Surmodics Inc (SRDX) 2012 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the SurModics first-quarter 2012 earnings conference call. During today's presentation all participants will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator instructions) Today's conference is being recorded February 6, 2012. I would now like to turn the conference over to Tim Arens, interim Chief Financial Officer. Please go ahead.

Thank you, Alicia. Good morning and welcome to SurModics's fiscal 2012 first-quarter conference call. Also with me on the call is Gary Maharaj, our Chief Executive Officer.

Our press release reporting our full first-quarter results was issued earlier this morning and is available on our website at 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 2011 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 comment on our restatement for fiscal 2011 and will highlight select financial results for the quarter. Gary will then discuss our key achievements for the quarter and provide an update on our strategy and growth drivers. Following this discussion we will open the call to take your questions.

Before we begin with our financial highlights, let me take a moment to explain the delay in issuing our full results for the first quarter and the postponement of our earnings conference call last week. During the preparation of our first-quarter earnings results, our accounting team discovered that the fourth-quarter 2011 pharmaceuticals-related asset impairment charge was calculated incorrectly. Our internal team moved quickly to address the issue, and management determined that a restatement was necessary for our full year and fourth-quarter 2011 financial results.

However, this particular restatement was unique in that it involved complex, non-routine accounting issues around the asset impairment charge. We felt that we could reach a conclusion on this matter prior to the originally scheduled earnings call. However, we determined shortly before the call that further analysis was necessary to ensure the accuracy of the asset impairment charge. We apologize for any inconvenience this may have caused, and thank you all for your patience and understanding.

Accordingly, we will be restating our fiscal 2011 financials in an amended 10-K filing, which should be available within the next two weeks. Before I provide you with additional details on the restatement, I want to make three points very clear. First, this is a non-cash impairment charge and pertains to a non-routine accounting event associated with our former pharmaceuticals business. Second, the restatement has no effect on continuing operations. And third, we do not believe the restatement is systemic in any way.

Let me now describe the issue leading to the restatement. As you likely remember, on November 17, 2011, we announced the completion of the previously announced sale of substantially all of our SurModics pharmaceutical assets to Evonik industries. Under the terms of the sale the entire portfolio of products and services of SurModics pharmaceuticals, including the Company's cGMP development and manufacturing facility located in Birmingham, Alabama, was acquired by Evonik for $30 million in cash.

In the 4th quarter of fiscal 2011 a $17.9 million asset impairment charge related to the pharma assets was taken. We have now determined the Pharma carrying value utilized in Q4 fiscal 2011 to determine the amount of the asset impairment charge should have excluded certain deferred revenue, deferred taxes, and other liabilities, totaling $10.2 million. As a result, the asset impairment charge should have been $28.1 million. Therefore, the restated net loss for Q4 fiscal 2011 and the full year fiscal 2011 are $18.7 million and $18.5 million, respectively.

The diluted loss per share for Q4 fiscal 2011 and full-year fiscal 2011 are $1.07 and $1.06, respectively. Importantly, this issue was spotted internally by our accounting team, and we have moved quickly and in accordance with SEC guidelines to address the issue.

Let me now continue on to our first-quarter financial highlights. Unless otherwise noted, first-quarter financial results discuss today exclude discontinued operations. I will address the results from our discontinued operations in more detail a bit later in my comments.

Our efforts to strengthen our core businesses continue to yield positive results as our hydrophilic coatings have delivered their 10th consecutive quarter of revenue growth, and our In Vitro Diagnostic Products have delivered their 5th consecutive quarter of revenue growth.

Revenue for the first quarter totaled $11.9 million, a 5% decline from the $12.5 million recorded in the first quarter of last year. Our first-quarter revenue was impacted by a $2 million in revenue associated with Cypher and Cypher Select Plus drug-eluting stents. Excluding the impact of Cypher, revenue increased 14% from the year-ago period.

Growth in our core hydrophilic coatings and IVD products have made the contributions towards offsetting the impact of the lost revenue associated with Cypher. Together, these core product offerings generated nearly $1 million of revenue growth in the quarter that partially offset the declines in Cypher-related revenue, as I noted earlier.

