Surmodics Inc (SRDX) 2009 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the SurModics fourth quarter and fiscal year 2009 earnings conference call.

At this time, all participants are in a listen-only mode. Later we will conduct an question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder this conference is being recorded today Wednesday, November 4, 2009.

I would now turn the conference over to our host, Phil Ankeny. Please go ahead.

Thank you Ryan. Good afternoon. And welcome to SurModics fiscal 2009 fourth quarter and full year 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 10K for fiscal year 2008 identifies certain factors that could cause 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 developments or events.

On today's call I will address the Company's quarterly and full year financial results. Bruce will then highlight achievements for the quarter and the year, examine progress against our published fiscal 2009 company goals, and conclude with the announcement of our fiscal year 2010 goals. Finally, we will open up the call to your questions.

Let me begin by reviewing key fourth quarter and full year financial results and then provide some commentary around a few highlights and special items. For the fourth quarter of fiscal 2009, revenue was $19.2 million, down 17% from the year earlier period but up 6% sequentially. Product sales grew throughout the year from a low of $3.9 million in the first quarter to a high for the year of $5.6 million in the fourth quarter. Diluted earnings per share was $0.16 and cash flow from operations was $6.6 million.

For fiscal year 2009, on a GAAP basis, full year revenue was $121.5 million, up 25%; but on a non-GAAP basis revenue of $86.8 million was down 22%. As we have said in the past, Merck's termination of our agreement caused us to recognize in the first quarter approximately $35 million of deferred revenue. Please refer to the supplemental tables in our earnings release for an explanation of our non-GAAP accounting. GAAP diluted earnings per share was $2.15 compared with $0.80 last year. On a non-GAAP basis, diluted EPS was $1.07, down $0.29. And lastly cash flow from operations for the year was $31.3 million.

Turning to our segment reporting, let me start with our therapeutic segment. Cardiovascular revenue for the fourth quarter was $9.8 million, down 12% year-over-year and down 3% sequentially. Our cardiovascular results were impacted by the continuing decrease in Cypher sales. Specifically Johnson & Johnson reported that sales for the quarter of the Cypher Sirolimus-eluting Coronary Stent were approximately $211 million, down 27% year-over-year. However drug-eluting stent penetration rates increases to an estimated 75% in the United States, up from 71% in the year earlier period. This trend is important as SurModics participates in a number of other partnered products and development efforts in the drug-eluting stent area. Excluding Cypher related revenue, the cardiovascular revenue increased sequentially again this quarter.

Moving on now to ophthalmology. Revenue of $1.9 million was down 29% year-over-year but up 4% sequentially. The new license agreement with Genentech, which we announced a month ago, confirms the value of our technologies in this important market. Our reported financials do not incorporate any impact of the new license agreement; for example the up front license fee, as the agreement was not signed until early in fiscal year 2010. However, our historical ophthalmology results do include some R&D revenue generated on the Genentech program as well as several other ongoing ophthalmology customer development programs.

Rounding out the therapeutic segment, other market's revenue was $2.9 million, down 41% year-over-year and down 17% sequentially. However this revenue level was roughly in line with second quarter results. Recall that the majority of revenue in other markets is R&D revenue; and for the fourth quarter, total R&D revenue for the entire company was 14% lower sequentially. It is not unusual for R&D revenue to fluctuate from quarter to quarter. It is merely the result of the ebbs and flows of activity in our various customer development programs. Importantly, we continue to add new customers to our R&D pipeline.

Turning to our diagnostic segment. For the fourth quarter diagnostic revenue was $4.6 million, up 2% year-over-year and up 62% sequentially. Full year revenue of $16.5 million decreased 23% as results were impacted by lower royalty revenue following the expiration in December 2008 of the lateral flow immuno assay technology patents licensed to Abbott. Revenue relating to these patents continued through the second quarter of fiscal 2009. Additionally, the recent patent litigation settlement between Abbott and Church and Dwight resulted in a payment obligation from Abbott to SurModics of $1.25 million, which we recorded as royalty income in the fourth quarter since it relates to past sales of Church and Dwight's lateral flow diagnostics products.

Within the diagnostic segment, fourth quarter sales of our diagnostics component products such as stabilization products, substrates, antigens, and micro array slides were strong, generating sequential growth of 20%. Our steady performance here is much like our hydrophilic coatings business. Together these businesses serve as the back bone for our consistent ongoing financial performance given the recurring nature of their revenue and profit. They provide a stable foundation of financial bedrock for our less predictable drug delivery opportunities.

