Surmodics Inc (SRDX) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, thank you for standing by. Welcome to the SurModics' Third Quarter 2012 Earnings Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Wednesday, August 1st, 2012.

I would now like to turn the conference over to our host, Mr. Tim Arens, Vice President and interim Chief Financial Officer. Please go ahead, sir.

Thank you, Kelly. Good afternoon and welcome to SurModics' Fiscal 2012 Third Quarter Earnings Call. Also with me on the call is Gary Maharaj, our Chief Executive Officer.

Our press release reporting our full third quarter results was issued earlier this afternoon and is available on our website at SurModics.com. Also issued earlier this afternoon was our press release announcing our plan to launch a tender offer to purchase up to $55 million of SurModics' common stock. Details related to the tender offer will be set forth in our offer to purchase, which will be filed with the Securities and Exchange Commission.

Before we begin, it's 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'll provide an overview of our financial results, highlights for the quarter, and an updated outlook for 2012. Gary will then discuss our key achievements of the quarter and provide an update on our growth drivers and strategies, including additional detail on our plans to offer a tender offer to purchase up to $55 million of our common stock. Following this discussion, we'll open the call to take questions.

Unless otherwise noted, third quarter financial results discussed today exclude the $112,000 third quarter loss associated with discontinued operations. Thus, the financial information that I discuss relates to our continuing operations, and as in many cases, on a non-GAAP basis. As in past quarters, I'll provide insights and performance comparisons excluding the financial impact related to the discontinuation of Cordis' Cypher and Cypher Select Plus drug-eluting stents. You'll recall that in prior periods, we've generated both product and royalty revenue based on sales of these Cordi products, which have in incorporated our proprietary drug delivery in hydrophilic coating technologies.

Our earnings announcement issued earlier this afternoon provides supplemental non-GAAP financial information that adjust for Cypher and certain of specific charges. We believe that these adjustments provide meaningful insight into our core operating performance and an alternative perspective of our operating results. It is worth noting that beginning with Q1 of fiscal 2013, the discontinuation of these Cordis products will no longer have a meaningful impact on our comparative numbers.

Our financial performance, excluding Cypher, resulted in strong revenue growth while our core businesses generated reported operating income during the quarter. Revenue for the third quarter totaled $14 million, which is up 7% from the $13 million reported in the third quarter of last year. On a comparative basis, our third quarter revenue growth, when adjusting for the net change of $1.1 million in revenue associated with Cypher, increased 17% from the year ago period.

We delivered solid bottom line results during the quarter, with operating income of $4.8 million. On a non-GAAP basis, operating income was $4.6 million, up 55% from the prior year. Non-GAAP operating margin was 33%, up 800 basis points, compared with the prior year period, drive by the strength of the Cordis revenue performance.

On a GAAP basis, our diluted earnings per share was $0.18 for the third quarter, compared to diluted earnings per share of $0.17 from the year ago period. Excluding the impact to Cypher, non-GAAP diluted earnings per share in the third quarter grew 42% and was $0.17 compared to non-GAAP diluted earnings per share of $0.12 from the year ago period.

I'll now turn our discussion to performance by business unit. For the third quarter, Medical Device sales, which include revenue from both our hydrophilic coatings and device drug delivery technologies totaled $10.3 million, up 7% from the $9.6 million reported in the year ago period. Excluding Cypher, Medical Device revenue grew 22%.

Third quarter results include hydrophilic coatings revenue of $10 million, which was up 18% compared with the year ago period. Hydrophilic coatings revenue growth was broad based with strong growth in each of our revenue lines. Notably, we continue to see strong growth in our research and development revenue, which nearly doubled from the year ago period. Driving this performance was an increase in the number of Medical Device customers leveraging our coating services to support their pre-clinical, clinical and commercial activities. These research and development activities may lead to future royalty revenue.

