Sonic Innovations Inc. Q2 2008 Earnings Call Transcript

Sonic Innovations Inc. (SNCI)

Q2 2008 Earnings Call Transcript

August 5, 2008 5:00 pm ET

Executives

Mike Halloran – VP and CFO

Sam Westover – Chairman, President and CEO

Analysts

Josh Zable – Natixis Bleichroeder

Andrew [ph] – Stephens Inc.

Sam Bergman – Bayberry Capital

Gary Siperstein – Eliot Rose Asset Management

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the second quarter Sonic Innovations earnings conference call. My name is Sue and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. (Operator instructions) I would like now the turn the presentation over to your host for today’s call, Mr. Mike Halloran, Vice President and Chief Financial Officer. Please proceed.

Mike Halloran

Just for those of who, who have joined (inaudible) Sonic Innovations second quarter 2008 conference call.

I would like to just give a brief before we move into a review of the second quarter and our thoughts on the future, I'd like to remind everyone that during the course of this conference call, we will offer projections and other forward-looking statements regarding future events and the future financial performance of Sonic Innovations. I wish to caution you that these statements are just predictions and that actual events or results may differ materially and adversely.

I refer you to the documents we file from time to time with the Securities and Exchange Commission and specifically, the section entitled, "Factors that may affect future performance," included in Part 1, Item 1A of our annual report on Form 10-K for the year ended December 31, 2007, and Part 2, Item 1A of our 2008 quarterly reports on Form 10-Q, which identifies important factors that could cause our actual results to differ materially and adversely from those contained in our projections and forward-looking statements.

With that Safe Harbor statement, let me turn the call over to our President and CEO, Sam Westover. Sam?

Sam Westover

Thank you, Mike. Good afternoon and welcome to our earnings call. There is a lot going on in Sonic Innovations right now. We are aggressively growing our strategic businesses and eliminating non-strategic activities. As we announced last quarter, we are cleaning up parts of the company that are inconsistent with our strategy. To remind you our strategy is to produce great products, deliver superior service, and vertically integrate.

Our products have the best sound processing, leading noise reduction and excellent feedback cancellation. Sue, I am told that I can’t be heard is that true?

Operator

Your line is open. Let me see. Let me go and check it out right now. Okay, your line is open.

Sam Westover

All right. I think we had some technical difficulties here. So, let me start at the beginning. So, again there is a lot going on at Sonic Innovations. We are aggressively growing our strategic businesses and eliminating non-strategic activities. As we announced last quarter, we are cleaning up the parts of the company that are inconsistent with our strategy. Our strategy is to produce great products, deliver superior service, and vertically integrate.

Our products have the best sound processing, leading noise reduction and excellent feedback cancellation. They are small and easy to use. We have launched 2 products this year and we are launching 3 new products this week. We will launch 2 more products by the end of the year. Our customer service is consistently rated as world class and the best in the business. Our vertically integrated businesses grew during the second quarter to 47% in revenue and 27% in operating profit, significantly above the market. More than 60% of our revenue is from vertically integrated businesses. So our strategy is working. The elimination of non-strategic activities is going very well and almost finished. We will have eliminated 50 employees when we are done. We have outsourced our Danish sales and administration. We have consolidated our UK office into our German office. We have discontinued our unprofitable domiciliary business in the Netherlands. We are in the process of disposing a few old retail stores that did not fit into our long-term strategies. These actions improve our profitability going forward and facilitate our ability to focus on our strategic operations.

The operating expenses and restructuring charges mask the underlying improvement in the profitability of the company. As the dust settles, we have a much stronger focused and profitable business. Mike is going to discuss the historical numbers in a minute, but I want to take a moment and help you see through the dust because we have an uncommon market opportunity for you. We have included a schedule in the press release titled non-GAAP adjusted net income and earnings per share. This schedule breaks out our continuing activities as though our restructuring had taken place in 2006 instead of 2008. So, you are able to compare the 2008 results excluding the restructuring with the comparable numbers in 2007.

