金百利克拉克 (KMB) 2004 Q2 法說會逐字稿

Welcome to the I-Flow second-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, Tuesday July 27, 2004.

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

Please proceed sir.

Thank you, Nick.

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

Jim Talevich, our Chief Financial Officer, and I look forward to answering your questions after our prepared remarks.

As we mentioned this morning, the second quarter of 2004 was another quarter of record performance for I-Flow.

Here is a quick review of some of the key metrics.

Total revenue increased 51 percent compared to the same quarter in the prior year.

This growth reflected increases in each of our business units.

Oncology Infusion Services was up 35 percent, IV Infusion Therapy grew 22 percent, and the continued surge in sales of our ON-Q products drove Regional Anesthesia sales up by 96 percent.

And even this dramatic increase in Regional Anesthesia sales by our direct sales force is an understatement, since in last year's second quarter we shipped product to DJ Orthopedics under the former distribution agreement.

If you back out the PainBuster sales to DJ Orthopedics from the prior quarter -- prior year quarter, Regional Anesthesia sales through our dedicated sales force in the second quarter increased by a strong 138 percent.

Clearly, we had another quarter of solid progress toward our goal of establishing ON-Q as a standard of care for post-surgical pain relief.

By the end of the second quarter, we believe our direct hospital sales force was calling on more than 700 hospitals throughout the United States.

This group totaled 87 quota-carrying sales professionals calling on hospitals and surgeons, compared to 76 professionals at the end of the first quarter and 60 at the end of last year.

Because we were able to hire new salespeople during the second quarter sooner than originally planned, our recruiting and selling expenses for this quarter were higher than anticipated.

This is a timing issue for these expenses, and not an area of concern.

In fact, we consider this to be a positive development since we are finding it easier to recruit and hire qualified people as the opportunity to join the I-Flow team and sell the ON-Q products is becoming more attractive to a surgical salesperson as the product continues to gain traction.

With our well-publicized strategy to grow top-line sales as rapidly as possible at the expense of short-term earnings, the sooner we add people and get them productive, the sooner we achieve our goals.

We still plan to hit our target of 150 quota-carrying sales professionals by the end of the year, some of whom will be calling on ambulatory surgery centers -- what we call ASCs -- and other outpatient facilities.

We began hiring for the separate direct ambulatory surgery center sales force with an initial 13 professionals joining the ON-Q team in the second quarter.

These hires facilitated our moving forward with the ON-Q Third-Party Billing Program for ASCs that we discussed in our last call, and we now have just over 65 facilities signed up.

By taking the reimbursement risk out of the equations for facilities that adopt our ON-Q products, this innovative third-party billing program is an important tool to help make ON-Q readily available in the outpatient surgery setting.

We believe that the ASC market has exciting incremental sales potential for us, but of course, it will take time before it becomes a meaningful contributor to our growth.

Since this program is new, and the dedicated sales force is just now being hired and trained, gross billings were not significant, and less than $100,000 in net billings were recognized in the ON-Q revenue for the second quarter.

In summary, our efforts to increase awareness and adoption of ON-Q are paying off.

By making ON-Q more widely available through the expansion of our two direct sales forces, supported by a multifaceted marketing approach, we are meeting with increasing success.

Specifically, we are supporting our direct sales push with clinical research that demonstrates the benefits of ON-Q in reducing pain without the use of narcotics in more and more surgical indications.

We are making our target customers aware of these results through aggressive, carefully targeted marketing and publicity campaigns, and we have developed innovative programs to make it easier for surgeons and hospitals to adopt our products by minimizing or eliminating facility reimbursement risks.

There were other significant developments during the second quarter that I will review with you after Jim reviews the numbers.

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 by management.

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

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

The statements made during this call are made only as of today's date, and we undertake no obligation to update these statements.

Revenue for the second quarter ended June 30, 2004 rose 51 percent, to a record $17,167,000 from $11,383,000 for the second quarter of 2003.

The largest component of the increase was in the Regional Anesthesia market which increased by 96 percent, to $7,513,000 from $3,839,000 for last year's second quarter.

Gross profit increased by 63 percent overall, including the effect of an increase in gross profit as a percentage of revenues by 5 percentage points to 70 percent of revenues.

Net income for this year's second quarter was a loss of $1,504,000, or 7 cents per share.

This compares to net income of $22,000, or zero cents per share, for last year's second quarter, which included net income of $78,000 from discontinued operations related to Spinal Specialties.

Selling, general and administrative expenses increased by $6,839,000 for the quarter ended June 30, 2004, to $13,763,000 compared to $6,924,000 in the prior year first quarter.

This increase was primarily due to increased selling and marketing expenses related to the Company's ON-Q product line.

Moving to the balance sheet, total cash increased by $37,851,000 to $53,036,000 as of June 30, 2004, compared to $15,185,000 as of December 31, 2003.

The cash increase included net proceeds to the Company of approximately $43 million from the Company's sale of 2,990,000 shares of stock in a public offering that closed on April 19, 2004.

