金百利克拉克 (KMB) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the I-Flow first quarter 2007 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 Thursday, May 3, 2007.

I would now like to turn the conference ever to Don Earhart, Chief Executive Officer.

Please go ahead, sir.

Thank you, Xavier.

Good morning, everyone, and thank you for joining us for I-Flow's first quarter 2007 results conference call.

Chief Financial Officer Jim Talevich and I will be available to answer your questions immediately following our prepared remarks.

The financial results we announced this morning were highlighted by a 34% increase in revenue in our regional anesthesia business, for a first quarter record of $19.1 million, compared to $14.3 million for the first quarter of 2006, and a 22% increase in total revenue from continuing operations to $24.3 million compared to $19.9 million in the prior year quarter.

This performance is in line with the guidance we gave you on our last conference call for revenue growth in regional anesthesia to exceed 30%, and growth in total revenue from continuing operations to exceed 20% for 2007.

Based on our first quarter results, we are confirming this guidance for the rest of the year.

This outstanding performance by our regional anesthesia business reflected another quarter of strong sales of our proprietary ON-Q products for relieving post-surgical pain using a local anesthetic.

For quite a while now, I have been reporting to you the results of clinical study after clinical study confirming the efficacy of ON-Q across a wide range of surgical procedures.

The most recent study's results have only strengthened this trend.

Just two weeks ago, we were very excited to announce preliminary results of an ON-Q prospective human study to measure infections in colorectal surgery presented at the Annual Meeting of the Surgical Infection Society in Toronto, Canada.

This trial was designed to evaluate the effects of ON-Q PainBuster when used with ON-Q SilverSoaker antimicrobial catheters to reduce the incidence of surgical site infections.

The early results of the ongoing study indicate a statistically significant reduction in the rate of surgical site infections and a statistically significant decrease in the length of hospital stay for patients who received ON-Q versus those who received only narcotics.

Narcotics are today's standard of care for treating the pain following surgery and ON-Q's number-one competitor.

The preliminary findings captured the outcomes of 120 patients undergoing abdominal colorectal surgery, 72 of whom received a continuous local anesthetic using ON-Q, and 48 who received traditional pain relief treatment.

The results revealed that at 30 days after their surgery, patients who received ON-Q had a statistically significant lower risk of developing surgical site infections.

Zero percent infections with ON-Q versus the control group of almost 23% infections.

Additionally, patients treated with ON-Q had statistically significant shorter hospital stays of almost a two-day reduction.

It is important to note that even though these findings are preliminary, they are highly statistically significant, with p-values of less than 0.001.

We are continuing to enroll patients, and we expect to complete this multi-center study before year end.

We initiated the prospective colorectal human study based on the findings of a recent infection meta-analysis spanning nearly 10 different surgical specialties that was also presented at the Surgical Infection Society annual meeting in Toronto.

This meta-analysis, consisting of a systematic review of 50 studies encompassing more than 4,000 patients, was done to determine the effect ON-Q had on the incidence of surgical site infections.

The results showed that the reported surgical site infection rate in clinical trials with ON-Q in a non-silver-coated catheter versus standard pain treatments was approximately one-third as compared to the national average.

Again, a significant improvement.

It appears that ON-Q's ability to relieve post-surgical pain when used with a local anesthetic may be accompanied by additional benefits that result from factors like the antimicrobial benefits of the local anesthetic, the increase of oxygen delivered to the tissue, the improved immune response of the patient because of reduced narcotic intake, and last but not least, the patient will experience better pain relief with ON-Q, as proven and confirmed by the approved FDA labeling for ON-Q.

As good as these meta-analysis results are, I often wonder if they would have been even better if a silver-coated antimicrobial Soaker catheter would have been available and used instead, like in our still ongoing colorectal study.

These studies play a key role in I-Flow's efforts to expand ON-Q's therapeutic benefits beyond pain relief into the area of surgical site care and potentially get more and more patients back to normal faster following surgery.

