Minrad International, Inc. Q2 2008 Earnings Call Transcript

Minrad International, Inc. (BUF)

Q2 2008 Earnings Call Transcript

August 14, 2008 4:30 pm ET

Executives

Bill Burns – Chairman and CEO

Chuck Trego – EVP and CFO

Dave DiGiacinto – President and COO

Dennis Goupil – EVP and Chief Technology Officer

Analysts

Rick Hodyne [ph]

Joseph Moss [ph]

Brett Dunlap [ph]

David McCarthy [ph]

Damien Prenzie [ph]

Presentation

Operator

Good afternoon, ladies and gentlemen, and thank you for waiting. Welcome to the second quarter earnings conference call. All lines have been placed on listen-only mode, and the floor will be opened for your questions and comments following the presentation. Without further ado, it is my pleasure to turn the floor over to your host, Mr. Bill Burns. Mr. Burns, the floor is yours.

Bill Burns

Hello, everybody. Thank you for joining us today. I am in Orchard Park and with me is Karen Sonnhalter, our Controller; and Bill Rolfe, our VP and Treasurer. Joining us from our Bethlehem, Pennsylvania facility are Chuck Trego, our CFO; Dennis Goupil, our CTO; and Dave DiGiacinto, our President and Chief Operating Officer. Kirk Kamsler, our Senior VP, Commercial Development, is traveling at the moment and can't be on the call. Chuck is going to go through an analysis of our second-quarter performance. We will then, just as we have always done, handle the five or six questions we get asked most frequently, and then open it to the floor for your questions. Chuck, I will start with you.

Chuck Trego

Thank you, Bill. Good afternoon, everyone. I will comment today on our financial results for the second quarter and first six months of 2008, compared to the same period last year, and the key drivers of our financial results.

Revenue is $4.2 million for the second quarter of 2008, down 4% compared to the $4.3 million of revenue in the second quarter of 2007. However, year-to-date revenue of $15.9 million increased by 121% over the first half of last year.

Net loss for the second quarter of 2008 was $11.7 million or $0.24 loss per basic and diluted share, compared to a net loss of $3.4 million or $0.07 loss per basic and diluted share in the second quarter of 2007. The company had a net loss through June 30, 2008 of $14.9 million or $0.30 per basic and diluted share, compared to a net loss of $6.8 million or $0.14 per basic and diluted share for the first half of 2007. I want to point out included in the net loss for both the second quarter and first half of 2008 is a charge of $4.6 million related to the early extinguishment of debt, which I will discuss in a few minutes.

Now, let's look in more depth at the various components of revenue, expense, and earnings for these periods. Revenue increased in the second quarter of 2008 versus the same period in 2007 in all geographies except the Western Hemisphere, where strong Western Hemisphere revenue in the second quarter of 2007 created a challenging year-on-year comparison for this region. For the six-month period ended June 30, growth was strong in all regions, again except for the Western Hemisphere, driven by very significant growth that occurred in the first quarter of 2008. In particular, U.S. revenue grew significantly versus 2007, where approval to sell sevoflurane did not occur until May 2007. U.S. revenue accounted for 53% of the total six-month revenue in 2008, versus 22% of the total for the comparable period last year.

Looking at revenue by product line, the 4% decline in the second quarter versus the second quarter of last year was driven by the shortfall in the sevoflurane product line due to product availability in the second quarter of 2008, which I will discuss in more detail when I comment in a few minutes on the changes in gross profit. The decline in sevoflurane, however, was partially offset by growth in other inhalants during the second quarter. The 121% increase in revenue for the six months ended June 30, 2008 was driven by growth across all product lines. Sevoflurane growth for the six-month period ended June 30, 2008 was the result of strong performance of this product line in the first quarter. The $6.9 million sevoflurane increase accounted for 79% of the revenue growth for the first six months of 2008.

