金百利克拉克 (KMB) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thanks for standing by.

Welcome to the I-Flow Corp. third-quarter results conference call.

During the presentation all participants will be in a listen only mode.

Afterwards, we will conduct a question-and-answer session. [Operator Instructions].

As a reminder this conference is being recorded Wednesday, Oct. 29, 2003.

I would now like to turn the conference over to Don Earhart, Chief Executive Officer with I-Flow Corporation.

Please go ahead, sir.

Thank you operator.

Good morning and thank you for joining us for I-Flow's third-quarter results conference call.

With me this morning is Chief Financial Officer Jim Talevich.

After our prepared remarks, we will be glad to answer your questions.

This was another solid quarter for I-Flow as our growth continued to accelerate.

Although the third-quarter is typically our weakest quarter, the summer months were very productive as each of our three primary business segments met or exceeded expectations.

This strong performance enabled us to achieve record revenues for the seventh consecutive quarter.

And most important, top line growth continued to be powered by expanding market penetration of the ON-Q Post-operative Pain Management System.

These results reflect the growing acceptance of ON-Q as a treatment option that enables patients to experience less pain, fewer side effects and shorter recovery time following surgery so that they can get back to their normal lives faster.

We are very pleased with our progress as we enter the Home Stretch of fiscal 2003 and we remain focused on maximizing long-term growth at the expense of short-term profits While strategically positioning I-Flow in the Surgical Pain Relief market.

I will now turn the call over to Jim to discuss the financial results.

After his review, I will have some additional comments on the quarter.

Jim.

Thanks Don.

Before we continue please note that this conference call will include forward-looking statements.

These statements are based on current expectations, estimates, and projections about our business based in part on assumptions made by management.

These statements are not guarantees of future performance and actual results may differ materially.

A more detailed discussion of these risks and uncertainties is contained in this morning's press release at I-Flow Corporation's various filings with the SEC.

These statements made during this call are made only as of the date of the call and we undertake no obligation to update the statements.

Net revenues for the third quarter ended September 30th, 2003, increased 35 percent to a record $12,985,000 from $9,639,000 in the third-quarter 2002.

By market segment regional anesthesia revenues increased by 66 percent to $5,195,000.

Oncology Infusion Services increased by 30 percent to 3,275,000 and IV Infusion Therapy revenues increased by 13 percent to 4,515,000.

Gross profit increased by 34 percent overall to 7,928,000 for the quarter from 5,928,000 for the quarter ended September 30th, 2002.

Selling general and administrative expenses increased to 7,968,000 for the third-quarter of 2003 from 5,209,000 in the prior year quarter primarily due to increased selling and marketing expenses to support the 2003 ON-Q sales expansion effort, which included the addition of approximately 40 sales representatives and, secondarily, due to the $100,000 entry fee for admission to the NASDAQ national market system in July.

Research and development expenses increased by 9 percent to $589,000 for the quarter, compared to $542,000 in the prior year quarter due to increased prototyping expenses.

The net loss for the quarter ended September 30th, 2003 was $386,000 or 2 cents per diluted share compared to net income of $107,000 or 1 cent per diluted share for the same period last year.

For the nine months ended September 30th, 2003, revenues increased 33 percent to a record $36,712,000 from $27,694,000 for the nine months ended September 30th, 2002.

By market segment, Regional Anesthesia revenues increased by 64 percent to 14,258,000.

Oncology Infusion Services revenues increased by 26 percent to 9,619,000 and IV Infusion Therapy revenues increased by 13 percent to $12,835,000.

Gross profit increased by 36 percent overall to 22,683,000 for the nine months ended September 30, 2003 from 16,735,000 for the nine months ended September 30th, 2002.

Selling, general, and administrative expenses increased to 21,636,000 for the first nine months of 2003 versus 14,525,000 for the comparable period in the prior year - primarily due to additional sales personnel.

Research and development expense decreased slightly to 1,611,000 for the first nine months of 2003 from 1,633,000 in the prior year period.

The net loss for the nine months ended September 30th, 2003, was 347,000 or 2 cents per diluted share compared to a net loss of 3,125,000 or 20 cents per diluted share for the nine months ended September 30th, 2002.

The loss in the prior year period included the effect of the change in accounting principle for goodwill.

Net income before the effects of the change in accounting principle for last year's first nine months was $349,000 or 2 cents per diluted share.

Moving to the balance sheet, total cash increased on the year-to-date basis by 9.8 million to 11.3 million as of September 30th, 2003.

The cash increase includes the net proceeds from the Company's private placement of stock on September 4th for 12.5 million..

These cash amounts do not include the anticipated proceeds from the sale of our Spinal Specialities subsidiary for approximately $6 million.

Total assets increased on a year-to-date basis by 13.9 million to 47.3 million as of September 30th, 2003, from 33.4 million as of December 31, 2002.

Total liabilities increased to 6.7 million as of September 30th, 2003, from 5.9 million as of December 30, 2002.

During the quarter ended September 30th, 2003, the Company repaid its bank lines of credit of 1.8 million and the Company is currently debt free.