As we progress throughout our fiscal year, we anticipate that growth in our core businesses will continue to offset the quarterly Cypher impact. For your information, Cypher fiscal 2011 revenues was $1.6 million in Q2, $1.3 million in Q3, and $1.6 million in Q4.

On a GAAP basis, our diluted earnings per share was $0.12 for the first quarter compared to diluted earnings per share $0.16 from the year-ago period. Excluding the impact of Cypher, qualified therapeutic grant income, and one-time charges, diluted earnings per share in the first quarter was $0.11 compared to diluted earnings per share $0.08 from the year-ago period.

I will now turn our discussion to performance by business unit. For the first quarter, total medical device sales, which includes revenue from both our hydrophilic coatings and device drug delivery technologies, were $8.9 million, down 10% from the $9.8 million reported in the year-ago period.

First-quarter results included hydrophilic coatings revenue of $8.2 million, representing 8% growth compared with the year-ago period. Device drug delivery revenue of $700,000 declined 69% compared with the year-ago period. As a reminder, a significant portion of the Cypher revenue is reported in device drug delivery.

Driving our first-quarter hydrophilic coatings performance was strong royalty revenue growth from key customers. Device drug delivery revenue was largely comprised of milestone revenue earned from Orbis's niche as this customer continues to make progress towards the commercialization of its combo dual-therapy stent, which incorporates our Symbiosis biodegradable polymer. Excluding the impact of Cypher, Medical Device revenue grew 14% from the year-ago period.

Medical Device generated $3.9 million of operating income during the quarter, a 32% decline from the year-ago period. Excluding Cypher and the $800,000 of Q1 2011 therapeutic grant income, Medical Device operating income grew 24% from the year-ago period.

For the first quarter In Vitro Diagnostics sales of $3 million grew 13% compared with the $2.7 million recorded in Q1 of fiscal 2011. In Vitro Diagnostics performance continues to benefit from the growing diagnostic test kit customer base and increasing demand for our dried and liquid protein stabilizers and Colorimetric substrates, especially among our key customers. IVD generated $900,000 of operating income during the quarter, a 23% increase from last year.

Now let's discuss our revenue summary by category. Royalty and license fees, which are generated primarily in our Medical Device business unit, were $6.6 million, down 12% from $7.5 million reported last year. Excluding the impact of Cypher, royalty and license fees grew 10% in the first quarter of fiscal 2012. Product sales of $4.6 million in the first quarter of fiscal 2012 were up 4% compared to last year. When excluding the Q1 fiscal 2011 Cypher product revenue of approximately $500,000, product sales grew 18%.

Lastly, R&D revenue in the first quarter was $700,000, an increase of 21% from the $550,000 reported last year. Commercial coating support for certain of our hydrophilic coatings customers drove the increase in R&D revenue.

Reviewing our product gross margins, we generated gross margins of 66% in the first quarter of fiscal 2012 compared with 65% last year. Our IVD business saw improvement in gross margins from the consolidation of our BioFX manufacturing operations into our Eden Prairie, Minnesota, facility.

Moving on to a review of our operating costs, SG&A expenses in the first quarter of fiscal year 2012 were 29% of revenue compared with 30% in the year-ago period. Excluding Cypher revenue, SG&A during the first quarter of fiscal year 2011 was approximately 32% of revenue. SG&A expenses declined 7% percent from last year, mainly as a result of efforts undertaken over the past year to align the Company's cost structure with our core businesses.

Research and development expenses were 31% of first-quarter revenue compared with 20% in the first quarter of fiscal 2011. Excluding the $800,000 qualified therapeutic grant income, R&D expenses as a percentage of first-quarter fiscal 2011 revenue was 27%. R&D expense grew 9% from the year-ago period when excluding the qualified therapeutic grant income. Our R&D expense growth was a result of increased product development activities in both of our business units.

Taking a quick review of our balance sheet, I would note that at the end of December we had cash and investments of $94.4 million. This balance includes $27.1 million of cash proceeds from the pharma asset sale. Not included in this balance is the additional $2.9 million recently released from escrow established in connection with the $30 million sale of our pharma related assets. All amounts associated with that transaction that were held in escrow have now been released.

Operating cash flow was $1.9 million during the first quarter. This quarter's operating cash flow was lower than recent periods, mainly because of the cash payments associated with our variable compensation plan and other accrued liabilities.