We adjusted the restructuring charges, the related revenues and expenses. We believe that this will help you see the new direction of the company and today’s opportunity. So, I am very proud of the progress that we have made in the first half of 2008 compared to the same period in 2007. Adjusted revenue, this is from the non-GAAP schedule, adjusted revenue increased 20%, operating income increased 181%, and net income improved a remarkable 314%. Net income increased from $291,000 to $1,204,000. The gross margin is flat and operating expenses as a percentage of revenue declined from 62.8% to 61.7%. This schedule, which excludes the restructuring charges and related expenses and revenues, provides a clear perspective of our future and we feel very proud of these outstanding results. There will be about $600,000 of additional restructuring charges in the third quarter, which should wrap up the transition. We expect the second half of this year to produce earnings that are exceptionally strong.

We are continuing to make acquisitions. Since our last call, we have acquired $1.6 million in retail revenue for a total of $5.8 million this year. There has been no change in our pricing discipline. We are now targeting $10 million of acquisition this year. This target allows us to focus on restructuring and eliminates any consideration of raising capital in the current environment.

In the first quarter, we launched a new product called ion 400. Ion 400, the newest member of the ion family of products, adds handsfree automatic feature to the market’s smallest micro BTE, behind the ear, product. In addition, ion 400 provides excellent moisture resistance. In laboratory testing ion 400 outperformed all competitive products tested when subjected to extreme moisture and humidity conditions. Ion 400 also offers voice alerts, automatic and adaptive directionality in a robust adaptive feedback management system.

In April, we launched another product called Velocity mini. The new Velocity mini BTE is the smallest full featured behind the ear product on the market. The mini BTE extends the premium features found in Velocity into a form factor that offers both open ear and standard fittings, a powerful fitting range and extendable functionality such as bluetooth and direct audio input support.

This week, we began shipping 3 new products in the Velocity family, Velocity 4, Velocity 12, and Velocity 24. This family of products offers a range of prices and features. Velocity 4 is targeted at the current economy where some consumers are looking for lower priced alternatives. Velocity 24 is our newest high-end product and Velocity 12 is a midranged product. The Velocity series provides solutions designed to meet each patient’s individual lifestyle budget and hearing needs. Every Velocity product features Sonic sound digital processing that provides exceptionally natural sound. Velocity’s noise reduction goes beyond simply providing a comfortable listening experience and actually improves speech understanding and noise. All Velocity products offer directional technologies to improve hearing in noisy situations. Velocity 24 and Velocity 12 have additional automatic and adaptive directional options that provide handsfree operation in a wide variety of listening environments. During the remainder of this year, we will be releasing 2 more products for a total of 7 products this year. We also have products in development that are planned for release in the spring.

To summarize, over the past quarters we have grown revenue substantially, increased gross profit, and reduced SG&A expenses, but not enough. This quarter we are reducing our going forward SG&A expenses through our restructuring activities. Restructuring hurts when you do it as you see in this quarter’s results but will be more efficient and productive going forward and you will see the benefits in our second half profits. Our strategic is working. Vertically integration continues to produce impressive returns growing 47% in revenue and 27% in operating profits. Our service levels are the best in the business and we continue to produce great products with new features and benefits.

After Mike goes through the details of the financials we will open the call for questions. Mike.

Mike Halloran

Thank you Sam. In summary the second quarter was a transition quarter for Sonic. We made considerable progress with our restructuring program as Sam indicated. We are in the process of eliminating unprofitable businesses and customers and reducing head count by more than 50 positions. The operating loss associated with the location subject to the restructuring was $0.7 million in Q1 2008, $1.2 million in Q2 2008 and is expected to be $0.2 million in Q3 2008 and then turning to a profit of $0.1 million in Q4 2008. That is a $1.2 million loss this quarter swinging to $0.1 million profit in Q4 2008. The primary driver of the incremental loss in Q2 2008 over Q1 2008 was the write-offs of inventory and accounts receivable of about $0.4 million and the improvement in Q3 and Q4 obviously as the restructuring is complete.