Now let's turn to a review of operating expenses. First, let's take a look at product cost, which decreased 16% year-over-year while product sales decreased only 2%. Accordingly, we are pleased that our gross margin on products was 61% for the fourth quarter, up from 55% in the year ago quarter. For the fiscal year, our gross margin on products improved to 61% from 58% last year. Total operating expenses, excluding product cost, were $13.1 million in the fourth quarter, down 15% year-over-year but up 14% sequentially. There were some one time expense items in the quarter including approximately $500,000 of expense related to write-offs of certain technology assets.

We also had an adjustment in our stock-based compensation charges which while not technically a one-time charge, it did contribute to the sequential growth in operating expenses. For fiscal year 2009, operating expenses excluding product cost as well as restructuring charges and in process research and development decreased 16% in total from 2008. As an example, we did not have any annual variable compensation charges for fiscal 2009 because we did not meet our financial objectives.

While SurModics has reduced our expenses year-over-year, we continue to invest significant resources in research and development. As some of you may have already noticed from our financial tables in the press release, we are now breaking out these expenses into customer funded R&D and internal R&D. This new disclosure illuminates the favorable margin we make performing R&D services on customer projects. As you can see, we generated a 29.6% margin on R&D revenue in the fourth quarter.

The full year margin is higher but is distorted by the recognition of deferred R&D revenue from Merck for which we had previously recognized the associated expenses. This new disclosure also highlights the substantial investments we are making to create new technology and intellectual property through internal innovation, which will fuel our business into the future. In the fourth quarter, our internal R&D investment amounted to 31% of total revenue.

Lastly, let me turn to our balance sheet, which is in excellent shape. As of September 30th, SurModics had cash and investments totaling $47.9 million and zero debt. Given our optimism for the future, we leveraged our strong balance sheet and invested in our business in fiscal 2009 as we seek to enhance the Company's positioning for profitable long-term growth. In this regard we strive to balance our deployment of capital for share repurchases, facilities related investments, and business development.

On the share repurchase front, during fiscal 2009 the Company repurchased approximately $15 million of SurModics stock. Going forward we currently have $7 million remaining under our $35 million authorization. Additionally, while most of the investment is behind us, we continue to invest in to complete our CGMP manufacturing facility in Alabama, which Bruce will discuss in more detail in his comments.

Lastly, on the business development front, we are evaluating a number of opportunities that have the potential to advance our long term strategic objectives. We will keep you updated as appropriate.

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

Thanks Phil. Let me also welcome everyone to today's call.

Fiscal 2009 was a challenging year for SurModics as it was for many companies given this difficult economic environment. Nonetheless, we made significant progress in a number of key areas within our business. We broadened and deepened our ophthalmology and cardiovascular businesses and made good progress with our SurModics pharmaceuticals business. Importantly, we are close to finalizing our new CGMP manufacturing facility in Alabama, which will be a key enabler of our long-term growth. And as a testament to our financial strength, we made these accomplishments while preserving a strong balance sheet and generating good operating cash flow.

Our progress in strengthening our technology offerings and advancing our pipeline in fiscal 2009 was tempered, of course, by the impact of one of the worst economic recessions in history, the depth and magnitude which were both unanticipated and certainly unprecedented. While we are disappointed with our financial performance, we achieved five of our seven corporate goals during the year and achieved a sixth just five days into fiscal 2010, all of which we believe favorably positions the Company for the future.

Specifically, we signed 22 new licenses of our technology and our customers launched 12 new product classes against our goals of 18 and 10 respectively. Importantly, this marks the fifth consecutive year that we have executed at least 18 licenses per year with our customers for a total of 113 license agreements signed during this fire year period. As for customer product launches, fiscal 2009 marks the fourth consecutive year that our customers have launched at least 10 new product classes with a total of 55 new product classes launched over this four year period.

In fiscal 2009, we signed two new customer licenses using SurModics drug delivery technology outside of ophthalmology and both were in cardiovascular. And we signed two additional customer licenses relating to SurModics pharmaceuticals technology other than Genentech, enabling us to meet these two goals for the year. Next we returned 50% of our operating cash flow to shareholders in the form of share repurchases exceeding our goal of returning one third of operating cash flow.

