Surmodics Inc (SRDX) 2009 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the SurModics third quarter 2009 earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Wednesday, July 29, 2009.

I would now like to turn the conference over to Mr. Phil Ankeny, Senior Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Erinn. Good afternoon, and welcome to SurModics' fiscal 2009 third 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 this 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 address the Company's quarterly financial results. Bruce will then highlight quarterly achievements, SurModics positioning and outlook, and review 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 third quarter financial results and then provide more specific information on discrete line items. My discussion of revenue will include component and end market breakdowns, as well as significant revenue drivers. Finally, I will discuss expenses and review our balance sheet and cash flow.

Third quarter revenue was $18.2 million compared with $24.3 million in the year-earlier period and $20.9 million in the second quarter. If we focus on the sequential comparison, the impact of certain revenue transitions becomes clear.

If you back out the two revenue items that contributed to second quarter results but were absent in the third quarter -- namely, the revenue associated with the final Merck payment for R&D activities and royalties from Abbott -- total revenue in the third quarter increased modestly compared with the adjusted second quarter total.

The Company reported operating income of $4.7 million compared with $7.2 million in the prior-year period and $6.2 million in the second quarter. Net income was $3.5 million during the period, compared with $4.8 million in the third quarter of 2008 and $4.2 million in the second quarter. Diluted earnings per share was $0.20, compared with $0.26 in the prior-year period and $0.24 in the second quarter.

Next, I will look at revenue across end markets, beginning with the Therapeutic segment. In the cardiovascular market, revenue was $10.1 million for the quarter -- a 13% decrease from $11.6 million in the third quarter of fiscal 2008, but up 5% sequentially, compared with the second quarter. The most visible component of our cardiovascular results is the royalties generated from the Cypher Sirolimus-eluting Coronary Stent from Cordis Corporation, a Johnson & Johnson company.

Earlier this month, J&J reported worldwide Cypher stent sales of approximately $234 million for the June quarter, down 41% year-over-year as that product continues to be impacted by the US market entries of Abbott's XIENCE and Boston Scientific's PROMUS Drug-eluting stents.

Cypher Stent sales in the United States were $69 million, while sales outside the US were $165 million. Sequentially, Cypher stent sales were down 7% on a worldwide basis but actually increased 1% in the United States. In terms of marketshare, J&J estimated that it had 14% share in the US and 27% outside the US during the quarter. Marketshare in the US declined by only 1 percentage point compared with the March quarter.

While competitive products have eroded the marketshare for the Cypher stent, 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 to an estimated 74% in the US, up from 66% in the year-earlier period.

This trend is an important positive for SurModics, given our continued broad-based participation in the drug-eluting stent space, with a number of other partnered products and projects.

Looking again at our overall cardiovascular results, while Cypher sales were 41% lower than a year ago, our cardiovascular revenue was down 13% year-over-year. On a sequential basis, third quarter cardiovascular revenue actually increased 5%, compared with the second quarter, despite the continued sequential decrease in Cypher sales. We attribute these results to the value of our broad portfolio of customers and products in our cardiovascular business.

Next, in Ophthalmology, we generated revenue of $1.8 million in the third quarter, compared with $3.2 million in the year-ago quarter. On a sequential basis, Ophthalmology revenue decreased from approximately $3.7 million in the second quarter. However, as we discussed on our earnings call last quarter, our second quarter results included approximately $1.2 million of R&D revenue associated with our remaining Ophthalmology project activities with Merck.

If you exclude the Merck R&D revenue from the second quarter results, Ophthalmology revenue was down 29% sequentially. We do not regard this as noteworthy, as the revenue we are currently generating in Ophthalmology is principally R&D revenue, and we typically see quarter-on-quarter fluctuations as customer programs goes through ebbs and flows of activity.

Rounding out the Therapeutic segment, revenue in other markets was $3.5 million for the quarter, a decrease of 8% compared with $3.8 million in the third quarter of fiscal 2008. On a sequential basis, other markets revenue increased 20%, compared with $2.9 million in the second quarter of fiscal 2009.

The vast majority of revenue in other markets comes from our SurModics pharmaceuticals business, where the broad portfolio of customer projects continues to generate strong results.

And lastly, revenue in the Diagnostic segment was $2.8 million, compared with $5.7 million in the prior-year. The decrease is driven principally by lower royalty revenue. As a reminder, the second quarter of fiscal 2009 was the final period in which SurModics earned royalty revenue from the lateral flow amino assay technology patents, licensed to Abbott, as the underlying United States patents expired in December 2008.

On a sequential basis, diagnostic revenue decreased 40% compared with the previous quarter. However, if you exclude the $1.6 million of royalty revenue from Abbott in the second quarter, total diagnostic revenue decreased only 8%. Since we are now at a point where the revenue in the Diagnostic segment is comprised almost entirely of product sales, we will focus our commentary there.