Property, plant and equipment increased by $2,225,000 to $8,969,000 as of June 30, 2004, compared to $6,744,000 as of December 31, 2003, primarily due to purchases of additional electronic infusion pumps by the Company's InfuSystem subsidiary to support its growing rental business.

Total assets increased on a year-to-date basis by $42,943,000 to $94,839,000 as of June 30, 2004, from $51,896,000 as of December 31, 2003.

The Company had no long-term debt outstanding as of June 30, 2004, having repaid all bank debt during the previous fiscal year ended December 31, 2003.

Don?

Thanks, Jim.

I want to highlight one very important development during the second quarter that appears to have gone largely unnoticed by Wall Street, and that is, after a review of 15 clinical studies where the ON-Q PainBuster and Soaker Catheter were used to treat pain following surgery, the FDA cleared two new label indications for our proprietary brand.

We can now label ON-Q as offering significantly better pain relief than narcotics; and secondly, when ON-Q is used with narcotics, significantly less narcotics will be used.

Expressed another way, the FDA has cleared us to label that ON-Q is significantly better than narcotics at reducing the pain following surgery, and when it is used in combination with narcotics to treat the pain following surgery, significantly less narcotics will be needed.

We know of no other device in the world that has received clearance from the FDA or any other regulatory body to be able to make these types of claims.

Now, why is this so important?

Back in 1998, the FDA cleared the ON-Q pump as a legitimate method to deliver non-narcotic anesthetic agents to a surgical site.

This method claim was tremendously important, of course, and you can see how we have run with it.

However, a method claim is considerably less powerful than an outcome, or label claim.

Being able to put on the ON-Q package that it is significantly better than narcotics at reducing the pain following surgery is very powerful.

Both surgeons and hospital administrators know that outcome claims for medical devices can only be made after a thorough review by the FDA.

Up until this watershed event, it has been up to I-Flow to convince surgeons and hospitals of the ON-Q's benefit, solely on the intuitiveness of the therapy and the results of our clinical studies as presented by our direct sales force.

This we have done through our investments in clinical studies over the past several years, the results of which have been amazingly consistent in support of ON-Q for post-surgical pain relief.

It was on the findings of 15 of these clinical studies that the FDA issued this latest and greatly expanded clearance that allows us to label for specific outcomes.

The new outcomes claims significantly enhance the credibility of the ON-Q products.

These new claims can be printed on the label of the ON-Q kits we sell for all surgeries, and we are quickly moving to implement this.

For us, this is comparable to a drug company being able to label a pain medication as being specifically applicable for the treatment of headaches.

With additional clinical studies nearing completion, with the potential to address new and possibly even more compelling reasons than pain relief -- like wound healing and reduced risk of infection -- we expect in the near future to have additional reasons for surgeons and hospital administrators to adopt the use of ON-Q.

As these studies are completed, the data will be potentially submitted to the FDA requesting clearance for additional outcome claims.

Ask yourself, if the FDA has cleared I-Flow to label ON-Q as being significantly better at treating the pain following surgery than narcotics, and if narcotics is today's current standard of care, what does that make ON-Q?

Doesn't that make it the new gold standard?

Here's another thing to think about.

If the FDA agrees that ON-Q is better then systemic narcotics at treating the pain following surgery, won't surgeons be more inclined to view it as a new best practice, and thus use it more?

Won't the insurers be more inclined to reimburse for it?

And finally, when patients find out that they can have less pain following surgery using less if any narcotics, won't they insist on it?

To us it seems to make logical sense that once all of these parties learn of ON-Q and its benefits, they will all help to drive adoption.

To summarize, the validation of the ON-Q family of products has been tremendously enhanced by the FDA's clearance of new label indications.

While I can't tell you the precise dollar amount of ON-Q sales in the quarter that were directly attributable to this clearance, we believe there is no doubt that it has stimulated interest in ON-Q and helped us obtain meetings with people we had trouble getting meetings with before.

In the second quarter we delivered outstanding performance in all three of our business segments.

Oncology continues to benefit from additional protocols requiring the use of electronic ambulatory pumps, and more oncologists are adopting the InfuSystem program to obtain these pumps.

IV Infusion Services continues to surprise us with its strong double-digit growth.

And needless to say, we made excellent progress toward achieving our strategic objectives in our Regional Anesthesia business.

We increased ON-Q revenue by more than the 80 percent we had previously estimated during the recent fundraising by almost doubling it; we accelerated the hiring of salespeople; we increased our investment in marketing and public relations, and we expanded our clinical research to address new surgical applications and new indications like wound healing and reduced risk of infection.

And finally, we announced today that the Board of Directors has authorized the repurchase of up to 1 million shares of the Company's common stock.

With our goal being to establish the ON-Q family products as the standard of care for post-surgical pain relief, and with the rapid progress we are experiencing in increasing awareness and driving adoption, we believe the Company's value is not fully reflected in I-Flow's current stock price, and that our stock represents one of the most attractive investment opportunities available to us and our stockholders.

Our debt-free cash-rich balance sheet allows us to support this repurchase plan while maintaining our financial flexibility.