Lastly and perhaps most importantly, we completed our agreement with Genentech satisfying our objective of signing a new customer license using SurModics drug delivery technology in ophthalmology. While we were a few days outside of fiscal 2009, we nevertheless signed this historic agreement while not compromising the quality and value of the terms of the agreement, which we believe should benefit the Company for years to come.

As we discussed in early October, our Genentech agreement is another major advancement toward realizing our strategic vision of developing technologies that address important clinical needs in the large and growing ophthalmology market. The prospect of developing a sustained delivery formulation using our proprietary biodegradable microparticles in combination with a known, approved, and highly successful drug in Lucentis is a tremendous opportunity for SurModics and an important validation of our critically enabling technologies.

Lucentis is the world's leading prescription medicine for the treatment of AMD and currently has more than $2 billion in annualized worldwide sales based upon results published by Roche and Novartis for the first half of 2009. Additionally, Lucentis is in late stage clinical trials in patients with DME and RVO, two additional indications. The agreement with Genentech has not affected our other customer programs and relationships in ophthalmology.

Since July, the total number of projects we have in ophthalmology has decreased slightly mostly as a result of funding challenges for our customers in this difficult financing environment. None of the projects that have gone away were significant revenue generators. And again, none have been lost as a result of our signing of the Genentech agreement.

Of importance, three of our current customers in ophthalmology are top ten pharmaceutical companies including Roche & Genentech up from the two which I reported in July. On balance, we believe our portfolio of customer projects in ophthalmology is healthier than it has ever been. While we are excited about the opportunity with Genentech, we are making significant progress across all of our technology platforms and generating positive momentum on a number of other customer supported programs. Our progress positions us well to continue our efforts in building an enduring great company with significant and sustainable growth opportunities ahead of us.

In addition to the Genentech license there are several additional prominent revenue generating opportunities before us. While Cypher related revenues have continued to decrease, our overall cardiovascular franchise is strengthening. In the stent market our portfolio of licensed customer product opportunities, both on the market and in our pipeline, is substantial. We are also taking important steps in diversifying our exposure beyond stents within the cardiovascular space. We are partnering with a number of companies on the development of exciting new products including minimally invasive heart valves, stent graphs for peripheral applications, prohealing stents and drug eluting balloons.

During the fiscal year, we signed our first license agreement involving a drug eluting balloon. And as we discussed in our July conference call, drug eluting balloons are widely regarded as a promising area in the medical device field for the treatment for vascular disease with potential advantages even over drug eluting stents. We believe this is an area that leverages our drug delivery technologies and capabilities particularly well.

As another example of the opportunities we see within the cardiovascular space, we are pleased to report that one of our licensed customers, Evalve was recently acquired by Abbott. Evalve has a novel device for the minimally invasive repair of mitrovalves in the heart. We look forward to working with Abbott, a current SurModics customer on this exciting product.

Another important growth driver is SurModics pharmaceuticals. This business has reached an encouraging inflection point by converting three sustained drug delivery partnership programs into licenses in the past three months. As we've said in the past and consistent with our strategy, converting this business to our licensing business model and changing the mix of revenue to include more royalties and license fees is critical to our long term success. And we think we are making good progress.

License agreements we have signed have attractive financial terms and represent good growth opportunities for the Company. Further they demonstrate the important progress we are making with our business model as well as our success in licensing our proprietary drug delivery technologies to pharmaceutical and biotech customers. One of these agreements is with an as of now undisclosed partner for the development of an oncology product.

Another agreement, which we announced on Monday of this week, relates to the development and commercialization of a sustained release formulation of New Path's NP201 for the treatment of Parkinson's disease, a significant unmet clinical need in a large and growing market. The use of our proprietary implant technology is an ideal match in this clinical area, as dose levels must be carefully controlled to achieve optimal clinical outcomes. As we mentioned earlier, we are nearing completion of our CGMP development and manufacturing facility in Alabama.

The agreement with New Path as well as the oncology program I mentioned, anticipate the use of this facility for the production of clinical materials and ultimately commercial supply. These opportunities and our previously announced agreement with Genentech serve as good examples of how the CGMP facility broadens our scope of customer engagement and makes us a more valuable partner.

Currently the facility is tracking to our time line and budget and should begin operations later this calendar year or early next year. With the construction largely complete, existing and prospective customers are getting a clear picture of our capabilities. It's truly an impressive facility and it has already attracted and will continue to aid in attracting new customers. Further, it also encourages our existing customers to think of SurModics as a more capable business partner.

