Aspect Medical Systems, Inc. Q1 2008 Earnings Call Transcript

Apr.20.08 | About: Aspect Medical (ASPM)

Aspect Medical Systems, Inc. (ASPM) Q1 2008 Earnings Call April 17, 2008 10:00 AM ET

Executives

Brian Gately-Financial Relations Board

Nassib G. Chamoun-President and Chief Executive Officer

Michael Falvey-Chief Financial Officer

William Floyd-Vice President Worldwide Sales and Marketing

Scott Kelley M.D.-Vice President and Medical Director

Analysts

Eli Kammerman-Cowen & Co.

Tao Levy-Deutsche Bank

Isaac Ro-Leerink Swann

Jonathan Block-SunTrust Robinson Humphrey

Joshua Zable-Natexis Bleichroeder

Operator

Welcome to the Aspect Medical Systems First Quarter 2008 Earnings Conference Call. (Operator Instructions) I would now like to turn the conference over to Brian Gately of the Financial Relations Board.

Thank you. I’d like to thank everyone for joining us today. Earlier in the day we sent a press release outlining the results for the first quarter. If anyone has not received the release, please call the financial relations board at 312-266-7800 and my assistant will send you another copy. Before we begin the call, we’d like to remind the participants that certain statements in this conference call are forward-looking statements within the meaning of the Private Securities Litigation Reform Act.

These forward-looking statements include statements concerning the expected value and benefits of BIS monitoring our plans to initiate new studies and execute on key business strategies in 2008. Our expectations regarding the effect of the New England Journal of Medicine article on our business and our guidance regarding second quarter results and other projections we will make today, April 17, 2008.

These statements involve risks and uncertainties. Among the factors that could cause actual events to differ materially from these forward-looking statements in this conference call, are those set forward under the heading "Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2007 as filed with the Securities and Exchange Commission.

In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date.

While we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our views change; therefore, you should not rely on these forward-looking statements as representative of our views as of any date subsequent to today. During this call we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles.

Reconciliation of non-GAAP financial measures to the most directly comparable GAAP measures are available in the investor relations section of our web site www.aspectmedical.com under the heading “non-GAAP financial measures”.

With that said, I’d like to introduce Aspect’s president and Chief Executive Officer, Nassib Chamoun. Mr. Nassib will begin the call by presenting an overview of the first quarter of 2008 and the call will later be opened to your questions. Nassib, you may go ahead.

Nassib Chamoun

Good morning and welcome. Joining me this morning are Michael Falvey our CFO, William Floyd or VP of Worldwide Sales and Marketing, and Scott Kelley our Vice President and Medical Director. I will begin the call by reviewing the high lights of the quarter. Mike will provide some additional financial details and provide our outlook for Q2; I will then discuss our plans and strategy for the balance of 2008 before taking your questions.

Overall, we are pleased with the quarter. Compared with the first quarter of 2007, Worldwide sensor revenue increased 18%, US sensor revenue increased by 13%, International sensor revenue increased by 36% and the Worldwide installed base of BIS sockets increased to almost 50,000 units, an increase of 19%; these results continue to reflect the positive impact of the shift in strategy of our field organization and the value of our clinical education and training programs.

We continue to perform well against competition and to date the impact of the recent New England Journal article on our sales has been minimal. In the five weeks since the publication we have had an opportunity to communicate with many of our customers, and most have said that the article will not change the way they use BIS monitoring.

A small number of prospective customers in the US have delayed the start of planned new evaluations of our device to allow their staff members to evaluate the New England Journal publication and for us to answer their questions, but we are confident that most of these hospitals will ultimately elect to go ahead and the evaluations will commence later this quarter.

Several of these deals are already back on track, after clinicians’ had the opportunity to review and discuss the article. Most important, many of our customers have reaffirmed their belief in the value of BIS monitoring and have stated that “one study, particularly one that many believe is so flawed, will not change the way they use BIS monitoring”.

These customers tell us that they use BISs system to achieve a variety of clinical goals: to reduce the incidence of intraoperative awareness, to be sure, but also to minimize excessive exposure to anesthetics, to improve the quality of patients recovery and even to create efficiencies such as reductions in anesthetic drug usage; simply stated, BISs system to personalize the care of their patients and to make choices consistent with modern anesthesia care to optimize the quality, the efficiency, and the safety of the care they provide their patients.

Since our conference call last month, following the New England Journal publication, we have submitted a formal response to the journal detailing our concerns about the design of the Avidan study, the incorrect statistical assumptions resulting in an underpowered study and the author’s inappropriate interpretation of the limited data reported.

We expect to post our response publicly after the journal decides whether publication in the journal is warranted, and we continue to hear from anesthesiologists from around the world who share many of our views about this study and have independently submitted responses to the Journal.

As many of you know the ASA has provided initial funding for two additional studies to further examine the role of brain monitoring to reduce the incidence of awareness. Most of the funded investigations have selected the BIS technology. We look forward to seeing the results of these studies, and to date there have been three major studies of the value of BIS monitoring to assist anesthesia professionals to reduce the incidence of awareness, two of which have involved high-risk patients.

These studies have included almost 10,000 patients and each has shown that BIS monitoring contributes to a reduction in the incidence of awareness of approximately 80% from the rate expected. These studies also suggest, particularly the study, that when awareness did occur among the patients who are BIS monitored, the events happened early in the case, shortly after intubation and at a time when BIS values were relatively high or not available for viewing by the clinician.

In those cases of awareness, in the BIS guided group in the Avidan study, unexplained gaps in BIS trends also suggest that inadequate training and vigilance may have been contributing factors.

