I-Flow Corporation Q2 2008 Earnings Call Transcript

I-Flow Corporation (IFLO)

Q2 2008 Earnings Call Transcript

August 5, 2008 11:00 am ET

Executives

Donald Earhart – Chairman, President and CEO

Jim Talevich – CFO

Analysts

Matt Dolan – Roth Capital Partners

Greg Brash – Sidoti & Company

Bill Miller – J.M. Hartwell Limited Partnership

Tim Vestal – Kleinheinz Capital Partners

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the I-Flow second quarter 2008 results conference call. During the presentation all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator instructions) As a reminder, this conference is being recorded Tuesday, August 5, 2008.

It is now my pleasure to turn the conference over the Mr. Donald Earhart, Chief Executive Officer. Please go ahead, sir.

Donald Earhart

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

Earlier this morning we announced for the three months ended June 30, 2008, the revenue from continuing operations increased 21% to a record $35.3 million compared to $29.1 million for the same period of the prior year. Sales of Acute Care products, which include Regional Anesthesia, consisting of ON-Q and AcryMed revenues, increased 21% for the second quarter of 2008 to $27.9 million compared to $23 million for the second quarter of 2007.

IV Infusion Therapy revenue increased 22% to $7.4 million for the second quarter of 2008 from $6.1 million a year earlier.

The loss from continuing operations before income taxes for this year’s second quarter was $11.5 million. The $11.5 million loss amount included $12.2 million of certain litigation and insurance charges, including a $3.5 million expense to purchase retroactive insurance policies to significantly increase the company's product liability insurance coverage, and $8.7 million in loss contingency that the company accrued in connection with ongoing litigation. Excluding the litigation and insurance charges, the income from continuing operations before income taxes for the second quarter of 2008 would have been approximately $630,000. This compares to a loss from continuing operations before income taxes of $2.4 million for the second quarter of 2007 and a loss of $1.3 million for the first quarter of 2008.

The solid second quarter revenue growth overall and improved bottom line performance, excluding the litigation and insurance charges are especially noteworthy in view of the weak economy and the resulting fall-off in the number of elective and non-life threatening surgical procedures during the period.

We continued to see published reports and hear anecdotally throughout the quarter that an increasing number of Americans postponed health care. Many people, including those with health insurance, delayed or opted against receiving medical care or elective procedures because of concerns about cost and in some cases, missing days of work.

Our sales force saw the effect of the reported slowdown on scheduled hospital surgeries across the U.S. and had to respond quickly to mitigate the impact on our ON-Q product line sales. By focusing on utilization of our ON-Q family of products for relief of post-surgical pain without narcotics in bariatric, colorectal, thoracic, heart, trauma, and other non-elective and crucial procedures, our team drove the 13% increase in RA revenues versus last year's second quarter. Perhaps more notable and a better indication of the second quarter's performance is the increase in Regional Anesthesia revenues of 15% compared to the first quarter of 2008, despite the continued slowdown in total surgeries, and with little or no change in headcount in our sales organization compared to the first quarter.

The ON-Q C-bloc Continuous Nerve Block System, which is optimized for anesthesiologists and continuous peripheral nerve blocks primarily used for orthopedic surgeries, was a stand-out performer once again in this year's second quarter, just as it has been every quarter since we launched this line extension several years ago.

ON-Q C-bloc sales increased 59% for the second quarter of 2008 to $6.1 million from $3.8 million for the second quarter of 2007. Driving this growth is the shift in orthopedic surgery such as shoulders, hips, and knees that are moving to continuous peripheral nerve blocks largely because of the better patients outcomes and reimbursement of the physician.

In addition, we are educating and training anesthesiologists across the U.S. in seven dedicated ON-Q training centers to help accelerate the adoption of this therapy for treating the pain following orthopedic surgery.

Our newest member of the I-Flow team, AcryMed Incorporated, a developer of innovative infection control and wound healing products, acquired in February 2008, contributed revenues of approximately $1.8 million for the second quarter. This marks further progress in I-Flow's continuing evolution into an integrated Acute Care Products Company focused on developing and marketing proprietary disposable medical devices that improve patient outcomes. We are confident in our strategy to leverage our dedicated Regional Anesthesia sales and marketing organization to sell other Acute Care products made special by the unique AcryMed silver antimicrobial nanocoating.

