Surmodics Inc (SRDX) 2012 Q4 法說會逐字稿

Good afternoon ladies and gentlemen, and thank you for standing by. Welcome to the SurModics Fourth 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, November 6, 2012. I would now like to turn the conference over to Tim Arens, Vice President of Finance and Interim CEO. Please go ahead.

Thank you Douglas. Good afternoon, and welcome to SurModics fiscal 2012 fourth quarter and full year earnings call. Also with me on the call is Gary Maharaj, our Chief Executive Officer. Our press release reporting our quarterly and full year results was issued earlier this afternoon, 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 be also archived for further 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 provide an overview of our financial results for the quarter and the year, as well as discuss our outlook for fiscal 2013. Gary will then discuss our strategy and growth drivers moving forward. Following this discussion, we will open the call to take your questions.

As we look back at our fiscal 2012 performance, let us begin our discussion with a few highlights related to the year. We achieved record Hydrophilic coating revenue and record In Vitro Diagnostics product revenue during the year. We came in at the upper end of our full year revenue and earnings-per-share outlook. As a reminder, our guidance called for revenues to be in the range of $51 million to $52 million and earnings to be in the range of $0.56 to $0.59 per share. And we also announced and completed our $55 million share repurchase. Before I fully discuss our results from continuing operations for the fourth quarter and full year, let me first address a few items that will lend some clarity to our results. The items that affect our non-GAAP results include our fourth quarter share repurchase, our second quarter impairment loss, and the discontinuation of Cordis' Cypher and Cypher Select Plus drug alluding stints.

In early September, the company completed its modified Dutch auction tender and repurchased more than 16% of the Company's outstanding common stock at a price of $19 per share. Following our purchase of nearly 2.9 million shares, the Company has 14.65 million shares of common stock outstanding. As our repurchase was completed well into the fourth quarter of fiscal 2012, our weighted average diluted share count in the quarter is 16.9 million shares outstanding, compared with 17.6 million at the end of the third quarter. The full effect of our repurchase will be reflected in fiscal 2013 and in future years. For the quarter and the year, our non-GAAP results, which can be seen in the supplemental tables found in today's earnings release, reflect adjustments related to two GAAP expenses. Stock repurchase costs and the second quarter impairment loss related to our equity investment in OctoPlus. Our GAAP results include approximately $500,000 of fourth quarter expense associated with our tender offer, and the $800,000 second quarter impairment loss related to our equity investment in OctoPlus.

Turning to Cypher, during our fourth quarter of fiscal 2012, we generated less than $100,000 of revenue associated with Cordis' Cypher and Cypher Select Plus drug alluding stints. By comparison in the fourth quarter of 2011, we generated $1.6 million of Cypher revenue. For the full year, we generated approximately $400,000 of revenue from Cypher compared with $6.6 million in fiscal 2011. Beginning with our first quarter of fiscal 2013, the discontinuation of these Cypher products will no longer have a meaningful impact in our comparative numbers. Going forward, the growth generated by our business will be much clearer. We believe that these non-GAAP adjustments provide meaningful insight into the performance of our continuing operations, and an alternative perspective of our operating results.

Moving on to our fiscal 2012 fourth quarter results. Our financial performance, excluding Cypher, resulted in solid revenue growth, while our core business generated strong non-GAAP operating income growth. Revenue for the fourth quarter totaled $13.8 million, which is a slight decline from the $13.9 million reported in the fourth quarter of last year. On a comparative basis, our fourth quarter revenue growth when adjusting for the net change of $1.5 million in revenue associated with Cypher, increased 12% from the year-ago period.

We delivered fourth quarter operating income of $4.6 million. On a non-GAAP basis, operating income was $5.1 million, an increase of 116 % from the prior year. Non-GAAP operating margin was 37%, up 1800 basis points compared with the prior year period. Driven by the strength of the Cordis revenue performance and strong contributions from last year's productivity and cost actions related to the strategic realignment of our business. On a GAAP basis, our diluted earnings-per-share from continuing operations was $0.17 for the fourth quarter, compared with diluted earnings-per-share of $0.13 from the year-ago period. On a non-GAAP basis, diluted earnings-per-share grew 111% and was $0.19 compared with non-GAAP diluted earnings-per-share of $0.09 from the fourth quarter of last year.