We continue to see strong double-digit royalty growth in key Medical Device market segments, including neurovascular, peripheral and trans-catheter heart valve repair and replacement. During the quarter, we saw a return to royalty growth in the coronary and cardiac rhythm management market segment. After a 9% decline in the second quarter, the third quarter generated 5% growth in this market segment when adjusting for Cypher. This was growth was primarily driven by recently launched customer products. Partially offsetting the growth in our hydrophilic coating technologies, device drug delivery revenue of $230,000, declined nearly $800,000 from last year's third quarter. This decline was largely attributable to Cypher.

On the bottomline, Medical Device generated $5.2 million of operating income during the quarter, representing a 13% increase from the year ago period. Excluding Cypher, Medical Device operating income grew 52% from the year ago period driven by higher revenue.

Looking at our In Vitro Diagnostics business unit, our IVD sales for the third quarter totaled $3.7 million, an increase of 7% compared with $3.4 million in the third quarter of fiscal 2011. Our IVD business unit has now generated seven consecutive quarters of year on year revenue growth. We achieved record diagnostic product revenue during the quarter. Our product revenue performance was broad-based, as we saw growth across most of our key product lines and customer segments.

I'd like to take a moment to provide some insight around this quarter's operating income. IVD generated $1.1 million of operating income in the quarter, down 26% from last year's third quarter. IVD operating income was affected by a $650,000 increase in product costs from the year ago period. We anticipate that our IVD business unit will see a return to normal operating margins going forward.

Now let's discuss our revenue summary by category. Royalty and license fees, which are generated primarily in our Medical Device business unit were $7.1 million, down 5% from the $7.5 million reported last year. Excluding the impact of Cypher, royalty and license fees grew 11% in the third quarter of fiscal 2012. Product sales of $5.7 million grew 15% from the year ago period. Broad-based product revenue growth was seen in the quarter with hydrophilic coating reagents growing double digits and IVD product sales growing in the high single digits. Lastly, R&D revenue in the third quarter was $1.1 million, a doubling from the $550,000 reported last year. Coatings services support for certain of our hydrophilic customers drove the increase in R&D revenue.

Moving on. We generated product gross margins of 61% in the third quarter of fiscal year 2012, compared with 74% last year. However, when looking at the year-over-year comparison, it's worth noting that our fiscal 2011 third quarter product margin was the highest seen in either fiscal 2011 or fiscal 2012. In the third quarter of fiscal 2012, we had increased product costs, which negatively impacted margins. Other recent quarters have seen product gross margins range from 64% to 68%. Going forward, we expect that our product gross margins will return to our normal historical range. To reviewing operating margins, third quarter of fiscal 2012 operating margins were 34% compared with 33% last year.

SG&A expenses for the third quarter of fiscal 2012 were 24% of revenue, compared with 27% in the year ago period. SG&A expenses declined 3% from last year, mainly as a result of last year's cost reduction efforts. Research and development expenses were 25% of third quarter revenue compared with 30% in the third quarter fiscal 2011. R&D expenses declined 10% from the year ago period, as a result of last year's productivity and cost actions.

Taking a quick review of our balance sheet, our cash and investments totaled $108.2 million. We continued to generate solid cash flow during the quarter. Cash flow from operations was $5.8 million in the third quarter. Management and the Board regularly evaluate the use of our cash and in just a moment, Gary will provide an update on our plan to commence a tender offer to repurchase up to $55 million of our common stock. This tender offer, if fully subscribed, represents a return of approximately half of our total cash and investments to shareholders.

Finally, turning to guidance. As you saw in our press release, we've increased our revenue and earnings per share outlook for the full year fiscal 2012 as a result of our strong year-to-date performance. It's important to note that our outlook excludes any share count reduction and expense associated with our planned self tender share repurchase. Revenue from continuing operations for fiscal 2012 is now expected to be in the range of $51 million to $52 million, above our initial guidance of $47 million to $51 million.

