CAS Medical Systems, Inc. Q2 2008 Earnings Call Transcript

CAS Medical Systems, Inc. (CASM)

Q2 2008 Earnings Call Transcript

August 6, 2008 10:00 am ET

Executives

Susan Carron – Director of Corporate Communications

Andrew Kersey – President and CEO

Jeffery Baird – CFO

Analysts

Fred Ehrman – BMI Capital

Sam Bergman – Bayberry Capital Management

Michael Wood – Oppenheimer & Co.

Michael Cook [ph] – Shareholder.com

David Nathanson [ph] – Daymon Associates [ph]

Michael Michelson [ph] – Rainwater Associates [ph]

Louis Lubrano [ph] – BMI Capital

Presentation

Operator

Good day and welcome to the CAS Medical Systems second quarter 2008 earnings results conference call. Today’s conference is being recorded. At this time I would like to turn the conference over to Susan Carron, Director of Corporate Communications. Please go ahead.

Susan Carron

Thank you and welcome to the CAS Medical Systems second quarter 2008 earnings conference call. Hosting today’s conference call are Andrew Kersey, President and Chief Executive Officer and Jeffery Baird, Chief Financial Officer. Andrew will begin with an overview of the quarter and recent developments. He will then hand the call over to Jeff who will discuss the financial results. Andrew will then continue with specifics on the FORE-SIGHT Absolute Cerebral Oximeter, including the commercial launch into the Neonatal/Infant market. We will then open the call for your questions.

Before management begins their formal remarks I would like to remind you that to the extent the company’s statements or comments represent forward-looking statement I refer you to the risk and cautionary factors in today’s press release as well as the company’s most recent SEC filings. In addition, this call is being recorded on behalf of CAS Medical Systems and is copyrighted material. It cannot be rerecorded or rebroadcast without the company’s express permission. As you know, participation implies consent to our taping. Once management has completed their formal remarks, we will open the call up for questions.

Now, I would like to turn the call over to Andrew Kersey, President and Chief Executive Officer of CAS Medical Systems.

Andrew Kersey

Thank you, Susan, and thanks to everyone for joining us on today’s call. As reported earlier this morning, revenues for the second quarter increased 32% over the prior year and sequentially increased 17% over the first quarter of this year. Year-to-date revenues for the first six months increased 13% over last year’s levels.

During the second quarter, sales of our vital signs monitors to U.S. customers along with sales of blood pressure cuff accessories showed a marked increase both over Q2 or last year and the first quarter of this year. These product lines, along with our OEM non-invasive blood pressure monitoring technology, are showing strong momentum as we enter the second half of the year. Additionally, FORE-SIGHT sensor revenues approached $400,000 and grew over 60% over the first quarter.

Our core businesses continue to generate earnings necessary to fund our growth and our investment in our new FORE-SIGHT technology. We recognize that improvements in gross profit rates are vital to generating the income levels and cash flows necessary to fully realize our opportunities. Towards that end, we have developed a number of initiatives to address and improve our results from operations. We have made certain changes to our organization and our focus, which Jeff will talk about later in the call. With these changes, we are confident that we can achieve further improved results.

Market acceptance of our FORE-SIGHT Cerebral Oximeter continues to grow. We recently announced the installation of our 100^th monitor, an important milestone for the company. The business model to-date in the adult cardio-vascular operating room is one where customers purchased disposable sensors for use with the company’s monitors. As our installed base continues to grow, sales of sensors have accelerated. At the current rate of sales, annualized sensor revenue is over $2 million and continuing to grow.

We also recently reported the commercial launch and first sales of our Neonatal/Infant Sensors. The market opportunity in the neonatal arena is a large one with the potential for monitoring neonatal patients throughout their length of stay in the cardio-vascular OR and neonatal ICU before, during, and after surgery. FORE-SIGHT’s absolute measurement technology improves the quality of patient care by providing clinicians with previously unavailable information regarding the balance of oxygen supply and demand in the brain.

I will add some further details on FORE-SIGHT later in the call but first I would like to hand the call over to Jeffery Baird, our CFO, to review the financial details for the second quarter.

Jeffery Baird

Thanks, Andrew. Revenues for the second quarter ended June 30, 2008, totaled $10.5 million, an increase of $2.5 million or 32% over the revenues of $8.0 million reported for the same period in 2007. Revenues increased in all product areas led by sales of vital signs monitors to U.S. customers, sales of OEM products, and sales of blood pressure cuffs. Vital signs sales include products marketed by CASMED under its exclusive worldwide sales and marketing agreement with Analogic Corporation.

In the area of FORE-SIGHT, the company placed 25 monitors with customers. Under these arrangements, the company retains title to the device while the customer purchases the disposable sensors. Sensor revenues for the second quarter of 2008 totaled approximately $400,000.

For the second quarter, the company recorded a net loss of $32,000 or $0.00 per basic and diluted common share, compared to a net loss of $301,000 or $0.03 per basic and diluted common share reported for the period of the prior year. This improvement is largely from increases in revenue and reductions in operating expenses as a percentage of sales and modest improvements in gross profit rates.

Stock compensation expense was $91,000 for the second quarter of 2008 compared to $37,000 for the same period of the prior year. For the six month period ended June 30, 2008, the company reports revenues totaling $19.5 million, an increase of $2.2 million, or 13% over the $17.3 million reported for the first half of 2007. The increase in revenues was led by increased sales of the company’s OEM non-invasive blood pressure technology and blood pressure cuffs. Sales of FORE-SIGHT products, primarily disposable sensors, reached $650,000 for the first half of 2008.