A sequential decrease principally reflects timing of customer orders. Further, while many of our customers have returned to more normal buying patterns, we continue to see some customers exhibit a more cautious approach.

This discussion on diagnostics offers a natural segueway to comment on SurModics' intellectual property strategy. The lateral flow immunoassay technology embodied in the patents licensed to Abbott was developed in the early days of SurModics. As the Company shifted its focus from diagnostics to medical devices in the mid-'80s, we made a strategic decision not to pursue the development of successor technology for the lateral flow patent; instead, allocating resources to other promising long-term opportunities in the medical device industry.

In contrast, we are always developing successive generations of technology and IP relating to our core business, as we seek to ensure continuity of these principal royalty streams. We continue to pursue the development of new technologies and aggressively file new IP, based on our inventions. In fact, the number of patent applications we file is trending higher for fiscal 2009.

Overall, our IP strategy has been instrumental in driving the recurring revenue characteristics that continue to make our business model so unique and powerful.

I will now turn to a review of our results on a revenue component basis. Royalties and license fees were $8.2 million compared with $13.6 million in the year-ago quarter. On a sequential basis, royalties and license fees decreased 18% from $10.1 million in the second quarter. However, if you exclude the $1.6 million in Abbott royalties from the second quarter results, royalties and license fees were down only 3%, despite the 7% sequential decrease in Cypher sales.

Product sales were $5.1 million, up 7% sequentially, and a 15% increase from $4.4 million in the third quarter of fiscal 2008. Encouragingly, our broad customer base appears to be returning to more typical buying patterns. We're not completely out of the woods, but product sales are definitely improving.

Finally, research and development revenue was $4.9 million during the quarter, a 22% decrease from $6.2 million in the year-ago quarter and 20% lower on a sequential basis. However, if you exclude the roughly $1.2 million in R&D revenue from Merck in the second quarter, R&D revenue was essentially flat on a sequential basis.

Overall, we continue to see customers employ a more cautious approach to R&D investment compared to last year. Importantly, however, we are seeing signs of -- selected signs of improvement. Further, our broad portfolio of customer projects has allowed us to maintain healthy overall R&D revenue.

Next, I will turn to a review of our operating expenses. We are dedicated to maximizing profitability and optimizing our resources, and our continued prudent expense management helped us maintain good profitability in the quarter, in spite of the decrease in revenue.

Total operating expenses, excluding product costs, for the third quarter were $11.5 million. We have reduced our operating expenses, excluding product costs, by roughly $3.8 million or 25% compared with the year-ago quarter. On a sequential basis, operating expenses, excluding product costs, decreased by over $1.4 million or 10%.

While SurModics is prudently managing expenses, we continue to invest significant resources in support of our long-term growth through technology leadership and superior innovation. In the third quarter, we dedicated 42% of revenue to R&D. Overall, R&D expenses of $7.6 million constituted roughly two-thirds of total operating expenses, excluding product costs.

Our robust R&D capabilities have been further enhanced by the changes in our organizational structure announced in November, 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 27% lower year-over-year, in part as a result of the R&D costs associated with our support of Merck in the year-ago period, but more importantly, because of the organizational changes we have made. On a sequential basis, R&D expenses were 10% lower compared with the second quarter, reflecting the benefits of the organizational changes.

SG&A expenses were $3.9 million, a 19% decrease compared with the year-ago quarter and 11% lower sequentially, compared with the second quarter.

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

As of June 30, SurModics had a cash and investments balance totaling $51.5 million and $0 debt. Cash flow from operations was $7.9 million during the quarter compared with $13.7 million in the year-ago quarter. Cash flow from operations was $24.8 million for the first nine months of fiscal 2009, compared with $22.6 million in the first nine months of fiscal 2008.

I am pleased to report that we have successfully subleased the building we formally occupied here in Eden Prairie, Minnesota. This transaction will have a modestly positive impact on cash flow going forward.

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

In support of this objective, we have continued to invest in our new development and CGMP manufacturing facility in Alabama. We are creating a world-class facility to provide exceptional CGMP manufacturing services for our customers. [The buildout] is progressing smoothly, with encouraging customer interest, and continues to track to our timeline and budget.

On the share repurchase front, the Company did not repurchase any shares in the third quarter. However, since announcing our latest share repurchase program in November 2007, SurModics has spent approximately $28 million buying back over 900,000 shares of Company stock. At this time, we have $7 million remaining under our $35 million authorization.

On the business development front, we are seeing numerous opportunities at attractive valuations, and believe we can leverage our strong balance sheet to consummate transactions that advance our strategic objectives.

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

Thank you, Phil, and welcome, everyone, to the call today.