Diluted earnings per share from continuing operations is now expected to be in the range of $0.56 to $0.59 per share, above our initial guidance of $0.45 to $0.53 per share. Our outlook is based upon a 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?

Thank you, Tim. I'm pleased our reported financial results demonstrate the continued execution of our overarching goal to return SurModics to profitable growth. Our most recent results and corresponding positive momentum that we have generated over the course of this fiscal year is a result of our strategic objectives and a testament to the efforts of our talented team of employees that have taken up this charge.

While we are proud of our recent accomplishments during this quarter, rest assured that we will not be satisfied with only near term progress. Our team's mindset here at SurModics is to ensure that we establish this type of performance as an ongoing consistent result. We remain every vigilant about ongoing goal to build a great organization that is an industry leader, deliver strong results and has high impact in the markets that we serve.

In keeping with the theme that we set at the beginning of this fiscal year, year two, as I call it, of SurModics' transformation, will be continued to be defined by the following three areas. First a focus on our ability to drive our core business to generate profitable growth and cash flow. Second, discovery in R&D to drive organic growth and optimize long-term returns from our product development pipeline. And third, to define our strategy for use of cash on the balance sheet. Let's review each of these strategic priorities in more detail.

First, our ability to profitably expand our core businesses to generate long-term growth. In the Medical Device business unit, our co-initiatives leave us well-positioned in the fast growing areas, such as trans-catheter valves, peripheral vascular applications, and we expect to see these become even more relevant to our revenues during the next year. In the third quarter, as Tim said, we saw record quarterly hydrophilic coating revenue and in addition, three medical device customers launched new products that licensed our hydrophilic coating technology.

The number of feasibility studies with our next generation of hydrophilic coatings platforms, which I refer to as Gen Five, continues to increase. Gen Five, as you recall, provides the same low friction capabilities expected from prior generations of SurModics hydrophilics coatings and provides enhanced durability for multiple vascular applications. We are continuing to invest in expanding the capabilities of Gen Five to the many variations of multiple substrate materials that exist and even more challenging applications.

In our IVD business unit, we continued to execute in our plan to create organic growth in our core business. These plans include adding new diagnostic test customers, increasing our sales of current products to existing customers and launching new products. It pleases me to note that the business has now achieved seven consecutive quarters of year-on-year revenue growth. In fact, during the last quarter, we gained six new diagnostics customer who order our products as components to their kits. We feel really good about the progress we've made and the opportunity we see across both of these core businesses.

Our second area of focus that is part of our long growth strategy and helps (inaudible) is R&D. In Medical Devices, we have had two key areas of focus pertaining to R&D;as I described earlier, our Gen Five hydrophilic coating and second, our drug-coated balloon project. During the past three months on our drug-coated balloon project, we've focused on optimizing the coating application process to improve the consistency and effectiveness of drug delivery and tissue uptake. Our aim of our customers are consistent coating with a predictable target tissue optic characteristic while minimizing unintended drug loss in the vascular tube. We remain very excited about our drug coated balloon efforts and embrace the challenges inherent in the development of such a platform.

In July, our IVD business unit launched yet another product. This time in our BioFX Colorimetric Substrate line, called BioFX TMBX, which improves both the dynamic range and irreproducibility of certain quantities of assays. This is the second product launch in fiscal 2012 by the IVD team.

Finally, let's talk about a third strategic area of focus that defines our year; the appropriate deployment of the cash on our balance sheet to create shareholder value. If you recall, last quarter we announced authorization to repurchase up to $50 million of shares with the details of the repurchase to be announced at a later date. Including the amount remaining under a previously approved share repurchase authorization, we are now authorized to repurchase up to $55 million of our common stock.