Given the results from the three prior studies, as well as our own experience with more than 25 million patients, we are confident that future studies of BIS monitoring and awareness are likely to reproduce the basic findings of the earlier studies that BIS monitoring contributes to a substantial reduction in anesthesia awareness compared to true standard clinical practice; having said that, we also hope that these studies avoid the failings of the Avidan study: first, the studies need to be properly designed and adequately powered, especially when active, alternate interventions are being compared to BIS; second, participating anesthesia professionals need to be vigilant and adequately trained to ensure appropriate use of BIS and reasonable compliance with what ever protocols are studied; and third, given growing concerns about excessive exposure to volatile anesthetics.

To the extent these studies attempt to compare BIS with a formalistic dosing protocol, such as the one used in the Avidan study, the investigators need to examine the possible adverse affects of such protocols on patient outcomes.

Before turning the call over to Mike, I’d like to make one further comment about the breadth and depth of research that supports the use of BIS monitoring. As of February 2008, merely 40 randomized, controlled trials have been published, which have measured the clinical outcomes from anesthesia care utilizing BIS or other anesthetic effect monitoring devices compared with routine anesthesia care; moreover, the rate of growth in Aspect’s Worldwide installed base of BIS monitors and modules over the last ten years, more than 30% per year is exceeded only by the rate of growth and the cumulative number of published articles and abstracts that reference BIS monitoring over the same period; there are now more than 3,100 of these publications.

This extensive bibliography is the result of Aspect’s commitment to research and scientific collaborations with many of the leading anesthesia investigators from around the world. That legacy continues with numerous ongoing BIS studies in a variety of areas.

In past conference calls we have highlighted a number of these initiatives including long-term outcome studies at the Cleveland Clinic focusing on patients undergoing vascular or cancer surgery, a post-operative inflammatory response study in an elderly orthopedic surgery population at Emery University, ICU sedation outcome studies at Duke and Vanderbilt University and a multi-center pediatric awareness incidence study.

We are also supporting investigations examining the impact of anesthetic factors on post-operative delirium and cognitive dysfunction, as well as a comprehensive statistical analysis of Medicare Med Fars outcome files from 2001 to 2005 to identify anesthetic risk factors for post surgical mortality. We expect that a number of these studies will either be presented scientific meetings or published in the coming year, and we anticipate communicating these to you when they appear.

Looking ahead, in the coming months we anticipate initiating at least two multi-center initiatives: one in the depression area, which I will describe later and the second, a series of studies to further validate the relationship between our new composites variability index CVI and patient responses to painful stimuli during surgery. These studies will be commencing shortly and should be completed later in the year.

The point I want to emphasize in mentioning all of these studies is that Aspect and many of the leading experts in the field recognize that the value of BIS monitoring is broad based and extends well beyond the issue of awareness.

Knowledgeable clinicians view the Avidan study in the context of this compelling body of evidence and although, like many of you, we were surprised that the New England Journal chose to publish this study, we believe and continue to grow in confidence that a single under powered study whose conclusions are nor supported by the data is unlikely to have a significant impact on how our customers view and use our product.

With that, I’d like to ask Mike to review the financial results for the quarter in more detail.

Michael Falvey

Q1 was a solid quarter. We are the high end of our guidance range for product revenue within the range of our GAAP earning per share guidance and exceeded our guidance for non-GAAP earning per share.

Our product revenue grew 9% to over $24 million, reflecting the continuing shift in our strategy to develop stronger utilization of our BIS technology with in our substantial customer base. Worldwide sensor revenue of $21 million grew at an 18% rate over Q1 of 2007. US sensor revenue of $16 million grew at a 13% rate over last year.

US sensor pricing remains strong with average selling prices staying at about the same level as the prior quarter and the prior year. International sensor revenue of $5 million has grown even faster. Compared to Q1 of 2007 international sensor revenue grew at a rate of 36%. International sensor pricing was slightly higher than last quarter and about even with Q1 of last year.

As expected, worldwide hardware revenue of $4 million declined 22% from the first quarter of 2007 as we continued our shift in emphasis from acquiring new customers top rounding our operating room penetration in existing customers.

Monitor revenue of just over $2 million declined 278% from last year. Monitor unit sales of 718 declined by 25% with a 66% decline in the US, but a 25% increase internationally. After an unusually light fourth quarter, international monitor revenues were strong, growing 36% over the prior year. After several years of reducing monitor prices to make our technology more available, our monitor pricing in the United States has stabilized, with average selling prices close to $3.500, which is slightly more than last year and last quarter.

OEM module shipments were strong in the quarter with shipments of over 1,500 units, a 6% increase over last year. Module revenue was just under $1 million a 12% decline from Q1 2007. Included in this quarters unit shipments are over 200 no charge units that we provided to two different OEM partners as part of special programs designed to promote sensor utilization.

We shipped approximately 2,300 monitor and module units during the quarter, with our OEM partners accounting for over 68% of new units sold. Our partners continue to be an important component of our strategy to make our technology available and to meet our customer’s need for integrated solutions.

As of Q1 of 2008 we estimate that Aspect’s worldwide installed base of monitors and OEM modules exceeds 49,000 units, including more than 28,500 in the US and more than 20,500 in the rest of the world: this represents a worldwide increase of 19% from the end of Q1 2007.

With a 9% year-over-year gain in product revenue, total revenue was 1% more than the first quarter of 2007, reflecting the elimination of alliance revenue following the discontinuance of our partnership with Boston Scientific in the second quarter of last year.

Turning to manufacturing margins and operating expenses: we did option to pass 123-R; we now report the full impact of share-based compensation expense in our income statement. To assist in comparison to prior year results and to provide additional information to investors, we also provide non-GAAP results, which excludes share-based compensation.

