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Executives

Don Earhart – Chairman, President and CEO

Jim Talevich – CFO and Treasurer

Analysts

Matt Dolan – Roth Capital Partners

Herb Buchbinder – Wachovia Securities

Greg Brash – Sidoti & Co.

William Miller – JM Hartwell

Steve Kruger – Foresight Investments

I-Flow Corporation (IFLO) Q3 2008 Earnings Call Transcript November 5, 2008 11:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the I-Flow third quarter 2008 results conference call. (Operator instructions) I would now like to turn the conference over to Don Earhart. Please go ahead, sir.

Don Earhart

Thank you, Benjamin. Good morning, everyone, and thank you for joining us for I-Flow’s 2008 third quarter results conference call. Chief Financial Officer Jim Talevich and I will be available to answer your questions following our prepared remarks.

Total revenue from continuing operations for the third quarter of 2008 increased 14% to $32.2 million, compared to $28.2 million for the third quarter of 2007. Within this total, sales of our flagship ON-Q product lines in our Regional Anesthesia business increased 11% to $24.8 million, compared to $22.3 million for the third quarter of 2007.

AcryMed, Inc., a developer of innovative infection control and wound healing products, we acquired in February 2008, generated revenue of $1.5 million for this third quarter.

Revenue for Regional Anesthesia and AcryMed together, that is our Acute Care Products business, focused on developing and marketing proprietary disposable medical devices that improve patient outcomes, increased 18% to $26.3 million for the third quarter of 2008, compared to $22.3 million for the third quarter of a year ago. IV Infusion Therapy revenue increased 1% to $5.9 million when compared to third quarter of 2007.

The loss from continuing operations before income taxes for the third quarter of 2008 was $15.4 million. This included a purchase accounting write-off of $11.6 million of in-process research and development costs related to the AcryMed acquisition, an impairment loss of $4.6 million on the common shares of InfuSystem Holding, Incorporated, formerly known as HAPC, Inc., purchased by I-Flow in October 2007 in connection with the sale of InfuSystem to HAPC and $136,000 of certain litigation and insurance charges.

Excluding the in-process R&D costs, the impairment loss and certain litigation and insurance charges, income from continuing operations before income tax for the third quarter of 2008 increased to approximately $941,000. In comparison, in the third quarter of 2007, I-Flow reported a loss from continuing operations before income taxes of $1.1 million. The improvement was more than $2 million.

In other words, we delivered revenue and income growth before income taxes and special charges in this year’s third quarter, despite the substantial headwinds of both the weakening economy and Hurricane Ike and the resulting slowdown in surgical procedures.

In line with our plan to make ON-Q essential for every applicable surgery, our sales and marketing force drove this improved financial performance by focusing physicians’ attention on ON-Q’s key benefits. The significant reduction in narcotics intake when ON-Q is used, coupled with significantly better pain relief, shorter hospital stays and the possibility of fewer infections in surgeries like cardiovascular, thoracic, bariatric, colorectal, trauma and other non-elective and crucial procedures. This strategy is in line with our plan to make our ON-Q products an essential part of every surgery performed in a hospital.

The slowdown in surgeries is confirmed by numerous published reports and anecdotal evidence from our customers that people are postponing and in some cases even canceling their healthcare events. The immediate effect on hospitals is increased financial pressure, forcing some hospitals to lay off workers in order to conserve cash and hopefully stay solvent.

Even individuals with health insurance are not immune, sometimes delaying or deciding against receiving medical care or having surgery because of their insurance deductible or concerns about missing days of work. This has led to fewer elective and non-life-threatening surgeries being performed and this segment of the market represents approximately 40% of the surgical procedures, which are responsible for our ON-Q revenue.

With fewer surgeries becoming available to our existing ON-Q users, we are emphasizing, to a greater degree, the need to identify and train new surgeons and anesthesiologists as a way to further increase the growth in our ON-Q revenues. The timing for these two events, the fewer surgeries from existing users and the gain in surgeries from new users, is not concurrent. The fewer surgeries from existing users is immediate, while the gain in surgeries from new users is more long-term.

On a positive note, we strengthened our balance sheet in the third quarter by being cash flow positive. We ended the quarter with $47.7 million in cash, equivalents, and short-term investments and a debt-free capital structure, leaving I-Flow with a debt-to-equity ratio of zero.

When you add the face value of our HAPC note, which is now paying principal and almost 9% interest, to our quarter-ending cash balance, it works out to $3.20 per share, which leads me to believe that our stock is severely undervalued.

We are in a strong financial position to weather the economic storm and to increase our market share and penetration while many of our competitors are finding it more and more difficult to compete in a market that we dominate.

As we have all year, we continue to benefit from strong selling prices of our Regional Anesthesia products, as average selling prices increased 2% versus last year’s third quarter. Gross margins continued strong at 73%, the same as the third quarter a year ago.