Gross profit grew 104% for the first six months of 2008. A strong first-quarter performance made possible by the startup of our new sevoflurane production line in December 2007 was the primary growth driver for the increase in gross profit for the first six months of 2008. However, in the second quarter, sevoflurane production and therefore revenue growth was significantly constrained by several factors. Early in the second quarter 2008, there was a planned shutdown for the cleanout of the process equipment at our Bethlehem facility. Also early in the quarter, due to the inability to obtain raw materials because of our funding constraints that I talked about in our last quarter call, also limited production in the second quarter. In early June, when raw materials did become available; and equipment breakdown, unplanned in our sevoflurane reactor, caused equipment damage and loss of production capacity for several days, primarily in the sevoflurane production area. All of these factors contributed to low capacity utilization which drove unfavorable manufacturing variances in the second quarter and was a contributing factor in the gross profit decline of 148% and a decline in the gross profit margin of 3,600 basis points versus the prior year. By the end of the second quarter, our Bethlehem facility returned to normal operations.

Gross profit for the second quarter was also unfavorably impacted by inventory write-downs at our Orchard Park, New York facility, primarily for our consumable inventory nearing its expiration date and write-downs for image guidance devices that are now considered obsolete.

Operating expenses for the quarter ended June 30, 2008 increased by $1.4 million or 32% versus the second quarter of 2007. $1 million of the increase is due to our establishing a non-cash reserve for the Accounts Receivable due from the company's U.S. distributor with whom we are working to develop a collection plan in the future. Finance and administration costs increased $1 million, while sales and marketing costs and research and development costs decreased by $0.1 million and $0.5 million, respectively. Finance and administration costs growth of $1 million, which was a 92% increase, was driven by higher stock-option expense, bad debt expense on international receivables, and increased salary expense and severance costs versus the prior year.

The sales and marketing decrease represented a 7% decline versus the prior year, primarily due to lower sales commissions. The research and development cost decline of $500,000 or 34% was made possible by several actions, including the completion of several projects, reductions in spending in non-core areas, and the transfer of resources to other priorities within the company. Partially offsetting the research and development cost reductions was a $1 million increase investment in the conscious sedation project.

For the first six months of 2008, operating expenses increased $3.8 million or 44% versus the first half of 2007. This increase was comprised of a $1 million increase due to establishment of a non-cash reserve that I talked about earlier, a $1.7 million increase in sales and marketing expenses, a $1.5 million increase in finance and administration expenses, less a $400,000 decrease in research and development spending. The sales and marketing expense growth of $1.7 million or 42% was driven by a $1.5 million expenditure that was incurred in the first quarter for the World Congress of Anesthesia, a once-every-four-year event, and an additional $200,000 in freight expenses to support increased volume of sales. The $1.5 million finance and administration expense growth, which was an increase of 67%, was driven by higher incentive compensation expense versus the same period last year, as well as several other factors previously disclosed and discussed. Research and development cost reductions of 17% versus the prior year, or $400,000 occurred in the second quarter, as I commented on previously.

Non-operating expense was $5.4 million for the second quarter of 2008, as compared to minimal non-operating expenses in the same period last year. The non-operating expense includes $1.1 million of interest expense, $4.6 million loss on early extinguishment of debt less interest income and other income of $300,000. Interest expense of $1.1 million consists primarily of interest on two long-term debt arrangements in place for portions of the period. The Laminar term loan for $15 million was put in place in February and was extinguished in May. Our senior secured convertible note financing of $40 million was secured in May. Interest expense during the second quarter from these two arrangements totaled $1 million. The remaining interest expense related to developmental loans with the Commonwealth of Pennsylvania. The loss on the early extinguishment of debt was due to the retirement of a Laminar Note prior to maturity. Included in this charge are a 5% redemption fee of $800,000, the write-off of the unamortized balance of warrant expense of $3.2 million, and unamortized loan fees of $600,000.

Non-operating expense for the first half of 2008 was $6 million, compared to net non-operating income of $100,000 in the comparable period of 2007. Of the increase of $6.1 million, $5.3 million related to the second quarter which I previously commented on. The balance of the increase, which is $800,000, was driven by additional interest due to the laminar debt, the Commonwealth of Pennsylvania developmental loans and a demand facility which has since been extinguished with First Niagara Bank.

Now, I will turn the call back to Bill to comment on the key questions.