A full reconciliation of GAAP to non-GAAP results is available on our earnings release and on our web site. In total, share-based compensation added approximately $100,000 to our cost of revenue and $1.8 million for our operating expenses in the quarter. The discussion that follows excludes the impact of share-based expenses.

On a year-over-year basis with product revenue growing at 9% we were able to create modest gains in operating leverage with product margins improving slightly and operating expenses increasing my only 3%. In the first quarter of 2j008, non-GAAP gross product margin was 73.9% compared to 73.6% in Q1 of 2007 and 75.8% in Q4 of 2007.

Gross product margins declined nearly 2 points from Q4 levels, principally because of strong growth in international monitors, which carry a lower gross margin, and because of the three OEM module units I spoke of earlier. Compared to Q1 of 2007 the slight improvement in product margin is due to a favorable change in the mix of hardware and sensor revenue partially off set by some quarterly manufacturing variances.

Operating expenses increased 3% from last year with higher growth in G&A off set by lower spending on our recently completed BRITE trial which was in full swing in Q1 of 2007. We expect to maintain spending growth in the mid to high single digit range with most of the growth coming in sales and marketing. Earlier this quarter we instituted a retention program for our sales team and we are considering an expansion of our field sales force.

In total, GAAP pre-tax earnings of $189,000 and non-GAAP pre-tax earnings of $2.1 million in Q1 of 2008 were down from the prior year because of the loss of alliance revenue and interest expense on our convertible debt, partially off set by a moderate expansion of our product operating margin. The after tax GAAP loss was $235,000 or $0.01 per share, while we posted non-GAAP after tax earnings of $1.1 million or $0.06 per share.

A note on taxes: as we mentioned in prior quarters, our GAAP effective rate is higher than the non-GAAP rate because of the treatment of incentive stock options or ISOs. In addition, in this quarter we had a one-time charge of $275,000 to record evaluation allowance against R&D credits that are likely to expire unused over the next three years. We expect that the full year GAAP effective rate will be between 50 and 100% and the non-GAAP effective rate will be between 35 and 40%. We expect to make only small alternative minimum tax payments over the next several years.

Finally, the company ended Q1 2008 with cash, cash equivalents and marketable securities of $111 million in debt of $125 million, and during the quarter we generated $1.8 million from operating activities.

Our guidance for Q2 is as follows: we expect total revenue and product revenue to be with in a range of 20.4 to $25.4 million, and after tax earnings per share to range between a loss of $0.03 and a loss of $0.01 on a GAAP basis, and after tax earnings per fully diluted share to range between earnings of $0.03 to $0.05 on a non-GAAP basis after excluding the impact of equity based compensation.

Our guidance for Q2 product revenue corresponds to product revenue growth in the 6 to 10% range and reflects sensor growth in the range that we have seen in recent quarters and a smaller rate of decline in hardware revenue as the prior year comparables become less challenging. This revenue guidance also reflects our observation that US sensor revenue growth rates in the weeks since publication of the New England Journal of Medicine study have stayed within the range that we have seen in prior quarters.

On the spending side we expect growth rates that are a little bit higher than what we saw in Q1 due to the sales force retention program put in place a few weeks ago and slight increases in other areas of sales and marketing and R&D.

I will now turn the call back to Nassib.

Nassib Chamoun

Thank you, Mike. For the balance of 2008 the key elements of Aspect’s strategy are as follows: near term our principle goal is to capture as much of the substantial untapped opportunity in the OR market in as cost effective a manner as possible. We are very pleased with our customers response to the various steps we have taken to enhance the clinical education programs we are offering our customers including increased use of peer to peer coaching in the OR and institution wide training, and these programs will remain center pieces of our US sales strategy in 2008. We also plan to maintain a dedicated, integrated delivery network sales group to build on last year’s success.

In the product area our near and mid-term strategy will be to bring enhancements and new products to the market that reflect ways in which anesthesia practices are evolving and changing, and that will give our substantial installed customer base new reasons for using our technology.

The first new product we expect to bring online is our bilateral monitoring system and the next will be our composite variability measure of BIS and EMG, known as CVI. We also expect to initiate an expanded effort this year to demonstrate how our technology can be used by proponents of intravenous anesthesia and integrated with closed loop anesthesia systems that ere beginning to emerge in Europe.

One of the important trends occurring in anesthesia is a growing interest in intravenous anesthesia and concern about the adverse effects of inhaled anesthetics, and Aspect’s product strategy has and will continue to evolve accordingly. Over the past nine years Aspect has collaborated with several investigators in Europe in the development of innovative open and closed loop anesthesia systems and we expect that this effort will have greater visibility in 2008 and beyond.

Earlier in the call I summarized our various clinical research initiatives that are on going and these, of course, will remain a priority for the year. One of the advantages of our continuing commitment to support global clinical research is that it allows Aspect to remain closely engaged with anesthesia’s academic researchers and thought leaders. We also believe that this gives us an opportunity to work with professional societies around the world to consider the appropriate use of brain monitoring as part of their guidelines.

On the neuroscience front, in December Aspect announced the positive results of the BRITE study. Not only did Aspect’s bio marker ATR emerge as a reliable predictor of both response and remission to antidepressant therapy, the BRITE study also suggested that ATR guided treatment may lead to better patient outcomes, particularly for patients who are identified as unlikely to respond to the first line medication and can be promptly moved to more efficacious regiment.

Abstracts summarizing detailed results of the BRITE trial have been accepted for presentation at three major scientific conferences in Q2 ’08, including The Society of Biological Psychiatry and American Psychiatric Association annual meetings in Washington D.C., followed by the 2008 NCDO meeting, which is co-sponsored by the National Institutes of Mental Health and the American Society of Clinical Psychopharmacology.

