Respironics F1Q08 (Qtr End 9/30/07) Earnings Call Transcript

Oct.25.07 | About: Respironics Inc. (RESP)

Respironics Inc.(RESP) F1Q08 (Qtr End 9/30/07) Earnings Call October 25, 2007 8:30 AM ET

Executives

Julie Tu - CRB

John Miclot - CEO

Dan Bevevino - CFO

Craig Reynolds - COO

Damian Ripple - Corporate Controller

Analysts

Tim Lee - Caris & Capital

Joshua Zable - Natexis

Jason Mills - Canaccord Adams

Glenn Novarro - Banc of America

Joanne Wuensch - BMO Capital Markets

Vincent Ritchie - Wachovia

Jason Rogers - Great LakesReview

Vic Chopra - Morgan Stanley

Operator

Good morning, ladies and gentlemen, and thank you forstanding by. Welcome to the Respironics' First Quarter 2008 Earnings Call.During today's presentation, all parties will be in a listen-only mode.Following the presentation, the conference will be open for questions.(Operator Instructions). As a reminder today's conference is on ThursdayOctober 25th, 2007.

At this time, I would like to turn today's presentation overto Julie Tu with the Financial Relations Board. Please go ahead.

Julie Tu

Good morning, and thank you all for participating inRespironics' conference call to discuss the 2008 first quarter results. Youshould have received the copy of the press release by now. If anyone stillneeds another copy, you can call my office at 212-827-3746, and SamanthaAlfonso will send you one immediately following the call.

For today's call we have John Miclot, Chief ExecutiveOfficer; Dan Bevevino, Chief Financial Officer; Craig Reynolds, Chief OperatingOfficer; and Damian Ripple, Corporate Controller. This conference call willfollow the standard format followed by a question-and-answer session.

Before we start, the Company has asked me to remind you thatforward-looking statements can differ materially from actual results, andrelying on them is subject to risk. Factors that can cause forward-lookingstatements in this conference call and webcast to differ materially from actualresults, are discussed in the Company's press release, as well as its periodicfilings with the SEC.

Investors can view the Company's press release, which is accessibleon its internet site at www.respironics.com, for additional information aboutthe Company's use of non-GAAP financial measures.

With that, I'd like to turn the call over to John Miclot.Please go ahead, John.

John Miclot

Thank you, and good morning everybody. We're very pleased,once again, to report record results, and with global revenue, a growth of 17%and 22% growth in earnings per share. Given this quarter's results, we have nowmet or exceeded our estimates for eight consecutive years. Our performance was,once again, very balanced across both product lines and geographies.

Key growth drivers were 20% global fleet growth, of which18% was domestic and 24% was international, clearly outpacing market growth.These results demonstrate the success of our refreshed product line and ourinternational expansion initiatives.

We are very pleased with the continued success of our Flextechnology and particularly the rapid acceptance and growth of our Auto A Flexsystem, as well as the continued adoption of OptiLife. In addition, we are veryoptimistic about the investments we are making in the patient interface arena,where we expect to launch several new products in fiscal year ’08.

We also made good progress in expanding our efforts in thebroader sleep markets, with the acquisition of Apollo Light Systems, and a $7.5million equity investment in a development stage sleep company.

Our hospital business continued to perform well, with eachof the business units of Critical Care, Respiratory Drug Delivery, andChildren's Medical Ventures positively contributing to our results. During thequarter, we invested $18.1 million in research and development, directed at oursleep and respiratory business.

In addition to the sleep products I mentioned earlier, weare expecting to introduce a number of new ventilators during the fiscal year.We remain very optimistic about the strength of our business. And given ourstrong first quarter results, we are raising our annual revenue guidance from$1.36 billion to $1.38 billion and we are raising the low end of earnings pershare guidance resulting in a new range from $1.93 to $1.98.

Equally important, we are very confident in our ability todeliver our long-term strategic value creators of mid-teens revenue growth and15% to 20% earnings per share growth, while assuring we continue leadership inour core businesses of sleep, ventilation and international expansion, whilebroadening the scope in the broader sleep and respiratory space.

With that I would like to turn it over to Dan Bevevino.

Dan Bevevino

Good morning. I will go through the revenue detail and ourgrowth strategy year-over-year. Then make some comments on our incomestatement, and finally, just make some comments on our guidance for theremainder of the year.