In addition, we are keeping tight controls on expenses, while still maintaining an urgent and aggressive posture to grow ON-Q. Because of these controls, SG&A expenses from continuing operations increased only 4% to $22.5 million for the third quarter of 2008 from $21.6 million for the third quarter of 2007.

In September, I-Flow was awarded a three-year national purchasing contract by HealthTrust Purchasing Group, or HPG, a health group purchasing organization, or GPO, to make the ON-Q Pain Relief System available to all its members. HPG supports over 1,400 not-for-profit and for-profit acute care facilities, as well as ambulatory surgery centers, physician’s practices and alternate care sites, with an annual purchasing volume by its members of more than $13 billion.

This contract includes ON-Q PainBuster, ON-Q SilverSoaker Antimicrobial Catheter with Silver Guard, and ON-Q C-bloc and remains in effect until September 30, 2011. I-Flow’s agreement with HealthTrust will help the GPO’s member organization optimize post-surgical care for their patients by offering them better pain control after surgery, while significantly reducing patients’ narcotic intake.

Clinical research has shown that ON-Q improves post-surgical outcomes by significantly reducing the need for narcotics, while providing significantly better pain relief than narcotics alone, so patients get well faster. With ON-Q patients, patients are discharged from the hospital earlier, which frequently leads to cost savings and even more important, less time spent in the hospital means less chance of becoming the recipient of a hospital-acquired condition.

I will have more to say about the new Centers for Medicare and Medicaid Reimbursement rule related to hospital-acquired conditions later on in my prepared remarks.

During the third quarter, AcryMed received clearance from the FDA for its oxygen enriched topical hydrophilic closed cell foam wound dressing. This dressing is intended to supply oxygen, as well as manage wound moisture in difficult-to-heal wounds. Composed of a proprietary material that is treated chemically to generate and capture oxygen, the dressing is indicated for topical application to burns and acute and chronic wounds and may be ideal for many patients that may benefit from supplemental oxygen but do not have access to hyperbaric oxygen or where that treatment may be contraindicated.

Patents for the product have been issued in the US and Europe and others are pending. Upon the completion of clinical studies, I-Flow plans to make the product commercially available in the second half of 2009. We are excited about the potential for this new product, which we believe will help drive a paradigm shift toward the use of oxygen enrichment for wound care.

AcryMed is an important contributor to I-Flow’s evolution into an integrated acute care products company. We are leveraging our dedicated sales and marketing organization by selling products from the AcryMed pipeline in the emerging market for acute care, even as we continue building our ON-Q franchise for post-surgical pain relief. We also see a variety of new revenue opportunities from licensing AcryMed products and technologies that are not within our core competencies.

I will have additional comments after Jim reviews the numbers. Jim?

Jim Talevich

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 September 30, 2008, revenue from continuing operations increased 14% to $32.2 million from $28.2 million for the third quarter of 2007. Sales of I-Flow’s Acute Care products, which include RA, consisting of ON-Q and AcryMed revenues, increased 18% to $26.3 million, compared to $22.3 million for the third quarter a year ago.

Total revenue from RA increased 11% for the third quarter of 2008, versus the prior year quarter, to $24.8 million from $22.3 million last year. AcryMed revenues were $1.5 million for this year’s third quarter.

IV Infusion Therapy revenues for the third quarter of 2008 of $5.9 million was comparable to the third quarter of 2007. The gross profit percentage for the third quarter of 2008 of 73% was also comparable to the third quarter of 2007.

SG&A expenses from continuing operations increased 4% to $22.5 million for the third quarter of 2008, from $21.6 million for the third quarter of 2007, reflecting continued effective control over operating costs. The SG&A expenses from continuing operations included stock-based compensation expense of $1.8 million for each of the third quarters of 2008 and 2007.

The Company’s loss from continuing operations before income taxes for the third quarter of 2008 was $15.4 million, which included a purchase accounting write-off of $11.6 million of purchased in-process R&D costs related to the AcryMed acquisition.

In addition, the Company recorded an impairment loss during the third quarter of 2008 of $4.6 million on the common shares of InfuSystem Holdings, Inc., formerly known as HAPC, purchased by I-Flow in October 2007 in connection with the sale of InfuSystem to HAPC.

Excluding the $11.6 million charge for purchased in-process R&D, the $4.6 million for impairment loss and $136,000 of certain litigation and insurance charges, the Company would have reported a pretax profit of $941,000 for the quarter, as shown in the reconciliation table attached to today’s press release.

The net loss for the three months ended September 30, 2008 was $14.1 million, or $0.59 per basic and diluted share. This compares to net income for the three months ended September 30, 2007, including both continuing and discontinued operations, of $1.2 million, or $0.05 per basic and diluted share.

