Surmodics Inc (SRDX) 2005 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the SurModics Third Quarter 2005 Earnings conference call. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded Wednesday, July 20, 2005. I would now like to turn the conference over to Mr. Phil Ankeny, CFO and vice president of Business Development. Please go ahead, sir.

Thank you, Matt. Good afternoon and welcome to the Fiscal 2005 Third Quarter SurModics conference call. Thank you for joining us today. I am Phil Ankeny, chief financial officer and vice president of Business Development. With me on the call today are Bruce Barclay, president and chief executive officer, and Loren Miller, vice president 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 Reform Act of 1995. Actual results may differ, and factors that may cause such results to differ are identified beginning on page 14 of the Company's fiscal 2004 Form 10-K annual report, and in the MD&A section of the Company's Form 10-Q filed after the 10-K.

Now I would like to provide a brief overview of the contents of today's call. First, Bruce will highlight quarterly achievements and key personnel changes. Then I will review our financial and operating results for the quarter. Bruce will then follow with some highlights from a few key pipeline opportunities, and, finally, we, along with Loren, will open up the call to your questions. Now I would like to turn things over to Bruce.

Thanks, Phil. We appreciate all of you joining us this afternoon on the call. I am pleased to present highlights from SurModics fiscal year 2005 third quarter. First, we delivered record revenue this quarter totaling $16.5 million. This marks our fourth consecutive quarter of record revenue. Each of the Company's distinct commercial business units contributed to this growth, which we believe reflects the uniqueness of our business model and our ability to serve a broad and growing customer base.

Second, I am pleased to report that revenue generated from customers other than Cordis, exceeded Cordis revenue for the fifth consecutive quarter despite continued growth and the third straight quarter of record sales of Cypher, the Sirolimus-eluting coronary stent from Cordis Corporation, the Johnson & Johnson Company. The growth in non-Cordis revenue exceeds the Cordis revenue both sequentially and on a year-over-year basis.

Third, SurModics realized record net income of $6.1 million, and diluted earnings per share of 32 cents. Again, adjusted net income has been at record levels for four straight quarters.

And fourth, the Company signed five new licenses in the third quarter, bringing the total new licenses for fiscal year 2005 to 15. In doing so, we surpassed our goal of 12 new licenses for the full year, with the fourth quarter still remaining.

In summary, our business continues to be strong and SurModics employees are doing an exceptional job of implementing our seven-point growth plan for revenue growth. Aside from the record-setting financial performance reported this quarter, we previously announced important personnel changes that I want to remind you off. We announced last month the appointment of Paul Lopez as president of the Ophthalmology Division of SurModics. Paul brings to SurModics over 20 years of experience in the medical device and pharmaceutical industries, with an emphasis in ophthalmology. He will focus his efforts on the continued development and commercialization of the technologies we acquired from InnoRx including I-Vation, which is our lead product in ophthalmology, targeting both age-related macular degeneration, or AMD, and diabetic macular edema, DME. We welcome Paul to the SurModics team.

In addition, on July 1, SurModics implemented the final step of its senior management succession plan. Dale Olseth stepped down as SurModics CEO, but will remain on the board of directors serving as executive chairman. Dale is much beloved and highly respected both at SurModics and throughout the medical technology community. His remarkable career achievements were recently recognized by Ernst and Young, who presented Dale with an Entrepreneur of the Year award in the category of breakthrough technology. All of us at SurModics express our deep gratitude to Dale for his nearly 20 years of leadership at SurModics, dedicated service, and friendship. We are delighted that he continues to serve the Company as executive chairman.

I am honored to assume the leadership position at SurModics and am determined to continue Dale's legacy of innovation and integrity. I want to express my excitement and confidence for the future of our Company. We are positioned for continued growth by staying true to our core tenets of developing innovative technologies and maintaining strong customer relationships. In addition, we are committed to our long-term strategy of moving into higher margin, higher value projects that will provide us with greater opportunities for long-term shareholder value creation. Together with our dedicated employees, we will work to continue exploring the opportunities in front of us, especially in the area of convergence of drugs and devices. With that, I'd like to turn the call over to Phil for a financial review.