Don?

Thank you, Jim.

Traditionally, the third-quarter is when many doctors and other health-care professionals who make purchase decisions to take their vacations - which means that they're unavailable for sales presentations.

In light of this, we are particularly pleased with I-Flow's performance.

For the quarter, ON-Q sales were up 91 percent over the comparable period a year ago and 69 percent ahead of the first nine months of 2003.

These results point to an increased use of ON-Q following a growing variety of surgeries, including open heart, bariatric (ph), C-section, hysterectomy, hernia, colorectal, mastectomy and orthopedics to name just a few.

The publication of Clinical Studies confirming the efficacy of the ON-Q technology and aggressive implementation of our sales and marketing programs are driving the acceptance of ON-Q as an emerging standard of care for post-operative pain relief.

We mentioned on the last conference call that our performance in fiscal 2003 is significant because the comparison of this year's results to last year's numbers is an apples to apples comparison since cents neither period includes Johnson & Johnson's [indiscernible] surgery subsidiary as I-Flow's distributor.

Clearly, we are benefiting from our independence as a direct distribution organization.

The ongoing change in the composition of our business is another key reason for our strong gross margin.

Two years ago, in 2001, Regional Anesthesia was only 25 percent of our total revenue.

In fiscal 2002, Regional Anesthesia increased dramatically to 32 percent of total revenue.

Through the first nine months of this year there has been another dramatic shift.

Regional Anesthesia has jumped to 39 percent of our total business, followed by IV Infusion Therapy at 35 percent, and Oncology Infusion Services at 26 percent.

We look for further revenue growth and margin improvement as the higher margin ON-Q products become an increasingly larger part of our total sales since they're growing at the faster rate.

During the last three months, we added another nine reps to our ON-Q sales network, giving us more than 85 sales representatives nationwide with plans to grow 100 by year-end 2003.

With less than 1 percent of the potential surgeries now benefiting from the therapeutic and economic advantages of technology like the ON-Q, we have only scratched the surface of this large and underpenetrated market estimated to be in excess of 15 million surgeries, annually, in the U.S. alone.

Clearly, this opportunity is substantial and we will continue to invest heavily in our sales and marketing infrastructure to build share for the ON-Q brand.

I'd like to note at this time yesterday's $6 million sale of our Spinal Specialities subsidiary plus last month's 12.5 million private placement will help provide the financial resources necessary to fund our ON-Q expansion therapy.

These funds are earmarked for programs that will continue to expand our ON-Q sales force and to provide the resources needed to educate consumers.

As I said earlier, all three of our primary businesses turned in strong performances.

And now more detail about the factors that led to these strong results and we will look at these details as we look at each of the business units.

First is Regional Anesthesia.

Third-quarter regional anesthesia sales which consist primarily of ON-Q increased 67 percent over the prior year quarter.

For the first nine months, sales increased 64 percent.

I mentioned earlier the addition of salespeople, but that's not the only reason why we are strongly growing this business.

In my opening comments, I mentioned the clinical studies demonstrating the efficacy and economic benefits of the ON-Q technology are a key component of the continuing ramp of this innovative pain relief technology.

During the quarter, ON-Q was featured in a presentation at the 21st World Congress in Endourology.

The presentation highlighted the benefits of using ON-Q to deliver non-narcotic site-specific pain relief for patients who underwent laparoscopic/robotic surgery for urological malignancy.

The results were impressive.

The ON-Q patients required half the amount of narcotics and had an earlier return to normal bowel function and ambulation.

Additionally, there were no wound infections and no wound abnormalities were seen on post operative follow-up three months later.

In September, the world-renowned Cancer Center M.B.

Anderson (ph) [indiscernible] at the University of Texas began to study to evaluate the post surgical benefits of ON-Q for women undergoing breast reconstructive surgery.

All of the participants will be evaluated on the amount of narcotics necessary to alleviate their pain and the pace of their overall recovery.

Earlier this month, the Journal of American Society of Anesthesiologists published a study of the safety and efficacy of using ON-Q following coronary artery bypass graft surgery.

The study found that patients using ON-Q reported significantly lower scores, experienced a 63 percent reduction in the use of narcotics, and - more importantly - left the hospital a day and a half earlier than normal.

Last week ON-Q was featured in two presentations at the American College of Surgeons 89th Annual Clinical Congress.

One study focused on chest surgery and involved 110 patients who received an ON-Q pump, epidural [indiscernible] combination of the two for post surgical pain management.

The ON-Q patients experienced a dramatic decrease in narcotic use and pain and an increase in lung volume in comparison to those using the epidural pump or the combination of the two.

The other study involved 50 patients who were given the ON-Q to manage their pain after inguinal hernia surgery.

Some received a local anesthetic and others a saline placebo.

The patients receiving the local anesthetic experienced a decrease in pain for an average of five days following surgery and had no infections or wound changes.

It goes without saying that recognition at professional forums and in prestigious peer journals is an invaluable tool for supporting the efficacy of ON-Q.