In addition, we are generating encouraging new data on several of our most important technology offerings, as further evidence of their clinical utility. For example, some of our highest potential technologies continue to successfully advance in clinical studies in fiscal 2009 including our symbiosis biodegradable polymer, our FINALE prohealing coating and our I-vation TA Intravitreal Implant.

Finally we continue to advance our broad pipeline, which we view as a portfolio of opportunities that enable future growth and diversification for years to come. We have more than 100 licensed products generating royalties and nearly 190 customer projects in our pipeline not yet on the market. As of September 30th, we had a total of 106 licensed customers, several with multiple licenses, up from 101 a year ago.

SurModics customers had 103 licensed product classes on the market generating royalty revenue; and while this number is unchanged from a year ago,, we believe the quality of these products has improved substantially over this 12 month period. The total number of licensed products not yet launched was 108 compared with 105 in the prior year period. Major nonlicensed opportunity stood at 80 compared with 88 a year ago. In total, the Company has 188 potential commercial products in development.

At this point I'll conclude with SurModics' fiscal 2010 objectives. As in previous years, these goals are designed to offer insight into how we manage our business as well as where some of our growth opportunities exist. Some of these goals are aspirational in nature as we often don't control the timing related to the customer dependent objectives. Our first goal is to sign 18 new customer license agreements with SurModics' customers in fiscal 2010.

Second, among these 18 new licenses, we expect to sign two new licenses relating to SurModics' pharmaceuticals drug delivery technology; in addition to the agreement already announced in fiscal 2010 with Genentech. Third, we expect that our customers will launch 10 new product classes incorporating SurModics licensed technology. These launches are significant, as you know, because they mark the point in our business model when the flow of royalties to SurModics begins.

Fourth,we expect at least one of our customers to initiate a new human clinical trial for a product using SurModics' drug delivery technology. This goal was not accomplished in fiscal 2009 and we continue to see this as an important goal for fiscal 2010. Finally, we expect to qualify and bring our new CGMP manufacturing facility online during the fiscal year to make it available to current and future customers for years to come. As we have done in the past, we'll keep you updated on our progress throughout the year.

In closing, despite a challenging environment we made significant progress in fiscal 2009 against our strategic initiatives, which we expect will help us better grow our business. Our portfolio of opportunities is significant, and we believe a source of future growth for years to come. Although pleased with our progress, we are by no means satisfied. We have a lot of exciting opportunities in front of us and we remain confident in our position as we look to the future.

Operator, that concludes our prepared remarks. We would like to now open the call to questions.

Thank you. (Operator Instructions)

Our first question comes from the line of Richard Rinkoff with Craig-Hallum Group. Please go ahead.

Thank you.

I want to clarify something. Did you say that you received 1.25 million in basically back payments from Abbott in the fourth quarter?

Yes. Essentially.

Okay.

And of the $0.5 million charge for write-off of technology assets, where was that on the expense line?

It's principally within R&D.

Okay.

So that would account for why R&D went up so much?

Yes. That's a big factor in there. Absolutely.

Now that you've broken out customer R&D from non-customer R&D on the expense line, should we assume that the markup that you said was about 29% is indicative of what we could expect going forward; and should we also expect that the two lines revenue and expense should track each other going forward or would there be randomness?

Both good questions, Rick.

I would say that first of all, our R&D revenue does tend to fluctuate from quarter to quarter as it has over the years. And so the expense that is attributed to supporting that revenue is also going to fluctuate roughly in line with the margin that you see there. There may be some volatility to the margin, but in that general neighborhood is how you should think about it.

All right.

And if you were successful in your goal starting human clinical, at least one in drug deliver, would you receive a milestone for that?

Depends upon which one we accomplish first, but it's highly possible.

Would that be--depending again on which one, could the number be an eight digit number or should we think of something a lot less than that?

I can't comment on that, Rick.

Okay.

I wanted to clarify one other statement that you made. You said three out of your how many customers are top ten farmers and were you counting Roche & Genentech as one or two.

Yes, I commented that there were three current customers today in ophthalmology paying us to do development work that were top ten pharma and Roche & Genentech is one of the three.

You didn't say how many it was?

I did not, no.

Okay.

And when you say that at least one dropped out, should we assume that that's Jerini, who basically went away because of lack of funding or is there more than that?

That is fair to assume that at least one was Jerini, yes. We had a couple of projects with them.

Thank you.

Thank you.