According to the Centers for Disease Control and Prevention's National Nosocomial Infection Surveillance System, surgical site infections often increase patient length of stay in the hospital by an average of seven or more days and cost the health care system hundreds of millions of dollars each year.

We also reported recently on the first pediatric study, highlighting the positive outcome seen when ON-Q and a local anesthetic are used to treat the pain following surgery in young heart patients.

Results of a two-year study at world-renowned Miami Children's Hospital suggest ON-Q provides significantly better pain control for infants and children requiring heart surgery.

Patients in the study who received the ON-Q experienced effective pain relief, used significantly less narcotics, and experienced a return of bowel function sooner than patients in the control group.

The research, conducted by the Congenital Heart Institute at Miami Children's Hospital and the Arnold Palmer Hospital for Children, demonstrates that ON-Q can not only relieve pain, but can truly redefine recovery for pediatric patients undergoing heart surgery.

These powerful new studies on reduced infections and better pain relief for children add to the independent pain relief meta-analysis I discussed on our last call, which was published in the December Journal of the American College of Surgeons.

As you may recall, this study of 44 different randomized clinical trials involving more than 2,000 patients confirmed the efficacy of continuous wound catheters that deliver a local anesthetic, including ON-Q, for post-surgical pain relief.

The accumulation of such compelling clinical data supporting the benefits of ON-Q is encouraging more and more hospitals, ambulatory surgery centers, surgeons, anesthesiologists, and their patients to use ON-Q.

The consistently positive study results help strengthen our belief that ON-Q has the potential to replace narcotics as the standard of care, resulting in a multi-billion market opportunity for I-Flow.

In addition, based on the preliminary results of the colorectal infection study and the completed infection meta-analysis, we believe ON-Q may reduce the incidence of infection as well.

Now I am going to turn the call over to Jim Talevich to review the 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 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.

For the three months ended March 31, 2007, revenue from continuing operations increased 22% to $24.3 million, from $19.9 million for the first quarter of 2006.

The increase included the effect of a 34% increase in regional anesthesia revenues over the prior year quarter.

IV infusion therapy revenue decreased 8% to $5.2 million for the first quarter of 2007 from $5.6 million a year earlier.

As we announced previously, we expected revenue growth in our IV infusion therapy business to moderate following an exceptionally strong performance in the fourth quarter of 2006.

Reflecting the renewed expansion of the Company's sales force and marketing programs, SG&A expenses from continuing operations increased 26%, to $21.2 million for the first quarter of 2007, from $16.9 million for the first quarter of 2006.

SG&A expenses from continuing operations included stock-based compensation expense of $1.2 million, and $0.8 million for the first quarter of 2007 and 2006, respectively.

The loss from continuing operations net of tax for the first quarter of 2007 was $2.2 million, or $0.09 per basic and diluted share.

This compares to a loss from continuing operations net of tax for the first quarter of 2006 of $1.9 million, or $0.08 per basic and diluted share.

Income from discontinued operations net of tax for the first quarter of 2007 was $1.3 million, or $0.05 per diluted share.

For the first quarter of 2006, income from discontinued operations net of tax was $1.4 million, or $0.06 per diluted share.

Net loss for the three months ended March 31, 2007, including both continuing and discontinued operations, was $0.9 million, including stock-based compensation expense of $1.2 million.

This compares to net loss for the three months ended March 31, 2006, of $0.5 million, including stock-based compensation expenses of $0.8 million.

In March 31, 2007, I-Flow reported net working capital from continuing operations of approximately $48.3 million, including cash and cash equivalents and short-term investments of $21.5 million, no long-term debt, and shareholders' equity of $90.5 million.

Now I'm going to turn the call over to Don Earhart, who has some final comments to make.

Thanks, Jim.

With momentum on our side, we stepped up our efforts in the first quarter to take advantage of our outstanding long-term growth opportunity by beginning once again to expand our sales force and increase our marketing activities.

As we informed you during our last conference call, we had planned to increase spending in these critical areas in the second half of the year following the anticipated closing of the sale of our InfuSystem subsidiary.

