金百利克拉克 (KMB) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the I-Flow second quarter 2007 results conference call.

(OPERATOR INSTRUCTIONS)

I would now like to turn the conference over to Mr.

Don Earhart, CEO and President.

Please go ahead, sir.

Thank you, Pedro.

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

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

As we reported in our press release this morning, second quarter revenue in our regional anesthesia business increased 35% to $23 million, a quarterly record, and total revenue from continuing operations increased 30% to $29.1 million.

For the first half of 2007, regional anesthesia revenue increased 35% to a first-half record $42.1 million, and total revenue from continuing operations for the first half of 2007 increased 26% to $53.4 million.

This performance is in line with our previous guidance for revenue growth in 2007, regional anesthesia to grow in excess of 30% and total revenue from continuing operations in excess of 20%.

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

Growth in our regional anesthesia business is continuing to benefit from the successful implementation of our strategic initiatives to drive usage of our proprietary ON-Q products for relieving post-surgical pain, using a local anesthetic instead of narcotics, and ultimately, to replace narcotics as the standard of care in this multi-billion dollar market opportunity.

We are helping surgeons and anesthesiologists redefine recovery for their patients and get more patients back on their feet faster following surgery.

What's more, our business generated cash during the second quarter, and our overall cash position increased by more than $4 million, even as we invested in the planned expansion of our marketing programs and ON-Q sales organization.

This sales organization now numbers almost 300 persons, nearly 200 of which are quota-carrying sales professionals.

This increase in the number of feet on the street is one of the reasons for our continued strong growth in ON-Q sales in the second quarter.

And, based on our historical experience, we are confident that the contributions of the newest members of our sales team will increase as they move up the learning curve just as others have done before them.

With the average selling price of our ON-Q products basically the same as the second quarter, a year ago, the increase in ON-Q sales revenue of 35% can be attributed to the people additions in 2007 and to the increase in productivity from our tenured sales representatives.

What is even more encouraging is the 20% sequential growth from the first quarter of 2007 to the second quarter of 2007.

Our focus on driving top line sales via the responsible and measured deployment of resources is paying off as expected.

But the growth in our sales force alone would not be enough to deliver the rapid growth in ON-Q sales if our products did not offer meaningful clinical benefits.

That's why another critical factor driving demand for our ON-Q products and helping us bolster our position of market leadership is the steadily expanding body of compelling clinical evidence, evidence that demonstrates the efficacy of ON-Q in reducing pain after surgery without narcotics.

Perhaps the most encouraging aspect of our clinical trials is that the clinical trial results are mirrored with real outcomes with real patients, outcomes that our customers see with their patients every day.

I mentioned a couple of examples last quarter, including an independent pain relief meta-analysis published in a prestigious surgical journal in December 2006, confirming the efficacy of continuous wound catheters that deliver local anesthetic, including ON-Q, for post-surgical pain relief.

In addition, I shared with you the first pediatric study highlighting the positive outcomes seen when ON-Q is used to treat pain after surgery in young heart patients.

By encouraging more and more hospitals, ambulatory surgery centers, surgeons, anesthesiologists, and their patients to use our products, we believe the accumulation of consistently positive outcomes that mirror our clinical results contributes significantly to our sustained rapid growth in ON-Q sales.

Just as exciting, many of these studies are yielding additional solid clinical data in support of our efforts to expand ON-Q's therapeutic benefits beyond pain relief and into the broader arena of surgical site infection.

For example, on our last call, I referred to the results of an infection meta-analysis which revealed a lower rate of surgical site infections with ON-Q than with standard pain relief treatments.

This is important because according to the Centers for Disease Control and Prevention's National Nosocomial Infections surveillance system, surgical site infections often increase patient length of stay in the hospital by an average of seven days or more, and the cost of the health care system exceeds hundreds of millions of dollars each year.

That is why we are so excited by the results of our ongoing study of the effects of ON-Q PainBuster with ON-Q SilverSoaker Antimicrobial Catheter in reducing surgical site infections in colorectal surgeries.

By the end of the second quarter, data has been accumulated on more than 167 patients.

The results continue to indicate a statistically significant reduction in the rate of surgical site infections and a statistically significant decrease in length of hospital stay for patients who received ON-Q versus those who received only narcotics, ON-Q's primary competitor.

We have submitted these data to the FDA in support of our request for an expanded efficacy claim for ON-Q with the SilverSoaker catheter when used to deliver a local anesthetic into a surgical site to relieve the pain following surgery.

In the meantime, the study is continuing and the number of patients completed now exceeds 240.

I have more news to discuss after Jim reviews the second quarter results in detail.