On the marketing side, we announced a copromotion agreement for ON-Q with Steiner Sports which represents such noteworthy professional athletes as New York Yankee All-Star Derek Jeter, NBA All-Star Jason Kidd, former heavyweight champ Muhammad Ali, Homerun King Mark McGuire and Hall of Famer Sandy Koufax.

These are impressive names.

However, the real value of this relationship is that I-Flow gains immediate access to National Football League trainers and their high-profile athlete patients.

In terms of getting the ON-Q message out, some of you may have seen the Dow Jones story that crossed the wire last week.

This piece entitled, "I-Flow Device Successful at Cutting Post Surgical Pain", was written by a reporter in the Chicago Dow Jones bureau who notes that quote "in studies of the device involving various surgical procedures, there has been less need for patients to take powerful narcotics that can cause addiction."

If you haven't already seen the posting I encourage you to check it out as it provides a very nice account of how and why ON-Q is the better alternative and why it is becoming increasingly more popular as an alternative to narcotics for treating post-operative pain, getting the message to consumers that narcotics can be dangerous and that there is a better way.

That better way is regional anesthesia and the ON-Q.

In addition, sales of Spinal Specialities Chronic Pain Products increased 25 percent over last year's third-quarter.

Although we are pleased with the success of Spinal Specialities, it no longer supports our primary strategic goal of making the ON-Q Post-op Pain Relief System the standard of care for post-operative pain relief.

Therefore, as we announced in yesterday's press release, I-Flow has entered into an agreement to sell its wholly-owned Spinal Specialities subsidiary to the Integra LifeSciences Holdings Corporation for approximately $6 million in cash.

Consummation of the transaction which is expected later this month or early November is subject to satisfaction of a number of customary conditions.

The importance of this transaction is primarily strategic with approximately $17 million in total cash after the sale and, virtually, no debt.

I-Flow is well positioned to focus on its core strategy as a recognized leader in the rapidly growing market for site-specific post-operative pain management, using regional anesthetics.

Next, let's talk about Oncology Infusion Services.

Sales for our infusion pump management subsidiary rose 30 percent in the third-quarter over last year's third-quarter.

For the nine months, sales were up 26 percent.

InfuSystem's co-marketing program with major pharmaceutical companies to provide physicians with pumps to administer the new drugs Camptosar and Eloxatin for treating colorectal cancer grew steadily during the quarter.

These new drugs protocols are having a positive impact on the clinical use of ambulatory infusion pumps for chemotherapy which, in turn, benefits InfuSystem's.

We're also using the InfuSystem provider contracts and medical billing expertise in a synergistic way to begin driving growth in the Regional Anesthesia market by providing the ON-Q family of products to outpatient surgery centers.

We plan to add dedicated sales representatives to call on outpatient surgery centers and provide yet another channel for physicians and patients to receive the clinical and economical benefits of ON-Q.

InfuSystem currently has more than 120 million lives under managed care contracts or approximately two-thirds of the insured patients eligible for treatment within the ambulatory oncology pump management market.

This core business continues to provide a solid foundation to develop and support new innovative pump services program that capitalize on market opportunities and provide opportunities for I-Flow to grow even further.

Our Infusion Therapy business will address next worldwide sales for IV Infusion Therapy which includes our intravenous elastomery pumps, mechanical and infusion devices and electronic infusion pumps and disposables grew at 13 percent over the comparable quarter last year.

Nine-month sales increased 13 percent over last year.

Increased sales of elastomeric pumps is the primary reason for this growth, driven by the products ease-of-use, reliability and reduced need for nursing intervention when compared to the clinical alternatives.

In conclusion.

We made good progress this quarter as ON-Q continued to gain acceptance with surgeons, nurses and hospital administrators.

There is still a lot of work to do as we focus on changing habits.

We expect to accomplish this by expanding our dedicated sales force and providing the necessary marketing support, continue with clinical studies to improve the cost savings and clinical advantages over narcotics, implement programs like our third party billing to make the product accessible to more patients, continue to expand the product offering to capture more surgeries and to expand the size of the potential market.

In summary, we intend to take full advantage of the opportunity to replace narcotics as the standard of care for treating post-operative time in some 15 million plus surgeries performed each year in the U.S. alone.

Operator, we're ready for the first question.

[Operator Instructions] William Plovanic (ph) with First Albany.

Good morning.

Good quarter.

Couple questions for you, first on the Steiner Sports contract.

Is there going to be any overlap with DJ Orthopedics?

No, we do not expect any overlap, Bill, it impacted this time.

We're considering not renewing our ongoing relationship with DJ Orthopedics.

So there will be no overlap at all with this.

Okay, and then, if you look at the -- talked about outpatient surgery revenues, included in the oncology help drive that, was that a significant number?

Where does that top into the revenue mix and that's basically the question -- what type number was it in the quarter and where in the revenue mix will that flow to?

Bill, we've not disclosed that.

Bill, this is Don.

We do not disclose that as Jim said.

However there is no number for ON-Q in the numbers reported for ON-Q Systems.

That is captured in the total ON-Q number for the Corporation.

So that's not even in there.

It's still a relatively small number at this time because that program is just beginning.