The company reports a net loss $562,000, or $0.05 per basic and diluted common share compared to a net loss of $221,000, or $ 0.02 per basic and diluted common share reported for the same period last year. Cost of sales as a percentage of sales for the first six months of 2008 rose to 68% from 65% for the first half of 2007 as a result of higher cost of sales in the first quarter of this year.

First quarter cost of sales were significantly affected by product mix and higher fixed manufacturing cost as a percentage of revenues, which were also below expectations. Increases in FORE-SIGHT sales and marketing related expenses impacted the company’s six month operating results, increasing to approximately $1.5 million from $800,000 for the first half of 2007.

Offsetting these increases were reductions in R&D spending. R&D efforts were supported by approximately $255,000 of reimbursements from the NIH under a $2.8 million multi-year grant received during September 2007. As a result of these factors, operating expenses remained at 36% of sales for both periods reported.

Stock compensation expense was $231,000 for the first six months of 2008 compared to $131,000 for the same period of the prior year. The company generated cash from operations of $335,000 during the first six months of this year, a significant improvement over $1.1 million of cash used by operations for the first six months of 2007.

Expenditures for property and equipment and intangible assets reached $1.3 million for the first six months of 2008 compared to $800,000 for the same period of the prior year. Expenditures for FORE-SIGHT monitors at customer sites accounted for $576,000 of the spending. Other capital expenditures include production equipment for FORE-SIGHT sensor manufacturing, and blood pressure cuff capacity increases as well as various information technology related investments. Spending for intangible assets primarily included accrued contract costs, deferred finance charges and patent related costs.

Borrowings against the company’s line of credit have increased $296,000 to $2.5 million at June 30, 2008, while long-term debt was reduced by $284,000 from December 31, 2007. During May, 2008, the company consummated a private placement of 333,333 shares of it common stock for a total consideration of $1.0 million.

During the second quarter of 2008, we implemented cost reduction efforts to improve our income levels and cash from operations. These steps include reductions in personnel, planned reduction and consolidation of lease space, product cost reductions, and reductions in certain non-discretionary spending, including advertising and promotions. We have implemented price increase in selected areas affected by materials cost increases.

We have also begun an initiative to reduce our inventory levels, which have risen $1.1 million since the start of 2008. To achieve our goals we have reorganized our manufacturing operations management team in the areas of materials planning, procurement, and inventory control, and we have strengthened our quality management resources. We are also realizing process improvements in our blood pressure cuff facility in Jacksonville, Florida, which will result in improved productivity, lower costs, and shortened delivery times to our customers. We are confident that we will realize reductions in inventory by the end of 2008 as well as productivity improvements necessary for sustained profitability and improved cash flows.

Expenditures associated with the FORE-SIGHT product, including those for the upcoming launch of the Neonatal/Infant Sensor, are expected to continue, however. The company believes that these expenses are necessary to capitalize on the opportunity to increase product awareness and gain market share. Much of the spending required for product development and manufacturing start-up has been completed. In addition, the company continues to draw on its $2.8 million multi-year grant from the NIH to funds its clinical resource efforts into new applications of this important technology. As of June 30, 2008, a maximum of approximately $2.8 million remains under the award.

As a result of the changes in plans outlined above, we expect to limit further borrowing needs under our line of credit for the remember of 2008. We believe that our sources of funds, including cash flow and borrowings available under our line of credit will be sufficient to meet our current and expected short-term requirements. We may also seek additional capital as needed to ensure our continued expansion efforts.

On the strength of the second quarter and our momentum in both our cored product business and in the foresight opportunity, we are confirming our revenues at the upper end of our guidance at $42 million to $43 million with approximately $300,000 to $500,000 of after-tax losses during full year 2008.

I would now like to hand the call back Andrew to discuss further specifics on the FORE-SIGHT Absolute Cerebral Oximeter, our Neonatal/Infant product launch, and our plans for the rest of the year.

Andrew Kersey

Thanks, Jeff. First, I would like to provide some more details on the uses of the FORE-SIGHT Cerebral Oximeter in the adult cardio-vascular market. As we announced last week, we have now installed over 100 FORE-SIGHT monitors into over 45 accounts. This base of units with current sensor utilization rate is producing increasing recurring revenues, which are currently at an annualized rate of $2 million, an increase of over 30% above the running rate of $1.5 million reported last quarter.

We are confident about our technical and clinical advantage in this marketplace as absolute measurement of cerebral oxygenation is showing its superiority over trends-based measurement. Our user list is growing and includes hospitals that are both new to cerebral oximetry and those that have converted from trend-only systems. Our customers continue to comment on the value of absolute measurement to establishing threshold values to guide clinical interventions.

As FORE-SIGHT product gains wider acceptance in the adult cardio-vascular operating room, our potential customer pipeline continues to expand and we expect installations to continue to ramp up. We are continuing to focus on this important market space to grow this business and expand our sensor usage as we create – as well as create a springboard into related markets such as high-risk surgeries.

On the clinical side, we have over 20 additional monitors that are being used in clinical research at various locations throughout North America and Europe. These studies are expanding clinical applications and demonstrating the value of absolute measurement of cerebral oxygen saturation in a variety of clinical applications and surgeries. The NIH-funded multi-center study on cognitive decline and delirium in elderly patients undergoing major surgery, continues its 70 research sites. In addition, our $2.8 million multi-year grant from the NIH continues to fund research to expand the applications of our FORE-SIGHT technology.