Before I turn the call over, however, let me add that we still expect to close the sale of our InfuSystems subsidiary for approximately $140 million this year.

The SEC is being especially rigorous in its review of transactions involving special purpose acquisition corporation, and so the review is consuming a lot more time than we originally anticipated.

As we announced on Tuesday, we agreed to the most recent amendment to the stock purchase agreement to extend the termination date to October 1, 2007.

We hope this will allow HAPC sufficient time to obtain SEC approval of the proxy, obtain the necessary shareholder votes, and close on the sale of InfuSystems sooner rather than later.

Remember, I-Flow does not control this process of reviews.

The communications are between HAPC, the buyer, and the SEC, and we only participate by providing to HAPC answers, as needed, to questions raised during these reviews.

With that, I'm going to turn this over to 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 space, 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 June 30, 2007, revenue from continuing operations increased 30% to $29.1 million from $22.4 million for the second quarter of 2006.

The increase included the effect of a 35% increase in regional anesthesia revenue over the prior-year quarter.

IV Infusion Therapy revenues increased 12% to $6.1 million for the second quarter of 2007 from $5.4 million, a year earlier.

Net income for the three months ended June 30, 2007, including both continuing and discontinued operations, was $0.6 million, including stock-based compensation expense of $1.9 million.

This compares to the net income for the three months ended June 30, 2006 of $0.4 million, including stock-based compensation of $1.7 million.

Reflecting the expansion of the Company's sales force and marketing programs, operating expenses from continuing operations increased 30% to $23.6 million for the second quarter of 2007 from $18.1 million for the second quarter of 2006.

Operating expenses from continuing operations included stock-based compensation expense of $1.8 million and $1.7 million for the second quarter of 2007 and 2006, respectively.

The loss from continuing operations, net of tax, for the second quarter of 2007 was $1.6 million, or $0.06 per diluted share.

This compares to a loss from continuing operations, net of tax, for the second quarter of 2006 of $0.8 million, or $0.03 per diluted share.

Income from discontinued operations, net of tax, for the second quarter of 2007 was $2.2 million, or $0.09 per basic and diluted share.

For the second quarter of 2006, income from discontinued operations, net of tax, was $1.3 million, or $0.06 per basic and diluted share.

On April 24, 2007, the Michigan Tax Tribunal granted a Motion for Summary Disposition in favor of the Company's InfuSystems subsidiary in connection with its liability for use taxes on purchases of infusion pumps.

Due to this favorable ruling, I-Flow's results for the second quarter included the reversal of the previously recorded tax liability of $1.5 million within assets held for sale and reversal of cumulative expense of $0.9 million, consisting of $0.6 million cost of sales and $0.3 million accrued interest expense, within discontinued operations.

At June 30, 2007, I-Flow reported net working capital from continuing operations of approximately $54.8 million, including cash and cash equivalents and short-term investments of $29 million, no long-term debt, and shareholders' equity of $94.3 million.

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

Thanks, Jim.

ON-Q C-bloc continues to be an especially strong catalyst for us with revenues increased 148% to $3.8 million in the second quarter and 147% to $6.3 million for the six months ended June 30, 2007 when compared to the same periods in the prior year.

This growth is primarily due to heightened customer awareness, of clinical efficacy, of favorable insurance reimbursement environment, and a steady stream of new products from I-Flow that feature larger capacity pumps to enable more days of therapy in certain orthopedic applications.

We are committed to continuing to deploy resources, as needed, to support C-bloc, our fastest growing segment on a percentage basis of our broad ON-Q product line.

That brings me to another exciting development, our recent announcement of the formation of a strategic alliance between I-Flow and GE Healthcare to conduct clinical trials and explore joint opportunities in the anesthesiology market.

This exclusive alliance combines the resources of the market-leading supplier of regional anesthesia infusion pumps, that would be I-Flow, with our ON-Q C-bloc system and a market leader in global ultrasound and global compact ultrasound, that would be GE Healthcare.

We are confident that this will turn out to be a winning combination.

In the initial phase of our alliance, we will conduct a multi-center prospective randomized clinical study on the use of ultrasound for the placement of continuous peripheral nerve blocks for regional pain management.

The goal is to measure the effectiveness of using GE's compact ultrasound products for making nerves easier to find in less time with better outcomes.

Naturally, I-Flow's ON-Q C-bloc will be used as the pump of choice for maintaining the block.

This is an important study for both I-Flow and GE, making it easier for anesthesiologists to see and place a catheter for a continuous peripheral nerve block, should speed up the adoption of this therapy, and therefore increase the use of pumps like I-Flow's C-bloc.