The positive data from the BRITE trial has also enabled us to begin modeling the potential economic benefits of the APR biomarker for payers and employers, and these preliminary analyses are being presented in an abstract at the NCDO conference as well as the May 2008 annual meeting of the International Society for pharmacoeconomics and Outcomes Research in Toronto.

Following up on the successful completion of the BRITE trial, the primary focus of our neuroscience effort in 2008 is the initiation and execution of a pivotal study to prospectively validate our ATR biomarker as a predictor of antidepressant treatment response. The pivotal trial, which we intend to initiate midyear, is named RAPID, which stands for rapid assessment for prediction of improvement in depression and is being designed with input from our investigators and feedback from meetings and communications with the FDA.

If successful we believe the RAPID trial will lead to a regulatory filing in 2009. The need for response predictors is even more obvious when considering the costly and invasive treatments that are currently in development such as implantable neurostimulation for treatment resistant depress. We believe our platform biomarker technology may prove to be valuable in the optimization of neurostimulation treatment for neuropsychiatric conditions and are exploring a number of research avenues in 2008.

Aspect will also continue to follow patients in two major longitudinal trials to evaluate our EEG based measure of cognitive function. Nearly 400 subjects are now enrolled in the Cape Cod Memory study in which normal, elderly subjects are given EEG and cognitive tests very three months to investigate EEG correlates of function and predictors of future cognitive decline. We also continue to collect data from our Mild Cognitive Impairment study.

Before opening the call to your questions I want to leave you with a clear understanding about how we see the market for our core technology evolving and how we believe our strategy will help us to capture the considerable untapped potential. By focusing on our best and our largest existing hospital customers and our champions within those hospitals, we believe we have the best chance of influencing those clinicians who have not yet incorporated BIS as a routine component of their practice.

Those who best understand the technology, who have grown to appreciate this clinical value and are recognized for the quality of the care they deliver, are our most important advocates. We believe this, in turn, is the most efficient and effective way for Aspect to promote the growth of sensor utilization. I will also add that this strategy has helped us immeasurably in dealing with the initial fallouts from the New England Journal publication.

The relationship our reps have with our existing customers allowed them to reach out very quickly and efficiently to ensure that our customers were aware of exactly what the Avidan study was and what it was not. By continuing to collaborate with the most prominent clinical investigators, academics, and thought leaders around the world, and by investing significantly in clinical education, we believe that clinicians everywhere are more likely to pay attention, to understand and to appreciate the clinical value of using BIS to titrate anesthetics. We expect that this will also lead to greater utilization.

Three, by developing products that evolve with changes effecting the practice of anesthesia, such as the growing interest in intravenous anesthesia and concerns about excessive exposure to volatile anesthetics or which augment current practices such as assisting clinicians to manage interoperative pain, we believe that existing customers will broaden their use of our technology and that potential customers will have new reason to consider using BIS for the first time; and fourth, by continuing to invest in clinical trials that demonstrate the patients safety and outcome benefits of customizing anesthesia for each patient and avoiding the adverse effects of too little or too much, we believe that anesthesia professionals will be increasingly drawn to our technology.

With that, I’d like to open the call to your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Eli Kammerman with Cowen.

Eli Kammerman-Cowen & Co.

Hello. First question is the percent of total sales derived from sensors seem to hit a new high on a historical basis, or close to it, but yet the gross margin didn’t expand that much compared to the year ago period. How do you explain that the gross margin wasn’t more on par with where it was in the second half of ’07 rather than the first half of ’07?

Michael Falvey

This is Mike. If you looked at the last, probably six quarters, as part of the shift in strategy of really focusing on existing customers in the US the trends you point to have definitely occurred, in terms of, an increasingly richer mixture of our total revenue is coming from those high margin sensor sales and so what we’ve seen over the last six quarters is a pretty nice increase in our, what we refer to as our product gross margin, so excluding the alliance revenue.

Depending on which point of comparison you want to use, last quarter or the same quarter of last year, and I think both are relevant, there is a couple of things that you need to consider; compared to last quarter, we’ve had about the same mixture of hardware to sensors except for two pretty important components: one is, as I pointed out Q4 was an unusually low quarter for international monitor units and that rebounded very nicely in Q1.

We telegraphed on the last call that we thought that was just a temporary aberration last quarter internationally, so it’s good to see that trend return, but those units do tend to be lower margin and that took about somewhere between ½ and 1 point off of our margin in total, and the second factor to consider is the fact that, as I mentioned in my remarks, we shipped a little over 200 units to two different OEM partners at no charge and these were as part of some programs that we’ve put in place with those partners ─ we do do that from time to time; it was a little unusually strong in this quarter, but we think it’s going to set us up nicely for future sensor growth.

Eli Kammerman-Cowen & Co.

Were those 200 units’ monitors or modules?

Michael Falvey

Those are modules.

Eli Kammerman-Cowen & Co.

Okay, thanks for that and next…

Michael Falvey

Compared to last year, the explanation is a little bit different. We do have a very strong product mix, but we did have a couple of flips in some quarterly manufacturing margins that took the overall increase down a little bit, but we did still show an increase versus last year.

Eli Kammerman-Cowen & Co.

Okay, my next question is I thought we’d see more of a pricing increase in US sensor pricing. Did you all implement a pricing increase at all or are we seeing the effects of discounting and that’s the reason it was flat year-over-year, what happened with that?

Michael Falvey

We did do a pretty considerable price increase, two fourth quarters ago, last fourth quarter we were much more selective in our price increases, so we’ve been expecting plus or minus 1% on the USASP and we were pretty much flat. As we look ahead for this year I would stick with a, probably flat pricing may be down a little bit and with this focus on getting our existing customers to utilize more, the only down side is that they both start to qualify for volume breaks and that might push pricing down a little bit, but it has the benefits of bringing much higher utilization, which drive our total revenue up and it’s still at a very, very attractive margin.