Just as a reminder, we will be utilizing our new moresummarized format in terms of our revenue disclosures, and this is consistentwith what we discussed in our last quarter's conference call. So with that, Iwill start with domestic sleep therapy. It came in at $134.9 million for thequarter versus last year's $113.9 million and that is an 18% increase and thatis driven both by our electromechanical devices, the core M Series, as well asthe new A- Flex and Auto SV units, and a strong performance across the board onour patient interface devices as well.

In the other sleep and home respiratory category, totalrevenues there for the quarter were $25.9 million, versus last years $24.2million. That is an increase of 7%, and in that number there is a strongperformance from our home oxygen systems, the new stationary concentratorEverFlo, as well as our new portable oxygen concentrated EverGo. That offsetsome smaller decreases in our OEM and other business, as well as sleepdiagnostics. So total Sleep and Home Respiratory came in at $160.7 millionversus last year's $138.3 million, for an increase of 16% overall.

Turning to Domestic Hospital, total revenuesthere were $48.2 million in the current year quarter, versus $43.3 million lastyear, which is an increase of 11%. Key growth drivers there included thenon-invasive ventilation systems and related masks and accessories, as well asstrong growth in Respiratory Drug Delivery, and solid growth in Children'sMedical Ventures.

We did start to feel the impact of our exiting from theoximetry business in the cardio respiratory monitoring category. That is veryconsistent with what we guided to on last quarter's conference call. So, on adomestic basis we finished the quarter at roughly $209 million in totalrevenues, versus last year's $181.6 million, for a domestic increase of 15%.

Turning to the international side, our international sleeptherapy revenues were $49.4 million, versus last year's $39.9 million. And as John mentioned, and it was mentionedin the press release, that was a 24% growth in the international market place.Again across the board in terms of both electromechanical devices as well aspatient interface, we had strong performance in the international markets.

The category of other sleep and home respiratory,internationally, came in at $24.9 million in the current year quarter, that'sversus $18.8 million last year, which is an increase of 33%. That strongperformance was driven by our home oxygen systems, as well as our home non-invasiveventilation systems. Those were the primary growth drivers there.

International hospital for the quarter came in at $28.3million versus last year's $26.3 million, which was an increase of 8%. Again wesaw a growth in our non-invasive ventilation systems, and also strong growth inrespiratory drug delivery. And we did feel some of the downward pressure fromexiting the Oximetry Business.

So in total, internationally, as we mentioned the $102.7million in the current year quarter versus $85 million last year and theinternational increase, was 21%, with total revenues of $311.6 million.

Turing to the full income statement, and starting with thatglobal revenue number of a $311.6 million, our cost of sales on those revenueswere $144.6 million for resulting gross margin of a $167 million, or roughly54%. That’s very much in line with our expectations, as well as our guidancethat reflects an improvement from the first quarter of last fiscal year, andreflects some efficiencies in the M Series and the manufacturing area. Also, itdoes reflect the impact of stronger home respiratory revenues and oxygensystems, which do carry a lower gross margin.

Our G&A expense came in at $47.5 million for thequarter, that’s 15% of revenues. So we mentioned in the press release that doesinclude a healthy contribution to our incentive compensation plans, based onthe strong operating results. It also does include an accrual for professionaltax service fees to the service provider, which helped us earn the tax creditthat I'll be discussing in a minute.

Our sales and marketing expense for the quarter came in at$63.2 million or 20%. That simplyreflects our normal recurring expenses, as well as some meeting and trade showexpenses that occurred during the quarter.

In research and development, we came in at $18.1 million or6%, that’s reflecting a strong investment in our core spaces, as well as nearly$1 million of R&D expense that was accelerated during the quarter,primarily in the sleep area. And then, we had an in-process R&D charge ofapproximately $5.4 million. We mentioned in the press release, and as Johnmentioned, we did make an equity investment in a development stage sleepcompany, the total investment there was $7.5 million. Under the accounting rules,we were required to recognize a portion of that as in-process R&D, and thatportion was $5.4 million.

The operating income after those expenses is $32.8 million,or 11% of revenues. Just as a reference point, if you were to back out theone-time items there, including that in-process R&D charge, you would beclose to 13% on that operating income line.

Our restructuring and acquisition expenses in the quartercame in at roughly $600,000, and our other income was a positive $5.2 million,that includes just a normal interest income component and about $2 million offoreign currency gains, as the foreign currencies gained versus the dollar insome of the key markets we are in.

