Surmodics Inc (SRDX) 2006 Q1 法說會逐字稿

Good afternoon ladies and gentlemen. Welcome to SurModics first quarter 2006 earnings 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. As a reminder, this conference if being recorded today, Wednesday, January 25, 2006.

I would now like to turn the conference over to Philip Ankeny, Chief Financial Officer and Vice President of Business development.

Please go ahead, sir.

Thank you very much, Mary. Good afternoon and welcome to SurModics first quarter fiscal 2006 conference call. Thank you for joining us today. I am joined on the call today by 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, let me remind you that some of the statements made during this call may be considered forward-looking statements. The 10-K for the fiscal year 2005 identify certain factors that could cause the Company’s actual results to differ materially from those projected in any forward-looking statements made during this call. The 10-K and subsequent filings are available through the Company or online. Now let me turn the call briefly over to Bruce Barclay.

Good afternoon. This is Bruce Barclay. Let me extend my thanks as well for all of you for joining us today. Slight change of plans this afternoon. I have been fighting a cold for the last several days and as you can tell, while I feel fine, I am losing my voice and I am unable to personally deliver my comments to you this afternoon. So rather than ask you all to endure my mostly inaudible delivery, I have asked Phil to read my comments to you today. You can be certain that I have prepared and approved all of my remarks that Phil will deliver to you, and I am available for the Q&A. So please accept my apologies for the change in plan, and thank you again for joining us on the call.

Phil?

At this time, I will provide a brief overview of today’s call. First, I will cover the quarter’s operating and financial results and in place of Bruce I will then highlight quarterly achievements and discuss a few key pipeline opportunities and then finally we, along with Loren, will open up the call to your questions.

As you will note from our earnings release, SurModics had another strong quarter. I will begin with an overview of first quarter financial results and then break down the numbers by revenue component and business segment. First quarter revenue was 16.5 million, a 17% increase from 14.1 million in the year-earlier period. On a GAAP basis, operating income was 8.6 million. Net income was 6.2 million and diluted earnings per share was $0.33 per share. GAAP results also include a $465,000, or $0.02 per diluted share benefit related to the reversal of a tax reserve. On a non-GAAP basis, operating income grew 12% to a record 9.7 million from 8.7 million in the prior year period. Our business model we remain strong producing an operating margin of 59% and a net margin of 40% for the quarter. Net income increased 24% to a record 6.6 million from 5.3 million in the same period last year. This quarter marks the sixth consecutive quarter of record non-GAAP net income. Diluted earnings per share was a record $0.35 compared with $0.30 in the first quarter from fiscal 2005. It is important to note that this quarter marks the first period in which SurModics GAAP results include the expensing of stock options as required by SFAS 123(R). However, to provide easier comparative analysis for investors, we present non-GAAP results excluding non-cash equity compensation items and the tax benefit I mentioned earlier. Please see our financial tables and the footnotes provided in the press release for a detailed explanation and reconciliation of GAAP and non-GAAP figures.

Next, I will discuss the components of toto revenue. Royalties and license fees were 12.3 million, up 22% from the year-ago quarter. Results were strong across our royalty generating product spectrum, highlighting the advantages of our broad-based portfolio. Additionally, SurModics non-Cordis revenue exceeded Cordis revenue for the seventh consecutive quarter despite continued growth in Cordis revenue, which I will discuss next.

Johnson & Johnson, the parent company of Cordis, reported another record quarter for CYPHER. Clinical data continues to reinforce its superior safety and efficacy of CYPHER. Impressively, J&J sales of CYPHER reached to record 670 million in the recent quarter. J&J reported that CYPHER’s market share was 46% in the U.S. market and 58% outside the U.S. Analysts continue to expect CYPHER to retain sole control of the Japanese drug-eluting stent market until calendar 2007. Recall that Japan is the second largest market for drug-eluting stents in the world behind the U.S. Further J&J expects additional manufacturing capacity to come online during the first half of 2006. Finally, J&J announced Monday that CYPHER received updated labeling from FDA approving the use of overlapping CYPHER stents. This change makes CYPHER the only drug-eluting stent with this new label.

