Surmodics Inc (SRDX) 2009 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the SurModics Second Quarter 2009 Earnings Conference Call. (Operator instructions) This conference is being recorded today, Wednesday, April 29th of 2009. At this time I'd now like to turn the conference over to Mr. Phil Ankeny, Senior Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Vince. Good afternoon and welcome to SurModics' fiscal 2009 second quarter conference call. Thank you for joining us today.

Our press release reporting quarterly results was issued earlier this afternoon and is available on our website at www. SurModics.com. Joining me on the call today is Bruce Barclay, our President and Chief Executive Officer.

Before we begin, it is my duty to inform you that this conference call is being webcast and is accessible through the "Investor Relations" section of the SurModics website where the audio recording of the webcast will also be archived for future reference.

I will remind you that some of the statements made during the call may be considered forward-looking. The 10-K for fiscal year 2008 identifies 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 Company does not undertake any duty to update any forward-looking statements as a result of new information or future events or developments.

On today's call, I will cover the Company's quarterly financial results. Bruce will then highlight quarterly achievements, revenue drivers, and progress against our published fiscal 2009 Company goals and finally, we will open the call to your questions.

I will begin with an overview of second quarter financial results and follow that with more specific information on discrete line items. My discussion of revenue will break it down by component and market and also review significant revenue drivers. Finally, I will cover expenses and review our balance sheet and cash flow.

Second quarter revenue was $20.9 million, compared with $25.7 million in the year earlier period. The Company reported operating income of $6.2 million, compared with $7.2 million in the prior year period. Net income was $4.2 million during the period, compared with $5.1 million in the second quarter of 2008. Diluted earnings per share was $0.24, compared with $0.28 in the prior year period.

Let me start with a review of revenue. First I will review our result across markets. As discussed last November and consistent with our patient-focused vision, SurModics has reorganized into clinically and market-focused business units to improve the visibility, marketing and adoption of our broad array of technologies. In connection with these organizational changes, we are now reporting our revenue under two segments - therapeutic and diagnostic.

The diagnostic segment contains our in vitro technologies business unit, while the therapeutic segment consists of our various drug delivery and surface modification technologies. To help investors understand the moving parts of our business we provide additional disclosure by breaking out the therapeutic segment revenue into three distinct markets - cardiovascular, ophthalmology and other markets.

Revenue from SurModics Pharmaceuticals, formerly Brookwood Pharmaceuticals in Alabama, is categorized into these three market areas. As you might expect, given it's largely pharma and biotech customer base, a substantial amount of SurModics Pharma's revenue falls into other markets, such as oncology, neurology and dermatology, to name a few.

Beginning with the therapeutics segment and the cardiovascular market, revenue was $9.6 million for the quarter, a 23% decrease from $12.4 million in the second quarter of fiscal 2008. To put these results in the proper context, let me discuss the CYPHER Sirolimus-Eluting Coronary Stent from Cordis Corporation, a Johnson & Johnson company.

Earlier this month, J&J reported worldwide CYPHER sales of approximately $252 million, down 37% year-over-year, as the product continues to be impacted by the US market entries of Abbott's XIENCE and Boston Scientific's PROMUS drug-eluting stents. CYPHER sales in the US were $68 million, while OUS sales were $184 million. J&J reported that it had an estimated 15% market share in the US and 31% outside the US during the quarter.

While competitive products have eroded CYPHER's market share, they have also contributed to the growth and sustainability of the overall drug-eluting stent market. This is evidenced by the increase in drug-eluting stent penetration rates this quarter to an estimated 74% in the US, up from 65% just a year earlier. This trend is certainly positive for SurModics given our continued broad-based participation in the drug-eluting stent space.

Getting back to our cardiovascular results, while total cardiovascular revenue was down 23% year-over-year, the growth in our broad portfolio of revenue streams helped dampen the impact of the 37% year-over-year decrease in CYPHER sales. On a sequential basis, second quarter cardiovascular revenue decreased 8.0%, compared with the first quarter of 2009, roughly inline with the 7.0% sequential decrease in CYPHER sales.

Next, in ophthalmology, we generated revenue of $3.7 million in the second quarter, compared with $3.0 million in the year-ago quarter. On a sequential basis, excluding the $43.8 million of revenue that was recognized in the first quarter as a result of termination of the Merck agreement, ophthalmology revenue increased significant from approximately $1.0 million in the first quarter.

