Surmodics Inc (SRDX) 2004 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the SurModics first quarter 2004 conference call. At this time, all participants are in a listen-only mode. Following today’s presentation, instructions will be given for the question and answer session. If anyone needs assistance at any time during the conference, please press the star followed by the zero on your touchtone phone. And as a reminder, this conference is being recorded today, Wednesday, January 21, 2004. I would now like to turn the conference over to Ms. Marian Briggs. Please go ahead, Ma’am.

Thank you. Thanks to all of you for joining us today. With me are Dale Olseth, SurModics Chairman and CEO, who will give a brief overview of the quarter. Phil Ankeny, VP and CFO, who will provide an overview of the quarterly financial results. Bruce Barclay, the company’s new President and COO will discuss operational highlights and Loren Miller, VP and Controller, who is available for the Q&A session.

Before we begin, I must preface all comments with the safe harbor statement. Some of the comments made today will be forward-looking and are made under the Private Securities Litigation Act of 1995. Actual results may differ and factors that may cause such results to differ are identified in our press release for the first quarter and beginning on page 12 of the company’s fiscal 2003 Form 10K annual report. Now I will turn the call over to Dale Olseth.

Thank you, Marian, and good afternoon. We appreciate all of you joining us today. SurModics had a good first quarter. Compared to the prior year period, revenues rose 50% and net income grew 89% to $4.1 million or 23 cents per diluted share. Our employees have worked very hard to deliver these gains this opening quarter. Phil Ankeny will comment more on the quarter in a few minutes. Let me say that the first quarter royalties and license fees set a record for the company. Our royalty numbers from J&J though weren’t as strong as some analysts had anticipated. I want to reiterate that SurModics’ relationship with Cordis continues to grow and strengthen. We are working with Cordis on their next two generations of drug coated stents and we are strategic partners with them in developing other sophisticated devices as well. We remain excited about the prospects for additional applications utilizing SurModics technology for the site specific release of a drug from the surface of a device. As we’ve said before, our drug delivery matrix is applicable across a broad range of applications, not just stents. We are seeing now heightened activity in this arena. During the quarter, we signed a total of six new licenses, a quarterly record, and you will hear more on that in a few minutes.

Now I’d like to say a few words about our new President and COO, Bruce Barclay, who joined the company on December 1. As you are aware, we searched for a long time to find the right candidate to fill this very important position. Bruce’s background is ideal. His extensive operating experience in many facets of the medical device and healthcare industry makes him a perfect fit from both a strategic and an operations perspective. Some of you have already had a chance to visit with Bruce and we think you will agree that he is an excellent addition to our senior management team. We are excited about the skills, background and enthusiasm he brings to this assignment and we will now be able to accelerate the execution of certain strategic plans. Before Bruce presents an operational overview, I’m going to ask Phil Ankeny to cover the financials for us. Phil?

Thank you very much, Dale. As you will note from the earnings release as well as Dale’s comments, we had a good first quarter, although our numbers do reflect lower sales of CYPHER than some analysts had projected. Our results are down sequentially form the previous quarter but we posted robust year over year gains. Revenue in the first quarter rose 50% to $12.1 million from 8.0 million in the first quarter of fiscal 2003. Income from operations was $6.3 million, a 120% gain from the prior year period. And net income for the quarter was 4.1 million or 23 cents per diluted share, almost double the 2.2 million or 12 cents per diluted share we reported a year ago.

Royalties and license fees reached an all time quarterly record of 8.6 million up 122% over the first quarter of fiscal 2003. Product sales were 2.6 million, a 14% decline from the prior year’s quarter primarily reflecting lower reagent sales. Development revenue was 0.9 million, down 24% from the year ago quarter and this was expected because we are no longer performing coating work for Cordis’ clinical trials as we were last year. Regarding Cordis royalties, yesterday Johnson & Johnson disclosed that sales of CYPHER were $550 million worldwide the quarter ended December 31st, below the estimates some analysts had published. But we are encouraged by J&J’s confidence in the future of CYPHER. J&J is a very strong competitor and they currently have the only approved drug eluding stent on the U.S. market. Furthermore, CYPHER has outstanding clinical data. Now that CYPHER has been on the market in the U.S. nearly nine months, physicians have real world clinical experience from approximately half a million patients At the end of the day, physicians will decide which stent to use based on patient outcomes.