And the resulting pre tax income was $37.5 million or 12% ofrevenues. We had income taxes of approximately $10 million, which does reflectthe one time credit for extraterritorial income that we mentioned in the pressrelease. So we had a lower effective tax rate in the quarter, and our resultingnet income was $27.5 million or 9% of revenues. Our diluted shares outstandingare approximately 75,064,000, and we earned approximately $0.37 a share.

Just for purposes of clarification, I was going to walkthrough the one-items that flow through the income statement. Again, we had atax benefit of roughly $4.3 million, that's on a pre-tax basis and that isafter we recognized the professional service fees associated with that, sothat's $4.3 million for the tax benefit. And then we had the foreign currencybenefit of roughly $2 million. So, we had approximately $6.3 million ofpositives that flows through the income statement. We offset that withinvestments in the in-process R&D category of $5.4 million and roughly $1million of accelerated internal research and development associated with thesleep markets. So we offset that $6.3 million of favorable one-items.

And again, just to clarify we would have made our quarter inour guidance and estimates. Without those one-items we would have been able tomake a healthy contribution to profit sharing as well.

At this point, I am just going to turn briefly to ourguidance. John touched on this for the remainder of the year. We've updated itand raised our revenue guidance from $1.360 billion to $1.380 billion. Reallythere's nothing new in terms of our outlook, rather we continue to be verypositive on the core growth drivers in the business. This we outlined in theJuly conference call.

So we continue to look for strong growth and sleep therapyfor the remainder of the year and our Home Oxygen and Home NIV business in theinternational market. And then on the hospital side, we look for the NIVbusiness, the Respiratory Drug Delivery business as well as Children's MedicalVentures to drive our growth for the remainder of the year.

In terms of earnings per share, we averaged at the low endof that guidance up to a $1.93, and our new range is $1.93 to $1.98. So basedon the strong performance in the quarter we are reporting today, as well as ourcontinued positive outlook for the next three quarters, we are raising ourguidance a bit.

So with that I well turn it over to Damian Ripple to reviewour balance sheet and cash flows for the quarter.

Damian Ripple

Thanks, Dan. In addition to the real strong revenue andearnings performance, we also had an outstanding quarter of balance sheetmanagement and cash flows. Our cash in short-term investments increased, by $15million in the first quarter, to a balance of $322 million at September 30th.As noted in the press release, this is after we invested $14 million foracquisitions. And as we typically do in the first quarter, we also made severallarge cash payments for items that were accrued at June 30th, includingpayments of our incentive compensation pertaining to last fiscal year.

So in light of this, we are really pleased with the net cashwe generated of $29 million, excluding acquisitions. That compared to $15million that we generated in the first quarter of last year ex-acquisitions.

I will provide some highlights of the main drivers of ourcash flow and touch on some key balance sheet metrics as well. We generated$38.5 million of cash for operating activities on net income of $27.5 million.In the key areas of working capital, our receivables declined by $5 million inthe quarter, and our DSO was 62 days for the quarter, compared to 64 days inthe prior year first quarter.

We invested about $11 million in inventory. That represents7% growth since June 30th. That's fairly consistent with our internal businessplan and is embedded in the full year cash flow guidance that we provided toyou in July.

In investing activities, we used $33 million that includes$19 million for capital expenditures, and $14 million for acquisitions andstrategic investments. We did describe those investments in the press release.

From financing activities we've generated $9 million. That'salmost entirely related to stock option activity, as well as the small amountof net cash flow from lease-financing in Japan. Our total debt, includingthe current portion, is up $4.5 million during the quarter versus last year endto a balance of just under $50 million. The majority of that increase isactually from the impact of a stronger Japanese Yen on the balance sheet, anddoes not represent net borrowings.

Lastly, I'll provide an update on our full fiscal year, 2008cash-flow guidance. We are raising our projected net cash flows from $120million to $125 million, based on a very strong first quarter of cashgeneration. And as noted, we are raising the lower end of our earnings pershare outlook for the year to $1.93.

Our guidance remains unchanged from that which we providedin July, as it relates to key working capital areas, as well as capitalinvestments. And it also continues to exclude any new acquisitions, as well asthe new manufacturing center that we announced last quarter.

So with that, I will turn the call back over to John toaddress your questions.

John Miclot

Thank you. We are happy now to open it up for questions.