Bill Burns

Thanks, Chuck. I'm going to handle the first question. Obviously, for a lot of people, the question is after having such a difficult second quarter where we had the plant shakedown and the timing differences and then a business interruption, can we affirm our $50 million revenue guidance for 2008? And while the second quarter was difficult for the reasons Chuck mentioned, we are not updating our forecast for guidance for the year. We already have sufficient international orders to drive over $10 million in revenue in this quarter. We expect similar, greater international volume in the fourth quarter. The key issue in achieving the annual target will be our ongoing success with U.S. GPOs, and most of the key GPO decisions will be in the September/October period. We continue to believe this is a healthy business with a lot of enthusiasm on the part of our customers.

Dave, you have the second question, I believe?

Dave DiGiacinto

Yes. Again, just to reiterate some things that Chuck had mentioned earlier about the second-quarter revenues and why they were very low, three factors contributed to low production and revenue in the second quarter.

The first was our previously announced shutdown in April to do what we call a shakedown analysis of our new sevoflurane line. We initially thought this was a three-week project, extended an extra three to four days.

Secondly, while we had $7.5 million in inventory, which was principally WIP, a work in progress, at the end of the first quarter, delays in receipts of key raw materials due to lead-time extension from Pacific Rim suppliers and cash constraints prior to our May 5 closing of the $40 million debenture caused periodic interruption throughout the quarter.

Finally, in June, as Chuck alluded, we had a disruption on one of our production reactors. This resulted in a loss of in-process inventories and approximately 7 days of production and postponed approximately $2 million in revenue in the third quarter, as we projected. As we enter the third quarter, our inventory levels are up substantially and we have a high level of work in progress.

Chuck, are there more questions?

Chuck Trego

Yes, the third question we thought would be of interest is to comment a little further on our margins. As I talked about in my comments, margins went down instead of up in the second quarter. So the obvious question is, when will we see normal margins return to this business? Our gross margins this quarter were adversely impacted by the factors that Dave discussed, including a revaluation of our image guidance inventory and the establishment of some reserves associated with that. We anticipate to return to normal markets in the third quarter. We do not anticipate any exceptional or unusual items to occur. Production volume for the third quarter is forecast at levels higher than the first quarter. The only caveat is that we will have an exceptionally strong international mix to our revenue in the third quarter, where pricing tends to be a little lower than the U.S., reflecting distributor freight and duty cost. Based on our performance quarter-to-date and the visibility we have on our shipments, we would anticipate margin enhancement in the third quarter and for the balance of 2008 compared with the first quarter.

Bill Burns

Dennis, you were going to comment on new products and product approvals?

Dennis Goupil

Yes, thank you. We reported previously filing our desflurane NDA and are presently awaiting FDA notification that the application has been accepted for review. Further, in the second quarter, we forwarded our European application. We plan to file our conscious sedation 510K in the fourth quarter. Regarding new product approvals, we continue to meet our goals reflecting filings in 2006 and early 2007. On June 30, we had 17 sevoflurane approvals and are selling sevo in 15 countries. A key second-quarter approval was for Petrem, our veterinary sevoflurane product which we launched in July.

Bill Burns

Chuck, liquidity?

Chuck Trego

To comment on liquidity, a question we anticipated that might be asked is do we have sufficient liquidity to meet our 2008 business objectives? And the answer is yes. We expect to generate significant cash flow in the third quarter and the fourth quarter from intermediate inventory conversion generated at the end of the second quarter, in-process cost reductions that are being pursued, and stronger cash management as well as collections by higher levels of international shipments in the third and fourth quarters. Our plan to reach profitability during the second half has not changed. As you know, this is the primary driver of our cash flow. Longer term, our ongoing growth may require additional financing. However, all investors should remember we have a carve-out in our convertible debenture funding to allow us to establish a $10 million secured working capital financing. We have been speaking to banks on a low-key basis following our fundraising in May and will continue to do so. We are confident that we can establish a credit line that will be put in place, if and when it is needed, to supplement the other sources of cash flow that we have.

Bill Burns

Thanks, Chuck. Dave, you were going to handle the domestic side of the business?

Dave DiGiacinto

Yes. As you heard Bill speak earlier about our upside on the international business third and fourth quarters, I just want to give you a brief overview on the domestic side of the business. End-user sevoflurane volume has more than doubled since the end of the first quarter. This reflects an ongoing GPO conversion and continued penetration of the pain and surgery centers. In the first quarter, we shipped approximately $7 million worth of product to our U.S. distributor to fill the wholesale and distributor pipeline. This provided them with ample inventory to meet second-quarter needs. Presently, we estimate that RxElite has approximately three to four months on hand of sevo. And I would like to establish that, going forward, that both companies are discussing and working proactively to ensure the growth and continuity of our US business.