We still expect this transaction to close around midyear, but we have decided to respond to the unprecedented positive clinical results we are seeing when ON-Q is used by moving forward the time line to increase our sales headcount and our marketing support.

To this end, in January, we began hiring additional salespeople, clinical specialists and nurses, with the goal being to have 300 people in our sales organization by early second quarter, a 20% increase in headcount.

We ended Quarter 1 with around 290 people versus approximately 250 people at year end 2006.

Of the additional headcount, approximately seven were quota-carrying sales representatives, with the remainder being clinicals.

In addition, we spent marketing dollars on programs to increase the awareness among surgeons of the pain relief meta-analysis results published in the Journal of the American College of Surgeons.

Our incremental marketing tactics have included an ON-Q proven professional advertising campaign, additional promotional activities at national trade shows, an increase in regional trade shows and local physician seminars, and additional staff and educational resources to support the growth of ON-Q C-bloc, our continuous nerve block product.

We will now continue to spend the dollars necessary to inform surgeons, anesthesiologists, hospital administrators, insurance companies, and consumers of the preliminary results of the colorectal infection study and the final results of the infection meta-analysis.

With the positive patient outcomes we have seen from our recent clinical studies on infections and pain, we feel compelled to make our customers aware of these benefits as soon as possible so that they can begin choosing wisely the method to use when treating the pain following surgery.

After all, based on the compelling clinical evidence demonstrating ON-Q's pain relief superiority to narcotics, and on the positive results of our two surgical site infection studies, why would any surgeon not want to use ON-Q?

Could it be a lack of awareness of ON-Q's numerous benefits?

If a lack of awareness is the problem, and we at I-Flow believe that to be the case, the quickest and best solution for increasing awareness is to add more salespeople and to support their efforts with the appropriate marketing spend.

Needless to say, we will do everything we possibly can to exploit what we believe to be an exceptional opportunity.

Xavier, we are ready for the first question.

Thank you, sir.

(Operator Instructions.) One moment, please, for the first question.

Our first question comes from the line of Raj Denhoy.

Please go ahead.

Good morning, guys.

Maybe I could ask a couple of questions.

I mean, obviously, you've outlined an increased spending level here going forward.

Are you willing to maybe bracket what that might look like?

I mean, it stepped up here a little bit, tells the marketing spending.

Should we expect it at this rate, a little over $21 million a quarter, or are we expecting it to kind of even grow pretty substantially off of here?

No, I don't think you're going to see a substantial growth to what you saw in the first quarter.

So in absolute dollar basis, kind of continue it at where it is now?

Yes, we should be in that ballpark.

Okay, okay.

You also mentioned a number of salespeople that you've already added, or sales headcount in general that you've already added.

I think the numbers you gave are that you had 250 people at the end of the year, of '06, and you've got 290 now.

But of that additional 40 that you've added, only seven of those were quota carrying?

Am I getting that right?

Yes, you're correct.

So the quota carrying is right now maybe 205 to 210, something like that?

Yes.

We, numbers estimate around 200, between 200 and 210 is where we'd like to be.

Okay.

For quota carrying.

Okay.

Maybe just a couple of other ones as well.

The RA business is up nicely, but it was still down a bit sequentially here in the first quarter.

Is there anything behind that, or is there an explanation behind that you can offer?

No, we--.

I think it was just sort of the first time we've seen that sequential pattern here, where the first quarter was down a little bit over the fourth.

No, we've always had an issue between first quarter and fourth quarter, in which the sales reps in the fourth quarter drive very hard to make their bonuses at the end of the year, and we had a higher than normal percentage actually hit quota in the fourth quarter, and that's probably the reason.

Okay, okay.

So some sales probably got pulled forward a little bit, only because we had a higher percentage of reps hit quota.

But we are very pleased with that $19-plus million, because first quarter's a tough one for us.

Sure, sure.

Just, I guess in the past you were able to still show some sequential growth, but I guess the numbers are getting relatively large now.

Numbers are getting bigger, and we had more reps hit quota.

Okay.

I don't think you offered the unit versus price growth in RA?

Maybe I missed it.

No, we're still holding for $190 being our average price.