It should be noted that AcryMed had numerous projects they were working on prior to the acquisition and since then have added many more new customers, bringing with them new projects. You may recall from our last conference call that AcryMed develops products for our Acute Care sales force and also out-licenses technology to companies like Baxter and Medline. A typical project takes an average of 18 months from conception to having a product ready to market. This timeline is driven by the product development, testing, regulatory approvals, and finally, the development of the manufacturing process, which is typically unique to each new product.

The average selling price of our ON-Q pumps continues to increase. Second quarter average selling prices for our Regional Anesthesia product increased 5% versus last year’s second quarter. Gross margins were strong, increasing to 73% versus 72% in the second quarter a year ago.

Both of these improvements are partially due to the increased efforts of our sales force to grow non-elective surgeries, resulting in higher second quarter sales of our larger, more expensive and higher margin ON-Q pump models and to a mix shift away from smaller pumps used mainly in elective or postponable surgeries.

We are pleased with results of our efforts to control SG&A expenses to well below our revenue growth. SG&A expenses from continuing operations increased only 9% for the second quarter of 2008. Our tight control over SG&A expenses played a significant role in our ability to deliver a year-over-year and sequential improvement in bottom line performance before taxes and the litigation and insurance charges I mentioned earlier.

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

Jim Talevich

Thanks Don. Before we continue, please note that this conference call will include forward-looking statements. These statements are based on current expectations, estimates, and projections about our business based in part on assumptions made by management. These statements are not guarantees of future performance and actual results may differ materially. A more detailed discussion of these risks and uncertainties is contained in this morning’s press release and I-Flow Corporation’s various filing with the SEC. The statements made during this call are made only as of today’s date and we undertake no obligation to update these statements.

For the three months ended June 30, 2008, revenue from continuing operations increased 21% to a record $35.3 million from $29.1 million for the same period of the prior year. Sales of I-Flow’s Acute Care products, which include RA, consisting of ON-Q, and AcryMed revenues, increased 21% to $27.9 million compared to $23 million for the second quarter of 2007.

Total revenue from RA increased 13% for the second quarter of 2008 versus the prior year quarter to $26.1 million from $23 million last year. AcryMed revenues were $1.8 million for this year’s second quarter.

IV Infusion Therapy revenues increased 22% to $7.4 million for the second quarter of 2008 from $6.1 million a year earlier.

Gross profit was 73% of total revenues for the second quarter of 2008 versus 72% for the second quarter of 2007.

SG&A expenses from continuing operations increased 9% to $24.9 million for the second quarter of 2008 from $23 million for the second quarter of 2007, which included stock-based compensation expense of $1.9 million for the second quarter of 2008 versus $1.8 million for the second quarter of 2007. The company also incurred a total of $12.1 million in certain litigation and insurance charges to significantly increase the company's product liability insurance coverage and accrue a loss contingency related to the chondrolysis lawsuits.

The loss before income taxes from continuing operations was $11.5 million for the second quarter of 2008. Excluding the $12.2 million for litigation and insurance charges, the company would have reported a pre-tax profit of $630,000 for the quarter, as shown in the reconciliation table attached to today’s press release.

The loss from continuing operations, net of tax, for the second quarter of 2008 was $11.4 million, or $0.47 per basic and diluted share. This compares to a loss from continuing operations, net of tax, for the second quarter of 2007 of $1.6 million, or $0.06 per basic and diluted share.

Income from discontinued operations, related to the company's former InfuSystem subsidiary divested on October 25, 2007, net of tax, for the second quarter of 2007 was $2.2 million, or $0.09 per basic and diluted share.

The net loss for the three months ended June 30, 2008 was $11.4 million, or $0.47 per basic and diluted share. This compares to net income for the three months ended June 30, 2007, including both continuing and discontinued operations, of $0.6 million, or $0.03 per basic and diluted share.

At June 30, 2008, I-Flow reported net working capital of approximately $69.9 million, including cash and cash equivalents, and short-term investments of $47.8 million, no long-term debt, and shareholders' equity of $132.9 million.

Now, I will turn the call over to Don Earhart for some final comments before we take questions. Don?

Donald Earhart

Thank you, Jim. As Jim just mentioned, this year’s second quarter results include certain litigation and insurance charges of approximately $3.5 million to purchase retroactive insurance policies to significantly increase the company’s product liability insurance coverage at $8.7 million in loss contingency that the company accrued in connection with ongoing litigation. As we have reported previously, I-Flow has been named as a defendant in lawsuits seeking damages as a result of chondrolysis in the shoulder joint, allegedly due to the continuous infusion of a local anesthetic into the joint space, following surgery, using an infusion pump.