Thank you, Bruce. As you will note from our earnings release and Bruce's comments, SurModics posted a fourth straight quarter of record revenue. Revenue was $16.5 million representing a 44 percent increase from 11.4 million for the year earlier period. Income from operations was a record $9.1 million, a 60 percent increase from the adjusted total of 5.7 million in the prior year period. And net income for the quarter was 6.1 million, or 32 cents per diluted share, compared with an adjusted 3.8 million, or 21 cents per diluted share a year ago. Please note that the adjusted figures reported for the third quarter of 2004 exclude the one-time impairment charge of 16.5 million taken against the Company's contract manufacturing facility in Bloomington, which SurModics intends to sell. Our business model continues to be very profitable with an operating margin of 55 percent for the quarter, and a net margin of 37 percent for the quarter.

Next, I'd like to briefly touch on royalties and license fees in greater detail. Third quarter royalties and license fees reached an all-time record of 12.7 million, up 69 percent from the year ago quarter. Results were strong across our royalty-generating products, highlighting the advantages of our broad-based portfolio. Among other strong performance in our mix of customers, FoxHollow, a medical device company addressing peripheral vascular disease, has done very well, and we expect that customer relationship to continue to thrive.

Another significant contributor to third-quarter royalties and license fees was Cypher. Johnson & Johnson, the parent company of Cordis, reported the third straight record quarter for Cypher with worldwide sales of $659 million, 320 million in the U.S., and 339 million internationally. This is an increase of 42 million from last quarter's record sales of $617 million. Cypher gained market share in the domestic drug-eluting stent market, and also posted impressive growth internationally. Not only is penetration growing in overseas markets, but Cypher has gained market share leadership in international markets excluding Japan in the June quarter.

In addition, noteworthy sales are occurring in the expanding Japanese market, where sales were 129 million in the June quarter, up 11 percent sequentially from the previous quarter. Further, based on new disclosure from Boston Scientific yesterday, we expect Cypher to retain sole control of the Japanese DES market until calendar 2007, which is later than the fourth quarter of 2006 date previously provided for taxes.

Next, let's turn to other lines of revenue. Total product sales were 2.7 million, a 5 percent decrease from the prior year period. Sequentially, product sales were up 15 percent. As we have mentioned repeatedly in the past, lower product sales on a year-over-year basis reflects a contractual stepdown in reagent prices to Cordis. Research and development revenue was 1.2 million for the quarter, up 3 percent from the year ago quarter, and up 4 percent sequentially from 1.1 million last quarter.

Now, turning to SurModics business segments. Revenue in our Drug Delivery segment was 7.9 million in the third quarter, up 38 percent from the prior year period. Recall that the third quarter of fiscal 2004 marked the first full quarter following the March 2004 FDA approval of Boston Scientific's Taxus stent in the United States. Growth and royalties this quarter more than offset the significant decrease in reagent revenue and modest decrease in R&D revenue in the segment.

In the Hydrophilic and Other segment, revenue increased 29 percent year-over-year to 4.8 million on strong growth in both royalties and R&D revenue.

Lastly, Diagnostics revenue increased 90 percent year-over-year to 3.8 million. The strong growth resulted principally from our amended agreement with Abbott signed earlier this fiscal year, and growth in stabilization products and genomic slides.

Turning to Expenses, total operating expenses excluding product costs were $6.6 million, compared with $4.9 million a year ago, and up sequentially from $5.8 million in the March quarter. Again, please note this comparable figure excludes the asset impairment charge taken in last year's third quarter. We remain deeply committed to investment in R&D, and to protecting the results of those innovations through the patent process. For the third quarter of this year, we dedicated 27 percent of revenue to R&D, up from 25 percent last quarter. Further, R&D expense constituted 68 percent of total expenses excluding product costs. Some of the expense increase is attributable to our acquisition of InnoRx. As we stated previously, SurModics is absorbing the operations and expenses of InnoRx, including the clinical trial for I-Vation. In the long-term, we hope to offset some of the expenses by signing agreements with development and distribution partners interested in the I-Vation and other InnoRx technology. Bruce will have more on that later.