There is a high degree of confidence with the forecast because that we have little expense exposure and we are conservative in our expectations on what revenue we will retain once the restructuring is complete. The restructuring costs are expected to finish at $4.4 million for 2008 an increase of $0.6 million from our Q1 2008 expectation. The increase is a result of selling some old retail locations that did not fit into our long-term strategy. The Q1 expectation was $2.5 million in cash and $1.3 million in non-cash charges. The total will now be $2 million in cash and $2.4 million in non-cash. This is a savings of $0.5 million in cash from our first quarter projection. In addition, the restructuring charges we reserved $0.4 million for inventory and accounts receivable as previously stated but these are recorded as operating expenses. This restructuring activity will have a payback of less than 1 year. In addition to the costs previously mentioned we incurred $1.1 million in expenses associated with the annual AAA convention in Q2 2008 and this is an increase of $0.2 million over 2007.

As for future guidance, I expect quarterly sales for Q3 and Q4 to be in the $33 to $35 million range after restructuring and net income to be $0.03 to $0.05 per share. The $0.03 to $0.05 per share excludes the $0.6 million in restructuring charges in the second half of 2008 and the expected reversal of the reserve of Australian deferred income tax assets, which I will explain later.

Total sales for the year will be approximately $135 million. The reduction in sales from our previous guidance is due to matching our acquisition activity with capital availability and cash generation. Our original guidance for acquisitions was $20 million. It is now $10 million. I will now go through more detail of operations.

Net sales in the second quarter 2008 were $35.3 million, up 16.2% from second quarter 2007 net sales of $30.4 million. Year-to-date sales increased 13.2% over 2007. Once again, operations where we have vertically integrated did extremely well with sales growth up 47.4% and 43.5% for the 3 and 6 months ended June 30, 2008, respectively over the corresponding period. This demonstrates the company's vertical integration strategy is growing sales at a high rate and with our increased focus on profitability this should improve as well.

By segment, North American second quarter sales of $12.3 million increased $0.5 million or 5%. In order to improve North American wholesale sales, we are launching this week a new product series in the mid and low price category to meet our customers needs. Given the slowdown in the US economy there is clear pull to lower priced products.

European sales of $14.7 million increased 15.4% over 2007 second quarter sales of 12.8. Excluding operations subject to our restructuring European growth rate would have been 34%.

Rest of world sales of $8.3 million in the second quarter of 2008 were up $2.5 million or 41% from 2007 sales of 5.8 [ph]. This was a record for rest of world sales. Rest of world sales year-to-date has increased 35.1%. We opened new retail locations in 2007 and have increased our marketing and selling efforts.

Gross margin of 62.4% for the second quarter of 2008 was down 1.3% from last year’s second quarter margin of 63.7%, but on a year-to-date basis gross margin has increased from 62.5% to 63.1%. The reduction in second quarter was due primarily to two items, lower average sales prices in North America and a $0.3 million write-off of inventory and equipment. I expect gross margin in Q3 and Q4 2008 to be approximately 63% to 64%.

Selling, general, and administrative expense in the second quarter of 2008 of $20.3 million was up $2.8 million from last year's second quarter level. SG&A expenses increased mainly due to $1.9 million growth for the vertical integration initiative, including acquisitions and integration costs, and $1.3 million for foreign currency, and in all other areas was $0.4 million reduction. Selling, general, and administrative expenses as a percentage of sales for the second quarter went down 2.6% year-over-year if you exclude restructuring and operations subject to the restructuring. On a year-to-date basis it is essentially flat at 54.5%. Further excluding acquisitions in 2007 and 2008, SG&A expense as a percentage of sales decreased 4.1% for the quarter ended June 30, 2008, over the previous year and decreased 1% year-to-date.

Total restructuring cost in 2008 as previously said would be $4.4 million; $0.6 million would come in the back half. Total cash payments will be $2 million and non-cash will be $2.4 million. The non-cash charges relate to goodwill and intangibles associated with two European operations.