In Europe, studies are underway at various locations to support a wider launch of the product. Studies include beating heart surgery, carotid, and shunting studies, as well as ECMO, or extracorporeal membrane oxygenation, applications. Data from these and other studies are planned to be presented at the Germany anesthesia meeting, or HIA, in September. This is key conference in Berlin with over 4000 attendees from around the world. Also during the quarter two abstracts were accepted for presentation at this year’s American society of Anesthesiology, or ASA, meeting in Orlando, Florida, in mid-October.

And also, a paper from Professor Hemmerling of Montreal General Hospital titled, “Significant decrease in cerebral oxygen saturation during single lung ventilation measured using absolute cerebral oximetry,” has been accepted for publication in the British Journal of Anesthesia. Additionally, there are several other manuscripts highlighting the use of FORE-SIGHT that are in the final stages of preparation for submittal publication.

As announced last week, we are very excited about the commercial launch and first sales of our Neonatal/Infant Sensor. We believe that the market for the FORE-SIGHT in the perioperative care of neonatal and infant is substantial. These patients require monitoring before, during, and after surgery in the NIQ, the OR, and the cardiac ICU. And this movement between the critical areas requires the use of up to three separate monitors for a single patient and necessitates the use of a device that can measure cerebral oxygen saturation consistently and without the need for a base line reading. FORE-SIGHT is the only cerebral oximeter that can meet this requirement.

FORE-SIGHT Neonatal/Infant Sensors were introduced at the American Association of Thoracic Surgeons Meeting in May and beta and customer preference testing has been underway all this year at several key clinical sites to optimize the user and patient interface features. We believe that our product provides superior monitoring capabilities that are required for this marketplace. We are continuing our planned investment in sales and marketing of the FORE-SIGHT product and expect to see continued sales growth in the second half of the year. There is excitement in the clinical community about the availability of the Neonatal/Infant Sensor, which we believe will result in sales of both monitors and recurring revenue of sensors in the coming months.

We plan to enter this market with a mixed model sales structure. We will use our manufacturer representative groups with neonatal ICU experience to supplemental our own direct sales efforts. Initially we will have four direct sales representative targeted at key population centers, and as we grow the sales opportunity we will continue to investment further in more direct sales representatives. Our goal is to build out our direct sales force to over 30 representatives focused on this pediatric opportunity over the coming years.

As Jeff previously stated, we estimate revenues for 2008 to come in at $42 million to $43 million. We also expect to regain profitability during the second half of this year even as we continue to invest in the FORE-SIGHT opportunity. We remain confident about the potential for growth and expansion of our business, in particular, cerebral oximetry, which we believe is the cornerstone of our future.

On behalf of Jeff and myself and the team at CASMED, I thank you for taking time to join us this morning, and we look forward to reporting on our results again in – to you in the near future. I would now like to hand the call over for questions. Teresa, would you please go ahead and queue up the questions?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And our first question is from Fred Ehrman with BMI Capital.

Fred Ehrman – BMI Capital

Congratulations, Andrew and Jeff, for a very nice quarter. Can you project how many oximeters you will have installed in the second half?

Andrew Kersey

Yes, good morning, Fred. That’s – we’ve certainly got internal projections on that and I think the thing that I would say there is we expect to see continued growth from the adult side as well as obviously early market penetration in the neonatal side. We are at that 2% threshold now in the adult market. It really is a little bit of a slower market to tackle for a multitude of reasons. Certainly market interest has been enormous as far as the product goes, but the sales cycle is just a lot longer than we had predicted. Our pipeline is remarkably strong as far as the adult opportunity goes and so should we start seeing those convert to sales this coming six months we should have a strong second half of the year as far as the adult market opportunity is concerned.

The neonatal market opportunity, obviously, we have just started getting out there. We have already quoted several accounts as far as monitor sales are concerned and we really expect to get off to a running start there, but it’s just too early to accurately define what expectations are.

Fred Ehrman – BMI Capital

What specifically are the difficulties in entering the cardio-vascular operating room market?

Andrew Kersey

Yes, that’s – the adult market is always seen as a profit center for the hospitals. There is just many, many cost constraints there and the politics make it a challenging market to rapidly penetrate. As you know, there are a number of influences and decision makers involved in bringing cerebral oximetry in and the group that has the most influence can actually vary from one hospital to the other. So you go to perfusionists, you got the cardio-vascular surgeons, you got the anesthesiologist, and obviously at the end of the chain there you’ve got the hospital admin folks that want to contain costs in anyway that they can. So, it’s a market that is just very, very politically sensitive. And that leads to a very difficult, slow sales process with multiple hurdles and committees to overcome. And sadly, inaction is often the path of least resistance when you get into those committees where even when you have one strong champion it can be so easy just to slow that process down.

So, again, the clinical and technical feedback that we are getting from the adult, cardio-vascular is really very, very positive. And I think that the 100 milestone, it’s not an enormous number by any stretch of the imagination, but I think it is significant in the sense that it really does show that we are out there. We are making a mark. We are accelerating without doubt in my mind. And we are going to continue to – as we get out there with further market penetration, the acceleration should continue.

Fred Ehrman – BMI Capital

You foresee at some point having direct sales as opposed to using distributors?