Question-And-AnswerSession

Operator

Thank you, sir. Ladies and gentleman at this time we willbegin the question and answer session. (Operator Instruction) Our firstquestion will come from line of Tim Lee with Caris & Capital. Please goahead.

Tim Lee - Caris & Capital

Hi guys, good morning Tim Lee.

John Miclot

Good morning, Tim.

Tim Lee - Caris &Capital

Hey John, in your comments you talked about rolling out inthe series of new patient interfaces, I guess to the balance of the year. Canyou give us some sense of what the things would be and also what types of masks,are they Full Face Mask, hybrids or just any color that you can provide on thatfront, please?

John Miclot

Sure. I think we would say that we have opportunities acrossthe continuing of our product portfolio, certainly a Full Face Mask is aproduct that is one that we have been in development for and likely to be in anearly entrance in terms of our success with the introduction of that product.We also continue to refine and try to broaden the scope of our nasal pillows offerings.And then finally, as you are aware, we have significant franchise in the gelarena, for standard type mask and we are certainly focusing there.

In terms of the Cadence, it’s a bit difficult to each ofappeal to the FDA process, on approval process, but I can tell you that we aremaking excellent progress and certainly would expect to see some of those inthe second half of the year.

Tim Lee - Caris &Capital

And, just in terms of mask, I mean if we had to look at yourcurrent offering right now, where would you think that, which product was theleast competitive and needs the refreshing?

John Miclot

I would say that, no, we are very, very confident in theproduct portfolios that we have, with probably our Full Face Mask being thebest opportunity for enhancement.

Tim Lee - Caris &Capital

And then one quick one, if I may. Just, can you provide usany color on how EverFlo and EverGo are rolling out and its potential impact onthe gross margin here to the balance of the year? Thank you.

John Miclot

I can tell you the products are being extraordinarily wellreceived it’s evident in our growth in terms of that particular part of ourbusiness. As we stated, we are not competing on price in any of those segmentsand so we are really emphasizing the service benefits of the EverFlo and on theEverGo, it’s really focused a rental opportunity for our home care providers toprovide products to patients that are traveling. In terms of gross margins, Iwill pass that to Dan.

Daniel Bevevino

Hey Tim, it's Dan. I think we've got that into our guidance,we expected to continue to see growth in that category and that's reflected inour guidance that we would see gross margins roughly consistent with the prioryear itself. So it's included in there.

Tim Lee - Caris &Capital

Okay. Thank you.

Dan Bevevino

Welcome.

Operator

Thank you. Our next question will come from the line ofJoshua Zable with Natexis. Please go ahead.

Joshua Zable - Natexis

Hey, guys. Thanks for taking my call.

John Miclot

Hey, Joshua

Joshua Zable - Natexis

Congratulations on a great quarter again. A Couple of quickones here, can you give us any color into that investments in that sleepcompany that you made?

John Miclot

As you know, we've been investing for some time in our SleepWell Ventures space, and as I mentioned in the last conference call there is afair of internal development that we see in clinical environments and we wouldhope to start seeing some of the benefits and returns of the investments thatwe've been making in that space.

In addition to that we've been looking outside theorganizations for ways to either augment that or create additionalopportunities in areas that we might not be currently developing within thecontext of the company. And certainly the Apollo Light Systems is a greatexample of a technology that puts us into circadian rhythm management andprovides us a real opportunity in treatment for not only circadian rhythms, butinsomnia.

The particular investment that we may or making, we believewill provide us some opportunities in the mild to moderate sleep apnea space,snoring cessation areas like that, which really takes us to 20 million severesleep apnea patients and broadens the potential patient population to over 50million in the United States by treating less severe sleep apnea with differenttypes of technologies.

Joshua Zable -Natixis

Great and then just on the other side of spectrum, you guysobviously got rid of the oximetry business. Can you just give us a little bitcolor on that?

John Miclot

Yeah. I guess, we were in terms of the product portfolio, wehad that was a reusable oximetry device that really was targeted and acceptedby very, very small portion of the marketplace, and in order to really becompetitive in oximetry, we would have to make significant investments tocreate state of the art oximetry products. We chose to instead join with Masimoand create a relationship there that we previously announced and they arereally able to provide us with the state-of-the-art kind of technology that weneeded. And frankly we viewed use of our R&D assets better served in thesleep and respiratory space.

In terms of financial elements I'll ask Dan to cover thatfor you.