As Dale mentioned earlier, we signed six new licenses in the first quarter, an excellent start to the year. In fact, this is an all time record for a single quarter. We now have a total of 60 licensed customers, covering 134 product applications. Of these, 70 products are already generating royalties to SurModics and our customers launched two new products in the first quarter and we expect a total of 10 to 12 new products to reach commercialization this fiscal year compared with eight in fiscal 2003. Our operating expenses for the first quarter rose 10% to $5.1 million as the company invests for future growth, particularly in research and development where quarterly expenses grew 18% over the year ago quarter.

Our balance sheet remains strong with 99.2 million of total assets, 90.2 million of shareholders’ equity, and no debt. As of December 31, the company had a cash and investment balance of $49.8 million. We continue to examine our options for deploying the cash from our very healthy balance sheet. Expect to hear more from us as the year unfolds.

And now, a word on revenue and EPS guidance. We understand the frustration some of you have felt because we have not provided specific earnings guidance. But the reality of the situation is that there are simply too many moving parts for us to be comfortable with any projected numbers right now. The CYPHER stent is our single largest revenue driver at present and CYPHER revenues are determined by many factors, most of which are largely outside our control. These include growth of the drug eluding stent market, conversion rates, timing of FDA approval of a second stent, and the subsequent competitive dynamics, to name only a few. Therefore, we are uncomfortable giving any specific quantified guidance at this time. Nevertheless, we remain optimistic about the growth prospects at SurModics. We have numerous areas in our strategic plan with significant growth potential and we are aggressively pursuing those opportunities. At this point, I’d like to turn the call over to Bruce Barclay.

Thanks, Phil. Let me extend my welcome to everyone joining the call today as well. It’s a real pleasure for me to be with SurModics and I’m excited about the opportunity that helps take SurModics to its next stage of growth and success. In my comments today, I‘ll cover three topics. First, my initial impression since joining the company. Second, a brief look at the company’s strategic direction. And third, our new license agreements and other operational highlights for the quarter. In deciding to join SurModics, I focused on three things. First is the increasing importance expressed by many medical device companies of providing surface modification solutions for their new products and the value these solutions bring to their customer, the physician. SurModics, in my view, has exceptional technology and is well positioned to work with these medical device companies and help them bring new, value added products to the market. Second, the SurModics business model is very compelling with high gross margins and a strong balance sheet. And third, the people. From an outstanding board and senior management team with demonstrated success, to an employee base that is technically sophisticated and sincere in their efforts to deliver strong results, with this background I enthusiastically joined the management team at SurModics. It’s been nearly two months since I joined the company and now that I’ve had a chance to interact with many employees and further explore some of our key business and strategic opportunities, I can tell you that I’m even more excited and optimistic than I was after completing my due diligence on the company. With a highly skilled staff, unparalleled coatings technology and expertise, I believe SurModics has the potential to create truly innovative products and solutions for our current and future customers as we move forward.

In fact, the company today has a very unique opportunity to capitalize on the trend toward convergence. That is, where medical device and pharmaceutical industries are realizing that drugs and devices can be combined to create significant benefits for patients. Drug eluding stents are just the first example of this convergence of drugs and devices and how powerful the new products created can be. In the next decade we expect to see many new products and therapies that are made possible by a combination of drugs and devices. Trend towards convergence holds a significant strategic importance for SurModics. Because our company already has the needed technology, market expertise and business relationships in place, we are particularly well positioned to exploit these new opportunities. As drugs and devices come together, SurModics is located squarely in the middle, ready to serve as a highly experienced and skilled business partner for a wide range of customers.

The company has mentioned in the past that our management team has been working on a new strategic plan. It has now been completed. The initial results of that effort are outlined in our fiscal 2003 annual report which has just been released. As we discussed there, in order to maximize our growing opportunity, we are focusing on four key markets, cardiovascular, ophthalmology, orthopedics and neurology. Let me comment on these one by one. First we have a strong presence in the cardiovascular market. As you are already aware, we are working with Johnson & Johnson Cordis division to create the second generation of its drug eluding stent and we continue to explore other opportunities in this area as well. In the ophthalmology market, we signed our first significant agreement for an ophthalmic drug delivery application in 2003 and development activities in this important area are quite active at the company. In fact, at our annual shareholders meeting next Monday, we’re pleased to have as our guest speaker the physician we are collaborating with on an implant to treat ocular disease. You’ll hear him describe their device and how SurModics coating is helping make it possible. It’s an exciting development in ophthalmology, not just because it represents another compelling combination of drugs and devices, but also because it holds potential to revolutionize the way certain diseases of the eye are treated. If you are not able to attend the annual meeting in person, we encourage you to listen to the web cast.