At September 30, 2008, I-Flow reported net working capital of approximately $72 million, including cash and cash equivalents and short-term investments of $47.7 million, no long-term debt, and shareholders’ equity of $122.4 million.

On August 12, 2008, we announced that our Board of Directors has authorized the repurchase of up to an additional 1 million shares of the Company’s common stock under the Company’s share repurchase program, for a total of up to 2 million shares authorized for repurchase under the program. The shares may be repurchased in open market or privately negotiated transactions at the discretion of management, subject to its assessment of market conditions and other factors.

The stock repurchase program was also extended to August 8, 2009, unless terminated sooner by the Board of Directors. Through September 30, 2008, the Company had repurchased approximately 832,000 shares for approximately $10.3 million under the program, which was initially announced on February 22, 2008.

Now I will turn the call back to Don Earhart for his final comments before we take questions. Don?

Don Earhart

Thank you, Jim.

The ON-Q value proposition becomes even more compelling with the implementation of the new Centers for Medicare and Medicaid, or CMS reimbursement rule, related to Hospital-Acquired Conditions or HACs. HACs are defined by CMS as non-events or events that should never have happened, or another way of putting it, things they consider to be hospital mistakes.

The new CMS guidelines state that certain HACs are no longer reimbursed. So, for discharges occurring after October 1, 2008, hospitals will not receive additional payment for patients in whom certain conditions were not present on admission.

The initial list includes 11 HACs that CMS previously paid for, in total or in part, and where reimbursement is now zero. CMS has effectively moved the cost of treating these conditions from the government to the hospital and since hospitals will more than likely not be able to eliminate all HACs, the cost burden for treatment is now theirs.

This becomes even more burdensome for hospitals, as private insurers are following the CMS lead. Hospitals nationwide are already struggling to achieve profitability in a depressed economic climate, combined with diminished surgical volumes. Adding the new CMS rule to their reimbursement risk makes achieving profitability for hospitals even more difficult.

As a result, we believe hospitals will seek products and therapies that significantly improve their overall efficiency by improving patient outcomes, shorten hospital stays, increase patient output or throughput by turning the beds, and by doing so reduce the chances of an HAC.

Numerous clinical studies have shown that ON-Q is ideal for this new reimbursement environment. Studies have shown that significantly less narcotics are needed when ON-Q is used and because of this, patients get well faster and go home sooner, resulting in faster bed turns and increasing the number of beds available for new patients and remember, less time spent in the hospital means less chance for an HAC to occur.

To inform hospitals and surgeons on how ON-Q can help them to successfully manage the changing environment, we have trained our sales force and provided them with materials to educate surgeons and administrators about the added benefits of ON-Q. We are also supporting this effort with a professional and trade journal ad campaign scheduled to begin this week.

Needless to say, we are excited about the potential opportunity this change in reimbursement will bring in the months ahead and how it may help us accelerate ON-Q’s usage.

And now I want to address our patent lawsuit. We believe our lawsuit against Apex Medical Technologies for infringing one of our patents and for misappropriating our trade secrets is a strong one and therefore, we expect to eventually prevail.

It is important to note, however, that our Company’s success to date is not built solely around any single patent.

Rather, our success is based on a total package that includes a high quality, disposable pump, a patented Silver-Coated Soaker Catheter, more than 60 clinical studies, our FDA-cleared indications that ON-Q significantly reduces the need for narcotics and provides better pain relief than narcotics alone following surgery and last but not least, our unsurpassed surgical sales force that spans the US.

No other company in the market today even comes close to matching the breadth of our quality product line and the strength of our distribution. That is why we are, today, the leader in this space and we are determined not just to maintain but to enhance our position.

Our goal, going forward, is to maintain double-digit revenue growth even in this tough environment, while also delivering ever-increasing profitability and positive cash flow to further strengthen our already strong balance sheet.

Therefore, based on the current volatile and unprecedented economic and market conditions, which remain fluid, we expect growth in total revenue of approximately 13% for 2008, including growth in RA of approximately 11%. We also expect to be profitable for the fourth quarter of 2008 and for 2008 in total, excluding the special charges identified in today’s financial release.

And now, Benjamin, we are ready for the first question.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from the line of Matt Dolan with Roth Capitals. Please go ahead sir.

Matt Dolan – Roth Capital Partners

Hey, Don, good morning.

Don Earhart

Good morning, Matt.

Matt Dolan – Roth Capital Partners

Good morning. First question is really on these procedural trends. We’re hearing similar outcomes as you are from companies, hospitals and even doctors that procedures are getting slower and they have been since mid-year. Hospital spending in October has been very tight and so forth. So, given the reach of where your reps sit in the hospital across multiple procedures, can you help us, on maybe a month-to-month basis, how the quarter played out and how that trend has gone into the first month of the fourth quarter?