Let me end by saying, even though we continued to accomplish much, we will not be satisfied until the world recognizes ON-Q as a gold standard for treating pain following surgery.

Our opportunity is vast and we are committed to making the most of it.

Nick, we are now ready to take questions.

(OPERATOR INSTRUCTIONS).

William Plovanic, First Albany (indiscernible).

Congratulations on a great quarter.

A couple of questions.

First of all, just some housekeeping for Jim.

Sales and marketing and R&D -- could you give us the split for the quarter?

Sure.

Sales and marketing for the quarter was 9 million 940;

R&D was 691,000.

691.

And then I can pull the G&A out of that.

Actually I was looking for (inaudible).

And the G&A?

That would be 3 million 823.

You had said that the IV Infusion and the Oncology businesses, they're just doing extremely well, better than expectations.

What is driving that?

The Oncology -- Bill, this is Don.

The Oncology business is being driven by new protocols, and we're getting a second benefit that we had not planned on.

When a doctor adopts the program for some of the new protocols and brings ambulatory pumps into his office, he finds out very quickly that he might as well start using them for older drugs or protocols that he was not doing before.

So since he's already committed to bringing the pumps in for some of the new drugs, he's beginning to use the pumps now for some of the old drugs -- protocols which he avoided in the past to stay away from the pumps.

So we're getting a double hit on this.

On the IV Infusion Therapy business, the only thing I can explain that by is the fact that when you use disposable pumps like our balloon pumps to deliver IV drugs, it's very easy for the patient, and therefore eliminates a lot of the costs associated with putting nurses in the field to train, retrain and retrain patients.

So people are beginning to understand the productivity savings associated with very simple devices being used in the home that do not require nurses to go out and teach.

That's the only way we can explain the increase.

Let's switch over to the more important business, the Regional Anesthesia.

For the hospital piece of that, you said -- can you give us a split between the outside reps, inside reps?

And then moving over to the ambulatory surgery center, just give us the absolute numbers where we are today and what the hiring plans are for the third quarter?

Let me see if I can get all this (multiple speakers) -- this number right here.

If you take everybody associated with the sales side -- which includes the inside, it includes the quota-carrying reps, and it includes the new ASC reps -- we're up to about 172 people right now.

So we've got 87 on the hospital side, 13 on the ambulatory surgery center side, giving us a total of 100 quota-carrying reps.

And then the remainder of that is all support groups.

That's as of the end of June.

It sounds like you have done some more hiring even since then.

Yes we have.

We had a training class.

To give you some idea, the second week in July, we had 47 people in the training class.

Now some of those are included in the 100 I talked about earlier, but we have another wave that came in in July.

It's just unbelievable how opportunistic we have been able to hire.

Are you still seeing -- just give us an idea on how long it takes these people in the hospital market to get to profitability, to hit that quota of 20,000?

And then after six months how many of them are there?

We're finding that -- I tell people like yourself that you should always assume six months or less, but we are seeing five months -- somewhere between five and four months with most of our new reps.

They're becoming more productive for a couple of reasons.

Number one, we're able to hire very good people; and number two, we are getting some traction, Bill.

And we're also seeing that the FDA clearance is healthy.

Lastly, and I'll jump back in the queue -- on the ambulatory surgery center, you mentioned that there was very little contribution from that in the quarter, less than 100,000.

Considering the number of facilities you have signed up, the billing that's going out now that you're trying to collect off the insurance companies, what can we expect for that as we go into the third quarter and the fourth quarter?

Could we expect that to triple, (indiscernible) the 300,000 to $500,000 range in the third quarter, really finally get some traction?

The way it's working right now is that we're finding that we have to submit twice on most of the billings.

In other words, we submit the first time, and if we don't get paid then we do the appeal.

And the difference in how much we get paid and the percentage jumps significantly on the second appeal, or I should say the first appeal, which is the second submission.

So that's because of course that this is a brand new product to most insurance companies, and we're spending time educating them on what we have got.

So I would not assume you're going to see much in the way of a contribution in the third quarter, but you'll begin to see more of a contribution in the fourth quarter.

The other thing is we're being very, very conservative on how much we actually take to the revenue line, where the gross billings are significantly greater than the 100,000.

But again, until we have history we're going to be very conservative.

Jason Kroll, Roth Capital.

My question revolves around the labeling.

With the labeling now backed by the FDA reduction -- significant reduction in (indiscernible) narcotic intake, can you also position that for specific surgeries, whether it be cardiovascular or general surgery?

And is that your intent to do that?

We do have the ability to put together what we call surgery-specific kits.

For example, we could put together a cardiovascular kit.

Of the 15 submissions that we did, the 15 clinicals, they represent 15 different surgeries.

So we could do 15 different kits if we wanted to.

We have not decided to do that at this time, Jason, because we're not sure it's that important.

The label claims we have are general and are against all surgeries.

However, you can't make a specific kit designed for a specific type of surgery unless you have a clinical study to back it up.

So even though we can label across the board for all surgeries, the new indications, we can still only make up about 15 different kits.