Eli Kammerman-Cowen & Co.

All right, then I’ll wrap it up with this question: do you expect to see R&D spending go up by 10% or more this year because of the initiation of this new depression trial?

Michael Falvey

If you look at our results for this quarter, we had a very small increase in R&D spending: we do expect that’s going to pick up a little bit in the second half for the two trials the Nassib referred to, the final trail in the neuro program and also our CBI trial, but I don’t think it’s going to be that big an increase, it should still be in the mid to high single digits.

Eli Kammerman-Cowen & Co.

Okay, thanks very much.

Operator

We’ll take our next question from Tao Levy at Deutsche Bank.

Tao Levy-Deutsche Bank

Good morning.

Michael Falvey

Good morning, Tao.

Tao Levy-Deutsche Bank

First, is there any way you can quantify, Nassib I think earlier on you said there is a minimal impact from the New England Journal of Medicine, maybe just a bit little more on what you’ve seen over the last couple weeks, specifically in terms of trends or questions: not necessarily from prospective customers, but from your current string of users.

Michael Falvey

This is Mike. Quantitatively, and I’ll turn it over to Bill to give you more of the color behind it, we haven’t seen much of an impact at all, it’s a very short period, five weeks and we look at our sensor volumes daily, weekly, monthly; and if you look at the weekly volumes, they’ve been right in the range that we’ve seen over the last two to three quarters, so typically it will fall within a range of 10% to 15% growth; the average for the last couple of quarters has been around 13, 14% and we’re not seeing anything funny in the daily patterns either. So, it may be too early to tell, but from what we’ve seen so far, we’re not seeing an impact in our sensor sales.

William Floyd

The only accounts we’ve had, out of our 2,500 accounts we had two that actually were on auto ship, lowered their auto ships, but that can easily come back. We talked about the delay of some of the accounts, as they are looking at expanding; there are about 20 accounts that were delayed for a couple of weeks, but the majority of these are back on track and we expect that these are going to go through this quarter; so the first couple of weeks it was a little crazy, but other than that, we’ve seen it’s business as usual now.

Tao Levy-Deutsche Bank

So with that backdrop is there any way to try to quantify or give us some granularity into your second quarter sensor revenue growth both in the US and OUS, and on that, any differences in the views on the Avidan paper from the US and international customers?

Michael Falvey

Yes, as I mentioned and giving a little bit of color behind the guidance for Q2, the expectation is that sensor growth will remain, in the US, about where we’ve seen it: so, we are not expecting any kind of decline based on what we’ve seen so far.

Internationally we haven’t seen any impact from the New England Journal in either our hardware or our sensor sales; in fact, the growth there has exceeded even our own internal expectations. As I mentioned in my comments, international sensor growth in the quarter was 35%, if it dropped a little from that, we would still be very happy with that kind of performance, and I’ll let Nassib talk a little bit about the thought leader response internationally.

William Floyd

Yes, let me add a couple comments and then I’ll pass it over to Scott or Nassib. Our international team really has not seen any impact; they use it mostly for titration, so they look at this study. The number on question we get is how did this study get published, but they’ve seen really very, very little impact internationally.

In the US, really our clinicians have, again, questions about how this got published, but they quickly see through the ─ it was empowered, they see data’s missing and they just don’t draw those same conclusions; so once we have that discussion and once we have had a chance ─ it clearly comes in that it’s not going to change their habits. Scott, you’ve been out in the field too?

Scott Kelley M.D.

Yes and what’s really interesting is this single article has become, I think, the number one journal club article in anesthesia departments around the world, because it gives a great example of exploring study design. As Bill indicated, the whole issue of ─ it was an underpowered study, and to really highlight that with clinicians so that they understand that although the author believes it’s a negative study, he really couldn’t make that conclusion.

More importantly, our customers indentify that the clinicians in the Avidan study really weren’t using the technology appropriately or applying the expected degrees of clinical diligence, and finally, we’re all aware of the consequences and flexibility of this formulistic dosing approach, it doesn’t work in clinical anesthesia; so people need choice, they need flexibility and that’s why they turn to our technology.

Tao Levy-Deutsche Bank

Okay. My last question is Mike, could you break out the foreign currency benefit that you saw in the quarter and is that part of the reason why international might have been so strong? In addition, you had made a comment regarding retention of the sales force; could you just go into a little more details as to what that’s all about, the background behind that et cetera?

Michael Falvey

Sure, Tao. As we’ve talked in the past, we do not have a very large foreign currency impact on either our expenses or our revenue and the piece that is exposed from a revenue side almost exactly offsets on the expense side; so we’ve got a pretty natural hedge there.

We price most of our international business in dollars, because we’re selling through our major OEM partners and many of our non-European customers price in dollars as well; so, we may getting a little bit of a lift from the strengthening euro over the last three or four years in the revenue number, but I don’t think it’s that discernable.

On the retention piece, you know these are not atypical situations: we have a field whose highly trained, it’s well tenured, highly successful, and the first two weeks, I’ll tell you, it was pretty crazy, it was a feeding frenzy with recruiters calling up saying “is Aspect going out of business?”, “you need to look at other positions”; so we basically put this in as a preventive measure and I’ll tell you that we’ve not lost anyone to the New England Journal.

Our field is very focused and as Scott said, we’re using this study as we go in and talk to clinicians, because it allows us to really discuss the awareness challenges and it’s been very helpful for us.

Tao Levy-Deutsche Bank

Great. Thank you very much for answering all the questions.

Michael Falvey

Sure.

Operator

Our next question will come from Isaac Ro with Leerink Swann.