And since finding the nerve for a continuous nerve block is one of the fastest growing opportunities for using ultrasound, GE should be able to sell more portable ultrasound machines, as well.

We took delivery of the first 40 ultrasound systems from GE Healthcare at the end of June.

Our goal is to place all of them in clinical sites during the current quarter, and we expect patient enrollment to begin by early fourth quarter.

Using our ON-Q C-bloc device and GE's portable ultrasound machine, the LOGIQ e machine, we hope to expand this study with additional systems later this year.

Pedro?

We are now ready for the first question.

(OPERATOR INSTRUCTIONS).

Our first question comes from the line of Alex Arrow.

Please proceed.

Thanks.

Good morning, Don and Jim.

The SG&A, which was a little higher than we expected, seems to be tracking along with sales, but maybe you could, first, just tell us what the marketing or sales expense was and give us an update on your sales force hiring limit that would lead to the bump up in SG&A?

Well, as you know, Alex, this is Don Earhart, as you know, our goal is to drive top line.

And at the same time, internally, our goal is to maintain cash flow positive.

And that's exactly what we are doing, so we are focused on driving that top line and those costs in G&A are related to the sales additions that we actually hired in the first quarter.

We're seeing the full expense in the second quarter.

And, of course, we're paying more commissions, as well, as the sales actually are growing much faster than we though.

So, we're doing exactly what we said we're going to do.

We're going to drive and focus on the top line, and our goal is to stay cash flow positive, and we're going after this market as fast as we can with marketing programs related to ultrasound and C-bloc, as well as supporting our sales force in other areas of surgeries.

Okay, so would you say it's the ultrasound and C-bloc marketing programs?

Or is it the new sales hires?

Can you quantify where --?

It's all of the above.

It's all of the above, Alex.

How much do marketing programs, can you say how much do marketing programs cost for the ultrasound and C-bloc initiatives?

No, we don't break that out.

Okay.

Did I miss you?

Did you give a headcount update on the sales force and how many were hired during the quarter and how many you're up to now?

We didn't hire anything except replacements during this quarter.

Everybody was hired in the first quarter.

And we said that our sales organization now, in total, including clinical support, is about 300.

It's just short of 300, and quota carrying reps, we said in the call, were just below 200.

So, we have about 200 quota carrying reps, about 192 or 193.

Okay, thanks.

My next question, if we could just go on to the HAPC, the questions.

I know that the SEC is taking a tightening of SPACs and asking more questions of SPACs, but even that, it does seem like there's been more questions in this case.

Can you give us just any detail about the nature of, I mean, just whether they're totally perfunctory, and I know it's between the SEC and HAPC, but is HAPC telling you anything about the nature of these questions that can enlighten us to why they keep getting delayed?

We actually see the questions, Alex, and there's nothing there that should prevent approval of the proxy.

We have not seen any of that.

It's just the tedious process of review that seems to go forward with the SPAC.

And again, like I said in my conference call, I-Flow doesn't control any of that.

All we do is provide answers where necessary to some of those questions to HAPC, but all the negotiations are between HAPC and the SEC.

We do not get involved at all other than to push hard.

So, we're as exasperated as anybody else, but we do believe now we are very, very close because there aren't any questions that are being asked that can't be answered.

Could you give us an example of a non-confidential type of question just to give us some view as to how routine these questions are?

Or is that pushing too much?

No, you're pushing too much, but you can ask HAPC that question.

But I don't want to break confidence with them by giving you questions.

Okay.

Now, the clinical study that, thanks for the update on the, any effective, the pneumonia study is another one that you've mentioned in your pipeline that we're looking forward to hearing about.

Can you give us the timeline on when that's going to happen?

Yes, it looks like we've got the protocols are all written, we're in the process of the IRB being approved, and our goal is to start that in August, which is actually this month, starting before the end of August.

Now, that means we've got three studies going, actually.

We are continuing with the colorectal, even though we have submitted 167 patients to the FDA, we are continuing to gather more patients there.

Number two, we are going to start the ultrasound program very shortly.

All of that's been approved.

And number three, we're going to start the heart study, hopefully this month, as well.

So, we're going to have a lot of clinical effort going on in the summer months.

Okay, is the heart study what you're calling the pneumonia study or are those two different things?

Yes.

We're going to measure two things.

We're going to measure infections and pneumonia.

The most important, we believe, will be pneumonia.

And if that starts this month, assuming it goes well, when might we hear the first results as per a press release from you like you did with the colorectal?

It would be some time next year.

If we have really outstanding results like we did on the colorectal and we have those results early, we could probably announce something preliminary first quarter, next year.

But again, we have to get enough patients to make it meaningful.