As additional studies, however, are completed for different types of surgeries, they now can also be made up as a special kit.

But we don't see a benefit right now to doing that, and of course you can imagine what would happen to our SKUs or our number of products we would have to sell if we were to make up individual kits.

We'd almost have to become a custom business.

What specifically, Don, in the quarter did you see in terms of surgeries, where you saw the bulk of ON-Q's going to, whether it be cardiovascular or hernia, or bariatric stuff? (indiscernible) prioritized some of that, the key ones?

Really it -- again, it's still all of the inpatient type surgeries, because that's what we target with the hospital sales force.

And with the ambulatory surgery center sales force just starting, we're not targeting the outpatient that much.

But again, it's the big stuff.

It's -- heart surgeries across the board are very good for us.

Bariatrics is growing very nicely.

Some of the oncology surgeries are doing very well.

OB/GYN is doing very well.

We are also getting some of the inpatient orthopedic surgeries, like hips and total knees.

So it's really all of the big stuff is very good for us, because that's what we target.

Are you seeing anything out there from a competitive standpoint coming -- you know, your competitors and mostly in the orthopedic field; are you seeing any of those guys venture out into the general surgery arena?

You know, every now and then you will see a hospital bring in, say, a competitor and try to use them outside of orthopedics, but it's still a very small effort.

And so far it's not been successful, Jason.

You know, again, those reps -- our competitive reps are not trained to be in those surgeries.

And the product doesn't work as well because they don't have the true Soaker Catheter, which you need for the longer incisions.

So it's not been a real threat for us.

There are pockets, but it is small.

Finally just back to the infusion therapy business, because it was so strong in the quarter.

How should we be thinking about modeling for that business going forward?

Were there any onetime type large sales in the quarter, or is a 20 -- lower 20 percent growth rate sustainable throughout the year?

What are you thinking in terms of expectations for that business?

In the second quarter, we had a significantly large order from our largest domestic distributor.

That was a surprise.

And again, remember they don't have any minimums that they half to meet, so this is not a loading order of any kind; this is an order that they actually needed.

Now, we have received at least two months of the third quarter order and we're not seeing the same kind of an increase.

However, it is still strong.

But I would not assume we're going to do 22 percent in the third quarter.

My feeling is it's probably mid to high single-digits for the year.

Spencer Nam, SG Cowen.

Thanks for taking my questions.

Just a couple of questions for you.

The first question is related to productivity, sales productivity.

You mentioned in your announcement this morning that now the ON-Q is available at over 700 hospitals.

And that previously the number 700 was also mentioned.

I was just curious -- based on that, whether we could assume that per hospital usage of ON-Q is growing rapidly, and if you have any additional data that could color some of that.

I think the best way to look at it, Spencer, is that I believe the last time we had the conference call, we talked about somewhere around 675 hospitals.

So if we're just now a little over 700 hospitals, then that sales increase comes from a very small increase of the number of hospitals.

So if you do the math, you can quickly figure out that we're getting significant productivity increases or significant volume increases from our existing accounts.

We're getting the penetration we've been looking for, because remember, our strategy is deep and wide.

And our strategy is not to target hospitals; it's to hire representatives who bring us Rolodexes who bring us surgeons.

We target surgeons, who may happen to be in a new hospital.

And when they are in a new hospital, that's how we get a new hospital.

But with hospitals, with the number of hospitals we're servicing going from, say, 675 to a little over 700.

And the revenue -- when you take out the DJ revenue from last year growing at 138 percent -- you can see that we're doing a lot more business in the existing accounts.

That's very helpful.

Thank you.

The second question I have is on the outlook.

You didn't mention that in your call specifically.

I was wondering if there is any specific guidance or outlook that you have in terms of the revenue target growth rates, anything in that direction?

No.

We don't give any targets, Spencer, I'm sorry.

That's fine.

On that, you've been growing at over 90 percent year-over-year for the last two quarters, and I was wondering if -- what factors would -- whether there are factors that could even push that even higher, and what's your thoughts on that going forward?

Well, if we had not had those DJ sales last year and we were only looking at direct sales force contribution -- like I said before it would be 138 -- there's no reason to believe based on what we know today it's going to be less than 90, and with additional people coming on board between now and the end of the year, there's a very good chance it could be greater than 90.

My final question on that is -- on that comment, with the big training class that you mentioned, do you foresee that the 100 -- the quota-carrying number that you're trying to target for the year -- you may be able to complete that well before the end of the year, or how do you see the timeline over the next six months?

Well, we think it's going to be more difficult to recruit during the summer months, because a lot of the representatives are on vacation.

But I do believe we're going to continue with our recruiting efforts, and we hope to have everybody on board by, say, November by the end of November.

Because our goal is to get them on board, get them trained so that on January 1 2005, we can drive more profitability.

Alex Arrow, Lazard.

Thanks, Don.

Congratulations as well.

First on the hospital distribution;

I know that your goal in the past had been to get each hospital up to $1 million run rate.

And I know you said you're in 700 hospitals now.