My comments today will briefly highlight quarterly achievements, SurModics positioning and outlook, and conclude with a review of progress against our published fiscal 2009 goals.

As you heard from Phil, SurModics delivered another profitable quarter in a very difficult economic environment. Importantly, we continued to make steady progress towards the achievement of our fiscal 2009 goals, particularly in the area of newly-signed license agreements and customer product launches.

Additionally, our continued focus on operating efficiency in this difficult environment, including the changes to our organizational structure and cost-cutting initiatives undertaken last year, have greatly benefited the first three quarters of fiscal 2009, and are yielding positive results from both a financial and operational standpoint.

We have made additional cost structure adjustments, including previously-announced executive salary reductions, as we vigorously focus on managing expenses to improve operating efficiency and ultimately, boost our profitability going forward.

As Phil mentioned, our prudent expense management approach resulted in reducing operating expenses from the second quarter to the third quarter, which builds on the reductions we generated compared to the third quarter of last year. These actions in no way diminish our commitment to customer-centric innovation, which we expect to drive our licensing business model well into the future.

Looking at the business from a high level, and similar to second quarter results, difficult macroeconomic conditions continued for most companies in our third quarter, and SurModics was no exception. Healthcare is often cited as an industry that is resistant to economic cycles; as most companies in this industry have seen, that has not been the case.

The economic slowdown creates ripple effects in the healthcare sector. For example, when patients defer certain medical procedures and doctor visits, it causes hospitals to experience weakness. Hospitals may in turn reduce their orders to medical device, pharma, and diagnostic companies. Facing lower sales of their products, some companies may elect to dial back their R&D spending, which again, can affect SurModics.

Beyond the macro economy, SurModics continues to face additional headwinds in fiscal 2009, including certain one-time charges and other events, such as the termination of the Merck agreement, the expiration of our diagnostic patents and the associated royalty stream from Abbott, and declining royalties from Cypher.

These factors have impacted Company results throughout the year, and as we have stated on previous conference calls, will likely make comparables to prior-year periods a challenge in the near-term. Nonetheless, I strongly believe that SurModics' broad and diverse technology platforms, significant number and quality of customer programs, and strong financial condition are positioning us well for long-term growth.

We did deliver several positive results in the third quarter, which I will highlight in a moment, including increased product sales from a broad cross-section in SurModic's customers, compared to the first and second quarters.

Before updating you on Company progress in the quarter, I want to take a moment to highlight a few of SurModics' most unique and important characteristics, which will form the foundation for long-term success.

Among the most notable 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. Today, our business serves roughly a dozen different clinical and market areas, demonstrating the breadth of our capabilities and technology offerings.

SurModics is further differentiated from competitors by our proven innovative technology and successful history with the FDA and other regulatory bodies, which has enabled our customers to repeatedly develop and commercialize new products while minimizing risk. In fact, our customers have over 100 different products on the market paying us royalties, based on technologies they've licensed from SurModics.

Another important distinction from our competitors are two core components of our business that provide a steady, recurring source of revenue and cash flow. Hydrophilic technology coatings and our in vitro diagnostics products.

These two core components serve as the foundation for our consistent, profitable financial performance. We're actively protecting and aggressively enhancing these core components to sustain and expand these revenue and cash flow streams.

Beyond these stable core businesses, SurModics maintains a host of exciting opportunities in our Drug Delivery pipeline, whose outcomes, both timing and magnitude, can be a bit more difficult to predict with certainty, but nonetheless, maintain the potential to become extremely valuable.

For example, our Ophthalmology-related technologies provide some of our most compelling opportunities. SurModics has customer development programs numbering in the double digits. These customer programs target sustained delivery of a variety of drugs from small molecules to large, and address both back of the eye and front of the eye applications, leveraging several SurModics proprietary platforms.

For example, as evidence of a strong interest in our technology portfolio and capabilities, SurModics is currently working with two Top 10 Pharma companies. Further, SurModics continues to make significant development progress with our Drug Delivery systems for Ophthalmology, as demonstrated by the ongoing programs presented at the ARVO conference in May.

Dr. Pravin Dugel delivered a podium presentation featuring results from the 36-month follow-up from the I-vation TA Phase I clinical trial for patients with diabetic macular edema, or DME. These results demonstrated that the I-vation Drug delivery system is easily implanted and removed, and that the I-vation TA product is safe and well-tolerated. There were no product-related serious adverse events in the clinical trial after three years.

Although this study was not powered to draw any conclusions regarding efficacy, results showed a significant trend towards early and sustained reduction in macular thickness, and a corresponding benefit to visual acuity. We believe this preliminary efficacy data indicates that this treatment is promising. We are encouraged by these results and the significant advancements made in the development of this technology.