Andrew Kersey

For the adult market I think that the MR model works well. Why we are in this placement model is well the MR model works quite well for us certainly as we get into the neonatal opportunity where we have got – where we expect to sell every single monitor. We are definitely looking towards direct selling in that particular application. But the MRs have done a great job for us this past year. They’ve got the relationships. It is a big relationship sale [ph] as far the products go. We do want to expand into further markets. I am not sure that we are hitting all market opportunities today, and that’s something that we have gone back to our MR groups to make sure that we are getting out to every single cardio-vascular opportunity that’s’ out there. But I think that the MR model has worked well for us in this first year. We continue to review, I guess, would be the way I’d put it that the overall industry continues to become more aware of cerebral oximetry. And so we get more options as we move forward, as we become more successful.

Fred Ehrman – BMI Capital

Have you had any comments from any of your users comparing your product to your competitor?

Andrew Kersey

Sure. Only favorable as far as technology and performance goes. We’ve – I think that the great thing I could say about our products is the folks that are out there using the products are extremely happy. Our competitor is going back in and trying to convert those accounts with fairly aggressive tactics, but they continue to be supporters and users of our technology. So, I am – I think we are very, very pleased with the clinical feedback that we get.

Fred Ehrman – BMI Capital

Have you converted any of the other going from them to you?

Andrew Kersey

Sure. Sure. I don’t have the specifics as far the numbers, but I would say that there are several known accounts that we have converted, and we continue to look to convert their accounts. As we go forward, we want to take the whole cardio-vascular market. So, inevitably, we are going to take accounts from them.

Fred Ehrman – BMI Capital

And final question, how big do you think the market is?

Andrew Kersey

Yes, I think that’s – again, if you look we are saying we are kind of 2% into the market at 100 monitors. The adult market is where I am talking at this moment, the adult cardio-vascular, around about 5000 cardio-vascular ORs out there so that would – that should be the number of monitors that could go out there. And around about 700,000 procedures done in the cardio-vascular arena between CABG patients, heart valve replacements, and other related surgeries such as aortic arch surgery, things like that. So, that’s – the 700,000 patients, I guess, would be the size of the market from the U.S. markets and ASPs up above 100 would be what I would expect them to come in at. Our ASPs, we are looking to continue to increase sensor ASPs in the adult market as we continue to be more successful there.

Fred Ehrman – BMI Capital

Alright, one more question. How many sensors per month would you hope to achieve, what’s your goal per monitor, or dollars per month?

Andrew Kersey

Well, I guess typically for this no cap placement model, we are looking at a minimum of 20 sensors per monitor per month. Our average sensor utilization rate at this moment is about 17 per month. So, we are pretty much on target. Some accounts are doing better than the 20 and some are behind, but we are averaging 17. There is definitely room to grow there and it’s an area that we continue to focus on because we want our accounts to be 100% saturated using our monitors to the full extent. But if you do the numbers and you say 5000 CVORs and 700,000 possible cases, that would average out to about 12 cases per month and 20 – therefore, 24 sensors per month. But the ones that are low utilization, we really haven’t – we haven’t captured too many of those guys at this moment in time and those are going to be the ones that are going to be required to purchase the monitors. So, I do see them coming on board as we become more successful.

Fred Ehrman – BMI Capital

Thanks very much.

Andrew Kersey

Thanks, Fred.

Operator

Thank you. And our next question is from Sam Bergman with Bayberry Capital Management.

Sam Bergman – Bayberry Capital Management

Good morning, Andrew and Jeff, how are you?

Andrew Kersey

Hey, good morning, Sam.

Jeffery Baird

Good morning, Sam.

Sam Bergman – Bayberry Capital Management

Several questions. First of all, how long is the Analogic agreement for?

Andrew Kersey

It is a five-year agreement with kind of terms – yes, options to expand in there. It’s now – we are one year, just over one year into it I guess.

Sam Bergman – Bayberry Capital Management

And the milestones being met?

Andrew Kersey

I think that from both sides we are looking and saying that sales is slower than we would have liked. Even the product pipeline has been a little bit slower than we would expect. So, both companies continue to work together. I think that’s the one thing that I would say is that both companies are interested in making this thing work together. So we continue to do best efforts from our sales perspective. You know the co-branding of the products took a little bit longer than we would have hoped, which certainly more adversely affected our U.S. sales than it did our domestic sales efforts – than our international sales efforts. But the lack of products coming out the central stage things I guess certainly tweaked us as far as our ability to succeed in the U.S. market is concerned. But we are aggressively moving beyond that.

Sam Bergman – Bayberry Capital Management

What’s the opportunity for the FORE-SIGHT and the neonatal products to get into some GPO contracts?

Andrew Kersey

Yes, I think it’s still early days as far as FORE-SIGHT goes and its recognition. There are some GPO contracts that are out there that allow you to get in as a new technology or technology of interest. And in actual fact I think we are on one very small contract out in on the west coast there. But it’s not necessarily the best place for us to be at this moment in time until we continue to develop the market further and like all negotiations go in with a position of strength when it comes to negotiating the GPO contracts.

Sam Bergman – Bayberry Capital Management

Okay. And the next question is regarding inventory. I think if I go back two or three conference on earnings reports there was a very strong emphasis on inventory control, yet the inventory is up about 8% this quarter. What’s happened that the inventory is still on the increase and the management has not been able to put their hands on controlling it better?

