Moog Inc (MOG.A) 2006 Q1 法說會逐字稿

Good afternoon ladies and gentlemen. And welcome to the Zevex's first quarter earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded today, Wednesday April 26th of 2006.

I would now like to turn the conference over to the Investor Relations Assistant, [Colleen Dalls]. Please go ahead.

Good afternoon, and thank you for participating in today's conference call. Joining me today are, President and Chief Executive Officer, David McNally, and, Chief Financial Officer, Phil McStotts, to discuss 2006 first quarter financial results.

A short time ago the [investors] released financial results for the first quarter 2006. If you have not received a news release, or if you would like to be added to the Company's fax or email list, please contact me at 801-264-1001 ext.203. A replay of this conference call will be available on our website at www.zevex.com. On the Zevex's home page click on the microphone symbol to hear the replay broadcast. You may also access archives copies of Zevex's news releases on the investor relations portion of our website.

Before we proceed, it is my duty to inform you that comments made by Management during this conference call may contain forward looking statements that involve risks and uncertainties regarding the future results of Zevex International. Please refer to the Company's filings with the Securities and Exchange Commission including the Company's form 10K, for the year ended December 31, 2005, and the form 10Q for the first quarter 2006, which we expect to file by May 5th. These filings identify specific risk factors and may cause actual results to differ materially from these--those described in forward looking statements. Now I'd like to turn the call over to David McNally, our CEO.

Thank you [Colleen]. Good afternoon listeners, and welcome to our first quarter 2006 conference call. We are delighted to announce record results for the quarter. As you may have seen by now, first quarter revenue grew 77% to $10.6 million, compared with revenue of $6 million for last years first quarter. We reported net income of $0.36 per share for the first quarter of 2006, compared with net income of $0.01 per share for the first quarter of 2005. Compared to last years first quarter, revenue from our Therapeutics division increased by 140%. And revenue from our Applied Technology division increased by 19%. Phil McStotts will go into more detail on our financial performance during his review.

For those of you who may not know, we are committed to two businesses, our Therapeutics division and our Applied Technology division. Our Therapeutics division makes and sells enternal nutrition pumps, which are used by patients who cannot feed themselves. We believe that our pumps are superior to all others offered in the market, because they combine accuracy and nutrition delivery with small size, durability, long battery life, and patented safety features that allow enteral patients to enjoy unprecedented mobility. In addition we develop, manufacture and market disposable sets and accessories for the pumps.

We are focused globally on the Home Health Care Market, which due to the aging population and pressure on controlling health care costs, is the fastest growing market segment for enteral nutrition delivery devices.

Last year we received a silver medical design excellence award from Canon Communications, for the EnteraLite Infinity pump. In August Numico, our exclusive distributor of a private labeled version of the EnteraLite Infinity, launched the Flocare Infinity in European markets.Market acceptance of this product has continued to go well. In the United States, sales of disposable sets are accelerating, based upon our rapidly growing installed base of pumps.

Our Applied Technology division develops and manufactures medical device components and systems under private label for many of the world's leading original equipment manufacturers. Our core competencies in this division include expertise in sensors, food management, and surgical ultrasound. We make surgical tools, components, and systems that improve the safety and effectiveness of cataract surgery, open heart surgery, colon resection, organ transplantation, dialysis, blood component harvesting, and infusion therapies.

Before I provide insight into our performance and prospects, I'd like to turn the call over to our Chief Financial Officer, Phil McStotts, who will provide detail on our financial results.

Thanks Dave. Revenue for the first quarter of 2006 increased 77% to $10.6 million compared with revenue of $6 million for the first quarter of 2005. Net income was a record $1.5 million or $0.36 per share, compared with net income of $45,000 or $0.01 per share for the first quarter of 2005. Notably net income for the first quarter of 2006 reflects a $95,000 charge relating to outstanding stock options as required under new accounting rules. In addition, in the first quarter, we recorded a tax benefit of $446,000 which was related to a partial reversal of evaluation allowance from a prior period.