Since Merck canceled our agreement, rights to the I-vation TA product have fully returned to SurModics. We are talking to potential partners about the opportunity to carry this product forward. SurModics has elected not to fund the Phase II clinical trial on our own. As such, the funding of the remaining clinical trials would be the responsibility of a new partner.

Among our most important fiscal 2009 goals is the signing of a new license using SurModics' drug delivery technology in ophthalmology. We continue to work toward our goal of signing a license agreement this fiscal year and are making excellent progress. Nevertheless, we are approaching the negotiation prudently and carefully, and will not sacrifice terms for timing.

While we fully believe SurModics will consummate a second license agreement, it may or may not occur by fiscal year-end. Regardless of timing of our next license agreement, we remain confident that ophthalmology will be a strong contributor to SurModics' revenue growth and diversification in the years to come.

Another important growth driver is our SurModics pharmaceutical business, which has a number of exciting sustained drug delivery partnered programs across a broad range of clinical areas.

SurModics pharma continues to make good progress with customer development programs, and we are pleased to report that another one of our customers progressed in the clinical evaluation of their drug, recently initiating a Phase II clinical trial. This recent customer milestone is another demonstration of the continued progress we are making at our SurModics pharma business.

Also, our cardiovascular franchise remains healthy. Our portfolio of licensed stent-related customer product opportunities, both on the market and future pipeline products, numbers in the double digits as well.

In a positive recent development, one of our partners, Medtronic, received regulatory and reimbursement approval in Japan for the endeavor drug-eluting stent in May. While we had no impact on our royalties from Medtronic in the third quarter, we do expect royalties associated with Japanese sales to be included in our fourth quarter results.

Another positive development was XTENT's receipt of a CE Mark for their drug-eluting stent. If XTENT is successful in its efforts to partner with another company that can provide distribution capabilities, SurModics will be positioned to receive royalties on sales of this novel product.

Johnson & Johnson's next generation DES product, the NEVO Sirolimus-eluting Coronary stent, which incorporates SurModics' hydrophilic coating technology on the delivery system, is also making good progress. Six-month clinical data for NEVO were presented at the EuroPCR conference in May, showing that the product was superior to the TAXUS Liberte stent in reducing tissue growth within the stent.

Cordis continues to be enthusiastic about the product, stating that NEVO will offer a unique combination of safety, efficacy and deliverability that offer the potential to return quarters to global leadership in the drug-eluting stent market. Cordis plans to file for CE Mark approval in 2009.

Importantly, this third-generation DES product will yield a royalty arrangement more favorable for SurModics than the first-generation Cypher product.

As a final example of our opportunities within the stent area, Nexeon MedSystems, our partner for the Finale Prohealing Coating Technology, continues to enroll patients in its European clinical trial designed to evaluate their stent with our novel extracellular matrix protein.

Outside of DES but still within cardiovascular, we are partnering with a number of companies on the development of exciting new products. Potential products include minimally invasive heart valves, stent graphs for peripheral applications, and drug-eluting balloons, where our most enabling technologies and capabilities are particularly relevant and valued.

We're excited to have signed our first license agreement in the drug-eluting balloon space during the third quarter. SurModics is working on the development of drug-eluting delivery coatings for our partner's drug-eluting balloons. This new opportunity further broadens our portfolio of customer applications, leveraging our Drug Delivery technology, and allows us to address an exciting high-profile, new market opportunity. We will provide additional information on this specific opportunity when we can.

Drug-eluting balloons are widely regarded as a highly promising area in the medical field. Two groundbreaking bodies of research, the PEPCAD II trial in coronary arteries, and the Thunder study in peripheral arteries, demonstrated proof-of-concept for using drug-eluting balloons in treating vascular disease.

There's some experts who argue that drug-eluting balloons could potentially displace stents altogether. While we acknowledge that this is not a majority viewpoint, we regard drug-eluting balloons as both a defensive as well as an offensive opportunity for SurModics. Regardless, we are well-positioned to participate in the drug-eluting balloon market, as it unfolds.

In addition to the multiple growth drivers we just discussed, SurModics has a broad portfolio of opportunities that enables us to continue to diversify our revenue streams and deliver solid growth long-term. We regard our business as a portfolio of opportunities, and this diversification has benefited us over the past few years, especially in times of economic uncertainty.

We have more than 100 licensed products generating royalties and nearly 200 projects in our pipeline not yet on the market. As of June 30, we had a total of 105 licensed customers, several with multiple licenses, up from 101 a year ago. SurModics' customers had 105 licensed product classes on the market generating royalty revenue, compared with 102 a year ago.

The total number of licensed products not yet launched was 105, comparable with the prior-year period. Major non-licensed opportunities stood at 87, compared with 98 a year ago. In total, the Company has 192 potential commercial products in development.