Patent-related legal costs also contributed to the growth in R&D expense. Bruce will explain how our investment in intellectual property to protect innovation at SurModics is generating positive results. G&A expense was also up sequentially, reflecting various compensation items.

Now let's examine the balance sheet, which continues to be in outstanding condition. At the end of the third quarter, SurModics had a cash and investment balance of 65.4 million, and zero debt. We regard our cash position as an important asset. It enables us to aggressively pursue opportunities that support our growth strategy and enhance our position in the market. Accordingly, we continually seek opportunities to leverage our strong balance sheet and add value to SurModics. During the quarter we put our balance sheet to good use by making a strategic investment in ThermopeutiX, an early stage company developing novel medical devices for the treatment of vascular and neurovascular diseases, including stroke.

Lastly, our cash flow continues to be very strong. Cash flow from operations was $10.1 million during the third quarter, an increase of 65 percent over the prior year.

At this time I'll turn the call back over to Bruce.

Thanks, Phil. We believe that results from the third quarter, a well as some of our recent announcements, demonstrate the value of our technology portfolio and our responsiveness to market needs. We are committed to creating and maintaining outstanding customer relationships and bringing good science and technology to our customers. By combining these two key principles, SurModics is able to continually add new products to our pipeline and hopefully enhance shareholder values.

At this point I'd like to discuss a few key pipeline opportunities in more detail. First, I'll walk through our recent developments in the rapidly evolving ophthalmology industry, and discuss how SurModics is positioning sustained release I-Vation drug delivery system as an enabling technology in a market that many experts anticipate will reach between $2.5 to $7 billion over the next six years. As many of you who follow the AMD and DME markets know, there have been some exciting new clinical data presented over the last few months. Until recently, despite the large unmet clinical needs, available therapies could only slow down the deterioration of vision associated with these diseases. Now new drugs, in particular Lucentis from Genentech, have shown the ability to not only retard the progression of the disease, but actually reverse it. This is exciting news for patients and for the entire industry including Genentech. The tremendous optimism being generated by this new drug validates the significance of this market and underscores the unmet clinical needs.

We expect others in the states to follow through with additional advance therapies, ones that can also reverse vision loss. Nevertheless, these therapies in their current or future state will still have limitations that we believe position us very well in this market. The InnoRx I-Vation technology offers patients suffering from AMD and DME considerable advantages. It replaces multiple injections with a single implant providing long-term controlled release, which could represent a significant advance in therapeutic treatment, including the possibility of improved patient compliance, reduced side effects, and greater efficacy. In contrast, Lucentis must be delivered via injection every four weeks, and Macugen from Eyetech at six-week intervals. A large number of injections required to deliver these therapies typically over a two-year regimen is inconvenient for patients and may result in lower patient compliance.

SurModics' own products, the I-Vation intravitreal implant drug delivery system with the drug triamcinolone acetonide is still at a very early stage. We are excited about the results thus far and believe we are moving in the right direction. Meeting the expectations we set out for you last quarter, the Phase I trial began prior quarter end, when we enrolled our first patient in that trial. Early feedback has been encouraging, as clinicians were very pleased with the initial results. The surgical procedures went well with no complications or safety conditions reported during the postoperative visits to date. We will continue to seek full enrollment and hope to have the 30-patient Phase I trial fully enrolled by calendar year-end. Following full enrollment, followup data will be compiled over the ensuing six months, and will then be submitted to FDA to request commencement of the Phase II trial.

As we discussed in the past, the InnoRx platform can be developed either alone by SurModics or with a partner, using the partner's own proprietary drug targeting a specific indication. Discussions with potential partners are ongoing and we believe our negotiating position will be greatly enhanced once we have the Phase I clinical data in hand. We remain diligent in our efforts to realize the full potential of this technology.

