金百利克拉克 (KMB) 2004 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the I-Flow fourth quarter and year-end results conference call.

During the presentation all participants are in a listen-only mode.

Afterwards we will conduct a question-and-answer session.

At that time if you have a question, please press the 1 followed by the 4 on your telephone keypad.

As a reminder this conference call is being recorded Tuesday, February 22nd, 2005.

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

Please go ahead, sir.

Thank you, Maurice.

Good morning everyone and thank you for joining us for I-Flow's fourth quarter and 2004 results conference call.

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

This morning we reported another strong quarter and an even better year.

Net revenue for the fourth quarter of 2004 increased 54 percent to a record 21.1 million dollars, driven by a 99 percent increase in regional anesthesia sales to $10.4 million, and a 59 percent growth in Oncology Infusion Services sales to $5.4 million.

Regional anesthesia sales in the prior year included $468,000 of sales to the company's former distributor, D.J. orthopedics, plus $4.8 million of direct sales.

The increase in direct sales of ON-Q for the quarter was 119 percent.

We are pleased by this performance.

Our growth for 2004 as a whole was equally satisfying with all three of our business units contributing.

Total net revenue increased 51 percent to a record $71.1 million.

Regional anesthesia sales increased 101 percent.

That would have been 126 percent for direct sales, and Oncology Infusion Services sales grew by 49 percent.

Even our legacy business, IV infusion therapy sales, grew by 8 percent.

On today's call I want to focus on how our many accomplishments in 2004 have positioned I-Flow for continued strong growth in 2005 and beyond.

But before I do, let me turn the call over to I-Flow's CFO, Jim Talevich to review our financial results in detail.

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.

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

For the three months ended December 31, 2004, net revenue increased 54 percent to a record $21,121,000, compared to net revenue of $13,703,000 for the fourth quarter 2003.

Gross profit rose to 71 percent of revenue for the fourth quarter of 2004 compared to 61 percent for the same period of the prior year.

Operating expenses for the fourth quarter of 2004 increased by $10,337,000 compared to the prior year quarter, primarily due to the ON-Q salesforce expansion and increased marketing expenses, and secondarily due to an incremental $808,000 for outside consulting and auditing costs associated with the implementation of section 404 of the Sarbanes-Oxley Act of 2002.

The net loss for this year's fourth quarter was $12,336,000, or $0.56 per share, which included incremental provision for income taxes due to an increase in the valuation allowance for deferred tax assets effectively writing down the Company's deferred tax assets to zero.

Of the $12,336,000 loss, $8,808,000 is attributable to the increase in this valuation allowance.

The write-down is a noncash accounting entry representing a conservative application of statement of Financial Accounting Standards #109 accounting for income taxes which address financial accounting for deferred tax assets.

If the Company were to become consistently profitable in the future, the valuation allowance may be reversed, resulting in increased earnings in the period of reversal.

This compares to net income for the fourth quarter of 2003 of $804,000, or $0.04 per diluted share which included income from discontinued operations net of tax of $68,000 and a gain on sale of discontinued operations net of tax of $2,283,000.

For the 12 months ended December 31, 2004, net revenue increased by 51 percent to a record $71,145,000, from $47,043,000 for 2003.

Gross profit improved to 70 percent of revenue for 2004 compared to 63 percent for 2003.

The net loss for 2004 was $17,110,000, or $0.83 per share, which included incremental provision for income taxes due to an increase in the valuation allowance for deferred tax assets, effectively writing down the Company's deferred tax assets to zero.

Of the $17,110,000 loss, $8,808,000 is attributable to the increase in this valuation allowance.

This compares to net income for 2003 of $457,000, or $0.03 per share, which included income from discontinued operations net of tax of $328,000, and a gain on sale of discontinued operations net of tax of $2,283,000.

Moving to the balance sheet, total cash increased by $28,923,000 to $44,108,000 as of December 31, 2004, compared to $15,185,000 as of December 31, 2003.

The cash increase included net proceeds to the Company of $43 million from the Company's sale of approximately 3 million shares of stock in a public offering that closed on April 19th, 2004.

Property, plant, and equipment increased by $4,353,000 to $11,097,000 as of December 31, 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 full-year basis, by $32,534,000 to $84,430,000 as of December 31, 2004 and $51,896,000 as of December 31, 2003.

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

Don.

Thanks, Jim.

Several years ago, when it became clear to us that our proprietary ON-Q technology offered us the opportunity to revolutionize the management of post-surgical pain, we knew we had within our grasp an outstanding long-term growth opportunity.

By making our ON-Q technology available we could literally redefine recovery for millions of patients having surgery every day.