Isaac Ro-Leerink Swann

Hi. My first question would be just a little bit more detail on the OEM program. I’m just wondering, would these 200 systems that we’re sort of giving away here, and when was that program kind of conceived and put into place? In addition, do you expect to continue doing things like that for other partners later this year and just some more details around those items?

Michael Falvey

I think both of the programs that I mentioned have been kind of in the works probably since the middle of the fourth quarter and each program is a little bit different. It takes some planning, but usually what we’ll do is in return for the OEM agreeing to place those modules, at either significant discounts or in some cases even free, we agreed that we’ll lower our price to them. As I mentioned, we do this from time to time.

I think this is the first quarter where we had two of these come through and it actually became visible in the results and as far as the second part of the question, would we consider it going forward, absolutely. If the overall program makes sense for us, it makes sense for our partner. We try to be flexible and help meet customer needs.

Nassib Chamoun

We will try to be strategic with these. It’s a program that’s always available to work with our partners and give them access to certain accounts that are important to them, or to allow them to give us access to certain accounts that are important to us. As Mike said, we do them almost every quarter, but this quarter a couple of big ones.

Michael Falvey

I should add that the pricing on the modules is already extraordinarily low. We sell these to some partners almost at cost. We tried to leave as much of that hardware margin in place for our EOMs to make it attractive to them to help us place these units. We really focus our economics, then, on the sensor utilization, and really working with customers on education and promotion and really get them to use the technology thoroughly.

Isaac Ro-Leerink Swann

Okay. As a follow up, when you talk about margins on the modules, is the module product area as a whole, is that gross margin positive at this point?

Michael Falvey

Yes, but it’s the slimmest margin that we have of any of our products.

Isaac Ro-Leerink Swann

Okay. Then, what kind of goals do you guys set for sensor growth in the accounts where you’re kind of providing free modules?

William Floyd

I’m not going to go into any type of detail, but just to say we do strategically what makes a lot of sense for us to ─ you know these are large accounts looking to commit to bids and

Michael Falvey

In some cases they are countries; so we may make a deal with an OEM for a particular country if they’ll agree to a three or four quarter promotion program; so it can be large individual customers or entire regions.

Isaac Ro-Leerink Swann

Okay and then, just turning back to domestic; have you guys seen any impact from the current credit environment as it relates to hospital spending, and how do you feel about pricing specifically for monitors going forward for the rest of the year? Do you feel like budgets are maybe being a little tighter here, or is there any reason to think there might be an issue here as it relates to timing of capital spending?

Michael Falvey

You know I think we would see that kind of an affect in two areas, one is in our collections activities and our account receivable balances, and you’ll notice that our accounts receivable did pick up a little bit, we’re not too concerned. There is a little slower paying activity in the 0 to 60 category, so you don’t worry about that too much until it starts to work its way out.

I think as you start to head into a recession, we start to be a little bit more careful in terms of credit we extend, and sort of putting the right pressure on to make sure the payments come in. We are in a very fortunate situation given that we have a recurring revenue stream that we can work with customers in terms of the new orders they place in order to make sure they stay reasonably current on old units.

The other place that we would see it would be on the pricing activity. I think that we expect the US hardware pricing should stay with in the range that we’ve seen it. I’ll turn it over to Bill as to, in terms of, has he seen any increased price sensitivity?

William Floyd

No, we really haven’t. Don’t forget, we did a shift in sales strategy to focus on existing customers. Our customer footprint continues to expand, but it’s really with our OEM partners and it’s just, we’re really less sensitive to those capital markets, so we really have not seen an impact from that.

Isaac Ro-Leerink Swann

Okay, would that have to do with the relative ASC of a BIS monitor versus like an MRI system, is just sort of fly’s lower on the radar?

Michael Falvey

Yes, this is only going to hit the capital budget if they start to be multi-unit deals, and it is relatively inexpensive, and as, I think the last question pointed out, a large part of, almost 85% of our revenue is now coming from those recurring sensors.

Isaac Ro-Leerink Swann

Okay great. Last question here would be on, you mentioned, I think, briefly potentially looking at an expansion of your field sales force; roughly where was the headcount at the end of the first quarter, maybe versus a year ago and where do you think it’ll be by the year end?

William Floyd

We ended, roughly, in the 70 range. Again, our shift in sales strategy has been working. We’ve been focusing on existing accounts with training and education; the strategy is working, you know peer to peer education, institutional training; so this model is working and so we’re doing an analysis to see about expanding this and trying to scale it; so we’ll give you more color on that in the next quarter.

Nassib Chamoun

Isaac, just at a strategic level, the one thing that the New England Journal article has allowed us to do is, to some extent stress test the opportunity, our customers commitment, and really the potential to expand this business.

We’re very, very pleased with how the customers have responded. How opinion leaders have responded. How the model has worked for us, and in terms of the impact this article has had on us, which is fairly insignificant at this point, there are a few isolated situations that we’re dealing with; but at the end, we see a model that’s working and that’s giving us some leverage.

We see an opportunity to build on that and potentially accelerate growth; we’re trying to understand the pros and cons of doing that and once we have something of substance, we’ll put it forward. But, like I said, what looked so ominous a few weeks ago ended up being a terrific opportunity to understand the strength in our business and the potential ahead.

Isaac Ro-Leerink Swann

Thanks very much.

Operator

We’ll take our next question from Jonathan Block at SunTrust Robinson Humphrey.

Jonathan Block-SunTrust Robinson Humphrey

Hey you guys good morning. Mike, my first question is maybe for you. I think you mentioned the 200 modules on the international side that were shipped to some of the OEM guys, but anything that we should view on the international monitor side that you would deem one time, because that number seemed very strong as well.