We believe these lawsuits are without merit and as to I-Flow and we will defend ourselves vigorously. Having said that, however, we are not prepared to bet the company on a favorable outcome, and therefore we have taken what we believe to be prudent and responsible steps to protect I-Flow and our shareholders from the unpredictable and potentially high cost of this litigation.

We are in the middle of launching a new marketing campaign for ON-Q that centers on having physicians make our products an essential part of all their surgeries. We are doing this by focusing physicians on the significant narcotic reduction when ON-Q is used, coupled with the superior pain relief, and the possibility of reduced infections. The latter is particularly relevant in the face of the pending October 1, 2008 Medicare changes that eliminate payments for hospital-acquired conditions and even opens up additional sales call points, like infection control, in the hospital.

Even though most hospitals know about the pending changes in CMS reimbursement, our customer and sales force feedback says that you have started doing anything special to get ready. We believe our new campaign will not only help hospitals to recognize their need, but at the same time will offer them a best practice solution for treating the pain following surgery.

We have officially launched our newest product in the ON-Q family of infusion pumps, the ON-Q E, a disposable epidural pump for labor and delivery. Our competition is non-sterile electronic pumps requiring programming each time they are used. We are positioning ON-Q E as the simpler way to do epidurals and since each ON-Q E is delivered sterile to the patient and used by one patient only there is less chance of an infection being transported from patient to patient. In addition, ON-Q E does not need to be programmed, which today is a major cause of hospital errors when electronic pumps are used.

We believe ON-Q E is not only the simplest way, it is the safest way to do labor and delivery epidurals. With the present market size in the U.S. believed to be in excess of $300 million and the call point in the hospital, the anesthesiologist, we are well positioned to introduce this new and exciting pump to, in many cases, the same customer we sell the C-bloc pumps to.

The first half of 2008 has not been an easy environment to obtain growth. With the number of surgeries performed in many hospitals growing at a much slower rate, and in many cases not growing at all, we must meet the challenge by finding other ways to grow our revenue. So far we have been successful in doing so.

Saying all of that, we continue to expect growth in total revenue of approximately 20% for 2008. This will be driven by revised growth expectations for 2008 of approximately 23% growth in Acute Care products, at approximately 17% growth in Regional Anesthesia revenues with growth being stronger in the second half of the year as we launch the ON-Q E and other new products. These changes in Acute Care and Regional Anesthesia guidance are being made based on current market conditions.

Finally, we now anticipate that I-Flow will be profitable for the second half of 2008 with a possible exception of non-cash purchase accounting adjustments from our acquisition of AcryMed, and there is a good chance that before any special charges, I-Flow will be profitable for the full year.

I-Flow is today a supplier of Acute Care products that relieve pain, help reduce the incidence of infections, enhance healing while getting patients well sooner. We are confident that our plan to leverage the ON-Q sales force and marketing infrastructure by layering in complementary new medical products for the Acute Care market will deliver sustained rapid growth and will enhance shareholder value in the long term. We have many of the right products now, a host of exciting new products and product line extensions in the pipeline, as well as the financial resources, and the experienced management team we need to implement our strategy.

We believe our second quarter and year-to-date results show that we are making good progress toward our two goals of becoming both a profitable and a high growth Acute Care products company.

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

Question-and-Answer Session

Operator

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

Matt Dolan – Roth Capital Partners

Hi guys, good morning.

Donald Earhart

Hi, Matt.

Matt Dolan – Roth Capital Partners

First question on the guidance given that growth continues to be challenging in this environment and your reduction in the assumptions for the second half of the year, are you – can you help us out relative to how you are formulating your guidance? Are you becoming more conservative than you were previously or how much are you now counting on new products and the impact of anti-infection, et cetera, on hitting those goals?

Donald Earhart

Well, Matt, the guidance we are giving is based on what we know today and what we believe our opportunities are for the second half of the year. If the economy gets much worse that could affect our ability to achieve that guidance. If we get a little help from the economy that could help us beat that guidance. So, all I can say at this time is that’s the guidance that we think is the best number to give at this time based on what we know today.