Moving on to discontinued operations, as a result of the sale of pharmaceutical assets which were completed on November 17, the Company reported $2.5 million of pretax income from discontinued operations in the first quarter of 2012. In addition, the Company reported a $1.7 million pretax loss from the sale of pharmaceutical assets, primarily related to transaction costs.

We are reaffirming our revenue and earnings per share outlook for the full-year fiscal 2012. As reminder, or full-year revenue outlook remains unchanged and is expected to be in the range of $47 million to $51 million. GAAP diluted earnings per share from continuing operations also remains unchanged and is expected to be in the range of $0.45 to $0.53 per share. Our outlook is based on the diluted share count of 17.6 million shares.

At this point I would like to turn the call over to our Chief Executive Officer, Gary Maharaj. Gary?

The completion of the sale of our pharma assets was one big step towards returning SurModics to profitability and focused revenue growth in our core businesses. In fact, in this first year, year one, as I call it, of the transformation of SurModics, our team accomplished the following goals. We exceeded our operating plans. We sold the pharma assets. We put in place the management team for the future. We adjusted our cost structure to align with our future business needs, and we implemented a strategic focus on our core businesses to improve our execution and to maximize our returns.

All of these were intended to set the stage for growth entering year two. As you can see from the reported results, the organic growth without Cypher in our core hydrophilic coatings and IVD businesses is strong.

Year two will be defined by three areas. First, our ability to execute on and expand our higher-margin core businesses to generate profitable growth and cash flow. Second, our investment in internal R&D to drive organic growth and optimize long-term returns from this pipeline. And third, our strategy for use of cash on the balance sheet on our ongoing cash generation.

Let's review each of these in more detail. In both the Medical Device and IVD businesses, our customers face increasing headwinds in terms of healthcare costs, increasing regulatory scrutiny, and single-digit overall market growth. Our demonstrated ability to deeply understand these issues and provide solutions that help our customers reduce their costs and mitigate regulatory risk makes SurModics an important strategic partner. As a result, we believe that we can consistently exceed this intrinsic market growth rate.

With respect to medical devices, our key growth initiatives are focused on expanding our leadership in hydrophilic coatings and developing new drug delivery platforms. Today we are well positioned in the higher growth trans-catheter valve and neurovascular applications with our hydrophilic coatings. We're excited about more products in these categories, where we are being selected as a coating technology of choice in both the US and Europe for high-value vascularly-delivered devices.

In addition, we are a component of the drug delivery stent coating of Orbis niche combo dual-therapy stent, which demonstrated positive clinical trial results, as presented in November of 2011, at the Transcatheter Cardiovascular Therapeutic Conference in San Francisco.

We're pleased to report the SurModics's next-generation hydrophilic reagents are now available for purchase by our licensed customer base. This next-generation platform, as I have described earlier, provides a compelling value proposition, eliminating the trade-off between lubricity and the durability.

In fact, repeated internal catheter testing confirms our ability to provide significant reduction in particulates, coupled with best in class lubricity and ease of application in the manufacturing environment. As part of our commercialization process, we have initiated broader pilot feasibility studies with our customers in selected applications. The results are very encouraging. As reminder, the targeted segments for growth with this new coatings platform are core market segments of angioplasty, stent delivery, neurovascular, and other specialty catheters seeking advanced lubricity with reduced particulates.

We also see an opportunity to help customers who currently use proprietary in-house coatings by demonstrating that we can meaningfully improve their product performance. We have also taken several important steps to accelerate sales and grow profitability in our IVD business. Our change towards a customer-focused sales structure, where historically we have been focused on products, has been positive. This new structure, in combination with our market-leading product performance, quality of service, and support continue to increase our base of customers. Later this month we anticipate launching an updated website with e-commerce capabilities that will support our customers with valuable content and simple options to purchase our products online.

Finally, the integration of the BioFX product line into our Eden Prairie operation has improved both our customer focus and operational efficiency, which contributes to an increase in gross margin and IVD.

