Surmodics Inc (SRDX) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the SurModics third-quarter 2011 earnings conference call. During today's presentation all parties will be in a listen-only mode.

(Operator Instructions)

This conference is being recorded today, Wednesday the 3rd of August, 2011. I would now like to turn the conference over to Phil Ankeny, Senior Vice President and Chief Financial Officer. Please go ahead.

Thank you, Luke. Good afternoon and welcome to SurModics' fiscal third quarter 2011 conference call. Thank you all for joining us today. Also with me on the call is Gary Maharaj, our Chief Executive Officer. Let me first apologize for the technical difficulties before we were able to commence our call today.

Our press release reporting quarterly results was issued earlier this afternoon and is available on our website at www.surmodics.com.

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 2010 identifies certain factors that could cause the Company's actual results to differ materially from those projected in any forward-looking statement made during this call. The Company does not undertake any duty to update any forward-looking statement as a result of new information or future events or developments.

I will begin with some highlights of our financials. For the third quarter of fiscal 2011, we reported revenue of $18 million, up 3% on a sequential basis. On a GAAP basis, diluted earnings per share was $0.22. On a non-GAAP basis, assuming a normalized effective tax rate of 38% percent, diluted earnings per share was $0.13 and cash flow from operations was $3.8 million. Please refer to the supplemental tables in our earnings release for an explanation of our non-GAAP accounting.

Let me now provide an overview of our third-quarter results by revenue line. Royalties and license fees for the third quarter were $7.5 million, down 2% on a sequential basis. Johnson & Johnson reported that sales of the CYPHER Sirolimus-eluting Coronary Stent were approximately $64 million in the quarter, a decrease of approximately 61% year-over-year. These sales results implied an earned royalty that is below the quarterly minimum royalty specified in our license agreement with Cordis. As a result, SurModics will receive a minimum royalty of $1 million for the quarter.

Compared with the second quarter, our royalty for the J&J drug delivery license was down 13% sequentially. In addition, in mid-June, J&J announced that Cordis made the decision to cease production of it's CYPHER and CYPHER SELECT Plus Sirolimus-eluting Coronary Stents by the end of the calendar year. While we were disappointed by this decision, we had already anticipated the eventual sunset of royalties from CYPHER in our strategic and operating plans.

Importantly, J&J's decision reinforces and validates our long-term strategic plan of focusing on our core Hydrophilic Technology and In Vitro Diagnostics businesses. Going forward, we expect our fiscal fourth quarter will include the $1 million minimum royalty. Beyond Q4, we expect royalties to be based on a percentage of CYPHER sales, if any.

Product sales in the third quarter of 2011 were $5.8 million, up modestly on a sequential basis, but posting another all time high for the Company. Lastly, R&D revenue in the third quarter was $4.6 million, up 15% sequentially, reflecting the strong performance of our pharma business.

I will now shift gears and discuss results by business unit.

Revenue in our Medical Device business was $9.6 million in the third quarter, down 4% sequentially. The most significant drivers were the decrease in royalties from CYPHER and lower reagent sales. However, in spite of this sequential decrease, the Medical Device business continues to be a consistent cash flow generator and a source of stability with ample growth potential. As you will recall, we began disclosing operating profit by segment last quarter, which you will find as an additional table in today's press release. As has historically been the case, Medical Device was our most profitable business during the third quarter, generating an operating profit of $4.5 million. Given our core capabilities and the strength of our pipeline in this segment, we have confident that this business will remain a strong performer for us going forward.

Now let's turn to our In Vitro Diagnostics business. We are pleased with the results of IVD, which has also been a source of stability for SurModics. Revenue in IVD was $3.4 million in the quarter up 3% sequentially. IVD also contributed nicely to the Company's profitability, generating an operating profit of $1.4 million for the quarter. We are pleased with the performance of this business and are excited about last week's launch of our new Assay Diluent product. This represents our first new product introduction in our core product offerings in years and the feedback from customers has been encouraging.

Lastly, our Pharmaceuticals business generated revenue of $5 million in the third quarter, up 19% sequentially. This strong performance was primarily a result of an uptick in activity in our various customer R&D programs, both existing programs and new ones. The Pharma business generated an operating loss for the quarter of $0.8 million, which is an improvement sequentially compared with an operating loss of $2.3 million in the second quarter.

Turning now to operating expenses, total R&D expenses decreased 5% sequentially, as we continue to explore opportunities to be more efficient in our operations. We held SG&A expenses relatively constant compared with the second quarter. In the area of other income, our investment income benefited from some modest gains in our investment portfolio.

On the bottom line, third quarter diluted earnings per share was $0.22 on a GAAP basis. However, adjusting for a normalized tax rate of 38% non-GAAP EPS was $0.13 in the third quarter, up from $0.08 in the second quarter.

