine months of '04, or an 18% increase.

Operating expenses as I mentioned earlier, were up 2.8 million over third quarter last year, 1.2 million of this was expensing of the purchase and in-process R&D. The remaining 1.6 million increase was principally patent litigation cost, Sarbanes-Oxley compliance cost, and increased IT costs needed to support our growth plan. We had also some increases in sales and marketing, partial offset by reductions in administrative costs.

In spite of temporary reduction in revenue we continue to generate positive cash flow. We finished the quarter with 81.6 million in cash and short-term investments, this is a decrease from June 2004, due to our repurchase of 10.1 million of stock at an average price of $27.75 per share.

For the quarter operating cash flow was 2.1 million for the first nine months, our operating cash flow was 18.6 million. We expect our capital expenditures for the remainder of 2004 to be about $1 million bringing the total for the year to about 6 million. Remember in 2002 and 2003, we upgraded all of our facilities to handle a substantial increase in output, and we do not expect any substantial increase in capital expenditures for remainder of 2004 and 2005. Receivables at the end of the third quarter were 14.4 million, down from 16.2 million at the end of June 2004. DSOs were 83 at September 30th 2004, up 13 days compared to 70 days at June 30, 2004. Change is due to timing of shipments. The aging is relatively unchanged, and they are all collectible. Inventory September 30 '04 was 9.6 million, compared to 9.4 million in June. Day sales and inventory at September 30, '04 based on quarter end balances, is 90 days, compared with 97 at the end of June '04. Now I'd like to turn the call back over to Doc, to discuss the balance of '04 and ongoing business trends.

Even though we are in the middle of a temporary set-back, due to inventory reduction at Hospira, we are encouraged by the long-term growth opportunities at ICU. We continue to diversify our product line and increase our channels of distribution. Our proprietary manufacturing processes will enable ICU to continue to be the low-cost manufacturer of leading products for years to come.

I'd like to highlight a few of the results that Frank mentioned for the third quarter. Operating cash flow, 2.1. Free cash flow, 600,000. Cash, 81.6. Stock buyback 10.1. Accounts receivable, 14.4. DSOs, 83. Total inventory, 96. Finished goods, 4.5. Finished good turns 9. Finished goods turns, excluding bulk, which is mainly custom, 58. DSIs, 90.

CapEx total for the quarter, 2.8. CapEx for 2004 expected, 6.0. CapEx maintenance for the quarter, 1.5.

Sales by product group. Custom set source, 3 million. Custom total, 6.3 million. Custom with Clave, 12.1. Clave, 7.7. Punctur-Guard, half a million.

Sales by channel. Hospira, 5.7 million. Domestic distribution, 5.0. International, 1.5, 1.6 million.

So what are we targeting for the rest of 2004? As a result of Hospira being more aggressive than our previous earnings conference call, and with our help, they're reducing inventory more than we previously anticipated, and we now forecast that our sales to Hospira for the fourth quarter will be less than they were in the third quarter. Our other distribution channels should improve over the third quarter of 2004. But we see a total revenue coming in somewhat lower than the third quarter. Therefore we expect to report a loss in the fourth quarter.

Based on these facts and our results for the first nine months, our revenue for 2005 will be approximately 73 million. I'm sorry, '04, 73 million. Because we know that the inventory reduction program in Hospira will only have a temporary effect on our business, and because of our growth in other areas, we will continue to invest in growing the business, and continue to ramp up our sales force internationally and make additional investments domestically as well.

So our recurring operating expenses will stay about the same or somewhat higher than in third quarter, due to our expected ramp in in sales, both domestically and internationally. All in all, we expect earnings to be in the range of 30 cents for the year 2004. It is a bit early to talk about 2005, but one thing is quite clear. The reduced revenue in earnings level of 2004, are from a temporary factors which we cannot control. That is Hospira's spin-off and inventory reduction. That will all be behind us very, very soon.

We expect to return to profitability in the first quarter '05, and the year 2005 should be an excellent year as we return to more normal growth patterns. In summary we are excited about 2005. Our advanced manufacturing processes enable to us deliver high quality proprietary products in record time, and at the lowest cost to our customers. We are in the majority of the distribution channels for IV sets, and we continue to capture market share. We're the market leader in the growing custom IV set market ,and we're moving into a large and relatively untapped international market, with the leading marketeer of medical devices, Hospira. We also believe that our solid balance sheet is a competitive advantage, as it gives us ability to drive shareholder value to opportunistic share buy backs, acquisitions, and further investments in our business, that will drive internal efficiency and enable to us introduce or acquire new products to drive long-term growth for years to come. Now I'd like to turn the meeting over to questions. Operator.