Our Therapeutics division revenue for the first quarter of 2006 increased by 140% to $6.9 million, compared with $2.9 million for the first quarter of 2005. Specifically sales of domestic Enteral feeding pumps and disposable delivery sets increased by 22% or $531,000 compared with last years first quarter. Like--while international sales of pumps and sets in the same period increased by $3.5 million or 841%.

Increase in these international sales was due primarily to increased revenue from Nutricia Clinical, a division of Royal Numico and our largest strategic international distribution partner. Sales from our Therapeutic division in the first quarter of 2006 accounted for 65% of our total revenue.

Our Applied Technology division revenue for the first quarter of 2006 increased by 19% to $3.7 million compared with $3.1 million for the first quarter of 2005. Revenue from sensors and hand pieces grew by $732,000 or 33% over the first quarter of 2005, while revenue from Medical Systems declined $278,000 or 34%. Revenue from Engineering services provided increased by 164% or $143,000 over the first quarter of 2005. Sales from our Applied Technology division in the first quarter of 2006 accounted for 35% of our total revenue.

Our gross profit as a percentage of revenue was approximately 35.4% for the first quarter of 2006 compared to 36.5% for the first quarter of 2005. We primarily attribute the decrease in gross profit during the first quarter of 2006 as compared to the prior year to the different product mix delivered during each period, and the addition in 2006 of approximately $800,000 in lower margin service revenue. The service revenue is generated by maintenance of Nutricia Clinical enteral feeding pumps and is performed by our--on our behalf by a third party service provider in Europe.

Following general and administrative expenses during the first quarter of 2006 were $2.392 million compared to $1.790 million for the first quarter of 2005. The increase is primarily related to increased investment in sales and marketing. And increased general administrative expenses including recruiting expenses, personnel insurance costs, legal fees, noncash stock-based compensation expense, and incentive bonus accruals. [inaudible] sales growth in the first quarter of 2006, our selling, general and administrative expenses actually decreased as a percentage of sales from 30% in the first quarter of 2005 to 23% in the first quarter of 2006.

For the first quarter of 2006 we had net income of $1.477 million or $0.36 per share compared with net income of $45,000 or $0.01 per share for the first quarter of 2005. The increase in net income during 2006 as compared to 2005 is primarily related to increase in revenue in 2006, and the resulting increase in our gross profit, which was partly offset by increased selling general and administrative expenses. As I mentioned earlier, net income for the first quarter of 2006 reflects a $95,000 charge relating to stock option expense under the new accounting rules. Without this stock options expense our earnings would have increased by an additional $0.03 per share.

Also in the first quarter, we recorded a tax benefit of $446,000 from the partial reversal of the valuation allowance from a prior period. This benefit contributed a $0.11 per share of our reported earnings. During the first quarter of 2005, we had an income tax expense of $3,000. The income tax benefit in 2006 is due to the reversal of a part of our deferred tax asset valuation allowance. This includes our net operating loss carry forwards as a result of our continued operations and expected profitable results of the future operations.

Income tax expense in 2005 represents minimum tax payments due to the various states in which we were required to file. We expect we will continue to realize a portion of deferred tax assets related to state net operating loss carried forwards in the remaining periods of 2006, which would result in a partial reversal of related valuation allowance. We expect to have an effective tax rate of approximately 20% for the 2006 physical year and normalizing into the mid 30% range for 2007.

Our backlog of Applied Technology orders was $7.7 million at March 31, 2006, up from $5.4 million at March 31, 2005. Working capital at March 31,2006 was $9.4 million compared to $7.9 million at December 31, 2005, and $6.1 million at March 31, 2005.

The outstanding balance of our funded debt at March 31, 2006 was $1.953 million compared to $2.107 million at March 31, 2005. Total stockholder equity was $16.9 million at March 31,2006, compared with $15.1 million at December 31, 2005 and $12.8 million at March 31, 2005. Now I'd like to turn the call back over to Dave.