Okay, but you could potentially do that with like 120 patients and that would be about first quarter?

If we got the same kind of results, we could, as we did with the colorectal.

But again, now, nobody really knows the incident of pneumonia.

It's only a guess.

And remember now, we follow patients for 30 days where everybody else keeping track only keeps track until they leave the hospital.

Right.

All right, all right.

Thanks a lot, Don.

Okay.

Our next question comes from Brian Wong from First Albany Capital.

Please proceed, sir.

Thanks for taking my questions.

Jim, if you could give us what the G&A number was for the quarter?

4677.

Great, thanks.

And then, in terms of [CU], you mentioned you did replace some of your sales reps in the quarter.

I would assume that's just natural turnover?

Oh, yes.

That's a very small number, Brian.

The hiring we really did in the second quarter was to replace any that left, but we had quite a few promotions that we actually backfilled.

Okay.

What would you say the average tenure of your rep now is?

It's well over a year.

I just told you, about 18 months.

Okay.

So most of them are up and running and hitting the --?

Oh yes, yes.

That 20% growth from quarter to quarter, that's really by the tenured reps.

The new reps played very little in the growth, first quarter, I'm sorry, second quarter versus first quarter.

That was really the tenured reps.

Okay.

And they got no benefit, by the way, in the second quarter on average selling price.

That was flat at about 197.

If you remember, first quarter, our average was about 190 and the average price was about 197 in the second quarter.

Since you're talking about that, do you expect that to boost upwards now that you're pushing your C-bloc, which I would assume have a higher selling price?

I can't really answer that question because it was interesting, on first quarter, it went down to 190 and everybody asked me the question, "What's going on?".

Now, it's back up to 197.

It's all very mix related, and that's something I really can't predict.

But one thing that is true as we continue to grow the C-bloc franchise faster, you're going to see more gross margin dollars, for sure.

And by the way, our sales force is very optimistic about the third and the fourth quarter, and they are focusing heavily on the ultrasound project and therefore growing C-bloc.

You're going to see a lot of effort in the third and fourth quarter in placing those 40 machines because when they're sitting in my warehouse, they don't do me any good.

Okay.

And then, since you mentioned it as well, the gross margin, a little bit less than I expected.

Is there anything going on there that we should be concerned about?

No, the only thing that happened there is that the IV business came back strong.

Okay.

Now, remember, first quarter, everybody was concerned because it was down 8%.

Now, it's about what?

12%, 13%, but what that does is it dilutes by margin average.

But I'll take it.

Right.

I'll take it.

It's really a mix issue.

Is there anything going on in the IV business that is driving it?

Or is that just lumpy, quarter to quarter?

No, it's like I tried to explain in the first quarter.

Since we sell to distributors, we don't control the orders.

We had very strong orders in the fourth and third quarter of last year, and obviously, then that hurt our first quarter.

But second quarter, it's coming back.

And at the end of the year, we expect it to be somewhere in the mid-to-high single-digit growth.

Okay.

And then, obviously, your bottom line was a little bit below what the Street was expecting.

Does this impact, I believe, previously, you'd said that you wanted to hit break even by yearend on a GAAP basis.

Does that impact this at all?

Or do you still predict that?

No, this is the key, Brian.

Once we close on InfuSystems, we become profitable at the existing run rate.

What I've always said is that I-Flow is a continuing operation and I've always made the assumption that InfuSystems would be sold.

As soon as we hit a run rate of somewhere around $90 million, we would be profitable.

If we had closed on InfuSystems, as planned in the first quarter, originally, we probably would have been there, second quarter.

And when we do finally get it closed, because of the cash we will have on the balance sheet and the interest from the note, we should be able to meet our goal of around a $90-million run rate in RA should generate a profitable bottom line.

Does that make sense?

Yes, it does.

Okay, so that's, so I-Flow, as a continuing operation, assumes we sold InfuSystems.

All right.

Got you.

Now, again, and the interesting thing here is, let me get this out, if we did not sell InfuSystems, which we don't believe will happen, but let's say it did, we would have been profitable this quarter because if you take a look, including InfuSystems, we put $0.03 on the bottom line.

Right.

Yes, I saw that.

It's only called discontinued operations because the accounting people force us to do that, but we still own InfuSystems.

We still run InfuSystems.

That's still I-Flow, today.

Got you.

And then, on the sale of InfuSystems, if you could remind us exactly when does HAPC have, what's their deadline before they have to dissolve?

I believe it's the end of the year.

If you just want to let me see if -- Jim?

April 2008.

Yes, April 2008.

Did you get that, Brian?

I did.

Okay.

Great.

Thank you.