Opportunities in the orthopedics arena are under active evaluation and we believe they can be of significance for SurModics as well. In the neurology market we have an existing relationship with Target Therapeutics, a subsidiary of Boston Scientific, that sells a very successful infusion catheter used in brain applications and we intend to expand on our participation in the neurology field going forward.

Now I’d like to recap some of our operational successes for the first quarter. As mentioned, we had a lot of activity on the licensing front, signing six new license agreements. All six incorporate our PhotoLink lubricity technology. Four of them fall in the vascular field and particularly satisfying to us, one application displaces a competitor’s technology. Also, just a few days ago, we announced a new agreement with TheraCare Life Sciences to market and distribute our line to stabilization products used in diagnostic kits. The stabilization line currently represents a small portion of SurModics revenue, but TheraCare’s experience in the diagnostic market and their distribution capability make them an excellent strategic partner for these products. We’ve made strong progress in this quarter and it bodes well for our future prospects and opportunities. We intend to be more aggressive in many ways, in particular on both the technology and intellectual property fronts. With a strong, well articulated patent capability, we hope to capitalize on previously untapped markets and revenue opportunities. Expect to hear more details as fiscal 2004 progresses. That concludes our prepared comments and now we’d like to open it up to questions. Operator?

Thank you, Sir. Ladies and gentlemen, at this time we will begin the question and answer session. If you have a question, please press the star followed by the one on your pushbutton telephone. If you would like to decline from the polling process, press the star followed by the two. You will hear a three tone prompt acknowledging your selection. Your questions will be polled in the order they are received. If you are using speaker equipment, you will need to lift the handset before pressing the numbers. One moment, please, for the first question. Our first question comes from Jayson Bedford with Adams Harkness. Please go ahead with your question.

Good afternoon, guys, and welcome, Bruce. A few quick questions for you. In the past you’ve eluded to a second licensed stent manufacturer. I realize you can’t reveal the name. Can you give us a sense as to where they are in clinical trials?

At this time we can’t talk about where they are in their pipeline unfortunately.

Okay. And then, just on the ophthalmology partner, any idea as to when you can generate revenue from that partnership?

The partnership will generate revenue on the commercial development front as the product is being developed. In terms of when they would generate their own sales and correspondingly royalty revenue flows to us, we don’t know at this time. It largely depends on the success of the animal studies and their clinical trials and how that unfolds. It’s unlikely to happen this year or next so it’s just a question of how aggressively they can effect the time line beyond that.

Okay. Then so just one final question. In terms of the guidance, I realize you can’t give kind of top and bottom line guidance. Any idea as to the increase in cost or expenses? Can you give us any guidance on kind of the cost structure that you see going forward?

With Bruce now on board, and he’s still in the process of assessing the new requirements of the organization and what we’ve got today, and so we have not reached any conclusions yet exactly what areas will require investment and which will not. So at this time, it’s premature to give you much indication of where that’s headed.

Okay, thanks. I’ll jump back in the queue.

Thank you. Our next question comes from Kent Holden with Giganon Securities. Please go ahead with your question.

I’m sorry, I had my mute on. Following up on the prior question, are there other products a little further along in the studies that may generate revenues sooner?

We’ve got a number of products that are in development and as you heard from Phil, just like with the ophthalmic application, revenue on both the commercial development side gives an opportunity and also on the royalty side. Coming in new to the organization, one of the things I am looking at actively in the assessment of the organization is trying to identify those opportunities that we can expedite through activity here and that’s actively being reviewed right now.

Right, but the ophthalmology product is in animal studies now, so that’s quite some time away. Are there others that will be commercialized products within the next 3, 6, 9 months?