Thank you Phil. This quarters record results reflect strong sales growth from both of our business divisions. Total revenue from our Therapeutics Division grew 140%. Sales of domestic Enteral feeding pumps and disposal delivering sets increased by 22% over the first quarter of 2005. Domestic Ambulatory product sales grew 37% based upon the continued success of our sales force in driving demand for our EnteraLite Infinity and EnteraLite pumps and disposable sets.

International sales of pumps and sets in the same period increased by 841%. The increase in these international sales was due primarily to increased revenue from Nutricia Clinical. International's Therapeutics sales exceeded our expectations based upon the accelerated introduction of the Flocare Infinity portable feeding pump by Nutricia Clinical in Europe. Nutricia related demand for service from our third party service provider in Europe was also exceptional during the quarter generating $800,000 in revenue. Based upon having achieved $3.5 million in total revenue with Nutricia Clinical during the first quarter, we are increasing our projection for Nutricia revenue from $8 million to $10 million for the full year 2006.

Total revenue from the Applied Technology Division increased by 19%. Revenue from sensors and hand pieces grew 33% based upon the success of some of our largest customers in capturing additional market share. Although systems revenue declined, the lifeport kidney transporter and disposable set business with organ recovery systems is running very strong as market acceptance for the lifeport continues to increase demand. A decline in systems revenue during the first quarter was due to a fluctuation in demand from one of our other customers.

Meanwhile, we are working to bring to market more component and systems products that utilize our core technologies for other Applied Technology customers. It is noteworthy that Engineering Service revenue increased 164% during the first quarter. Much of this revenue is generated from customers that are planning to introduce products to the market later this year and beyond. We are assisting these customers and the development of new products and we expect to manufacture and service those products throughout their product life cycles.

Based upon the strength that we are forecasting for our two divisions and barring any unforeseen events, we are raising our overall 2006 corporate revenue growth forecast from 20% to 25%. Although we did not give earnings guidance, I would like to note several items that will impact our earnings in the quarters ahead.

Earlier this month we announced reaching a settlement for $1 million related to defending our patents. We had identified a possible infringement situation last year and filed a suit earlier this year against an infusion pump supplier that holds a small market share of the U.S. IV pump market. One of the terms of the settlement agreement was for Zevex to hold confidential the name of the other party. Based upon projected litigation costs to us of approximately $500,000 per year for an estimated two to three years and the remaining patent life of approximately 6 years, we settled for $1 million. This will be recorded in the income statement as other income during the second quarter of this year, net of less than $100,000 in associated legal expenses.

I would also like to note that we will continue to incur stock option expenses in the quarters and years ahead. Our Board of Directors and Executive Team believe that stock options are an important motivational and retention tool and we intend to continue to utilize them to align shareholder and employee interests.

Finally, our tax benefits are expected to decline during the quarters ahead as Phil described earlier. Now operator, I would like to open the conference call up to questions from our listeners.

Thank you. Ladies and gentlemen, at this time will begin the question and answer session. [OPERATOR INSTRUCTIONS] And our first question is from [Chad McCurdy] with Institutional Equities. Please go ahead.

Gentlemen congratulations on a great quarter.

Thank you, Chad.

I've got a few questions that I had and some of them I guess were like kind of to the quarter and some of them generally about the business here. I'm aware that the contracts that you've got with Royal Numico, you are conducting the equipment contracts in U.S. dollars and the services contract is conducted in Euros is that correct?

That's correct.

Why are you--why the differentiation there?

The differentiation really comes because of the service provider, that --the third party service provider we use in Europe.

Okay. So it's just a matter of having one less currency conversion than 'cause you're having to pay them in Euros?

That is correct.

Ok well that makes sense that. And I was curious as to why you have elected to use the direct sales model here in North America versus using a large distributor overseas?

The--and this is Dave. I'll respond to that Chad. The--in the U.S. when we entered the market 10 years ago, it truly began as a pioneering effort this was an area that we had identified as [ambulatory] therapy for enteral nutrition delivery, that had not been proven in the market as of yet. And as we have progressed over the past decade, we have been leveraging partners in the home healthcare sector who provide equipment to provide sales, more than sales support actually, help to drive sales and the benefits for--of our technology for patients.

