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Executives

Mary Ann Victor – VP & CAO

Bruce Barrett – President & CEO

Bill Iacona - CFO

Analysts

Matthew Dodds - Citigroup

Gregory Brash – Sidoti & Company

Charley Jones – Barrington Research

Sara Michelmore – Cowen and Company

Jonathan Block - SunTrust Robinson Humphrey

Hank Miller – RBC Wealth Management

Somanetics Corporation (SMTS) Q2 2008 Earnings Call June 18, 2008 10:00 AM ET

Operator

Good day everyone and welcome to Somanetics Corporation second quarter 2008 financial results conference call. (Operator Instructions) With us today from the company are Bruce Barrett, the company’s President and Chief Executive Officer, Bill Iacona, Chief Financial Officer and Mary Ann Victor, Chief Administrative Officer. At this time for opening remarks I’d like to turn the conference over to Mary Ann Victor; please go ahead.

Mary Ann Victor

Good morning everyone. Thank you for attending our second quarter 2008 investor conference call. Statements in this call concerning our future business, operating results, expected net revenues, anticipated investments and other guidance are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such statements are based upon management's expectations as of today, June 18, 2008. You are cautioned not to place undue reliance on these statements. Information contained in these statements is inherently uncertain and actual performance and results may differ materially.

Factors that could cause actual results to differ materially from any forward-looking statements include economic conditions in general and in the healthcare market; market demand for our products; our dependence on the INVOS System and disposable sensors; our dependence on distributors and independent sales representative firms for a substantial portion of our sales; our dependence on single-source suppliers; potential competition; the effective management of our growth; our ability to attract and retain key personnel; the potential for product liability claims; government regulation; changes in our deferred tax assets; equity compensation expenses; the challenges associated with developing products and obtaining and maintaining regulatory approvals; research and development; the lengthy sales cycle for our products; employee turnover; changes in actual or estimated future taxable income; changes in accounting rules; enforceability and the cost of enforcement of our patents; potential infringements of others patents; and the other factors set forth from time to time in our SEC filings, including the 2007 Annual Report on Form 10-K filed on February 6 and the 2008 first quarter 10-Q filed on April 2.

The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements that may be made today.

I'll now turn the call over to our President and CEO, Bruce Barrett.

Bruce Barrett

Thank you Mary Ann. Good morning and welcome to our second quarter call. I will begin with a brief review of our business. Bill will follow with a more detailed review of our financial results for the second quarter and six months ended May 31. Then I will discuss our plans and expectations for the balance of the year and answer your questions.

The team produced a 40% increase in net revenues in the second quarter to a record $12.7 million. Gross and operating margins were 87% and 32% respectively and diluted earnings per share were $0.21. In the second quarter US INVOS hardware net revenues were strong at $2.7 million. Edwards Lifesciences, our distribution partner in Japan, also contributed with higher then forecast INVOS hardware purchases.

The highlight of the quarter was the progress made with the launch of sensors for infants and neonates in the pediatric and neonatal ICUs. In the US we sold 2,600 of these sensors to 29 customer accounts for approximately $500,000 in revenue. Outside the US, Covidien, our distribution partner in Europe, The Middle East, Africa, and Canada, also purchased sensors to support their launch. Covidien also invested to conduct a Master Class in Paris in April to support the launch of these sensors and expansion of their efforts in the pediatric and neonatal ICUs. This educational seminar was dedicated to discussing the use of INVOS technology in these markets. Nearly 200 pediatric [intensivists] and neonatologists from around Europe and The Middle East attended the program.

In May we received an important FDA 510(k) clearance to expand our labeling to include monitoring changes in the oxygen saturation of any tissue beneath the sensor rather then being restricted to brain and skeletal muscle tissue. This new claim supports our efforts with neonatal patients where customers apply the sensors over the bowels and kidneys to detect ischemia in these tissues. Also in the quarter we continued to implement our software upgrade program in adult cardiac surgery accounts to our new INVOS software that facilitates enrollment in the Society for Thoracic Surgeons Adult Cardiac Surgery database.

As discussed previously the Society for Thoracic Surgeons has included cerebral oximetry as a metric in their adult cardiac surgery database and we are working towards facilitating enrollment with software that automates collection of the cerebral oximetry data. To date we have upgraded software and accounts representing about 14,000 adult cardiac surgery procedures annually.

In summary I’m very pleased with where we stand entering the second half of the year. Our second quarter financial performance was ahead of our expectations and as important the launch of sensors for infants and neonates and timely expansion of our product labeling are positive developments that should contribute to our continued growth in the second half of the year.

And now Bill will review our financial results with you.

Bill Iacona

Thank you Bruce. As we reported this morning our net revenues for our second quarter were a record $12.7 million, a 40% increase over 2007. For the six months ended May 31, our net revenues increased 25% to $21.4 million. US net revenues increased 32% in the second quarter to $10.2 million and increased to $17.7 million for the first six months of the year. For the quarter and year-to-date US sales represented 80% and 82% of our net revenues respectively. For the quarter US disposable sensor revenues increased 21% to $7.5 million and our INVOS hardware revenues increased 82% to a record $2.7 million. For the six months ended May 31, US disposable sensor revenues increased 24% to $14.1 million and INVOS hardware revenues increased 20% to $3.5 million.

Our international net revenues were $2.5 million and $3.8 million respectively for the quarter and six month period ended May 31. For the quarter international net revenues increased 83% due to the strength of ordering from Edwards Lifesciences in Japan and continued contribution from Covidien in Europe. For the six months ended May 31, international net revenues increased 37%.

In Q2 we placed 148 INVOS monitors in 54 hospital accounts in the US. Internationally we sold 137 monitors. Year-to-date we have placed 228 INVOS monitors in the United States and 206 monitors internationally. As of May 31, our installed base of INVOS monitors in the US grew to 2,234 being used in 687 hospital accounts. In Q2 our US SomaSensor unit sales increased 15% to 71,818 and year-to-date unit sales increased 18% to 136,308.

In the US pediatric sensor sales represented approximately 33% of our total sensor revenues and 27% of our total sensor units for the quarter and approximately 31% of our total sensor revenues and 26% of our total sensor units for the six months ended. Total company sensor unit sales increased to 108,168 in the second quarter and increased to 195,798 for the six month period.

In the United States our average selling price for sensors increased 5% for both the quarter and six months ended May 31, primarily because of increased sales of our pediatric sensors which sell for a higher price then our adult sensor. Gross margin was 87% for our second quarter and first six months of fiscal 2008 and as we’ve stated we expect our gross margin to be 87% to 88% for the year 2008 depending on the mix of sales between US and international.

For Q2 operating expenses increased 29% compared to the same period a year ago and for the first half of 2008 operating expenses increased 27%. These increases are primarily related to our addition of sales and marketing and R&D personnel and increased expenditures on sales and marketing activities including trade shows, product sponsorship, and sales training.