Our technical teams are extremely busy working on the multiple customer projects spread across our various platforms for drug delivery in the eye. Bruce will speak more about this opportunity in a few minutes.

Rounding out the therapeutic segment, revenue in other markets was $2.9 million for the quarter, compared with $4.8 million in the second quarter of fiscal 2008 and $3.8 million in the first quarter of fiscal 2009. The decrease in other markets revenue principally reflects lower R&D activity on some customer projects in this area.

As we have said in the past, our work on development projects can ebb and flow, depending on the varying customer needs relative to the projects, resulting in non-linear revenue patterns for individual projects. We remain enthusiastic about this area and do not believe that lower second quarter revenue reflect any trends or are indicative of future results.

Lastly, revenue for our in vitro technologies business reported under the diagnostics segment was $4.7 million, compared with $5.5 million in the prior year. The decrease is driven almost entirely by lower royalty revenue.

As a reminder, the second quarter was the final period in which SurModics earned royalty revenue from the lateral-flow immunoassay technology patents licensed to Abbott, because those patents expired in the first quarter of fiscal 2009. And the royalty revenue earned from Abbott in the second quarter was significantly lower than the year-ago quarter.

On a sequential basis, diagnostic revenue increase 11%, compared with the first quarter, driven by 39% growth in product sales. As we discussed in last quarter's call, sales of our in vitro products were weak in the first quarter, as many customers had cut back on inventory investment. We understand this phenomenon was not unique to SurModics. While we cannot say with certainly if customers' buying patterns have returned entirely to normal, we were pleased with the strong results for our in vitro products following the difficult first quarter of fiscal 2009.

On a revenue component basis, royalties and license fees were $10.1 million, compared with $13.8 million in the year-ago quarter. On a sequential basis, excluding the deferred license fee revenue from Merck that was recognized in the first quarter of 2009, as well as the $9.0 million license fee that was received in the first quarter, royalties and license fees were roughly flat compared with the first quarter.

Product sales were $4.8 million, up 24% sequentially and a 2.0% increase from $4.7 million in the second quarter of fiscal 2008. Encouragingly, many customers, not just those in our diagnostic area, but more broadly across our customer base, appear to have largely returned to more typical buying patterns.

Finally, R&D revenue was $6.1 million during the quarter, a 15% decrease from $7.2 million in the second quarter of fiscal 2008. Included in second quarter R&D revenue is some revenue from Merck associated with our remaining activities on our ophthalmology projects with Merck. In light of weaker spending by many companies in the current environment, including healthcare

In light of weaker spending by many companies in the current environment, including healthcare companies, we are satisfied with these results. We are continuing to see customers take a more cautious approach to R&D investment than they have in the recent past. Selected large customers are facing more constrained budgets for R&D projects and smaller customers are confronting an extremely difficult financing market.

Fortunately, we are seeing some signs of improvement. Further, our broad portfolio of customer projects has allowed us to maintain strong overall R&D revenue, with the ultimate goal of helping advanced customers' products to the marketplace.

Next, I will turn to a review of operating expenses. We are devoted to maximizing profitability and optimizing our resources and have taken certain actions to reduce expenses from the first quarter to the second. Total operating expenses, excluding product costs for the second quarter, were $12.9 million.

We have reduced our operating expenses, excluding product costs, by nearly $3.5 million, or 21%, compared with the year-ago quarter. On a sequential basis, if you also exclude the IP R&D charge and the restructuring charges from the first quarter of fiscal 2009, we have reduced our operating expenses, excluding product costs, by over $1.1 million or 8.0%.

Building off the organizational restructuring implemented in November, which we expect to save SurModics approximately $2.0 million on an annualized basis, the Company has implemented additional expense control measures. For example, the senior management team offered to take a salary reduction that took effect this month and going forward, we will continue to manage expenses carefully.

Even though we are prudently managing expenses, SurModics continues to invest significant resources in support of our technology leadership and innovation. In the second quarter we dedicated 41% of revenue to R&D. Overall, R&D expenses of $8.5 million constituted roughly two-thirds of total operating expenses, excluding product costs.

Our robust R&D capabilities have been further enhanced by the recent changes in our organizational structure, including the implementation of a more centralized R&D function designed to improve the effectiveness of existing and new technologies across multiple clinical applications. We expect these changes to improve the return on our R&D investments, as we can now more easily allocate resources to selected opportunities across the Company.

Compared to historical levels, our R&D expenses were 18% lower than the year-ago quarter and 9.0% lower sequentially, compared with the first quarter.