So there wasn't much price in the quarter, then?

No, uh-uh.

Price was basically flat.

Okay.

And then I'll just ask one last question and then I'll get back in line or let some other people jump in here, but you know, in the study that, the infections that you reported, it looked very compelling, but the one thing that kind of stuck out was that the control group had, I think you said, 23% infection, which is significantly higher than what you see in the literature, and I wonder if you have any thoughts around why that control group would be so high.

Yes, we do have some thoughts around that.

In our original meta-analysis in which we looked at infection rates, we compared our infection rate to the CDC averages, and we have learned, and most people know, that the CDC averages are usually well understated.

The reason they're understated is hospitals report their infection rates at the time the patient leaves.

They don't follow patients for 30 days like we do, so infections can occur after they've left, which end up with readmissions, and of course, number two, the reporting by a hospital is voluntary.

So it wouldn't be nearly as accurate.

But what's interesting here, Raj, is we found a study in the New England Journal of Medicine which was published in December of last year, in which they compared two different antibiotics in preventing infection rates in colorectal surgeries.

So this is exactly what we're doing, and they compared the effect of two different antibiotics on reducing infection rates.

The better of the two antibiotics had a 17% infection rate.

The other antibiotic had a 26% infection rate.

So when you think about what is the true infection rate for colorectal surgeries, it's probably north of 20%.

So when you look at that, then our 23% infection rate for those who did not get ON-Q look like it's probably right.

Okay.

That makes sense.

Thanks a lot.

Our next question comes from the line of Greg Brash from Sidoti.

Good morning, guys.

I have a question regarding--is there any particular area with ON-Q, sort of procedures, where you're experiencing stronger growth, or is it stronger growth across the board?

Well, I think the growth across the board of those surgeries that we focus on is there.

But again, remember, we focus on mostly the bigger surgeries.

That's where our sales force spends most of their time, which means we're doing hearts, thoracic, bariatrics, the bigger surgeries that generate bigger pumps and therefore generate larger revenues for I-Flow.

Okay.

But it works in all kinds of surgeries.

And we are spending a lot of time on continuous nerve block, which is the C-bloc product, because that's expanding very fast.

And then with C-bloc, then you'd be seeing stronger growth in sort of the orthopedic procedures?

Yes, yes.

In fact, our growth, I believe last quarter, was 144% in C-bloc, which is greater than our overall growth.

Okay.

I was also curious regarding using ON-Q with pediatric patients.

I mean, it seems obvious that you'd want to use a device like ON-Q instead of giving a child narcotics.

Is this something you're already out there marketing for these types of procedures?

Yes, we've had people--or I should say surgeons--using the product on children for a long time, but we've not had a clinical study proving its benefits.

And that was the reason for the Miami Children's Study, and now we have a published clinical study that actually shows the benefits.

There was always some concern in the early days about whether or not they would get too much medicine or not enough medicine, what is the right concentration, what flow rate should the pump run at, et cetera, when you're talking about children.

And so the Miami study was actually done to help prove that it does work and to also set some parameters around concentrations and flow rates.

Okay.

Any idea how big the, just the potential pediatric market would be, that would be opportunity for you guys?

Well, it's all part of the 20 million surgeries that we say is our market opportunity.

I don't how much of that is children versus how much is adults, and again, where's the cutoff?

Is the cutoff three years old?

Is the cutoff 12 years old?

Is the cutoff 18 years old?

I don't know the answer.

I hear you.

Fair enough.

Would it be possible for you to give the breakdown or just sort of the percent of ON-Q sales that were SilverSoaker or tunneling?

The last time I looked, we think that silver is probably 25% of our total sales and growing, and I believe the results from the colorectal study's probably going to speed that up.

And tunneling, boy, that's a tough one.

We don't really know the answer to that question on how much is tunneling.

Okay.

One last one.

This is probably for Jim.

Would it be possible for you to break down the sales and marketing in G&A?

You gave the total number.

For selling and marketing was 17141.

Okay.

Thank you very much.

Appreciate you taking the time.