Dan Bevevino

Josh we had mentioned in the July call that we expected tosee anywhere between $6 million and $8 million of drop off in that cardiorespiratory monitoring category. That just kind of frames out for you whatlevel what that was achieving.

Joshua Zable -Natixis

Okay. Great and then just one last question more in general.It seems like the sleep markets help the -- I know my experience of talking tohome providers. It seems like environment in general is getting just a littlebit better out there for guys like yourselves. I know you guys are always veryopen about dialing in pricing in general, that’s the market as it is. But haveyou seen sort of at least general pressure, I guess on the environment to easeup a little bit or can you give us any comments about the general marketplace?

John Miclot

Well I believe that, we have always been bullish about themarketplace. We don't think that we have at all said that we felt like therewas any kind of slowing or pressure associated with the health of the market. Iwould reiterate that that's been our position. I can tell you that we wouldcontinue to view this as a very, very healthy market. I can tell that there isjust great continued evidence out there about the problems of this disorder,the importance of providing therapy to patients and I am very proud of thesuccess we've had with our strategy, which is really focused in on creating aneconomical way to assure compliance. And during the quarter we had a sizeablebenefit from the auto A-Flex technology, which is as creating a whole newmethod to deal with the long-term compliance and needs of patients that changeover time. And I think that all that just bodes very, very well for thecontinued health of this marketplace.

Joshua Zable -Natixis

Great. Well, I'll let someone else ask some questions.Thanks very much, congrats again guys.

Operator

Thank you. Your next question will come from the line of JasonMills with Canaccord Adams, please go ahead.

Jason Mills -Canaccord Adams

Hey John, hey Dan can you hear okay?

John Miclot

Hey Jason, yes absolutely.

Jason Mills -Canaccord Adams

Thank you. I am sorry, I missed out here. Congratulation onanother good quarter. Dan once again it looks like there could have been apretty good beep in the quarter, it seems to be a ton of leverage in the middleon the P&L arguably with eight straight years of hitting or meetingguidance. I am wondering, my question I am getting to a question which is, whenwe look at operating margins it looks like given the one timers that was alittle subdued in the quarter and you took initiatives that really resulted inthat, but longer term what are you guys targeting for a longer term operatingmargins? Can we see this, for example, at 20% which is seemingly where its beentracking for the last several years?

Dan Bevevino

Well I guess my comment would, I'll start with our strategicfinancial objectives. We've been stating consistently that we are driving thecompany to achieve mid teens topline in 15% to 20% earnings per share growth.So just implicit in that is that on a year-over-year basis we'll be able toimprove our operating margins. Last year we were in that 15% to 16% rangetowards the end of the year, that number for us to achieve those objectivesthat number has to continue to tick up and I think on a long term basis youcould get into that range of 20%. I would just tell you that we are verycomfortable, there is leverage in our income statement. We've stated thisbefore that we think the SG&A category is certainly the first place wewould go.

R&D, we would expect to grow at least commensurate withour revenues, as we think there is enough invest opportunities in our businessto drive that and that’s what we need to invest to keep the revenue growing.And then, the gross margin will really just depend on our customer mix andproduct mix and geographic mix, but they are definitely as leveraging atP&L and would steer to SG&A first.

Jason Mills -Canaccord Adams

Right, yeah, that is consistent with what you said. I justwanted to hear it reiterated from time to time, it’s good to hear. Secondly,John, on the sleep business, you touched a little bit on what you are workingon now, with respect to your core value generator and pacing your facebusinesses.

And you touched briefly on some developments or someinitiatives, for a longer term opportunities in sleep. At the CHEST meetingearlier this week, obviously, have you probably tuned about phrenologist. Therewas some discussion on OSA and treating of the patient and patient care. And,while CPAP obviously is going to be around for a while, I guess that what yourthoughts on how quickly we are going to see Respironics bring to marketproducts that address the underlying physiologies of these, which you talkedabout on your analyst day, as well as at other times. Are we talking about twoto three, four to five, ten to twelve years, maybe just a little bit more colorthere would be helpful.

John Miclot

Well, I think, that our thinking is that there is alwaysgoing to a room for positive airway pressure devices and that’s going to remainthe gold standard of therapy for the treatment of certainly server obstructivesleep apnea. And as you are seeing, there’s, that’s even expanding into thearea of treatment for, like with our autoSV for periodic breathing andapplications like that. We also still think there are opportunities to enhancethe overall heart performance in the heart failure patients with positiveairway pressure. At the same time, there are these, mild to moderate patientsand individuals that snore, they don't have significant apnea, where we believethat there are likely technologies that are more surgically oriented, moredirected towards the ENT. I think that because of the nature of thosetechnologies, they are probably more in that two to three year horizon becauseof the surgical procedures that would accompany the therapy.