Matt Dolan – Roth Capital Partners

Okay. And secondly, a couple of questions on the charges, the litigation, and insurance side of things. How many – can you give us how many cases have been filed, when they were filed, just some more commentary there? And then with this insurance how much coverage do you have relative to the worst-case scenario in this outcome however likely.

Donald Earhart

Again, we don’t really talk about our legal plans or I should say strategy to fight these cases, but there are approximately 30 cases today. Most of them fall into the previous insurance period, which is where we bought the additional insurance. So we have today about $35 million in coverage, which we have identified for that period. Going forward into the new insurance period in which I don’t believe we have any cases at this time, we have about $50 million in insurance in place. So, we think we are well covered and can handle whatever outcome would be expected. But again, we will fight this vigorously because we do not believe that the ON-Q pump causes chondrolysis.

Matt Dolan – Roth Capital Partners

Okay. And then just to clarify on the profitability guidance, would you be guiding to profitability for the year maintaining that guidance excluding the litigation charges?

Donald Earhart

Well, as I said in my conference calls, we believe we have a very good chance of being profitable for the total year. The guidance is for the second half, but I did say we believe we can be profitable for the total year as well. We have an excellent chance of that.

Matt Dolan – Roth Capital Partners

Okay. And finally on AcryMed, nice result there I think running ahead of what we expected at least on a run rate basis for the year. Any new deals in the pipeline there that we could expect in the second half of the year.

Donald Earhart

Matt, again, there are lots of new deals going on at AcryMed, but nothing we can announce at this time, but keep in mind any deals since the acquisition, before we see any meaningful revenues can take about 18 months. However, there were deals already in place when we bought AcryMed, and so we could see something sooner than that on those deals that were already in place.

Matt Dolan – Roth Capital Partners

Okay, but no timing expectations, so we can get on those (inaudible)?

Donald Earhart

Well, we have to be very careful, Matt, because the customers who deal with us at AcryMed want everything kept confidential and secret until they are ready to launch, for obvious reasons.

Matt Dolan – Roth Capital Partners

Alright. Fair enough. Thanks guys.

Donald Earhart

Okay.

Operator

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

Greg Brash – Sidoti & Company

Hi guys, thanks for taking my call.

Donald Earhart

Yes, Greg.

Jim Talevich

Hi.

Greg Brash – Sidoti & Company

Hi, Don. Could you possibly just help clarify the new marketing campaign from the previous one you had? Is the main difference just your focus on infection prevention here?

Donald Earhart

No, we’ve – the campaign has always been about reducing narcotics, which leads to all kinds of good things including reduced infections and people getting well faster. All we are doing is back to the basics and reemphasizing because sometimes our sales force gets off track a little bit and they want to lead with something else. They need to lead with the fact that we reduce narcotics first, which then leads to fewer infections, people getting well faster, and going home sooner. And that’s really all we are doing. So it’s not really anything new. It’s just making sure that they lead with the narcotic reduction and they end up also making a call on the infection control people. Because we do have a great infection control story.

Greg Brash – Sidoti & Company

Okay. That makes a lot of sense. And then now just regarding the CMS rules, regarding infection and the October 1^st day, do you feel your best opportunity to benefit from that rule is in licensing AcryMed to new technologies and selling your infection preventive wound care products, or is – do you think there is an opportunity in selling say an ON-Q with Silver Soaker where a doctor may be more willing to use it just because it’s coated with silver and it could reduce the risk of infection?

Donald Earhart

We have always had an infection reduction product from the first day because once you eliminate the narcotics or reduce them significantly you improve the immune system. One of the biggest negatives about narcotics is they suppress the immune system, which hinders the body from fighting its own infections. So, we have an infection story today. We just have not been pounding on it as hard as we should, and that’s what we are going to do. So we believe, when we call on infection control today, we have a couple of things to offer. We can help them achieve their goal by having fewer infections if they can reduce treating the pain with narcotics and using a local anesthetic because we’ll keep the body then strong and not compromise the immune system. Plus we get people out sooner. The sooner you get people out of the hospital, the less chance there is of an infection. You don’t want to stay in the hospital any longer than you have to. And we have proven, we send people home sooner.

In addition to that, we do have products from AcryMed like we have the silver coated dressings, we have the catheter, of course, which helps eliminate any chance of an infection when our product is used. And we have got other new products coming from AcryMed that we will be talking to them about as well. So it’s really two-pronged – eliminate the narcotics, you have fewer infections. You eliminate or you add silver and you have to eliminate them a second time.