Our next question comes from the line of Adrian Dawes from Hartwell.

Please go ahead.

Hello, Adrian.

Please go ahead, sir.

Our next question comes from the line of Jim Molloy from Oppenheimer.

Please go ahead.

Hi.

Thanks for taking my question.

Hope my question's more acceptable than the last one.

Hi, Jim.

How are you?

The, I had a question on the number of procedures in the quarter.

Do you have a number you can throw out, or procedure per rep in the quarter?

I don't have those kind of numbers, but you can tell the number of pumps sold by dividing the $19.1 million by just over $190.

Okay.

Then any thoughts on the InfuSystems?

I know it's obviously out of your hands, but any communication you can share on when that vote might go?

I know there's a proxy out there, and any thoughts on the price tag, the $140 million?

Is that still solid?

Yes, everything is still as it was at the time we signed the deal.

I think you might have seen their press release yesterday in which they talked about that they were still going forward, and we'd given them an extension.

It's in the hands of the SEC right now, so they're waiting for that to come back from the SEC before they go for a vote.

So there's no reason for us to believe today that anything has changed.

Okay.

And then on the price per procedure, you're flat for the quarter.

Any thoughts on what caused that to be flat?

I mean, obviously, things can happen, but it seems like it's been going up at a pretty good clip in the past.

No, I don't have any special reasons for that.

If it is, basically what it is, the mix, as I have said before, we've got more and more reps now who are focusing on big pumps, so maybe we saw the big spurge to big pumps, but we are introducing some new models as I speak that will take the price of a pump up another $100 to $150.

So I think we'll see additional jumps in the future.

We just didn't see it in the first quarter.

Maybe a final question and related to Infusystems.

Any thought on the revenue number for the quarter?

For InfuSystems?

Yes.

No, I don't have any thoughts on that.

But do you have it?

Oh, sure.

It's about, let's see.

It was $7.9 million.

Okay.

Thank you very much.

Our next question comes from the line of Tim Vestal from Kleinheinz.

Please go ahead, sir.

Hi.

Good morning, guys.

I have a question on your sales force.

How long does it typically take for a salesperson to become breakeven?

Well, if you talk about a territory manager or a quota-carrying rep, they usually have six months to become profitable.

That means they've got to clear the breakeven mark.

That's a requirement, by the way, when we hire a sales rep.

Now, when you talk about clinical specialists, or nurses, which is what we hired mostly in the first quarter, they begin to become productive much quicker because they're assigned to a territory rep, and they actually then are backup and spend a lot of their time in surgery.

So they become productive very quickly.

Okay.

Great.

Thank you.

Our next question comes from the line of John Nevins with Wachovia Securities.

Please go ahead.

Good morning, guys.

The clinical study on the colorectal, the infection study.

Do we have enough data now, since it is statistically significant, to go to the FDA?

I think on the last call, you talked about the time line of the study being, you know, you get the data, you analyze it, then you submit a poster and the FDA--could you kind of update us on where that stands, and do we have enough to go to the FDA, or do we still have to wait until we get 1,000 patients?

This is John, right?

Yes.

Yes, John.

Believe it or not, we're not waiting.

We are already preparing the document for the FDA as we speak.

Okay, great.

We're going to take what we have, because the statistics are so overwhelmingly positive in our favor.

Right.

We'll get their comments.

Best case is they'll believe it like it is.

Worst case is we might have to do some tweaking to the protocol, which means we go back and do another 100 patients, we've got significance.

Gotcha.

So yes, we are preparing that document as we speak.

So this could actually move the time line up for your best-case scenario on getting labeling for infection reductions?

If we are lucky, like we were on the previous request from the FDA, we could have labeling sooner rather than later.

Fabulous.

Thanks, fellas.

Appreciate it.

Okay.

Our next question comes from the line of Steve Krueger from Foresight Investing.

Please go ahead, sir.

Good morning, Don.

Could you tell us how much of the increase in SG&A spending was related to all of the incremental marketing and added salespeople in the first quarter?

Jim, why don't you handle that?