Jason Mills -Canaccord Adams

And that would be incremental to your Positive AirwayPressure business, I would presume?

John Miclot

Yeah. We would be and as well as creating a new marketsegment.

Jason Mills -Canaccord Adams

Right, okay. Last question and I'll get back in queue. Well,sort of awaiting the MedCAC CMS's decision on home reimbursed to diagnosis. Isuppose, It seems to me like if they do reimburse, if at all the modest positive,but I am wondering your perspective on reimbursement for in some diagnostictest in lieu of establishing reimbursement of our process by which patientswould get self-titrated at home as well.

Do you need both for, it to really have an impact on marketgrowth. Do you think or do you think any reimbursement that all would becatalytic modestly or moderately to market growth?

John Miclot

I guess, our view of it is, is that we would view it as anoverall positive to the organization. We think that if one could capture maybesome of the patients that don't find their way to the lab, that choose not togo into a clinical environment to get diagnosed.

We have created a series of platforms that can create ahighly efficient method of both diagnosing and titrating the patient in thehome. And in terms of our auto A-flex its uniquely positioned, because theclinician can determine what type of therapy they want to provide the patientremotely through out the night, if they want just have a straight [sleep path]or if they want to have pressure relief or if they want to have autotitratingplus pressure and support and pressure relief. That really, in terms of theopportunity should it emerge, we are prepared with a series of products thatare already approved in the marketplace to really sort of create a methodologyin way to assure that we benefit, as well as efficiently manage the patient.

Jason Mills -Canaccord Adams

Great. Thanks guy, great quarter.

John Miclot

Thank you.

Operator

Thank you. Our next question will come from line of GlennNovarro with Banc of America. Please go ahead.

Glenn Novarro - Bancof America

Thanks. Good morning.

John Miclot

Hi, Glen.

Glenn Novarro - Bancof America

In you press release, you talked about international sleepshare gain, but there was no commentary regarding the U.S. markets. So, two questions,one your 18% domestic sleep growth, was that in line with the market? Did youtake share or loose share? Question number one, and then number two, withrespect to the international market, again you mentioned you took shares, sowho did you take share from? And were there any particular territories that youwere strong in, perhaps Japanfor instance? That's the question one multiplied and then just quickly for Dan,tax rate for 2Q and for the rest of the year?

John Miclot

Thanks, Glenn. I assume that those were three questionsversus one added back.

Glenn Novarro - Bancof America

Good counting.

John Miclot

In terms of the overall market growth in the U.S.we still view that as a 15% to 20% grower and we would view the 18% to be atthe high end of market growth. In terms of the international market again, wedefined that as a 15% to 20% growth market and we certainly believe, reallyeven against some top comps in the prior year, that business is not just, thisis not a one quarter phenomena that we have been able to gain market share inthe international markets. There are numerous competitors within the context ofthe international market and I wouldn't identify anyone particular competitoras to having taken share from.

Glenn Novarro - Bancof America

Okay. So U.S.it's fair to say you were a share gainer?

John Miclot

We feel very good about the growth in terms of as being atthe high-end of the market growth.

Glenn Novarro - Bancof America

Okay. And then just Dan the tax rate?

Dan Bevevino

Yeah Glenn, we are holding our outlook on the tax rates forthe next three quarters and as we mentioned in July that's in the neighborhoodof 35% to 36%. I think when you add that to the lower tax rate in this quarterwe just reported, you get to a blended rate for the year of about 34%.

Glenn Novarro - Bancof America.

Okay, great. Thank you.

John Miclot

Thanks, Glenn.

Operator

Thank you. Your next question will come from line of JoanneWuensch with BMO Capital Markets. Please go ahead.

Joanne Wuensch - BMOCapital Markets

Thank you very much. A bigger picture question, investorsfrequently think of you guys as a sleep therapy company and more and more, asyou make more acquisitions and brand out, you are becoming a broader respiratorycompany, and have been frankly for quite sometime. When you think about makingacquisitions and investments how do you decide where to invest, and where toacquire?