Jeffery Baird

Sam, I think we alluded to some changes that we are making in the areas of operations management. Frankly, if you look at the inventory increase from December to June 30, nearly all of the $1.1 million is in some key areas, largely inventory in our Jacksonville, Florida operations that manufactures blood pressure cuffs. Quite frankly, we’ve – we had some growth initiatives there. We built inventory ahead of those initiatives. I am going to tell you quite honestly we didn’t manage the procurement as well as we should have, hence the reason for a new management team in the areas of planning and procurement. We have also had increases in inventory for Analogic as well as FORE-SIGHT, but most of the inventory that the company holds has grown rather slowly. I look at vital signs monitoring and OEM technologies, demo, service, apnea, we’ve got good control of those inventories. We just have not done as well a job as we should have in the blood pressure cuff area. And we are paying attention to that right now. The new management team is in – been in place for about 30 days. We have already canceled purchase orders in the neighborhood of $1.5 million as it relates to blood pressure cuffs and we have pushed a number of purchase orders out. And so I think we are aggressive. I think we are doing the right things right now. Unfortunately, we were a little bit slower than we should have been to get to it. But I think that we have a lot of confidence that inventory will come down between now and end of the year.

Sam Bergman – Bayberry Capital Management

Okay. In terms of growing the FORE-SIGHT business and the neonatal business, I assume the SG&A is going to spike a little bit more for the next six months. When do you think CASMED and the shareholders will see the bottom line improve because number one, revenue is growing better than SG&A. Is that a 2009 phenomenon or is it longer than that?

Andrew Kersey

I think typically we’ve broadcast for the past six months that we expect to return to profitability in the second half of this year and that remains the consistent theme. We were virtually breakeven this quarter with a good quarter, yet we are continuing to invest further as far as FORE-SIGHT goes, although the majority of the significant investments really have taken place. So we are continuing to build our sales. We are continuing to be aggressive as far as the opportunity is concerned. But I doing that we are also looking at resource within the organization and we are moving resource around rather than necessarily continuing to add resources. So I don’t really see significant changes as far as SG&A goes. Jeff, have you got anything further–?

Jeffery Baird

And, Sam, I think that we said our operating expenses for the six months remained at about 36%. So while we grow FORE-SIGHT related expenditures we try to at least cap expenditure in the non-FORE-SIGHT related area and to Andrew’s point, we will move resources around as we need to that. I think the one thing that I am very excited about is that as we start to sell into the neonatal areas, we look at very strong gross margins in that area, which will support the growth of the company, the addition of sales resources, additional marketing expenditure, and at the same time allowing us to be profitable. So the key driver for us, Sam, really is growth. Earnings are important to the company, cash flow is very important, but the key driver is start getting into the FORE-SIGHT markets and push growth as much as possible.

Sam Bergman – Bayberry Capital Management

Well, the last question is regard to both your new technologies, FORE-SIGHT and neonatal, which seem to be really (inaudible) technology and will do well in the future. Do you think the resource you have besides doing any type of financing, is adequate, or do you think it makes more sense perhaps in the neonatal to align yourself with another company maybe like Madis [ph] Medical or some large organization so you can drive those revenues?

Andrew Kersey

Yes, I think – I actually think we’ve got a great track record out in the neonatal world already. It’s actually a very different experience to what we faced in the adult CVOR where one of the questions, one of the challenges we faced were, “Who the heck are you guys?” We really did not have a presence in the adult CVOR prior to last year. In the neonatal ICU, we’ve got 20 plus years experience of – the company was actually founded looking at the neonatal opportunity for blood pressure cuffs. And we expanded beyond there into the Klear-Trace electrodes. The Klear-Trace electrodes are extremely well known out in the neonatal ICU, and so we think we are able to leverage other parts of our businesses to actually really start making great penetration as far as the neonatal opportunity is concerned. That said, we are starting with a limited sales force and cherry picking key opportunities using our manufacturer rep groups to supplement our direct sales efforts. So if we are out there and we see this rather explosive growth opportunity, obviously we’d be re-reviewing plans and looking to be more aggressive as far as our investments go, but today we think we have got the cash needed. We think we have got the resources needed to really make great success and great headway into this market. As we become more successful, be it the adult market, be it the neonatal market, be it other related markets, I think that there will be interest from other companies, but again we want to make sure that we are at the negotiating table with a position of power and not one of weakness. So, we are going after this market.

Sam Bergman – Bayberry Capital Management

When do you think the neonatal market will really spike?

Andrew Kersey

Well, it’s very, very early days today. But the fact that we are – that we have neonatal ICUs contacting us saying we’d like to see the product, we’d like an evaluation is a very, very promising sign. As I had mentioned, we’ve already quoted a few key installation, and really I actually think that the neonatal market is going to be a market that welcomes cerebral oximetry with open arms. So I am very excited about that opportunity.

Sam Bergman – Bayberry Capital Management

So, in that market again are you just selling the consumables and holding on to the products

Andrew Kersey

No, in that market – it’s a very, very marketplace–

Sam Bergman – Bayberry Capital Management

You sell both?

Andrew Kersey

We thoroughly expect to sell every single monitor at good margins. It’s a very different – it’s a different marketplace to the adult CVOR where you’ve got the challenge of the guy that benefits the most, which is probably the cardio-vascular surgeon, isn’t necessarily the one that is paying the bill for the product, it turns out to be the anesthesiologist.

Sam Bergman – Bayberry Capital Management

I see.