Second quarter income before income taxes increased 31% to approximately $4.8 million from $3.6 million a year ago and for the six month period, increased to $6.5 million. Net income for Q2 was approximately $3.1 million or $0.21 per diluted share and for the six month period was $4.1 million or $0.28 per diluted share. While we do not expect our reported income tax expense to reflect material cash tax payments for the foreseeable future given our previous NOLs we have begun making state income tax payments. Our recognized income tax rate in the second quarter was 36% and as we stated we expect our effective tax rate for fiscal 2008 to approximate 36%.

In April we initiated a $15 million stock repurchase program and then expanded the program in May to $30 million. To date we have purchased 1,209,029 shares at an average price of $15.94 for approximately $19.3 million including commissions. As of May 31, our cash and investments balance was $73 million and we had no borrowings. Our cash provided by operations for the first half of 2008 was $6.4 million.

I will now turn the call back over to Bruce who will talk about our business for the rest of 2008.

Bruce Barrett

Thank you Bill. As we enter the back half of fiscal 2008, our financial guidance remains unchanged. We are currently on pace to perform in the mid to upper end of the range of our guidance for net revenues of $46.2 million to $50 million. We continue to forecast gross margin in the range of 87% to 88% and while our operating margin is 23% of sales year-to-date, we expect it to improve to between 25% and 27% of sales by year-end.

We are experiencing exciting growth in the pediatric and neonatal market segments for the INVOS technology and the recent launch of cerebral and somatic sensors for infants and neonates and new 510(k) labeling expanding our claims, position us to continue to drive growth in these market segments. Sensor revenue in the pediatric and neonatal markets combined increased 66% in the first half of the year. And the majority of our US INVOS hardware revenues are associated with these market segments making these markets even more important to our financial results.

Adult sensor revenue increased 13% in the first half of the year. Our adult sensor business is predominantly cardio vascular surgeries and we expect growth in this market segment to continue in the 10% to 20% range in the second half of the year.

Investment increases in sales, education, clinical research, and R&D will be weighted towards the higher potential, faster developing pediatric and neonatal ICU markets. In US sales and education we currently have five region managers, 26 sales representatives and 28 education specialists. We will be adding to the sales and education team over time to accommodate increasing activity in the pediatric and neonatal ICUs. We will also be establishing a modest direct presence in Europe to support Covidien.

In clinical research numerous clinical studies that use the INVOS system in various pediatric and neonatal ICU applications are completed, underway or planned. Some are sponsored by Somanetics and some are being funded independently. Certain studies are focusing on establishing the base line or normal INVOS values in cerebral and somatic tissues in helping neonates as well as neonates with differing pathologies. One study is documenting changes in oxygen saturation in cerebral and somatic tissues in pre-term infants in the first three weeks of life.

Other studies are evaluating clinical applications in infants and neonates. For example, studies are evaluating use of the INVOS system in septic shock and determine the need for blood transfusions in neonates and several studies are looking at determining the role of the INVOS technology in helping address the critical problem of bowel ischemia or necrotizing enterocolitis referred to as NEC, which is associated with high morbidity and mortality in pre-term infants.

Results from these and other studies should begin to be presented at conferences and published in 2009. These results will be important to driving broader adoption of the INVOS technology in these markets. In R&D we are pursuing advances to our INVOS technology that we believe will sustain our significant technological leadership position in this developing marketplace and we are continuing to pursue advances to our labeling to further strengthen our position in the marketplace.

In summary I believe we are taking the right steps to increase shareholder value and I’m optimistic about the second half of the year and our future. And now I’d be glad to answer any of your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Matthew Dodds - Citigroup

Matthew Dodds – Citigroup

I just want to drill a little bit more into the early success of the PICU and NICU markets, I’m just wondering the impact that you’re seeing, certainly the expansion of the labeling is pretty recent but I’m just wondering if you are seeing any early signs about what kind of traction this will get you in the market?

Bruce Barrett

As far as the labeling it’s too early to tell. We just received it here within the last four weeks or so but what it does for us is it allows us to be more specific about the application of the technology because the use is really being extended from the way its already been used in congenital heart patients which are largely neonates for many years now, and that use that has been developed and published is related to putting the sensors either over the kidney region and looking at changes in oxygen saturation of the kidneys, or putting it over the bowels and monitoring what they thought were changes in the bowel saturation, as well as monitoring the brain obviously.

What the 510(k) does for us is we included all our neonatal piglet research in the 510(k) which allows us to now use it in our marketing and sales efforts and what we’ve found by [Dr. Weeder] who has been involved with all that research as our employee, he has been going around to present at various accounts around the country, to their neonatologist and what we’ve found is that that research that demonstrates our ability to definitively detect ischemia in the bowels and kidneys and brain of the piglet model, which is the accepted model for neonates, is very compelling to the customer.

So being able to use that data is a big step forward for us in terms of validation of the technology that it really is looking at changes in saturation in these organs. Then the next thing is just that we’re able to now work with labeling that doesn’t limit us to saying that this is just measuring skeletal muscle tissue when you put it over the bowels, you’re actually measuring whatever tissue is beneath the sensor and clearly that’s bowel tissue. So it’s going to free us up dramatically from where we were with our ability to basically communicate the technology and what it’s really doing in this marketplace but it’s too early to tell exactly what impact it’s going to have.

What we’re finding in general is that people are very eager to get a chance to try the technology so we’re not in any short supply of people who want to evaluate and who theoretically believe that the technology holds great merit for what they’re doing with their patients in a wide variety of applications. What I would expect we will also find is that now that we have a tool that can readily be applied, it’s going to take some time for there to be enough definitive data that the masses of people are going to want to use it for a wide variety of applications.

I think you’re going to find there’s going to be a lot of early adopters who are going to use it selectively in specific applications while they learn to understand how its applied on their own and benefit from the data that’s already out there for congenital heart, so I think there’s going to be a process here. We’re ahead of the curve as to where we thought we’d be. I think we said last quarter we were hopeful we’d get into 15 or 20 accounts, I know we were in—we sold the 29 last quarter, I think we’re in 33 or 35 as we said here today. We’re obviously stretching our educational resources in the field so we know we’re going to be adding to that capability as we move through the back half of the year. But we feel pretty good about it but it’s very difficult to predict exactly what the impact is going to be until we get a little further down into the launch.

Matthew Dodds – Citigroup

I think you had mentioned earlier on in the year that maybe you had expected minimal revenue contribution for the NICU market, just wondering if you could kind of parse it out in that mid to upper end of your guidance range for the year, what portion of that in absolute dollar terms do you think will be derived from either the NICU PICU or combined markets, just to get a little bit more granularity?