And by the way, the introduction of the ON-Q E, the epidural pump, we believe that’s also going to reduce the chance of an infection because every patient will now get a sterile, clean, never used before pump, which will now be placed on them for their epidural. Today, they are receiving electronic devices, which, we know, have bugs covered all over them, and they have been used from patient to patient and there is lot’s of opportunity for an infection. So we are attacking this many different ways.

Greg Brash – Sidoti & Company

Okay. Alright. And then just you were referring to the elective procedures, obviously you are seeing a slowdown there. Will it be possible to quantify maybe what percent of your business on the ON-Q side is exposed to elective procedures? Is it 10%, is it 30%?

Donald Earhart

I’d say it’s probably less than 10% of our business is exposed. But again, you have to be careful here because surgeries like knees, shoulders, ankles, those are not elective necessarily but you can postpone them. So you really got to count those as well because there is a lot of surgeries like hernias that if I don’t have money right now or I can't afford to be off work I may postpone those. And that’s what we are seeing. You can't postpone heart or any of the cancer surgery. So they are delayed but they are not lost. That’s the key. Sooner or later we’ll get them.

Greg Brash – Sidoti & Company

Okay. So when you say maybe less than 10% of your business is elective procedures and then on top of that you would add orthopedic surgeries where I mean some procedures are getting postponed at the moment.

Donald Earhart

Yes, at one time we did a survey of our orthopedic surgeries and they were about 25% of our total and a significant portion of those would be considered postponable.

Greg Brash – Sidoti & Company

Okay. That’s very helpful, Don. One final question for Jim. Can you just break down the SG&A between selling and marketing and the G&A?

Jim Talevich

Sure. Yes, selling and marketing was $19.4 million. I will give you the number $19,353,000. G&A is $5,585,000.

Greg Brash – Sidoti & Company

Great. Alright, thank you guys. Thanks for taking my questions.

Donald Earhart

Thank you, Greg.

Operator

Our next question comes from the line of Bill Miller with Hartwell. Please go ahead.

Bill Miller – J.M. Hartwell Limited Partnership

Hi, Don.

Donald Earhart

Hello Bill.

Bill Miller – J.M. Hartwell Limited Partnership

I am going back to the October 1 deadline for a second, if I could. The hospitals, are they just going to cocoon and don’t know what’s going on? What is it going to take besides your sales force to educate? The first time they don’t give reimbursement insurance company, what pressures are the insurance companies putting on the hospitals or other decision makers? Why isn’t this happening is what I am really asking because here we are in August, and from what you say not happening very easily. So where is the pressure have to come from, how will it come? What will be wake up call (inaudible) broken up and then I have got another question.

Donald Earhart

Well, Bill, and again this is conjecture on my part, but I think it’s going to take them not getting paid a few times for them to wake up. I think it’s only been until recently that hospitals even understand they had a problem because they were not reporting most of their infections, they were not reporting most of their problems, and it’s only been recently that they have had to actually report these things so that the world actually knows that there is a problem in the hospital. I think it’s been ignored for years. So I think it’s going to take them some financial hits before they are going to wake up but now some hospitals are getting ready, but it’s in the minority. But I think now is the time for us to lay the siege that we help immediately. (inaudible) yes, you are there.

Bill Miller – J.M. Hartwell Limited Partnership

Is there any competitor which is at all akin to the silver coating that AcryMed has? Is there anybody out there with anything else that could be substituted for the silver coating that AcryMed has and – is your – what is your strategy in terms of licensing it to people – to companies, obviously, that don’t have the products that you will ever want to develop to take advantage of your silver coating.

Donald Earhart

Well, there are other coatings out there. There are antimicrobial coatings out there besides silver. There are other silver processes as well. As I mentioned on the conference call several quarters ago when we bought AcryMed that we did a complete analysis of the marketplace and we believe that the nanocoating at AcryMed was the best and had the greatest opportunity to go on the most different products for the largest number of different products. So that’s why we bought AcryMed. But there is always competition out there but we believe we have a leg up because I think we have the best coating.

Our strategy on licensing is to license products to people that we have no intentions of selling and that’s exactly what we have done with the Baxter product because we have not intentions of selling an IV connector. And on the Medline side, those licensing agreements have been in place for years but we would not sell those types of dressings even if we had them today. So we strategically license to those areas where we don’t intend to play.