Well, let's see.

There were a lot of pieces there.

Basically, the SG&A, when you look at the total increase, I think the biggest piece was probably--again, we don't have it separated between the new people and the old people.

But from a year-to-year increase, about $3 million of the total increase was actual selling expense, and about $350,000 was marketing.

Does that help you?

A little bit.

You said you added about 40 people in total.

Right.

In the first quarter and, you know, I'm not sure what you're paying those guys, but even if we take $100,000 a year annualized, fully loaded, and even if you say they're onboard the whole quarter, that's only about $1 million, and that's probably high.

And then you said you had some incremental marketing expenses, advertising and so forth.

How much do you think the incremental marketing and advertising added up to?

A ballpark, order of magnitude?

Now, before we answer that question, help me again.

Now this is who?

This is Steve Krueger, Don.

Yes.

Steve, you need to help us recruit some salespeople, because we can't find any for $100,000.

But if you saw some out there that can do the job for 100, you let us know.

Well, but you're not paying these, you're just paying these guys base salary right now, I'm assuming.

Right?

Well, in some cases where you bring in a territory manager, and you've got to also guarantee their commissions for a period of time until they have a chance to build the territory.

I guess what I'm really wondering, Don, thinking longer term, is how does this scale?

You've continued to talk about a multi-billion dollar market opportunity, and I believe that.

You're at $100 million now, so to think that you could get to $300 million or $400 million or $500 million, that should be well within your sights.

And I'm wondering how the income statement in the P&L model scales when you get to that kind of level.

You know, what level of profitability do you reach?

I think the best way to answer your question is we have said over and over again, when the ON-Q product line reaches a run rate of approximately $85 million, we are profitable, including stock-based compensation.

So if $85 million is the magic number, based on our forecast or our projections for this year which we have mentioned earlier, we should be at that run rate going out of the year or sooner.

Right.

But how does that profitability scale from there in terms of--?

Well, that means we're breaking even overall, so every dollar, every incremental dollar is going to generate, with a product that's got 90% margins, it's going to generate a significant portion of that at, towards the bottom line.

The only thing we're going to be taking out of that is sales expenses and commissions.

Well, it should happen that way, Don, and I assumed it would, but what's got me concerned is there was just the first quarter here but we did see a healthy increase in revenues, but not one of those dollars was dropped to the bottom line.

And that's why I'm wondering how it scales from here.

Well, I've just given you the scale.

The scale is when we get $85 million, we break even.

By the way, we are going, the reason why we spent the money we did in the first quarter is because of the clinical results that we received from the New England Journal on pain, and then we turned around and got the colorectal data.

We're not going to sit here and let this opportunity pass us by.

No, and I don't think you should.

We have the resources to do it, and that's exactly what we're doing.

And I'm happy to hear that.

I'm still trying to wonder, maybe it's ultimately a question of salesman productivity.

What level of productivity do you think you can get to?

You're at about $300,000 or $400,000 a year for a quota-carrying salesperson now.

What do you get to in two or three or four years with all the fabulous results and data that you're getting with the efficacy of ON-Q?

Do you get to $1 million per salesman?

Well, we right now have a handful of salespeople who are doing over $1 million.

We have a large number of that sales organization that's been here over a year that is now approaching $700,000 and $800,000 a year, and then we have, of course, clinical specialists who don't count.

They don't have quotas.

And we have new people who have quotas that are smaller than that.

So we already have proof that a rep, a good rep who's been here two or three years, can approach $1 million or more in actual sales.

And how many quota-carrying reps do you expect to exit 2007 with?

Quota-carrying reps?

Probably around 210.

So that kind of sales force, within a year or two should be capable of generating over $200 million in ON-Q sales.

I'm not going to make that commitment, but I think we're getting close.

I think that number's pretty good.

Okay.

Last question for the moment.

How many hospitals are actively using ON-Q right now?

The last time we looked, it's a little over 2,000 have used at least once the product.

And is that in 2006, you had 2,000 different hospitals that used it?