Bruce Barrett

Well I think I had made a comment last quarter or the quarter before, that we were hopeful that the launch of these sensors, the infant sensors, would contribute an incremental $1 million this year. The reality is if we really parse it out, they probably contributed $1 million this quarter. If we just look at sensors, they contributed I think around $600,000 or $650,000. What’s a little bit difficult for us to be real definitive on is there’s going to be people who use the pediatric sensors, who have used them for years, who are going to switch to these new sensors at a higher price, and then there’s going to be new customers who are just incremental business altogether. And there’s also going to be as you know, we only ship one type of monitor regardless of where its used in the hospital, adults, pediatrics, neonates, its going to be very difficult for us to specifically know what revenue on our monitors are entirely tied to new customers and related to these sensors and which aren’t sold.

With that kind of—as some background if you look at our revenue today I would say that the revenue is going to be significantly higher then the $1 million but its not all incremental, some of its upgrading existing customers from the pediatric sensor to these new sensors. And some of it is going to be a reallocation of our resource from the slower growing, less productive adult cardio vascular surgery business to this marketplace which makes it not all incremental in that regard either but we don’t have a good fix on what the ramp is going to be, but we do think its going to be something obviously significantly higher then the $1 million we thought we were hoping to be at this year.

Operator

Your next question comes from the line of Gregory Brash – Sidoti & Company

Gregory Brash – Sidoti & Company

Just wanted to follow-up a little bit on the neonatal opportunity, do you think here that physicians are more inclined to adopt a new technology like the INVOS versus thoracic surgeons in the OR? Is there maybe a different mindset towards patient care or are they more inclined to adopt a technology without seeing mounds of clinical data?

Bruce Barrett

I don’t know about that last point but as far as all the other points, the answer is yes. If you look at the adult cardio vascular surgery marketplace you have a marketplace that has witnessed declining procedural volumes over the years as well as declining reimbursements and you have a very political operating room environment where it’s the surgeon who is responsible for the outcome and is interested in our technology but they expect anesthesia to pay for it because anesthesia is responsible for monitoring.

That whole environment speaks to a market of very difficult sales processes, very political sales processes, people not wanting to spend money on new technology, just a very financially constrained environment. When you go into the neonatal ICU, and the pediatric ICU, you have a different environment. You have the people running the unit who will be the ones who are the beneficiaries of the technology to the extent it offers benefit. So for example, if you try to sell anesthesia in the adult cardiac OR on the benefit of monitoring the brain being that you might get people out of the ICU faster, out of the hospital faster, they’ll have better outcomes, but you’re going to pay for it on your budget, its not the anesthesiologist who pays for it who is the beneficiary.

If you benefit the neonatal ICU or the pediatric ICU, you’re benefiting the people who are responsible for that unit, if you’re helping those patients do better and get out of their units faster. So that’s different. You’re also working as you get into the smaller patients, with patients that they can’t get the information that they want as readily as you can on an adult patient. You can’t take a lot of blood samples out of a pre-term infant because they don’t have a lot of blood volume. You don’t want to be invasive any more then you need to because they’re very susceptible to infection. So they’re very open to non-invasive sorts of technologies.

And we also have the incremental benefit that if you put our technology over the bowels or kidneys of an adult, who knows what you’re going to be measuring because of the differing layers and thicknesses of fat and muscle tissue on adults, but when you get into the neonates, they don’t have those issues and you’re definitely getting down into organs. And the value of being able to monitor into organs is, we think, going to be proven to be very worthwhile.

Gregory Brash – Sidoti & Company

Do you believe that’s going to be one of the main drivers in the neonatal, I know your competitor doesn’t have, or doesn’t as far as I know, isn’t planning to measure somatic tissue? Do you believe that’s what the doctors are really looking for in that space?

Bruce Barrett

I know of very few situations where any of the pediatric or neonatal clinicians aren’t monitoring something above and beyond the brain. Whether they happen to think the bowel is the right place to place it or the kidney, I’m unfamiliar with hardly any physicians strictly monitoring cerebral so I think if you look from a competitive standpoint, at least the one competitor on the market today has numerous significant limitations. One is the labeling as it relates to the types of tissues they measure and the other is that they’re limited to 2.5 kg and there’s not too many neonates that are pre-term infants that weigh more then five or six pounds. So I think we’ve got some great advantages from a labeling standpoint in this market at the moment and those can go away at any time obviously.

But I think the key is that we’ll be the ones out there that are being used with all the data and all the educational support to help people understand how to utilize this and to train their staff to use it properly in their environments.

Gregory Brash – Sidoti & Company

And then just on the monitor side, I know it was weak last quarter and you rebounded here, did anything change on your end, commission structure for reps or different marketing approach or is this just some of the deals coming through and also gaining more traction in I guess both the neonatal and pediatric ICU? It looks like a larger percentage then usual of your monitors were actually sold.

Bruce Barrett

Yes I think it’s a number of things. I think we really couldn’t understand the first quarter being what it was so I’m not too surprised that now we’ve had a heavier quarter. But I think fundamentally if you look at our business the majority of the hardware that we sell is in the pediatrics and now as we move more aggressively with the neonatal ICU it’ll be in the neonatal ICU. So if that’s where the most of our growth is going to come from, we would expect that we would continue to be strong in our hardware revenues over time and certainly we see fluctuations from a quarter to a quarter but over time, I can’t see at least right now unless a competitive situation changes, why we wouldn’t continue to witness growth in hardware given the growth that we’re going to be experiencing we believe in the pediatric and neonatal ICU markets.

Gregory Brash – Sidoti & Company

Any reason for the decline in SomaSensor revenue from the quarter, I mean you still saw 21% growth but I believe it was in the high 20s last quarter?

Bruce Barrett

At least if you look at—well international has got fluctuations no matter what because we’ve got people purchasing for stock that they then redistribute but if you look at the US and you look at quarter-to-quarter, the US sensor in the adult area—in overall was up I think 12% over first quarter but not up much more then that over last year’s second quarter. So the reality is we have fluctuations in our quarter-to-quarter sensor business as well and we were up against a fairly tough comparison in this quarter. If you look to the second half of the year I think you’re going to see that we’re up against a fairly reasonably tough comparison in the third quarter for US sensors. And then we’ve got a fairly weak comparison for the fourth quarter so I think overall though you’re going to see that adult sensors are going to be up in the 10% to 20% range and I wouldn’t doubt that you continue to see us perform in the greater then 60% growth in especially the US, where we’re really focusing our efforts on the pediatric and neonatal markets as well.

Operator

Your next question comes from the line of Charley Jones – Barrington Research

Charley Jones – Barrington Research

First could you characterize your evaluation pipeline, you’ve talked to us about it in the past and where you’re at with your sales reps and how many reps you think you’re going to need to add in the third and fourth quarter?

Bruce Barrett

I knew I’d get that question; we’re trying to come up with what the right answer would be because the reality is we know we’re going to be adding, but we’re still—its going to be mostly related to the launch of these new sensors then the degree of success that we have in the neonatal ICUs. So if I were to give you a broad range of adds to the US organization I would say it would be somewhere between 10 and 20 additions associated with this launch and our expanded efforts. That’ll be predominantly in the US clinical education ranks. It’ll be somewhat in sales and somewhat in R&D.