John Miclot

I think we sort of have a pretty disciplined acquisitionapproach, and actually if you looked at the number of acquisitions we've donewe've been very successful at integrating them into business. I think they fallin to sort of three categories, certainly in the sleep space, in our primarilybusiness there is very little opportunity for acquisition there. We've reallymade that an internal competency in an area that we think our internal researchand development dollars buy well. But in this space for the broader sleepdisorders with over 80 different sleep disorders and in the area of snoringsensation and potential other mild to moderate apnea opportunities. We thinkthat is a very, very nice area for us to continue to look for acquisitionopportunities.

The second one, in terms of the respiratory space, it reallygoes across the portfolio. We have a very active number of opportunities in therespiratory drug delivery space that would be – would more like a businessdevelopment type of relationships where we would maybe be investing orco-developing, not necessarily acquiring. But there are also opportunities inthe ventilation area to basically take technologies, to enhance algorithms andone of the areas that we are particularly excited about in that space, is whatwe call our ability to create a clinical advisor, where we would be able toreally deal with the shortage of respiratory therapist, be it our non-invasiveventilation technology and educate the clinician that’s monitoring and managingthat patient how best to utilize the device to optimize ventilation. Thosekinds of things can be either again license or acquisition opportunities.

And then the third area is where we have been probably mostactive and that’s in the international distribution arena, where we continue tosee opportunities. The final comment I guess I would make, in term of ouracquisition strategies is, having the management team come along with thebusiness is extremely important to us and I think a key to the success of howwe’ve acquired businesses. So for example, when with our latest in Apollo, wesee a very, very important role being played by the existing management team.

Joanne Wuensch - BMOCapital Markets

Okay. And, sort of a different question, talking up previousone. You had a lot of juice, if you will, in the middle of the incomestatement. Is it an internal policy not to let that fall through the bottomline? How do you think about that?

John Miclot

Well, I will start and then Dan can add some detail to that.There is no internal policy at all. We would say that we would not drop that tothe bottom line. I think we go through a very disciplined exercise at lookinghow there might be opportunities within the organization to accelerate thegrowth of the company and our primary driver is always built around a notion ofcontinuing to generate growth and hit our strategic long-term guidance. I thinkthat's where our consistent and predictable performance drives itself from.

I think that if you look at the history of the organization,it is certainly driven by the creation and productivity of our R&D pipelineand when we find the opportunity to accelerate some of the initiatives withinthe context of that R&D pipeline we are going to certainly do that.Obviously, the ability to utilize some of these dollars that would flow throughthe expense line to broaden the opportunity space in the areas via acquisitionsor "in-process R&D" or but again I think good uses of the money.But we have in the past dropped and beat earnings guidance and you saw it todayraise our low-end in terms of earnings.

Joanne Wuensch - BMOCapital Markets

Okay. Thank you very much.

Operator

Thank you. Our next question will come from the line VincentRitchie with Wachovia. Please go ahead.

Vincent Ritchie -Wachovia

Hi guys. Thanks for taking my question. Just a quickquestion on the OUS market: You guys -- what are you seeing in Germany?Are you seeing share gains there? What's the kind of the environment?

John Miclot

We don't really talk specifically about each market, but Ican tell you that we had a very, very balanced set of contributions acrossmajor European markets and certainly Japanand Australiawere important contributors to the international growth.

Vincent Ritchie -Wachovia

And in terms of the [O2] market with [oxygen] being cut from36 to 18 month, how is that going to affect your product portfolio and yourofferings.

John Miclot

That's a proposed legislation that actually currently fellout of the SCHIP bill when it was vetoed and actually never made it in to thatprior to the veto. So, there is currently no legislation in place that wouldchange that. We certainly still view it as a risk to the business and to ourhome care providers and we are working very, very closely with them to try toassure that the appropriate lobbying efforts and educations are happening tocontinue to see 36 months as the objective.

Vincent Ritchie -Wachovia

Okay. Great and then my last question is on the [autoSV]market. What do you think there? Is that, what kind of the trend right now?

John Miclot

That's product actually made a healthy contribution to ourresults in the quarter. We still view it as a relatively small patientpopulation, but certainly given the reimbursement structures and the sellingprice of the device in an important segment, we are very pleased with thecompetitive nature of our product. Its being very, very well received and I cantell you that it made a meaningful contribution in the quarter.

Vincent Ritchie -Wachovia

Great. Thanks for taking my question.