That was in the fourth quarter of last year is the last time we looked, we had about 2,200 hospitals that had placed at least an order during that quarter for the product.

Okay.

But again, that's not our focus.

Our focus is not to add hospitals.

Once we get a hospital, we go deep.

Deep inside each hospital.

Okay.

Great.

Thanks very much, Don.

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

Please go ahead.

Hi.

It's [Seth Gunderman] for Alex.

And a quick question.

Can you explain the $1.5 million tax liability and the $900,000 expense related to the discontinued operation and how does it relate to the recent ruling?

Oh, this on the Michigan tax thing?

Yes.

What is that, exactly?

Well, the basically, use tax is another word for sales tax, and if somebody forgets to charge a sales tax, then you owe the state you're in a use tax, is what that means.

But the State of Michigan audited them a few years ago, audited InfuSystem, our Detroit subsidiary, and they told them that they owed 6% sales taxes on all of the pumps that they buy.

And as you know, that's a pump rental business.

So we contested that decision by the State of Michigan, and we have been appealing that decision, and we won.

Okay, and this reversal should go into effect this quarter?

Yes, that will go into the second quarter.

Okay.

And what about the $900,000 expense that you mentioned there?

The--maybe if you can show me what you're referring to?

Yes, you talk about assets and held for sale, (inaudible) expense (inaudible), $1,000.

Oh, well, the, just the, what happens is that you, if you pay that use tax when you, on those pumps when you buy them, then you hit depreciation with that additional cost.

So basically, you're depreciating the additional cost of the pumps, and you're immediately expensing the use tax on these operating supplies for the disposable kits.

That's what that is.

And then also interest.

We've been accruing interest that we would theoretically owe the State of Michigan, and then we're not going to have to pay that interest because we won.

Okay.

Now it's clear.

Thank you very much.

Our next question comes from the line of Adrian Dawes from Hartwell.

Please go ahead.

Don, I'm wondering how soon you think all of your infection studies and the results thereof will be usable and effectively used by your salesmen?

That's the first thing.

The second thing is, do you have any other studies that you can tell us about that are ongoing, either in for C-bloc pain management or for the infections?

Yes.

First of all, Bill, we believe that we're going to be able to utilize the preliminary data from the colorectal study along with the meta-analysis that was presented on the same podium in Toronto.

So we are preparing the marketing materials as I speak to put in the hands of the sales organization so that they'll know how to talk about it and how to present it.

We're already in the process of drafting letters and materials for the insurance companies so that they will know about it.

So our goal is to get to surgeons, hospital administrators, insurance companies, and ultimately, somewhere down the road, to consumers to make sure they understand that there may be an opportunity to reduce their chance of infection if they use our product.

So that's what we're doing with the infection stuff, so we're doing something now.

We're not waiting for the FDA or anybody else or the end of the study.

Other studies that we're doing, we are in the process of launching a C-bloc study which will utilize ultrasound as the method for finding the nerve.

And what we're measuring there is whether or not we get better outcomes and faster blocks if ultrasound is used.

And we're partnering with SonoSite and GE, who will be providing the ultrasound machines, and of course, we will provide the pumps.

So we are doing that study, and then we are getting ready to do a hard study in which we will measure the incidence of pneumonia, and that one will follow once we launch the C-bloc study with ultrasound.

So we have quite a few things going on that we think are going to be very positive.

Again, a heart surgeon's number-one concern is pneumonia.

Patients don't breathe deep after the surgery, and a lot of them get pneumonia.

So if we can make that difference-- and we know our pump does allow people to breathe and not have pain--that can be another winner for us.

And pneumonia is considered just another form of infection.

Exactly right.

But it's not tied to the surgical site.

It happens in a different way.

Right.

And the other question, Don, is if you had one entity to understand infection, it would be the insurance companies or it would be the doctors themselves, because if you can get to the insurance companies, will they be able to mandate no matter whether a doctor wants to use it or not, mandate using this pump?

I think, Bill, the person we would want to convince would be the hospital administrator and the surgeon.

It's really in the hospitals.