R&D expense in the second quarter 2008 and second quarter of 2007 was $2.2 million. We expect research and development expenses to be between $2.1 million to $2.3 million per quarter going forward.

Operating loss was $3.6 million for the second quarter of 2008 and $4.2 million year-to-date compared with $0.3 million loss in Q2 of 2007 and a year-to-date gain of $0.4 million. Three things drove this change. First, the 2008 restructuring and intangible write-offs of $3.2 million for the quarter and $3.8 million year-to-date. Second the continuing softening in North America wholesale sales, primarily resulting from the downturn in the US economy as we discussed in the past 2 quarters. And finally European operations that are subject to our restructuring activities. Partially offsetting this is the improvement in those geographies where we are vertically integrated. Excluding restructuring costs and the related operations, our net income would have improved on a year-to-date basis from $0.3 million to $1.2 million.

Other income loss was a loss of $0.1 million in Q2 2008 and year-to-date income of $0.3 million. We expect other income loss to be a loss of approximately $0.1 million per quarter in Q3 and Q4.

We had an income tax expense of $0.3 million in the second quarter of 2008 and $0.6 million year-to-date approximately the same as last year. I would expect our income tax provision to be roughly $0.4 million in Q3 and Q4 because of foreign locations driving the tax are profitable and we use a transfer pricing method based on net sales. I want to remind everyone that last quarter we stated we have a reserve against deferred tax assets in our Australian operation and based upon our projections the approximate $1.3 million reserve will be reversed to income in Q3 2008.

Our net operating loss carry-forwards are approximately $21.5 million in the US and $19.2 million in the balance of the world.

Our European restructuring activities and the company’s focus on reducing costs will improve our forecasting accuracy because of the volatility in those locations subject to this program.

Accordingly, we are improving the company’s earnings dependability and expect to be more consistent in delivering profits and increasing earnings per share.

Basic weighted average shares outstanding for the second quarter were $27.3 million in 2008 versus $26.5 million in 2007.

Turning to the balance sheet, we generated significant cash this quarter in operations with our focus on managing cash and working capital. Our operating cash flow this quarter was $4.4 million. We reduced receivables and we also implemented a plan for reducing inventory, the benefits of which we will realize in future quarters, not in Q2. This could lower inventory $2 million from today’s level.

As of June 30, 2008, cash and marketable securities totaled $15.2 million. As of March 31, 2008, approximately $5.2 million of our cash balance was restricted for collateral for a loan. In Q2 2008 the collateral requirement was eliminated. Therefore all $15 million is available to fund acquisitions and operations.

We also have available and currently unused a $6 million line of credit. And finally, we have no intentions of raising capital at a stock price of $2.60.

At this time, we would like to take questions.

Question-and-Answer Session

Operator

(Operator instructions) And the first question comes from the line of Josh Zable from Natixis Bleichroeder. Please proceed.

Josh Zable – Natixis Bleichroeder

Hi, guys. Congrats on a great quarter here and thanks for taking my question.

Mike Halloran

Thank you.

Sam Westover

Thank you, Joshua.

Josh Zable – Natixis Bleichroeder

Just a couple of quick housekeeping, before I get to the questions Mike, I just wanted to make sure, did you say SG&A for the third and fourth quarter you are looking for what? I am sorry. And then also I think you gave you said $0.03 to $0.05 per share on the third and fourth quarter, I just want to make sure I heard that. So that will be profitable both in the third and fourth quarter?

Sam Westover

Yes, we anticipate being $0.03 to $0.07 per share profitable excluding two factors, one would be the $600,000 we expect in the second quarter for – in the third and fourth quarter for restructuring and the $1.3 million reversal for Australian deferred tax asset, the reserve.

Josh Zable – Natixis Bleichroeder

That is pretty impressive guys, awesome work there. And then just Mike when you get a chance (inaudible) with the SG&A. I know you are looking through it, so just when you get a chance. I will ask my other question here.