Turning to the full year 2012, GAAP revenue was $51.9 million, a decline of 2% from fiscal 2011. On a comparative basis, our fiscal 2012 full year revenue growth when adjusting for the net change of $6.2 million in revenue associated with Cypher, increased 12% from the year-ago period. We delivered operating income of $16.3 million in fiscal 2012, an increase of 11% from fiscal 2011. On a non-GAAP basis, fiscal 2012 operating income was $16.5 million, up 68% from fiscal 2011. Our non-GAAP operating margin for the full year 2012 was 32%, and increase of 1100 basis points from last year. On a GAAP basis, our fiscal 2012 diluted earnings-per-share from continuing operations was $0.58, compared with diluted earnings-per-share of $0.63 in fiscal 2011. On a non-GAAP basis, diluted earnings-per-share from continuing operations increased 61%, and was $0.61 compared with non-GAAP diluted earnings-per-share of $0.38 in fiscal 2011.

Turning our attention to our Medical Device business unit, fourth quarter Medical Device sales, which include revenue from both our Hydrophilic coatings and device drug delivery coatings totaled $10 million, a slight decline from the $10.2 million reported in the year-ago period. During the quarter, we nearly offset the $1.6 million of the Cypher revenue generated in the fourth quarter of fiscal 2011. As a result of our strong Hydrophilic coating performance, our Medical Device non-GAAP revenue increased 15% compared with the prior year period. During the quarter, Hydrophilic coating revenue increased 13% from last year to $9.9 million. Device drug delivery coating revenue of approximately $80,000 declined 94%, compared with the $1.4 million earned in the fourth quarter of fiscal 2011.

For the year, we achieved record Hydrophilic coating revenue of $36.8 million, representing 10% growth compared with fiscal 2011. Adjusting for Cypher, our Hydrophilic coatings revenue increased 13%. Device drug delivery coating revenue of $1.1 million declined 82% from last year's $6 million. This decline was attributable to Cypher. During the fourth quarter, and during fiscal 2012, we saw double digit Hydrophilic coating royalty revenue growth in all key medical device market segments including neurovascular, peripheral, and trans catheter heart valve replacement. The past year has seen these three market segments increase in importance as they have grown to represent half of our total Hydrophilic coating royalty revenue. Medical Device generated $5.2 million of GAAP operating income during the quarter, representing a 5% increase from the year-ago period. Adjusting for Cypher, medical device operating income increased greater than 50% to $5.2 million from the year-ago period, driven by higher revenue.

Looking at our In Vitro Diagnostics business unit, our IVD sales for the fourth quarter totaled $3.8 million an increase of 5% compared with the year ago period. Our IVD business unit has generated eight consecutive quarters of year-on-year revenue growth, and for the second consecutive quarter achieved record diagnostic product revenue. For the full year, In Vitro Diagnostic sales totaled $14 million, an increase of 7% from the $13.2 million generated in fiscal 2011. For the full year, we achieved record diagnostic product revenue. Among the bright spots during the year and one that aligns with our core extension activities, was the growing impact of molecular diagnostics on our business performance. We saw strong double digit growth in our product sales to this growing diagnostic market.

You will recall, that our third quarter performance saw pressure on the IVD operating income line as product costs increased, which impacted our third quarter diagnostic product gross margins. Our fourth quarter product gross margins of 63% saw a 200 basis point improvement from the third quarter. In part, because of the improved product gross margin, our fourth quarter IVD operating income increased 35% compared with the year-ago period to $1.3 million.

Now let's discuss our fourth quarter 2012 revenue summary by category. Royalty and license fees, which are generated primarily in our Medical Device business unit were $7.4 million, a decline of 4% from the $7.7 million reported last year. Excluding the impact of Cypher, royalty and license fees increased 11% in the fourth quarter of fiscal 2012. Fourth quarter product sales of $5.3 million declined 6% from the year-ago period. Impacting the quarter's product sales performance was a 20% decline in Medical Device reagent sales, principally from the Cypher impact. Excluding Cypher, product sales increased 3% in the fourth quarter of fiscal 2012.

Lastly, R&D revenue in the fourth quarter was $1.1 million, a doubling from the $547,000 reported last year. Coating services support for certain of our Hydrophilic customers was a primary driver of the increase in R&D revenue. SG&A expenses in the fourth quarter of fiscal 2012 were 27% of revenue, compared with 30% in the year ago period. SG&A expenses declined 9% from last year, mainly as a result of last year's cost reduction efforts and our ongoing efficiency improvements. Research and development expenses in the fourth quarter of 2012 were 25% of revenue, compared with 27% in the year-ago period. R&D expenses declined 8% from last year. Taking a quick review of our balance sheet, our cash and investments totalled $58.1 million. Our cash and investment balance reflects a use of $55 million for our share repurchase that was completed in the fourth quarter. We continued to generate solid cash flow during the quarter. Cash flow from operations was $5.6 million during the fourth quarter.