We quickly developed a strategic plan aimed at achieving an aggressive goal, to establish our ON-Q brand as the new best practice for treating post-surgical pain and to ultimately replace narcotics as the standard of care.

This may have seemed grandiose at the time, but our successes have convinced us our goal is realistic, and today we are even more committed to making it happen, with the U.S. market opportunity exceeding $2 billion and less than 3 percent of this market penetrated to date, we still have a lot more success to look forward to.

Our strategy to increase awareness and drive adoption of ON-Q is multifaceted, and is proving to be successful.

It starts with the hiring and training of a first-class surgical salesforce, supported by independent third-party clinical studies that prove the benefits of ON-Q in an expanding number of surgical applications.

Next, we add third-party insurance billing programs that reduce the cost to outpatient surgery centers that want to use the ON-Q on their patients.

Last but not least, we launch advertising campaigns to increase awareness, initially targeting surgeons and in the future, targeting consumers planning to have surgery.

Let's now look at the progress we made in 2004 to implement the strategy.

Regarding our salesforce, by the end of the year we had achieved our longstanding target of approximately 150 quota carrying sales professionals calling on surgeons practicing in hospitals, outpatient hospital surgery centers, and ambulatory surgery centers.

Our combined salesforce, including sales associates, inside sales representatives, nurses, sales management, and other supporting players, now exceeds 230 professionals supporting our ON-Q products.

This growth and the number of feet on the street is the main reason ON-Q is now available in more than 1,000 hospitals and other surgery facilities throughout the United States.

An increase of more than 50 percent from just one year ago.

The hiring of more than 70 territory managers and numerous field support people during the second half of 2004 turned out to be a bigger challenge than we had originally thought.

Not only did we have to find, recruit, hire, and train experienced sales people, we had to carve out a new territory for each of them from an existing territory.

Some customers gained a new salesperson while losing the old.

The old salesperson had to give up the accounts in the new territory, some of which they may have been working on for a year or longer, and the new salesperson had to move quickly to minimize the change and to prevent any customer disruptions.

These conversions did not always happen smoothly, but even so, we accomplished the task within the time frame promised. and still delivered a second -- a strong second half of revenue growth.

The best news is, this unusual period of expansion is behind us, and we can now focus all of our attention on growing the regional anesthesia revenues.

During 2004 we also increased our distribution opportunities by establishing relationships with four of the major group purchasing organizations in the United States. [Novation, Med Assets, Consortia, and Premier].

Today we have the necessary critical mass of sales professionals with the skills needed to effectively sell into the member facilities of these organizations.

And sell we must.

As I noted on the last call, these relationships open the door to our salespeople, but it's still up to us to convince the member facilities of the benefits of ON-Q and once completed, drive the adoption.

Now that we have reached our planned number of regional anesthesia salespeople, the increases in operating expenses associated with the massive hiring and training effort we began in 2002 is mostly behind us.

This is not to say that all work on our salesforce is complete.

You never finish developing and training a salesforce, and those efforts will continue.

And this year, every member of our sales team and marketing team will be challenged to increase productivity so that we as a Company can achieve our sales goal for 2005, and in the years to come, achieve profitability for the Company as a whole.

Regarding support for third-party research, today more than 44 published and presented studies on the use of ON-Q have been completed, and more are underway.

These studies consistently demonstrate the benefits of ON-Q in significantly reducing pain and narcotics intake after surgery.

It was on the strength of these studies that in 2004, we were able to obtain FDA clearance for enhanced labeling of ON-Q as being superior to narcotics alone, for reducing the pain following surgery.

Remember, narcotics is our main competition, and we can now label that we are significantly better.

All ON-Q branded products sold within the United States, Canada, and the European Union's 25 member states are now cleared to carry this enhanced labeling.

Increasing the product's credibility and, therefore, our ability to market and sell the ON-Q family of products worldwide.

Several recently published studies nicely illustrate the general trend.

Study data at the San Antonio breast cancer symposium highlighted the benefits of ON-Q to reduce pain after mastectomy surgery, while reducing or eliminating use of narcotics.

Approximately one in eight women will be diagnosed with breast cancer in her lifetime.

Considering the magnitude of this woman's health issue, it is particularly gratifying that ON-Q has proven to have such a meaningful benefit for patients recovering from this type of surgery.

Separately, the publication of two studies of post-surgical pain relief after hernia surgery, revealed that patients who receive pain relief with ON-Q realized a significant reduction in pain and in the need for narcotics following their surgery.

The clinical results are consistent and clear.