Don Earhart

Well, Matt, as we always do in the third quarter, which is our summer quarter and therefore normally our weakest quarter, we had actually a pretty good July and August and was doing pretty good until the hurricane hit and took out Houston and took out parts of Louisiana and Mississippi. That really did hurt us.

In fact, we couldn’t even ship into Houston. UPS, for several weeks, couldn’t get product in there, etc. So, we were actually tracking pretty good, but we did experience a slowdown because of the summer, as compared to other quarters, but I think, without the hurricane effect we probably would have done as well in the third quarter as we did in the second. That’s about what we lost, from Houston shutting down, parts of Mississippi and of course, parts of Louisiana.

I don’t want to give any indication on going forward. However, we do believe we’re making the right moves in the fourth quarter as we’ve retrained the sales force and changed some of our call points and again, we don’t know what the effect is going to be in December when a lot of individuals have got these healthcare savings programs where if they don’t spend the money they lose it, but we have not really built that into our numbers, but if that actually happens, as it’s happened in the past, we might do a little bit better.

So that’s kind of how we look at the fourth quarter, but we’re being very careful in the fourth quarter, because we don’t know how the economy is going to continue to go and it doesn’t look positive right now.

Matt Dolan – Roth Capital Partners

Okay, so just to recap on Hurricane Ike, it sounds like that’s about $1.3 million in revenue that you feel like you’ve lost there?

Don Earhart

Yes, we think it was something just short of $1 million.

Matt Dolan – Roth Capital Partners

Okay. I guess – and a follow-up, some statistics you’ve given in the past. Can you touch on price versus mix in the quarter, unit growth versus price appreciation, and also new accounts? I know that’s part of the strategy here, as existing accounts get soft. So how many new accounts were ordering versus existing?

Don Earhart

Well, again, the only thing we report on is how many accounts actually purchased in the quarter and that’s made up of new accounts and of course it’s made up of old accounts who may not have purchased.

We have lost some of our older accounts on the plastic side who we know did not buy in the third quarter, but we have gained new accounts. The net effect is almost exactly the same. We were just slightly down in the number of accounts that bought in the third quarter. So we were down about 70 accounts out of a total of 3,000, but again, that’s made up of new accounts and it’s also made up of old accounts that did not buy.

Now, our actual pricing benefit in the third quarter was only 2%, so all of the rest of the growth came from productivity.

Matt Dolan – Roth Capital Partners

Okay, great, and then on the profitability guidance, we’ve taken down the growth assumptions for the year, given all the noise we’ve talked about surrounding the economy. Still maintaining your full year outlook to be profitable, excluding charges, are there any expense control mechanisms that you’re going to be putting into place here? Or how are you looking about costs going forward, since the actual overall revenue number is going to come in lighter than you had indicated in July?

Don Earhart

Well, the good news is, Matt, is we’ve determined that even at today’s sales we can make money. So, if we don’t grow at all going forward, we do have the ability to make money. We’ve been saying it all along that because of our margins and the leverage we have, that getting to the number where we are, which is approximately $100 million run rate on the RA side, we’re profitable.

So we believe very strongly that any growth will generate additional profits. We’ve already put the cost controls in place and we believe we have the infrastructure we need to continue to grow and build this business. So, with a strong balance sheet and we believe we’re at that revenue number that generates profit and as that continues to get bigger, we’ll generate more profit. So we’re feeling pretty good right now about where we stand financially.

Matt Dolan – Roth Capital Partners

Okay and just a follow-up, I guess more specifically. On the last call I think we talked about profitability for the second half of the year, not necessarily for the full year and now we’re back to full year profitability. So it sounds like you’re more optimistic there, despite a slower top-line. So is the sales force staying the same size, those types of things? Are there any new cost-cutting initiatives in place or is it status quo and maybe the margins are coming in a little better than you had originally anticipated?

Don Earhart

Well, the margins have held very strong and I think the good news is that we have not had to discount and that’s been very, very positive. The way our competitors play the game is they try to go into our existing accounts and they drop price, but we’ve been able to maintain those accounts, losing relatively few, yet we don’t have to play the price game at the level they do. So we’ve been able to maintain our pricing, which keeps our margins strong.

On the headcount side, the sales force is slightly less than it was at the end of the last quarter. That’s because we just haven’t filled the slots yet, but we planned to keep our sales force approximately the same, right around that 300 number, when you count management and clinical support, and about 200 quota-carrying reps, but we are watching expenses very closely and we’re being very careful of how we spend our money.

Matt Dolan – Roth Capital Partners

Okay, thanks. I’ll let somebody else on.

Operator

Our next question comes from the line of Herb Buchbinder, Wachovia Securities. Please go ahead sir.