Let's talk now about R&D. As I have said before, R&D is at the heart of value creation and organic growth for SurModics. We have overhauled and reframed the R&D pipeline in both medical devices and IVD to optimize long-term return. Our pipeline consists of the three portfolios I've described in past calls -- ideas, experiments, and projects. We are being very careful to invest appropriate amount of diligence to our R&D ideas and experiments before committing to full funding to full-fledged projects.

In IVD, we continue to accelerate our development and launch of new products. As a follow on to the two new products introduced last year, we have several new development projects underway. We expect to launch these new diagnostics products in the next quarter. These products will further differentiate our offerings because of the effect on improving the accuracy of diagnostic test kits. In addition to these upcoming launches, our R&D pipeline continues to be filled with other experiments and projects that will satisfy key market needs.

In medical devices we have started initial scoping work in our experiment portfolio, involving unsolved large problems on medical devices where the surface interaction can play a role. While I will not comment on ideation and experiments, I can share news about the projects currently underway.

We have already discussed our next-generation hydrophilic coatings platform, called TRO 5, and its ongoing qualification in multiple Medical Device applications. I would like to spend some more time on our drug-coated balloon project. Drug-coated balloons may offer better alternatives than current therapies in the areas of the vasculature where placing a stent is not ideal. Examples of this are interventions in the peripheral vessels, such as the superficial femoral artery and the coronary vessels that treat in-stent restenosis. The worldwide market for drug-coated balloons is predicted to be over $1 billion annually.

Several first-generation products are already in the market outside of the US, and one product currently has an Investigational Device Exemption in the US. We actually continue to be excited with results of our ongoing preclinical studies, which demonstrate a high degree of control of drug release and retention on the vessel walls we treated. We are aggressively supporting this project in R&D in order to further understand the value of our solution and the needs of our customers who may want to license this technology from us.

During the last 12 months our technical team has completed greater than 60 formulation experiments to rapidly extract the best formulation for preclinical testing. This focused effort of our talented team of scientists and engineers, along with our continued investment in preclinical studies, has yielded several potential options. Most recently, we have completed a series of 28-day experiments, including histology. These data have provided very encouraging results related to the controlled drug uptake in both coronary and peripheral tissue when compared to other commercially available drug-coated balloons. SurModics is now positioned to have deeper value-added client conversations on this unique platform for licensing in the near future.

Let's turn to the third item, to use of cash in our balance sheet. We are executing a disciplined and strategic process to determine how best we can deploy this capital, a process that continues today. However, there are two points that I need to emphasize up front. First, we are evaluating all options to use our balance sheet to the best advantage of our business and our shareholders.

Second, we do not expect to deploy a significant portion of our cash reserves on acquisitions. Along with our Board, we are carefully evaluating the sources and potential uses of cash based on our strategy to create -- that is, grow -- value for our shareholders. This will help guide us to the appropriate balance of the three uses of cash I see -- cash deployment to create value, cash returns to shareholders to redistribute value, and cash reserves for both opportunistic investments and to mitigate risk.

In summary, we are excited about our opportunities going forward. These include growth from core products, our R&D opportunities that are catalysts for future growth, and finally, the strategic and disciplined use of cash to create return and protect value for all shareholders.

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

(Operator instructions) Ernest Andberg, Feltl and Company.

How can we on the outside judge, let's say, the Medical Device business, and where the growth might look like 2 to 3 years down the road with your new high (inaudible) coatings technology and endeavors in the coated balloons?

You know, it's difficult to speculate, but 2 to 3 years down the road, we certainly will be the major player in hydrophilic coatings for minimally invasive devices. Added onto that, we will be exercising this drug delivery capability that the Company has always had. And the drug-coated balloon is really our first foray into that type of drug delivery product.

So I would expect, if we are successful, the drug-coated balloon -- certainly, these things will take time for our customers to get through the regulatory channels. It may not be contributing maximum cash flow, given the regulatory environment. But in addition, we would have queued up other things that we have in our experiment platform now that will contribute to delivery of some ingredient off the surface to prevent problems, such as infection, as one example.

So the cash flows will be weighted over time, not because of the shrinking of hydrophilic revenues, but because of the addition of revenues and cash flows from other platforms.