Can you give us any color on how many if any of those 700 have reached their potential of approximately $1 million dollar run rate?

Any hospitals that have crossed that line?

No, they haven't, Alex.

We still have lots of opportunity in all 700 of those hospitals.

Can you give us any kind of quantitative measure of -- of maybe what are the 10 best hospitals, how much are they doing per hospital?

That's a statistic I don't have handy.

If you call us this week, we could probably give you our top-10 hospitals, but we probably would not give you the number of dollars.

But I'd give you the top-10.

Okay.

Under the marketing program, you mentioned you've been coming up with a new marketing program that incorporates the new labeling.

Can you tell us -- A, if you can say how much you're going to spend on this marketing program; and B, anything about it and what regions it might play in.

And C, whether it would be direct to consumer or physician, or any other details about that?

Yes.

Right now what we're doing is changing all of our literature so that it shows a gold balloon type picture with the indications on it.

So all the literature is being changed.

We're in the process of putting out on all of the kids.

It's not on all the kids yet, but it will be very soon -- the new indications.

So it's a little bit like labeling the aspirin bottle for headaches.

We're now going to label the ON-Q kids for the two indications.

And on the marketing side, in terms of a specific program of any size, we are in discussions right now with a firm in New York -- a very big firm in New York to talk about just what it is we need to do.

But it probably will be targeted at surgeons initially, because it's still the surgeon that we need to get to.

So again, I can't say anything about that yet.

We have made no commitments; we're still in the early stages of talking about how do we get the information to the surgeon and how do we get the information then to the hospital, and then how do we get the information to the consumer?

How soon would the extents of that new marketing program start showing up, can you say that?

Probably wouldn't show up until the end of the fourth quarter.

In the fourth quarter would be the earliest.

On your buyback program, given that you're not yet profitable and that you do have such a huge opportunity for hiring more salespeople, we were a little surprised that you'd be using cash for a buyback at this stage.

Can you discuss your strategy for why you would be doing that versus saving that cash just to hire more salespeople and take the thing further?

When we voted on the buyback program, the stock was sitting at $9.

And we figure that it's worth a little bit more than $9 dollars, Alex.

So again, we have no commitment to win or how many shares we have to buy at any given time.

But we have authorization to buy up to a million should it make sense.

And at 9 and $10, I think that's probably a pretty good investment considering the fact that we have the cash to do it with.

And based on turning profitable in 2005, we have more than enough money on the balance sheet to get us there.

Can you say -- previously I think you said end of '05; can you be any more specific about what part in '05 you think you might turn profitable?

Right now, we're still telling the world that we're targeting fourth-quarter of 2005 to cross the line.

You know, with the kind of growth we're getting today it might happen sooner, and hopefully it won't happen later.

But we are getting growth today that is beyond whatever we budgeted.

Along the lines of the buyback, can you say whether there's been any new insider buying that hasn't shown up yet in the filings, for example?

No.

There's no insider buying that we know about.

I'm looking to Jim Talevich.

Jim Stone, PSK Advisors.

Congratulations again for a nice quarter, folks.

I've got mainly some housekeeping questions.

Last quarter you gave us a number for 121 in the sales force.

Is that what's corresponding to the 172 number you gave us, or was that corresponding to a different number?

No, that's the 172.

When you were talking 150 salesmen by year-end, is that both hospital and ambulatory, or is that strictly hospital?

That's a combination of the two.

Okay.

Are there any metrics you can give us on the 700 hospitals, that tell us a bit about how many might be small hospitals, how many might be large hospitals; some sort of potential (inaudible) trying to get at some sort of a potential for those hospitals.

Jim, I can't tell you how many are big or small.

And again, I wouldn't know how to measure that unless it would be on the number of bids or whatever.

But I could tell you this.

As we believe that an average hospital should be able to generate about $1 million in revenue, when it's -- when we've captured it all.

That would be the average hospital.

And you think that's a goal attainable in a few years type of thing.

Yes.

I think that was all that I had at this point.

Thank you very much and keep up the good work.

Bill Miller (ph), Hartwell (ph).

Fabulous quarter.

It's just been sensational.

How are you?

The questions I have go back to the sales force again.

Several of them.

How should we look at the productivity?

How much turnover have you had?

Can you give us any -- anything on the quality of the sales force your hiring, where they're coming from, experience levels, etc.

And one of the things you didn't mention but I assume is obvious is that the labeling from the FDA has brought the attention of some of the salespeople have announced -- hey, this is an easy play;

I might as well make it.

But can you give me any color on that particular aspect of it?

And finally, from what I gather the third quarter will really be the first quarter where you'll have a labeling in place on the product, on the kits, etc.

And should we use that as our gauge for how important the FDA is?

Should we wait until the fourth quarter, or will it be a combination?

How can you help us with that kind of guidance?

Let's talk about the third quarter first.

Again, we don't give guidance, Bill, but keep in mind now, third quarter is vacation quarter.

You get a lot of surgeons who go on vacation with their family in the third quarter.

If you take a look at last year, we had growth in the third quarter, we had good in third quarter.