Herb Buchbinder – Wachovia Securities

Hi Don. Can you tell us how did AcryMed due versus your expectations in the quarter with a $1.5 million in revenue? And I’m actually using one of their products and I’ve been through the hyperbaric and I just wanted you to kind of explain, the hyperbaric is very expensive, it’s not always eligible for insurance, how that might affect the way you price and market your oxygen enrichment product.

Don Earhart

Well, let me ask you, Herb, is it working for you?

Herb Buchbinder – Wachovia Securities

Well, I’ve only been on it for three days. It’s very encouraging. I’ve got a pretty good sized wound from some surgery I had and the doctors are optimistic, but I switched from using a Dakin solution where I was dipping some gauze and now using the SilvaSorb that I just started. It’s just two days ago, so it’s too soon to tell. It could take weeks before I’ll know what kind of success it has, but I’m using one of AcryMed’s old products. I’m really more interested in the new one, but so I have a vested interest in you right now.

Don Earhart

Well, we’re pretty happy with the $1.5 million we reported in the quarter. Again, a significant portion of that, of course, is the licensing fees that they get, as well as the manufacturing they do for Baxter and Medline. So that’s what makes up that number.

On the oxygen dressing side, we were very, very pleased with the fact that that 510(k) got approved in less than 60 days, which is extremely fast, and the FDA gave us back the approval and we’re now in a position where we can start manufacturing the product and placing it on patients.

So we’re in the process, right now, of developing the manufacturing process. That’s going to take several months to do and then we’re going to start putting on patients so that we can understand the real benefits and as we understand and identify the real benefits, we will then go back to the FDA and ask for claims.

So we hope to be in a position where we’ll actually have dressings for patients to use in early next year, probably early second quarter, but we won’t actually begin marketing the product until we know exactly what we can claim, until the second half of the year, but we’re very excited about that oxygen technology.

Herb Buchbinder – Wachovia Securities

The fact that I said hyperbaric is very expensive and sometimes not available for insurance reimbursement that will, I assume, keep this product priced pretty high?

Don Earhart

Yes. I think so, and the way its designed, again without having done all the experiments, right now it’s designed so that you would have to change that bandage every couple days. So it would be a great disposable, but it eliminates your having to go to visit a hyperbaric chamber facility and that’s very expensive.

Herb Buchbinder – Wachovia Securities

Where will you manufacture –?

Don Earhart

And you’ll be able to change the dressing home. I’m sorry?

Herb Buchbinder – Wachovia Securities

Where will you manufacture the product?

Don Earhart

We’ll probably have it manufactured for us on the outside.

Herb Buchbinder – Wachovia Securities

Okay.

Don Earhart

A contract manufacturer will do that for us.

Herb Buchbinder – Wachovia Securities

Okay. Thanks a lot.

Don Earhart

Okay.

Operator

Our next question comes from the line of Greg Brash with Sidoti & Co. Please go ahead sir.

Greg Brash – Sidoti & Co.

Hi guys, thanks for taking my call. Just have a question regarding the guidance. I mean, it looks like if you add back the revenue that you missed because due to Hurricane Ike, you did pretty well in Regional Anesthesia in the quarter, mid-double-digit growth, but your guidance is implying on the Regional Anesthesia side for around 4% to 5% growth in Q4 here. Just curious if you’re just trying to be ultraconservative or if there’s something you’re seeing that procedure volumes are really that bad, that it’s going to decline to that sort of level.

Don Earhart

No. We’re looking at the comps for last year, which were over $25 million. So, when we compare ourselves with what we did this quarter, what we see in terms of an economic situation and if we get no benefit from people using up their medical insurance, which I mentioned earlier, which people tend to use up in December, then we would see pretty much a flat quarter. So that’s why we’ve only shown 3% to 4% growth on that side for guidance, hoping that we can do better.

Don Earhart

Okay, so –.

Don Earhart

It really comes back to the comp that we looked at from fourth quarter of ‘07 and things don’t look that good in the fourth quarter, from an economic standpoint, but again, there’s a lot of people with money set aside for their medical that they have not spent yet. So, hopefully, they’ll break loose on that in December.

Greg Brash – Sidoti & Co.

Okay and then, Jim, if you don’t mind, can you break out the SG&A to the sales and marketing and G&A lines?

Jim Talevich

Sure. For the quarter, selling and marketing was $16,965,000. G&A was $5,551,000.

Greg Brash – Sidoti & Co.

Okay, very helpful and just curious where, other than not hiring sales reps here in ‘08, where is the cost cutting coming from?

Don Earhart

We’re watching everything. We’re watching what we spend, time to marketing side. We’re watching what we spend on the sales side. We’ve cut back dinners where they make no sense. We’ve cut back going to shows that don’t get us any benefit. We’ve done a lot of things to keep our expenses in line.

Greg Brash – Sidoti & Co.