Mike Halloran

I will do.

Josh Zable – Natixis Bleichroeder

Just in general on the market growth here, I mean, you guys actually grew by around 5% in North America, I know, typically market growth is 5% to 6%. Obviously you always want to grow faster than market, but are we seeing any sort of pick up in the market or is the market kind of slowed down and you guys are taking share? Can you just give us a little bit of color what you are seeing out there in general market trends?

Mike Halloran

Sure. The market in North America is still soft. The – actually the industry numbers excluding the VA show it is shrinking a little bit. So, we are very pleased we have been able to show growth in a pretty tough environment. And it is not unlike other retail activities in North America. So, it is a difficult environment. Now in the rest of the world, it is a little bit different because the economies are a little bit better and there is also the government subsidies of hearing aids there. So, in some markets you can get a free hearing aid. So, it doesn’t really matter if the market is soft, but in the US there is no reimbursement. So, it is a fee for service environment.

Josh Zable – Natixis Bleichroeder

Right then it leads right into my other question, I mean, outside the US you guys are really kicking some butt here, you know, kicking butt a lot of things have to go right, so clearly you are doing a lot of those things right, but can you just help us understand is it that your product portfolio was strong or is it execution, is it sales and marketing, I mean, you guys are a lot smaller player than a lot of the big boys out there, but you seem to be doing some damage out there. So, can you just give us a little bit of color?

Sam Westover

Sure. First of all, there is no one answer. It really is the combination of everything coming together and we are very strong as a vertically integrated company outside the US. So, I think it just shows the power of being able to go all the way from designing new product to manufacturing it to distributing it right to the customer. We control the entire channel and when we do that we can provide a very high quality experience to the customer and people can tell the difference. So, we are becoming more and more popular and better accepted in these markets and we are going to be doing the same thing in the US, just the newer activity.

Josh Zable – Natixis Bleichroeder

Well, congrats guys. Mike, just – I will let someone else get the question, just follow it out when you get a second?

Mike Halloran

Joshua, I would say about 54% what we are looking at as SG&A as a percent of sales.

Josh Zable – Natixis Bleichroeder

Awesome guys. Congrats, I know it is a tough environment out there, but you guys are doing a great job. We really appreciate it.

Mike Halloran

Thanks Joshua.

Sam Westover

Thank you Joshua.

Operator

And the next question comes from the line of Shawn Fitz from Stephens Inc. Please proceed.

Andrew – Stephens Inc.

Good afternoon guys. This is actually Andrew [ph] for Shawn. Just a couple of quick questions for Mike. Could you – you might have already given these numbers, what was the currency impact in the period and then secondly the acquired revenue [ph] in the period?

Mike Halloran

Good question. So, you are talking for year-to-date or for the quarter. You just want the quarter?

Andrew – Stephens Inc.

Just the quarter.

Mike Halloran

The quarter year-over-year increase is $2.3 million for acquisitions or 7.6% of our growth and the foreign currency is 7.4 million or 7.4%, excuse me.

Andrew – Stephens Inc.

Okay, great. Thanks a lot.

Mike Halloran

Okay.

Operator

(Operator instructions) And the next question comes from Sam Bergman. Please proceed.

Sam Bergman – Bayberry Capital

Good afternoon Sam and Michael. How are you?

Mike Halloran

Good.

Sam Westover

Hi, Sam.

Sam Bergman – Bayberry Capital

A couple of questions regarding the retail stores. Can you give me a count of retail stores in the US and a count for overseas?

Sam Westover

Well, let us see. I am guessing. Mike correct me. We have got about 40 in the US and about 45, 50 overseas. Well, it is all a bit different – actually we have got a few hundred overseas. So it is difficult to – there are not all owned and retail but we have retail locations where we provide care. So, we own 45, 50 of our own – not it is still higher. Sorry, 50, 55 of our own and then we have got 200, 300 locations where we provide service.

Sam Bergman – Bayberry Capital

And the ones that were closed were in the United States or the ones that weren’t making money or were there overseas?