When you look into Europe, we’re still in the process of evaluating exactly how many headcount we want to put. I’m sure we’ll put at least three to six and then the question is do we want to be the educators in Europe or is Covidien going to be the educators in Europe as we look to 2009 and putting the proper resources in place to support the neonatal launch there. And that’s something that we just have to work through with Covidien as we go through the coming months.

Charley Jones – Barrington Research

Is that opportunity up to you whether or not you’re going to put the clinical specialist in Europe or is that something that they have to agree to?

Bruce Barrett

I think its, you know, obviously we can put people there. There’s no reason why we can’t but the only way people are going to be effective is if we work as good partners and we’ve been good partners to date and I would expect we will be moving forward. It’s just a matter of everyone understanding who is going to be financially responsible and how is that financial responsibility going to be accommodated.

Charley Jones – Barrington Research

Where are you at versus your plan for the first six months of the year, could you characterize that for us?

Bruce Barrett

Basically we obviously started off with a tough first quarter; we made up some ground in the second quarter. I think if you look at it we’re a little behind where we wanted to be at the end of the half so we didn’t make all the first quarter shortfall up but we made up more then half of it. And I think we told you in the first quarter we were behind about $1.3 million. So we made up about half of it. If you look at the bottom line, if you look at operating margin we’re actually a little bit ahead of where we thought we’d be this time of year even though the percent is a little behind our annual guidance, we expected to be more heavily weighted as we move through the year. And then if you look at the bottom line, we’re a little bit behind on diluted EPS just because we converted some interest income—we got less interest income then we planned because we didn’t forecast as much of a decline in interest rates as has occurred. And also we’ve taken cash that otherwise would have collected interest and bought back shares. On the net income line we’re behind but its interest related not operating related.

Charley Jones – Barrington Research

What percentage of your monitors were sold?

Bill Iacona

In the quarter we sold about three quarters of them, so on a year-to-date basis that takes us to about 70% actually of all units placed in the US that what were sold. So very strong, very strong quarter which pulls up the year-to-date numbers.

Charley Jones – Barrington Research

Are you still holding that list price pretty well or at least getting 25ish on that?

Bill Iacona

We are yes. When you look to the hardware sales for the second quarter you’re not going to see anything there that there’s a trend toward significant discounts or anything like that.

Charley Jones – Barrington Research

Was there any pull-forward in the quarter? Were there any incentives that you think might have pulled some revenue forward into Q3 or characterize that?

Bill Iacona

I would say no to that and I think Bruce agrees. I think you’re just in a situation where we came out of the first quarter, we had a light first quarter we all know that, and we were pretty clear about the fact that we had evaluated our pipeline. We still thought the pipeline was strong for the year and we still had confidence; we didn’t think the first quarter was a trend. And I think we’d probably make that same statement now. We still feel confident about the pipeline but its just timing. You just never really know when the capital budgets are going to be available, when the hospitals are going to have the money available to buy the units. So in terms of what was pushed back from the first quarter or what might be pulled forward from the third quarter, it’s just really tough to say but I think the thought is that we’re still confident that we can sell hardware.

Charley Jones – Barrington Research

Out of the 29 or 33 customers you guys had, how many of those, were all those neonatal customers or were some of those pediatric customers and if they weren’t—if none of those were pediatric how many customers do you think you’ve been able to have start using the neonatal sensor in pediatrics?

Bruce Barrett

That’s a question I don’t know exactly the answer to but predominantly the people who are using this sensor are in the neonatal ICU and some of them were using the pediatric sensor before but it was very cumbersome to work with so they were using it very selectively. So the majority of the new—of those 29 accounts, are accounts that were using our pediatric sensor in pediatrics maybe and a few may have been using them in the neonatal ICU but the bulk of what we’re selling is to the neonatal ICU.

And that’s really just to give you a little bit more color, that’s why Bill stopped saying we’ve got this many new customer accounts and this many existing customers that we put in those monitors in because frankly most of the neonatal ICUs that were in are existing customers, they just didn’t use it in the neonatal ICU before so we’re capitalizing on the fact that we’ve got good internal champions for the technology in the pediatric ICU to talk to the folks in the neonatal ICU and help us get going and its very productive also from a sales standpoint because you’ve already got a reason to be in the account.

Charley Jones – Barrington Research

To go a little bit further into pediatrics, we’ve talked about in the past that maybe some pediatric, not the neonatal ICUs within those hospitals that were using the pediatric sensor in the pediatric ICU, but if we really just look at the pediatric ICU, we’ve talked about in the past that maybe some of these users would really start to use the neonatal sensor much more. Do you get any sense of whether or not that is or is not going to happen at this point?

Bruce Barrett

My sense is that it is going to happen just because of the orders that we’re seeing come in now. We had a little bit of this last month but for the most part, we took the position the first couple of months as we got started that we didn’t want to upgrade existing customers in the pediatric ICU to the new sensor because we just didn’t have that much experience with the new sensor. So why take a risk with a new product and upgrade your best existing customers to it and then find out that you’ve got a problem that you didn’t know you had with it. So we wanted to gain a couple of months more of experience with the new sensor before we started upgrading.

As we said here today though, I can see that we’ve got some existing customers who are ordering. The cost on the new sensor at the moment because we are in relatively low volume is quite a bit higher then the other sensor but we’re getting the price for it so we’re getting up-charges between $25.00 and $35.00 per sensor and some customers are just paying list to get started which is even a higher up-charge here in the early going anyways. I think you’re going to see a transition from the pediatric to the infant sensor in quite a number of our accounts and the only thing that would limit it probably from being 100% is that we’re going to at least get the price for it to cover the loss of margin in the cost of goods. Then over time obviously we’ll have a higher, hopefully, ASP and we’ll get our cost out of the product and so we’ll come out on the positive side there.

Charley Jones – Barrington Research

And how much of your sensor growth was due to ASP in the quarter? Not total revenue growth but just sensor growth because you had such a strong monitor quarter.

Bruce Barrett

Well there’s very little that was associated maybe 1% or so that was associated with actual price. It would be all related to—most of that is related to mix. Just the fact that we have our higher priced pediatric businesses growing at such a much faster rate then our adult sensor business which is lower priced.

Charley Jones – Barrington Research

Could you give us an update on the diabetic trial and how much—if you are going to start a new trial when do you expect that to start and how much do you expect it to cost and how much is going to end up in 2008?

Bruce Barrett

With the diabetic trial, the data we’ve been getting in and we’ve gotten all the data in from—there’s two centers participating; the VA in Durham and Duke. We’ve gotten all the data in from the VA in Durham that we’ve loaded up and we started looking at but we’re waiting on the data from Duke to add to that. So during this quarter hopefully we’ll get the rest of the data from Duke. There’s insulin-dependant and non-insulin dependant diabetics included in the study and the folks at the VA after seeing what they’d enrolled so far decided that they’d like to include additional insulin-dependant diabetics. So they’re going to continue to actually add some patients to the study as we go through this quarter as well. So hopefully by next quarter I will have some color on that.