Our next call comes from Mark Mullikin from Piper Jaffray.

Please proceed with your question.

Good morning.

Can you hear me okay?

Sure can, Mark.

Great.

I was wondering if you could actually break out what the InfuSystems sales were this quarter?

Yes, just a moment.

Jim will get it for you.

Yes, Mark, it's $7.832 million.

Okay.

And then, on the gross margin, you had a really strong first quarter on that line but it's dipped into the second quarter.

As I look at the revenue mix here, as a percentage, regional anesthesia is pretty much the same level, so is there something else going on in the mix on the regional anesthesia side that might be pressuring gross margins?

Because what I'm trying to reconcile is the sequential increase with the ASP but the gross margin percentage is going down.

Well, like I said earlier, Mark, the IV contributed heavily in the second quarter and did not in the first quarter, and I don't know any other answer to your question.

As a percentage of total revenue though, it was pretty much the same, relative to the first quarter.

There's also a mix effect within IV as to --

Okay.

Yes --

The gross margin on the IV piece of it may have been lower in the second quarter than in the first quarter.

Yes, Jim makes a good point there because our margins, domestically, are not nearly as good as they are, internationally, on the IV side.

So as you get a swing from, and that's about half and half of our business, is about half international and about half domestic, so if you get a significant swing between the two, you'll actually lose margin on the IV side.

Okay, I see.

Yes, that's a good point.

And then, on the deal with GE, do you generate any revenue directly from that like when you take delivery of those systems and place them, is there any revenue being generated by that?

No, we don't get any commissions or any revenue from placing the machines.

They are all going to be placed as part of a clinical study, therefore we can't charge the user at all.

Okay.

Are you paying GE any money as part of this or --?

Yes, I'm renting the equipment from GE.

Oh, and how much expense is that?

Can you --?

I can't give that.

GE has sworn me to secrecy since we have one heck of a deal.

Okay, so you're renting the machines from, the 40 machines, though?

Yes, I rent them monthly as part of my expense for the clinical study.

And that's flowing through the SG&A line?

Yes.

Okay.

Now, the interesting thing here is, of course, as they get started in the study, they have to use my C-bloc product.

So rest assured, Mark, that the return comes very fast as they use my C-bloc product to cover that rental.

Okay, very good.

Thank you.

Okay.

Our next question comes from Greg Brash from Sidoti & Company.

Please proceed, sir.

I was wondering if you still planned on concluding the colorectal infection study after 500 patients.

The answer to that question is probably yes and there's an outside chance we may not get to 500 patients before we conclude it.

Okay, and would you expect to see final results in Q4?

Is that still the plan?

Our goal today, it's a parallel goal.

We have two things going on at the same time.

Number one, we have submitted 167 patients to the FDA, asking for a claim.

The claim is basically to allow us to put on our package that we significantly reduced the chance of an infection in colorectal surgeries when our product is used.

That's the claim we've asked for.

That doesn't mean we're going to get it, but that's the claim we asked for.

And parallel with that, I am continuing with the study, and when I decide to close it down, our goal is to try and be at a meeting before the end of the year to announce the final results.

And in that case, it will definitely be over 240 patients, which is where we are today.

Okay, so --?

And regardless of what the FDA does, I expect to be at a meeting before the end of the year so I can tell the world the results and begin to use that to market the product.

Okay, I guess that leads into my second question.

Do you think presenting that data and having your sales reps armed with the data is enough?

Or is it necessary to get it published in a top publication to have a real serious impact on your sales?

Well, our goal is to be at a meeting with at least a poster, which gives us many of the same benefits as a published document.

Okay, so --?

So the peer-reviewed poster and, of course, following that, it would be a published article.

So the answer to your question is yes, we think it will be very powerful.

In fact, our preliminary data has already opened up doors.

Yes.

Okay, one more question.

What percent of total sales did the SilverSoaker contribute?

Do you have that data?

No, I don't.

Remember now, we sell the SilverSoaker as part of a package.

Yes.

In the past, you've broken, I think last quarter, you mentioned it was around 25% of total sales, SilverSoaker.

I was wondering if that was still increasing.

Okay, I'm looking at my operations guy.

He tells me it's exceeding 40% now.

Okay.

So, 40% of our total sales would include Silver.

Okay.

Thanks, Don.

Okay.

Thank you.

Our next question comes from Scott Henry of Oppenheimer.

Please proceed with your question.

Thank you.

First, for Jim, just a couple of questions on the one-time issues.

I just want to make sure we have them in the right place.

Am I correct that the $1.5 million tax liability, is that the $796,000 showing up as a tax benefit?

The $1.5 million is only balance sheet, Scott.