Our balance sheet and operating cash flow continued to be strong. Our cash and investments at the end of the third quarter totaled $63.2 million and we had zero debt. Operating cash flow for the third quarter was $3.8 million. As a result of better than expected 9 month results and our expectations for the remainder of the year, we believe it is appropriate to update our full-year fiscal 2011 guidance.

We are raising the low end of our full-year expected revenue from $63 million to $65 million, and now expect our full-year revenue to be between $65 million and $68 million. Non-GAAP diluted earnings per share is now expected to be in the range of $0.28 to $0.38 per share, up from our previous range of $0.13 to $0.26 per share. Including event-specific charges such as restructuring charges and goodwill impairment charges, GAAP diluted EPS is now expected to be in the range of $0.03 to $0.13, compared to our previous range of a loss of $0.21 to a loss of $0.08 per share. At this point I would like to turn the call over to our Chief Executive Officer, Gary Maharaj. Gary.

Thank you, Phil. The past few months have been busy and quite productive for our Company. As I outlined in our last call, we are focused on 3 main areas in 2011. First, achieve our financial plan for the fiscal year. Second, complete the strategic alternatives review process for the pharmaceutical business. And third, develop a strategic plan to guide the Company. I'm pleased to say that we are making great progress in each of these priorities.

[Starting with our] financial plan. As Phil just discussed, our third quarter results put us in a good position to achieve our fiscal 2011 full-year target, and we raised our full year earnings guidance yet again. This has not happened since. It is a result of renewed focus and a passion to achieve results in each of our business units.

Second priority for the Company is to reach a conclusion in the review of strategic alternatives for our pharmaceutical business. As we have said all along, we are committed to producing the best possible outcome for all of our stakeholders. We have received significant interest from a number of parties and the process remains on track with our expectation. We expect to conclude this process by the end of calendar year 2011. I want to emphasize this is a very active and high priority process for us.

Finally, I want to take the remainder of the time to update you on the strategic planning process for the Company. As you may recall, our strategy is based on the principle that sustained profitable growth requires a well defined and strong core as a foundation of the business. As a result, our approach is twofold. First we will define the core business for Medical Device and IVD business units, and then focus on strengthening the core to drive profitable growth over the near term. Second, we will have carefully assessed the opportunities to expand from within this core to deliver further sustained profitable growth over the medium and long term.

We began our strategic planning process by applying this approach to the Medical Device business. As you recall from the last quarter, we have defined the core for Medical Device as follows -- hydrophilic coatings for minimally invasive medical devices. During the third quarter we applied a similar approach to the IVD business and have defined the core of this business as follows -- immunoassay reagents that improve the performance of diagnostics tests. These definitions are carefully chosen as they highlight our core strengths and competitive advantages in each business. Importantly, these definitions also speak to the current cash flow engine of each business and our lowest risk opportunities for near-term profitable growth.

Since I've already discussed our Medical Device core business in previous calls, let me spend a little more time on the IVD business. Our immunoassay reagents that improve the performance of diagnostic test kits are based on 4 product platforms. First, dried protein stabilization, StabilGuard and StabilCoat products. These formulations stabilize and retain activity of a protein dried to a surface material. Second, liquid protein stabilization. Our StabilZyme realm of products. These formulations stabilize and retain activity of a protein in a liquid medium. Third, colorimetric substrates, our BioFX Colorimetric Substrate line. These formulations change color, signal the positive or negative reaction in a diagnostic test. In essence these substrates indicate the presence or absence of a disease. And fourth, the biomolecule attachment to surfaces, our CodeLink microarray slide line. These products immobilize specific biological entities to a surface material. Microarray slides are typically used for DNA and protein analysis.

Now, all IVD products offer some compelling customer benefits. Not only do they extend shelf life and reduce material costs, they can offer the clinical benefit of helping detect a disease, even at low concentrations of the disease in a patient sample, which offers the potential of detecting disease earlier.

Looking at both our IVD and Medical Device businesses, I am pleased with the progress that we made during the quarter, having defined the core of these businesses in a crisp and clear manner, we are actually now actively implementing our strategic plan. We have increased our focus on each business and are seeing positive early results. I have personally met with many of our key customers to understand their needs and how SurModics can increase our competitiveness and our ability to partner with them. And I am pleased to say we continue to be well positioned as a valued partner to our customer base.

During the quarter we signed 5 new licenses with Medical Device customers, including some in high growth strategic areas for SurModics.

[For the] next strategy step, as you may recall the second step is to carefully assess the opportunities required to expand the call and further deliver a profitable growth over the medium and long term. As a technology based business, R&D is at the heart of value creation for SurModics. Accordingly, we continue to assess and reset the priorities in our R&D portfolio to ensure we optimize our investments in long-term returns.