Andrew Kersey

And in the neonatal ICU, even in congenital heart surgery folks the guy that gets the most benefit is usually the guy that controls the purse strings as well, and so we do not see the limitations as far as issues go with selling monitors and certainly our competition is already out there. They’ve got a month or two head start on us. But we think we are extremely well positioned to tackle this market.

Sam Bergman – Bayberry Capital Management

And last question (inaudible) in terms of Medtronic, can you give us an update on the business there and where you are at?

Andrew Kersey

Yes, I can't comment as far Physio-Control Medtronic, as far as their position with the FDA, that’s for them to talk about. But the one thing I would say is from our perspective shipments were strong in Q2. Shipments remained strong. And the forecast is really very, very good for the rest of the year. So, Physio is one of those items that I don’t believe needs to be talked about. Certainly from a management discussion perspective, we think that they are well on track.

Sam Bergman – Bayberry Capital Management

Thank you very much. Looking forward to a better second half–

Andrew Kersey

Thank you, Sam.

Jeffery Baird

Thank you, Sam.

Operator

Thank you. And our next question is from Michael Wood with Oppenheimer.

Michael Wood – Oppenheimer & Co.

Hey guys.

Andrew Kersey

Hey, good morning, Michael.

Jeffery Baird

Hi Michael.

Michael Wood – Oppenheimer & Co.

Good morning, Jeff. Good morning, Andrew. Nice job doing – what you guys were able to do in the quarter and lot of my question were already answered about the inventory and so forth. I do have a question for you though as far as neonatal, if you could explain to me just really brief why it’s – you say the adult market is hard to penetrate because of the clinical reasons. How much easier is the neonatal and why is that so much more profitable for us?

Andrew Kersey

Well, again, the neonatal market – that – it’s just a very different environment the adult cardio-vascular. In the neonatal environment you have the people running the unit who are the ones that are the direct beneficiaries of the technology and so if you benefit – if your product is a benefit to the ICU be at the neonatal or the pediatric, it’s directly benefiting the people who are responsible. And you are helping those patients – they are passionate about patients' outcome here, and so if you can get your patients through the unit faster with fewer complications it’s just a much easier, far more direct sell.

When we look at the adult cardio-vascular market, as I say, there are multiple influences. Invariably even with extremely positive clinical outcomes, clinical results from our evaluations, it then still has to go through this evaluation committee where they are saying, okay, we are adding extra cost here, what does it – how are we going to pay for this extra cost?

In the neonatal ICU, the guy making the decisions or the people making the decisions, they are the people that we are talking to on the daily basis. So it really is a much easier sell. As well as that – why is it so important in the neonatal world? Well, you are working with much, much smaller patients and really the amount of information that you can get from neonatal, quality information really is not the same as you can get from an adult patient. For example, you can't take a lot of blood sample because for a neonatal patient every single drop of blood is critical. And so you really don’t want to be invasive. You don’t want to be invasive anyway because of risk situations as well. And so the clinical staff they are kind of welcoming with open arms any product that – any technology that can given them further insight into the treatments that they are doing with their patients, are they benefiting or not for the patients. So, it just is a very different market.

Michael Wood – Oppenheimer & Co.

Jeff mentioned the margins are – would be better and so forth. Is it because it’s cheaper for us to sell because it’s faster or is there – what’s then – where is there – it’s seems to me that you are insinuating that a machine and a neonatal will make us more money than an adult market. Is that true?

Andrew Kersey

Well, there is multiple reasons behind that one. A, again in the adult market, today’s it’s generally a placement model, so you are not getting revenue from the monitor initially as well as that the ASPs, the sensor ASPs in the neonatal market are generally, fairly significantly higher than they are in the adult market. The adult market, the ASPs are not where we want them to be. We are going to train that to market to move those ASPs up. But in the neonatal, the ASPs really are setting up at the level that we’d like to see them.

Michael Wood – Oppenheimer & Co.

So – and what about the sensors themselves.

Andrew Kersey

Sensors themselves, the neonatal sensor is a smaller, easier to manufacture, less costly product, so, again, all very, very helpful as far as ASPs go. So we are remarkable excited as far as the margins that we are going to get from the neonatal opportunity.

Michael Wood – Oppenheimer & Co.

And what about the number of units per month? You mentioned some numbers for the adult market. What would you – what’s your guesstimates? Can you give us a little color on what your guesstimates on the number of units on the sensors, for the children?

Andrew Kersey

Yes, that one is a little bit tricky. Certainly our model, we are using an extremely conservative model as far as sensor usage goes. What we have seen in our beta testing – we had beta testing going on at some six or so sites throughout the year. Typically, they have used two sensors per patient, sometimes one where there is just not enough room for two cerebral sensors. We recommend changing the sensors and checking the sensors on a regular basis. Like all optical sensors you need to be very careful with the babies because they have incredibly sensitive skin and you need to avoid pressure and heat blisters. Indeed, that’s actually one of the factors that we think we’ve got in our favor here is unlike pulse oximetry sensors and competitive sensors, which have LEDs in the sensor itself, our optical light sources are way back in the monitor. And so our sensor has no risk of generating heat at the patient’s skin and a burn that’s – the neonatal folks latch on to this very, very quickly after their year’s experience with pulse oximetries causing burn issues with babies. And so the challenges of inadvertent burns created by localized heat is very much reduced. I think it will depend from one institution to the next as far as their practice goes. With our sensors I would say that you can certainly remove them, clean the patient’s skin, move them slightly as far the baby – as far the site goes. And so you can use a sensor for multiple days. Indeed we have had a sensor used in one location for several days, but that’s not something that I would recommend. Our estimates are saying that up to five days is – would be a conservative model as far as sensor usage goes in the ICU unlike the OR where every single patient gets a new set of sensors. So, it’s a slower number of sensors that you get from each monitor, but it is a much larger market.