Internationally, we came upon an opportunity in, as a matter of fact Numico and Zevex found each other as we looked--we looked to expand globally and they were looking for the best pump technology in the world and we came together strategically. In the U.S. we are using a model of working together with the largest and most aggressive home care providers to help drive our sales forward. So that we can get maximum leverage with our direct sales force.

So domestically, you're using the home health care providers to help you drive the sales of your pumps?

That is correct. That's part of our benefit selling strategy. The technology of our product line is so powerful that we are able to direct flows of patients from the discharge planners at hospitals to home care providers who are looking to secure referral streams. We are actually delivering not only pump technology but referral streams based on the benefits of our technology.

And a good example of that is the agreement with Option Care that we previously announced that they've really taken the product and run with it.

Okay. Now on the disposable side, I understand that there's part of the disposables that you all are supplying to [rural] Numico the patented pieces, and part of it that they're manufacturing themselves. What about it on the domestic sales side? How much of the disposals are, where you've got a relationship with the home health care providers, are they using all the disposables provided by you?

That is correct. In the U.S. we are providing the entire disposable set packaged to our customer base.

And does that include a the nutritional supplement or is that coming from a third provider?

That comes from a third provider. Our--we are--our products are food diagnostic. They can deliver any of the suppliers foods in the global market.

Okay. So they could even deliver the nutrition from Abbett or Tyco]or I guess I should Kendall?

From Abbett. Kendall does not presently provided any foods. But certainly our products are used every day to deliver Abbett foods and Nestle's Foods and [Novartics] food.

Okay and then my last question here and I'll let somebody else talk. You guys spoke at a couple conferences at the end of last year, and I was just wondering if you had had any feedback yet on whether or not the analyst from those brokerage firms might initiate coverage, and when they might do it or what events that might be looking for?

We've certainly had conversations, numerous conversations with analysts as they follow our progress. But we have no indication of when they might publish reports on the Company.

Okay.

Hold their cards pretty close to their chests.

Do you have any other conferences scheduled for right now?

We actually will be putting forth a press release on our next conference within a week's time.

Okay, alright thank you.

Your welcome.

Thank you our next question is from [Lawrence Jennin] with [Wood Bush Morgan]. Please go ahead.

Hi Phil and Dave. Congratulations on an excellent quarter.

Thanks [Lawrence].

The--quick question I had actually was more of a follow up of what the previous gentlemen was just talking about. And that is obviously you guys have been incredibly successful with the sales and marketing strategy through your relationship with Numico. And it sounds like you're pursuing a domestic strategy by partnering with these home health care providers. I was wondering maybe if you could just elaborate a little bit about any efforts directed toward building your own internal sales force and going after working directly with the hospitals themselves and those purchasing agents?

And I'll be happy to comment on that, [Lawrence]. We actually are doing that, in some cases we do sell of course through group purchasing organizations where we're on contract with them in some cases directly to home health care providers that are captive to integrated delivery networks for the hospitals themselves. And so do we--we do sell to a number of different channels, but overall the overriding factor is that we're utilizing our benefit selling strategy for the clinical benefits of our product and the quality of life benefits to drive sales into the referral sources.

The, we sell to individual home care providers as well as large national networks, Option Care is an example that I mentioned. We do sell to others as well, and in that distribution strategy, even some of the box movers, the large distributors also buy our product to satisfy the needs of some of their customers.

The key element that our sales force provides is that they are able to detail the products and the benefits that those products hold for patients as well as for the home care providers and the lower costs that they may experience with our equipment as well. So they're really technical experts also with a great sensitivity to the clinical side of the business as well. In terms of expanding our sales force, we have over the past year-and-a-half expanded it about 25%.

By adding some new personnel, some new Managers in the field that we call our Territory Managers. We are cautious about adding more because we want to make sure that we're utilizing all the resources available to us to get maximum impact with those Business Managers managing the business and utilizing the resources we have available to us in terms of our customer base. Does that answer your question, [Lawrence]?