Surgical patients with ON-Q recover faster, with less pain, and less, if any, narcotics are needed.

In addition, there is new clinical evidence that treating pain with ON-Q after hernia, cesarean and breast cancer surgeries can result in a reduction of pain well after the pump is removed.

This could have important implications in minimizing the incidence of chronic pain following these types of surgeries.

Regarding insurance reimbursement, we recently announced the first payment received from Medicare for ON-Q related to a specific case when the device was used for a patient following hernia surgery.

The decision that ON-Q was, 1) a covered benefit, and 2) medically necessary as defined by the surgeon and therefore payable, was made by an administrative law judge based upon the law and on the clinical evidence submitted by I-Flow.

The Company's case featured highlights of ON-Q's enhanced labeling, as well as clinical data demonstrating the benefits of the ON-Q Soaker catheter.

We plan to use the decision as a supporting point for both Medicare and private insurance companies, to encourage widespread reimbursement for our product.

We will continue to push hard on the [Demercs] to change their policy to deny payment for disposable pumps used to deliver local anesthetics to treat pain caused by surgery so that they will now be payable.

We also entered into contracts with 12 managed care organizations representing HMOs, PPOs, and workmen's compensation providers, to begin to routinely reimburse for ON-Q for post-surgical pain relief.

With these contracts, ON-Q will be accessible to more than 7 million patients who may undergo surgery in an outpatient facility.

In addition to the enhanced ON-Q labeling and the many published and presented clinical studies on ON-Q, we were able to leverage the strong insurer relationships built up over the years by our InfuSystem subsidiary to achieve this.

Our first contracted payment success in the managed care arena.

Finally, regarding advertising and marketing, as I announced on our last call we have retained a world-class healthcare advertising agency to help us strengthen our brand messages in both the professional and consumer markets.

Following a period of primary market research to test messaging with surgeons across the U.S., I am excited to report that we are -- that we recently launched a new advertising campaign in leading surgical journals built around the message platform, redefining recovery.

A theme that we believe aptly summarizes the impact ON-Q is having on post-surgical care everywhere is has been adopted.

Initially, this campaign is targeted at heart and bariatric surgeons and may be expanded as we begin to see meaningful results.

Summarizing 2004 ON-Q accomplishments, 1) we more than doubled the size of the ON-Q salesforce. 2) We helped get published and or presented additional third-party studies that supported the use of ON-Q, now totaling more than 44. 3) We received new label claims that allow us to state that ON-Q is significantly better at treating pain following surgery, than our primary competition, narcotics. 4) We made significant progress in obtaining insurance reimbursement for the ON-Q, both with private carriers and with Medicare. 5) we developed the redefined recovery advertising campaign for ON-Q, which was launched at the I-Flow national sales meeting in January 2005.

And last but not least, we found the time to grow our regional anesthesia revenues by more than 100 percent, and our total revenues by more than 50 percent.

I-Flow also entered into a national agreement with Abbott to make available to its members, InfuSystems third-party billing program for chemotherapy systems.

By the way, we continue to be bullish about the future growth of our Oncology Infusion Services business.

Our optimism is based on the increased number of office-based oncologists who are now using InfuSystem pumps to provide multiple-day infusions of chemotherapy drugs.

We believe InfuSystem is the undisputed market leader for third-party billing of pumps used by oncologists, and we see nothing on the horizon to change this.

As we look into 2005, we remain optimistic that we can continue to grow our regional anesthesia revenue by approximately 80 percent, and grow our total revenue by approximately 40 percent.

In addition, we remain optimistic that I-Flow as an entity will be profitable in the fourth quarter of this calendar year, excluding stock-based compensation expense, or some yet unknown accounting change that we do not control.

Maurice, we are now ready to take questions.

Thank you.

Ladies and gentlemen, if you would like to register for a question, please press the 1 is followed by the 4 on your telephone keypad. [OPERATOR INSTRUCTIONS]

Our first question comes from the line of Bill Plovanic for First Albany Capital.

Hi, Bill.

Sorry for the noise.

I'm actually at the airport.

Couple questions.

First, on the salesforce, can you give us an idea what the split was behind the hospital and the ASC reps, and then can you give us a feel for the turnover that you've seen in the last quarter or so?

Right now we have about 23 sales reps on the ASC side, the ambulatory surgery center side, and the remainder would be on the hospital side.

And the turnover is less than 10 percent, as we've stated before.

Okay.

And you stated that you expect incremental adds, but can you quantify that a little more for us?

Is this only a 10 or 20 percent increase to the sales force in '05 versus '04?

Well, right now we're at about 147, so I don't see planned any more than 5 or so adds.