Thank you. Yes, the question-and-answer session will be held electronically. If you'd like to ask a question please press the star key followed by the digit 1 on your telephone keypad at this time. Once again to ask a question please press star 1. Once again, just press star 1 for questions. We'll take our first question from Bruce Cranna, Leerink Swann.

Hi, good morning, guys.

Hey, Bruce.

Kind of a lot of stuff to go through here. I guess what I really want to do is initially spend some time with Hospira in the quarter. I know we went through this last quarter just trying to figure out, you know, where we should be -- or how we should be thinking about this, this customer of yours on sort of a dependable organic rate of growth, and where this business is today, if I kind of go back over the past year and smooth out some numbers in terms of Clave sales, and Hospira, do you feel that what did you this quarter is absolutely positively unrepresentative? In other words, sort of a $4 million or $5 million number, and, you know, at least from a modeling standpoint going forward, and I know you don't want to comment on '05 but it's kind of the same question. Should we be thinking of this business as, you know, 5 million run rate a quarter, or 10, or what can you tell us about Hospira, their commentary in terms of sell-through? I know you say it's positive, but you've got to put a finer point on that because we're going to need to figure out the fact of if it's doable. So best guess on what this business is really, base today and what we're looking at as some kind of organic rate of growth on that business.

Frank, you want to take that?

Bruce, the quarter this past quarter is not at all indicative of the volume of business that we will be doing with them in the future. We've had a temporary decline in the sales to them as they shrink their inventory. It's significant to severe and we're going to have more of that in the fourth quarter. By the first quarter next year, we would think that we'll be back on a normal even keel. Don't want to give what you the number will be for the first quarter. We don't know it ourselves, but it will be substantially higher than it was in either the third or fourth quarter this year.

Bruce, we have the sell-through numbers in units and dollars that Hospira has. We have access to that information now. We didn't have access to a large part of it, which was packaged finished goods. Now we have access to that information.

We know what the sell-through is in terms of units and in terms of dollars. We know the growth rate. We know their inventory levels exactly. So we know exactly being more aggressive than we were in the last call, as far as reducing their inventory numbers we know exactly when they'll have to order, and in what quantities. So I think we have a pretty good handle on 2005, first quarter and second quarter 2005, in terms of what their needs are. I don't know if that's direct to your question, but the sell-through really hasn't changed, the growth rate hasn't changed at Hospira as far as the customers goes. This is just a temporary bracketed issue.

At one point they were -- well, back when it was Abbott, they were giving you a nine-month rolling forecast. Is that still happening?

That is correct. They do still give us a nine-month rolling forecast. But we're not going to use that nine-month rolling forecast as we have in the past. We're using -- we're working out, as I say, they've given us access to the same screens their people have in terms of inventory levels so we're going to use that to control manufacturing shipments, and to work closer with them than they have in the past. The forecast is --.

You're looking at numbers they've provided you with respect to their sell-through?

I'm sorry?

You're looking at numbers they have provided you with respect to their actual sell-through?

They've actually given our manufacturing people access to the same screens that they're looking at. Remember, they're moving from the legacy system which Abbott had, to their own integrated system for MRP. So we're actually getting access to the same screens, the same screens that their production people are looking at, because working closer rather than farther away. Remember, if it was Abbott, they carried a lot more -- they carried a lot of inventory. That was typical. I remember having a discussion with Abbott, trying to get them to carry less inventory and they said it couldn't be done. Hospira is a different animal. They're certainly being much more aggressive in terms of inventory management, than Abbott ever would have done.

And only because you've had problems way back, Doc, I think it was Baxter and gainsmanship, have you verified any of those sell-through figures independently?

Yeah.

You're comfortable with what they're giving you?

Let me let Frank answer that.

We go through these pretty carefully with them Bruce, and talk to our own people in the field about them too. Our people are making sure they're accurate because that's what drive their commissions.

We pay all the commissions on those sales.

We're comfortable that the sell-through numbers they give us are accurate.