Michael Falvey

It was very strong. I think it was probably a reversion to trends though. If you look at the trend in international monitors we’re usually selling 400 to 500 of those a quarter, and Q4 is usually a strong quarter for us and it dipped down a bit; but I think what happened is, it was just, as we’ve mentioned in the past when we talk about why we give ranges on the revenue guidance, it’s sometimes difficult to predict exactly when these hardware orders are going to land.

So, I think what happened is we had a little bit lower than normal Q4 and it kind of reverted to trends and maybe a little bit better than trend in Q1. Going forward we hope to see the trend continue, that we’ve seen this quarter and once in awhile we’ll have a quarter like we did last Q4, but hopefully it will be a little bit stronger going forward.

In terms of the modules, we typically look at global module sales and because the geographic break out of that nearly reflects where the OEM partner takes delivery of those modules and then they can go any where in the world from there. That’s why it’s a little easier to focus on installed base, to see the impact of those final shipments; so those free units are actually sprinkled between domestic and international and the end user customers are sprinkled between domestic and international.

Jonathan Block-SunTrust Robinson Humphrey

Okay, got it, understood. Just one other, sort of nit picky one, on the international side: on the sensor ASP, I think that happens in 1Q, because it just seems that it’s the only quarter where the realized ASP is the strongest, it jumps just north of nine and then seems to trickle down. Is there any thing from ordering patterns where we get a little bit of an artificial lift in 1Q?

Michael Falvey

No. As you point out, it’s an ASP phenomena and I think you pointed this out last Q1. You’ve got good eagle eyes there. It’s purely a mix of country that’s driving that and that mix seems to flip every Q1 and be a little bit higher than it is in the other quarters; so, there’s nothing artificial going on there.

Jonathan Block-SunTrust Robinson Humphrey

Okay great. More importantly, you mentioned, I believe it was two other studies being sponsored by the ASA and do you have any details there? I mean, we all hope that it’s more thorough and a greater end that’s associated with these studies, but do you have any color? Are they just targeting awareness, or are these studies more robust in nature from both the number of patients and post op metrics that their going to follow?

Michael Falvey

I’m going to let Scott answer this one, because he’s very familiar with the process that led to these studies and the studies themselves.

Scott Kelley M.D.

Well, John, it is a great question. Unfortunately, it may indicate some of the short sightedness of the way the ASA commissioned these studies: they were specifically focused on the issue of awareness; but I believe the Avidan paper will make them reconsider as they potentially restore additional funding to the studies, to be really concerned about study design, particularly the power involved with other interventions in these studies that have been accepted, as well as looking at the broad patient benefits for alternative techniques to avoid awareness.

I think was we approach this concept of what do patients and hospitals expect from anesthesia care, it’s inappropriate to focus only on intraoperative awareness: they really need to look at patient outcomes, the perioperative efficiency, quality, and side effects of anesthesia care; so I would hope the ASA gives serious consideration to including those endpoints in these funded trials.

Jonathan Block-SunTrust Robinson Humphrey

Okay, great. Just as a follow up to that same question, let’s say it is focused on just awareness; hypothetically we’ll just focus on awareness. What would change? Would it be a control group where you can say it represents more every day life in the OR?

Scott Kelley M.D.

You know, we just don’t know that. All we’ve really seen from these two studies are really paragraph descriptions: there is no rigor on what’s really involved in those alternative interventions, so again, not knowing that, does it really reflect a true standard control. Is it really what most patients will receive as an alternative to BIS monitoring? But, I think we expect nothing new from these studies.

We have continually looked at the performance of our technology, not only in clinical trials, now involving basically 10,000 patients for an awareness outcome, but more importantly, 25 million routine uses. In the last couple of weeks we’ve talked to some of our largest customers that in single institutions have used our technology more than 100,000 times: they are happy with the performance on awareness, but more importantly, they ear happy with the overall contribution to quality of care.

We believe we will continue to advocate that position to take a global look at the impacts of our technology on anesthesia care versus any other alternative intervention. We are ready. We are confident that they will continue to see the impact. The key issues will be, what is the training of our providers using our technology, are they using it appropriately, are they maintaining the stance of clinical vigilance. If they use it properly they will see the impact. We have thorough confidence in the outcome of those studies.

Jonathan Block-SunTrust Robinson Humphrey

Okay, great. Two more if I may. Is there a time maybe where you can say you’ve essentially signed off on the impact from the Avidan study; in other words you mentioned sensor growth was great worldwide at 18, it was solid here in the US, you mentioned some maybe monitors from customers that are lengthening the evaluation process.

Is that it and then we move on? How frequently are some of your customers ordering sensors, or maybe they made a big order right before the Avidan study and they’re at risk. Where do we need to get to in 2008 to say, “If there is any damage, it’s now behind the company”?

Nassib Chamoun

Well, I think like we said earlier, part of the reason, you know we wanted to bring those results earlier, to give you as much information as we can as to what happened during the last few weeks. I can tell you the most watched number in this company, whether there is a New England Journal article or not, is our daily sensor shipments and sensor ordering patterns.

As far as we can tell so far, five weeks into it, the frequency of orders, the number of customers that are ordering, the size of the orders, the percentage growth year-over-year, quarter-over-quarter, have been with in the range that they have been in for the last several quarters. So, having said that, I don’t want to be completely dismissive and say that there couldn’t be something the pipe over the next few weeks that would change that. The likelihood is lower every week that goes by. I’d like to believe that the Q2 and Q3 are behind us.

Ultimately we can say we’ve been completely out of this one. But, we’re very, very pleased with how our customers and opinion leaders have reacted from around the world, it gives us great confidence in the fundamentals of this business and how clinicians have adopted and integrated this into their practice.