Sam Westover

They were overseas.

Sam Bergman – Bayberry Capital

They were overseas. The ones you bought in ’07 and early ’08. How would you compare their sales figures quarter-over-quarter since the purchase?

Sam Westover

It is mixed. So, we purchased them in various geographies around the world. So, some are doing very, very well where they are up I don’t know, I don’t even have the good numbers.

Mike Halloran

Yes, I can say probably it depends on the location. Some we have had success; I would say probably 10 – plus 10% in some locations, maybe as much as 15%. And then there are other locations where it is probably down 20% to 25%. So, it is a wide range and there is a number of factors Sam that go into that. One obviously is the retention of the audiologist and secondly is the marketing and consistency of the marketing.

Sam Bergman – Bayberry Capital

In the wholesale business in the 3 products that are expected to be out in this coming quarter, do you have any idea of what that should add to revenue on a – over the next 6 months?

Mike Halloran

It is difficult to predict new quarters but we have been listening to the market and there has been a strong request for different features in lower end and mid priced products. So, we have developed these products that we think are exactly what the market is looking for and we are very optimistic, but we haven’t launched them yet. They will probably be – they will start being shipped tomorrow or the next day and we will see how they do, but new products usually give a bump to revenue and to the bottom line. So, we are optimistic. I don’t know if you want (inaudible).

Sam Westover

I – it is tough to tell about the impact. Tough to tell Sam, you know, clearly it is meeting the market need and any time you are meeting the market needs your sales should increase. On the other hand there are a number of things that are going on in the reverse side, acquisition – we are doing acquisitions of retail, our competitions is doing acquisition of retail. So, there are a number of factors going on in the economy where we are at the bottom of the economy, in the expectations of the economy. So, – but clearly the things we can control we are improving in doing.

Mike Halloran

And one of the core philosophies of our company is exceed customer expectation and profit [ph]. So, we listen very hard to the customers and this is exactly what they have asked for.

Sam Bergman – Bayberry Capital

And just one last question, in terms of the alliances that has been put together in the past, any of the alliance partners getting these product in the third and fourth quarter?

Sam Westover

Yes, they will. Actually they all will. So that should be a plus. Some of the alliance partners are taking some pretty big hits here in this economy. So, some of them aren’t doing as well as we are, which is unfortunate. We feel their pain but we are helping them giving them what they need.

Sam Bergman – Bayberry Capital

How does that compare to prior quarters when you had new products, in terms of what they took from you from the range of new products? Is it greater or is it about the same?

Sam Westover

You know Sam it is hard to tell. We just were launching the products this week. So we don’t have any experience yet and then secondly we in the past it depends on what products you are launching. In the past, if we launched a new chip we would have a large launching event, spend maybe a million dollars like we did last year. We launched Velocity. We spent a million dollars, had a bunch of people fly into a location. With these new products we are not having a huge launch party but clearly we are advertising them strong through other methods. Costs will be down, probably sales we won’t have as big a bump and you can see those bumps in our history from when we launch products we won’t have as big a bump but I believe the net profit will improve because costs aren’t going to be as heavy but yet we will have an incremental sales.

Mike Halloran

Normally, we like to launch products in the spring and in the fall. But there was such as need for this particular product line that we accelerated the release of the product, which would have been in October. We moved that now to the first part of August. August isn’t a great time because lot of people are on location but the need was so big that we wanted to get it out as soon as possible. We haven’t ever released a product in August before. So, we will see what happens. It is all positive. It is just a question of how positive.

Sam Bergman – Bayberry Capital

So then when is the next new chip set coming out for Sonic. It is next year?

Sam Westover

It will be either late next year or the beginning of the following year.

Sam Bergman – Bayberry Capital

Okay, thank you very much.

Sam Westover

Thank you Sam.

Operator

You have a follow up question from Josh Zable from Natixis. Please proceed.