Our objective here was to strike the right balance between continuing to fund the organic growth through investments in R&D pipeline, while maintaining the financial flexibility to be both optimistic and manage risk while returning excess cash to shareholders. Today, we're pleased to announce that our Board of Directors has authorized a modified Dutch Auction process to repurchase up to $55 million of the Company's common stock. This tender offer is expected to commence on or about Monday, August 6th, 2012, and the details related to the tender offer will be set forth in our offer to purchase to be filed with the SEC. The size of this tender offer represents more than 50% of our balance sheet cash, it demonstrates our commitment towards distributing value by returning excess cash to our shareholders.

In conjunction with our Board, we'll continue to evaluate the appropriate balance of three uses of cash; cash deployment to create value, cash returns to shareholders to redistribute value, and cash reserves of both opportunistic investments and to manage risks.

In summary, we continue to make progress against and generate excitement around the three critical areas that we have defined as part of our transformational growth strategy; growth from our core products, our R&D opportunities, and finally, the strategic use and disciplined use of cash to create, return and protect value for all shareholders. We firmly believe that our commitment to executing against these key strategic objectives will continue to position the Company to achieve our goal of delivering sustainable, long-term, double-digit growth.

Operator, this concludes our prepared remarks. We'd like now to open the call to questions. Thank you.

(Operator Instructions). Our first question comes from the line of Ross Taylor with CL King. Please go ahead.

Hi, maybe start with a couple of financial questions. Within the product costs, the $650,000 amounts to all identified. Can you give any color as to what that is? Or why it suddenly arose this quarter? My other question related to the financials is the royalty and license fee revenue amounts. I just wondered if that included sort of any unusual or sizeable license fees in this quarter?

This is Tim. Thank you for the question. With regard to product costs in the quarter, looking at it from a year-on-year prospective, one thing to keep in mind is the product revenue increased about $750,000 from the year ago period. So a good portion of the increased product costs came from increased product revenue, that's part of it. Part of the other incremental increases in the product costs rising would be scrap and product mix. So those are some of your primary drivers.

Okay. That helps. And then on the question about the royalties and the license fees?

No there's are no unique license fees or royalties that were large or non-recurring or potential to be recurring in the Q3 of fiscal 2012.

Okay. And maybe just two or three other quick questions. The increase in R&D revenue, is this a reflection of uptake or high interest levels in your Gen Five coatings?

Ross, this is about more a lot of the customers are going through clinical development or through commercialization, looking to leverage our expertise to coat to help them to get to market faster. It's something we've been putting more energy, effort and focus on. It's not driven by Gen Five.

Okay. My last question, the drug-eluting balloon, you mentioned now that a lot of your focus there is on the coating process. It suggests your content with the science behind coating you've developed and the elution properties it has and the results you've seen in the pre-clinical studies?

What I'll characterize it as, it is a very tight coupling between small variations in the application process and the consistency in tissue uptake. What we like to do, as we've looked at some of the other products on the market, one of the things we like to use as our mantra was really consistency. They're very much coupled together, so I wouldn't say you have a stable platform in the drug delivery, then you stay really focused afterwards on the application process. What we're finding is they're both very intimately connected. So it becomes a circular feedback loop where you have to address one to ensure the other. Does that make any sense?

Yes, that does. Thank you very much.

Thanks, Ross.

Thank you. Our next question comes from the line of Beth Lilly with GAMCO Investors. Please go ahead.

Good afternoon, Gary and Tim.

Hi, Beth.

I have one question. The modified Dutch tender, can you talk about what exactly that means? There's no price range given, so what happens on August 6th?

Beth, this is Tim. Thank you for the question. You're right, there is no price range at this point. We're just announcing our intention to implement the Dutch tender. On or around the sixth, you'll see more details around the conditions of the terms, including the price range. We'll just ask people to wait on or about the sixth and they'll have more insight and information with regard to pricing on the tender.

Can you just help provide a little insight on why you didn't name the price range today as opposed to waiting till the sixth?

Another good question. Really the main reason here is we've had really quite honestly a good quarter, we've increased our outlook for the year. In terms of setting pricing before letting the market digest this information, we felt it would be better for us to allow the market to look at this news and that will help with the pricing.