Frankly, I look at the additional studies and say they will only further reinforce the adoption of this technology into the marketplace, because there are only two outcomes, they are either going to demonstrate value or they are going to demonstrate that it wasn’t used properly.

Because, the experience that we have seen in the trials and in 25 million patients and in conversations with some of the largest customers that I have personally visited with, in addition to many others is look, we know our experiences, we know what it does for awareness and this is not real life; what we do here everyday is real life and that’s the technology for our practice and for our care.

So, I would say we’re at a good point and we need, probably a few more weeks, a few more months behind us, just to make sure, because we’ve touched a large number of our customers, probably those that represent 60 to 70% of our sensor business; however it takes awhile, for our field, for us to touch everybody and make sure that we haven’t seen any effect at all. I hope that answers your question. I can’t predict the future, but I can tell you where the numbers are at, literally, as off last nights shipments; so and that’s where we stand.

Jonathan Block-SunTrust Robinson Humphrey

That’s very helpful, thanks guys, I’ve got a couple of other small ones, but I’ll just follow up on this call. Thank you.

Michael Falvey

Thank you.

Operator

We’ll take our next question from Joshua Zable from Natexis.

Joshua Zable-Natexis Bleichroeder

Hey guys, thanks for taking the call and congratulations on a great quarter.

Michael Falvey

Thank you, Josh.

Joshua Zable-Natexis Bleichroeder

Most of my questions have been answered. Just for clarification here, obviously you guys have a bunch of data demonstrating the utility of BIS monitoring. The next sorts of studies you’re talking about here are sponsored by the ASA. I know it’s obviously difficult to predict the timing, but I guess I’m trying to think about the way you just answered the question in terms of, when will the next headline in terms of data be positive; so when do you think that those, I know obviously you don’t have too much information, but when do you think it’s likely that their all finished and the data is out there from those studies?

Scott Kelley M.D.

Well, this is Scott, the funding of the ASA studies were announced in October 2007, giving those groups of investigators the opportunity to move forward with implementation. We still haven’t seen those studies posted on clinicaltrials.gov, so it’s not clear if they’ve started patient enrollment. We continue to believe that as more and more evidence accumulates about the impact of our technology, some will be on the awareness focus; we continue to look at awareness and beyond, look at important measures of patient outcomes.

We’re very focused on things that hospitals are concerned about, whether it’s hospital acquired complications; just recently, in fact yesterday, hospitals are now going to have to start focusing on the occurrence of delirium and there is lots of thought leaders that believe this clearly relates to anesthetic techniques and management; so we believe our outcome studies are in the right place at the right time.

As an ASA member, I believe there are funding studies that have such a narrow focus that we will gather the evidence, we don’t expect any surprises, but we’re going to continue to say, “you have to look at the comprehensive benefits and impact of anesthesia care”. Therefore, we’re in the right place. Our studies are looking at bigger issues and it’s really, the burden is on the ASA to change the focus of their studies and to really look at patient care.

Michael Falvey

If you look at where this specialty is heading, where Medicare is heading, it’s all about outcomes, it’s all about understanding the broader picture in patient care. I think the future is in understanding the issues of anesthetic toxicity, understanding the impact of over dosing and under dosing on certain patient populations, looking at post operative cognitive dysfunction, delirium, cancer recurrence and cancer related mortality in relation to anesthetic technique and interventions in the perioperative setting and we have a series of trials that address all of these endpoints, because that is where the future is at.

We finished the awareness trials in 2002, that’s kind of, the last battle. You have to look forward and look at what impact anesthetic management can have on patient outcomes, and on society, and I believe anesthesiologists can make a huge difference, and the clinicians delivering anesthesia can make a huge difference for patients. Aspect is committed to understanding how each patient population can be targeted within a certain anesthetic level to achieve the best outcomes for it and that’s where the future is for…

Scott Kelley M.D.

And it’s all about, you know the Avidan approach formulistic dosing, one size fits all, really doesn’t cut it in this age of personalized medicine where I have to think about each patient as an individual and what’s different about their particular situation, whether it’s the comorbidities they bring into the operating room, their ability to tolerate even small amounts of anesthetics, or their different challenges in clinical outcomes; so to me it’s a management technique that’s so outdated. It may have worked in the 1970s, but currently, I need to be really on top of my game for delivering personalized care.

Joshua Zable-Natexis Bleichroeder

Great. Thank you guys very much for the clarification, I really appreciate it.

Operator

We have a follow up question from Eli Kammerman with Cowen.

Eli Kammerman-Cowen & Co.

Thanks for taking the follow up, I’ll try to make it quick. My question is, how long do you expect the new trial for the depression marker to take, and do you expect to find a partner for that product in 2008?

Nassib Chamoun

The trial is expected to run for about 12 to 15 months, depending upon enrollment. We are in active discussions with a number of prospective partners. Whether we sign an agreement in 2008 or later in 2009 all depends on the terms and the type of partnership agreement we are seeking; so at this point, I’d hate to speculate about timing, but I can reassure that it’s a high priority for us, and we’re in active discussions with several key partners and players in the space.

Eli Kammerman-Cowen & Co.

Okay. Thanks very much for taking the follow up.

Operator

It appears we have no further questions at this time. I’d like to turn the conference back over t management for any additional or closing remarks.

Nassib Chamoun

Thank you all for your questions this morning. I will close by simply reiterating our confidence in the future. Aspect’s vision is to build a leading brain monitoring franchise with businesses in several major markets.

In our core business we have built a solid foundation, and we believe we are making the right investments to capture more of the unrealized opportunity and, in the neuroscience area we believe that the products that emerge from this area have the potential to become a big part of our future. Thank you all for your questions this morning. Mike and I are available if you have any further question. Thank you.

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