Yes. Absolutely. Thanks very much, look forward to you guys enjoying continued success here.

Thank you.

Our next question is from [Kevin Reader] with [Silver Gate] Capital. Please go ahead.

Hi, guys. Great quarter. I wanted to ask you on the fact that you did 3.5 million in the quarter with Nutricia and what--is there reason you're expecting -- are you expecting a slowdown or is this just kind of traditional conservatism here?

It is an extraordinary quarter. I have to say, Kevin, that Numico really, really accelerated their launch in this first quarter of the year.

Ok.

And realistically we see them backing off a bit on that as well as we see the service revenue declining as the installed base of their pumps is replaced with our new technology. So we are--we're trying to be -- take a realistic approach to what lies ahead for the rest of the year when we, after 3. 5 million in the first quarter, we make an estimate of 10 million for the year.

Yes, okay. That's great. So explain the service revenue. Is you--is taking--switching the pumps out or was is it?

Actually the service revenue is associated with maintaining the installed base of pumps. That Nutricia Clinical has in the field. Presently, the greater portion of those pumps are pumps that they previously manufactured in years past. And so we are paid to service those pumps through our third party provider. And as we move forward, more and more of that installed base will be switched out with our Infinity technology. That is a lower-cost technology in terms of maintenance and so the reality is that what we'd expect to see as service revenue replaced with new pump revenue.

Okay. So they're proactively--Numico's proactively switching out their entire, their entire pump base?

Yes, I would say they are proactively and systematically in a controlled fashion changing out that installed base to get to our superior technology.

Okay. From what I understand they have a pretty large installed base, so that's good news. Okay thanks very much.

You're welcome.

Thank you. Our next question is from [Don Littlewood] with [Littlewood Burke Company]. Please go ahead.

Well, you fellows have made me a believer.

Thank you, Don and thank for your support through the years.

Right. A couple of quick questions. Numico is expanding--they're going to expand beyond Europe have they indicated when that might be and what launch dates they might have?

They have--behind the scenes they're sharing with us their plans for expansion, not to get out of line and announce where their launching, I can say that they are preceding beyond Europe this year. So that process has already begun.

Very good. With Option Care is there any sort of order rate there or is it not quite that simple with them?

It's not quite that simple. The disposable set stream is consistent in building as they install more pumps through their facilities. They have provided us feedback that they are replacing a substantial portion of their installed base with our pumps as they buy more of them. And our sales people and theirs are working very well together in the field calling on gastrointerologists and discharge planners. So I'd say it's a steady bill that's not [abolis] or a onetime event with them. We're seeing a steady build of the business together as they replace part of their installed base but more importantly even go after new patients together with our sales people.

Very good. The second shift, is that shaping up to be relatively efficient at this point?

They're extremely efficient. We just reviewed the quality metrics in our normal quality review, and they're key performance indicators are on par with our day shift. They're an outstanding group and it's a great credit to our operations team.

Excellent. Is there an explanation, further explanation, on this $1 million payment versus the possibility of royalty payments through the life of the patent?

We did consider that. Both parties did consider that possibility, and we decided that it was in the best interest collectively, best interest of the companies, to go ahead and settle it in one lump sum payment. We think that we did better by handling it this way than by risking uncertain future volumes with the royalty payment. And they, of course, wanted to get it all tidied up at once.

Sure. Do you think consider them to be a significant possible competitor of yours?

We do not. As a matter of fact, part of the settlement terms is that they cannot use the license which we granted as part of the settlement agreement in the Enteral area.

Excellent. Great job and it sounds like it's going to keep on going. It's terrific. Thanks.

Thank you Don.

Thank you. Our next question is from [Calvin Wills] with [Kazoo] Capital. Please go ahead.

Congratulations gentlemen that was a great quarter. I have a couple questions here about your intellectual property and your patent portfolio that I'd like to start with. In the last 10Q you reported that he had 35 U.S. patents and 30 international patents. Are all those patents in support of the pump technology or do some of them support products in you Therapeutics division?