But the goal being to be right around 150.

Okay.

And then, Jim, can you give us an idea, I think typically in the fourth quarter you have some pretty large costs associated with the stock that you hand out and the extra bonuses as the reps exceed their goals.

Can you kind of frame what that cost or the impact of that was on the P&L in the fourth quarter?

It's pretty substantial.

I don't have that number with me, but it's about 900,000, I would say.

Okay.

And two more questions, then I'll let other people jump in.

Also, Jim, can you frame for us, if I look at the RA business, if you cut out the ambulatory surgery center and the international sales contribution in the quarter, could you give us some color on that?

You want those out?

Yeah, what was the growth in the RA business if you take it out, year-over-year?

Yeah, there's a couple pieces there.

The international -- the international part of RA was about a million dollars.

This year?

Yes, in 2004.

Okay.

And -- and the billing piece was very small.

It was less than a million.

Call it a half a million. is that for the whole year, you're saying?

Yeah.

For the whole year?

Yes.

Okay.

And then lastly, the write-down of the tax assets, typically that's done when you turn profitable.

What was the thinking, why is it being done so early?

Well, the -- yeah, basically it's just a historical calculation based on your earnings, you know, essentially.

Basically because we have a loss, we have to value that is zero.

The way FAS 109 is set up, it's an all or nothing type of thing, where it's either 100 percent reserve or 0 percent reserve.

It's really not a judgmental type of thing, and it's just a mechanical calculation due to the fact that we had a loss for the year, then we'd take 100 percent reserve, and then when you become profitable, consistently, then you reverse the whole thing all at once and you have a similar gigantic number sliding through the other direction.

Okay.

And, Don, on the turnover, that less than 10 percent, was that the fourth quarter or the full-year calculation?

No that would be a full-year calculation, Bill.

It's much less than 10 percent to date.

great.

Don't forget, some of that turnover is forced.

Right.

Thank you very much.

You're welcome.

Thank you.

Our next question comes from the line of Adrian [Doors] from Hartwell.

Adrian Doors.

Congratulations on a great quarter.

Thanks, Adrian.

Couple questions with regard to guidance.

Looking at 80 percent growth in the regional anesthesia business just simple arithmetic would suggest that's putting very low expectations on the other two pieces of the business.

Can you talk a little bit about what you expect in '05 for the oncology and the infusion business?

Thank you.

We don't break that out separately, Adrian, but, again, I don't think we can plan on 50 percent growth in that business to continue.

So the number that we're expecting to grow on the oncology side is going to be significantly less than 50 percent.

However, probably 30 percent or better.

On the IV infusion therapy business we're not expecting much, if any, growth on that side.

So the growth will be carried by regional anesthesia and by oncology.

Follow-up question.

What proportion of the salesforce exceeded quota in the fourth quarter, and how would -- did individuals who passed sales quota react?

Did they ease up a little bit as we came into the end of the quarter?

First of all, for the total year, we passed out awards to about 40 percent of those who were eligible, and again, to be eligible, you had to be with the Company at least six months.

So about 40 percent of the eligible reps made their quota, and second, there were enough incentives in place in the fourth quarter so we had few, if any, ease up.

Thank you.

You're welcome.

Thank you.

Our next question comes from the line of Spencer Nam from SG Cowen.

Please proceed.

Thanks for taking my questions.

Couple of quick questions, then one or two follow-up questions.

Okay.

First of all, maybe if you could break up the SG&A between sales and marketing and G&A.

Is that possible right now?

Yes.

Just one moment, Spencer.

Sure.

Yeah, expenses, if I look at this correctly, looks like 44.4 million sales and marketing and 16.4 G&A.

That's for the year, right?

Yes.

Great.

Thanks.

And looking at 2005, what sort of additional spending are we thinking about?

Are we looking in terms of obviously the ramp-up, you know, is complete on the salesforce.

But do you see any additional big ticket items that are looming ahead of us going into this year?

The overall spending shouldn't grow that much, Spencer.

We'll still have some Sarbanes costs, and, of course, the marketing program for the first half of the year will cost us some money.

That's the advertising plan.

And we don't know yet what the second half will look like on the marketing side.

It depends on what happens on the front half of the year.

But overall I would say it's going to be relatively flat.

Great.

One final -- couple of quick follow-up questions.

On the reimbursement side that, with all these activities that are building up right now, do you plan to take any direct actions with Medicare, for example, to secure a CPT code, or get a more formalized reimbursement plan this year or anytime -- anytime in the near future?

I have to be very careful what I say here, Spencer, but I think you can assume all of the above are happening.