Does that answer the question?

Yes it does and just a couple of housekeeping - actually one more.

Gross margins as we look at it was up year-over-year but it was down sequentially from the first -- from the last three quarters and considering that the RA business is growing so quickly I am just curious as to why that would be down?

What is happening is we're having this terrible problem with our two lower margin businesses still growing.

And since they're growing so fast, the mix isn't changing enough so that Regional Anesthesia can continue to influence the higher margins.

We've got oncology growing much faster than we had projected and we got the homecare business growing much faster than we projected and even though the Regional Anesthesia business is growing very strongly, it's not growing fast enough for it to effect margins like that.

Does that make any sense?

Yes it does.

We got this terrible problem.

Our two lower margin businesses are growing faster than we projected.

That's a bad problem to have.

[indiscernible] problem, Bill.

Two questions for Jim, wondered if we could get the inventories and the accounts receivable at the end of the quarter?

The inventory number is 8.4 million and the receivable number is 11.9 million.

Jason Kroll with Roth Capital.

I guess, let's start with surgeon adoption and particularly I know you mentioned a bunch of procedures, Don.

If I asked you the top three that you're seeing the most adoption with the ON-Q, could you maybe just talk about those three? 1, 2, 3.

What I did when I listed them in my earlier talk I put them in level of importance.

So if you take a look at what I said, open heart, bariatric, C-section, hysterectomy.

Those are probably the top four.

The others are still important but those are probably our top four.

Do you see that mix changing?

I know you guys had a [indiscernible] last week - did you see any indication of other potential surgeries or surgeons coming on board to -- or looking at the products?

If you go back to what our strategy is, Jason, it is to go after the surgeons who are performing the - I hate to use the word bigger - but the more complicated surgeries and the more expensive surgeries because they get whatever they want in their procedures.

So it makes it an easier sell for us because No. 1, they recognize very quickly the advantages of the ON-Q over what they're doing now with narcotics so they adopt faster and because they get what they want in a hospital they have a tendency to help us more as we then take it to the committees.

So the answer to your question is, we will continue to focus on those surgeries where the surgeon has more clout and can get what he wants because he helps us open the door in the hospital to all surgeries.

Does that make any sense?

Absolutely.

You mentioned the [indiscernible] Orthopedics relationship.

How much of your ON-Q sales right now are orthopedic applications and then - how would you, I guess if you don't renew that relationship, effectively target that market?

No. 1, we don't give those kinds of numbers but I will say this is that we have a significant sales with DJ that we will have the opportunity now to capture on a direct basis just like we did the [indiscernible].

Remember that the opportunity there will be significant increase in revenues on that which we capture and an improvement in margins.

And now that we have a sales force in place that is already trained and we continue to add to that sales force, we expect us to be a benefit for the Company as opposed to a negative.

All right, of the 80 you mentioned that are placed in the sales force what is the breakdown in the hospital and in the billing reps?

We don't really give that out, but really getting that off the top of my head I would say about 10 today are billing reps.

The rest are dedicated to the hospital side - either inside reps or outside reps.

Now we will be substantially increasing the number of billing reps.

So the most of the 20 are going to be billing in Q4?

I would say about half that we have will probably be on the billing side because we would like to be at the 20 by the end of the year.

Now whether we get there or not, Jason, I don't know yet, but we would like to be fully staffed about 20 on the billing side.

We consider that to be an extremely big opportunity for us.

Longer-term 2004 you continue seeing additions in the sales force and if I asked you 2004 and [indiscernible] how many [indiscernible] hospitals and combined billing reps would you like to see in your sales force?

I don't have the answer to that but we will continue to be opportunistic in the opportunities to increase market penetration become available which means we will add salespeople as the territories grow and it makes sense to split them into two or three will add additional salespeople and of course we will be very opportunistic on a marketing side to make sure that we take advantage of any opportunity that would help us get the word out to surgeons or consumers.

Adrian Doss with JM Hartwell.

Congratulations on a great quarter.

Could you talk a little bit about the combination of new sales force and productivity that you are currently seeing and what you're expecting run rates to be as we look out into '04 and then I have a couple after that?

Adrian, we don't give that kind of information.

One of the things that I think is important is that right now we have about six salespeople that have been with us a year or longer.

So if you take six out of that total of 80 or 85 it is not very many.

Most of the salespeople we have today have been with us, obviously, for less than a year.

So it is still very difficult to measure what their productivity should be but I will say this.

That in the early days of hiring the sales force we found that it took 6 to 9 months for them to reach a point we would call breakeven.

Breakeven being that they start paying for themselves.

We're finding that has been reduced to somewhere between four and six months.

And as we continue to gain share and as we give them territories that have more base, we expect that to speed up even further.

So what would we give as a quota for sales reps today?

I think somewhere between 400 and $500,000 (ph) would be the average quota today but of course that will increase as we continue to make progress on a number of surgeries that we capture.

Great.

Maybe you can sort of give us a sense of what the six longest tenured salespeople are doing on average?

Is it above that quota you set so it's a conservative number for '04?