But whether or not we'll have blowout growth is another question, because do have the vacation issue.

At the same time, some of our reps who have been around for a year also have vacation in the summer, so we're not exactly sure exactly what's going to in third quarter.

We are expecting a good quarter, but I don't know if we can expect a blowout quarter.

But I do believe the fourth quarter ought to be exciting, because by that time we will have more people hired; those we hired at the end of June and early July will have three and four months under their belt; and again, we still look at productivity as somewhere around the five-month mark, maybe a little bit less.

So it ought to be an exciting fourth quarter, and definitely exciting as we go into 2005.

Bill, I can't remember all five or six of those questions.

How about turnover done in the sales force, whether you've hired any new regional managers?

Can we look at the third quarter in any way for the labeling impact, both on the sales force and or the insurance companies, or do you think that's still too early to happen?

No; there's already an impact on the labeling.

We are seeing the benefits of the labeling already.

Now it's not explosive, only because of the awareness issue.

Remember our biggest issue is awareness and our second biggest issues is adoption.

So again, a lot of people aren't aware of the labeling because they're not aware of the ON-Q.

So as we solve the ON-Q awareness, we solve the labeling awareness.

So the labeling is helping us right now with our existing customers, and helping us expand that business.

On turnover, turnover -- voluntary turnover is still very, very low.

And in fact, I can only think of one person in the second quarter -- there might be two, but I can only think of one -- that left on their own.

If you take a look at our total turnover, it's still less than 5 percent.

Now that's tremendously better than what it was in 2002, if you remember, Bill, when we had about 50 percent turnover.

Right.

We have had a couple of new regional managers come on board.

And by the way, those were actually promotions from within.

So the most recent regional managers come from the sales force; they were star performers last year who now have a chance to manage.

So turnover is low and people leaving on their own is very low.

That's traffic.

That really does me fine.

Just keep going.

Vivian Wall (ph), Federated Kaufman Fund.

Great quarter.

I have a couple of questions, and one is -- I'm looking at the C-sections out there are about 1 million in the U.S.

And you've get some pretty good data there.

Is that easy pickings for you?

You know it's becoming easier for us, Vivian, because it works so well in C-sections.

But again, I hate to use the word easy because, you know, Bill Miller was talking about how easy it is for our salespeople.

It's easy if you want to spend eight hours a week out there and doing about five or six surgeries a day.

That's what we call easy.

So it works very well for C-sections; that is definitely a target for us.

We're getting more and more of them as women become aware and surgeons become aware of the product.

You know, those million are definitely a target.

Just an unrelated question, but if you could comment.

The reimbursement for chemo is front and center at C&S (ph) today.

And I'm wondering what you're hearing from your customer base as to how that would impact your infusion catheter products next year, if it all?

I don't know if it makes a difference if the drugs are infused or if they're given in bolus form.

I think you're referring to the fact that they're supposedly cutting the reimbursement on the drug.

Yes.

The nice thing about that is, is that the drug dispensing is only a small part of what an oncologist can bill for if he's on our program.

He can bill for the hookup of the pump; he can bill for the drug dispensing; he can bill for the disconnect of the pump when it comes off; and if he wants to he can bring the patient in everyday for an office visit, draw blood and bill for the office visit and the lab fee.

So the drug portion is a small part of the total billing when he uses our program, and the indications we have is that they're actually going to increase the reimbursement on those other services when they decrease the reimbursement on the drug.

So we actually believe it's going to be a wash, Vivian.

And even if it's not a wash, there's still a lot of other ways that an oncologist can benefit from our program.

Just in the hospital business, what's happening with the hospital purchasing contract?

They're going very nicely, and stay close to the Internet for the next couple of weeks; we may have some more announcements.

Thank you.

Good luck.

William Plovanic, First Albany.

You had also mentioned potentially we could see some new labeling, maybe wound healing, reduced risk of infection -- that is down the line.

Is that something that is zero to three months away, or is that three to six or six to 12?

It's probably beyond this year, Bill.

But again, one of those studies will be finished and published -- I should say presented -- not published, but presented before for the end of the year, we think the October timeframe.

And if the results are what we think they're going to be that at least puts us in the queue to go after some kind of indications with those results.

And we have a full-blown study starting in animals to hopefully be able to prove a reduced infection claim.

And that will start probably within the next two months.

So that would be, again, after the first of the year type of a deal.

So we're going after those indications with a vengeance because we believe that all the information we can gather that makes the product more valuable is in our best interest.

Excellent.

On the gross margins, that was a very strong gross margin in the quarter.

Is this assuming that the revenue levels stay up this way at these levels that we could see gross margins at least flat if not expanding from here?

We think they're going to continue to go up.

There's no reason to believe today they won't.

Remember, we did that 70 percent gross margin even with a 22 percent increase in our IV business, which is our lowest margin business.

So I don't think we can expect another 22 percent increase in IV business in the third quarter.

We would love to have that; but I'm not sure we can expect that.

So as the Regional Anesthesia continues to grow at greater than 100 percent when we eliminate the DJ piece, those margins are going to continue to climb.