Tim, you were good enough to give us the breakdown of the J&J Cypher stent related revenues in the next three quarters. It's difficult, again, here on the outside to understand how the other three quarters went when, as you describe them to us, ex-discontinued operations and ex-stent business. Sort of a double question here -- one, can you break down those revenue numbers by royalties and product sales so we can get a feel there? And can you give us restated numbers for the other three quarters of the year?

Right. So let me refer you to the earnings release from earlier this morning. I think the final two pages of the release provide some supplemental information that pertain to the first quarter 2011 and first quarter 2012. You will see the Cypher-related royalty and license fee revenue as well as the Cypher product sales.

The information that I provided -- the Cypher revenue impact in 2011 for quarters two through four -- I haven't provided any detailed breakout in terms of what portion came from product sales and what amount came from royalties. We will probably be providing that. I don't have that in front of me, but we will be providing that as we go through the year.

It would be helpful to us on the outside judging the prospects if you could do that now in an 8-K rather than as you go through the year.

Right. I fully appreciate that. Let me say this. What you are seeing here, like in Q1 of 2011 -- you are seeing about 25% of the revenue come from product sales from Cypher. I would say using that as a proxy is probably not going to be too far off. In some quarters it's less, but that would be a general rule of thumb to provide you with a little guidance at this point.

(Operator instructions) Ross Taylor with C.L. King.

I have a couple of questions. First of all, with your new hydrophilic coating technology, it seems like it's available a little bit earlier than I expected. But can you comment as to whether you think that can actually cause your hydrophilic revenues to accelerate in your fiscal year 2013, for example? Or should we kind of just expect steady-state growth compared to fiscal year '12 in that product category?

It depends on the uptake. I think we have said before the first calendar quarter, we would be doing the pre-commercialization. So it's available, but, as you know, just to describe the commercialization process, we allow currently licensed customers on select applications and substrates to start validating it on their products. So it doesn't imply that we have cash flow coming in from it this point, but we will go through that pre-commercialization or commercialization process by customers faster.

As far as what it would mean in terms of acceleration through 2013, again, it's hard to speculate. But I -- this is better than the previous generations. And so I'm confident that as customers run it through their rigorous testing, they will see the value and want to port over to this, certainly, on their new device applications.

As far as the sub markets for it, anything where you want durability and lubricity at the same time are ideal target markets for this in different parts of the vasculature. So part of it will depend on how many licenses we sign where this is the ideal coating for new to the world device applications looking for more durability.

I expected to accelerate over the next -- over the three quarters from the time it's first being sold or bringing in cash flows.

Okay, that helps. Another question related to hydrophilic is, I think today is the first time you have really disclosed your technologies on the safety in valve. Can you help us quantify at all how much that may contribute to growth in fiscal year '12, or any clarity to help us provide estimates as to how much revenue that may contribute?

My response is probably something you can appreciate. We don't provide guidance on customer-specific programs. What I might suggest is taking a look at what Edwards might be saying about their expected revenue from that particular product. And I think it has been pretty well characterized what our average royalty rates are; you can see that in our 10-K. You might want to just use that as a basis for formulating some initial thoughts.

Okay, all right. I will gave that a try. At other questions, then -- can you just tell us --

Just to make sure, Tim and I just looked at each other. The royalty rate is not on the valve itself. We would covet that, but it's under delivery system.

Right, right. Yes, and I guess that's the challenge, is just trying to establish the value of the delivery system versus the value of the valve as it relates to the ASP on the valve. Just two other questions -- Gary, can you repeat some of your statements, you broke up just a little bit, at least on my end, about your comments about how willing you are to deploy some of the cash towards acquisitions?

In conjunction with the Board, we are looking at all options for deployment of cash. The part I probably broke up one is just showing investors we are not looking to deploy a significant portion of that cash on single acquisitions. We are compelled to look at acquisitions that would strengthen the core, but I don't want to have people think we're going to go out and spend the bulk or even a large part of our balance sheet on a single acquisition.

The biggest thing for us is really -- as you know, Ross, cash is a strategic asset. So it should really -- deployment should be based on sources and uses of cash that the strategy requires. And then we look at our capital structure and also look at the reserves we have in terms of mitigating risk, having some cash on hand, and frankly, even having some cash on hand to be opportunistic in the future.