Next, I will revisit the high-level outlook we provided on our year-end conference call last November. As a reminder, we articulated an expectation of roughly flat revenue and diluted EPS on a non-GAAP basis, compared with fiscal 2008 non-GAAP results.

Unfortunately, given the dramatic decline in the global economy and the unexpected impact the economy had on our customers, the expectation has been a challenge for us to meet. However, while the current operating environment remains difficult, we are seeing pockets of recovery, and certain of our second and third quarter results reflect that.

Nevertheless, despite the modest improvement in the economy, after completing three quarters of fiscal 2009, we know longer believe the Company can make up for the earlier shortfall in the final three months of the fiscal year.

As recently as our earnings call last quarter, we did have specific revenue and earnings opportunities identified and risk-adjusted to meet our earnings outlook for the fiscal year. At this time, however, and mostly due to timing, we do not anticipate achieving our full-year outlook of roughly flat non-GAAP revenue and diluted EPS.

As we look at the fourth quarter of fiscal 2009, we see a fairly wide range of potential outcomes for our financial results. However, at a minimum, we believe fourth quarter revenue will be approximately in line with the third quarter.

Last November, we offered a high-level outlook for fiscal 2009 to provide context for several important revenue transitions we've been navigating. Our commentary was intended to position our view of SurModics' long-term prospects, and included the period of transition we are now going through; but also stressed the long-term growth opportunities we continue to see.

Our characterization of fiscal 2009 revenue and diluted EPS as being roughly flat compared with fiscal 2008 was not the key takeaway from this discussion. Rather, the broader context of how the near-term outlook fits into the long-term opportunity for revenue and earnings growth was the most important message back then, and continues to be today.

Finally, I will touch on SurModics' fiscal 2009 goals. To view our published fiscal 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, as we often don't control the timing of all aspects related to our customer activities.

This year, we articulated a goal of signing 18 new licenses with our customers in fiscal 2009. I'm pleased to report that SurModics achieved this goal within the first nine months of the year, adding four new license agreements in the third quarter, to bring our fiscal year-to-date total to 18.

Importantly, this marks the fifth consecutive year that we have executed at least 18 license agreements per year with our customers, with a total of 109 new license agreements signed during this five-year period, demonstrating the strength of our business model and the relevance of our technology.

Another goal was our expectation that SurModics' customers would launch 10 new product classes in fiscal 2009. Our customers launched three new product classes into the marketplace in the third quarter, allowing us to meet our full-year goal here as well, with another quarter to go. This represents the fourth consecutive year that our customers have launched at least 10 new products in the year, with a total of 53 new product classes launched over this four-year period.

We met another fiscal 2009 goal earlier this year with the signing of a new customer license using SurModics' Drug Delivery technology in cardiovascular. Additionally, as noted earlier, we're making good progress toward our objective of signing an ophthalmology license, as well as two customer licenses from SurModics Pharmaceuticals.

We're pleased with the progress made against SurModics' ambitious fiscal 2009 goals, and our exceptional employees continue to work hard to achieve the remaining goals by the end of our fiscal year.

In closing, SurModics maintains numerous advantages, which position the Company favorably for long-term success. 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 of our markets are in non-elective areas, such as cardiovascular, ophthalmology, oncology and the like. Importantly, the potential growth in drug delivery remains strong, and we have the technologies and expertise to help meet this growing demand. SurModics is successfully executing against our long-term strategy and investing in R&D that will foster future growth.

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

(Operator Instructions). Ross Taylor, C.L. King.

Just have two or three questions. First, related to some of the financials. R&D expense in the quarter -- do you think R&D is going to stay at roughly this level going forward or for at least the next several quarters?

Ross, we would look at R&D probably trending up a little bit going forward; not enormously, but I think going forward, there definitely will be some increase.

Okay. And for product sales, is there any particular categories or other factors that drove the increases there?

We had a strong quarter in the reagents area and the diagnostics products continued to do quite well. And so, it's pretty much across the board.

Okay. And final question relates to your ophthalmology program. To the extent you can elaborate on this, are there any technical hurdles that remain before you're able -- to get closer to signing another agreement? Or can you elaborate or shed any light at all, in terms of what things might need to be overcome before you can reach an agreement?

I would say this is product development and there are always technical hurdles. I would say that, given the number of customer projects that we have in-house, and they are all at different stages in the development process, in many cases, we've overcome several technical hurdles that, at least when we began the programs, we -- there was no certainty that we would be able to overcome.

So the teams have made terrific progress in many areas, but I would reiterate that this is product development and there's always another technical challenge to overcome until the product eventually makes it to market.

That said, I would say that we are very encouraged by where we are in some of our more advanced programs. And I think really beyond that, I can't comment beyond what I said in the prepared remarks.

Okay. Well, that's a help. Thanks very much.