Do you expect that to maybe pick up in the future, when the economy rebounds and maybe surgical volumes are on the rise, that you may go back out and do some of those marketing events that you’re scaling back on right now?

Don Earhart

Yes. I think, as the opportunity arises, we’ll do whatever we need to do, but I think the right thing to do right now is to get our sales organization focused on getting to the administrators and the C-suite to tell them about ON-Q and how they can utilize ON-Q to increase their med/surg. To help them with the problems they’ve got, to get to focus on these new HACs that are coming down from the CMS. We can help them.

Of these 11 items that are on that first list, we directly affect five of them and indirectly affect many of the others. So, by flipping the beds, getting people well sooner, getting them out of the hospital and remember, getting out sooner means less chance of an HAC happening. Those are all positive.

Greg Brash – Sidoti & Co.

Right.

Don Earhart

But we need to get that message out. We could be their salvation.

Greg Brash – Sidoti & Co.

Okay. And then, one last question regarding some of the new products, I know you’re looking to launch into the trauma and epidural markets. Curious if that happened in the quarter and what sort of feedback you’ve been getting from physicians.

Don Earhart

Well, we launched a complete line of products for trauma and that is going extremely well. Again, it’s in the very early stages, very similar to what happed with C-bloc about four years ago, where when we launched the C-bloc product it took a while for it to get traction.

But we were at a big show, a big trauma show, which actually took place in Hawaii. I fought to do that show myself, but they wouldn’t let me, but anyway, I sent two marketing people to Hawaii for that show and we had great response, including we supported a lunch in which we had about 50 doctors there, all excited. So we’re really excited about trauma, because we have a great product for trauma.

We just launched the Silver dressing full blast. We had been in a very minor launch all year long testing it and now we’re ready to blow it out and we just started doing that. So the Silver dressing, which is a non-Island dressing, is the first product from AcryMed that we’ve launched beyond the SilverSoaker and then we will follow that early next year with the same dressing, but an Island and then, of course, in the second half of next year we hope to follow that with the oxygen dressing.

So those are some of the products that we’ve got going. We have the epidural product, which, by the way, we’ve had out now for about three months. We’re beginning to get some traction there, but again that’s a slow build, just like C-bloc was. So, between trauma and epidurals, we have several new products out there and the Silver dressing.

Greg Brash – Sidoti & Co.

Great. Thanks, Don.

Don Earhart

Okay.

Operator

And our next question comes from William Miller, JM Hartwell. Please go ahead sir.

William Miller – JM Hartwell

Hi Don, hi Jim.

Don Earhart

Hi, Bill.

William Miller – JM Hartwell

Well, just they always get back to the same question. How can you reorient your sales force? How much productivity have you lost as you’re trying to refocus your sales force on the administrators in the hospital? And can you hire salesmen that already have relationships with the administrators in the hospital to aid and abet this process of acceptance, if you will? And therefore either replace existing salespeople or augment your sales force, because there are people that have a Rolodex of administrators in any given town?

Don Earhart

Now, Bill, we’ve taken the position that we can train our salespeople with what they need so that they can get to the infection control committees, they can get to the value analysis committees and from there that gets them in front of the administrators.

And don’t forget we have management, both zone vice presidents and regional directors who are at a much higher level and have the ability to make those presentations as well. So they’re responsible for many of the presentations that are being made to the administration.

That’s all being followed by an advertising campaign, which hits on Friday, starts on Friday of this week, in which will be in front of administrators and many of the magazines and articles that they would normally read, we will be there. So we have lots of ways to educate these people beyond just the sales organization.

William Miller – JM Hartwell

Great, thanks and just a couple of minor items; to what price have you marked your position in InfuSystems? That’s one.

And secondly, if you think that you purchased the last 837,000 shares of whatever it was, $12, a little over $12 and I think you have $3.20 in cash, or cash equivalents, etc, are you now back in the market? How soon can you be back in the market and why wouldn’t you spend more than you’ve allocated for several million shares rather than just one?

And then finally, if you could just comment on your legal expenses and how recurring those are over time, the legal or insurance, whatever your lawsuits are and when you think you’re going to get rid of your lawsuits, when those will come to some conclusion?

Don Earhart

You’ve asked me about four questions. Let’s take them one at a time, Bill. Which one do you want first?

William Miller – JM Hartwell

Your choice.

Don Earhart

I’m having a hard time remembering all four.

William Miller – JM Hartwell

(inaudible). I’m extending it and also augmenting it. The second was on the legal area of how nonrecurring these really are, how long you expect the lawsuits to continue and obviously I know what you think the likely outcomes are, but I mean, these can go on for years, these damn things and it’s obviously expensive.