SG&A expenses were $4.4 million, a 27% decrease compared with the year-ago quarter and 6.0% lower, sequentially, compared with the first quarter.

Now, let's turn to our strong balance sheet, which provides an important competitive advantage for SurModics in these difficult economic times.

As of March 31st, SurModics had a cash and investments balance totaling $58.9 million and zero debt. Cash flow from operations was $16.9 million for the first six months of fiscal 2009, compared with $8.9 million in the first six months of fiscal 2008. For the second quarter, operating cash flow was negative-$550,000, compared with positive-$4.5 million in the year-ago quarter.

A few factors combined to make operating cash flow slightly negative for the quarter. Primary among them is the fact that the second quarter is routinely our lowest operating cash flow quarter as we make two estimated tax payments in January and March during the period, compared with one payment in other quarters.

Additionally, our first quarter operating cash flow was higher than typical, as a result of the cash infusion of $9.0 million from Merck and while the associated taxes were accrued for P&L purposes in the first quarter, the cash taxes were not paid until the second quarter.

The final contributing factor related to accounts receivable, which was a $1.1 million use of cash in the second quarter after being at $2.8 million source of cash in the first quarter. We anticipate a return to positive quarterly operating cash flow in upcoming quarters.

Our strong financial position has allowed us to remain active in the deployment of capital. Our goal is to enhance shareholder value through the prudent balancing of share repurchase as well as business development and facilities-related investments.

In the second quarter, we repurchased approximately $2.2 million of SurModics stock. Since the November 2007 announcement of our second share repurchase program through March 31st of 2009, we have purchased over 900,000 shares and spent approximately $27.7 million. We have approximately $7.3 million remaining under this second $35 million authorization.

In February, SurModics further boosted its financial flexibility by finalizing a credit agreement with Wells Fargo that extends the Company up to $25 million under an unsecured revolving credit facility for a period of two years. Our profitable business model and healthy financial position allowed us to take advantage of the current low interest rate environment and lock in favorable terms. This new credit line enhances our liquidity position and provides additional flexibility in this uncertain environment.

The Company had no balance outstanding under the agreement as of March 31st and does not have any immediate plans to carry a balance. The decision to put in place the line of credit was by no means a reflection of any concerns we have about the Company or our prospects. Rather, we view the credit facility as a prudent tool to leverage in any economic environment, particularly the current one. And the ability to lock in favorable terms was attractive, especially since not all companies are afforded that luxury.

With that, I will now turn the call over to Bruce.

Thanks, Phil, and thanks to everyone for joining us on the call this afternoon. My comments today will briefly highlight quarterly achievements, industry and customer trends, SurModics' positioning and outlook, and conclude with a review of progress against our published fiscal 2009 goals.

SurModics is pleased to deliver solid financial results for the second quarter. The Company also made notable progress during the period toward meeting our fiscal 2009 goals. This progress was particularly evident in the areas of newly signed license agreements and customer product launches.

Our second quarter results are especially gratifying coming on the heels of soft product sales in the first quarter, which were impacted by the difficult economic environment. Product sales increased 24% on a sequential basis, compared with the first quarter.

While the market conditions remain challenging, we believe the Company's unique technologies and strong financial condition position us favorably for both the near- and long-term. SurModics' portfolio of stabile, recurring revenue products and projects continues to demonstrate it's significant value, despite the realities associated with the one-time charges and other events such as the termination of the Merck agreement, the expiration of our diagnostic patents and with it the Abbott royalty stream and declining royalties from CYPHER.

Against this backdrop, the Company's numerous advantages can sometimes be obscured. Among the most prominent of these advantages is our participation with healthcare customers, in multiple large markets where our technology is used to create sophisticated diagnostic tools and to solve a variety of unmet clinical needs, many in areas that are non-elective, such as cardiovascular, ophthalmology, oncology and the like.

Additionally, our enabling portfolio of technologies is benefited by the demographics of healthcare, including the rapid expansion of the over-60 population. Importantly, the potential growth in drug delivery remains strong and we have the technology and expertise to help meet this growing demand.

The Company continues to execute against our long-term strategy and invest in R&D that will foster future growth. We are implementing our strategies to build an enduring, great company by capitalizing on multiple revenue-generated opportunities as described in the following six areas.

First, one of the unique characteristics of our business is our ability to maintain active and ongoing relationships with a diversified set of customers and to partner in a range of markets and clinical applications. In the second quarter we generated revenue from 12 different clinical and marketing areas, demonstrating the breadth of our capability.