John Miclot

My pleasure.

Operator

Thank you. Our next question comes from the line of JasonRogers with the Great Lakes Review. Please go ahead.

Jason Rogers - Great Lakes Review

Good morning.

John Miclot

Good morning.

Jason Rogers - Great Lakes Review

I wanted to ask about the -- there is been a lot of pressmainly in the asthma area. I am wondering if there is any new developments toreport there in relation to your AAD systems?

John Miclot

I can tell that there are some certainly new guidelines beendiscussed that would enhance the monitoring and use of our products that aremore on the nebulizer side, spacer and peak flowmeter sides. All are intendedto try to be more diligent at predicting acute exacerbations and that’s whereyou run into very, very significant dollars with these types of patients. Themajority of the drugs that we are looking at for utilization with our AdaptiveAerosol Delivery technologies tend to be directed at other types of disease spaceother than asthma. So I don't think it has a direct impact on that part of ourbusiness but certainly is positive for our monitoring segments.

Jason Rogers - Great Lakes Review

Thank you.

Operator

Thank you. Our next question will come from the line of MattMiksic with Morgan Stanley. Please go ahead.

Vic Chopra - MorganStanley

Hi this is [Vic Chopra] calling for Matt Miksic.

John Miclot

Hi.

Vic Chopra - MorganStanley

I apologize if anybody asked because I have dialing in alittle bit later. So, I guess, first question is, what are you expecting theoverall sleep market to grow in terms of price and mix, still in the 15% to 20%range?

And secondly in terms of the recent Apollo Light Systemsacquisition, just wondering what the target market for that is and when do youexpect as to contribute meaningful, say about a run rate of $10 million ormore?

John Miclot

In terms of the overall sleep market we are very confidentand bullish in terms of the health of the segment and have talked about 15% to20% growth. In terms of Apollo its sort of a unique technology and the majorityof their current sales has have happened in the retail space, which we view asa nice edge on to expanding our channels and learning more about that. We thinkthat we can provide through our existing sleep sales organization anopportunity into the sleepless space and more of the clinical environment andthat’s what we believe the two are very complimentary in terms of being able tobroaden the scope of the opportunity there. In terms of contribution I'll turnthat to Dan.

Dan Bevevino

Yeah the Apollo is a relatively small company. Right nowtheir sales in the neighborhood of 5 million, so it kind of gives you a feelfor the scale of it as we start to integrate them.

Vic Chopra - MorganStanley

Okay. And just one last quick question in terms ofacquisitions going forward we can

We expect more technology bolt-ons, or larger platformacquisitions?

John Miclot

I would say that, as we look at the spaces, you wouldprobably see us continue to do the types of acquisitions that we have donehistorically, both in terms of technology, licensing agreements, equityinvestments and international distribution acquisitions.

Vic Chopra - MorganStanley

Okay. Great. Thank you.

John Miclot

We will take one more question.

Operator

Thank you. The final question will come from the line JoshuaZable with Natexis. Please go ahead.

Joshua Zable -Natexis

Hey, guys. Sorry, I didn’t mean to, I hope I didn’t cutanyone else up here, just wanted to ask about the ventilator market. I know youkind of eluded to that in general and then timing of the new products and then,I guess along with that, obviously Viasys is one of your larger competitors,which recently acquired generally in acquisition, there is some integrationtime, have you guys maybe able to take advantage of it? And specifically onthat, sort of [pulmonetics] line, if there was anything you guys can come outwith to kind of take advantage there, that’s probably their area of strength.It’s a lot of questions in one.

John Miclot

I am used to that with you, Josh. It’s not a problem. Hey, Iguess, I would start with on non-invasive ventilation, that is our primarycompetitive advantage and that’s where we see the majority of the opportunityfor continued expansion in our ventilation portfolio. We are investing veryheavily in next generation non-invasive and combined non-invasive and invasivetechnologies, again primarily driven at trying to avoid the in incubation of apatient or if the patient’s already on an in invasive ventilator trying to getthem off as quickly as possible by bridging with non-invasive ventilation.

The type of market that pulmonetics is going after is a homeinvasive segment. It is still a segment of interest, but I would say ourprimary R&D efforts are really directed more around continued expansion innon-invasive ventilation.

Joshua Zable -Natexis

Great. Thanks very much guys.

John Miclot

Have a great day. Thank you very much, everybody. Weappreciate it.

Operator

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