We are very aggressive in our efforts to get reimbursement not only with Medicare but with all private insurance carriers.

And as you can see from what happened just recently, we are showing some success on the private side, and because of the Medicare ruling in our favor, we have begun accepting Medicare patients in the ambulatory surgery centers.

So we are processing right now paperwork to Medicare and if denied, we will go through the appeal process until we are either successful in getting a policy change, or until we have a stack of appeals, and they finally will have to start honoring the judge's claims -- or the judge's ruling, I should say.

So the answer is, yes, we will be very aggressive in both areas.

Great.

Thank you.

Thank you.

Our next question comes from the line of Dave Turkaly from WR Hambrecht.

Thanks a lot.

Just curious as we look forward to '05, could you give us any hint on the gross margin line and specifically if the fourth quarter is going to be potentially profitable could you comment on what you think that might have to be for that to happen?

Thanks.

Just one second.

Yeah, Dave what we think is, is that we think gross margin will continue to climb, because regional anesthesia is growing much faster than any of the other businesses and it has the highest margin.

And number two, in the fourth quarter, our estimates are that we must be somewhere north of $17 million in the fourth quarter to break even.

So we are forecasting to be at that point -- I'm sorry, 17 million on the regional anesthesia side and about 30 million in total.

Yes, that's helpful.

In terms of the gross margin, for this quarter, is there something in there -- or do you expect, you know, as you go through '05, do you think this is a 75 percent by the end of the year, or can you just comment on what the trend in gross margin might be, maybe a little more specifically where it could get to by the end of the year?

Yeah, I think to be conservative we would say somewhere in the 70 to 75 percent range, somewhere in the middle.

Okay.

Great.

Then do you have U.S. versus OUS for the whole Company for the quarter?

I'm sorry, didn't understand.

Do you have U.S. versus OUS breakout for the quarter?

U.S. versus --.

international.

Oh, international.

For the quarter?

Yeah.

Just one moment.

Thanks.

Oh, for the quarter.

Okay.

You're talking about total sales or regional anesthesia?

I would take both, but if you could give me either or both, I'd appreciate it.

3.4 for total, and for regional anesthesia, about 300,000.

Great.

Thanks a lot.

You're welcome.

Thank you.

Our next question is comes from the line of Raj Denhoy with Piper Jaffray.

Please proceed.

Hi, actually, this is Mark Mullikin calling in for Raj.

Just a couple of questions I wanted to hit on here.

Relative to the ambulatory surgical center portion of the business, can you tell us at all, give us an idea of what sort of contribution that area made in the quarter?

Yeah, just one second.

It was a little over $300,000, Mark.

Okay.

And then as far as assumptions for 2005 what contribution are you factoring in from that area?

Something north of several million dollars.

Okay.

And shifting gears, what surgical procedures are really driving the business right now?

Did you see any acceleration in any areas, or, you know, deceleration in other areas?

Well, we've always been very successful in the larger surgeries, the heart, the bariatric, the thoracic, the surgeries that generate quite a bit of revenue, because doctors can, of course, use pumps without anybody questioning.

We're also doing a lot of ob-gyn surgeries now because of the benefits to women who are having cesareans and having babies and getting the product.

And because of the growth, it's accelerating in our ambulatory surgery center side we're seeing a lot of hernias, orthopedics, and even bunion-type surgeries.

Again, as that salesforce gets traction that will increase significantly.

So we're beginning to see surgeries across the board now.

It's not just in one or two areas.

Okay.

And I think you had previously said you expected some sort of decision out of some of the demercs on reimbursement by February, or by the end of February.

Any update on where that stands right now?

Well, I have to be careful what I say, but, Mark, we're in negotiations as I speak.

Okay.

So do you continue to expect it to be some time in February?

We haven't put a time frame on it, but I can tell you this, is we've started billing.

Okay.

We've started submitting for reimbursement to Medicare.

Okay.

we're not waiting for a decision.

And --.

we already have a decision.

We have an administrative law judge.

Right.

that says we should get paid.

So we're using that to our benefit.

And what's the payor mix on ON-Q between private insurers and Medicare?

Probably 10 percent Medicare.

Okay.

It's very small.

But the important thing is, is if we get a policy change by Medicare, then it makes it easier for us to get contracts with all of the major carriers, because they typically follow Medicare.

Right, right.

So it's a strategic move more than it is anything else.

Okay.

Very good.

Thank you very much.

You're welcome, Mark.

Our next question comes from the line of Alex Arrow from Lazard.

Please proceed with your question.

Hi, Alex.