What we will do though whenever we look at our results is we will look at alternative uses of resources and whether or not that’s the best use versus accelerating investments to support where we’re headed in the pediatric and neonatal area or not is something we’ll decide at the time. But first we have to get the data in, so hopefully by next quarter I’ll have a little more color on that.

Charley Jones – Barrington Research

You talked in the last quarter about maybe doing something in the back half of the year in the diabetic trial and that that could cause your R&D number to go up, do you think that you would just transfer those dollars to another program now and that money is still going to get spent or is that an opportunity for some increase into EPS in the second half because those expenses are getting pushed back?

Bruce Barrett

I think at the moment you can assume that if we don’t even have the data from the pilot until we get into starting the fourth quarter we wouldn’t be able to coordinate much enrollment for the back half of the year now. But I think you can also assume that our primary goal this year, especially given our early experience here with the infant sensors, is to make sure that we’ve got the sales and education resources in the field to drive that market. So we’re not really going to be trying to drop extra earnings to the bottom line as we look in the back half of the year because we think it’s much more important that we own this market and that we develop it as fast as we can. So we’ll be transferring those dollars into investing in this.

Operator

Your next question comes from the line of Sara Michelmore – Cowen and Company

Sara Michelmore – Cowen and Company

But just a few clarifications, can you just talk about the visibility in terms of the Edwards and Covidien ordering patterns and specifically it sounds like both of those took a lot of inventory. Can you just give us a sense of where you think they’re at and what you think ordering patterns may look like next couple of quarters?

Bruce Barrett

I’ll try to add some color to that; I’ve never been very successful at predicting it. Japan with Edwards has really contributed strongly the first half of the year with INVOS orders in particular but their sensor units are up. I think the reason for that is is that they received their Ministry of Health approval for the newest four channel monitor in the third quarter of 2007 whereas we had launched it as had Covidien launched it in May of 2006. So they were waiting on regulatory approval. With that regulatory approval they did a couple of things. One is they obviously wanted to get the best technology and the newest technology in the hands of their current customers, but they also implemented a program to be more aggressive about going and getting the competitive product out of the marketplace.

Hamamatsu in Japan, while we don’t see this in any other market in the world, in Japan, Hamamatsu has always been a very formidable competitor and probably has about half the market in Japan. What we’ve found is with the four channel monitor though that Edwards feels like they have a better product and they have the ability to gain market share and at least last month when our guy who runs international, Bob Sullivan, went over and met with Edwards they were reporting that they were making nice market share gains against Hamamatsu.

There’s a variety of things there that have caused Edwards to participate more strongly. As we look to the back half of the year, I don’t know how long that will continue. Obviously at some point they will get their existing base of customers upgraded and won’t need additional hardware for that particular initiative. But I think they’re going to contribute reasonably well in the back half of the year. I don’t know if they’ll be quite as strong as they were the first half, but they’ll be good.

With Covidien, I guess I would say that they contributed nicely in the first half of the year but even though international is doing very well overall, I’d say that the over achievement we saw from Edwards in Japan was somewhat matched by under achievement from purchases from Covidien in Europe and I would expect that will likely change as we go into the back half of the year for a variety of reasons. One is Covidien has minimum purchase requirements that they need to achieve in between now and September 30 pursuant to our agreement with them which will drive some purchases as well as just the fact that they’ve launched into the—launched these new sensors which we call neonatal sensors in Europe and they ran their Master Class and that’s going to demand resources as well both in terms of demonstration equipment as well as I’m sure they’ll experience some growth as we are in sensor demand associated with that launch.

So I think they’ll contribute more strongly in the back half of the year then what we saw in the first half of the year.

Sara Michelmore – Cowen and Company

In terms of the pacing of the next couple of quarters, coming off of a strong fiscal Q2 like this was of instrument revenue, should we think about seasonally and given that quarterly dynamic that going into Q3 we’re looking at a sequentially flat or down slightly in terms of absolute dollars?

Bruce Barrett

It’s typically what we experience and it usually gets—if there are fluctuations there, it’s usually related to Covidien ordering patterns more then anything because Covidien’s fiscal year ends September 30. So if they feel like they’re a little lean on inventory and they’ve got a lot of activity coming up in September, they can be fairly strong in the third quarter with purchases and if they feel like they’ve got solid inventory then they don’t worry about it until they get in to what’s our fourth quarter. But otherwise yes, you seasonally usually do see some—we’re really excited to enter our second and fourth quarter usually and we’re usually as little bit timid about what the first and third quarter can bring; first quarter because of the holiday season and third quarter because of the summer season.

Sara Michelmore – Cowen and Company

I know it’s still early in terms of trying to figure out exactly the sensor use patterns here in the pediatric and neonate market but what are you seeing in terms of how many sensors are being utilized per patient and then how often are they swapping the sensors out in the experience that you have to date?

Bruce Barrett

So far my understanding and what I’ve witnessed is that everyone is using two sensors on each patient. Some people are putting three. But some of these patients are awfully small so there’s really—there’s just not room for more then two. Our labeling says to use them for 24 hours. Obviously there are a couple of issues there from the customer standpoint. One is that some of these patients are in the hospital for weeks if not months in critically unstable condition so a change in these two sensors every day at the prices that they are, is extremely onerous. The other thing is is that a lot of these smaller patients have very tender skin so they’re not anxious to remove an adhesive product any more often then they need to. So what we’re actually seeing is that they’re trying to use the sensors as long as they can make them work and we’ve had our clinical people report back that there seems to be fairly good success by accounts making the sensors last for up to four days before they really can’t take them off, check the skin, reapply them and get good adhesion.

Now what that’s going to mean for their willingness to invest in the sensors and how many days or weeks they’re going to monitor individual patients, we just don’t have enough experience with that yet.

Operator

Your next question comes from the line of Jonathan Block - SunTrust Robinson Humphrey

Jonathan Block - SunTrust Robinson Humphrey

Can you just split out for me on the international side what was capital equipment and what was sensors?

Bill Iacona

For Q2 you’ve got hardware internationally of about $1.4 million and sensors at about $1.2 million.

Jonathan Block - SunTrust Robinson Humphrey

Just for modeling purposes going forward are we looking at exiting the quarter about 13.5 million shares, is that a good number to use?

Bill Iacona

In terms of shares that are actually outstanding or the weighted average share count?

Jonathan Block - SunTrust Robinson Humphrey

I’m sorry, we’ve got the weighted average for the quarter, and I’m just wondering for modeling purposes going forward, did all your stock buyback occur by the close of the quarter?

Bill Iacona

It did basically from the back two-thirds of the quarter, April and May.

Jonathan Block - SunTrust Robinson Humphrey

Okay, so we’re sitting at roughly 13.5?

Bill Iacona

Yes, that’s probably fair.