SurModics is further differentiated from competitors by our proven innovative technology and successful FDA track record, which has enabled multiple customers to successfully develop and commercialize new products. We believe our broad portfolio of technologies and the deep capabilities of our exceptional employees will allow us to continue to add new customer projects.

Two, another important differentiator from our competitors is the steady, recurring source of revenue derived from our hydrophilic and in vitro businesses that serve as the backbone for our consistent, ongoing financial performance. Our strategy is to protect and enhance our core businesses to sustain and expand these revenue streams.

Three, beyond the steady recurring performers, we have a number of very interesting opportunities in our pipeline, whose outcomes, both timing and magnitude, can be more difficult to predict with certainty, but which have the potential to become extremely valuable. Among them is our ophthalmology-related technologies.

We continue to add new ophthalmology projects and are making excellent progress in our partner-supported product development programs for back-of-the-eye and front-of-the-eye diseases, with both large and small molecule drugs. Today we have more paid customer projects in our ophthalmology pipeline than we have ever had in our history.

On last quarter's earnings call, we mentioned that we had signed one of the largest R&D agreements in our recent history with an ophthalmology customer. Work on that program is progressing as anticipated and we are currently negotiating a significant extension to that R&D contract, which we expect will also be in the millions of dollars.

In addition, our ophthalmology group will have a strong presence again this year at the upcoming ARVO meeting being held May 3rd through May7th in Fort Lauderdale, Florida. SurModics continues to make significant progress with our drug delivery systems for ophthalmology, as demonstrated by the results from our ongoing development programs we'll be presenting at the ARVO meeting.

We are especially excited about that Dr. Pravin Dugel will be delivering a podium presentation featuring the I-vation TA 36-month clinical results from the Phase I safety and preliminary efficacy trial, which is a very significant milestone for us in our Company. In addition to Dr. Dugel's podium presentation on these clinical results, SurModics will be featuring three other areas of research at the poster sessions.

Number four, our SurModics Pharmaceutical business is pursuing a number of exciting growth opportunities and our team in Alabama remains busy and is producing encouraging results. We are especially pleased that SurModics Pharmaceuticals generated our first license fee revenue during the second quarter, demonstrating good progress toward our business model.

Further, the PR Pharma acquisition opens new doors. We are pleased to report that the customer projects acquired from PR Pharma are integrating well and that the tech transfer is complete. These projects generated a full quarter of revenue in the second quarter.

Five, our cardiovascular franchise remains healthy. An important part of this business lies in coated and drug-eluting stents. Our portfolio of licensed stent-related customer product opportunities, both on the market and current pipeline products, numbers in the double-digits. Products that currently contribute to royalty revenue include by CYPHER and Medtronic's ENDEAVOR drug-eluting stent.

In a positive recent development, Medtronic received regulatory approval in Japan for ENDEAVOR and they expect to launch the product next month following reimbursement approval.

In January, we signed a second license with Nexeon MedSystems to collaborate on the development of a FINALE coated stent system to treat renal artery disease. Separately, Nexeon continues to make good progress in their European clinical trial evaluating the FINALE coated coronary stent system as an alternative to drug-eluting stents.

Another positive development was XTENT's recent receipt of a CE Mark for their drug-eluting stent, which is capable of delivering multiple custom length stents to treat lesions in numerous vessels with a single delivery system. Recall that XTENT's stent delivery system incorporates SurModics' hydrophilic coating as well.

One final note on stents. J&J's next generation drug-eluting stent product, the NEVO Sirolimus-eluting coronary stent, which incorporates SurModics' hydrophilic coating technology on the delivery system, is also making good progress. And Cordis continues to be enthusiastic about the product.

Six-month data for NEVO will be presented at the Euro PCR Conference in May and the results from this trial are expected to support the CE Mark approval in Europe and other countries that accept CE Mark designation. Remember that this second generation Conor Medsystems product produces a royalty favorable for SurModics, compared to the first generation CYPHER product.

Outside of drug-eluting stents, but within cardiovascular, we are both working with and in advance discussions with a number of companies developing exciting new products such as minimally invasive heart valves, stent grafts for peripheral applications and drug-eluting balloons, where our technologies and capabilities are particularly relevant and valued.

And six, finally, in addition to the multiple growth drivers I've just mentioned, SurModics has a broad portfolio of opportunities that enables us to continue to diversify our revenue streams and to deliver solid growth long-term. We regard our business as a portfolio of opportunities, with more than 100 licensed products generating royalties and nearly 200 projects in our pipeline not yet on the market.