Yes - the answer to the question is yes, doing better than that.

If we look at the balance sheet you've obviously got a very healthy cash position following the sale of Spinal Specialities how rapidly do you expect to use that cash?

And how much is going into inventory and receivables and so on?

What kind of ratio should we think of for every dollar of sales, how much working capital do you think you need to tie up in it?

Just a moment, Adrian.

I really don't understand the question in total.

We don't expect receivables to go up significantly or anything else because our days payments are very good.

I don't really know the answer to that one, Adrian, other than the fact that as we add salespeople and as they pick up speed fast or quicker, I don't expect us to spend all that money in the short term.

I expect us to get productivity and we will continue to grow this business without using all that cash if that's what you're asking me.

Great.

Thanks a lot and congratulations.

Howard Halpern with Taglich Brothers.

First question, I guess, with -- concerning Spinal Specialities.

Would you be able to give what the revenue contribution of Spinal Specialities was for the first nine months, either as [indiscernible] percentage basis?

Yeah, just one moment and we will get for you --

About 3.5 million.

Did you get that (indiscernible)?

And with the growth of your sales force the deployment of cash that you're going to make, you don't see any reason why that that shouldn't be offset to a greater degree in '04?

And [indiscernible]?

That $3 million.

I think what you're going to see next year is of course we will have to make up that revenue to stay at the same level but of course we will restate and compare ourselves to each quarter next year without Spinal.

I think you'll actually see an improvement in margins.

Because if you -- as you can guess, Spinal Specialities were nowhere near the margins of the ON-Q business.

As you know, we reported ON-Q growth being much greater than the overall growth of Regional Anesthesia which was held back by the growth of Spinal.

Okay and I guess at this point in time, how many I guess hospitals have you gotten into and how far along in each hospital are you having mature base I guess sales there?

Well only one percent of the total market capture between us and all the competitors, you can tell, it's a very small percentage of the opportunity that has been surrounded.

Of the number of hospitals we believe there is over 5,000 hospitals - we are in less than 500 right now.

And the penetration in those 500 is at the very beginning stages.

That's what makes the opportunity so exciting is they're still 99 percent of that market that's using narcotics and that's the opportunity we're going after.

And I guess what type of -- I'll use the word pipeline of different studies and presentations are there that I guess we will be seeing throughout the remainder of this year and into '04?

Well I think you're going to be very excited about what happens between now and the end of the year because we have a couple of very very important studies that will soon be published in some very important journals.

I think you'll find that to be very very impressive what you see as we go forward this year because we got some big studies to be published yet.

One final question.

How many shares outstanding [indiscernible] have?

Just a second and I'll have Jim check that for you.

18 million.

18 million -- did you get that?

I got it.

Bill Miller with JM Harwell.

I know you must be doing very well - a great quarter.

Just getting back to the sales force issue - I have three questions or two or three anyway.

One at the fourth quarter of last year seems to me you were approximately 25 salesmen - is that about right?

We actually left the year at 40 (ph) last year.

Now, that includes the outside and it includes a couple of people on the ampusystem side that was doing plastic surgery so...

So 40 last year and from the sounds of it, you're going to be at about 100 this year?

We hope to leave the year around 100.

Now the question I have is given the fact that you now raised an additional $6 million, you more than doubled, you went up 2 1/2 times in the sales force from last year to this.

What added advantage do you get by having that $6 million on the balance sheet.

Can you grow the sales force even faster than you did?

Does it just give you confidence to go out and hire people or take other marketing initiatives or is there some actual number that you have in mind?

Because 2 1/2 times in the sales force is really terrific and [indiscernible] [indiscernible] fantastic.

But can you really have that kind of growth now because you've done this Spinal Specialities deal or what do you hope to achieve in the way [indiscernible] simply sales force growth next year?

I think, Bill, it is going to take more than just simply sales force growth.

And the money that we have on the balance sheet can be used opportunistically on the marketing side as well.

As you well know that there are marketing programs out there that could chew up a significant amount of that 16 million or 17 million if we actually decided to invest that way.

We're not ready yet for those kinds of programs because we don't have enough users for it to make sense, but somewhere down the road, we're going to hit critical mass.

And it's now going to become important that we use some of that money on the marketing side to inform more surgeons and consumers like yourself that there's a better way.

We're not there yet, but as we continue to grow the base, we expect to get there in the near future.

So don't look at that money to be just for sales people.

That can be utilized in other ways to grow this market as well.

In theory, a salesman costs you what? $50,000 or so per year, [indiscernible] [indiscernible] if he had no revenues, he'd cost you 50,000 in salaries [indiscernible]

I wish that were true, Bill [indiscernible].

(inaudible)

Yeah, our typical sales rep if you include everything if he hits quota -- if he hits quota, his commission, his salary, his overhead - which is insurance, everything else - is about $250,000.

Car -- you count everything.

It's not cheap.

So he has to generate $250,000 approximately to break even?

We estimate about $20,000 a month.

That (indiscernible) means that you could hire with [indiscernible] [inaudible]

My problem is I don't think I could do it very quickly, Bill.