Josh Zable – Natixis Bleichroeder

Hi guys. Thanks for the follow-up here. Just a quick one on the retail strategy, you said you are keeping your pricing discipline. I know you obviously have a lot of stuff going on which makes sense that you are focusing on profitability before expanding and doing those things. That makes sense to me. Can you just help me understand if the pricing of the assets maybe more attractive to you right now or just what you are seeing out there, even with the remainder of $10 million?

Sam Westover

Sure, actually it is a little bit less attractive right now which is counterintuitive. I think a good analogy is if you are selling your house right now, you would really like to get last year’s price but it is just not available, and practices we are looking at, they are operating in a tough environment. Their earnings are down, therefore we are not willing to pay as much but they wish it was last year. So, I think there is a little bit less incentive to sell right – or it is a little harder to get a deal done right now than it would have been last year because we are not going to overpay. And if the practice isn’t doing as well, we are not going to pay as much for it.

Josh Zable – Natixis Bleichroeder

Well, guys, that is helpful. Thanks again, congrats.

Sam Westover

Thank you.

Operator

And the next question comes from the line of Gary Siperstein from Eliot Rose Asset Management. Please proceed.

Gary Siperstein – Eliot Rose Asset Management

Hi, guys congratulations. Great progress.

Sam Westover

Thanks Gary.

Gary Siperstein – Eliot Rose Asset Management

Sam, I think you – I got disconnected for a few minutes there. So, if this was asked I am sorry about that.

Sam Westover

I think we did too.

Gary Siperstein – Eliot Rose Asset Management

Okay, you mentioned the non-GAAP figures on the I guess the fourth page of your printout, the news release, growing $5.7 million in adjusted net income versus $1.2 or $0.21 a share. So that is if you take the restructuring charges and the one-time charges including Europe and everything and do it backwards retrospectively what you would have earned otherwise. So, is that correct then in assuming once we finish this year with the additional restructuring charges coming up, I mean that implies about $0.105 a quarter, $0.21 per 6 months, is that appropriate the way I am looking at it and can you annualize that $0.10 quarterly rate at some point next year?

Sam Westover

Go ahead.

Mike Halloran

Yes Gary, you are looking at it correct,. In addition we had $1.1 million in second quarter for the AAA that we don’t have in the back half for the year. So, you are correct. We are looking at it if it is $1.2 million that is $0.04 per share would be averaging 2. If we had the $1.1 million, I would give you from the AAA show it would say it is probably about 2.2 and that is about $0.04 per share per quarter.

Gary Siperstein – Eliot Rose Asset Management

Okay, and then the $0.21 then is the adding backward [ph] to restructuring.

Mike Halloran

That would just be the restructuring charges, the one-time charges.

Sam Westover

In our business, all the activities that are nonstrategic, we pulled out the revenue associated with those, all the costs associated with them and their restructuring charge. So, you could see what the quarter really looks like for the ongoing operations. So, the as adjusted numbers for ’08 compared to ’06 or ’07 show you how we are really doing.

Mike Halloran

It is like Gary if we did the restructuring program in late 2006 and we are done with it as of January 1, 2007, those two columns the far righted columns would be what we would be reporting today.

Gary Siperstein – Eliot Rose Asset Management

Okay, because next year you will be at AAA just probably at a lower level of expense.

Mike Halloran

That is correct Gary. (inaudible) And it would be a lower rate. This year ultimately it was about $1.2 million, $100,000 in the first quarter, $1.1 million this quarter. Next year we plan on probably 3 to 4 as much as $500,000 less.

Gary Siperstein – Eliot Rose Asset Management

Okay, super. So, again maybe I am just missing something. So it is not $0.10 a quarter? The $0.21 for the 6 months is not $0.10 a quarter, because you will be AAA next year?

Mike Halloran

Yes, if you go to far right column the $1.2 million that is kind of the key of what we will be reporting next year.

Gary Siperstein – Eliot Rose Asset Management

Okay, super. And at one point we were – and again I don’t know if this was asked, there was some US government program that we weren’t selling into or weren’t?