John Brady, Wachovia.

I guess my question goes back to the revenues, the 7 million in revenues from the ON-Q.

Am I correct on that?

The 7 million?

Yes.

How much that -- do you know how much of that has gone to stock shelves in the offices or hospitals, or how much of that has been repeat business, where the product's actually being used and used over and over again?

Remember, our customers are hospitals and they don't have large warehouses.

That's the nice thing about this business is that we're selling product that's being used very quickly.

So are you finding that you're getting a constant flow of reorders from the existing hospitals?

Yes.

The quota that these salespeople have, approximately what is the quota?

The quota changes now again because we're in a hiring wave, and so we're going to be bringing on a lot of new people who will have much lower quotas, which takes the average down.

From the 80 or so that are quota-carrying members at this stage.

The problem we've got, John, is -- let me just say it this way -- at the beginning of the year the quota was a little over $400,000 per rep.

Now that probably has changed --well, I know it's changed a little bit -- because we've got a lot of new reps on board.

Some of these new reps are going to be taking partial territories away from some of our existing reps.

So their quotas also change.

Because what we do is we slice a territory, giving a new rep a small piece to build on, which takes it away from the existing rep which changes their quotas.

So it's hard to -- when you're hiring like we are, the statistic is meaningless.

The key thing is that the number of salespeople that we have grown from quarter-to-quarter is small in comparison to the rate of revenue growth we have had.

What I'm looking at I guess at this stage -- and I don't have the amount of sales reps you had last year -- but at $7 million, even taking -- we'll say an average of 60 sales reps that were up and running over the last year or last quarter?

We had 60 at the end of last year.

Even if you use the 60, it breaks out to about 100,000 per rep, give or take.

Is that the numbers -- are those the numbers that are there, or am I missing something here?

That is for a quarter.

It's essentially for the quarter.

So about 100,000 on average for the quarter?

If we had $100,000 a year from each rep, we would be in serious trouble, John.

I guess that's the question I'm asking.

So the 400,000 annualized is really what your goal is at this stage?

That was the goal at the beginning of the year.

The revenues that you're posting, I assume in this type of a business you have to have a lot of giveaways; you have to give away a lot of the product to get people to take a look at it?

We so very little sampling, John.

Very little?

Don't have to.

When you're selling the product, let's say for one of the bigger surgeries, at $300, it's such a small part of a $15,000 surgery, you don't have to give it away.

A lot of the product that we use to teach doctors with we bill for.

That works out nicely.

We don't give away very much product.

My last question goes back to international opportunities.

I know last time you had mentioned there's a possibility of licensing.

Has that been pursued at all?

No; we have distributors coming on board.

We're not licensing the product to anybody per se.

We did just get a fairly significant quarter which we'll ship in the third quarter from our biggest partner in Europe for the Continuous Nerve Block side.

Is that the first order or they have been (multiple speakers)

That's the first order.

That's our distributor in Europe, B. Braun, has decided to take the C-bloc, our Continuous Nerve Block product, into the marketplace in Europe.

So we did get our first order, but it will not ship until third quarter -- this quarter. (multiple speakers) in comparison to what we're doing on the domestic side it's a small number, but it's a start.

Has there been interest from other firms over there?

Yes.

We have other smaller distributors in each of the countries, each of the major countries, that are starting to sell the ON-Q PainBuster product line, where B. Braun is going to sell the Continuous Nerve Block product line across all of Europe.

Again, one is sold to an anesthesiologist to do nerve blocks; the other is sold to a surgeon to take care of the pain following surgery.

So they're different products.

Pain technology.

What would you anticipate your revenues would have to be to start to show a profit?

I think we're talking somewhere in the neighborhood of 70 to 75 million on the Regional Anesthesia side, assuming we settle down on the hiring.

Bill Miller, Hartwell.

I'm back for one more.

I was curious, because we've had so many studies coming out of the FDA now -- not studies, but at least indications that overweight, obesity, etc. is a big problem.

Are bariatric operations going to be a major source of new revenue, or do you think there will be an explosion of attempts to -- in that vein, or so to speak?

Bill, I'm really glad you asked that question, because you know, those articles were all over the newspaper in the last two weeks.

And a lot of people missed the fact that one of our targets is bariatrics.

It's a great surgery for us because it does a great job in taking care of the pain when they go in for the initial surgery -- and by they way, those patients come back a year later to have all that excess skin taken off.

So it's a great surgery for us; it's a target we have; we're doing very well in bariatrics.

And with the government helping us out by calling obesity a disease, we expect to get more.

(multiple speakers) seen no indication yet of that taking place, though.

There hasn't been an acceleration in that particular operation as far as you're concerned yet?

No.

But there's an acceleration in our business in that operation.

Yes there is.

We're doing more and more bariatrics.

Bennett Knotman (ph), Shako (ph) Capital.

Nick, I think we lost Bennett.

Vivian Wall, Federated Kaufman Fund.

I'm wondering if you've been able to track how much of your PainBuster customers that were serviced by DJ have converted over to the ON-Q product?