Our next question comes from the line of Ross Taylor with CL King & Associates. Please go ahead.

Hi. Just two or three quick questions.

I wonder if you can talk about your royalty line, excluding the royalties you get from Cypher, whether you are seeing much growth there sequentially and I don't know if you can talk at all about your expectations for the year.

The royalties, if you were to normalize it for J&J and Abbott, you'd see that there's some growth there in the quarter, and going forward that's something that we really can't provide forward commentary on. A lot of it will depend on the trajectory of the Cypher royalties stream and many others in the portfolio. So probably not appropriate to give you a direction on that.

Okay. Fair enough.

And can you comment at all on what kind of technology you are providing for the Evalve?

Yes. That's a hydrophilic coating.

Okay. That's all my questions. Thanks.

Thanks for the call.

Our next question comes from the line of Brian Jeep with Sidoti & Company. Please go ahead.

Good evening, gentlemen.

Hello.

First question. I know endeavor was launched in Japan in the last fiscal quarter, but you would have recognized the royalty revenues on that--on those sales. Metronics said it was about $30 million in sales. Did you see revenues or royalties for that--for all those sales in this quarter?

I believe the endeavor Japanese sales there was some inclusion of that. If it's the exact amount that they reported, I don't have the report with me so I can't confirm the exact amount. But, yes, we should have had some royalties in there for Japanese sales.

All right. If I take the Church and Dwight revenue out of the sales line, I actually get a gross margin of about 88%. Can you give us any kind of indication on what you think we should expect for fiscal 2010?

Yes. The gross margin on a corporate consolidated basis is largely driven by the mix of the revenue, and the margin that is easiest to calculate is--or now two margins really. One is on product sales where if you took product sales less product cost you can determine the gross margin on our products; and that was 61% for the quarter, and that's been the ballpark that's been through the fiscal year. And then we also have the margin on the R&D revenue, which you can calculate based on the customer funded R&D costs against our R&D revenue, and as we said that was about 29.6 in the quarter. The overall margin will depend on the relative mix of royalties and license fees and the other pieces of the revenue.

Okay. All right.

And just one last question then I'll jump in the queue. Is the facility behind your original schedule? I guess I thought it would be completed by the end of this calendar year, but now potentially first quarter of 2010?

We have said either the end of this calendar year or first quarter of 2010. Likely to be the end of this calendar year, but we are out of an abundance of caution, making sure that we are not over promising there. So it will be close.

All right.

And then would CapEx continue to look like it has in the past few quarters in the current quarter, or would the build out mostly complete would we expect that to taper off some?

Particularly looking at fiscal year, it begins to taper off because most of the capital investment in the facility is behind us. We had most of the building--the investment of approximately $40 million history to date is already behind us. We expect between equipment and some of the final capital items to be somewhere around $5 million or so spilling into fiscal 2010.

Okay. Thank you.

Thanks for the call.

We have a followup question from the line of Ross Taylor with CL King & Associates. Please go ahead.

Two more questions.

One of your goals is to initiate a human clinical trial with a product using the SurModics drug delivery technology; and since this wasn't accomplished in FY'09 can we assume that maybe it's sooner rather than later in fiscal '10?

Well, there is potentially more than one. The goal is limited to one because it's frankly out of our hands. We have done our development activities on our end. So it's in the customers hands. Can't say exactly when it will be. We are hoping it would be sooner rather than later though, Ross.

Okay. All right.

And just last question. Your mix of R&D expense, maybe this was asked already. In fiscal '10, can you break that out approximately what it might be between customer R&D expense versus your own internal project? Might it be a similar mix to what we see in some of these historical numbers?

The easiest way to think about it is in aggregate the two lines together because we do budget R&D to fund both the internal programs as well as the customer programs and the amount of cost that gets attributed to the two areas really depends on the mix of revenue. And so I would encourage you to think about if you are for modeling purposes, those two lines together; and we probably see some bias in the upward direction on R&D expenses as we go forward but not substantial.

Would you see the same kind of bias on upward movement in R&D revenue then as well?

R&D revenue will depend again on the customer programs and our involvement in them; and that depends on the programs.

Okay. Thanks very much.

Thank you.

Mr. Ankeny, I am showing there are no further questions at this time.

Thanks very much.

Let me thank everyone again for participating in today's conference call and we look forward to speaking with all of you again when we announce our fiscal 2010 quarter results in January.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using ACT teleconference. You may now disconnect.