Jonathan Block - SunTrust Robinson Humphrey

Bruce, clearly neonate seems to be getting off the ground pretty well here, just when I isolate the cardio vascular market and I look specific to sensor unit growth, so sort of stripping out the ASP increase, I’ve got this deceleration in the growth from 25% in 2Q07 then it goes to 19%, 14% last quarter and my math implies mid single-digits, maybe about 5% or 6%, do those numbers sound right and then why do you think we’re seeing that level of deceleration in a market that is only 20% or 25% penetrated?

Bruce Barrett

I think you see that for a variety of reasons the most notable is just that over the time we’ve gotten what are going to be the early adopters with whatever data is available today and whatever catalysts there are. So I think we’re going to need a catalyst—I think we’re going to do better then mid single-digits obviously is you look over a longer period of time but if you look at what we need, we need a catalyst that’s going to compel the masses or we need a variety of events that combine, become a catalyst to compel the masses to feel like they need to use the technology.

We think one catalyst that we’re pursuing is the SPS database and we think that’s a very viable opportunity for us to compel the masses once we can get enough enrollment and if the data shows what we would expect it to show, that patients who are using—that this technology its used with do better then patients that its not used with as well as other data. Otherwise I think just the continued adoption by major university centers over time is going to continue to compel more people to adopt because people do tend to be fairly loyal to their alma mater as to where they trained. So the more New York universities and Cleveland clinics and Dukes and Johns Hopkins and so forth that adopt the technology, the more we have the ability to pursue those clinicians who train there to get them to use it at their accounts.

Still the things I mentioned earlier are all factors in the market. It’s a very political operating room environment. They’re very cash and operating expense constrained. They’re not the ones other then the surgeon potentially, the anesthesiologist who has to pay for it is not the one who receives the benefit of the technology; that benefit goes to the hospital if they can get patients out quicker and have them do better. There’s just a variety of things. As far as procedural volume, we hear mixed reports on what’s going on with procedural volume at the moment. It’s certainly been coming down over time and that could be a component as well. And to the extent that we do have competition, the competition that we’re having is in the adult cardiac OR at the moment even though I guess from the reported results of the competitor last quarter that’s a modest impact.

Jonathan Block - SunTrust Robinson Humphrey

You mentioned the competition, again the deceleration in the sensor growth is it that your current accounts are somewhat saturated, they may be awaiting more clinical data to increase their usage or is it a situation where that competitor, albeit limited, but that competitor has won some of your accounts so you’ve lost a couple, but in the accounts that you have they’re actually using your technology more frequently?

Bruce Barrett

I think the key is that our sales force is still relatively small but we’re adding to it so we’re gaining critical mass and when you take the opportunities that we have before us and you say you can keep fighting this very difficult political cash constrained sale in the adult cardiac OR which we will do, or you can reallocate some more of your time to what appears to be a much greener pasture in the pediatric and neonatal area now that we have these sensors, you can expect that there’s going to be some shift of our resource allocation from adult cardiac OR to these markets yet we’re going to continue to push in the adult cardiac OR obviously to some degree until a catalyst can develop that allows it to be a more robust growth story.

Jonathan Block - SunTrust Robinson Humphrey

Can you remind we where we are, I know we’ve had a lot of moving parts and you had the recent 510(k) approval, I’m just going back to fiscal year 2007 and I apologize if I’m not recalling this correctly, but there was a plan I believe to come out with a smaller sensor, it had less adhesion and the thought was that that would necessitate a 510(k) filing, was there [an end around] to that or is that still the plan? Is that current sensor that you have out there, how is that holding up? Does it apply to the whole neonate population there? Any color would be great.

Bruce Barrett

No I think there are going to prove to be a population of neonates that the sensor that we’ve launched today does not accommodate either because they’re too small or specifically in more cases, just because their skin is too undeveloped in the early days of birth. When a child is born before 28-30 weeks gestational age, they’re born with undeveloped skin which—that gestational age would probably be a great target market for our technology but it would be one that you’d probably wouldn’t want to put our adhesive on until a few days after the baby is born to avoid skin damage.

They’re having to deal with the skin damage issue with all different sorts or adhesives that they use in the neonatal ICU so they’re very conscious about who they put adhesives on. So there are a couple of directions that we’re moving. One is that we’re evaluating next generations of sensors that would eliminate the adhesive or dramatically reduce it for the patients who currently our adhesive is still not appropriate for and we’re also looking at shorter optical spacing to accommodate even the smallest of patients. And the minute you start talking about messing with your optical characteristics you’re definitely going to have to go for a new 510(k). And depending on what the design is of the adhesives or non-adhesive sensors we may, if they could potentially have any impact on the optical or electrical characteristics of the sensor we would go for a new 510(k) for those as well.

Essentially we’ve always known that we would have yet another generation or be further developments of our sensors for these areas and so there will be sensors in the future that are new that require new 510(k)s.

Jonathan Block - SunTrust Robinson Humphrey

You mentioned in most cases I believe you place into the cardio vascular market; there are greener pastures in neonatal and pediatric, what’s the feedback that you get? In other words, do you ever into a neonatal ICU and the sort of feedback is hey, why are we paying for this when other hospitals are having it placed for free? And then how long if you can remind me, was it in the CV market where you were once selling and then the market matured and you started to place?

Bruce Barrett

Actually in the CV adult cardiac market, we were never successful establishing a routine hardware purchase program. We do have accounts that purchase for their adult cardiac programs for whatever reason, but for the most part that’s always been more of a loner program. We had enough challenges in that marketplace and do today. Rather then make it even more difficult by asking them to work their way through a capital equipment budget when they’re really not trying to spend more money on their adult cardiac programs. If you look in the pediatrics area, we have pretty much always been successful on the other end of providing or establishing a hardware sales model so what you might find is that there are accounts who purchase larger volumes that we’re willing to work with them on the price of the monitor.

For example we had a community hospital that—a little unusual situation for us but nonetheless, we had a community hospital with a 20-bed neonatal ICU this quarter who heard about our technology, brought it in, tried it and immediately wanted to buy a bunch of units. They bought 10 so we gave them two for free to help them out on their average cost. So we will do that sort of thing but we’ve pretty well established a revenue generating hardware model in the pediatric and neonatal area that we intend to continue because it contributes significantly to our revenue.

Operator

Your next question is a follow-up from the line of Matthew Dodds – Citigroup

Matthew Dodds – Citigroup

On the interest income line, just wanted to bounce off you around $3 million for the year, does that sound appropriate?

Bill Iacona

It may actually even be a little bit less then that because if you look at where we’re at through six months and kind of the run rate for what we had for the quarter, when you keep in mind the fact that interest rates probably aren’t going anywhere and we may actually—we still have a share repurchase plan in place, so you probably might even want to pare that back a little bit.

Matthew Dodds – Citigroup

On the tax rate, you think 35% for the remainder of the year is, that’s where to target?