It is currently estimated that Medtronic has achieved a market share of 7% of the OUS market, excluding Japan, with its Endeavor drug-eluting stent. As we announced in November, SurModics provides the hydrophilic coating on the delivering system for Endeavor.

Now, let’s turn to other lines of revenue. Research and development revenue was 1.8 million for the quarter. The highest R&D revenue in four quarters, representing a 62% sequential gain from the September quarter. The figure shows a 7% decline from the first quarter of 2005 but keep in mind the prior year figures include contribution from InnoRx when it was an important R&D customer. We are pleased with the growth we have been experiencing in our R&D organization and believe it highlights the relevance of SurModics technology to our customers. Product sales increased 17% on a year-over-year basis to 2.3 million, as growth in reagents and stabilization sales offset lower slide sales to GE healthcare.

Now, I want to take a few moments to review our business segment. SurModics growing customer base and portfolio of royalty paying products continue to generate strong financial results. We recorded double-digit growth in all 3 segments during the quarter. First hydrophilic and other revenue came in at 5.2 million, a 22% gain from the year-earlier period. This segment has the broadest range of licensed customers contributing to royalty revenue. Second, drug delivery revenue was 8.3 million in the first quarter, increasing 16% year over year. And lastly, diagnostics revenue climbed to 3 million, an 11% gain from the year-earlier period.

On the expense front, total operating expenses, excluding product costs, were 6.1 million, our lowest total in 3 quarters. This decline underscores our continued efforts to invest responsibly in our business and gain further efficiencies across the company where appropriate, without compromising our investment in R&D.

Looking ahead, we expect a modest increase in R&D expenses from the first quarter figure. Also on the operating expense front, I am pleased to report that construction of new coating suite and manufacturing space at our Eden Prairie, MN headquarters is ahead of schedule and under budget. We expect to fully vacate the Bloomington facility in the third quarter of this fiscal year, at least a quarter ahead of our initial expectations. As a reminder, the Bloomington facility has been sold and we anticipate savings of approximately $1 million in annual operating expenses following the our exit of the facility which will positively impact our operation and provide additional opportunity for funding our R&D activity.

We continue to invest heavily in R&D, dedicating 25% of revenue in the first quarter up from 24% in the prior year period. R&D expense constituted 68% of total operating expenses excluding product costs. Costs from our new ophthalmology division and expenses relating to running the I-vation clinical trial are the primary contributors to the growth in expenses. Patent related legal costs were another contributor to R&D expense. Again, this is consistent with our strategy to vigilantly protect our product innovations and technology portfolio which are important competitive advantages and serve as the foundation of our technology licensing business models.

Moving on, let’s take a closer look at our balance sheet and cash flow. At the end of the first quarter, SurModics had a cash and investment balance of 80.5 million and no debt and cash flow from operations was 10.3 million in the first fiscal quarter of 2006 compared with 5.3 million in the year-ago quarter. We regard our strong financial position as a valuable asset as it enables us to aggressively pursue opportunities that support our growth strategy, enhance our market positioning, and add shareholder value. We have an active business development pipeline and we will continue to search for compelling opportunities to put our balance sheet to work.

I have now reached the section of our prepared remarks that Bruce would have delivered under normal circumstances. Our first quarter represented another strong period of financial and operational performance for SurModics and our sixth consecutive quarter of record non-GAAP net income. Our results demonstrate the value of our broad technology portfolio and SurModics’ responsiveness to the market needs. We are particularly pleased by the strong sequential growth in R&D revenue, which is at its highest level in four quarters. Our development organization is experiencing significant activity and we believe that the uptick in R&D revenue confirms the strong customer interest in SurModics technologies and validates the potential of our pipeline. By partnering with our growing customer base, we are making terrific progress on many high potential projects. For example, since the acquisition of InnoRx one year ago, our ophthalmology division has been busy discussing potential partnerships with companies developing drugs aimed at ophthalmic applications. The SurModics offering includes the site specific drug delivery platforms we acquired from InnoRx utilized in concert with SurModics broad array of drug delivery polymer matrix technology, both biodegradable and durable. Our technology also embraces the deep technical applications expertise gained over more than a decade of work in site-specific drug delivery. Our ability to successfully coat a variety of different surfaces with a multitude of drugs and polymer classes is unparalleled. The reception of the InnoRx technology by our customers has been exceptional and we are excited to report that SurModics currently has multiple paid feasibility and development programs in ophthalmology underway today, evaluating both our drug delivery platforms and polymer matrix technologies. At least one of these programs is being sponsored by a major pharmaceutical company. Our partners have been impressed by the drug-delivery potential of our intravitreal implant and the depth of our expertise and capabilities in the site-specific drug-delivery arena. Further, they recognize the value of our drug delivery technology to help differentiate their drug candidates in the large and strategically important ophthalmology market, which industry experts anticipate will reach 2.5 billion to 7 billion within six years. Recognition of that value proposition has helped to cure the customer funding required to launch these exciting development programs. We believe our progress with customers is further evident of the significant need for sustained release drug delivery technology in ophthalmology and that our and that our technology offering couldn’t be better time for the market needs that exist today.