We have - - actually in the last call we had talked about sort of our expectations for how many products our customers would be launching in fiscal 2004 and we expect somewhere in the order of 10 to 12 products to cross that line and actually be launched by our customers this year. And that’s up from 8 the prior year, so you know, there’s quite a bit of activity with our customers that we’ll add to our royalty portfolio as we move forward.

Anything the magnitude of the CYPHER stent?

I’d say none that are of that magnitude, at least initially.

Okay. Thank you.

Thank you. Our next question comes from Alan Kessler with Oracle Partners. Please go ahead with your question.

Hi, Dale. I was curious to know - - did this quarter’s performance include any milestone payments from Amersham?

Can you speak up? We’re having trouble getting you through here.

Does this quarter’s performance include any milestone payments from Amersham?

No, it did not. The development there, I think, is the acquisition of Amersham by Generous Electric, that may have some major implications over time. Amersham continues to do well and was making progress with us and then, of course, when the big announcement came, we said that one will throw a lot of uncertainty on the table for awhile. But the one thing that does interest us there is that the CEO of Amersham now is going to run GE Medical and we would not be surprised that we get some favorable insight into where they’re going to take genomic downstream. But that one, of course, is a meaningful contract. But now - - with the thing is not yet done with GE, but it could be a sleeper for us.

That sounds very promising. I wanted to also just understand, is that still a contractual agreement based on a minimum royalty or is that something that is based on ongoing sales?

The contract with Amersham has, like most of our royalty contracts, it has a feature where there are minimum royalties and as their sales ramp to a point where the “earned” royalty exceeds minimums, then that’s essentially what they pay. And Amersham is still in the phase where they are paying us minimums. One additional comment I’d like to make as people look forward to fiscal 2004 is that the contract does have some step ups in periods of time as well as some step downs in what those contractual minimums are from quarter to quarter. As you look at the full year of fiscal 2004, net net, there’s some step downs, so the overall royalties that would accrue to SurModics for the full fiscal 2004 would be down year over year from fiscal 2003.

I just want to make sure I understand my math correctly. Just looking back to what you had mentioned on the last conference call, there were apparently 58 license agreements as of the end of last quarter and you had added 5 during the course of the quarter ending September. As I understand it, you’ve added 6 and are now eluding to 60 license agreements, so what I’m trying to work out is have you in fact lost what looks to be a net amount, or not a net amount, but 4 contracts during the quarter, and if you could just give some color there?

Hi, Alan, this is Loren Miller. What you’re seeing there in terms of numbers last quarter - - the number you quoted was the number of licensees, but underneath a particular licensee, there may be several products. So while we signed 6 new licenses this quarter, some of them were with people that we have precious license agreements with, so there are more applications but there may not be an additional license fee. Does that make sense?

Not really, but I’ll follow up with you offline. Thanks.

Thank you. Our next question comes from Ryan Rauch with Sun Trust Robinson Humphrey. Please go ahead with your question.

Hi, guys, good afternoon. Just a couple quick questions. I understand that some of us had aggressive CYPHER estimates for you during the quarter but appear you came in light both on the royalty line and the product sales line and more specifically, it looks like it was the weakest royalty, not including (indiscernible), the weakest product sales line you’ve had in a little over a year. Can you kind of give us more detail why those two line items were weak during the quarter?

Hi, Ryan, this is Loren. As we’ve stated in the past, we expect product sales to decrease in this quarter for two reasons. One, Valley Oak is becoming, or Cordis is becoming quite efficient in their manufacturing and they’re using less of the reagents. And two, there is some contractual pricing in place and year over year the pricing is somewhat less than it was last year.

And then how about the royalty line?

What specifically were you asking about the royalties?

Well, it just appeared - - I mean, you missed consensus revenue by about $2 million or so, $2.1 and that wasn’t all drug eluding stent differential from analysts being aggressive. And on the royalty line, you missed our number by $400,000. That’s not including drug eluding stent. I’m just curious what exactly - - why was that weak? Was there any specific reason? Do you expect that to continue? It looked to me to be the weakest royalty quarter you’ve had excluding drug eluding stent in over a year. Maybe I’m missing something.

Historically, and I don’t know how long you’ve followed us, Ryan, Q1 did have a tendency to be our weakest quarter because of some contractual arrangements we had. The licenses, excuse me, the royalties have a step down feature so one of our larger licensees would hit in our first quarter, their third quarter, with lower royalties. That’s been hidden somewhat by the dramatic increase in Cordis royalties, so that’s a piece of it you might be missing there. I think Phil also had an additional comment.