Okay, so where would that, I guess, the $900,000 for discontinuing operations, is that a subtraction?

I guess that would be that much higher.

That's income in disc ops.

Okay, and I guess switching over to a question for Don.

It looks like the procedures per rep continues to move up pretty well.

Do you get a sense that, are you anywhere near a ceiling at how productive these reps can get?

Or do you think you're still pretty early in the curve?

Very early in the curve.

Yes, because you know what's nice, Scott, is that we have examples of representatives today who are doing well over $1 million, and they did $1 million last year, and they're going to do well over that, this year, and these are tenured reps that have been here three years.

So they still have a lot of growth left, not to mention the other people we have that aren't even close to $1 million in sales.

When you've got only 4% or 5% of the market penetrated, as we give them more and more ammunition to get more and more surgeons to try it, they're not having any problem with gaining sales.

But I guess just as a follow on to that, as the product becomes more well known and it somewhat sells itself, do you expect commissions as a percent of selling and marketing to start to decline and the profitability to start to move up?

And I guess, when do we start to see that inflection point?

The answer to your question is yes, we believe that that will change, the commission structure will change as the product gets easier to sell.

And the sales per rep will significantly increase over time.

And I really don't know the answer to your third question.

Once it becomes a standard of care, it's going to be a totally different ballgame.

Okay.

Thank you, Don.

All right.

Our next question comes from the line of [Tim Festal] from [KCD].

Please proceed.

Hey, good morning, guys.

My questions have been answered.

Thanks, Tim.

Our next question comes from the line of [Steve Krueger].

Please proceed, sir.

Good morning, Don.

Just a little bit further question on the colorectal study results and how you plan to use them.

I presume you've already filed some application with the FDA.

Could you give me a little bit more context to what actually you filed with the FDA at this point to which you're submitting data?

Yes.

When we got our claims, several years ago, as it relates to pain where we now can label that the ON-Q is indicated for significantly better pain relief than narcotics, that label, of course, is on our package.

When we submitted that, several years ago, we went through the same process that we're going through with the colorectal information.

So, we have submitted to the FDA a request under the 510(k) program, in which we're asking them to allow us to add to our label for ON-Q that in colorectal surgeries, when our product is used with the SilverSoaker Catheter, you will see a significant reduction in infections.

Okay, so you formally applied for expanded labels?

It is formal, yes.

And what, can you give me some insight into whether or not, or how, or at what point you might try to request or apply for expanded labeling that would give you a broad claim of antimicrobial efficacy as opposed to just limited to colorectal?

What's going to be interesting here, Steve, it's going to be interesting when we get the comments back from the FDA as to what they're going to need for us to go beyond colorectal.

Now, when we did the earlier one, several years ago, we had a half a dozen to a dozen different types of surgeries that we were able to submit.

In this case, we only have colorectal.

But remember, now, we are starting the heart program this month, and we're going to measure both infections and pneumonia.

And, of course, once that concludes, if the data is good and favorable, then we go back into the FDA some time next year and ask for hearts to be included, not only for infections but also for pneumonia.

So, I think we're going to have to knock these off one at a time until we get a couple of these surgeries before we can get labeling on multiple surgeries.

Okay, so asking for a broad claim of antimicrobial efficacy, in general, might still be two, three, four years out.

Yes, it could be.

But now, here's the interesting thing, don't forget that a surgeon who's doing colorectal is a general surgeon.

He's doing a lot of other stomach work, and if he's convinced that he's going to reduce infections in colorectal, why wouldn't he use it for the other stomach surgeries?

And we believe that heart surgeons and bariatric surgeons and other, and OB/GYN surgeons, etc., etc.

will catch on to the fact that if it works in the dirtiest of surgeries, it ought to work in the cleaner ones.

Right.

And that's what we're counting on.

And, by the way, based on the way our sales force is using the preliminary data, we believe that will be true.

Okay, terrific.

Don, just a quick comment, in the recent issue of U.S.

News & World Report on the Country's Best Hospitals, there was a blurb that talked very directly about changing practice in post-surgical pain management.

They're referring to C-bloc.

Did you see that?

Yes.

Yes, we did.

Could you comment on how significant seeing something like that in a mainstream media piece is?

Well, I don't know the exact effect of that, Steve, but I could tell you this -- every little piece that comes forward just helps us that much and makes it easier to sell.

It brings more attention to what we are doing and it turns out that patients begin asking more questions.

Next thing you know, the doctor's asking questions because his patient's insisting on it, and bingo.

We are now there and get our first surgery.

Yes.

It's, the word of mouth is getting better and better and higher and higher, everyday.

Okay.