Finally, I want to address our expectations for fiscal year 2013. For the full year, we expect GAAP revenue to be in the range of $55 million to $58 million, and diluted GAAP EPS to be in the range of $0.75 to $0.87. I'd like to offer some comments regarding this revenue and earnings-per-share outlook for fiscal 2013. First, our earnings-per-share outlook reflects and increase in our investment and technology innovation, and funding of our organic growth strategies to drive growth across the business. Second, our outlook reflects a tax rate of 38%. And third, and last, our share count consists of 14,650,000 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 very pleased with our most recent results, and the momentum we have generated over the course of this fiscal year. I'm particularly pleased looking back at fiscal 2012 that we accomplished the objectives and goals we established at the beginning of this year. We began the year by completing the sale of the Pharmaceuticals business, which was outside our core area of focus and expertise. Importantly, this allowed us to increase our focus and driving performance in our core Medical Device and IVD businesses leading to improved results in fiscal 2012 over the prior year, and at the top end of our financial guidance.

I'm especially proud of our ability to cover almost 90% of the loss of the Cypher revenues and profits within four quarters. I believe that this demonstrates not only the resiliency of SurModics, but it also highlights the strength of our core Hydrophilic coatings business and our efforts to diversify and expand our product portfolio, our customer base, and ultimately our revenue streams. Finally, we applied a balanced approach to putting our cash position and healthy balance sheet to work by investing in our pipeline for future growth, as well as executing a major share buy back during the fourth quarter. This effective execution of our plans for fiscal 2012, enabled us to return to profitable growth. In addition, our efforts helped us set up for success over the long-term as we pursue a goal of building a great organization that is the industry leader, delivers consistently strong results, and has high impact in the markets we serve.

I'm excited about fiscal 2013. Our strategy for relentlessly focusing on our core business has created a platform for profitable growth. In fiscal year 2013, we will continue this focus on driving and strengthening the core, while starting the process of methodically expanding our core. Now, we recognize and are prepared for the inherent challenge in balancing the tension of core growth with core expansion. However, our expansion strategy to go beyond Hydrophilic coatings for minimally invasive devices and diagnostic creations for amino acids is important and timely. By starting now, we can take a more methodical approach towards managing the risk and opportunities intrinsic to core expansion.

This measured approach also ensures that we are allocating our resources efficiently and in a way that maximizes successful contributions from our product pipeline. For me and most importantly, it represents a return to the passion of SurModics as a technology-based company engaged in the disciplined exploration, discovery, and application of technology to solve meaningful problems in the diagnosis and treatment of disease. In this uncertain global and economic and industry environment, we will remain focused on developing and commercializing products that are first and foremost best in class when it comes to patient safety, clinical relevance, and cost effectiveness. These attributes will help us to remain competitive, and at the forefront of this challenging environment.

Let me now spend a few minutes discussing our business units, and what we expect for fiscal 2013. Our Medical Device business had a good year of double digit growth, net of Cypher, based on the strength of core customer sales and the double digit growth in the trans catheter valve peripheral and neurovascular market segments. We are well-positioned with our generation 5 Hydrophilic coating platform to continue this growth. We continue feasibility and commercialization activities with Gen 5. In fact, the majority of new feasibility's are conducted on Gen 5. We continue also to make progress on qualifying Gen 5 on the full range of substrates and representative catheter designs used by our customers. These activities and focus will continue into fiscal 2013, and we are committed to seeing this product successfully through to its completion as we believe it will be a significant contributor to our future growth.

Our core expansion activities in the segment involve a return to device drug delivery as demonstrated by our pre-clinical research efforts on our drug coated balloon project. Importantly, we have already started experiments and other forms of surface modification that improve the performance of actual devices as opposed to delivery systems. We will consider providing more information on these experiments, only after they have progressed to full blown projects internally. However, this migration back to the device is an important guiding strategy for our future. Our pre-clinical results from the drug-coated balloon project continue to be very positive. We believe that our technology if it continues to proves successful, actually has the potential to set a new standard in maximizing targeted tissue uptake of the drug, while minimizing unintended drug losses in the blood stream. We will continue to invest in making progress on this drug-coated balloon in fiscal 2013 since it fulfills an important need with a large market opportunity. Upwards of $1 billion.

In the IVD business, we continue to focus on our core activities. As an example, in R&D we have applied some of our product development experiments to what's custom formulations of core products specific to the needs of key customers. Other resources have been focusing on experiments involving core products intentionally designed for emerging markets, where there are of different value propositions.