And then the third big component of that is the return of cash or redistribution of value to shareholders. So none of that covered what you probably missed when I was speaking.

That's good, thank you. And my last question just relates to the drug-eluting balloon project. How likely is it that that maybe gets licensed to multiple potential partners versus one partner bidding for an exclusive license?

I can't comment on where we are, but there certainly are interested partners. And the way we approach these deals is what is best for the partner or partners, and also trying to marry that with what's best for SurModics. It also depends on the data and how strong -- if we continue to see strong preclinical and animal results in terms of control of the drug on the balloon, that could have an impact on those negotiations as well.

Greg Macosko with Lord Abbett.

Just to follow up on Ross's question regarding exclusivity, the point being is that that is part of the negotiations with the customers?

Yes.

And then with regard to those different -- the licensing of various kinds of coatings, etc., how does this affect the customer in getting his products through the FDA? I assume that, obviously, if it's a good coating, it makes it better and easier, etc. But is there any advantage relative to just FDA approval as opposed to internal development that helps them by using one of your coatings?

Yes. We don't have FDA approval for sale of clearances. We do maintain a dossier on file with the FDA of our products. Our customers refer to that dossier in seeking the regulatory approvals required for their products. So by maintaining that file, it certainly helps customers in different parts of the world as well refer to that. And then the FDA can then look at those files on file and then help our customers get the approvals that they require.

Certainly, if customers are looking at highly acute applications where durability is critical, we believe that this coating will give them an advantage in seeking that approval. But certainly that's between the customer and the FDA.

I just might add to Gary's comments that customers make a decision on hydrophilic coatings for a number of reasons, obviously one being performance. And obviously, there's a price or value equation to this. But there's other buying criteria, and a very important one is SurModics has a long history of use on medical devices; that takes away risk for customers in their ability to get their technologies, their products through regulatory approval, given that we've had a long history of use. And Gary referenced that the fact that a device master file exists and our customers are allowed to utilize that in their submission.

So we look at it as being able to provide them with a lot of value around a lot of different points to help them get approval and de-risk their process.

Could you give us a little color just on what the customers internally are doing? I know we've talked in the past about some likelihood that customers may look more towards you or others to supply them externally with coatings and the like. Have you seen, just generally speaking, additional reduction in their internal resources used in the coating area such that, in effect, over a longer-term they might look toward -- to you?

What is unique about SurModics is the customer base we service, everything from garage startups, to midsized companies, to very large multinational medical device firms.

Well, you know I'm not talking about garages.

Right, right. But certainly, for the early companies and startups we have been providing more what we call bridge to manufacturing coating services. And in fact, we have scaled up that part of our service offering.

But in terms of the large customers, what they're looking for, I think coatings are clearly on their mind as they develop new products. It certainly is not the only thing, given the high risk of any medical device. And I have not seen a negative change in terms of how they approach SurModics, and especially the response we've gotten to the next generation of our coatings as we have made it available to select customers.

Their processes -- they would have their own devices coated and then conduct their own internal, rigorous testing of how the coating performs on the device.

I'll offer up a few additional comments that might be useful. First, there's a relatively small number of device manufacturers that are using in-house coatings, as we refer to them, on their medical device applications or products. And those few that are doing that -- they are, in fact, SurModics customers and utilizing our hydrophilic coatings on certain of their products.

We are not -- certainly, I can tell you that we are not hearing much in the way of these particular customers investing significant resources in developing next-generation coating platforms for their products. In fact, I can tell you that at least one of these companies that utilize in-house coatings has been talking to us about our new hydrophilic coating platform, which I think speaks volumes about our platform and also gives you some perspective on maybe how those companies that are using in-house coatings are thinking about their own technology.

So we feel real strong about what we have with our PRO -- or our new hydrophilic coatings platform. And it gets back to an earlier question about how do we think about this platform over the next several years. We are really excited about it, and we are excited in part because we think it provides us with opportunities to expand our market reach, if you will, specifically as it relates to in-house coatings. And so time will help us with that. Again, we're pretty excited internally here about what we have.

Good, good answer. And then finally, with regard to in-vitro, you mentioned some new products coming. I guess that's in fiscal third quarter?

No; we didn't provide specific quarter.

I think I said next quarter we are going to launch some.