Yes, thanks. Thanks for the questions.

Richard Rinkoff, Craig-Hallum.

Bruce, you had said that you don't believe that you're going to hit the non-GAAP revenue and earnings goals that you had established last year. Could you please remind us in dollars what those goals are? And then tell us on a comparable basis where your numbers are through nine months?

So the -- let me just jump in for a second here, Rick, on the actual numbers. So the numbers we were trying to use as a baseline were the non-GAAP results from our full-year fiscal 2008. So they were in a supplemental table to the Q4 earnings release. And they were $111 million in revenue and $1.51 in earnings per share -- both non-GAAP numbers.

Okay. And through nine months on a comparable basis, where are you?

Well, I'd say on the comparable basis, we're -- the nine-month numbers left the accrued -- or the deferred revenue that was booked that was non-cash. So, essentially, it's -- I know you and a number of the analysts have looked at the quarters excluding the $9 million Merck milestone payment that we got in Q1. Our non-GAAP view would include that.

What's the number, though? Because you're showing $102 million of revenue through nine months. But what's the apples-to-apples number that we should use to compare with the $111 million? [Or] should we take out of that $102 million?

It'd be the deferred revenue piece, which I think was around 35 million or thereabouts. I'd have to get you the exact numbers, Rick.

So, that would put it at roughly $67 million, right?

Yes.

And on an earnings basis, what number should we use? You're showing $2.00, but how should we -- or $1.99 -- how should we restate that?

Well, we had -- I'm trying to add the numbers -- going forward, we had -- Rick, yes, I think just because I don't have those precise numbers in front of me, let's handle that in a follow-up call and I can get you the precise numbers.

Okay. Well, let me -- you gave me an estimate of $67 million through nine months compared to the $111 million, which leaves a gap of $44 million. So what you're saying is you don't believe you're going to report $44 million in the fourth quarter. That's what you're saying, right?

That is what we're saying, but you'll recall last quarter, Rick, we actually pulled away from the top line number already.

Right. I understand, that that part is not new; but you added a line here that says -- Mainly Related to Timing. So should I infer that you do expect to report a $44 million or thereabouts quarter sometime in the next couple of quarters?

Well, again, I think that's a timing question. I think the timing we're referring to there is just by the end of September 30.

Right. I'm giving you quarters beyond that. So in other words, we should -- so, if you're running at, let's just say a $20 million rate now, we should expect a milestone payment or something in the range of $20 million to $25 million at some point, maybe in fiscal 2010?

I think the timing you're trying to read into that statement is timing of $44 million in one quarter, and I can't tell you that; I don't know that.

All right. But the point is that you expect to take in north of $20 million in some kind of license agreements at some point; it's not in anyone's model at the moment.

No, Rick, I'm not saying that either. You're reading too much into that. The simple statement is just to get to roughly flat on revenue -- which we had backed away from last quarter -- in this quarter, by September 30th, is not likely.

I got that.

Although, again, I would -- just to reiterate what we said in our statements, there are a wide range of outcomes for this fourth quarter. And what we're prepared to say as the minimum will be approximately on the top line what it is for the third quarter. I think to read more into it than that is not where we're prepared to go.

Yes, it's important to reiterate that the assumptions that allowed us to get to the kind of revenue number that we were anticipating was not just a single event. There were a number of opportunities that continue to be in our sites that are unlikely to all happen in the same quarter. That's just looking at it realistically.

And so that's why, to put it all in a quarter the way your calculus was trying to drive toward is probably just an unrealistic way to look at it. But the opportunities remain within our grasp.

All right. I'll switch to easier things -- two more quick questions.

Investment income -- up big. Was there some kind of gain in the quarter?

Yes, there was an investment gain in the portfolio, yes.

Could you quantify that?

It was around $0.5 million, I don't have the exact number in front of me.

Okay. And last question -- tax rate was low. Was that just kind of truing up through nine months? Or should we forecast 35% going forward?

That's a truing up. I'd use closer to 37%, 38% going forward.

Ernest Andberg, Feltl and Company.

You've had -- as you've discussed where you thought you would be after the second quarter and this quarter, you felt that you had a chance still at the end of Q2 to match your pro forma non-GAAP kind of expectations, and Rick has just tried to go over this. And you described it -- I think it was Phil -- several opportunities and Rick was driving at licensing fees.

Is it a combination of licensing fees and royalties to -- that you're not seeing, plus product sales you're not seeing? Or is it one or two or multiple significant license kind of deals that you thought you could get in before the end of the year?

So that's a progressive process here as we go through the year. There were -- and I think I'd made the comment in my prepared remarks that we had identified, early in the year and as late as the second quarter results, revenue opportunities that -- and we risk-adjust everything -- a revenue opportunity that still could have gotten us to the bottom-line number, to the earnings number. There were multiple of those things. And some of those we think we can still deliver; some we are less certain that we will deliver. So it wasn't one thing by any means.