Bill Iacona

Yes, I would say that we were at this point expecting a tax rate for the year on an annual basis of about 36% and to be honest, that’s going to depend on really the success for the balance of the year because as I mentioned as part of what we talked through in our comments, we have been paying some state income taxes because state NOLs don’t carry forward as long as the federal NOLs so if the year were to be more successful, perhaps that rate could be closer to 37%; less successful perhaps a little bit less. But you’re probably going to be somewhere right around 36% is what we’re forecasting on a tax rate for the year.

Matthew Dodds – Citigroup

I know we’re still working through fiscal 2008, but just on the topic of operating leverage and certainly you showed some really strong leverage in the current quarter just wondering as you look out and you obviously, you continue to [go forward] with headcount additions, in 2009 currently we’re more modeled I think in a mid 20s range and just wanted to get your thoughts about how you view revenue growth versus earnings growth going forward and how—what kind of operating leverage you’re expecting going forward and when you expect to really start to see an inflection there.

Bruce Barrett

Well if in total we experience a 25% to 27% operating margin this year which is what we’re forecasting, we would suggest that we already have some leverage for a business our size. But I guess beyond that I would say that that’s not our number one goal as we look into 2009. What we see is that we’ve got products that we’re in the midst of launching that open what we believe is a $600 million a year disposable opportunity if you look at global opportunity in the pediatric and neonatal ICUs and combine it. And we’ve got a very small percent of that so we’ve still got investments to make. I would suggest you do model something of a similar sort of operating margin next year as to what we have this year, but obviously there’s going to be things that can change that.

I think one thing that could change is just how much investment do we need to make in Europe next year and another is, is that we do—resources do always lag results a little bit here so we are going to be adding to the team to support this recent launch and to expand our activities in the pediatric and neonatal ICU but its going to be totally dependant on what our progress is also. We’re not just going to throw resources at it and see what happens. We’re going to have—there’ll be gates along the way especially related to how much we’re having success in terms of just generating demand. As well as gates related to when data is coming out and what we expect it to say and how much impact we think it can have on the marketplace adoption.

Matthew Dodds – Citigroup

You commented earlier, it sounds like because there’s always a bit of speculation as to what the relationship with Covidien is going to be like down the road, if you’re going to choose to go direct in Europe, and some of the comments you had earlier during your prepared remarks sounds like, during the Q&A specifically, it sounded like you believe that there is some hope that you can kind of come to some more equitable terms with Covidien. Is that a proper way to characterize it and have you started trying to negotiate that with Covidien at this point?

Bruce Barrett

Obviously the agreement expires in 2010, in February, so our target is to determine what the course is going to be in Europe no later certainly then the early part of 2009. And our options are pretty straight-forward. We can either re-up with Covidien on terms that we believe reflect more economically what’s reasonable and what I mean by that is we entered into an agreement in 2000 when we all thought the market price for the sensors was going to be in the $45.00 to $50.00 range, so we thought we were going to be giving them a premium margin at the time even at those prices in exchange for them making the heavy investments to develop a concept.

The market price over the years was never contemplated to go up at the time we signed the agreement, in fact it was only contemplated that it would go down. Then the market price has actually gone up to well over $100.00 ASP in Europe so as we said here today Covidien is enjoying quite a healthy margin of which we feel moving forward that, just giving our options, it would make no sense for us to continue under the current economic scheme because we could either go direct more profitably or we could even on paper certainly and we’re in discussions with the potential of at least considering alternatives who would be willing to operate for less margin. So those are the three options.

Certainly in my mind, the best option if it can be best for both sides, is for us to continue on with a partner that we have a very good relationship with who has done a lot of good for us and who we think with the right investments in terms of educational resources and so forth could be good for us in the future. So if that can work out that’s great. If that can’t work out, then the other two options are obviously—or three options really are to go direct, go to other partners, one or more, or do some combination, not take the full nut of trying to go direct throughout all of Europe but have particular strong partners in maybe a couple of countries and go direct in the others.

But I think you could certainly probably glean from my comments that my preference would be is that we could up with a relationship with Covidien longer term that makes sense for everyone but obviously that’s a two-sided discussion and I can’t speak for them.

Operator

Your next question comes from the line of Hank Miller – RBC Wealth Management

Hank Miller – RBC Wealth Management

I know I have sort of asked a little bit about this in the past but I know you’re in quite a lot of pediatric hospitals, have you taken a look to see of the pediatric hospitals how many have neonatal units and what’s your penetration in that neonatal unit is? In other words how much have you got left?

Bruce Barrett

Well within the pediatric hospitals there are about 400 hospitals in the US that have pediatric ICUs but only about 100 of those actually do congenital heart surgery which is where we really have focused over time. So if you look at those 100 accounts we’re in almost all of them in the OR for congenital heart surgeries and then we’re in about 50% of them at this point in round numbers in the ICU to post-operatively monitor the congenital hearts. And then in some smaller percent we’re in there being used more broadly for just other patients that come in to the pediatric ICU.

When you go over into the neonatal ICU there’s very few neonatal ICUs who have used our technology because congenital heart patients, once they go to surgery usually go back to the pediatric ICU so they’ve been monitoring neonates but in the pediatric ICU because that’s who they’ve predominantly been monitoring. There’s been some use predominantly for research in the neonatal ICU and for specific patients with physicians who happen to learn about our technology from their pediatric ICU colleagues. But you can assume that the neonatal ICU at the moment is unpenetrated and all opportunity for us.

Hank Miller – RBC Wealth Management

You touched briefly on the thoracic surgeons database, I know in the past you’ve commented that that was hopefully going to be a database you could draw on in your sales presentations, where do we sit with that as far as when do you expect that to be something you’d actually have a salesman go in and suggest that the I guess the anesthesiologist or the surgeon whomever, draw on that database to draw conclusions as to whether they should be using your product.

Bruce Barrett

I think you’re looking at a 2009 timeframe for anything to come out of the database. They’re going to want to obviously enroll 1,000s of patients. It’s a registry so the game with the registry is to get lots of numbers and then go look at the data and start parsing it to see what—mining it to see what you find. Domenic and his team is working with some thought leaders in the field to mine the data when we get enough enrollment to start looking at it to see what it says but I think realistically its going to be 2009 before you have enough enrollment that you can really make anything out of the data.

If it’s positive then once it’s presented, it would carry a certain amount of weight and once it’s published, which probably wouldn’t even by 2009 more likely 2010, it would carry even more weight. In the interim, what we can say about the STS database is that it was an evidence based decision for the STS to include cerebral oximetry in the database which suggests it has merit. It certainly gives it some creditability. And we do have accounts that are in evaluation right now because they want to use the technology because its part of the database and they think that gives it the kind of the creditability that suggests they should be using it so they can help include data into the database because they participate with whatever goes in the database.

So there has been some positive affect of it. Obviously based on our sensor growth rate in adults it’s not been substantial at this point. But we do think there’s more going on in the adult cardiac market for us then what’s been reflected in the first half numbers.