Bill Burns

I think that sums up the questions we normally receive when we get calls from all of you. I think the underlying message here is we had some timing differences in the second quarter. I think any of you bought a new car, you have the oil changed and check it out a little while after you start it up; that's what we did with the plant, except when you start up a new plant, it takes three to four weeks to go through it. I think Dave and Chuck did a great job raising $40 million in a tough market, and people made that investment because they believed in the company. We had an unfortunate event in June which the plant handled very well in terms of the safety of our employees. But in all this, our order rate is very strong and we are seeing margin enhancements in the operating side of the business. With those notes, I will turn it over to the shareholders on the phone and interested parties, and we will take your first question and we will direct it to the appropriate person here to answer.

Question-and-Answer Session

Operator

Certainly. The floor is now open for questions. (Operator instructions) And our first question comes from Rick Hodyne [ph]. Rick, please state your question.

Rick Hodyne

Yes. Good afternoon, guys. We have spoken several times before at conference calls in the past and I must admit, I'm a little surprised at the magnitude of the mess here on the second-quarter numbers. I guess we talked in the last conference call about sevo contract wins by RxElite taking somewhere between 60 and 90 days before they end up showing in your order book.

Bill Burns

Correct.

Rick Hodyne

RxElite posted a number of pretty significant contract wins in Q1 and Q2. Are those orders showing up in your books, or have they shown up in accordance with your expectations?

Bill Burns

Okay. Dave, I will handle that. I'm working with the GPOs with RxElite, so on this one, I can be pretty specific. We have seen four or five wins, Rick, but after you get a win, the process is pretty specific. You then have to put vaporizers in at the individual hospitals and depending on the size this can take two to three months to complete a system. During that time, the system continues to order product from their existing vendor and most hospitals have four to six weeks of inventory on hand when they finally convert over. Hospitals are not going to run out of anesthetic agents.

So the answer to your first question is yes, we are seeing those move forward. RxElite has made significant vaporizer placements in the – particularly since March when a number of these were announced, and we are seeing that revenue go through. Now, as Dave mentioned, we have good visibility on end-user sevoflurane purchases around the world, not just in the United States, and in the United States, they have doubled. But with the inventory they bought in the first quarter, they had ample supply to handle them through this quarter and more to the point, we will see the real pickup as their contracted volume picks up in the July and August period from vaporizers installed in the May/June period.

Jonathan Houssian, RxElite CEO, is going to be addressing this and providing more detailed numbers on their earnings call, which I believe is Monday but I haven't seen a time yet for that. But the answer is yes, we are seeing growth and we are also seeing larger systems and individual networks signing up with us, but it's a process and it's ongoing, but they are making good strides. When you can double your volume in a three or four-month period, you're getting traction.

Rick Hodyne

Based on the fact that we are now basically halfway through Q3, is Q3 going to look like Q1, or is it going to look like Q2? You must have a pretty good idea now, being halfway through the quarter, what your order flow and what your revenue performance is going to look like.

Bill Burns

Yes, let me take that in two pieces, in terms of what we just said, and I will kind of recapture them. I started out talking about the international business, where I indicated we have already either shipped product or have orders sufficient to drive over $10 million in revenue just in international in this quarter, which – if you compare that to the first quarter, that's significantly above first-quarter volume internationally and that reflects approvals in new markets and shipping to markets we've previously announced like Japan and Turkey where we've seen traction as we've gotten going.

Rick Hodyne

So that's $10 million we can count on?

Bill Burns

Well, I'm counting on it, yes. That's why I said it.

Rick Hodyne

Then second, I think Chuck addressed the margin issues; that margins would be at the first quarter – at least at the first-quarter levels. I think the key difference between now and the first quarter is we did have the one-time, $1.5 million World Congress expense in the first quarter that obviously won't be repeated in the third quarter. The mystery is the domestic volume. As Dave mentioned, there's three to four months on hand at RxElite presently. Whether they order this quarter, at the end of the quarter, or early October is really a timing difference, depending on the GPOs, but we see a lot of traction with the revenue numbers. Now, one thing I'll go back – part of our high second-quarter international is stuff that got held up with the plant issues at the end of the second quarter, but we are going all out shipping product and are seeing some pretty high-level wins overseas in some of the tenders there. Does that answer your question?