Now let’s discussed some specific on SurModics sustained release I-vation drug delivery system. As you might recall from our earlier calls, the InnoRx I-vation technology offers patients suffering from age-related macular degeneration, or AMD, and diabetic macular edema, or DME, considerable advantages over existing therapeutic treatment. For example, it replaces multiple injections with a single implant providing long-term controlled drug release, resulting in improved patient compliance, reduced side effects, and potentially greater efficacy. Our phase I clinical trial evaluating the safety of our I-vation intravitreal implant is currently ongoing in patients with DME. Approximately 80% of target enrollment has been achieved, and we believe enrollment will be completed soon. We are encouraged with the initial results as the implantation procedure has been routine with positive feedback from the treating physicians at our investigational sites. Preliminary results show that the implant appears safe and well tolerated with no serious adverse event reported. A complete unmasked safety assessment will be conducted later this year based upon the complete six-month follow-up data.

We are also pleased that our California ophthalmology operation has just been moved into our permanent facility in Irvine, CA. The new facility houses are very capable growing ophthalmology team.

Now, I’d like to provide an update on some of our other key pipeline opportunities. We are excited to report that Novocell commenced their phase I/II human clinical trial in December. The company also continues to achieve its development milestones on the stem cell front. Although the process remains at a very early stage, we are pleased with these developments and remain cautiously optimistic on Novocell’s prospects.

I would now like to discuss the advances we have made in our joint development agreement with the Donaldson Company. Before continuing, I would like to point out that this joint project will be featured in our upcoming annual meeting next Monday, January 30th, when we welcome Mr. Jim Giertz, senior vice president of the Donaldson Company and Professor Melvin Schindler, the cell biologist for Michigan State University, who helped pioneer the opportunity for Donaldson nanofiber technology in the cell culture field.

As a brief background, this collaboration combines Donaldson’s nanofiber technology with SurModics’ surface modification technology to provide dramatically improved cell culture technology. Some industry experts estimate the opportunities to be as large as $100 million for the cell research market and $500 million for the drug discovery high-throughput screening market. The feedback we have received from beta testing on the initial products has been encouraging and we have incorporated their comment both into our product launch strategy and future product iteration. We are excited about the technology and have received significant interest from potential distribution partner. Although we anticipate signing an agreement with a distribution partner at some point, we expect to launch the product soon and we will keep you informed as soon as we have new developments to share.

Another of our relationships, FoxHollow, continues to perform well. The Company’s new 2006 guidance included strong annual revenue projections of 210 to 220 million. The vast majority of this revenue is derived from Silver Hawk on which we are paid a royalty for our hydrophilic coating technology. In addition, FoxHollow has recently filed an IDE on their product for treating coronary disease. We are pleased to announce that SurModics is partnering on this coronary product and expect our mutually beneficial relationship with FoxHollow to continue to thrive. We recently signed an agreement with a marketing partner in Japan to help us better cover existing and new customers in this important region.