There aren't that many people available tomorrow so it'd take a long time to get there and number 2, I am not sure we can handle 300 today.

So how fast do you think you can ramp, you went from 40 to 100, that's fantastic.

That's really wonderful.

Can you take it from 100 to 200?

Hire half again is much more in other words, you did 60 last year, if you go 90 or to 100 this year or is that just too far-fetched to think?

The limiting factor is how fast the existing territories will grow.

If they reach a certain level we will split them.

So if they reach that level quickly we will add another rep.

The advantage being that we can give a brand-new rep some base business to build on.

And that really determines how fast we will add.

So as we bring on the new people and our existing people continue to grow their territories when they reach a certain level, we will split them, add another rep for the other piece and and that's how we will grow.

So -- to answer your question is I don't know the answer as to how fast.

But we will do it as quickly as those territories reach what we call a critical mass.

That's exactly what we're doing on the regions for example.

We had 4 regions prior to two weeks ago.

We have now taken those regions and split them into 8 and as those regions grow and the number of sales reps in each region grow, we will then split those probably into 12 and then into 16.

Each region will have anywhere from 8 to 10 reps.

That's terrific, Don.

One other small question.

In a normal year how much is the Regional Anesthesia down if you had to guess what, historically, has happened from the second quarter to the end of the third quarter?

What would you say it was normally down?

Ten percent quarter to quarter?

Are you talking about seasonality?

Yes.

Our third-quarter has always been a tough quarter for us, Bill, and that is because of all the vacation -- you not only have the vacations from the doctors, you have the vacations from your sales reps to worry about.

So what would you think, a normal seasonal factor is down 10 percent, second quarter third-quarter?

That is probably a good guess as any, Bill.

Ladies and gentlemen [Operator Instructions].

William Plovanic.

First Albany.

Couple of housekeeping questions to follow-up with.

One when you sell the C-bloc is that going to go -- question is, is that going to be sold with Spinal Specialities or are you going to keep that?

No, that will be kept with ON-Q where it is now, Bill.

In the early days when we purchased Spinal the plan at that time was to have C-bloc in the spinal organization.

When we got back the ON-Q product from [indiscernible] and we build a direct sales force, it made sense at that time to put it with the direct sales force and that's where it's been for the last two years.

So it stays with I-Flow - it does not go with Spinal.

Jim, can you give us the split on the sales and marketing on G&A in the quarter?

Between sales and marketing vs.

G&A?

Right.

Yeah, sales and marketing was 5.5 million.

And G&A was 2.5.

And then depreciation and amortization in the quarter?

Yeah.

I don't have that with me.

One more question.

Hello?

The percentage of hospitals that are reordering the product.

You said you have about just less than 500 hospitals that you're working with now.

What's been the reorder rates from the hospital you have signed up.

Very high - we don't give that number out but it is very high.

Once we penetrate, we tend to stay.

Mike Sturmbaum (ph) [indiscernible], private investor.

Does insurance coverage now cover the ON-Q system or [indiscernible]?

We get the question a lot about whether or not we have a reimbursement code.

Probably the best way to answer that question is is the ON-Q does have a reimbursement code.

The misunderstanding is that we don't have a reimbursement code but we actually do have a code, a published code, for the ON-Q.

Now since we have a code it's up to the insurance companies as to whether or not they want to reimburse it.

So when we take a look at Medicare - Medicare, typically, does not reimbursed for the product.

However, private insurance companies in many cases will reimburse for the product.

So if it is used in the hospital for an inpatient, it's covered under the DRGs and therefore the reimbursement code has no value.

That's why we do the clinical studies to show the cost savings, and the reduction and stay to justify its expenditure.

However, in the outpatient surgery centers, the code becomes very valuable.

That's why we're able to put in place a billing program to our InfuSystem subsidiary because they can bill this product using a legitimate code, a specific code to the product, to the insurance companies.

Now the reimbursement is different, depending on the insurance companies.

Some will pay, some will not pay, some will pay X amount, some will pay Y amount.

It's all over the board but so far we've been successful in collecting enough to make it a very interesting business.

On the Medicare side, however, since we know they do not reimburse for the product we do not bill it.

So it's not a program for Medicare.

It is a program for all other insurance carriers.

Do you expect the change in the Medicare coverage?

Yes, we are in the process of appealing that as we speak.

And I would hope in the next 6 to 9 months we will get a ruling.

Bennett Nottman with Schottke (ph) Capital.

Congratulations on the quarter.

Could you guys just talk a little bit about how the sell process might be switching if at all from sort of a missionary sale to more of a pull through sale, either within the hospitals that you've penetrated or within new hospitals as maybe they've heard about you through studies and have come out and what not and maybe what that's doing to sales rep effectiveness and that type of thing?

The biggest problem we have right now is that we get so many requests to bring the product into a surgeon or to a hospital that we just can't honor the requests because it pulls our sales people away from the customers they're servicing.

So we don't have a lack of leads and we don't have a lack of requests but what we have to be careful about is that when you go into a brand-new hospital, you've got to assume a six-month or longer process to get it approved by all the committees and to get it authorized to be used throughout the facility.