Another exciting development we'd like to update you on the progress of NovaCell. Recall that last year, NovaCell filed an IND application with the FDA as a condition to commence a human clinical trial of its encapsulated ILA cell approach to diabetes treatment. I am pleased to report today that NovaCell recently filed its response to the questions from FDA regarding its open IND application. The response included the chemical, manufacturing, and control documentation as required by FDA. The agency will review the materials and respond to the Company within 30 days. They may either have further questions or requirements, or may approve the Company to initiate Phase I and II clinical trials of encapsulated ILA cell transplants in type 1 diabetics. NovaCell is prepared to commence the trial as soon as approval is received. We are pleased with this new development and we remain consciously optimistic about NovaCell's prospects as they enter the human clinical trial stage of their development.

In May, SurModics entered into a joint development agreement with Donaldson Company to combine Donaldson's nanofiber technology with SurModics surface modification technology. By leveraging each company's strengths, we expect to significantly enhance the performance of new cell culture products that will offer significant advantages to researchers around the world. We believe the opportunity here is exciting. Scientists have long been frustrated by how poorly mammalian cells grow on Petrie dishes or glass surfaces. However, this challenge has been overcome through the use of Donaldson's synthetic nanofiber material, which has proven very successful at growing mammalian tissue and cell samples. But the growth sales most effectively outside the body both the substrate and the chemical environment must mimic as closely as possible the human situation.

So we are providing the chemical component, and SurModics and Donaldson are jointly developing products that incorporate SurModics' coating with protein, peptide, or growth factors typically found in the body. The resulting product will be important tools for scientists conducting drug discovery and cell research. Given Donaldson's scale in industrial manufacturing, it has more than enough capacity to meet the worldwide demand in the addressable markets we are jointly targeting. Donaldson's considerable experience and expertise in nanofibers, and their large scale manufacturing capacity offer significant advantages in a market comprised largely of small, independent labs that have difficulty producing the volume or the consistency of material scientists require. Industry experts estimate the market to be as large as $100 million for the cell research market, and as large as $500 million for the drug discovery, high throughput screening market.

The initial response SurModics has received from this relationship has been highly positive. We expect to have jointly developed products in the hands of prospective customers for evaluation by the end of our fiscal year.

We're also excited about the mounting evidence of heparin-coating technology on drug-eluting stents can help reduce thrombus or clotting. In March, working in concert with Dr. Rob Schwartz at the Minnesota Cardiovascular Research Institute, we were able to show dramatic reduction in clot formation when using SurModics heparin coating on drug-eluting stents. This data was presented earlier this year at the CRC Meeting in Washington, D.C. At the PCR Conference held in May in Paris, thrombosis was a very discussed topic, reinforcing our believe that this technology has the potential to play a significant role in future generations of drug-eluting stent products.

Moving on to Intellectual Property, while our expenses have grown reflecting the investment we continue to make in this area, we have made significant strides over the past 18 months in both creating new inventions, and also aggressively protecting those inventions through the patenting process. I am pleased to report that SurModics has filed 49 new patent applications over the past 18 months, almost the same number of patent applications we filed during the entire five years before that. This demonstrates our growing base of technology, our accelerating innovation engine, and our continued desire to protect our unique position in the market.

I am also pleased to report that SurModics signed five new licenses during the quarter. That brought our total -- our nine-month total to 15, already surpassing our full year goal of 12, and just short of our fiscal year 2004 record of 17 new licenses. One of those signed licenses is with a company called CardioMind, utilizing our Encore polymer technology. Encore has similar physical, mechanic and drug-elusion control properties to our Bravo polymer matrix, and stands as one of the eight drug delivery technologies available for license to customers. The license agreement couples Encore with CardioMind's low profile stent system for use in complex lesions where traditionally sized stent delivery technologies have difficulty reaching.