Rick Hodyne

I think so.

Bill Burns

Okay, thank you.

Rick Hodyne

Is there any possibility the third quarter could be profitable?

Bill Burns

I'm going to say yes, but one caution

Chuck mentioned mix as an issue, because our pricing to international customers is a little lower than our domestic customers because they have to pay freight and duties, and some buy in bulk. You know, if you just looked at the first quarter and took out the World Congress, I think we were flirting with an operating profit, and I think that's kind of where we're going to be. Chuck, do you want to add anything to that?

Chuck Trego

No, I concur. Our objective has been from the start and still is to be profitable in the second half of the year.

Bill Burns

Yes. Thanks, Chuck.

Rick Hodyne

Is that for the six months of the year or in the – in each of the quarter?

Chuck Trego

Second half, the second half of the year.

Rick Hodyne

As a whole?

Chuck Trego

Yes.

Rick Hodyne

Okay. You, Bill, I think, in your comments earlier, you said you weren't updating the guidance for the year. And just so I'm totally clear, you are not saying you are going to get the $50 million? You're just saying you are not prepared to affirm that number at this point because you –

Bill Burns

No. What I was saying is I'm not changing the number at this point; we're not updating it. We see the traction on international with orders right now, and I was trying to be pretty specific on that, that we see $10 million.

Rick Hodyne

No, I got that.

Bill Burns

And we see greater volume in the fourth quarter internationally. The issue really is how much of the GPOs conversions come in, in the September-October period. We just don't have enough visibility on that to say if it should change or not. I'm not trying to be clever here.

Rick Hodyne

No, I know.

Chuck Trego

Rick, I'd like to answer that question, too. This is Chuck speaking. That number was given in the first quarter and it was current as of the date it was given. We are not reaffirming that number at this point in time. And the revenue ramp-up that Bill talked about is all we are prepared to talk about this time as it relates to the third quarter.

Rick Hodyne

Okay.

Chuck Trego

We are not reaffirming that number just to answer – to be clear with the answer to your question there.

Rick Hodyne

Okay. One last question, for the moment anyways – I was reviewing what I would think would be a somewhat unusual 8-K filing with the SEC you guys made this morning regarding severance pay and incentive pay and retention?

Dave DiGiacinto

Rick, this is Dave. I will take on that question.

Rick Hodyne

Just let me ask my question first.

Dave DiGiacinto

Okay.

Rick Hodyne

Everything I read in that filing appears to be triggered on the presumption that there is a takeout. This whole filing to me smelled a little bit like a takeover defense. Have you been approached about somebody taking a shot at your company?

Bill Burns

Rick, just so you know – and I think this happens to all companies. From time to time, companies get inquiries for all or part of the business. And I think it's incumbent and important and the responsible thing to do for the Management and the Board to establish these policies. And I think if you look around, you'll find that most public companies do have these policies in place.

Rick Hodyne

I've – perhaps, but I don't recall too many that all of a sudden file an 8-K with this respect – sorry, under these terms, where the price of the transaction is specifically laid out in the divesting arrangements. It seems somewhat unusual at this point. I guess my question really is, have you been approached?

Dave DiGiacinto

I think you have seen the price. If you've read my contract back in March, there was also a price associated with that. I think, in order to establish a proper policy and something to base a – at least have a base for this type of policy, I think it's important that the Board and again the comp committee has something to work off of.

Rick Hodyne

I understand that, but you're still not answering my question. Have you been approached?

Dave DiGiacinto

Again, I will just answer it by saying, from time to time, companies get inquiries.

Rick Hodyne

Well, you're still not answering my question.

Bill Burns

I think that's all you're going to get at this time, Rick. So I'll take the next question.

Operator

At this time, we have no further questions. (Operator instructions) Okay, and our next question comes from Joseph Moss [ph]. Joseph, please state your question.

Joseph Moss

Yes, good afternoon. I'm an individual shareholder, and I have a question relating to an article that appeared on Forbes.com back on the 28th of July that indicated that the convertible noteholders might be threatening to convert to common shares. And I spoke with the author of that article and she actually did not have any definite information to that effect. I was wondering if you have any information concerning whether the convertible noteholders intend to convert or not.