Because the hospital is the one that's under the pressure to eliminate the infections, both by the FDA, CMS, the insurance companies, you know, everybody.

So we've got to convince the surgeon and then the hospital.

And if your salesmen have been calling on the hospital administrator or letting the doctors take care of convincing the hospital administrators?

Or are you going to set out a separate campaign for the hospital administrators?

We're going to do both.

We're going to give them materials to go to the surgeon, and we're going to give them materials to go to the administration.

And ultimately, Bill, we believe that if we prove this, it's going to become a legal issue.

Yes, I'm sure it will be, not a patient issue.

And that might be even more positive than the surgeons or the hospital wanted to use it, because then they'll be forced to use it.

Right.

And Don, and when do you think that, given all these programs and all the materials you're generating, et cetera, when do you think the salesmen will be able to see an uptick in their productivity so that the outlook for sales that you gave us for this quarter and gave us at the end of last year will be increased?

Bill, you know I like to avoid those kinds of question, but I will tell you this, is the materials will be in the hands of the sales force in less than two weeks.

So we will begin educating surgeons and hospital administrators within the next two weeks, and again, there will be some training that has to be done to make sure they understand how to present and answer questions, and then we're already, like I said earlier, contacting the insurance companies.

That will take time, but we have been seeing a productivity increase every quarter.

How much faster it increases going forward?

I'd rather not commit to that yet, Bill.

Well, you expect to see some impact, then, at least by the third quarter, and certainly the fourth.

Yes.

Okay.

And possibly even the second.

You just never know.

Let's hope.

Thanks a lot.

Our next question comes from the line of Matt Dolan with Roth Capital.

Please go ahead.

Hi, guys.

Good morning.

Just a couple of questions here.

First, on the reimbursement code we talked about earlier this year.

In the scope of C-bloc, are you seeing a lot of benefit there because of that code in the outpatient setting, or is that just more of an organic growth and acceleration in C-bloc that we're seeing?

Well, the code only affects the pump reimbursement.

As you already know, Matt, the anesthesiologist gets paid for placing that catheter and doing the block, so that's already been in place for several years.

So the new code affects only the pump expense.

And again, that's just like the pump expense in a hospital outpatient environment.

It will take time for that to become reimbursed.

Yes, but have you provided what the outpatient percentage of sales is looking like now?

The outpatient?

Well, we don't really separate the sales.

I can tell you this.

The billing side of the business is basically flat, and we want it to be that way as more and more of that business is becoming a sale.

And a lot of that's because of our emphasis on the nerve block business which, by the way, is the same surgery.

Most of the surgeries in an outpatient environment are related to orthopedics, so if we can get an anesthesiologist and a surgeon to do a block instead of doing wound site, we win big, because we sell a pump instead of taking on the extra work of doing the billing.

Right.

Okay.

In the quarter, any--?

(Inaudible - multiple speakers)

Can you help us quantify any contribution from custom kits?

It's still a small part of our contribution, but it's growing.

Okay.

And then finally, gross margin, you had a nice pump-up there.

I don't know if this has been covered yet, but is that sustainable level, about a 350 basis point bump-up from Q4.

Are we at a more reasonable level here that we should model off of?

Well, again, that depends on what our IV business is going to do.

Because remember, that's a mix.

So when the IV business is down but the regional anesthesia business is up, then margins go up.

Now, we expect our IV business to come back in the second quarter, not to the level it was in the fourth quarter, but we do expect it to be better than it was in the first quarter.

So I can't really answer that.

Sure.

Okay.

That helps.

Thanks, guys.

(Operator Instructions.) One moment please, for our next question.

Mr.

Earhart, there are no further questions at this time.

I will now turn the call back to you.

Please go ahead.

Thank you, Xavier.

ON-Q continues to prove itself in the clinic and in the marketplace.

We are committed to taking full advantage of the outstanding long-term growth opportunity ahead of us in our regional anesthesia business.

We look forward to reporting further progress when we announce our second quarter results in about three months.

As always, we thank you for your continuing support.

Thank you.

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

Thank you for your participation, and I ask that you please disconnect your lines.