Okay. So you'll put out all the terms and conditions on the sixth?

On or about the sixth, Beth.

Okay. Terrific. That's all I had. Thank you so much.

Thanks, Beth.

Thank you. Our next question comes from the line of Gregory Macosko with Lord Abbett. Please go ahead.

Yes, thank you. With regard to your expectations for the rest of 2012, looking forward, the increase is nice and into the top line, but it's relatively modest to how you've done in the second quarter. Give us a sense of how you're sizing that $51 million to $52 million?

Greg, this is Tim. The way we look at the range, we look at all available information. And if you're to look at it from a non-GAAP prospective, which is the way that we encourage people to also look at the business, certainly look at it from a GAAP prospective, but also from a non-GAAP -- you're looking at about 5% to 13% revenue growth for the fourth quarter. If you look at what we've done so far this year, it's 13% in Q1, 4% in Q2, and 18% here in Q3. So honestly we're looking at revenue growth that's kind of right where we've been at this year. So Q4 really doesn't look much different than what we've generated here for the first nine months of the year.

We could question that, but never mind. With regard to the 17% adjusted growth on the royalties and licensing. Is that volume driven, just in terms of the people that have the licenses and royalties? Is it because the volumes of their products and their uses of it was up? Is that really what's the driver there?

It's another fair question and a really good one. As we've described here, we're seeing really nice growth in some of the high growing market segments within Med Device. We've seen double digit royalty growth in all three of these segments, trans-catheter, heart valves, as well as peripheral vascular and neuro. Those applications are somewhat new, and those customers have launched products in the past and are continuing to see adoption of their products benefits us.

Okay, good. Then, finely, with regard to the in vitro diagnostics, is there a break even level that you perceive -- or a stabilization, excuse me, not break even -- but stabilization level relative to the operating profit there with regard to -- the revenues were up but the operating profit was down? Is there a point at which when we look forward the product costs, et cetera, will stabilize?

In fact, I would encourage people to think that our product costs for Q4 will look -- and our product gross margins will look awfully like what we've seen here Q1, Q2, time horizon. You're going to be looking at operating margins for the diagnostics business that will be around 30% plus or minus a couple hundred basis points. What we've seen here in Q3 is what I would term to be kind of an outlier.

That 30% as we look forward, is at least a starting point for where you're seeing it?

That's right.

Okay. Very good. Thank you very much.

Thank you. Our next question comes from the line of Jeffrey Warshauer with Sidoti & Company. Please go ahead.

Thanks for taking my question. When you talk about market opportunity in the Medical Device space, you talk about in-house device versus uncoated devices. Can you maybe just give a little more color of where you see traction in each of those, the past quarter and going forward?

Certainly. Keep in mind what we call coatings that are done in-house are also an overlap because a lot of these customers use SurModics' hydrophilic coatings on some products, but perhaps not on some of their high volume products. So they're at once a customer as well as an opportunity to grow. Part of that, we've certainly had early conversations for us and for these customers as we go through the qualification of our Gen Five platforms on particular substrates that will be more applicable to these customers, then we'll be in a better position to talk about an adoption process.

Gen 5, which is superior to the previous generations, has been qualified on certain devices and certain substrates, as we're marching through a whole big matrix of devices, substrates, and how those devices are made from those substrates. We're stepping very methodologically through that. And in-house coatings will be a part of that, but perhaps on the tail end of that march.

Do you think you see the hydrophilic coatings market growing at a higher pace? And where do you see yourself relative to that?

As Tim as described, the emerging high growth segments of trans-catheter, valves, neurovascular and peripheral vascular we're well-positioned and we continue to mine that with new customers in that area. Certainly the coronary segment is a big chunk of it. But as we see new devices in the visibility, we see unlicensed customer prospects now. We believe our opportunity in the market will continue to grow as we help numerous clients through their regulatory and product development timeline.