I guess in general we’ve not been able to give specific guidance that would break out the share of Cordis versus the rest of the royalties and so exact movements one line versus another, we really can’t comment too much on because we’re unable to break out that from a guidance perspective.

Okay, and then one follow up. Do you expect - - I know you’re not giving specific guidance, but are you expecting revenues and earnings to show an increase sequentially in Q2?

We can’t really forecast with any degree of confidence because the variables are quite large right now, largely with the growth of the drug eluding stent marketplace which is due to a number of factors. And then secondly, a very significant variable which could affect us is if a second stent competitor gets FDA approval, that event if it does happen would have a significant impact potentially on our numbers. So with all of those very specific variables, we just can’t comment on any specific directional guidance on a sequential basis either.

Okay, thanks a lot. Have a good afternoon.

Thank you. Our next question comes from Steve Donelski with Cooper Arch Capital. Please go ahead with your question.

Hi. I’m trying to get a little bit more understanding of the relationship between the CYPHER sales and your royalties. Yesterday J&J reported $559 million in sales. The quarter before was about $450. That’s up 28% sequentially and your royalty line was only up 1.2% sequentially. Has anything changed in the royalty rate? What’s the reason for the relationship for there, the non-relationship there?

Well, if you look at the royalty line, there’s a number of significant components there and so Cordis and the CYPHER stent are only one component of that. There’s the broad portfolio of all the PhotoLink applications that we have and there are some movements that happen in there. Some of them are competitive responses and whatnot to what happens in the cardiology market. And it’s also important to note that what I discussed just a few minutes ago in terms of contractual minimum royalties from Amersham, those had an effect on a sequential basis as well.

So would it be fair to say then if I took - - since nothing has changed, if I grew your royalty rate by 28% in the quarter sequentially, you get close to $11 million. The delta between that and what you printed is the difference you were talking about? The $2.2, $2.3 million or is that not the correct way to look at it?

Without being able to kind of compare numbers and make sure we’re understanding, I don’t want to comment right now. We can talk about that offline.

Okay and is there - - well, I guess last question. Is there a chance or I guess a comment, that you would give guidance - - and I understand that the J&J CYPHER stent is a lot you can’t control what they sell or don’t sell, but the base business, I would assume, is more stable. Is there any chance you would give guidance on that? And obviously not today, but at some point here in the near future so we know what the base business is generating?

Yes. As soon as we’re able to get out of the horrific dynamic situation that’s because of the magnitude of J&J and the high, that’s basically 100% gross margin that we, until that settles, we - - as soon as we get that settled, then we will get back to the guidance business to the best of our ability.

Thanks very much.

Okay, thank you. Are there - -

Thank you, ladies and gentlemen. If there are any additional questions, please press the star followed by the one at this time. As a reminder, if you are using speaker equipment, you will need to lift the handset before pressing the numbers. Our next question comes from James Terwilliger with Morgan Keegan.

Hey, Dale, can you hear me?

Yep, you’re clear.

Excellent. Two quick questions. First one - - the Abbott Labs manufacturing facility that got FDA approval - - does that have an impact for you guys that would be positive in terms of getting some of their diagnostic tests out on the market?

Hi, James, this is Loren. That will definitely have an impact. There’s a couple of things going on in there. You may have read that Abbott sold a portion of their diagnostics business to Inverness and that will have an impact on us in a positive sense. However, it’s too soon to say what the impact will be. But between those two events, the approval of their facility and the sale of that particular business, we do expect a pick up in royalties in that piece of our business.

And that would also help in terms of the diagnostic coating materials as well?

Probably not. The two aren’t related. One product is sold to diagnostic kit manufacturers and the piece that you were referring to earlier was more of a royalty arrangement on a very specific technology.

Okay, excellent. I want to - - could you discuss at all with a level of comfort the relationship in the press release regarding TheraCare and what that means for ‘04 and ‘05?