And I think that's the value of what we do, in terms of our business model. It's a very diversified portfolio of opportunities. We have hundreds and hundreds of customers, some big, some small, on product sales and development opportunities, and it's not one thing. There are, in some cases, some project-specific issues; in other cases, it's the environment that we're in -- just the malaise we're in right now from an economic standpoint.

So, unfortunately, it's probably not as straightforward as you would like for it to be, but at the same time, we've seen pockets of recovery, with a product sales number we've been pleased with. Not just because the number has grown, but we have seen a broader set of customers buying products.

Phil mentioned reagents numbers going up. That's obviously important from a revenue standpoint, but we also believe that that's a leading indicator of their applying our coatings within their factories and manufacturing floors to sell products which, hopefully, generate more royalties for us going forward.

So, encouraging signs, Ernie, but I would say there's still a number of factors that are weighing on sort of where we are today.

Okay. Adjusting for in the cardiovascular area, what were the driving factors to help that business as opposed to the negative factors there?

In cardiovascular, that is truly our broadest portfolio of customer opportunities and royalty streams. And so we do have more products that are getting on the market and contributing to that business, and continued growth in most of the products there -- not all, but certainly in most, there's growth.

And that business also benefits from the reagent sales that Bruce just talked about, as well as the R&D activities that we do for our customers there.

So sort of a -- you're saying across-the-board kind of improvements rather than any particular customer or product class?

Yes, I think that's fair.

And can you tell us where the investment gain came from? Was that a cash kind of improvement or accounting improvement in terms of price of a security or an actual sale of a security?

That is -- that's actual cash. We do have unrealized gains and losses from time to -- or almost every quarter in the portfolio. And none of those get run through the P&L. It's only when we sell securities and realized gains or losses that they get reflected through the P&L. And so we did sell some securities and did generate a gain.

Is that a strategic kind of investment or cash investments?

These are just in our bond portfolio (multiple speakers) --

All right, fine. Thank you.

(multiple speakers) the long-term investments line.

Thank you.

(Operator Instructions). Suraj Kalia, SMH Capital.

Bruce, Phil, what was the pro forma growth ex-acquisitions, specifically Brookwood and BioFX?

We no longer break out the performance of Brookwood and BioFX, so I'm not prepared to disclose that today.

You're looking at two acquisitions, Suraj, that were done over two years ago. So, just to remind you, those have been in the family for a long time, and the way we manage the business is to spread investments across the organization. So that's not particularly relevant today.

No, Bruce, I'm just trying to triangulate, is the run rate at the two companies that you acquired, has that been steady? Or -- given the aggregate to revenue number, where the decline is. How would you characterize that? Would you -- can you characterize whether the organic business -- obviously, we know Cypher, but can you characterize that the organic business was slightly softer or the acquisition business, have there been any R&D contract cancellations at Brookwood and/or BioFX?

We got a lot of questions there, Suraj. I think fundamentally, you're asking me the same question. Let me just say that we are very pleased with the acquisitions we've made, both at SurModics Pharmaceuticals, which was now what we called the Brookwood business and our BioFX business.

We are very happy with those transactions. They are going very well. We see tremendous opportunities in both. And as I said, they have been fully integrated into our thinking and into our operations and expense management. And that's the way we'll will run those going forward.

Fair enough. Bruce, just a macro level question. Given the common known thesis that hospitals are going to get squeezed out of $60 billion to $100 billion, and this will get transferred directly to device guys over the next 10 years -- you can pick and choose whichever number you want -- I think for the Street and most of the companies have gotten it right; they are going to see price declines -- at least that's what they are guiding to.

The question I have is, given the derivative revenue stream that you'll have, are you all seeing currently any pressure in negotiating royalty rates with your customers?

No, I wouldn't say so. I would say it's the normal dynamic in our negotiations. What's the -- there are multiple factors that we look at and that our negotiating partners look at, in terms of the value of the transaction, how enabling the technology is that we bring to bare, and the ultimate success of that product on the market. And it's balancing a number of the factors that you look at from the risk assessment to payments earlier versus later, and I would say those factors are very consistent.

Relative to what's going on in the healthcare markets generally, I like opposition. I like opposition a lot. We have a lot of activity around disposable products; around products that reduce cath/lab time and injury -- potential injury to patients; better ensure success of procedures in the marketplace. In our Drug Delivery businesses, I think we're providing definite value in being able to administer products that deliver a drug over a longer period of time; better compliance and better patient outcomes long-term.

So I'm -- relative to the long-term dynamics of this business, I really like our position going forward. And I think it's the economy -- I mean, there's a lot going on with the economy right now, as you well know. And I think, like a lot of companies, we're doing what we can to focus on what's most important and manage our way through this until better days come, and I'm convinced that they will.