I'll be happy to answer that, [Calvin]. This is Dave. Only a few of our patents were originally intended to support our Applied Technology business although most of our patents and our portfolio were originally developed therefore for our Therapeutics product line some can be used in medical device applications outside of Enteral nutrition delivery. Those patents can benefit our Applied Technology customers as well as our Therapeutics customers.

And just to give a little more clarity on that, when we co-develop a medical device or work with our Applied Technology Partners, typically if they're willing to pay us to develop a product for them, they will own the patent rights for their field of use. However we typically retain the right to utilize the intellectual property outside of that customer's field of use. So that is also a potential source of IP that we can apply to-- more Applied Technology applications.

Okay thank you. How many patents ours currently outstanding? Can you-- patent applications do you have?

We presently have 39 patents pending. So as you can see its a very prolific period for Intellectual property development. We believe that that's key to the value that we can unlock in the organization looking forward. So we have 39 patents pending including 12 U.S. and 27 foreign and we have more IP in development.

I'd like to ask now a general question, then I'm going to follow it up with more specific one. But when you look out towards the remainder of 2006, as investors we can make our own judgments about what part of the business looks great, but when you guys do it internally, what pops up, what part of the business are you most excited about?

Well, and I am happy to say that we're excited about all the elements of our business, but just to give you a little more color on that. We do truly believe that upside potential exists in each area of our business, including our domestic and international Therapeutics, we've talked a lot about Nutricia Clinical and Numico and it's a outstanding strategic relationship. We're very proud of partnering with them. But domestically, we have a very tenacious and skilled sales force that is achieving some great numbers for growth here in the U.S., so we're very excited about them.

And our Applied Technology Business, we are working on new applications to bring more products to market for existing and new customers. And we believe there's significant upside there as well and that is part of our plan, not only for growth in 2006 but beyond in 2007.

Okay, thank you. I got one last question here. I know that you added three senior Management positions at the end of 2005. The VP of Sales position, obviously we know what they're working on, but can you comment about the focus for your two Business Development Directors?

Yes, and as a matter of fact, we've added two and so now we have three. We have one for the western U.S. and Pacific Rim, we have one for the eastern U.S. and South America and we have one for Europe and Africa. And these business development directors are responsible for account management and growing our business with our existing customers, as well as identifying new opportunities to develop and manufacture products for other companies.

As a team our business development managers work under the direction of our VP of Sales and Marketing to develop new product applications that have the potential to drive growth beyond 2006, so they are also our eyes and ears on new applications helping to identify the tactical hits which are opportunities to develop products for 2006 and 2007, and then also strategic opportunities to develop brand new products to bring to market with new partners.

Okay well thank you for the answers there. I know you guys been at this for 20 years, so it's great to see the dedication paying off. I hope it continues to the rest of the year.

Thank you and I have to say [Calvin], we're having more fun than ever.

That's good.

Thank you our next question is from [Richard Durnley] with [inaudible] Partners, please go ahead.

Good afternoon. You must be smiling.

We are. We are, we're excited, thank you Dick.

A bunch of questions. Could you give some color as to the unit increases or dollar increases in just the disposables? Or some flavor as to-- you referenced in your prepared statements that, they were strong because of a growing installed base.

And I have to be cautious here for competitive reasons, as we have lots of listeners to our calls either live or afterwards. But I can say that typically the industry standard is that for each pump placed, typically approximately 12 to 15 disposable sets per month are used for that pump when it is placed in service per year afterward. And product life cycle of the pump is typically they're designed for at least a five year life, often times they last as much as 10 years.

But in terms of growth rates, I'd say the best way to estimate that would be in that it's the lion's share of our revenue, to look at the comparable revenue growth, for instance, when we talk about our domestic growth, to use that as a year-over-year, I should say quarter-over-quarter comparison in the volume of products that were selling in that particular area. Phil do you want to add any color to that?