Don Earhart

Okay, let’s take the stock buyback first. The stock buyback becomes in play again 48 hours after this conference call. So, and again, it’s up to management and management’s discretion to buy stock as they think it’s the right thing to do or the opportunity is there. So, I don’t talk about when we do or do not buy, but we have the ability to begin buying in 48 hours.

On the legal side, we actually have two lawsuits or two series of lawsuits. The chondrolysis cases, which we’ve already set aside money for, and that’s already been accounted for in our financials and then on the Apex lawsuit, you’re seeing those expenses every quarter as we go forward, so they’re already there.

When will that be resolved? I don’t know the answer to that question. Probably a couple of years, it could be, if it’s not settled earlier and on the chondrolysis, we believe those cases will go on for many years and by the way, the first one has not come to trial, so it’s interesting there that this has been going on now for over a year and the first one is yet to come to trial. So I don’t know the answer to all those questions. So I don’t know the answer to all those questions.

William Miller – JM Hartwell

Don whether we have insurance cover on these stuff.

Don Earhart

But we have $35 million set aside for the chondrolysis cases, for a year. Was it 2007, 2008?

Jim Talevich

Yes, the policy year ending June 1, 2008, we’ve got a tier of $35 million of coverage.

Don Earhart

Right and then for the following year, for 2008 to 2009, I believe we have $50 million.

Jim Talevich

Correct.

Don Earhart

Yes, but again, we have no idea what these are going to cost, if anything, other than the legal expenses, because one hasn’t gone to trial yet.

William Miller – JM Hartwell

And you pay the legal expenses? The insurance doesn’t cover any of that?

Don Earhart

No, the insurance covers the legal. There’s a deductible, but after the deductible it covers the legal.

William Miller – JM Hartwell

Okay, so the legal expenses that we see in this quarter, which are nonrecurring or at least not operating, will continue or not continue? And if they’re going to continue, will this be at the same level or not?

Jim Talevich

Yes, we don’t really have a guidance on that, but we expect fairly modest amounts as far as the actual. Are you talking about the $166,000?

William Miller – JM Hartwell

Yes, I guess so.

Jim Talevich

In general, we think we’re covered, based on what we see, on the chondrolysis accrual in general. It was our intention to put, to basically cover that with tier of coverage, so we estimated the self-insured retentions and the $166,000 you see in the reconciliation table in the press release is just a minor tweaking of that, based on some cases going away, etc.

William Miller – JM Hartwell

Okay, so that’s going to be the approximate number as we carry forward here?

Jim Talevich

We’re not capable of predicting that, Bill, but that’s what it is today.

William Miller – JM Hartwell

Okay, fine. Do you see any need or is there an availability of new salesmen that are so attractive you can’t resist?

Don Earhart

Not at this time, but again, remember we’re bringing new people onboard all the time as we turn over old, so if there’s anybody attractive out there we have plenty of opportunity to bring them onboard and fill in the existing slot, but adding additional to what we already have approved, I don’t see that right now, Bill.

William Miller – JM Hartwell

Okay, great. Thanks, Don, very much. Thanks, gentlemen.

Don Earhart

Okay.

Operator

(Operator instructions) And our next question comes from the line of Steve Kruger, Foresight Investments. Please go ahead.

Steve Kruger – Foresight Investments

Hey Don.

Don Earhart

Hi Steve.

Steve Kruger – Foresight Investments

A few questions, Don just continuing on the chondrolysis suit. Last conference call I think you mentioned that there were 30 cases that you’re aware of. Is that still a good number?

Don Earhart

I think, in the Q that will be out shortly, we have 37. We have to be careful about that number, Steve. Those are the number of cases filed. They’re not necessarily the number of cases where our pump was involved. So, when you file the case, we’ve found in the past is that after we get into the due diligence of that case, with several times we have found that it’s not our pump. It’s part of the competitor’s pumps, but right now we have cases filed against us, I believe, of 37.

Steve Kruger – Foresight Investments

So it’s 37 cases filed against you in particular, not your competitor?

Don Earhart

No. They’d be, I guess, us and could also include a drug company or another device company, but not a pump company.

Steve Kruger – Foresight Investments

Okay. Now, so I take it that not all of these 37 cases have gone through discovery? Wouldn’t you know, at this point, how many of the 37 in fact involve one of I-Flow’s devices?

Don Earhart

Again, we don’t give that number, Steve.

Steve Kruger – Foresight Investments

Okay.

Don Earhart

And the answer to your question on the 37, no, we have not had a chance to vet all 37. It takes a long time.

Steve Kruger – Foresight Investments

Is there a likelihood that those 37 will be consolidated into a class or are you expecting that each one of those will be litigated separately?

Don Earhart

The only thing I can tell you there is that putting them into a class has been tried and denied, because they are all so different. So we would expect them to all be tried separately, and again, that’ll take a long, long time.

Steve Kruger – Foresight Investments

Yes it sure will. Now, do you know –?