And final question -- Bruce, in your internal assessment or strategic mapping, to the extent that you can share, when do you think there could be a commercial product for ophthalmology on the market?

The great thing about our business model is that -- and Merck demonstrated this so well for us -- we generated nearly $50 million. And most of that was -- the most profitable part of $50 million in license fees and milestones long before that product ever hit the market. And frankly, that's the way this business model works.

And with the majority of our partners, we negotiate our license agreements very early on, and those where we see that we bring the most value going forward, we will get and extract multiple millions of dollars early on in many of those cases. So, the beauty of this business model is we generate a lot of cash before products ever hit the market.

When they hit the market is very, very dependent upon a number of things. We've got projects in the pipeline today that are formulating drugs that are new in some cases and others that aren't new, that have already been through FDA and are known safe, known to be effective. And we're formulating them for extended duration, which gets them to the market much sooner.

SurModics Pharmaceuticals, for example, we have multiple programs already in an extended Phase I, II or III testing, both in the US and outside the US. And so obviously we're more -- we [worry] about those for the market, but also from the de-risking of those technologies. So varied question, but one of the things I really believe is the strength of our business model.

I guess my question really was, when Merck signed the deal with you all, at least the way we look at it, those were different market conditions. And the new reality necessitates a different way of negotiating deals and/or signing contracts. I mean, my question really was -- when do you expect, to the extent you can share -- not when you look at milestone payments, when you left physically -- when do you all think realistically you all can physically have a product on the market?

Well, I don't know, Suraj, I've been negotiating contracts since 1980, and I'm actively involved on this end today. I'm living day-to-day the dynamic and I'm not seeing what you're saying exists. Otherwise, I think I've tried to answer your question before.

Thank you, gentlemen.

Thank you for the call.

Daniel Owczarski, Avondale Partners.

Can you go back to the R&D projects? Because I think early on in your prepared comments, Phil, you talked about the declining number of projects, and then in the Q&A, you talked maybe about R&D trending up. And was just trying to get an idea if what's going on right now, as far as potential partnership discussions, whether it's quiet or whether it's picking up or which way it truly is trending there.

Well, I think that, you know, there's a few things going on in R&D. I mean, it's -- there's the R&D expense we incur, which covers both the customer and funded projects that we do, as well as all the internal research and development that we do. And so, when we combine those two in aggregate, we report that on the income statement and that's the piece that we're saying we would see that trending up in Q4.

In terms of projects with customers, when you look at our aggregate pipeline, it continues to look pretty strong, with a lot more that are getting into the license category and more that are getting on to the market, and still a healthy portfolio of ones that are -- R&D projects that pay us R&D revenue but just have not signed licenses yet.

But any trends, is it -- are you having more discussions, fewer discussions, quality of discussions?

I think it continues to be normal dialogue. It's -- the only caveat is the pace at which people can afford to fund things in this current environment, and whether that's at all different from how they might have been able to do it two years ago or six months from now or who knows.

Okay. And then moving back to the stent business, Bruce, could you maybe repeat or talk a little bit more about what -- you had mentioned the NEVO royalties versus Cypher? I mean, should we infer that you're going to get paid more per stent on a NEVO than a Cypher?

So -- but what we're comparing is the first generation Cypher product that has -- what's still on in the market in the US, where there's no hydrophilic coating on the delivery system there. And we get a better royalty rate on NEVO for the delivery system than we do for the Drug Delivery polymer on Cypher. So that's the commentary there.

And I think what's -- while the royalty rate is favorable for us, what gets us most excited is the fact that the NEVO is a revolutionary technology that just has very strong clinical data, and Cordis believes they can regain share of leadership with this product. And that would clearly bode well for our royalties.

Okay. And then Phil, did you -- with the -- just on your cash ending for the quarter, is that down versus last quarter? And if it is, is there a reason for that?

Yes, it's down on the -- I think we're at $59 million last quarter, and the continued buildout of the Alabama facility has been the largest use of cash.

Okay. Can you quantify that at all or --? What you've invested year to -- maybe year-to-date or so?

Well, if you look at total CapEx year-to-date, the vast majority of which is the facility, is a little north of $21 million.

Okay. All right, perfect. Thanks.

Great. Thanks for the question.

Thank you. Ladies and gentlemen, this does conclude the question-and-answer session for today. I would like to turn the call back to management for any closing remarks.

Thanks, Operator. We want to thank you again for participating in this quarter's conference call. We look forward to speaking with you again when we announce our fourth quarter and full year results this fall.

Ladies and gentlemen, this concludes the SurModics third quarter 2009 earnings conference call. You may now disconnect. Thank you for using AT&T conferencing.