Chuck Trego

I will take that question. This is Chuck.

Bill Burns

Yes, it's a softball, go ahead, Chuck.

Chuck Trego

I'll take that question, Joe. I also, we also saw that article on Forbes.com. I can tell you for a fact, I placed six phone calls to the author of that article and sent a couple of e-mails, and I was never responded to as the Chief Financial Officer of our company, which I found kind of unusual. And the author of that article never spoke to anyone at our company before it was issued, so the information in the article, as far as I'm concerned, is speculation on the part of the author, since she spoke to no one at the company before issuing that article. And the article even mentions that the company had no comment, and the reason the company had no comment is we weren't contacted to comment on that article before it was published. So as far as I'm concerned, as the CFO of the company, that information in that article is speculation on their part. And I can't confirm or deny anything that's in there because I haven't had a chance – the author will not return the call. And specifically, as it relates to your question, we have no knowledge where that is the case.

Bill Burns

Chuck, can I ask you a favor? Would you go through, just so people understand, what the conversion price for those shareholders would be and also what that would do to our interest costs if they did convert?

Chuck Trego

Yes, the conversion price on that is $2.65 per share. And if they were to convert, it would reduce – it would have a dilution effect in terms of the shares outstanding but in terms of the profit of the company would improve dramatically because we have an 8% coupon on $40 million. So we are paying $3.2 million a year in interest expense that would go away if the noteholders decided to exercise their conversion rights above and – when the stock gets above the conversion price of $2.65 per share.

Joseph Moss

Okay, thank you very much.

Chuck Trego

Thank you, Joe.

Bill Burns

Are there any other questions?

Operator

Yes. Our next question comes from Brett Dunlap [ph]. Brett, please state your question.

Brett Dunlap

Hey, gentlemen. I guess my question just pertains to this uncollectible reserve of $1 million attributed to a U.S. distributor. Could you elaborate a little bit more on that?

Chuck Trego

Yes, Brett, this is Chuck. I can discuss that. As Bill stated earlier, we're talking about RxElite here. They built up inventory in the first quarter to support their growth plans. They owe us money for the inventory that they purchased in the first quarter. Since they have not sold all of that inventory yet, we've decided to repurchase some of that inventory from them at some point in the future as an option that we're looking at to reimburse us for part of the receivable that they owe us for the inventory that they've purchased up to this point in time at the end of the second quarter. The reserve that we booked is for the part of that receivable that we felt might be uncollectible if and when we reach an agreement with them to do this. And it's a reserve that we hope to recover, if we do purchase that inventory, and sell it in the future. It's non-cash, obviously, and if we are successful in working out this plan with them, then we will be able to recover that reserve when and if that inventory is purchased, and when it is sold.

Bill Burns

Are there any other questions?

Operator

Yes, we have another question from David McCarthy [ph]. David, please state your question.

David McCarthy

Yes, sorry. Just to circle around with that, you've just put a reserve against RxElite? Continuing to sell product to them? Hello?

Chuck Trego

I'll answer that question. They are a U.S. distributor. They a little long on inventory right now, as Bill talked about. And we are working with them to schedule our shipments in line with their needs when and if they need more inventory after they work it down to support sales, shipment of products to the GPOs that Bill earlier discussed.

Bill Burns

Right. I want to go one step further so everybody understands. We made a public announcement that the United States Food and Drug Administration increased our expiration dating on our product to three years. We are in a situation where we are looking for RxElite to run down their inventory, which has two years' dating, so we can replace it with the longer-dated inventory, because it will have more shelf life in the distributors. This is part of the swing between the third and fourth quarter. We would like to reduce the product that has a two-year dating and sell it all off, and replace it with the three-year dating which we just received and I believe we announced earlier this month. And so there is a timing difference here. Certainly, when we ship to RxElite, we want to ship them product that's got three years' dating, because it's a competitive advantage in the marketplace versus some of our other competitors.

Dave DiGiacinto

And David, this is in line with my comments about working with RxElite in helping them rationalize the inventory and at the same time cooperate with (inaudible) a more stable platform for growth going forward.