As of March 31, we had a total of 103 licensed customers, several with multiple licenses, up from 97 a year ago. SurModic' customers had 102 licensed product classes on the market generating royalty revenue, compared with 100 a year ago. The total number of licensed products not yet launched was 106, up from 103 a year ago. Major non-licensed opportunities stood at 92 on March 31st, compared with 90 a year ago. In total, the Company has 198 potential commercial products in development.

Switching gears, to changes to our organizational structure and our cost cutting initiatives undertaken in the first quarter of fiscal 2009 have already begun to yield positive results from both financial and operational standpoints. We have made additional cost structure adjustments as we vigorously focus on managing costs to improve operating efficiency and to boost our profitability going forward.

As Phil mentioned, we have reduced our operating expense, excluding product costs, 21% year-over-year and 8.0% sequentially.

SurModics is leveraging its financial strength to general shareholder value in a variety of ways. Our number one priority is maintaining the financial flexibility necessary to withstand whatever difficult market conditions arise.

We maintain several other areas of focus. This includes our continued investment in the development and cGMP manufacturing facility in Alabama, which is currently tracking to our timeline and budget. We also remain opportunistic on the business development front as we consider new opportunities that are emerging as a result of the currently challenging environment.

Finally, we will continue to execute our share repurchase program when appropriate.

With that review of our business and our revenue drivers, I want to revisit the high level outlook for fiscal 2009 we provided in our year-end conference call in early November 2008.

As a reminder, at that time we articulated an expectation of roughly flat revenue and diluted EPS on a non-GAAP basis, compared with the fiscal 2008 non-GAAP results. This high level outlook assumed a continued decline in CYPHER royalties and the discontinuation of the Abbott royalty stream beginning in the fiscal third quarter.

As the year has progressed, our expectations continue to be adversely influenced by the difficult economic environment, which has impacted our customers' decision-making process on the products they buy, the projects they fund, new projects they might approve and the sales of their own products, which impacted royalty revenue we received.

In January, when we discussed our first quarter results, I indicated that selected fundamentals had deteriorated appreciably since our November call. While we have seen pockets of recovery and there was relative strength in our second quarter results, the environment remains challenging and the near-term visibility is limited in some areas.

Despite this difficult climate, we still see potential paths that could allow us to reach the fiscal 2009 outlook we provided in November.

We continue to work with numerous significant customers on projects in cardiovascular, ophthalmology, and other markets that have the potential to generate R&D fees, as well as license fees and milestones of a magnitude that would meaningfully impact our full year fiscal 2009 results. Although predicting the timing of all of these is more difficult.

While we are comfortable with the Company's healthy outlook overall and our long-term growth potential, our ability to achieve specific financial results in a narrow timeframe is less certain. Today, based on these factors and how our year is tracking, we are less optimistic about achieving the revenue goal we articulated in November. But our disciplined expense management allows us to be more optimistic about the potential to achieve results close to our EPS outlook.

Finally, I will touch on SurModics' fiscal 2009 goals. We're only midway through the year and several of these goals are designed to measure a full year's activity. To view our published fiscal 2009 goals in their entirety, please visit our website.

As in previous years, these objectives are designed to offer insight into how we manage our business and to provide a view of the Company's future opportunities. These goals are aspirational in nature only, as we often don't control the timing of all aspects related to our customer objectives.

This year we articulated a goal of signing 18 new licenses with our customers. I'm pleased to report that SurModics had another strong quarter on this front as we added six new license agreements with customers, bringing our fiscal year-to-date total to 14.

We have also already met one of our fiscal 2009 goals with the signing of a new customer license using SurModics' drug delivery technology outside of ophthalmologist, or rather in the cardiovascular space. Additionally, we continue to make progress toward our objectives of signing an ophthalmology license and two customer licenses relating to our SurModics Pharmaceuticals technology.

Another goal was our expectation that SurModics' customers would launch 10 new product classes in financial 2009. Our customers delivered a strong quarter, with customers launching five new product classes in the marketplace, increasing our fiscal 2009 total to seven. We're pleased with the progress made against our ambitious fiscal 2009 goals and believe we are on track to achieve our remaining goals by the end of our fiscal year.

In closing, SurModics continues to demonstrate leadership and expertise in the application of biomaterials to the healthcare industry for the ultimate benefit of patients around the world. Our financial position remains healthy, which affords us the flexibility and the ability to meet a variety of challenges and capitalize on opportunities as they present themselves.