No I thinks thats--

Okay. Then for Numico, the accelerated introduction, why had they--why did they accelerate the intro? I would think, being a large company, they would pretty much get a schedule and stick to it. And then part B, was any of the quarter, reordering or is this still inventory filling essentially?

This is--these units are-- we're told, are going out to the field. That it's not a stockpiling situation. And I believed to the first question that what we're saying in Numico is being very successful in their market expansion for their entire business, which of course is the foods as well as the pumps. And I believe that the demand from their markets has been very strong and the markets have identified that if they have more pumps up front, they can also generate more food business in the current year.

So I believe that that had something to do with that as well. The demand from what we call Numico's markets, which are the divisions of Nutricia Clinical located in each country in which they compete.

Right, I see. And they, if memory serves, you operate on kind of a rolling forecast that they give you, is that?

That is correct.

Right, okay. Could it--alright, I'll just let it go at that. The Applied Tech business in the medical systems, if the transporter business is quite slow, everything considered in terms of dollars,isn't it?

Actually, relative to the -- relative to the systems business it's a major component of that business. Overall, I would consider them one of our top Applied Technology customers and an important one to us. What we're seeing there is the-- not only the continued acceptance of the life port where we're producing and they're selling more life port transporters, but also a dramatic increase in demand for the disposables. And that's very exciting as we provide those disposables as well.

Any -- is R&D or the engineering services include expenditures for new, new body parts?

With that right now, not currently. I'm sorry in relationship to organ recovery?

Yes.

Not currently is there any current work that Zevex is performing related to other organs.

Then the--it's nice to get a $1million, that maybe you hadn't budgeted for, maybe you had. Any thoughts on what you're going to do with the money?

I don't have any direct other than operations, Dick, that is pretty much will be what that is used for.

There are no immediate plans to go out and spend it. That's probably the best way to put it.

Well, you said you're happy with your current sales force, so--or the sizing of the current sales force and until you got them sort of on the ground and fully utilized. And you seem to be saying that R&D won't be going up dramatically.

We don't want to -- to backtrack after achieved some operating leverage. We want to be cautious about our expenditures and make sure that we're going to get the results that are going to benefit our shareholders and our operations from any of those investments.

In terms of R&D expenditure, of course we have our engineering services revenue that is funded by customers for products specifically for them. And then we have our internal research and development budget, which this first quarter was about 3% of revenue. We do see that increasing during the year for a total of what will likely be about 5% on the year. So--and that's as a matter of fact, that's a substantial driver behind this intellectual property portfolio, where we have 39 patents pending now. So we can--we're going to continue to invest in our own ideas for internal research and development, as well as develop products specifically for customers.

At the [inaudible] conference, you suggested that you'd be getting new products out toward the end of '06 and then into '07. Were you anticipating both Therapeutic and Applied Tech?

Yes.

Applications.

We are. And the--will the Applied Tech applications in the transporter kind of business or was that in other? There in other areas.

Ok.

We still--we're still very hopeful on expanding the platform, the life port transporter platform. Our customers actually doing the early clinical work behind the scenes there. And are continuing to perform on the initial work on looking at different organs and viability there while they continue to execute on their first application, which is the kidney.

Right. Well thank you very much.

You're welcome. Thank you, Don.

Thank you. Our next question is from [Bill Shriver] with Pine Cone Capital. Please go ahead.

Well Dave and Phil, congratulations on a great quarter.

Thank you, Bill.

And it's nice you'll be able to execute on things you've been talking about for the last several years, so my hat's off to you. I did just like to ask about the R&D expenditures. I know you started to touch on them here with the recent questions, but I think you said you'd see expenditures going up some during the year. But I wanted to ask what opportunities you see addressing, or threats you think you need to defend, may you can just talk a little bit about the plans for R&D.

In the R&D area, were doing some preliminary work going in actually into different surgical environments and clinical environments, first of all observing. And this is for our most far reaching R&D activities. Initially, our Vice President of Sales and Marketing is putting us in touch with leading clinicians and a number of different surgical fields to identify applications for both are sensing and our surgical technologies and the surgical of course being surgical ultrasound.