If I could ask a first question about competition, it's been a little while since you've given us your views on competition, or lack thereof, and my question is I know there's no current competition from any new modality, like slow-release anti drug pain control, slow-release drug formulation and other things that are in the pipeline.

But if there is anything out there that could eventually maybe be competition, what are the one or two products that you have on your radar screen that might eventually be competition for you?

I think the one that most people know about, and we haven't seen the product yet in the field, but that would be [Zimmer], we're expecting Zimmer to launch at any time now.

In fact, I believe there's a big orthopedic show this week --.

tomorrow.

-- which starts tomorrow that we expect them to officially launch.

So we're going to begin seeing the Zimmer sales people carrying a pump.

Then there are all the others who have been there for awhile, which includes D. J. orthopedics, Briggs, Striker, McKinley, even, I think, Scarlotto has come to the point now where it's almost nonexistent but the same players are there.

But on the pump side.

But aren't there some potential slow-release drugs, not with a pump model at all, but injectables that release over time so instead of extend the pain control function of the drug from two to three hours up to two to three days, because of slow release formulation technology?

Anything like that?

We all know about the study that failed in England about six months ago, I think that was A. P. pharma. we don't know of anything today that's close.

There are some things in Phase II trials which I believe direct is in.

But again, Sky pharma and everybody else are still a long ways off.

And, of course, they haven't proven that the technology will work, in especially the bigger surgeries.

So the answer to your question is, today, it's pumps, is all we see, that and narcotics.

Narcotics is our real competition.

Right.

We see a lot of narcotics.

Okay.

And then just before we leave that, speaking of narcotics, is there anything that the big pharma is doing, or is the amount of narcotic usage going down so inconsequential that they really don't have any actions that they're taking to influence it?

As you know, morphine is a generic drug, and many of the narcotic drugs are.

One of the things we believe will benefit us is all of this ballyhoo over the Cox 2 drugs.

People are thinking twice now before they prescribe Cox-2 drugs which by the way, was some of the competition.

When they would wean them off the morphine, they would put them on Cox-2 drugs.

Now with that becoming a potential problem, you might as well put them on our pump initially and leave them on there.

So we're actually seeing some benefits from the Cox-2 stuff.

Great.

If I could switch on to just a salesforce question, you had said back during the fourth quarter that one of the things influencing your selection of new reps was the best people were still holding out to collect their year-end bonuses with their previous companies, and if they weren't holding out for that, then maybe they weren't the best people to begin with.

Can you give us an update on how that turned out at the end of the year and maybe how that affects your hiring strategy?

Because we were able to bring a lot of those people on right after the beginning of the year, a half-dozen or more that held out, we've been able to get to our number.

Our number is almost 150 right now, 147 reps, so we're right where we want to be.

Now, one of the things that happened in the fourth quarter which we had not planned on, is that reps who came on board in the October -- September/October time frame, say towards the end of September, early October, they had a more difficult time getting traction because of the holidays in November and December.

So their Rolodex doctors weren't around during November and December, so it made it very difficult for them to get traction.

But, of course, that should all change in January, February, and going forward.

Okay.

And I apologize if you already said that on this call but have you said specifically your number of quota carrying reps you intend to expand to in 2005?

We're going to get to 150, we're about 147 right now.

By the end of '05?

Yeah.

So you're only 3 away from your quota for the next 12 months?

You're right.

We're going to spend this year driving regional anesthesia revenues instead of hiring.

Terrific.

On the ad campaign, can you -- or, rather, I guess the marketing campaign that might turn into an ad campaign and that you might do some direct to consumer, can you give us any color on that?

We are right now in magazines across the country for bariatric and heart surgeons with an advertising campaign, and there's no plans at this time to go to the consumer.

First of all, we're going to determine how well we've done in getting surgeons aware, so that's the first step.

So we are in 8 magazines this quarter, and we will be in 11 magazines next quarter.

With 2-page ads.

The theme being 'Redefining Recovery'.

Okay.

Great.

I guess is it possible to say whether those specific ads are having an impact so far but do you have any way of tracking whether you've got people answering those ads in particular?

Or whether it's other reasons?

We've got several different ways to track, but it's still too early, being only the second week.

We've got all kinds of ways we're going to track to see we're doing.

Final question, one last one, the hospital distribution.

Any hospitals up to one million in production, you said potentially if a hospital gets penetrated fully it could become a million dollar account.

Are you willing to say anything about how many, if any hospitals are up to the million dollar level?

The only thing I'll say is that we expect to have some hospitals this year that reach that level.

Okay.

Thank you.

You're welcome.

Thank you.