Right. And really, it pertains to this quarter. That's a good point, Gary. Gregory, you can expect that you will see us launched new in vitro diagnostic components this quarter.

Are we talking about something totally new, or is it kind of variations -- obviously, differences based on, maybe, that -- you mentioned the Assay Diluent and the bio effects of such a membrane -- is it products along that line as well as diagnostic kits?

That's exactly right. These are chemical component products that help to improve accuracy of diagnostic tests. And the thing that's really exciting for us is that there's just a lot of different diagnostic test formats that can benefit from having chemical components that are developed to optimize the results for that format. And so what you're going to be seeing from us are new technologies or new products that help our customers improve the accuracy of their diagnostic tests or help support different customer segments, whether it be a diagnostic testing customer or a researcher.

Yes. And in the first years, we are focusing on the core -- similar like using a baseball analogy, call these singles and doubles. As we plan for the longer-term aspects of R&D, what we're going to experiment on, then we will be looking for the triples and home runs. But really, this is a base hit strategy in terms of getting some products out there that we actually have had requests and demand for. And now we are trying to fulfill that by launching them.

Charley Jones with Barrington Research.

Thanks for taking my question. My first one is a clarification on some comments earlier about your transcatheter valve participation. I guess we've always been told in the past that on these hydrophilic coatings you are getting somewhere around -- I'm just going to say, you don't have to agree with it -- 1% on the total ASP of the device.

Now, in the case of Cypher Select, for example, you guys have the bio material on part of it that kept the drug on the stent, and you got that little piece, too. But you guys just described it a little bit differently for the transcatheter valve. Now, I can appreciate how that's a much more expensive device. But help us understand a little bit how that royalty rate fluctuates with that and what you are actually getting a royalty on.

And then secondly, for drug-coating balloons, what does that mean? Are we all of a sudden just getting the 1% on the delivery system? Or again, because the stents were all one big piece, are these transcatheter valves 1% on the total ASP?

Yes. Yeah, first of all, the Cypher --

It's a pretty big clarification.

Right. Cypher was like this as well. There was different components to that revenue stream. There was certainly the product we sold for the hydrophilic coatings. There was the royalty for the hydrophilic coatings. There was a product polymer that we sold for the drug delivery component of the stent, and then the fourth thing, there was a royalty base for the drug coating on the stent. So if you look at those four revenue streams -- and so what we are seeing is --

All right, let's exclude that one, actually. Let's look at FoxHollow. Let's look at whatever. You had a $3000 device. You were getting roughly a percent out of it. You weren't getting a percent on the catheter delivery system, just a couple hundred bucks.

Right.

So forget about Cypher. Let's go back to the transcatheter valve and the balloon, I guess.

Let me help you a bit on this. So you probably appreciate that we provide hydrophilic coatings for CRM applications.

Sure.

But we don't receive a percent of the royalty against the entire product ASP. So if you think about -- if you think about an ICD --

That's a very different thing. But okay.

So it's the same thing with a percutaneous valve. In these higher-priced applications, when you are talking about a hydrophilic coating to help enable the delivery --

Prevent a tear in a vein, yes.

[in a chemical location] -- we are going to get paid on the basis of the delivery system. Now every customer is a bit different, so it's difficult for me to give you a lot of specificity. But probably what I might -- to help you understand, to think about it from the perspective of -- if you think about the stent delivery system and what stents sell for, $1200, $2000, depending on where they are sold worldwide, there is a percentage on that. That might not be a bad way to help you think about it.

But every customer is a little bit different. It's hard to take an example and use that example across the spectrum of products.

Well, I just think you've got to be careful, then, about how you describe the transcatheter valve market as if it's a replacement for the stent market, when it's a very different --

Yes. We are not doing that. What Gary was trying to articulate was you are using an example where integrating royalty from two different coatings, one being for the delivery of drug off of the Cypher product --.

I understand.

So we wanted to provide clarity on that. So hopefully that eliminates the confusion.

Now, drug-coated balloons is a little bit different animal. And I just went to make sure that you appreciate this as well. In the drug coated balloon application there could be the potential for SurModics to generate multiple royalty streams. One would be on the hydrophilic coatings, to enable the delivery of that therapeutic benefit for a patient. But also there's a device drug delivery coating --

The polymer. I get it.