As far as core expansion activities are focused, we're focusing on the fast growing field of molecular diagnostics. Specifically in the area of cancer, infectious disease, and inherited disease. Our leverage in this molecular diagnostic market is based on two current core capabilities. First, our surface chemistry that is currently used to immobilize nucleic acids such as DNA and RNA for analysis. Second, our unique reagent capabilities in stabilizing the confirmation of proteins so that they remain active to binding in molecular diagnostic applications. But while these activities are early and exploratory, we're seeking ways to apply and develop our core technology in a large and growing segment such as molecular diagnostics. And this will be central to our core expansion in IVD in fiscal 2013.

So, the key issues at the waterfront for us this year are commercialization of our Gen 5 Hydrophilic coating platform; completing the pre-clinical assessment of our drug-coated balloon technology; conducting meaningful experiments on surface modifications that improve the performance of implantable Medical Devices. And finally, assessing the opportunity for core expansion into molecular diagnostics with our existing IVD technology. We believe that these objectives are most relevant, and represent an optimal balance of driving the core while beginning the process of expanding the core. We have dedicated a substantial amount of our resources to these key projects with excellent results to date.

The critical part of our success during the last seven quarters, can be attributed to the focus, clarity, and simplicity of our strategy. These efforts to reinvigorate our pipeline have been enabled by our healthy balance sheet and strong cash generation capabilities of our business model. The appropriate deployment of our cash to maximize shareholder value is also an important area of strategic focus that we are constantly evaluating. Our overriding objectives, to strike the balance between continuing to fund organic growth through investing in our pipeline and future growth, while maintaining the financial flexibility to be both opportunistic and to manage risk while returning excess cash to shareholders.

As you have seen recently and as I mentioned earlier, during the fourth quarter, we purchased over 16% of the Company's outstanding shares, which demonstrates our commitment to returning excess cash to shareholders. In conjunction with our Board, we'll continue to carefully evaluate the appropriate deployment of our cash going forward. Our team is excited about this year and is confident in our ability to make progress against our stated strategic, operational, and financial goals in fiscal 2013. Operator, this concludes our prepared remarks, and we'd like now to open the call for questions.

(Operator Instructions)

Charley Jones with Barrington Research.

Good afternoon. Congratulations on a great quarter.

Thank you Charley.

Yes, I guess I wanted to start a little bit on Gen 5 and just in general your coatings business. I was hoping you could talk just a little bit about the conversations you're having with companies that have in-house coatings and where you're at in that process, whether or not you can maybe set some expectations for 2013 there on in-house coatings?

Certainly. As a reminder to everyone, companies that use the majority of the coatings in-house are also in large part customers of SurModics and use our coatings on different products. And so we're always in conversations with them. I think our strategy in Gen 5 is to really ensure that we have satisfied our key customers first, and help them get it across the goal line on their devices. But we continue to be in strategic conversations with the companies you mentioned, Charley. We're certainly not planning or telegraphing our plans to commercialize these customers quite yet.

All right. I'll maybe give you a quarter there, but hopefully we can talk about that a little bit more going forward. I was also hoping that you could talk a little bit more about Gen 5, and the royalty rate expectation you have there. And do you think there's an opportunity for a tiered strategy here for, say, neuro or is that too difficult to achieve?

We -- certainly we look at Gen 5 as an upgraded technology in terms of what we're able to go to deliver to our customers. And by that I mean the fact that there is no trade-off between durability and lubricity, and so they can in particular optimize the lubricity values that they desire with this coating. A lot of this is depending on the application. Gen 5 represents actually a family of recipes to be precise, and that family has different cost of value propositions and cost propositions around it. So we really titrate it to the needs of that customer more so than the application.

All right. That's great. And then I was wondering if you could give us an update on where you're at with coating new surfaces, intra luminal, PTFE graphs, et cetera. Will we see some product development there, or do you think that's really more of a 2014 situation?

Well, as we look at those areas, and those are certainly rich areas for us to mine, some of those we have identified may take actually a different chemistry or a different approach versus the approach we're taking now. So I'll consider that really early exploration at this point, since it may require a different chemistry approach to the entire process.

If I could just sneak one more in, and I'll jump back in queue here. Can you give us a little more detail on where you're at with drug alluding balloon. I think most of us have heard you say something to the extent of you never know if the next set of pigs are going to come back. And there's going to be some issue. And I think a lot of us really maybe roll our eyes a little bit, because you seem so confident. So I'm just curious, are you at a de-risking stage that you can share with us and where are you at in kind of being able to commercialize this, whether it's figuring out how to do it in manufacturing or whatever?

Sure. That's a good point and you remember well, Charley. For me, from an R&D viewpoint, it's all about pending non-variability, and we feel really good with what we've seen through all the quarters I've been saying that. I think the thing for our team and for me, is really putting the statistics behind it to demonstrate repeatability of the results we're seeing. And so when I talk about the next five pre-clinical studies and how they come back, it really is adding to our statistical data base, which increases our confidence.