Bill Miller – J.M. Hartwell Limited Partnership

Okay, and then finally, how does the colon and rectal study, which was terribly successful, play at this point given the October 1 deadline? Can you bring that out? Is that something that you can use as a competitive advantage in some way because nobody else has that kind of data I assume? Is that just been put in the backburner or where does that stand now and how important is it?

Donald Earhart

Well, we – it is part of our pitch to infection control today, but again, to make that study as credible as we want it to be, we need to get it published. We are in the process of doing that as I speak. Doesn’t happen over night, but we hope to have it published by early next year. So that is right now going through the review process to be published. As soon as (inaudible)

Bill Miller – J.M. Hartwell Limited Partnership

(inaudible) review is it that is the negating factor on getting it published, FDA or who?

Donald Earhart

No, no, no. It will be the magazines, the journal, et cetera, who does the publication.

Bill Miller – J.M. Hartwell Limited Partnership

Okay. And it will be New England Journal of Medicine or something akin to that?

Donald Earhart

Something like that. We have to get in there – first of all, we have to be accepted and then we have to get in to their queue.

Bill Miller – J.M. Hartwell Limited Partnership

I see, okay. And finally, you repurchased some stock. You have probably been out of the box because you have been reporting. Are you planning, Don, repurchasing more, will you increase the amount that you can purchase? And how soon can you be back doing that? And then finally, can you talk about your InfuSystem’s position and what’s going on there?

Donald Earhart

The stock purchase, we expect to continue on that, and we can start purchasing again in 48 hours. So, yes, we intend to purchase up to the million. We have not authorized anything beyond that, but that doesn’t mean we won't authorize beyond that. Again, that will be a Board decision, and so I can't really talk anymore about it than that.

Bill Miller – J.M. Hartwell Limited Partnership

Okay.

Donald Earhart

And what’s the question on InfuSystems?

Bill Miller – J.M. Hartwell Limited Partnership

Well, you have, I assume, still go a bunch of stock in InfuSystems. You wrote it down in the last quarter. Has there been any effort to liquefy that or are we going to hang on to it or what’s your current stance?

Donald Earhart

Well, we are open to any offer, Bill, and if you like to buy some, we’d be glad to sell..

Bill Miller – J.M. Hartwell Limited Partnership

Well, I don’t think at this price now.

Donald Earhart

I am sorry.

Bill Miller – J.M. Hartwell Limited Partnership

Not at this price.

Donald Earhart

Okay, well that’s kind of the feeling everybody else has. We have been trying to sell it and been unsuccessful.

Bill Miller – J.M. Hartwell Limited Partnership

Okay. Okay, great, thanks.

Donald Earhart

Okay.

Operator

Our next question comes from the line of Tim Vestal with Kleinheinz Capital Partners. Please go ahead.

Donald Earhart

Hi, Tim.

Tim Vestal – Kleinheinz Capital Partners

Hi, good morning guys. Thanks for the color on your new products kind of market opportunity for those. Can you comment a little bit more on just the general market environment. Surgeries, elective surgeries were weak in the quarter. Just a little more color on the progression throughout the quarter and maybe regions that were weak? And have a couple of more questions.

Donald Earhart

Yes, that’s tough, Tim. All I can tell you is that we continue to see surgery boards half empty. Hospitals are not seeing the number of surgeries they saw in the past but all our reps are doing is, is they are focusing on the ones that are on the board and they typically are the ones that can't be postponed or are not elective. The nice thing there is, when we do that we sell larger pumps that cost more money, and cost us very little more to make. So the margins are getting better. In fact, the margins would have been out of sight if it had not been for the 22% increase in IV products, which significantly lowered our margins because those products don’t have the big margins that our ON-Q products have. So you would have seen a really high gross margin if our IV products had not grown as much as they had. So, we are watching it closely. Yes, I am sorry.

Tim Vestal – Kleinheinz Capital Partners

Was June – April, May, June, did things progressively weaken?

Donald Earhart

No, we had a very strong April, as I said before. May slowed down a little bit, but we think a lot of that’s because of vacations. But June came back strong. Yes so I think the quarter – the real positive here, Tim, is with actually fewer sales people than we had at the end of the first quarter – we are down about 10 or 15 sales people from first quarter – we were able to deliver 15% growth over first quarter in the second quarter, which we think is pretty good. That’s in a tough market.