Sam Westover

All right. That is the Veterans Administration. The VA will be we think will be sending out their RFP in the October timeframe and we will responding to that RFP and the award for that business will be second quarter of next year or – or not, yes second quarter of next year. So we will be responding to that and that could be a big pickup in business. It is odd that a US company isn’t allowed to sell product into the VA when there are only two US companies.

Gary Siperstein – Eliot Rose Asset Management

Okay right. The current vendor is international.

Sam Westover

That is right. Well there are 5. Is that right?

Mike Halloran

They are 5 vendors.

Sam Westover

They are 5 different suppliers and 4 of them are international. One of them is a US supplier.

Gary Siperstein – Eliot Rose Asset Management

Okay. So, we are doing things whether it with our Congressman or whatever facilities we have to try to enhance the ability of the other US manufacturer to participate?

Sam Westover

We are – unfortunately we got a new Congressman in the middle of our project, but we will work with that too. So, we know the people really well. It is a small industry and I know the head of the VA, and we have had ongoing discussions with him for a long time.

Gary Siperstein – Eliot Rose Asset Management

Okay. And what is the size of that contract.

Sam Westover

It is about 200,000 units a year.

Gary Siperstein – Eliot Rose Asset Management

Provided by 5 vendors?

Sam Westover

And if you figure those 2 million units sold in the US, it is about 10 – somewhere 10% and 15% of the market.

Gary Siperstein – Eliot Rose Asset Management

And that totaled those divided assuming they give it to 5 vendors again?

Mike Halloran

Correct.

Sam Westover

That is right.

Gary Siperstein – Eliot Rose Asset Management

Okay.

Sam Westover

And if we get the contract there is not a guaranteed number of units, but it gives you license to hunt. To go out and talk to their audiologist and convince him to choose your product.

Gary Siperstein – Eliot Rose Asset Management

Okay. And last you know you talked about valuation and you mentioned obviously the unwillingness to do financing down here, but we have a situation where you have almost $6 per share in sales, you know recession which would grow at some point and you know substantial earnings power and cash flow generation ability. At what point Sam would there be an expectation you know now that you are Chairman as well, to get the board to show some insider buying and or to augment when as the cash flow continues to increase, augment the domestic M&A with a buyback with the stock at crazy levels.

Sam Westover

The stock is at a crazy level and we have done the analysis and the vertically integration activity produces a better return for our shareholders than a stock buyback does. So, we are going to continue to pursue that, but we are not going to do it at the levels that would require us to go out and raise capital in the market place at these prices. So, that doesn’t make sense. And in terms of officers buying shares, you have seen some officer buying, I think earlier this year and so you have all the advantage you can’t buy shares whenever you want. We have restrictions that we have to go through. So, I know there is enthusiasm here, but we have to clear it with the council before we can do that just based on what we know about what is going on inside the company and it is frustrating when you have a situation like this where so many good things are happening that you know about and you can’t do anything about it, but that is just a way to us in today’s new regulatory environment.

Gary Siperstein – Eliot Rose Asset Management

Okay, thanks guys. Congratulations again on the improvement.

Sam Westover

Thanks Gary.

Operator

Now, this concludes the Q&A session. I would like to turn the call back over to Sam Westover for final comments.

Sam Westover

Well, thank you very much. Thanks for your continuing interest in Sonic Innovations. We feel very proud of the progress that we are making, although this quarter’s income statement has some dust in the air around it. Hopefully we have been able to explain so you can see through that and see clearly that the company is making very good progress. Our strategy is working very well and there is a significant market opportunity here with the stock at $2.60. So, we are demonstrating consistent substantial growth. Our cost cutting efforts are positioning us for strong earnings performance. So, we look forward to another greater quarter going forward and we look forward to updating you on our further progress in November. So, I wish you all a good day.

Mike Halloran

Thank you. Thank you, Sue.

Operator

Thank you for your participation in today’s conference. This includes the presentation. You may now disconnect. Good day.

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