Next, I will speak to the Company’s licensing efforts. During the first quarter, we signed four new licenses, making good progress toward our goal of 15 for fiscal year 2006. One of the quarter’s new licenses was signed with Edwards Life Sciences. We’re pleased to disclose this key player in the cardiovascular space as one of our customers. SurModics also signed a license with Conor Medsystems to provide the hydrophilic coating on the stent delivery system for their next generation drug-eluting stent. This is another example of the many ways we can participate in the $5 billion drug-eluting stent market. Currently, we have three business units serving the cardiology field including drug delivery, regenerative technologies, and hydrophilic technology. Our drug delivery business unit offers polymer system to provide site-specific controlled released drug delivery. Our regenerative technologies business unit is developing anti-thrombotic and pro-healing technologies which could play a significant role in future generations of drug eluting stent products.

And finally, our hydrophilic technology unit offers advance lubricious hydrophilic coatings on drug-eluting stent delivery catheters. The Conor license is an alogous to the Medtronic Endeavor license we announced in November. If you recall, SurModics hydrophilic technology was licensed to Medtronic to provide the lubricious coating on the delivery system of the Endeavor drug-eluting coronary stent.

Now for a rundown on the pipeline. As of December 31, we have a total of 76 customers, several with multiple licenses compared with 71 in the prior year period. Currently SurModics has 80 licensed product classes on the market generating royalty revenue, unchanged from a year ago. The total number of licensed products not yet launched was 74, up from 63 in the first fiscal quarter of 2005. Major non-licensed opportunities as of December 31 stood at 67, compared with 68 reported a year ago. In total, the Company now has 141 potential commercial products in development compared with 131 in the year earlier period. With exciting opportunities in each of the Company’s four focused markets -- cardiovascular, neurology, ophthalmology, and orthopedics. We continue to feel encouraged by the quality and opportunity provided by the projects in the pipeline today, particularly given the strong interest in our ophthalmology drug delivery platforms and polymer technology.

[Inaudible] launched another product in the marketplace during the quarter. In addition, several product line extensions were launched by SurModics customers over the past 3 months as well. Since they do not fit our customary definition of product launches with a license starting to pay royalties for the first time, we did not include them in our first quarter total. However, we believe some of these launches could become meaningful royalty generators in the future. As examples, we were pleased to be involved in the new launch of the pivot neuroinfusion steerable delivery system from Target Therapeutics, a division of Boston Scientific. Spectranetics also launched a product during the first fiscal quarter introducing their CLiRpath 2.5 turbo laser catheter.

Finally, several investors have inquired about the impact on SurModics of Boston Scientific’s pending acquisition of Guidant. It would be inappropriate for us to comment on this transaction in too much detail because it is still pending and there are many facts that remain unknown. It is important to remember that Johnson & Johnson, Boston Scientific, Guidant, and Abbott, the principle players in this matter, are all customers of SurModics. It is our belief that regardless of how the Guidant assets get divided up, we will have the opportunity to still work with them all going forward, especially in the area of convergent, which all have commented is strategically an area of growth. As you know, Johnson & Johnson is our largest customer today. During its earnings call on Tuesday, the company emphasized the strength of its medical devices division and the importance of that group to its growth growing forward. Guidant does have some biomaterial technologies on its own which J&J would have previously had access to. Since convergent is still important to J&J, we believe SurModics may become an even more critical technology partner to J&J in the area of biomaterial technology and expertise and development capability than if J&J acquisition of Guidant had gone through.

In addition, now that Guidant will not be joining Johnson & Johnson, the risk that CYPHER might be replaced by the Guidant drug-eluting stent, as some investors believe was possible, is no longer present. Further, it is also likely that there will be one less major drug-eluting stent product in the U.S. going forward if Abbott, whose current drug-eluting stent has the same drug and polymer as the Medtronic Endeavor drug-eluting stent will not market both product simultaneously. In some, we believe that Boston Scientific’s acquisition of Guidant creates exciting possibilities for SurModics to partner in new ways with each of these existing customers of ours.

In closing, we continue to execute on our revenue growth plan and deliver strong financial results and record earnings. We are encouraged by the increasing level of customer interest in our expanding portfolio of surface modification and drug-delivery technology. We know that SurModics is measured by results and we intend to continue to deliver results that matter. One year after closing the InnoRx acquisition, we are delighted by the strong interest from ophthalmology and pharmaceutical companies in our drug-delivery platforms, portfolio of polymer technology, and collaborative development capability. SurModics also continues to have an active pipeline of interesting business development opportunity. As the Company grows and our capabilities expand we will continue to seek out ways to give investors a better sense of our forward opportunity and provide more information on the contents of the pipeline. There are many reasons to be optimistic about SurModics’ future and we are encouraged by our achievements to date. As a reminder, please join us for our annual meeting of shareholders on Monday, January 30, at 4 o’clock p.m. Central time. We will host a live webcast that can be accessed through our SurModics.com website.