Let me move on to something else quickly. In terms of the gross margin, Frank, I'm sorry, you were going so fast, you had some numbers in terms of the down, I think your comment was on the 7 million on sales you had broken that up into pieces, is that right, in terms of --.

Let me go back over the pieces. Our sales dollars, sales, leave out the other income, were down 9.1 million. That reduced our standard gross margin by 4.9, okay. On top of that we had a production variance because the plant wasn't running all the time, and that production variance was about 2.9 for the quarter, but the impact on the year to year comparison was only 903,000 dollars, because as you recall we add a large production variance in the third quarter '03 as well. So the year to year comparative impact on margin was 5.8, that's the 4.9 plus the 0.9. But the actual underabsorbed overhead was 2.9 in total.

On average what is the fixed portion on a percentage basis of your COGS?

It's high. I don't have that number handy, Bruce. It's high.

85%?

On the stuff we make in San Clemente. The stuff we make in Mexico is altogether different, because that's manual labor, which is highly variable. Bruce, I don't have the number handy.

Frank, have you seen any uptick in cost of resin?

Recently we have, yes. Nothing we can't handle, but we have seen some.

Can you quantify that on a percentage or year-over-year basis?

Very, very small. The impact is more that we've been getting reductions in resin prices over the past -- as far back as anybody can remember. That has stopped and reversed very slightly. It's nothing we can't handle, though.

Then on the 4Q guidance if I'm doing the numbers right here, Doc, it sounds like 30 cents for the year, some where around a loss of 15 cents for Q4, does that make sense?

That is correct.

Alright, last question, then I'll get back into the queue. Just on kind of a macro basis or standpoint, I'm kind of curious, it seems like this would be something you would have been aware of, at least reasonably early in the quarter. I'm kind of curious why you wouldn't have preannounced your quarter, before kind of putting this up this morning.

Well, as a rule we don't do preannouncements. We've never done one, Bruce, in 15 years. We wait until the earnings conference call, as a rule.

Okay, guys. Thank you.

Thank you, Bruce.

Thank you. We'll take our next question from Daniel Owczarski with Belmont Harbor Capital.

2005, I was just hoping maybe you could talk a little bit more about that. If I remember right, on the last call, you had really been optimistic about it, thought that it could be a record year, now it sounds like maybe you might have some spill-over, some hangover from Hospira, and so I guess I'm starting, when I look at 2003, I'm wondering if you can even get back to those levels, or should we start there and maybe back down a little bit? Any thoughts on 2005 that you can further --.

Let me take that Frank. In 2005 we think it's going to be a very good year for a number of reasons. One is we know the sell-through. That's the first reason. We know that there will be, being very aggressive in the fourth quarter, reducing inventory to, we can only stop, they can only not buy product so long at this growth rate, then they have to accelerate their purchases to manufacture the product and assemble the product. We also know we're launching a number of new products. We know that international will kick in, in 2005. How aggressive it affects our numbers, it's too early to tell now.

But in the next earnings conference call we should be able to give you pretty good guidance as best we see it looking forward. We'll be into January then, so at that time we will, but we're very positive on 2005. If this was a problem with sales of the product, it would be a different story. This is a temporary bracketed reduction in inventory, and it won't come back.

And my job in the fourth quarter is to shake out any inventory that they have that could possibly come back and look attractive to Hospira to generate cash. We don't want that to ever look attractive in 2005, 2006. So anyway, we'll give you better guidance in January, but we think with the new products international, and as we see it, it should be a very, very good year. We don't want to put numbers on around it right now. We just think, as I said before, we think it's going to be a boomer.

As far as the -- I noticed in the press release, it looked like you tried to quantify the loss of sales to Hospira for this inventory reduction. Do you have, or can you give us a range or quantify what that shortage or shortfall would be year to date, and kind of what it will be all year?

Round numbers, Dan, it's in the 30 million range for the year. Some of that will fall in the fourth quarter. Actually closer to 34, 35, I think.

Okay. Then just the last question, I know that you're sensitive to Hospira, as far as sharing their sell-through numbers or growth rates or anything like that, but can you comment on any kind of market share trends or shifts, or are you seeing any impact from the smart side at all?

In total, Dan, we don't see very much of a shift at all. As usual, going back and forth with accounts, they'll pick up one, they'll lose one, but all in all, no real change at all.