I'm excited about our future and confident that we can deliver, continue to deliver sustainable long-term shareholder value for our investors.

Operator, that concludes our prepared remarks. We'd now like to open up the call to any questions that there may be.

Thank you, sir. (Operator instructions) One moment please, and our first question is from the line of Rick Rinkoff with Craig-Hallum. Please go ahead.

Thank you. Well, congratulations on a better quarter than one before that. I had a couple of questions here. First of all, you said the R&D includes a little bit of Merck. Could you tell us how much that was and while you're being so forthcoming, could you tell us what Abbott was in the quarter?

Yes, Rick, the Merck component was about $1.2 million, and on the Abbott front we're not prepared to disclose that number, but we did articulate that it was down from a year ago.

And what was it a year ago?

Well, the year-ago we gave the full year number.

Was it less than Merck this quarter?

Not prepared to answer it at that level.

Okay. Okay. You talked about your big ophthalmology contract and then I believe you used the words extending the relation -- well, what words did you use and what should we infer from that?

Let's see. I've already put my script away, Rick, so I don't remember exactly the words I used other than --.

Well, give us new words.

Other than, as we mentioned in the last conference call, we signed a very agreement with a customer in the millions of dollars for development activities and the team is very, very busy implementing those activities and doing a very nice job.

In the course of that, this customer wants additional work and we are in the process of negotiating and we expect to be finalizing here, in the not too distant future, additional R&D contract for additional work, again expected to be in the millions of dollars.

Okay. So they're expanding the agreement? They're not just extending it? Maybe that was the misinterpretation I had. On that front, ophthalmology was $3.7 million. About how much of it might have been that customer?

Going back to expanding versus extending, I'm not sure that I understand the difference other than I'm sure you understand the development programs these companies have begin with in vitro in animal and move forward, so it's more like that. It's more along just extending the development process.

Okay.

If you want to call that expanding, that's fine.

Okay.

And your second question was around ophthalmology. I'm sorry, I think I cut you off.

You report $3.7 million in the quarter. How much of it came from that one customer?

I don't have that number in front of me.

Was it a material amount, do you believe, or was it just one of many customers in that number?

Well, again, we've got several customers, more than we've ever had in our history. We have contracts with those companies that many of which are in excess of $1.0 million apiece. How they play out over time is very dependent upon the program and the specific requests that they have. So I can't -- like I said, without having those numbers in front of me, which I don't, I can't tell you exactly how much played out by customer in this quarter.

Okay and one more question.

Sure.

In the script that you no longer have, did you talk about minimally invasive heart valves or something in that nature?

I've pulled the script back. Yes I did talk about that.

Okay. Is that the transcatheter heart valves that we're talking about?

Yes, they're minimally invasive valve replacement, so using many of the techniques that those of you that are familiar with the cardiovascular space would know about, using those techniques, avoiding open heart surgery.

And what would SurModics be adding to those products?

Well, potentially a few things. I mean, we could be adding drug delivery technologies. We could be adding technologies like our FINALE Prohealing Coating, which is designed to minimize the impact of a foreign body within the body and then, of course, because it's minimally invasive, our hydrophilic coatings on delivery services. So, while I can't be specific at this point, I would tell you that we have a variety of technologies in play there.

Okay and one more last question. There are products like that on the market now. Are you in any of them or are these all development contracts you're talking about?

We've not been authorized to talk about who in particular we're working with, at this point.

But should we infer that some of the products are already being marketed and paying you royalties or that's still yet to come, maybe?

I think that's a pretty small world you're talking about there, so we really can't comment, Rick.

All right, thanks.

Good try, though. Thank you.

Ross Taylor, CL King & Associates

Hi. I might just start with a couple questions related to trying to model future quarters. But your R&D revenue and expense lines, I mean excluding what you had from Merck this quarter, I mean are those kind of good benchmarks to use as a base for the next several quarters?

Yes, I mean we don't really project on a revenue line item basis, but I think the general level of activity we have right now we do see as, generally speaking, sustainable, but I wouldn't give you a lot more precision than that.

Okay and how about on the expense side? I mean, occasionally you've been a little bit more open to projecting there, but is this quarter's expense number for R&D a good baseline to use for the next several quarters?

Yes, I'd say on the R&D side it would probably be flat to modestly up going forward and SG&A would probably be flat to modestly down.