Operator, that concludes our prepared remarks, and now we would like to open up the call to your questions.

Thank you. [OPERATOR INSTRUCTIONS]

Rick Rinkoff, Craig-Hallum

Good afternoon. A couple of question for you Phil, and Bruce can kind of whisper in the background. [Novocell], you’ve started the clinicals. Have there been any injections in humans yet?

Yes, there have been.

How many and how are they doing?

We’re not at liberty to share any results beyond what we’ve disclosed so far and Novocell will be putting out some sort of release at the appropriate time some time in the future.

Okay. Options expense. If I run the math on the numbers which you’ve conveniently provided in your non-GAAP and GAAP adjustment, it looks like it was around 4 cents for the quarter, is that right, and should we infer another 16 cent year?

If you’re looking at option expense -- this is Loren, Rick --

Yes.

-- I think it is fair to say that the run rate will be a little bit higher going forward as there was some option awards in the quarter that weren’t fully expensed. So a good number would be about 1.2 to $1.3 million per quarter going forward versus 1162 in the current quarter.

$1.2 million and $1.3 million before taxes, right?

That’s correct.

Okay. Royalty and license revenue, if you take out J&J, it looks as if the number might have gone down from the previous quarter. Is that accurate and why would that be?

There are, you know, as you know, there are many, many royalty relationships that contribute to that line and so we have some seasonality to some of the agreements we have. In addition we have tiering that customers progress through in different quarters that triggers in lower effective royalty rates for quarters and some of that tiering did get hit in this quarter.

So is that because there was a December quarter which was a year-end for may companies?

Correct. As you progress through the year companies will -- you know, a lot of these are actually results from companies September quarter that gets reported in our December quarter. So some of those can flow through for the September quarter and the December quarter.

So should we infer then that the March quarter numbers would not have that same tiering problem?

They will have some of those tiering problems, but there are other issues of seasonality that we anticipate oftentimes can offset some of those but exactly how it shakes out we never know until our customers report exactly their own results.

So basically you’re not giving me any real answer to any of those questions then, right? I mean, in terms of should we expect that number to trend higher again, we don’t really know.

As you know, Rick, we don’t provide specific revenue guidance and so we can’t go into the details of the specifics items with specific customers and how they’re hitting or what the trend might be. The only safe thing to say is that we have a lot of moving parts and you know we anticipate that there will be several moving parts as we go into the March quarter for us as well.

Donaldson, are all the expenses of the Donaldson in your income statement or at least your share of them and should we expect that to ramp up this quarter because they are about to launch.

We are incurring expense related to that, and it is only our share, as you suggest. The exact amount that it will potentially increase going forward remains to be seen. We don’t anticipate very significant increases in that at this point in time, but it’s too early to know conclusively.

And last question for the moment. Share count down, how did that happen?

Hi, Rick. This is Loren. The shares calculation was impacted by the expensing of stock options. The expensing of stock options has an impact both on the operating expenses and also on the shares outstanding. So I think you’ll find that as other companies report their shares, you know, see a compression between the different basic shares and then fully diluted shares.

So that will be a -- so the new level of outstanding shares full diluted will be continued going forward?

Correct.

Okay. Thanks.

Michael Bosman, Peninsula Capital

Hi, guys. Nice quarter. I just wanted to ask on the new – Phil, I think you mentioned, isn’t Spectranetics is a new CLiRpath product. Did I hear you correct?

Yes, that’s correct.

Okay. Is that for a similar procedure or similar market that FoxHollow competes in?

Let me try to answer that one. This is Bruce. The CLiRpath product as I understand it is more of a chronic total occlusion product. So it’s intended in part to help open up the lesion so that additional treatment can be provided. For the FoxHollow product you actually have to be able to get a guidewire across the lesion first before you can actually use it. What I am not sure of and this would be a better question for Spectranetics, obviously, is can you default with that product even after the wires are crossed. I think you can but I’m not positive with that. So it’s a long way of saying similar indications but I think the Spectranetics product actually has the ability to initially open up completely occluded lesions so you can get a guidewire across.