Our R&D portfolio now consists of three elements, ideas, experiments and projects. In order for an idea to evolve into a project for full funding internally, we put it through the crucible of experimentation where the critical market, technical, economic and intellectual property questions are answered. We commit to project funding only if these early answers are satisfactory. In the last 3 months, we have been busy completing the overhaul of our R&D portfolio in both the Medical Device and IVD businesses along these general lines. Since future cash flow streams are based on the accuracy of our decisions in that portfolio, we are being very careful to invest appropriate diligence before scaling up any experiments into full-fledged projects. Each of these elements has in balance now for the appropriate level of risk, return and timing.

Our project portfolio is currently focused on the core business. In Medical Devices, we intend to build on our leadership in hydrophilic coatings for minimally invasive systems. In order to do this, we have invested substantially in developing the next generation of PhotoLink coatings that perform dramatically better while maintaining the process efficiencies inherent to PhotoLink chemistry.

Our R&D scientists have recently had exciting breakthroughs in the development of this next generation platform. So much so that we believe we can introduce this new technology platform to customers in fiscal 2012. In our IVD business, last week we launched a SurModics Assay Diluent product at the American Association for Clinical Chemistry in Atlanta, Georgia. This represents an exciting return for SurModics in developing and launching new products at IVD market. We have several new pipeline projects underway and it is our aim to launch these within the next year.

Experiments portfolio. In that portfolio we are investigating the application of current core technology platforms to adjacent markets. And, in fact, we have started several exciting new experiments in this portfolio. 1 example of an ongoing experiment that is a high priority and which I can mention, is a pre-clinical characterization of a new drug delivery platform for drug coated balloon products. While still in its early stages, our R&D scientists have achieved some promising results, which suggest the potential to dramatically improve the performance curve over existing drug coated balloons designed for the treatment of coronary and peripheral artery disease.

In summary, we have high expectations where we can take this business and feel confident we can execute on our strategic plan to get us there. We remain on track with our previously stated goals and are committed to taking the necessary steps to transform SurModics into a focused and efficient business, capable of generating significant shareholder value through profitable growth. Operator, at this point, please open the line for questions. Thank you.

We will now begin the question-and-answer session. (Operator instructions). Our first question comes from the line of Ross Taylor. Please go ahead.

Hi. I have two or three questions. First one relates to the minimum royalty with Cypher. And I just wondered why it's going away after your fiscal Q4. And do you get anything you want to exchange for that, goodwill on some other projects with J and J?

Ross, this is Gary. You know what, Cypher, they have informed us recently that they are going to waive the exclusivity provision waiver with in that license. And by waiving the exclusivity provision, it also has as a result the waiving of the minimum royalty requirement.

Okay. That makes sense. Second question, just to help me out with modeling a little bit. The pharma business, I had been assuming was running at an annual operating loss rate of a little bit north of $10 million. And it sure looks like it's come well down from that. Would you comment at all about kind of what you think the annual operating loss of that business might be on an annual basis now?

Yes, we've been working hard with the team in Birmingham to look at opportunities for cost control. And they have been very successful in identifying areas, particularly as it relates to the CGMP facility for getting some efficiencies there. The real driver this quarter of the better operating profit was more on the revenue front and they've had an exceptionally strong quarter in the business. They have really been clicking on all cylinders this quarter.

You know, exactly how that pans out going forward depends on the pace of the customer programs and those are, as you know, Ross, challenging to predict with precision, you know, on a quarterly basis. So I would say based on the uptick in activity and some improvements on the cost side, yes, we think there's definitely an opportunity for that business to be less dilutive to the operating profit line than what we were envisioning at the beginning of the year. However, I think it's probably premature to predict an exact number there.

Okay. Fair enough. And last question, the new PhotoLink hydrophilic technology that you might be able to launch in fiscal year '12, do you think you can get better pricing for that potentially? And that be technology that's really just used on new products or could existing products be upgraded to that relatively simply?

Well I'm convinced we will be offering a better value because the performance curve, our scientists have been able to break some of the trade-offs and still achieve very low friction values that we thought were unachievable prior to this. While maintaining the clean and easy process of PhotoLink. So, we have not gotten to the point of the business model with that yet, but this will be a substantial value enhancement to the customers that choose this next generation.

Yes, the other piece I'd offer there, Ross, is what we have seen performance wise clearly could, for certain applications, be market share movers for those who embrace the technology early and get it to market in advance of competition. So we -- we think it definitely can set a new bar here and for those who are able to grasp the bull by the horns and get it across the regulatory goal line quickly and into their product line could have nice impact for our customers who see that vision for the right applications.

Okay. That's all very helpful. Thank you.

Thanks, Ross.

(Operator Instructions) Management, there are no further questions in the queue, please proceed.

Thank you. I'd like to thank everyone for listening in today and we look forward to speaking with you again when we announce our fourth quarter and full-year results this fall. Thank you.

Ladies and gentlemen, this concludes the SurModics third quarter 2011 earnings conference call. You may now disconnect. Thank you for your participation.