Additionally, SurModics entered into collaborative research agreement and license option with the University of Arizona and pioneering scientist, Dr. Stewart Williams. We believe the long-term performance of implantable medical devices can be improved, and the healing response accelerated by incorporating extra cellular matrix protein onto the surface of these devices. Dr. Williams' work has already demonstrated the feasibility of this approach, which we believe is applicable to many of our customers' products and technologies. This exciting partnership has the potential to lead to improved function of current and future generations of devices.

Also during the quarter, our customers launched one new product in the marketplace, bringing the total to seven new products launched this year. SurModics remains on pace to reach its goal of 10 new product launches for the fiscal year 2005. We now have a total of 81 coated products on the market, generating royalty revenue compared with 73 in the prior year period. The total number of licensed products not yet launched was 68, up from 61 a year ago. Major non-licensed opportunities stood at 51, compared with 58 a year ago. In total, the Company now has 119 potential commercial products in development. Each of the Company's distinct commercial business units is represented by this diverse and exciting group of opportunities.

In closing, the values that Dale and Phil will guide us well into the future. SurModics remains dedicated to enhancing the well being of patients by providing our customers with the world's foremost innovative surface modification and drug delivery technologies and products. I feel privileged to be taking over the leadership of SurModics at this exciting time in our history, and look forward to the opportunities that lie ahead. SurModics will build on the momentum created by our strategic seven-point growth plan, and our developing technologies. We believe that with the continued success of Cypher, coupled with the excellent execution of our diversification strategy as represented by the meaningful progress reported in ophthalmology, and by NovaCell and Donaldson Companies, not to mention the broad-based portfolio of other customer opportunities, positions the Company well for long-term success.

That concludes our prepared remarks. Matt, we'd now like to open it up for questions.

Thank you, sir. (OPERATOR INSTRUCTIONS) Our next question comes from Jayson Bedford. Please go ahead with your question, sir.

Hi, good morning. Can you hear me?

Yes we can, Jayson.

And, Bruce, congratulations on your appointment there.

Thank you very much.

A few quick questions. Just, first, from a modeling standpoint. Product sales had a nice sequential bump-up, and it sounds like from your commentary regarding Cypher-related revenues, the bump-up was not related to Cypher reagent. So I'm just wondering, was there a new product there, or what's really driving the product sales growth sequentially?

The real driver there, Jayson, is some of our stabilization products, which are performing nicely on a sequential basis.

Okay. And does that include the [inaudible] related revenue?

Yes. The [inaudible] distribution relationship, if you recall, was discontinued, and so before we were selling through a channel sort, which shows up obviously as lower sales to us, and end user sales being the margin attributed to them. So we're bringing it back in-house now so we can capture that additional margin, as well as capture the higher sale prices for the revenues we report.

Okay. And then just looking at reagent revenue related to Cypher, is there another stepdown in fiscal '06, or is this kind of bottomed out from a price standpoint?

This is bottomed out, so there are no further step-downs.

Right. And then, maybe Bruce, just on the products, looking at the 68 licensed products you have but not yet launched, how many of those are using one of the eight drug delivery polymers that you have?

You know, we have not broken those out, Jayson. I can tell you that there are -- we have multiple drug-elution projects in-house, though.

Okay. Any idea maybe of when is the earliest you can be on the market with another drug delivery polymer?

Again, it's not something we've broken out because our customers haven't. You know, those are confidential relationships and they'll stay that way until the customer agrees to go public with those.

Okay. Okay. And then, I guess, just looking at I-Vation, it sounds like you're waiting for the data from DME before you sign a partnership. Is that a fair comment, or just in terms of timing of your discussions with potential partners, when do you expect some sort of announcement?

We believe that once we have the 30 patients enrolled and the six-month follow up data in hand, that that's going to substantially improve our ability to increase the value of a relationship. So we are in active discussions with multiple companies at the moment, and I can't put a timing on those at all, other than just to say that we believe, as does Dr. de Juan, that this data that we're going to collect here over the course of the trial in the Phase I study will support the efficacy or support the safety of this product and give us some meaningful data from which we can discuss with our partner. So, I would say if the right value proposition was put on the table today, we would seriously consider it, but we're also not in a hurry, given the fact that we think we'll have good data here in the near future.