So number 1 is, we don't have a lack of request to bring the product in but we have to keep our existing people focused.

That's why we're hiring more people so that we can go after more of those leads.

Do you have any sort of count on the number of hospitals where you have sort of cleared all the committees and been approved this quarter versus last quarter?

And maybe how many are pending and maybe any sort of way where you can qualitatively start checking them off and move onto the next hospital, I guess?

No.

We don't publish those kinds of numbers.

We know what they are internally but we don't publish those kind of numbers.

We have to be very careful here.

We are a public company and we do have competition.

So some of these numbers we're not prepared to provide.

I'm sorry about that.

That's okay but as you get through committee and approved within one particular hospital are you then able to sort of more become an order taker and deliver product and send the salesperson on to the intensive and the next opportunity or does there -- is there still a lot of maintenance that salesperson has to do even when you've been through approval?

It's interesting.

When we go into a hospital we typically get 1, 2, or 3 surgeons using the product.

They then help us with the committee process.

So they help us get through the committees by supporting us.

Once we get through the committees and we get authorization to go across the hospital, that's really like a hunting license.

You still have to go into every surgeon and you've got to be with them when they do the surgeries, initially, so that they understand how to use the product, what is the best place for the catheter and etc., etc.

So the answer to your question is that once we get a hospital to give us the green light, we can stand months and possibly even a year or more just going after surgeries and growing the business within that hospital.

We believe a typical hospital can generate more than $.5 million in revenue.

Many hospitals will over $1 million in revenue if they adopt the ON-Q as a standard of care for the surgeries that I mentioned earlier.

So one hospital can be a huge win and, when we reach that point, we're actually looking at putting a dedicated person into the hospital to make sure they're there every day working with the doctors and the O.R. directors to have the product available for every surgery.

So if you're getting $1 million or more in revenue from a hospital, you can afford somebody -- this is not a senior level rep that costs you to $250,000.

This is more like a nursing rep who costs you significantly less that is there to answer questions and to make sure the product is being used on a regular basis.

That's actually the model we're looking at as we go further.

And as we convert some of these hospitals to fairly significant accounts.

Does that make sense?

It sure does.

Thank you.

Wes Schamm (ph) [indiscernible] with Welsh Capital.

Just wanted to ask you about the spine segment that you sold. [indiscernible] did you have a dedicated sales force for that segment or was it just a product that your whole entire sales force offered?

No, we did not have a direct sales force and the product -- are you talking about the Osteoject [indiscernible] product.

That's correct.

The biggest problem we had there is we did not have a direct sales force for that product.

The product we have - we believe - is excellent.

We believe it's a very very good product.

The problem is it takes a lot of resources to build a sales force to sell it.

Okay so how did you market that product?

It was just something that your entire sales force had and they were spending most of their time targeting [indiscernible] and what not?

We didn't market it at all through a sales force.

We marketed it through distributors and by telephone.

So you had independent distributors distributing the product then?

Yes.

How many distributors did you have distributing it?

We had about a half-dozen distributors actually signed on to distribute the product.

However, when we knew that we were going to move towards a sale we began to back off on the distribution network.

And so, really, it hasn't had any attention for probably about five months, four months, something like that.

But the product is excellent but here's the dilemma we had.

The total market for [indiscernible] we believe is about $250 million in the United States.

That's one tenth the size of what we believe is the potential market for the ON-Q.

Understood.

Those six distributors - do you have any idea how many reps that they had within their distributor?

They probably had any where from 5 to 10 reps per distributorship.

But again they weren't giving this product 100 percent of their time.

Understood.

So going back to that, how many regions did they cover?

The [indiscernible] ?

Probably 5, which was 25 for the U.S. or less.

We had to stop adding distributors when we made the decision to sell.

We couldn't sign contracts with the distributors and give them minimums when we made the decision to sell.

And how much -- what was the ASP for (indiscernible)system?

Our system was totally different from anybody else's because we used a reusable driver with a very inexpensive disposable kit.

So our margins were very, very high in that business.

But our average realized price doesn't make any sense because if you take a look at the competition they used a driver once and the disposable once.

And, therefore, they sell the kits for a much higher price than we do -- while we sell the driver for close to $1000 and then the kits are sold for a much lower price but the driver's reusable.

How much were the kits sold at?

They were sold somewhere in the neighborhood of $200.00.

$200?

How many [indiscernible], how many levels could you do with one kit?

Are you one of the competitors?

Because that's a good questions -- those kits went anywhere from $200 to $250 apiece.

But how many procedures could you do with a kit?

You could usually get 2 levels. (indiscernible) because of the strength of the driver you could deliver very thick cement which means you did not have problems with the cement leaking outside of the body.

I mean, it's an excellent excellent system.

Do you have a capitation (ph) system?

No.

So it was a needle [indiscernible] body no capitation system.

We believe you don't need a cap -- that type of a system.

Procedures do not need that.

So you had six distributors [indiscernible] six distributors but you really stopped focusing on and it was basically just independent reps and you only penetrated 25 percent of the U.S.?