Michael Wood – Oppenheimer & Co.

Can you touch on that just a bit, you mentioned that you think that we have a 2% penetration for your adult market. Where are we on the neonatal, what’s the size of that market?

Andrew Kersey

Well, the neonatal beds is about 13,000 neonatal beds out there in the U.S. at level three. When you add pediatric and you add the cardiac ICU beds as well so there is – you are talking about probably around a 20,000-bed opportunity for the U.S. and theoretically every single bed should have a cerebral oximeter. So the market size is quite, quite large. If you were to penetrate just 2% of the neonatal beds, the 13,000 neonatal beds, and you were to say, just pick a number, ASP of $25,000 for the monitor, we actually expect it to be above that, but if you play conservative and say $25,000 that’s a $6.5 million opportunity just to get to that 2% market gain, which certainly we hope to exceed that fairly rapidly.

Michael Wood – Oppenheimer & Co.

Alright guys. Thank you. I will step in queue.

Andrew Kersey

Thanks, Michael.

Jeffery Baird

Thank you, Michael.

Operator

(Operator instructions) Our next question is from Michael Cook [ph] with Shareholder.com.

Michael Cook – Shareholder.com

They have been answered.

Andrew Kersey

Thanks, Michael.

Operator

Our next question is from David Nathanson [ph] with Daymon Associates [ph].

David Nathanson – Daymon Associates

Good morning, guys.

Andrew Kersey

Hi David.

Jeffery Baird

Good morning.

David Nathanson – Daymon Associates

Just a quick question about the Society of Thoracic Surgeons was conducting some sort of data accumulation –

Andrew Kersey

Sure.

David Nathanson – Daymon Associates

Andrew, we spoke about this several months ago and the only question I have for you is whatever the process or their data accumulation of cerebral oximetry, is at absolute or is it trend, or can you differentiate the two?

Andrew Kersey

Yes, it was one of the things that we were unhappy with, was the fact that you could not differentiate between the two in the STS database. The STS database basically since January of this year has included data fields related to cerebral oximetry, so you the clinicians will answer information like the starting cerebral oximetry values, the amount of time below with certain thresholds and a good indicator is whether cerebral oximetry was the first indicator of something going wrong with the patient. So, all of those kind of information are actively getting entered by clinicians. One of our fears is that because it does not differentiate between our device and competitive devices, the data gets a little bit muddy when you throw it all together. But, we remain confident that it will support the use of cerebral oximetry as a beneficial tool in outcomes for cardiac surgery.

David Nathanson – Daymon Associates

I see. I just wanted to ask, you’ve covered just about everything I wanted to enquire, but the one thing that I just need a little more color on is future financial issues. At some point you guys are going to need some more money, or you are going to need to partner with somebody or do something to get some more inflow in. can you put a little color on what your current thinking is?

Andrew Kersey

Yes, I think that the market sees this as somewhat inevitable that we need to go out and get more money. We certainly don’t necessarily agree with that internally. Bank debt has remained flat for the past three months. We have got positive cash flows to-date and ended the quarter with near $1 million in cash in the bank. Yes, we are aggressive and yes, we are – we continue to evaluate options as they come up – partnerships where appropriate would certainly be looked at, but I think that we are well positioned to really become profitable in the second quarter and really start to be a cash-generating machine soon there afterwards. So I don’t think that we are internally as –

David Nathanson – Daymon Associates

And clearly you are not internally as worried as we are externally.

Andrew Kersey

Yes, now at the same time, obviously, externally there are concerns and we need to address them. Again, the company is extremely well positioned. We are generating cash. We do expect it to be profitable this second half of the year. We continue to evaluate I guess as would any company if the right opportunities present themselves. But we do not see the need – we are not rushing out there looking for cash at this moment. There’s just not an issue [ph].

David Nathanson – Daymon Associates

Thank you very much.

Andrew Kersey

Thanks, David.

Jeffery Baird

Thanks, David.

Operator

And our next question is from Michael Michelson [ph] with Rainwater Associates [ph].

Michael Michelson – Rainwater Associates

Yes, hi, Andrew.

Andrew Kersey

Hey, good morning, Michael.

Michael Michelson – Rainwater Associates

Very nice quarter, nice report. I had a question that no one seems to have addressed as yet. When you talk about sales, it is not clear to me whether you are actually selling the FORE-SIGHT unit into hospitals or whether it is essentially on a per-use basis? And if it is on a per-use basis, which is what I assume is mostly the case, how much does it cost you to install a unit and how many usages does it take before the line is crossed, before you recover the cost of placing that unit into a hospital?

Andrew Kersey

Yes, it’s a good question, Mike. For the past quarter, and in the adult cardio-vascular market, it’s the way that the market has been set up and so it’s pattern that we are following. For the past quarter we did not sell any of the 25 placed monitors. That said, this number does vary from one quarter to the next. We have already sold some monitors this quarter, as an example. So it’s a kind of lumpy effect that really you need to average out over several quarters. It really hasn’t – it’s not the significant metric as far as the adult cardio-vascular market is concerned whereas there is a placement of monitors has been a well established practice. Although that’s true, when you look that we are generating up to $2000 a month in sensor revenue for each placed monitors, the return on the investment is not too bad. So, yes, from a cash flow perspective it’s certainly one that we pay careful attention to, but you do quite quickly gain a return on that investment. That said, we do – as we gain more success in this marketplace, we look to shift this model. As the demand for the product increases we see no reason to start shifting this model towards a sales based model for the adult cardio-vascular market as well. So, we just need to establish our own ground rules. In this first year, this first 100 monitors has really been a key part to be able to go out there more aggressively into the market and start demanding higher ASPs as well as more monitor sales.