Okay. And will you release those data from the earlier patients in early calendar '06, or are you going to wait to kind of accrue the last patient before you press release those data?

I don't know the answer to that question at this point. That will all be dictated by what the FDA requires of us. I think given that it's a Phase I study, it's mostly looking at safety. I think we're going to be somewhat hesitant to release too much of that data until we're sure exactly what our Phase II plan is with FDA, which at the moment we don't have completely ironed out, so we'll have to see where we are at that time.

Okay, fair enough. And then just the last question on the Donaldson agreement. When is the earliest where you'll start to see any revenue impact from that agreement?

We expect, as we said during the script -- scripted portion of the call, we expect to have products available for evaluation with prospective customers before the end of our fiscal year here, so in the next couple of months. The exact timeline of when that turns into customer for sale units of a packaged product, we're not entirely clear. But it's definitely not measured in years until that gets on the market; it's really measured in a small number of quarters, but the exact timing we just don't know yet.

What's the regulatory path, or is there one?

Good question. There is none. It's been one of the real advantages we see to this partnership with Donaldson, is that in the in vitro diagnostics market, there is no FDA cycle that adds to the timelines.

Okay. That's it for me now. Thanks.

Thank you, Jayson.

Thank you sir. Our next question comes from Mike Osmond with Peninsula Capital. Please go ahead with your question, sir.

Hi Bruce and Phil. Congratulations on the quarter. Following up with Jayson's question with respect to Donaldson, have you guys -- do you guys have a plan of how those introductions will be made to the customers? Is this going to be a joint effort or will Donaldson be kind of leading those introductions?

We've established a management committee of small group of people between SurModics and Donaldson to work out issues exactly like that. We think that the requirement of selling these products to the research market will be very different than what it will take to sell to the [inaudible] screen market, and those are topics right now that are being discussed by this group. So I don't have a report today on that other than just to say that we know that that's going to be something we've got to get into place pretty quickly, because the products are going to be out at customers for evaluation here in the next couple of months, and we expect to get feedback and be in a position to launch not too long after that.

Okay. And what's the size or the potential size of this market? I mean, are we talking about a couple dozen customers, or are there several hundred?

Particularly in the cell research market, which is the $100 million roughly speaking market, that is a very fragmented market concentrated with lots and lots of researchers, a lot of them at universities, frankly.

Interesting. And then switching over to the Genentech and Lucentis data out, looks to be progressing pretty well. And with the actual reverse of the site loss, are you guys starting to kind of see this come to the market a little bit sooner than expectations, or are you getting more interest from other companies in terms of like a joint agreement or co-warranty efforts?

There is a lot of interest from other companies. I can't say whether it's related to Lucentis or not, but I can tell you that everyone recognizes that improvement can be made over monthly -- you know, every couple month type injections into the eye, and so I think the timing of this technology as relates our acquisition of it and our initiation of our clinical trial couldn’t have been better for us, frankly. What Lucentis has shown is that there is actually now the potential with that class of drugs and potentially others of reversing the effects of this disease, and that's terrific news, and that's really the headline. The subheadline is, at some point people aren't going to want to be injected every month with that drug, and so we just believe that the combination of our platform delivery systems with our multiple polymers is extremely well timed for us. There is a lot of interest right now in what we're doing.

Yes. Well, it sounds exciting. And then, lastly, is there any update on the partnership agreement, or the -- with the CABG Medical?

No update. We continue to work with them actively, but no update than what we've discussed before.

Well, congratulations on a good quarter, guys.

Thank you.

Thank you, sir. (OPERATOR INSTRUCTIONS) Mr. Ankeny, there are no further questions. Please continue.

I want to thank you again for participating in this quarter's conference call. We look forward to speaking with you again in October regarding our fourth quarter and full fiscal year 2005 results. Thank you.

Thank you, sir. Ladies and gentlemen, this concludes the SurModics Third Quarter 2005 earnings conference call. Thank you again for your participation. You may now disconnect.