Great, Don.

Thank you very much.

Okay.

Thank you.

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

Please proceed with your question.

Hey, guys.

Good morning.

Hi, Matt.

Just two quick ones, Don.

First, on the sales force, I apologize if this is repetitive, but going forward, looking at the second half of this year, any additions?

Or are you pretty content here at the 300 level?

The only planned hirings we have in the second half of the year are for replacements, for turnover.

Okay, so we can stick with 200 to 210 on the quota and 300 all in?

Yes, and we have no plans for anything greater than that right now.

Okay, great.

And then, looking into the second half and as we think about these new hires coming on more in Q2, can you maybe give us a comment on the seasonality of your business of the underlying business relative to maybe the incremental impact they have?

Well, the new people are just now becoming productive and we expect them to become more productive in the third and fourth quarter.

Remember, now, our third quarter typically mirrors our second quarter.

And what we're doing in the second half of the year as we're having regional meetings all around the country is we are focusing on productivity and execution.

That's what everybody is talking about.

So, third quarter typically is similar or very much alike what we do in the second quarter.

And fourth quarter, if you remember, Matt, is usually a huge quarter in comparison to the other three.

Right, okay.

So we start thinking a flat Q3 and then ramping in Q4, got it?

Yes.

Now, our biggest problem in third quarter is we run into vacations.

Okay, great.

Thanks, guys.

Okay.

(OPERATOR INSTRUCTIONS).

Our next question comes from the line of Brian Wong from First Albany Capital.

Please proceed with your question.

Thanks for the follow up.

Just one question.

What was your percentage of revenues from orthopedics this quarter?

I don't know the answer to that question because we can't get that data.

We know what the percentage in C-bloc was, which would be all orthopedics, and we have a feel for what we get on the billing side in orthopedics, but that would be a little bit of a guess.

But again, anything that was sold directly to the hospital or an ambulatory surgery center, we can't get that information under HIPAA.

Okay.

In terms of the C-bloc then, would you say that, do you have a sense of whether or not the doctors through orthopedics are moving towards just using C-bloc?

Or is it still a mix of both, C-bloc and other areas?

Well, for shoulders and knees, there's no question.

No question.

They're moving to C-bloc.

Those are the two natural areas.

For replacement knees, hips, definitely C-bloc.

For repairs, shoulders, knees, more and more C-bloc.

It just makes all the sense in the world, Brian, because there's great outcomes and everybody gets paid.

Right.

I guess what I'm getting at is do you see that there's definitely more room to penetrate?

Or are we hitting a saturation point yet?

I would guess we're probably in the same penetration level in C-bloc as we are overall.

It's very small.

There's a lot of penetration left to go.

And, by the way, using C-bloc versus using wound site is better therapy.

It's actually better.

And why do you say that?

You just seem to get better outcomes, because now I've taken the entire limb out and I'm not gambling on placing the catheter in the correct place and having some side pain.

You just get better control.

If I want to numb the knee, I place a catheter close to the knee.

I still might have some pain from somewhere around the knee that I'm not getting any of the medication to.

If I numb it with the femoral nerve, I got the entire leg out, therefore there will be no other pain.

And with C-bloc, I can titrate.

All of our C-bloc pumps, or I should say a large number of them, have the ability to increase or decrease the flow rates so we can titrate.

It's just a better, it's a better way to do it.

All right.

And then, lastly, in terms of any new products coming out, anything we should keep our ears on the ground for?

We've already introduced some new products in the C-bloc area, which is mainly bigger pumps, pumps that can be titrated along with boluses but with much larger volumes --

When was that?

I'm sorry?

When did you do that?

The tail end of the second quarter, so we'll see more of that in the third and fourth quarter as we roll that out.

Tunneling continues to grow, and we've introduced a family of disposable tunnelers in the second quarter, first and second quarter.

That's continuing to grow.

And, of course, our surgical business, our PainBuster business, where we place catheters close to, or tunnel close to, the surgical site, continued to grow as well and we've added additional volumes there, larger pumps, more features.

And we're introducing, by the way, another catheter.

Today, we have a one-inch, two-and-a-half-inch, five-inch, and ten-inch.

We're introducing a seven-and-a-half-inch, this quarter.

And we, of course, are promoting pre-filling of pumps in which we're working with pharmacies around the country, having the pumps filled before they get to the hospital.

So, there's all kinds of things we're doing to drive this business.

And then, how's the custom kit business doing?

Oh, doing very well, very well.

Again, it's a small piece of our business but it's growing very, very fast.

All right.

Thanks, again.

Thank you.

And our last question comes from Ross Nelson from CD Cap.

Please proceed with your question.