Yes - the problem we had was that we knew we were selling this thing for the last 4 to 6 months.

So none of your sales force that you -- that sales force you have right now they weren't selling any of this?

They had no involvement in all.

All right and that was 3.5 million for the first nine months?

Somewhere in that neighborhood - yes.

Steve Friedman with Thurston (ph) Capital.

In looking at the ON-Q numbers from the model that I have, it looks like you're getting around you have around 20 plus percent sequential growth roughly.

Just want to get an idea, is that in the ballpark - correct?

Just a moment and we will take a look at the numbers.

It's probably closer to 12 to 15 percent.

Okay, great and any kind of idea like whether that's going forward, if that's ramping, increasing the rate is increasing or staying flat or ... ?

I think you'll find that the growth is increasing from quarter to quarter.

Remember now third quarter was summer and we were just thankful we had any growth at all from second-quarter in summer because that's not normal for us and the rest of our businesses.

Jason Kroll with Roth Capital.

Don, quick question on the studies that you mentioned that you expect to be published here in the fourth-quarter.

What specifically are those?

Let me ask my chief medical guy if we are allowed to say anything yet, Jason.

I'm going to introduce you, Jason, you know Roger Massengale (ph) - Roger is going to answer that question directly.

Paul White's got another study coming out for orthopedic procedures for continuous air block application.

That one's in the Journal right now in it has already been accepted for this month.

What journal?

Anesthesia and analgesia (ph).

There's a couple more - we got word they shifted the date on one by 30 days and so until I have it in my hands, I don't want to commit on the others but there's a couple more that absolutely will come out.

I guess Roger since you're on the line any more focus on looking at [indiscernible] retrospectively [indiscernible] closure period during the studies?

Yes, of course, every study that we do we look at wound healing [indiscernible] and so every time we complete a study we can add that to the database and one day do a [indiscernible] analysis to go back over all the studies.

Right now we have over 1,000 patients under study and infection rates are substantially lower than the average for CDC, what CDC typically states is an infection rate, so right now we have pretty compelling data and that was summarized in a poster that Ellen Dye (ph) [indiscernible] presented at a nursing conference a few months back.

And, again, that data continues to come out, but the prospective studies as you know the work that we're doing in St. Louis we expect that will also be very encouraging.

Where we're looking specifically at the measures [indiscernible] wound healing and in that particular study oxygen retention in the wounds.

So, I think combines between all the studies is sort of a group, [indiscernible] I think it's a pretty compelling story.

After Ellen Dye published that type of data talked about in the poster, did you notice a considerable up take in adoption, I guess, was infection [indiscernible] concern and has it alleviated significantly or (indiscernible) somewhat sense that you've made that data more available?

It helped us a lot.

Again No. 1 concern is infection and we've always come out with sort of a story.

It helps to have a poster presentation that we can drop in front of them is and say here is some data.

And, again, every time we come out with another study it's yet more evidence that we can dump in their lap to indicate that this really isn't a problem Jason, it's not a hard objection to overcome going into the first several meetings.

Bill Miller with JM Hartwell.

Could you give us any idea of how much your current sales are with Dawn Joy (ph) for say, prospectively for this year and, secondly, can you give us any qualifications on the people [indiscernible] [technical difficulty] hired as salespeople?

On your first question, Bill, those are not numbers we published and I don't believe DJ publishes them either.

So we would not want to comment on that for obvious reasons, but I think we will see the same kind of benefit, Bill, that we saw when we picked up the Ethacon (ph) product in that we sell it to DJ for a fraction of what we sell it to the end-user.

So I think we will be okay.

I am sure you will be okay, [indiscernible] [inaudible]

That's a good question Bill -- you might want to ask DJ that question.

How about the people waiting in line to join your sales force?

Could you give some indication of the kind of people you're getting and qualifications they have and whether that's stretched into (indiscernible) people or whether it's easier than it was before?

It's actually easier to find good people than it was a year and a half ago when nobody knew anything about us and this was a real roll of the dice for most of these people.

It's still not easy.

I don't like the words easy to find [indiscernible] particular right now but let's just say this.

We are interviewing a number of candidates for these new slots.

And we expect to be able to fill them by the end of the year.

The type of representative we want is somebody who's got surgical experience, knows his way or her way around the OR, and likes living in scrubs.

That's very very important.

They've got to bring with them a network of surgeons that they already sell to because they will be under tremendous pressure to reach that breakeven mark in a very short period of time so they're going to want to bring a lot of friends and contacts and network to start using the product the day they arrive.

It's just in their best interest as well as in the best interest of the Corporation that they bring customers the day they come on board.

There are no further questions at this time.

Please continue.

Thank you very much for your interest in I-Flow.

We look forward to reporting our fourth-quarter and our fiscal 2003 results and hope that you will be able to join us for our next update.

Again thank you for your questions, they were excellent and for giving us the time to tell you the I-Flow and the ON-Q story.

Thank you.

Ladies and gentlemen, that does conclude your conference call for today.

We thank you for your participation and ask that you please disconnect your line.