Hank Miller – RBC Wealth Management

I know when you got included in the STS database that was a big event and hopefully it will be a big event as we go forward, are there other groups maybe within the pediatric or anesthesia or whatever that you’re working with to try to get inclusion there. So who would we be looking at?

Bruce Barrett

I would say that yes there are other groups that we have targeted. I would not suggest who they are on conference because for competitive reasons I’d rather not.

Operator

Your final question is a follow-up from the line of Charley Jones – Barrington Research

Charley Jones – Barrington Research

In the past you’ve mentioned that you have a few accounts, handful of accounts in your pediatric ICU customers that use sensors in pretty much all the patients that come in the door and that are admitted, do you expect a larger percentage of your neonatal ICUs to use a larger percentage of sensors on their patients? Do you think its going to be a situation where maybe we do use it and a majority of patients, or is it still going to be kind of niche just for these specific applications you’ve discussed so far?

Bruce Barrett

I think initially it’ll more likely then not be niched into specific applications just because the data needs to develop I think to support the kind of investment that would be required to use it more broadly. That’s not to say we won’t have examples of customers who want to use it broadly. And then I think it depends on which applications bare out. For example, if NEC, the bowel ischemia application proves itself out, which anecdotally we have exciting things that have happened with our technology in terms of identifying patients who are at risk of NEC, identifying patients who people thought had NEC and then it turns out that they didn’t and our monitor suggested they didn’t, we’ve got some early experience that suggests that may pan out.

But if the data really supports that you can either identify patients at risk of NEC, use this to help manage patients from developing NEC to a point that it has the same morbidity and mortality that it has today, or even just by identifying whose at risk of NEC, also identify which babies you could be feeding. Because they withhold feeding from a lot of pre-term infants because they’re fearful that the feeding itself can perpetuate NEC and so you have all these babies who really need to grow but they can’t give them nutrition because they’re scared they might develop NEC but they don’t know which ones.

So there are lots of opportunities in that whole area for monitoring oxygen in the bowels and identifying hopefully whether or not people are at risk of NEC and then helping to manage them. If that pans out then I think you’re going to have very broad usage throughout neonatal ICUs because that is a tragic problem. Its one that you can’t recognize readily until it’s usually a little bit too late. And while it’s more common in the early gestational aged patients, when it does occur in the older gestational aged patients, those are the ones where you think everything is going well and then all of a sudden you have a death.

So I think you could see an application like that, that’s just one example where it could be used broadly. Other places it could be used broadly is just a question of whether or not its worth the price point at the moment, would be for example just managing your blood pressure. No one knows what the blood pressure ought to be on a neonate. All they know is that you need pressure to push blood and oxygen to all the organs but when they have a blood pressure and they increase it, they don’t know if the increased blood pressure is increasing or reducing profusion to the end organs. Theoretically and we’ve demonstrated it certainly with our piglet model if you put these sensors in various locations of the body, you can see exactly if you’re improving or reducing the distribution of blood to the various parts of the body and see exactly what your therapeutic interventions are doing.

So there’s a lot of just common sense sort of things that have to be proven out I think in research for broad adoption but are exactly the sort of things that people are eager to try it for because it just makes sense. They don’t have this information and now they can get it non-invasively which is essentially risk free with a new technology that they just have to understand how to apply it.

Charley Jones – Barrington Research

Are you already getting a sense from the early signs here that this could be standard of care or is it just far too early for that or maybe another way to characterize that is if you look at these three markets, do you feel like neonatal is probably the most likely at this point to become standard of care because of the positive feedback because the data that you’ve seen even though it does need to be borne out over time through larger studies, could you characterize that for us?

Bruce Barrett

Well we’re certainly more optimistic about this market. It’s very much in our eyes like the congenital heart market. One might argue that we’re pretty much standard of care for congenital hearts as it is and certainly for certain segments of the congenital heart market. It’s a market that communicates well with each other. They’re eager to do research to see how they can improve the outcomes of these babies and you see the same thing with the neonatal ICU. You see people are really hungry to improve outcomes and who communicate well amongst themselves. So I think just the amount of research that’s already starting with this technology now that the sensors are a little bit—quite a bit more readily applied with the design for the infants, you’re seeing a lot of research take off and if we just follow that research where its going is is that there’s a lot of studies that are starting just in the concept of looking at NEC.

So there’s a whole lot of interest there. It’s a wide spread problem and if they can prove something there it’s a great opportunity for standard of care. There are also studies going on in other applications that could be maybe not quite as large, but for example shock, just the use of it in identifying that you have a patient going into shock and helping them manage them out of shock. That could be a fairly wide spread application so we just have to kind of follow the research that’s going on and it gives us reason to be positive that we have a good shot in this market just based on the overall dynamics of it.

Charley Jones – Barrington Research

Have you been told what percentage of the neonatal patients that are admitted either have NEC, bowel ischemia, kidney failure, shock, the different things that you have already seen that you can be somewhat helpful with, do you get an idea of what percentage of the neonatal patients that is?

Bruce Barrett

We have some indication. It’s very variable depending on demographics of a particular region whether or not you’re in an area where there’s good prenatal care, not good prenatal care, those sorts of things. It can vary dramatically even hospital to hospital but certainly region by region. But we have a good sense of what it is but the reality is is that a lot of—you don’t know who is going to have it if you look at NEC. Its more common in patients of gestational age between 24 and 28 weeks but when it happens to the 30 and 32 week gestational aged babies, it can be catastrophic so even if it happens less often, it’s not easily identified and it’s very expensive.

A baby that develops NEC ends up being in the hospital I think in an incremental 40 days if I recall the number correctly, so it’s a very expensive problem as well. We are getting at some of that data with certainly the applications that we’re interested in. And we have the benefit of we’re sort of starting from scratch so everything is upside from here at least near-term but we need to get the data as we move forward so that we can really say that this should be used more broadly.

Charley Jones – Barrington Research

So even though NEC may only occur in 10%, 20% whatever the percentage is, you may have to put it on pretty much all of them to find out which of those 10% to 20% are developing NEC because and its probably profitable to the hospitals anyway because if they have a 40-day length of stay that you can decrease and maybe make up the difference in all the patients. Is that the idea?

Bruce Barrett

Yes especially if you can show that you can identify it and may not just be the NEC patients that you help, it could be the patients that you thought were at risk of NEC but you withheld feeding and now you can feed them for example and those do better because they’re able to get nourishment and their organs can grow and they can do better as well. So we don’t know exactly what the story line is going to be until we have the data I guess is what it boils down to. But those are the most promising sort of applications as it relates to the NEC opportunity.

Operator

Mr. Barrett, there are no further questions; I’ll turn the call back over to you sir for any additional or closing remarks.

Bruce Barrett

Thank you very much. I have no additional or closing remarks other then to thank you for joining our call and we look forward to reporting back to you again next quarter. Thank you.

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Source: Somanetics Corporation F2Q08 (Qtr End 05/31/08) Earnings Call Transcript
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