Our next question comes from the line of Michael [Davidhoff] from Sidoti & Company.

Hi, guys.

Good morning.

Hi, Michael.

Most of my questions have been answered.

Just a couple of things.

Just getting back to competition, in terms of the pain pump competitors, mainly [Striker], have you seen any increased efforts on their part in the hospitals you're selling to?

No, it's been the same.

We have seen an emphasis on continuous nerve blocks with their product as opposed to wound site, but we still see Striker on a regular basis.

They haven't given up.

Nor would we expect them to.

So, you know, this is such a great product, and like the CEO of Zimmer said in their press release, this is a product doctors want, and it's a product that works.

So there will be others besides the ones that are in the field today.

Okay.

And then you made a comment, the operating expense growth you expect to be about flat for '05.

You're obviously talking on a fixed basis, right?

On a what?

A fixed basis, like that's just in terms of fixed SG&A cost, not taking into account commissions and bonuses, or --.

Yes.

Okay.

And then can you just break commissions and bonuses, or --.

Yes.

Okay.

And then can you just break out the receivables and inventory for the quarter?

Yeah, just one second.

Yeah, Mike, the receivables number was 15,765, and inventories is 8,366,000.

Okay.

Great.

And have you seen any benefit yet from the GPO contracts, or is it too early yet to really see that?

No, we've seen benefit, especially from the Novation and the Med Assets one.

It has opened up doors, but again, like I said in my script, it opens the door, but you've still got to walk through and do the selling, but it sure makes it a lot easier to get in now.

Great.

Thanks a lot, guys.

Thank you.

Our next question, follow-up question, comes from the line of Bill Plovanic from First Albany Capital.

Please proceed with your question.

Jim, on the G&A, backing into it, it's about 5.1 million in the quarter of which about 800,000 is one-time, gets to you about a 4.3 million number.

Is that, you know, should we kind of use that as a baseline as we roll through '05, or is there some more one-time charges in the fourth quarter?

You're specifically talking about G&A rather than sales and marketing?

Yes.

Yeah, what number are you coming one for the quarter on G&A?

5.1 million.

Yeah, that's what I have also.

I'm trying to think about what other pieces are in there.

I think that's high.

Well, let me put it this way.

The $808,000 we mentioned of incremental Sarbanes implementation cost, that was very severely loaded toward -- I mean, that was all incurred in the fourth quarter, I certainly wouldn't expect to see $808,000 per quarter from now on.

You will need to back that out.

What would you expect for the SOX costs going forward?

Quarter by quarter basis, maybe a fourth of that or something.

That would be a little bit back-end loaded towards 2005 as well, within 2005, but it something.

That would be a little bit back-end loaded towards 2005 as well, within 2005, but it will be less next year, but it won't go away.

It will never go away.

Okay.

That's all I had.

Thank you very much.

Thanks, Bill.

Thank you.

Our second follow-up question comes from the line of Adrian Doors from Hartwell.

Please proceed with your question.

In the guidance for 2005 what assumptions were you making on general levels of reimbursement, and tying that into -- can you talk a little bit about what you experienced in the fourth quarter in terms of average level of reimbursement?

Yeah, what we did, Adrian, is we assumed nothing has changed from a Medicare standpoint, that we would have to go through the appeal process, and we didn't make any assumptions that anything would change on the private side, even though we believe we'll gain more contracts.

So in the fourth quarter, we booked about 35 percent of the gross billings for ON-Q on the ambulatory surgery center side, and we've maintained that in our estimates for this year.

So we have not assumed anything better than what we're presently experiencing.

Okay.

Follow-up, you talked about the difficulty of hiring in the fourth quarter and historically you talked about some of the major metro markets, particularly on the East Coast, being difficult to hire.

Have you successfully filled in some of the blanks that were outstanding at the end of the third quarter, and if not, are you hopeful of doing so this year?

We are still struggling with the same markets we've been struggling with, and that's New York and Boston.

And, by the way, Adrian, if you though any good reps who would like to make some significant dollars and have fun selling a great product, let me know, would you?

We'll send you their resume.

Okay, thanks.

Thank you.

Our third follow-up question comes from the line of Spencer Nam with SG Cowen.

Just a quick question.

You mentioned the ON-Q sales growth to be about 80 percent for the year '05.

I was wondering maybe if you could make a comment on the volume growth, to use a similar growth in volume of pumps sold or something higher than that?

Well, since our average realized price is staying pretty much the same, I would just make the assumption, Spencer, that the units will grow about the same.

Thanks.

You're welcome.

Thank you.

And our last follow-up question comes from the line of Raj with Piper Jaffray.