Don Earhart

Yes and if we were to ever lose, of course you can expect us to appeal.

Steve Kruger – Foresight Investments

Right.

Don Earhart

Which will take a long, long time.

Steve Kruger – Foresight Investments

Right. Do you have any idea when the first case will come to trial?

Don Earhart

Probably next year.

Steve Kruger – Foresight Investments

Okay and do you know what’s the earliest date from which the incidents occurred that formed the basis of these suits? Do these go back to treatments that were done three, four, five years ago?

Don Earhart

Yes.

Steve Kruger – Foresight Investments

Or can you give us some color on that?

Don Earhart

Yes. It’s treatments that were done many years ago, before chondrolysis was even thought of. Before any of the papers that came out, the animal studies that came out, that talked about chondrolysis and remember now, there is no proof other than animal studies which suggest that pain pumps delivering a local anesthetic can cause chondrolysis.

I’ve said this argument before on the conference calls, is that a pain pump or a delivery device, whether it be a syringe or one of our pumps delivering a drug, how do you blame the device, because there’s no way the device can cause the disappearance of cartilage. It would have to be whatever is delivered into the site or would have to be the technique by the doctor or it would have to be the sutures or it’d have to be the staples or it’d have to be something else he used during the surgery, but it can’t be our pump, because our pump can’t cause cartilage to disappear.

Steve Kruger – Foresight Investments

Right.

Don Earhart

It’s like using a syringe to deliver a narcotic. We can’t be responsible for the side effects, if I’m the syringe manufacturer, of the drug.

Steve Kruger – Foresight Investments

Well, in the use of the ON-Q pumps, Don, to what extent do the doctors invent their own method as opposed to relying on guidance from you as to where to place the catheter?

Don Earhart

Again, we provide doctors with what others have done. Other than that, we make no recommendation.

Steve Kruger – Foresight Investments

Yes. Okay.

Don Earhart

And again, Steve, I think I’ve probably commented more on the litigation than I should and we need to move on to another subject.

Steve Kruger – Foresight Investments

All right, very good. Don, you make a very persuasive argument, to us certainly, about the benefits of this new HAC guideline from CMS and the affect it should have on the demand for your ON-Q product. What tangible evidence have you seen that that persuasiveness is being appreciated by your customers?

Don Earhart

I think it’s still too early, Steve, to see those benefits in total. The customers who now use our product are believers. We don’t have to sell the surgeon who is now using our product on a regular basis. He’s a believer.

What we have not gotten to yet is we’ve not gotten to the administration, in many cases, so that we can point out to them that as these HACs come down from CMS and are also honored by the private insurance companies, they’re going to have to get people in and out of the hospital much faster without any HACs happening. They’re going to be tremendous pressure to improve their efficiencies. That’s what we do

Steve Kruger – Foresight Investments

Right. Yes, got to find a standard, because it’s too early to tell whether administrators are actually buying the argument. You don’t know that yet.

Don Earhart

Well, what we do know, Steve, is that in talking to the sales organization, many hospitals have still done nothing to really get themselves ready for this program. That’s what the most amazing thing, is that hospitals are still living in a dream world.

Steve Kruger – Foresight Investments

Right.

Don Earhart

But when they stop getting paid for invoices in January of next year that’s when they’re going to wake up.

Steve Kruger – Foresight Investments

Right. Got you. On another question, Don, the wound care product that you hope to launch late next year, how much overlap is there going to be in call points for that product versus ON-Q? Is your sales force going to be calling on the same people or is it a whole different set of people in the hospitals?

Don Earhart

Yes, again, we have not decided yet how we’re going to distribute that product. My Vice President of Sales, he wants it real bad, but the question there is, does the call point make sense.

And secondly, we’ve already had some discussions with some very big players in the wound site area who are also interested in the product, should it work as well as we think its going to work. So, we have not decided yet what the distribution network will be for that product.

Steve Kruger – Foresight Investments

Okay. Last question. Stock-based compensation was $1.8 million in the quarter. Can you give us any sense about whether you expect that number to, the run rate, to continue on into the future or do you have any plans to change that up or down?

Don Earhart

We think it’ll be basically flat.

Steve Kruger – Foresight Investments

Okay. Thanks very much, Don.

Don Earhart

Okay, thank you, Steve.

Operator

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

Don Earhart

Well, thank you, Benjamin. I-Flow is well positioned to continue growing in these difficult economic times. We have the financial resources to fund growth, an aggressive and well-trained sales and marketing team, and with ON-Q the market-leading product proven to save hospitals money.

Therefore, we remain confident that our business fundamentals and our growth strategy remain on track and we look forward to reporting our progress on our fourth quarter and year-end results conference call in about four months. Thank you.

Operator

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.

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Source: I-Flow Corporation Q3 2008 Earnings Call Transcript
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