Okay, okay. And you mentioned that senior management was taking a reduction in salary. Is that going to be offset at all by some potential increases in incentive compensation or potentially some more stock-based compensation?

No it's not.

Okay and two other questions. I missed the beginning of your call and I just wondered if you'd talked about what your hydrophilic revenues were in the quarter, whether they were up or down versus the prior year? Just any specifics you can give on hydrophilic?

We've not broken that out as a component. The portfolio continues to perform quite well. Clearly there's some that are visible and people know discrete line items and so some products are struggling in the marketplace and our royalties are affected by that. But the continued growth of the portfolio, as well as growth of some of the underlying products, does continue to generate strong results for the hydrophilic portfolio.

Okay and my last question relates to ophthalmology and I don't know if you can answer this, but time has progressed over the last two years or so and you've added more R&D customers there. Has there been any change in the kind of mix of focus of these customers? Are they -- is it still largely concentrated back-of-the-eye or you're seeing more customers focused on front-of-the-eye diseases, as time has gone on?

The focus continues to be on the back of the eye, although we do have front-of-the-eye customers. I think most people see the sustained delivery of drugs to the back of the eye as a very significant opportunity. Front-of-the-eye, although is also a large opportunity, especially with a number of very effective drugs that are given once or twice a day via drops, coming off patent here in the next three to five years. So we have good conversations in both areas, but I would say today most of the work is back-of-the-eye.

Okay. All right, that's helpful. Thanks very much.

Thanks for the call.

Ernest Andberg, Feltl and Co.

Good afternoon. I was not on the beginning part of the call and so I apologize if I ask something you've covered. Did you quantify the billions of dollars of revenue you call sizeable on the ophthalmology contract, either the one existing or the one that could get signed? Or is it simply undefined millions of dollars?

It's -- we did not define it, Ernie. It's confidential under the contract. My comments were really around both the original contract and then the extension we're in decisions with now, just to give you a sense of order of magnitude. Ultimately you'll see those dollars roll up into the R&D revenue line with the other work that we're doing, but we did not quantify either one of those.

Okay, fair enough. That's it for me, now. Thank you.

Okay, thank you.

Thanks, Ernie.

Suraj Kalia, SMH Capital

Good afternoon, gentlemen, congratulations on a nice quarter.

Thanks, Suraj.

Bruce, Phil, just a comment first before I go into my questions. At least from my side, very few executives I've seen have taken pay cuts in the med-tech industry, so I comment you guys for taking that step, especially after the Merck debacle. I really commend you guys for that.

On the BD opportunities, Phil, maybe you can help us out here, are these early stage, mid-stage? Are these med-tech focused or these pharma focused, can you shed some color there?

No, I really can't give you a lot of color on what we're looking at, because it's all confidential things and they may or may not get done. But I would say that this environment certainly is presenting a number of very interesting and compelling, potentially compelling opportunities for us across the spectrum of the kinds of things we look for in business development opportunities.

And those, as we've discussed in the past, do run the gamut of technologies that we can either license in or acquire strategic investments in companies, as well as potentially M&A types of things that make sense for the business. And so we do see a lot of interesting things out there, but beyond that I really can't give a lot of color, just given the confidential nature of those discussions.

Let me reverse it, put it a little differently, Phil. When Bruce mentioned about the financial outlook for the remaining of the fiscal year, does that incorporate any potential targets you'll have already scoped out and maybe you're in advanced negotiations? Or would that be sort of gravy once you guys acquire some company or some product and then we would have to revisit numbers?

The discussion about any outlook was absent any business development acquired revenue, if you will, from an acquisition.

And Bruce, in terms of the outlook that you all have presented for the remaining -- considering the environment, this is still pretty decent outlook. But could you shed some more color on what specifically are you all seeing softness and is it primarily new projects and hence the R&D line is getting hit? Is it you all see sales more getting hits and hence the royalty line items would be softer? What do you see for the remaining part of the year?

I don't know if I can give you that level of color, just because that's confidential to us in our internal planning documentation. I think the point is just reflective of the fact that we do see our way to getting to those numbers, but given the reduced timeframe and the increased uncertainty, we want to make sure we're clear up-front that at least on the revenue line there is more uncertainty.

I would say, again on the EPS line, roughly flat still feels like it's doable to us, based upon where we are six months in the year. That could change, of course, depending upon the environment and customers. We did try to highlight in the prepared remarks some of the areas where we are seeing some pullback relative to especially our smaller Company's, that as you can imagine are having a little more difficulty getting financed if they need it going forward.