Pretty stable. And pricing is stable, or --.

Yes, pricing's been stable.

Okay, thank you.

We'll take our next question from Mitra Ramgopal with Sidoti & Company.

Couple of questions. Actually, in terms of the Hospira relationship, I was under the impression they have a certain amount that they had to purchase from you on an annual basis, so you had pretty good visibility, but it seems that ever since they've spun off from Abbott the relationship just hasn't been the same. Given that you've said, you know, you have pretty good comfort in terms of what you're going to see next year, I was hoping -- I mean, obviously you don't want to give a good number, but are we talking 50 cents? $1? $1.50? I mean, a couple months ago, you said it was going to be a good year --.

First of all, I said boomer. I didn't say record year.

No, in July when you reported you said it was going to be a record year.

If you allow us to get a little closer to the year, the next earnings call we'll give you pretty good guidance on it. As far as your first point, Mitra, the relationship with Hospira is every bit as strong as it was with Abbott. There's been no change at all. I was the one that met with the top people at Abbott, telling them that they can reduce their inventories in the past. Once Hospira spun off they've just basically, as I say, took a page out of our play book and they are freeing up cash. They're doing exactly what you and I would do, but the relationship is still very strong.

As far as orders and ordering product we've, you know, the relationship is such that we would never force them to order product that they don't need, and would not want them to order product that they -- especially going forward. We want that inventory to be as low as humanly possible, and basically to -- everything that they order, 2005, 2006, is product that they absolutely need. No excess cash tied up. I take issue that the relationship is every bit as strong if not stronger. Chris Begley and myself go back many years, and I don't think we have any issues whatsoever as far as -- remember, we focused on international.

We've done an international agreements, we're making a products form for the international growth. They have to grow internationally. They've made it quite clear that that's where they're going to push, and we're going with them. We're 12% of their sales, one of the high-margin products for them. As I said, our international agreements are strong, and their Clave products continue to sell and sell well, as we've stated before.

So I think, all in all nothing's really changed. If not -- this is a good thing. Eventually this would have happened. At some point they would have tried to limit their inventory. Better to get it out of the way, get it behind us, and create a new base to go forward.

Just as an aside I know you spent about 10 million in the quarter repurchasing shares, at around $27.75, given where the stock is trading right now I assume you're going to be more aggressive.

That's a good assumption.

Okay. Thanks.

We'll go next to Aria Cole, Eaton Vance.

Good morning, gentlemen. Best of luck going forward.

Haven't talked to you in a while.

I took the summer off. Regarding just on Hospira, one question on Hospira, second on custom sets. On Hospira, can you give a sense of to what degree if any, they've actually been ordering from you here in June, September, and what do you expect in December, has it been a complete shut-off or have orders continued at some nominal rate?

Take it in pieces. Set source is separate from the Hospira Clave business. They are ordering some Clave product from us. There are certain products that they do need inventory on, so it's not a complete shut off. The bulk of the issue is on the bulk nonsterile product that they buy from us and use in their manufacturing process. That's not to say that the other packaged products they buy from us, have not been impacted as well. But, you know, they are continuing to buy product from us.

Okay. And then on the custom set side, can you give us maybe some updates on how effectively they're going after this business? You talked about the -- focus on pump side. Specifically in terms of my question I'm trying to get a sense for how many sales people they have dedicated or maybe actively involved in trying to open up accounts with surgeons to sell custom sets, and then how productive these sales people are in terms of revenue they're generating from the custom set product line per year.

You're talking Hospira specifically?

Yeah. Well, doesn't need to be Hospira. How about on a general basis? But Hospira is the primary focal point.

Yes and no, because more than half of our custom sets go through our independent distributors.

Right.

It's a focused area on both sides. I don't know how many Hospira salesmen are actively pursuing the custom set business. They all have the opportunity. One of the things that's happened there recently, is that they're focusing more on the IV pump business and that's caused them to give a little less attention to the custom set business, and you can see that in the numbers. The growth area is not what it had been in the past. On the other hand,the domestic distributors are spending a lot of time pushing custom sets. It's a good business for them, and that's continuing to look very good.

Can you give us --.

shortly, though, once they -- put the focus back on the Clave and custom business.