We're looking for a new applications for our ultrasonic hand piece technology and systems technology for tissue removal, cutting, coagulation, trying to identify the right types of applications that we may be able to apply our technology to in the right competitive environment. In the sensors area, we of course have a strong base of technology and ultrasound and optics. And we're looking to apply those technologies to needs wherever fluids are flowing in or out of the body.

So in general, that's where we're looking, that's where our initial work is. That involves R&D and that R&D also is present in those surgeries and working with the marketing team to identify opportunities to solve needs. To identify needs and create a solution to those needs. And we see that as some of the best ground for opportunity for the future in terms of bringing new products to market and generating profitable revenue.

Okay. Do think thats a-- and those are areas where you have expertise in house or are you going to have to gout and find that expertise?

We have the expertise in-house although we are expanding our R&D team and our currently recruiting. We have even made new highers as recently as a few days ago and are continuing to expand that team.

Okay, great. Well thanks for that additional clarification. Keep up the good work and I'm glad to hear that things are going well.

Thank you, Bill.

Thank you. [OPERATOR INSTRUCTIONS] And our next question is a follow-up question from [Chad McCurdy]. Please go ahead.

Hi guys you made a reference, one of the gentlemen earlier asked the question about the service revenue declining with the install base of pumps under Royal Numico contractor, now I imagine that the same time we're also seeing a ramp in the disposable sets being sold to Royal Numico. And I just curious if it-- if there's kind of a direct offset or if you're seeing a decline, faster in the service revenue or a more rapid increase in the disposal revenue under the new pumps?

I'd say, and this is Dave. Chad realistically from our projection you can see that we do expect that in the three quarters following that we expect that compared to the first quarter, the first quarter was a very, and an extraordinary quarter in our minds. So the disposable set components that we sell to Nutricia Clinical we don't believe will offset the decline in service revenue. Even though the overall of that contract at 10 million this year will exceed our expectations and the minimum commitments associated with that contract.

Okay. And were you supplying disposable sets to them for their installed base?

We were not.

So as they replacing installed base then, you should be picking up additional incremental revenue?

Yes, yes we will be picking up additional revenue from the disposable set components. The but I just want to be cautious in setting expectations because the revenue generated from disposable set components is smaller compared to the sale of a complete disposable set in the U.S.

Okay. Let's see. And then after the last quarter, I spoke to Royal Numico and they expressed an interest in actually ramping that they would like to be able to ramp the replacement of their existing pumps faster. It sounds like they've done that in this last quarter, and I'm curious as to why you're saying that you see a slowdown coming?

Our forecast is based on the information that we have on hand from the rolling forecast. While of course, we don't doubt what they're telling you, when we put forth our forecast we just have to be careful and base that on what we have in writing.

Okay. And then I believe when you spoke at the [inaudible] conference, the guidance you gave was that you saw forward growth for this year began a minimum of 20%. And now you're saying its 25%. Are you saying it's-- you see growth being 25% this year or are you kind of establishing that as a base?

Were saying that we expect to grow 25% this year based on our current forecast and barring any unforeseen events. Both businesses looks torn enough that the we've raised our--raised the bar from 20 at 25% on the year.

Okay, alright that's all I had. Thank you.

Thank you.

Thank you. And Mr. McNally there are no further questions at this time. Please continue with any closing remarks you may have.

Thank you. In closing I would like to again recognize and thank our employees and leadership team. The results we have reported are a direct results of the efforts of our focused and dedicated team. I believe this team has the capacity and enthusiasm to continue to successfully grow this Company. We'll be holding our annual shareholder meeting on May 25th at 9:00 a.m. at our headquarters here in Salt Lake City. We welcome our shareholders to attend. Thank you all for participating today.

Thank you, sir. Ladies and gentlemen, this concludes the Zevex's first quarter earnings conference call. You may now disconnect and thank you for using ACP teleconferencing.