-- on the balloon. So there's two different opportunities there for us.

Okay, so back to the transcatheter valve, though -- are you getting a -- we are talking about big devices here, where your coating is very important on not causing dissection. So are you getting a larger royalty rate on the delivery system, so you are getting that value? Or are you still getting this very small royalty rate on this much smaller dollar amount?

I'm not, today, going to provide a lot of specifics on royalty rates on particular customers on product applications. But what I will tell you is, the way I want you and others to think about this is it's not going to be much different from what our general portfolio looks like today.

Well, I think it's a lot different when you have a $3000 Silver Hawk that you are getting 1% on and a $400 catheter delivery system that you're taking a $20,000 valve in there with. But I'll move on.

I like your thought right there, and that's a good way to think about it, Charlie.

Yes, okay. So what kind of premium rate are you expecting with this new coating? And I'm curious what percentage of your customers do you expect to adopt? I know you've got some competition with some weaker hydrophilic coatings at your heels over the next three years.

Absolutely. Certainly, competition in coatings is something we see all the time. We believe we will win those battles, not just because of this next-generation coating. I believe our customers are looking at the risks, also, of not using a SurModics if they currently use us in terms of their manufacturability, the service and support. When things go wrong, it's really good to know that you have the reputation of SurModics behind you in terms of making and coating millions of these devices.

As far as the premium on this, I prefer not to speak about that, because we are in multiple -- as we are negotiating this, is best for us to do that one-on-one with our customers, depending on application and depending on the acuity of the need for this type of coating. Certainly, we are intent on maintaining where we are with our prices and our royalties for these devices going forward.

I guess I get the impression from you that you expect the large, vast majority of your customers to switch to this new product over the next couple of years. Is that true?

And then finally, on this line, can they just pretty much -- if they have an existing product line out there, a Silver Hawk or whatever, can they immediately change today if they want? Or do they have to submit new regulatory filings? Or can they just --

Right. I can't speculate on what they need to do regulatory-wise. But I would expect that they would have to refile. It depends on the product and the FDA rules in that regard.

So it's more for new products?

So yes, so one of the things that will help the acceleration of this is it being selected as new products are going through the regulatory channels. But it will become part of the specification of those new products.

So we shouldn't expect you to be putting this on an existing product. You are going to have to come out with a new generation before you start to generate a higher royalty rate?

What you have described is really how it has worked for us in the past when we have introduced new hydrophilic coating platforms. You will see more often than not that the customers who are adopting it on products immediately in development are the new products or next-generation products. That's not to say that all customers do that. There have been occasions where some have gone back and put the coating on existing products. But that's not typically the way it works.

I would like to just point out that for some of us who have watched this Company for six years, just to watch other people come in and talk about acquisitions, it's -- I think you guys have got to look really closely at how you're going to redeploy this cash. And I think more of it should go back to the shareholders.

Right. I just want to emphasize, the reason I included in the word acquisition in there is to actually reassure people of exactly what you said.

Yes, I appreciate that.

-- that we are not going to go willy-nilly, and --

But I mean, not even willy-nilly, like no more than $5 million to $10 million over the next five years. Let's just -- let's change the strategy.

Right.

Okay.

And to be clear, we have no acquisition targets now. It's not like --

Well, then, let's redeploy the cash. All right. Thanks a lot, guys.

That's all the time we have for questions today. I would like to turn the conference back to management for any closing remarks.

Thank you. I appreciate everyone's participation today. Fiscal 2011 was a transformational year for the Company. We'll continue to build on that momentum in the first quarter of 2012. We do remain steadfast in our commitment to return SurModics to profitability and focus revenue growth in these core businesses.

I will remind everyone as we enter year two of our transformation, we will refocus on driving profitable growth, cash flow in our high-margin core businesses, investing in R&D to drive organic growth, and then implementing and executing against a long-term strategic plan to set the path of the sustainable growth for these businesses.

I believe that we are well on the path to achieving our 2012 guidance but also to sustain our double-digit long-term growth. Thanks, everyone, for participating in this quarter's call, and we look forward to providing further updates on the next quarter's call. Thank you.

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