So we've taken a more conservative view of those numbers over the next six months, but that's probably as much detail as I can give you beyond what I mentioned in the prepared remarks.

Fair enough and last question. Phil, the $1.2 million Merck revenues in the R&D line item, is it fair to say this is pretty much it, the last sub-line item, if I may, that will be contributed to Merck?

We believe so, yes. That's probably a fair way to look at it.

Thanks for taking my questions, guys.

Thank you, Suraj.

Thank you.

(Operator instructions) Daniel Owczarski, Avondale Partners

Yes, thanks, good afternoon.

Hi Dan.

Hi Dan.

A couple questions on the pharmaceutical division. There used to be a nice chart that you guys supplied talking about some of the pharmaceutical partners and what stage of development some of the projects were in and even some rough ideas on where they were focusing.

And I was just curious as to whether there were any updates as the later-stage projects that your partners are working on, what that Brookwood division, if there was a Phase III or Phase II that we're moving forward. Any updates on the later-stage or any milestones in the near-term for that division?

Dan, they do continue to make progress with a number of their customers who are in the later stages. I think the environment is one of uncertainty, because some of these companies are smaller and need to secure financing to move to the next steps in some of their programs.

But they do, have been, making nice clinical progress and so those prospects continue to look good, as long as they continue to secure adequate financing to roll the projects forward. And so they are making nice progress on the technical front and the clinical front. But probably can't give a lot more color because certain things need to happen over time, of course, to allow these to move to commercial stage where they would be generating royalties for us.

Then does that impact your potential to do manufacturing down in Birmingham? Or are you still getting some interest there as far as interested parties wanting bids or anything like that?

Oh, we are getting a lot of interest from companies. We're in discussions with some now. We also have companies today that we're doing commercial manufacturing, or more accurately clinical manufacturing, in our existing clean rooms in the other two facilities we have there.

So it is -- the facilitate isn't completed, but it's to a point now we can actually walk customers through it and show them where their particular project would be and how it would move through the facility. And I can tell you that the people are extremely impressed with what we're putting together down there. So we do have customers today and it would be our intent to add to that in the near future.

Okay and then just one last quickie, Phil, with the $1.2 million on Merck and you said that would be about it. What was that for? I missed your commentary on what specifically that was related to.

It's the final activities that our team did, supporting their projects, and so it was concluded during the quarter.

Okay. Thank you.

Thank you.

Ernest Andberg, Feltl and Co.

Bruce, you or Phil talked about the NEVO project with J&J and made a comment that the license -- I don't remember whether you said revenue or royalty would be comparable to the original CYPHER.

Yes.

Does that mean, in terms of rate, or in terms of absolute dollars flowing to you a better royalty on potentially lower sales?

It means royalty rate, Ernie. We don't -- we aren't in a position to know the success of not of the product, ultimately, but the royalty rate, that gets multiplied times the net sales that are generated by the customer is higher.

All right. Okay. Phil, could you help everyone listening how you're defining your scorecard pro forma? Are you -- you're including the Merck milestone in this year's revenue?

Yes. That would include the $9.0 million milestone we received in the first quarter.

Okay. When you're talking about pro forma, are you pro forma-ing last year at all?

Yes. The pro forma that we're comparing to for last year would be the supplemental non-GAAP table that we included in our fourth quarter earnings press release and that did the math on how the Merck revenue was accounted for. And so, while the first quarter had the recognition of a bunch of deferred revenue that related to the Merck agreement in there, effectively that's not cash. That was cash received in prior periods and so we're not including that in what we would define as the non-GAAP revenue and corresponding earnings for fiscal 2009.

Right.

But since the $9.0 million was net new cash received in the year, that we do include.

Are you pro forma-ing anything in '08 fiscal year from Merck? Or is it the $95 million you're talking about?

No. If you pulled up that last quarter earnings press release --

I don't --.

You'd see it was about $111 million in non-GAAP revenue and about $1.51 in non-GAAP earnings per share.

Thank you.

Thank you.

Thank you. At this time we have no further we have no additional questions. I'd like to turn it back to management for any closing remarks.

Great. Thanks very much. We want to thank everybody again for participating in this quarter's conference call. We look forward to speaking with you again for our third quarter call in July.

Thank you, sir. Ladies and gentlemen, that does conclude the SurModics Second Quarter 2009 Earnings Conference. Thank you very much for your participation and for using ACT Conferencing. You may now disconnect. 16