It’s a small piece of our business. It is an important relationship for us, though, because they are a distributor of products to the customers of the stabilization products that we’re selling to them. So I can’t be specific in terms of what the volume of business will be at this point, but we’re very, very excited about the relationship and very encouraged to have them as a partner given their existing relationship. That arrangement is exclusive in the United States and Puerto Rico and with some specific customers and so we’re very encouraged by that and look forward to working with them going forward.

Last question. Bruce, would you have any comment on the visibility of a drug coated peripheral stent out there on the horizon?

That’s a good question. In my previous position, we were developing products which we were hoping to launch in the U.S. for peripheral vascular applications. And it’s clear that all of the manufacturers were not as active on the peripheral stent development side for drug eluding capabilities but that is a very large market and that all of the customers, that is interventional cardiologists, would be the same customers that are using the CYPHER stent today. So there’s a lot of natural overlap and we were seeing a lot of increased interest as these companies like Johnson & Johnson and others got the development program going on the coronary side turning their attention to the peripheral side. So I do think that’s a terrific opportunity for drug eluding stents to expand naturally into and I think you’ll see a lot more activity there going forward.

All right. Thanks, guys. I’m going to jump back in queue. Thank you.

Thank you. Our next question comes from Sam Chang with RBC Capital markets. Please go ahead with your question.

Hi, good afternoon. Can you hear me?

Yep.

Just a question regarding product expenses. It took a pretty significant jump in the December quarter. I was wondering if you could explain what caused that and what it’s going to look like going forward?

Hi, Sam, this is Loren. What you’re seeing there is kind of a change in the mix. We sold more of our stabilization product, or our slide product, than we had in the prior quarter both sequentially and year over year and they have slightly lower margins. So that’s the only thing driving that is this kind of a change in the mix.

Okay, so is this basically the current level you would expect to see that going forward?

That’s a pretty fair statement.

Okay. And also, just trying to get some trends on the additional cost lines. Should we expect R&D expenses to pretty much stay at current absolute levels going forward or is that going to go up or down?

Let me take that one, this is Bruce. As I mentioned earlier, the organizational assessment is something that I’m actively doing right now and along with that is the expense on it to the organization. So it’s premature to say where that’s going to come out but I can tell you it’s under active assessment at this point and not only organizationally and structurally, but also just the expenses on it.

Okay. Thanks a lot guys.

Thank you. Our next question comes from Mr. Holden. Please go ahead with your follow up question.

Yes. In the guidance, or lack thereof, all of the analysts that I’ve been able to poll, were showing relatively higher revenues as well as earnings yet you didn’t preannounce. Was that primarily because you hadn’t issued guidance yourselves?

There’s really two factors there. One is precisely as you suggest, that we had not offered any formal guidance as a company. And the other factor is really that we had not been able to actually close the books on our quarter until just recently. And so until we actually get our reported sales numbers from Cordis as to what their CYPHER sales were for the quarter and that’s a significant component in trying to close our quarter, we did not get that report until just recently and so we were unable to close the quarter until not long ago.

Okay, and Mr. Olseth had said that you would be offering guidance once the stent business sort of settled out. When do you anticipate that happening?

We don’t know that, my friend. We’ll have to get through Boston Scientific and probably FDA and a few other places because the dynamics are so dynamic right now that we really can’t, in a good sense - - if we tried to give good guidance, it probably will be wrong. So until we have better input - - as soon as we do that, we will be giving guidance.

Okay, thank you.

Okay. Last question.

Thank you, Mr. Olseth. There are no further questions at this time. Please continue.

Okay. I want to thank you again for participating in our conference call this afternoon. As a reminder, our annual shareholder meeting will be held on Monday, January 26th, here in the twin cities, and we invite all of you to join us in person or via our web cast presentation. During this fiscal year and moving forward, we are focused on capitalizing on the opportunities that lay ahead before us in cardiology, ophthalmology, neurology and orthopedics. We are positioned right at the center of the convergence of medical devises and drugs and it’s an excellent place to be right now. Thank you.

Ladies and gentlemen, this concludes the SurModics first quarter 2004 conference call. If you would like to listen to a replay of today’s conference call, please dial 303-590-3000 or 1-800-405-2236 followed by the passcode 564438. Once again, if you would like to listen to a replay of today’s conference call, please dial 303-590-3000 or 1-800-405-2236 followed by the passcode 564438 You may now disconnect and thank you for using AT&T teleconferencing.