Great. So it sounds like it’s a potentially a new market for at least you guys.

Yes.

And then the Conor Medsystems. Is this a stent that you know that will compete directly with J&J and/or Boston Scientific or just for different applications?

This is their next generation drug-eluting stent. So it’s not on the current product that they have been recently data on, it’s on their next generation product. I mean, we certainly expect it to be at some point along the line another drug-eluting stent opportunity in the market.

Great. Thanks, guys.

Suraj Kalia, Rodman & Renshaw

Hi, guys. Good quarter. Phil, a quick question for you. I just heard you say the Guidant and Boston Scientific combination would be positive for SurModics. [Inaudible]

Hey, Suraj?

Sure.

We’re having a hard time hearing you. I’m wondering if everybody else is having a hard time too.

Can you hear me now?

That’s much better. Thank you.

Okay. I apologize. Phil, the question I had and I’ll rephrase it was I heard you – and correct me if I heard you wrong, say that the Guidant and Boston Scientific combination would potentially be positive for SurModics. Can you help expand on that how you think that would be positive because a couple of quarters ago when J&J first bid for Guidant on December 15, 2004, I think said there was a lot of enthusiasm on the SurModics call and I’m trying to understand what you’ll see in the Guidant Boston combination that would be incremental to SurModics? Can you help explain that?

I think you – this is Bruce, obviously. I think you present the question as a binary proposition and it’s actually not because there are no potentially pros and cons to us of each company of either company acquiring Guidant. I think the point that we wanted to make today was to have – because all four of those companies are customers of ours today and that each are emphasizing the importance of convergence to their future businesses that we have avenues existing today contacts, [inaudible] people contacts within those companies and technologies and development capabilities that they would all have of interest. So for us, you know, it’s an opportunity for us to continue to come in with some new faces and decision-makers and regardless of the scenario and present our technologies going forward. Not a lot of information known. There is a lot of activity yet to be done but we do see positive aspects to the combination of Boston and Guidant for us going forward.

The other comment you know we had – you know, as we’ve made comments on it is that whether it’s J&J buying Guidant or Boston Scientific buying Guidant and then divesting it over to Abbott. In either scenario, the net-net to the marketplace is likely to be one less drug-eluting stent platform in the market than prior to such an acquisition, which should benefit J&J’s ultimate market share.

The second question I have then, Phil or Bruce, if you can. [Inaudible] implant [inaudible] retinal specialist in the country has – are being targeted to a lot of docs and what they’re finding is Lucentis, specifically let’s take Lucentis, once you stop giving Lucentis the [inaudible] reverses. The question [inaudible] if this is a 30-gauge needle and it will have a certain – [inaudible] amount of drug that used in a [inaudible] amount of time, are you seeing anything on that front and I guess I’m curious to see how you would address the situation like that.

I think that’s the positive component to the technology that we offer today and that’s excitement that we see in this. Lucentis, our understanding is like yours that if you don’t continually administer it the effects can reverse and so we will know from bench and animal studies regardless of the drug when the effective dose of the drug stops and so because there is a need to continue to deliver the drug over time and because our implant can be reversed, can be taken out, we will have the ability to continually provide a disposable product to hopefully our customer participating in this market going forward. So I think the point you make is a good one and I think it reinforces the excitement that we have around the technology and certainly the multiple companies we have today paying us for development of their drugs on our products have seen the same thing.

Okay. Thanks, guys, again.

Thank you.

Thank you, management. I’m showing there are no further questions. I’ll turn the conference back to you for any closing comments you may have.

Thank you very much. We want to thank you again for participating in this quarter’s conference call. We are pleased to have again delivered record non-GAAP earnings in the first quarter of fiscal 2006, and we look forward to speaking with you again at our annual meeting next Monday and in April when we announce our second quarter results.

Thank you. Ladies and gentlemen, that does conclude today’s teleconference. Once again, thank you for your participation, and at this time you may disconnect.