The neonatal market, just to confirm this, Michael, the neonatal market is a very different arena there. And there we expect to sell all monitors at a very good ASP.

Michael Michelson – Rainwater Associates

Alright.

Andrew Kersey

So that will have an immediate effect as far as both cash flow and profitability is concerned.

Michael Michelson – Rainwater Associates

Alright. Well that helps. When you place a unit, say an adult unit into a hospital on a per-use basis, does the hospital have the option as I assume they do of using it with your bearing the cost of placing the unit and then purchasing it after they’ve become more familiar and once the hospital does purchase the unit itself what happens to the per-use revenue or do you then make money by selling them the sensors?

Andrew Kersey

Yes, Mike, I alluded to that earlier in the call, but I will clarify. Again, for the placement model that we’ve got out there, we are expecting 20 sensors a month, which is a – we are reasonably at that level as far as our sensor utilization goes. There are hospitals out there, the smaller hospitals that really cannot meet those metrics and for those hospitals we go and say okay, you need to purchase the monitor if you wanted to use cerebral oximetry. So, sensor utilization becomes less key for those monitors that are purchased and again as we move forward we are roughly 2% of the monitor market but maybe 3% plus of the sensor – available sensor utilization market as we stand today.

Michael Michelson – Rainwater Associates

Okay. Alright, yes, you did touch on that before but that helps. So that’s my last question. Thank you very much, Andrew.

Operator

And our next question is from Louis Lubrano [ph] with BMI Capital.

Louis Lubrano – BMI Capital

Good morning.

Andrew Kersey

Good morning, Luke.

Jeffery Baird

Good morning, Luke.

Louis Lubrano – BMI Capital

Alright. Wonder if you can guide me a little bit as a business model going into next year or whenever you sold your next 100 neonatal units whether it’s in a year or 18 months or three years. I assume they run for 25 grand each so that’s a $2.5 million sale?

Andrew Kersey

Yes, I would really like you to ask me that in three months time, but I think what I – the highlights I will give you is probably the easy way to look at this. The adult cardio-vascular market – some 1200 hospitals out there with cardio-vascular suites averaging about four cardio-vascular suites per hospital. So if you are getting four monitor placements in the adult for any one particular account, you are doing quite well. There are bigger ones out there, obviously, but the average is out at four.

In the neonatal world, you’ve got maybe 500-550 neonatal ICUs out in the U.S. and some 13,000 beds. The ratios are much, much different and so as an example the quotes that we have been given – that we have been doing this past month have been for multiple monitor sales, not just the one or two monitors that typically we do as far as placements into the adult market. And so modest success should get you to those numbers much faster than we did in the adult market. It’s a much bigger market. Yes, it’s – we are kind of entering this market on a level-playing field with the competitor and –

Louis Lubrano – BMI Capital

I was trying to focus on the bottom line. Otherwise, if you did a 100 of these units over whatever period of time it takes, that’s $2.5 million–

Andrew Kersey

That’s $2.5 million of good margin business.

Louis Lubrano – BMI Capital

–and I assume there is $0.5 million of sensors on an annualized rate.

Andrew Kersey

Yes, those are reasonable numbers, Luke.

Louis Lubrano – BMI Capital

The question is that I have what does that come back to on an operating percentage profit? Looking for leverage on – I mean I assume your experience are going to remain relatively –

Andrew Kersey

Yes, I think that’s fair. I think one of the expense question marks we’d mentioned that we are putting four people in place. That’s actually a net plus two on what we are today.

Louis Lubrano – BMI Capital

But do you make 10% on a $3 million, do you make 20% operating margin, I mean what’s the magnitude?

Andrew Kersey

The sales margin will be very, very good. Operating margin will depend on how many sales folks we actually club into the sales opportunity. I would expect it to be extremely favorable compared to where we are today.

Louis Lubrano – BMI Capital

I guess I will settle for that.

Jeffery Baird

Yes, that’s a tough – Luke, that’s a tough question. I mean we are entering the market now. We know that we need to add some resources to do this. We are encouraged by high – what we think are significantly higher gross margins on the products, but the overall contribution to the company is going to depend on how successful we are in the next six to 12 months and what percentage of the business – of the total business is represented by the neonatal FORE-SIGHT. Do we think it adds contribution margin? Certainly we do. But (inaudible) to tell you what the rate is going to be and what the overall contribution is too early to say –

Andrew Kersey

It’s just a little bit early, but if you can oblige us three month, Luke, then I think we’ll be a lot firmer about that.

Louis Lubrano – BMI Capital

Okay. Good luck. Thanks.

Andrew Kersey

Thank you, Luke.

Jeffery Baird

Thank you, Luke.

Operator

And there are no further questions.

Andrew Kersey

Okay, again, thank you for your time today and your continued support of CASMED. We look forward to reporting results again in the near future. Thank you.

Operator

This concludes today’s conference call. We thank you for your participation. You may now disconnect.

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