Vivian, we haven't actually done a lot of work in that area, but we do know we're getting some of them.

Again, I don't know the exact number of counts.

I was just trying to get a sense if you thought it was the majority, if that was easy pickings for you?

The problem is, is most of their business was done in the ASCs, in the ambulatory surgery centers.

We are now targeting that, so we expect to get a lot of it as we go forward.

But as the new salespeople have just been hired, we probably haven't gotten a lot of it going backwards.

And another question.

Could you give us the receivable number in the quarter?

Yes.

Jim will give you that number.

Hold on.

Yes, Vivian.

It's 12 million 317.

It's actually a decrease.

It's a decrease from last quarter, Vivian.

Thanks.

Another question on gross margin.

Could you give us a sense of how much mix towards the larger pumps contributed to that?

And what is happening with ASPs on an absolute basis?

ASPs are holding the same.

They have not changed at all for about three years.

Again, as we have had pressure on the smaller sizes, which is the size the competitors can compete against, we have been bringing out bigger sizes that are more expensive with more bells and whistles on them.

So we have been able to maintain the average price, and we're seeing about a 40/60 split. 60 percent of our product is the smaller pump and 40 percent is the larger.

Does that sound right, Jim?

Just the opposite?

I stand corrected, Vivian.

My operations guy tells me that it's closer now to 60 percent on the large side; that would be the 270 or larger, which is typically a four-day product; and 40 percent on the small size.

And a year ago it might have been flipped?

It just flipped.

Spencer Nam, SG Cowen.

When was the timeframe that I-Flow stopped distributing through DJ?

That was the end of last year.

So starting in 2004, we were no longer selling to DJ.

What percentage of the revenue -- the ON-Q revenue would fall into that category?

You mean last year?

Roughly.

Hold on a second.

About 12 percent.

Jim Stone, PSK Advisors.

Quick question.

How many quota salesman did you have at the end of the March quarter?

At the end of last quarter?

March quarter, not the June.

Oh, March. 89.

Let's see, hospital reps; no I'm sorry.

That's not correct.

Hold on a second -- 70-some. 76.

Bennett Knotman, Shako Capital

Sorry for my previous technical difficulties.

Could you just talk a little bit about how the FDA labeling might be helping you either getting reimbursement from Medicare or through the insurance companies, or just generally gaining acceptance on that front?

What it's helping us with, especially in the appeal process, Bennett, in which we educate these people that we now have label indications, that we're better than today's standard of care.

So if you're an insurance company and you deny the claim, you're denying best practice.

That puts you in kind of a funny situation.

Insurance companies want to provide for their patients best practice, and that's what we use now.

We are no longer an experimental product.

The FDA clearance says that this is no longer an experimental therapy; this is a real therapy proven by 15 clinical studies.

That's where it's helping us, Bennett.

And has the labeling also led to you officially being adopted as a best practice within any major hospitals, or anything that would sort of announcable to the outside world that I-Flow has emerged within certain areas as the standard of care?

Not today, but hold on to your hat.

Jerry Kumatos (ph), Trifon (ph) Capital.

I wanted to get some metrics concerning the per hospital potential that you have.

You also discussed something of per surgeon potential.

So could you give us a little bit of color surrounding that so that we know the potential of your product?

You talked about something like $1 million per hospital.

I guess that would be some very large centers, but what if we had looked at per surgeon or per procedure for -- I guess you need a high procedure surgeon, and stuff like that.

So give us some metrics surrounding that so that we can think about this more clearly.

I don't know exactly how to answer your question.

We for rough purposes talk about at least $1 million per hospital, and there's -- what -- 4500 hospitals in the country.

The small ones may be less, the big ones a lot more.

Just to give you an example, I won't use any name, but there's a hospital in Ohio that we are in the process of working with and getting surgeries in, that if you just look at heart surgeries alone, the opportunity is almost $2 million -- just for heart.

And that's one hospital.

So if you took a look at all the surgeries in that hospital, you're probably talking about a 3 or a $4 million opportunity.

Is that their existing volume?

That's existing volume.

That's existing volume with all of the products that they use in your category?

Yes, and just for heart surgeries.

Remember now, the product is extremely good for heart surgeries, and we have lots of clinical data on heart surgeries.

And that's one of the clinical studies that was presented to the FDA, in which we could if we wanted to, make a heart kit.

Yes -- in fact, if you take the market -- we keep talking about a market between 2.5 and $3 billion; divide that by 4500 hospitals, and you come out with over $600,000 per hospital.

We actually think that the market might be a little bit bigger than that.

And that's addressable by your existing products, or is that entire category --

We already have the products.

Jerry, the nice thing is we already have the product; that's not something you have to wait for.

We're still -- the goal is still to increase awareness and adoption.

That is the project.

That's the task.

There are no further questions at this time.

I now turn the conference back to you.

Thank you, Nick.

Thank you for your interest in I-Flow.

We look forward to reporting our progress to you on our third-quarter conference call in three months.

Again, thank you very much for your interest.

Good bye.

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

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

Thank you.