The part that you asked earlier about the uncoated devices, we consider that as almost two segments. There's devices that clearly today should be coated, but probably in the first generation design in the market haven't been and there's acknowledgement that they should have hydrophilic coating. Then there's another category of devices that have not been historically coated but that can be improved with the hydrophilic coating. We see an option to actually, certainly in the uncoated segment, get the devices where there's broad recognition that they should be coated first. The stretch to get the devices that are uncoated, and there's not a recognition that they should be coated is a slightly longer timeline.

This is Tim and I'll compliment Gary's response here. One of the things that has us really excited is we're well-positioned in some of these high growing market segments within Med Device. The way I want people to think about this is, the addressable markets are growing. A great example would be trans catheter valves. They only recently received market approval here in the US, just several quarters ago. And you're starting to see a nice uptick in adoption, you're seeing an increase in procedures.

As these emerging segments continue to grow and continue to see devices used in these procedures, we benefit and we win. Part of our growth is going to continue to come from more traditional segments as though customers continue to bring new products to market in coronary and CRM, but we'll continue to benefit from strong growth in some of the emerging markets that will help to increase the addressable markets for us.

Okay, thanks everyone.

Thank you, Jeff.

Thank you. (Operator Instructions). Our next question is a follow-up question from the line of Gregory Macosko with Lord Abbett. Please go ahead.

Yes, one final question. With regard to just the marketplace out there, have you been looking at any acquisitions? And have you had any candidates there, made some bids perhaps that didn't come through, or are you in discussions?

We typically would not comment on that. However, we have no acquisitions in mind at this point.

Okay. So, in other words, you're not even looking in a direction relative to acquiring something that would be in the coding area?

We certainly are always vigilant of opportunities on the horizon and that's how I'll characterize that.

Okay, thank you.

Thank you. We also have a follow-up question from the line of Ross Taylor. Please go ahead. Mr. Taylor, your line is open, please proceed with your question.

I'm sorry. Can you hear me now?

We can hear you fine, Ross.

Okay. Looking at your royalty revenues over the last three quarters, and sequentially things ticked down a little bit in March, then we had a big sequential uptick here in the June quarter. Is it new product introductions that are primarily driving the increase in June compared to what we saw in March? Or was it a recovery in the overall portfolio? I was just wondered if you could give any color on that?

Right, there's several things that are driving that. Just for the benefit of others, Ross, I believe you're referring to what we would consider to be adjusted for Cypher royalties. And so the way for folks to think about this is we benefited from new products being introduced. A really clear and good example of that would be Medtronic's recent introduction of it's latest drug-eluding stent, which happened a little over a quarter ago. We continue to see other customers launch new products in the coronary spaces, as well as in the other spaces we just commented on earlier.

I want to draw back on to that previous answer, which is we're seeing real nice growth in these emerging growth segments and the addressable market is increasing. That trend to see more procedures and more devices used to treat patients in neuro applications, peripheral applications as well as trans-catheter applications, trans-catheter heart value and repair applications, has really benefited us. That's where you're see some lift and some uptake.

And the coronary segment did rebound this quarter as well.

That's right.

That represented part of it.

All right, that's good. Thank you very much.

There are no further questions in the queue. I would like to turn the conference back over to management for closing remarks.

Thank you, everyone. We've continued to build momentum in the third quarter of 2012 with solid performances in our core businesses. We remain steadfast in our commitment to return SurModics to profitability and focused revenue growth in these core businesses. At the same time, we're compelled to continue investment in R&D and in new product introduction. Finally, we're please to be able to use the strength of our balance sheet in a return of cash to shareholders, in the form of the modified Dutch auction tender offer. I want to thank everyone to for participating in this quarter's conference call. We look forward to providing further updates on the next quarter's call. Thank you.

Thank you. Ladies and gentlemen, that concludes the SurModics Third Quarter 2012 Earnings Conference Call. AT&T would like to thank you for your participation. You may now disconnect.