Like I said, though, one of the biggest opportunities for custom sets is when they convert the pump business over. That opens the door for the Hospira rep and our product specialists to move in and customize the different sets for the hospital ICU, for anesthesia, for the general IV therapy department. So that's one of our greatest opportunities.

We're telling you they're focusing specifically on pumps right now. They're really not focusing on set source. But we're getting contracts, we're getting quotes and such, but that's not their main emphasis. That follows the pump set business which is, you know, they're launching their new pump. I think it's got a good review so far, and I think that's where their main focus is.

Okay.

Expect that custom set business to continue to grow at a pretty good clip, though, year to year, year-over-year.

No, I understand that, but I'm just trying to get a sense of how many accounts are maybe being opened on a quarterly basis to kind of get a sense of the business maybe is hitting that inflection point, then if the surgeons who have ordered, if they're continuing to reorder on a go-forward basis after the trials.

That's a hard question. After the trials -- we could probably give you -- if you save this question for the next earnings conference call, we can probably give you more specific breakdown on that. It's hard to break down the numbers.

Our success rate on this is good. One of the reasons it is difficult to quantify is, it that the sales cycle in some of these can be very long, sometimes as long as six months from the time we give them a sample until they actually place an order. But the hit rate is pretty healthy.

Okay. Thank you. Best of luck.

Once again if you would like to ask a question, please press star 1 on your telephone keypad. We'll go next to Conan Lawson, American Express.

Hi, good morning. Can you -- the fourth quarter guidance it looks like if revenues are coming in around 13 million, it looks like the gross margin will be around 30% to get to your loss of 15 cents, and that would mean that product gross margins are probably 25, 26%. Can you just -- and then sort of explain that, and then in the context of the inventory on the balance sheet, that that hasn't really come down, and when that comes down I would imagine that would be sort of another pressure on gross margins. Can you just kind of walk through that?

I don't have here with me what the gross margin is in the fourth quarter but it's going to be low. We're looking for a large amount of unabsorbed production overhead coming from San Clemente in the fourth quarter. The inventory per se, it will go out with the standard gross margin on it, it's the lack of production that's going cause the large unabsorbed bearings here in San Clemente. The inventory will probably come down a little bit by the end of the year, but is probably going to be more of a reduction next year.

When would you anticipate -- if you're expecting the first quarter gets better when would you ramp production? How far in advance of the, you know, kind of demand will you ramp production?

Very little at all. We've got plenty of capacity to meet the demand.

When you ramp up --.

and then on -- just on the share count, I think we're looking at a primary share count at 13.6 million shares. What's the fully diluted share count? I guess you're showing that because of the loss. What's the fully diluted share count?

Well, the primary fully diluted is the same in the last period. The dilutive shares, recollection, it's about 900,000. We'll have the number in the 10-Q.

Okay. Then just receivables do you have an expectation for that in the fourth quarter?

Should be -- I don't have the exact number, but it's probably going to be about the same as it is now.

Okay. But just going back to the original question, the 25, 26% product gross margin is that in the realm of what you're -- without being exact, is that kind of in the general vicinity?

Yes, plus or minus.

Receivables, third quarter of last year, were 15.8. They're 14.4. So they will be about the same.

Maybe a little less with the fourth quarter revenues.

About same.

Could be less.

All right, great. Thanks.

We shouldn't see this -- this should not -- this temporary setback, or inventory reduction, should not carry into 2005. At best, two, three weeks at best, and we think that's worst case scenario.

Just one final. Is the sell-through -- I know you don't want to talk specifically but you talked about a $35 million inventory reduction from Hospira this year. Is the sell through -- should we look at the kind of current quarter run rate of, you know, say, I don't know, 20, 25 million, plus the 35 million, or is that not the right way to look at it, as the sell-through number?

No, they're not that closely attached. Particularly this year, when they've been cutting back on the inventory. The sell-through is up by a healthy amount, but the -- it's not reflective at all of what they're buying us, just because of a temporary reduction in inventory.

Okay, thanks.

We'll give you better guidance in the January call. Should be true -- sales to Hospira and sell-through should match pretty closely in 2005.

Thank you. This will conclude the question-and-answer session. At this time, we'll turn the conference back over to you gentlemen for any additional or closing comments.

Appreciate you calling in, and we'll talk to you in January.

Thank you. This does conclude today's conference. We appreciate your participation. You may now disconnect.