Bill Burns

Yes, having longer dating will help us with the GPOs, but they will want to see that it's in the market when they sign up. So this is a pretty well thought out plan, on the part of both parties, to really make sure we can take advantage of this new FDA approval that is somewhat unique to Minrad.

David McCarthy

Okay. And a second question would be, you've written off $1 million worth of the image guidance because it's obsolete, but you didn't comment about the image guidance business at all.

Bill Burns

Let me address the obsolete piece first. First, the image guidance business, I think if you look at the press release, is up in line with the rest of our business in terms of sales. I think, on a year-to-date basis, it's up 165% versus the prior year. At the end of last year, we introduced a new software that allowed us to run product and set up in an operating room in about 30% to 40% of the time it previously took. We believe this will increase the adoption of the technology but also disposable sales, and so we reserved against certain of the older equipment, updating it, because really we want to get those products out in the market that have the greatest chance of generating disposable revenue. We did have some consumable product that we reserved because it's coming on its expiration dating. It may well be that we can extend that expiration dating, but until we get there, this was just prudent. I think, realistically, I will just take this. We scour the balance sheet and P&L with Chuck and Dave coming in to make sure that we've got a fresh start for the management team as we go forward here, and this was just one of the components. So, I mean, I don't think there was any intention to ignore image guidance. It's just, on an order of magnitude basis, it's about less than 5% of our business. By the way, the reserve was $500,000, not $1 million.

David McCarthy

Okay. Just to circle around again on another thing, while you're not (inaudible) in the $50 million guidance, are you walking away from this?

Chuck Trego

I don't think we can say anything more to answer that specifically without giving more guidance. I mean, the guidance that we gave when it was given back in February with $50 million, and that was current as of the date it was given. We are not providing any more guidance than what was given on revenue back in the first quarter.

David McCarthy

The holders of your notes, if they do convert and the dilution – dilutive effect would mean that there and then they own 40% of the company. Is that correct?

Bill Burns

I believe it is $40 million, divided by $2.65. That would be 15 million shares; it would be about 20% of the company.

Chuck Trego

That's correct, Bill. That's pretty decent math.

Bill Burns

Yes, and so, you know, as Chuck indicated earlier, we do not have any affirmation that the debtholders are converting, but if they did convert, it would be at a premium to the market price today and it would actually reduce our interest expense. I think this was kind of lost in the Forbes article.

David McCarthy

Yes, I understand that, but if somebody is going to make a run at you, that's an easy 20% to guess.

Bill Burns

Well, that's possible, yes.

David McCarthy

Okay, thanks very much.

Operator

We have one more question from Damien Prenzie [ph].

Damien Prenzie

Yes. There's only one question and that is have you guys renegotiated your exclusivity agreement with RxElite?

Bill Burns

No. The only thing that has been changed is, with the sevoflurane approval in the veterinary market, RxElite was a nonexclusive distributor of isoflurane in the veterinary market. We are taking that back on because we are already selling direct in that market as a second sevo entrant, and it just went together naturally. But they were nonexclusive on veterinary isoflurane.

Damien Prenzie

Right, but it seems, from what you're giving in terms of sales figures, they don't have a hope of meeting the exclusive – the exclusivity sales targets.

Bill Burns

Yes. Well, I think meeting the exclusivity sales targets is dependent on a couple of things. The first is the ramp-up in volume, which we think they are making real progress at. The second of course is when the targets have to be met by March 31 of 2009. It would be a substantial investment on RxElite's part in terms of inventory in the vaporizers to get there. I think that our contract is pretty explicit there as long as they are current, and at this point, they are, and they are beating their quarterly requirements, they will remain exclusive. Dave I think indicated we are being proactive in our working with RxElite in improving the growth and continuity of the business, and we're working very hard to see that they are successful and we are successful in this regard. I think that's all we're going to say. You may get different color from Jonathan Houssian on Monday.

Damien Prenzie

Right. Okay, wonderful. Thank you.

Bill Burns

Any more questions, folks? Well, if there are no more questions, I'd like to thank everyone for supporting the company. It's been a bumpy ride, but we are moving forward and I think you're going to be very happy with this company in the third quarter. Thanks very much, everybody. Bye.

Operator

Thank you. This does conclude today's teleconference. We thank you for your participation. You may disconnect your line at this time.

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