Tim Vestal – Kleinheinz Capital Partners

Right. Thank you. Let me ask you a couple of questions on the retroactive insurance policy.

Donald Earhart

Yes.

Tim Vestal – Kleinheinz Capital Partners

One, can you just elaborate a little bit more on what exactly retroactive insurance is and then there is $3.5 million charge. The way I thought I heard you say was that the $3.5 million buys you $15 million more of insurance coverage. Is that correct?

Donald Earhart

Let me let Jim answer that one for you.

Tim Vestal – Kleinheinz Capital Partners

Okay.

Jim Talevich

Hi, by retroactive insurance, we mean the fact that we have a policy year that goes from June 1 to June 1 – to the next June 1 of each year and we bought additional insurance for the year that just expired. We paid $3.5 million in premiums for that additional insurance, which increased our coverage from $10 million to a tier of $35 million.

Tim Vestal – Kleinheinz Capital Partners

Okay. So, the $3.5 million bought you $35 million of coverage.

Donald Earhart

Yes, and Tim, important there is that’s where the lawsuits are.

Tim Vestal – Kleinheinz Capital Partners

Right. So, the –

Donald Earhart

It was the right thing to do.

Tim Vestal – Kleinheinz Capital Partners

Sure. So the $8.7 million in contingency charges that you took, if worst-case scenario comes to pass, would you – you would be covered by your insurance, correct?

Jim Talevich

Right. Within those layers of insurance, the $35 million layers of insurance there is a $5 million self-insured retention, and then there is also deductibles within those policies as well. What we did was we simply accrued all the self-insured retentions on all the layers of insurance. And that’s what that number is, that $8.6 million number is.

Tim Vestal – Kleinheinz Capital Partners

Okay, great, thank you guys.

Donald Earhart

Thanks, Tim.

Operator

(Operator instructions) Our next question is a follow-up from the line of Mr. Bill Miller with Hartwell. Please go ahead, sir.

Bill Miller – J.M. Hartwell Limited Partnership

Don, just – are you planning to replace those 10 or 15 sales people that you have lost given the October 1 deadline or are they just gone, you are going to reduce the sales force and keep it at this level? What is your strategy?

Donald Earhart

No, Bill, we intend to replace them.

Bill Miller – J.M. Hartwell Limited Partnership

Yes, the October 1, the AcryMed, et cetera, give you a chance to upgrade or just how do you – what kind of sales money you are now looking for that you didn’t have before?

Donald Earhart

Well, the opportunity to hire is actually very good because not every company in the country anymore is growing. In fact there have been a lot of layoffs, especially in the pharmaceutical industry and we are bringing on, in many cases, pharmaceutical reps who have good background in anatomy, and all we have to do is teach them then what they need to know about our pump and catheter placements. So getting good people is something we are continuing to do. We just happened to be at this time down about 10 of our quota-carrying reps, but we intend to replace those people. No, we weren’t down to 10 for the whole quarter.

Bill Miller – J.M. Hartwell Limited Partnership

(inaudible) I was saying, will have them for the fourth quarter for instance out there –

Donald Earhart

Well, I just – I just signed reqs [ph] to hire three people yesterday, so we are moving.

Bill Miller – J.M. Hartwell Limited Partnership

Yes, okay. So will that not help you significantly in terms of meeting your sales goals –

Donald Earhart

Yes.

Bill Miller – J.M. Hartwell Limited Partnership

–if we get them on stream this quarter and then have them for the fourth quarter.

Donald Earhart

Oh, yes. Yes, we need them on board anyway to help us with the ON-Q E, Bill.

Bill Miller – J.M. Hartwell Limited Partnership

Okay, great. Good. Sounds like a good move. Thank you.

Donald Earhart

Okay.

Operator

We have no further questions at this time, Mr. Earhart. I will turn the call back to you.

Donald Earhart

Thank you, Shauna. I-Flow’s products treat pain, reduce infections, and speed healing, helping patients get better faster and saving money for hospitals and insurers. These benefits are the foundation for the rapid growth we have delivered over the past few years and we believe they’ve put us in an excellent position for continued rapid growth in the future despite the slowdown in the number of surgeries we are presently experiencing. We look forward to reporting our progress on our third quarter conference call in about three months. Thank you, and we look forward to talking to you again.

Operator

Ladies and gentlemen, that does conclude today’s conference call. We thank you all for your participation, and ask that you please disconnect your lines.

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