Hey, Don.

Great quarter on the revenue side.

However, I want to be the dead horse a little bit on the G&A side of things.

Can you just roughly describe when, I understand that you guys have some level of more fixed costs on the G&A side and some expanding sales and marketing costs with the GE agreement and with some of these clinical trials, and therefore the best G&A appeared to be relatively flat as a percent of sales, year over year.

But does there come a point where, and I understand the Company's goal is to be cash flow positive and you're going to spend to drive revenues, but at what point does leverage on the SG&A side start to kick in in terms of is there a sales number where that happens?

Is it when some of these clinical trials ramp up?

Is it, can you just roughly describe if, and when, that happens, just for modeling purposes?

Yes, Ross, that's a very difficult question.

For example, what if we announce the final results of the colorectal study sometime in the end of the third quarter or fourth quarter, middle of the fourth quarter, I think we will probably spend big in marketing to blast that information across the country.

That would be the smart thing to do.

What if the FDA came back and gave us a claim before the end of the year?

I think we would probably do something very big to make sure that the world knew about that.

And that, not only surgeons and hospitals knew about it, but we might even go after the consumer.

So, right now, today, as long as we are cash flow positive and we carefully determine what makes sense to spend the money on, we will probably continue to spend to drive this business.

That is our goal, to drive that top line and make sure we get as many people in the world knowing about what we have so we could make a difference in their lives, as well.

So, I really don't know the answer to your question because as opportunities arise, we will take advantage of them.

Okay.

Was the number that Jim gave for G&A, I believe it was, he said $4.677 million.

I assume that was a gross dollar amount for the quarter for straight G&A?

Is that correct?

That's correct.

Okay.

Can you give how that, I don't have the number from a year ago.

Do you know what that number was or how the trend was going just for pure G&A?

It was for prior year quarter was $2.8 million, but that was an unusually low quarter.

I think just the last two quarters running, fourth quarter of '06 was $5.2 million, first quarter this year was $4.0 million, just to give you an idea.

And what's the variability due to?

It's really just tightening of expenses.

I think, Ross, one of the things to help you out here is we're not adding people and we're not adding fixed items.

What we are doing is is taking advantage of what I call variable costs, in which we're spending the money on marketing and sales where we can drive business.

And a good example are the clinical studies, the ultrasound program, some of the advertising we've done in magazines as it relates to the meta-analysis that came out in December of last year in the American College of Surgeons Journal.

We spent a lot of money getting that out to the surgeons.

We're just taking advantage of the good news.

Okay, so if there is, to some degree, leverage with G&A and leverage with, you're not adding salespeople, so there's some fixed element of cost there.

You're saying that some of this increase in costs which have kept SG&A as a percentage of sales constant, some of these costs are to some degree non-recurring at some point.

It has to do with they're discretionary.

We're not adding accounting people, we're not adding management, we're not adding marketing people.

These are programs.

Okay, so they're non-recurring in nature.

I mean, not to say that they're going to --?

They're discretionary.

Not to say they're going to add next quarter, but --?

Yes.

But, for example, we spend a lot of money every quarter training anesthesiologists on how to do blocs.

We've got training centers all over the country.

We have approximately five or six now.

We plan to take that to 12.

So, any anesthesiologist who wants to learn how to do a bloc, we will send them to these training centers and we pay their expenses, and then, hopefully, they'll go back to their facility and begin using our product.

Okay, fair enough.

And then, one last quick question.

On the GE study, it sounded like, I didn't get a start and stop date.

I think it sounded like it was starting around August or September?

Yes, what we're doing right now is we're placing machines.

Once you place the machines, then GE has to come in and train everybody.

And what'll happen then is they'll do some blocs outside of the study until they get comfortable with the machine.

So, we don't expect to gather any data for the study till probably September, maybe as late as October, when people are ready, trained, know how to do the blocs, so that we get good information on what is better, doing a bloc with an ultrasound versus doing the bloc without ultrasound.

So, we've got to get the people trained, but we will spend this quarter, placing machines, and we will spend next quarter, getting the study rocking and rolling.

Okay.

Thanks.

Nice quarter on the revenue side.

Thanks.

Thank you, Ross.

Mr.

Earhart, there are no further questions at this time.

I will now turn the call back over to you to continue with your presentation or closing remarks.

Thanks, Pedro.

We are continuing to build our ON-Q franchise on the strength of the many important benefits our products provide physicians and their patients immediately following surgery.

Our products deliver real and measurable value to both our customers and to surgery patients.

We expect revenue growth to continue and, in return, deliver real value to our shareholders for years to come.

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

As always, we thank you for your continuing support.

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.