Please proceed.

Hi, it's Mark again.

Could you just break out the cost of goods between the products and the rentals?

I think you've done that in the past.

Well, let me give you the gross margins.

Okay.

Is that good enough?

Yeah, that's fine.

Okay.

On the ON-Q side, the gross margins are just short of 90 percent.

On the oncology side, they're right around 70 percent.

And on the IV infusion therapy side, they're right around 45 percent.

And that's for the quarter?

Yeah, that would be for the year.

For the year.

Yeah.

Be about the same for the quarter, wouldn't it, Jim?

Yeah.

Yeah, there was no change in the quarter.

Very good.

Thank you.

You're welcome.

Thank you.

Ladies and gentlemen, if you would like to register for a question, please press the 1-4, please.

Our next question comes from the line of Michael Lee from Welch Capital and Partners.

Please proceed with your question.

Hi, everyone.

Good quarter.

I just got a few questions here.

Not quite as many as Dr. Arrow.

Thanks, Michael.

No problem. [laughter] Sorry.

Your expenses for this first quarter in terms of the national sales meeting I just want to get a feel for if it's going to be exaggerated this year, because you've got a bunch of reps attending that meeting.

Could you speak to that, then I've got a few others.

Well, you know, we had a -- about 250 people at the national sales meeting out here in California, and, by the way, that was the week that it rained all week.

So you can imagine having all these type-A's locked up in a hotel with nothing to do except build an ark, and it was quite an exciting time, but, yes, that was a fairly expensive event for us.

Plus, we do have Sarbanes expenses in the first quarter as we finish the books for 2004, and, of course, our Sarbanes certification.

Okay.

So those expenses, though, are pretty much one-time in the first quarter, but they would be a little bit more than normal.

Okay.

Great.

And then couple of questions.

Just in terms of acuity, the doctors who currently use ON-Q for postsurgical pain, talk to us about how often they're using ON-Q in terms of penetration within, you know, a good client-patient load.

How has that gone over the past 12 months?

There's a certain amount of trialing with this product, and you talk about do you expect doctors who were sort of intermediate users of ON-Q to ramp up their utilization of the product, and how will that affects the sales reps going through the year?

You can tell from our growth that we're having some success and most of that success is coming from our existing users, and increasing the usage with their associates.

Those who go into a hospital and get a doctor to convert, not only does he begin using it for more and more surgeries, but his peers and his associates begin using it.

That's the way we built the business.

Again, we're only in a 1000 facilities or so, a little over a thousand facilities, so we still have a tremendous number of facilities to get into, and with penetration of less than 3 percent of the total surgeries now being treated with narcotics that are candidates for ON-Q we still have a long ways to go there.

So it's hard for me to comment on that because our strategy is to go deep and wide.

Once we capture a surgeon, is to get him to use it more and more, and to pass it on to his peers.

Okay.

Quick question on, what are your major conferences that you're going to be at this year?

I guess bariatric surgery, maybe ACOG, then if you talk a little about how much of your business, not exact numbers, but your exposure to large joint recon.

Can we go ahead and send you a list?

Yeah that would be fine.

But I just want to know what your big meetings are, what you target as your big meetings?

We have one big meeting target in each specialty.

Let me just send a list.

Okay?

Okay.

Thanks a lot.

You're welcome.

Thank you.

We have a third follow-up question from Adrian Doors Hartwell.

Just a final, I promise, question on the guidance for '05.

You specifically comment on excluding stock-based compensation.

Can you talk in generalities about the extent to which new shares, options, et cetera, will be issued as part of the incentive package to hit the targets that you're setting for the sales guys, and how that influenced the guidance?

Thank you.

Well, those who made quota last year will probably get a reload on the restricted shares.

So you can assume that that will increase.

But, again, those that vested go away.

And so we just add -- replace those.

On the options side, we're not doing anything unusual this year that we haven't done in the past.

However, I assume that will change in 2006, when there will be more pressure to reduce the number of options.

So we should think about a similar kind of number in terms of '05 as we saw in '04?

Would that be fair?

Yeah, I don't see any change today.

Okay, good.

Thank you.

You're welcome.

Thank you.

Mr. Earhart, there are no further questions at this time.

Please proceed with your presentation or closing remarks.

Thanks, Maurice.

Our many accomplishments in 2004 set the stage for continuous vigorous growth in 2005.

We are energized and excited by the opportunities ahead for our Company, and we look forward to updating you on our progress in quarter 1 in a few months.

Thank you for your continued support, and that ends my presentation.

Thank you.

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

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

Have a great evening, everyone.