The second thing our team has really focused on over the Summer, is really ensuring that our process is validated. Any time you go from lab scale to doing dozens or even potentially hundreds of catheters, you want to make sure that you have that repeatability. And that is golden for us. That we can not only get it to work once, but we can it to work multiple times and get it work on larger batches. And so coming out of this Summer's efforts, my sense of confidence has grown since we've been able to demonstrate that. So while we're less susceptible to the next five pre-clinical studies coming back because of the substantial data we have generated, I want to keep everybody reminded it's really pre-clinical work we're doing. So.

That's very helpful Gary. Thanks a lot. Congratulations. I'll jump back in queue here.

Thank you.

Ross Taylor with CL King.

Hello. I'll start off with just a couple of modeling questions. I wonder if you can you make any comments about where you expect R&D expense to be in fiscal year 2013. Just, maybe you can just -- any indication as to how much that expense line may grow next year, if at all?

Yes. I'll let Tim dive into some more of the detail, but we're committed to funding our organic growth, while maintaining the appropriate and communicated operating margins that we have historically delivered. And so when we look at our revenue growth and our incremental margins, we actually are funding incremental R&D out for our operating plan at this point. Tim, I expect spending to go up but not to really take margins down.

That's right. Gary, it's a great way to answer that. Ross this is Tim, how I would articulate is this we should be -- as you take a look at the earnings outlook that we provided, you ought to be thinking about really two things. There will be an increase in operating expenses to fund R&D. And R&D is probably going to be looking at a growth of somewhere mid single digits to low high single digits, say, 5% to 8% for 2013 to fund ideas, experiments, and projects. What I'll tell you is we don't typically provide a lot of insight around where we're at in terms of ideas, experiments, and projects. But probably one way to think about this is the mix of ideas, experiments, and projects are going to have a significant influence on the rate of expense growth for R&D and hence our range. So hopefully that provides people with some insight on how to model operating expenses and the R&D going forward.

Okay. No, that's good. And also with CapEx, they were very low in 2012. I just wondered if you can give any rough guidance as to whether they stay down in that range next year? And also, looking at the quarterly numbers for royalty revenues in 2012, the first half of the year was much lower in terms of absolute dollars than the second half of the year. And I wondered if that is primarily due to seasonality in the business, or whether some new product launches really caused that increase from H1 to H2?

Great. So let's start with the CapEx question. Yes, this year was abnormally low. Some of the CapEx expenses really more of a timing issue, and will start to flow into Q1 for things that were began in late fiscal 2012. Probably the best way to be thinking about CapEx for 2013 is it will probably be somewhere in the call it the $2 million to $2.5 million range.

Now with regard to the royalty rate question, there's a whole lot in there. There is seasonality of course, but as we've been saying over the last several quarters, we've seen really nice significant single digit growth in some of these important market segments within Medical Device, and we benefited. Trans catheter valves, peripheral neuro, we've just seen a nice revenue growth in those segments each quarter, both year-on-year as well as we're seeing a growth on a sequential basis within these segments as well. And that's really what's helping to drive the distribution of royalty revenue over the back half of 2012.

Okay. That's very helpful. And my last question, looking at some of your R&D projects, particularly in device drug delivery. Some of the you're doing outside of drug alluding balloons, say the ones that have the potential to be important contributors to revenues, would you expect the time frame in terms of getting those products to market is about the same as the drug alluding balloon, or are some of those shorter or should we think about them as actually being even longer time to market?

Sure. It depends on the -- we have a mix of intended device applications that these experiments are targeting. The drug alluding balloons in my opinion is at the high time end of the range, just because of substantial clinical work that needs to be done. Both for [CE] marking and for US FDA approval. And so I would say that would probably represent an outer bound. The things that we're experimenting with as well, while not much shorter, my opinion would be it would be shorter than the drug-coated balloon itself.

Okay. That's good. Thanks very much.

Ben Haynor with Feltl and Company.

Good afternoon gentlemen.

Hello Ben.

Great. Just had a few here. What needs to happen to get you to the higher range of your revenue guidance? And then what do you anticipate the mix looking like between the In Vitro Diagnostics and other revenue?

Thank you for the question. The way that I would have people characterize or think about what it will take for us to get to the higher end of our range is really continued success in these growth segments that we've seen. I would tell you that we would also be looking to have no real risks or impacts from a global economic perspective, or downturns in procedures within the health care environment. And it's continued success in capturing new customers and bringing new products to market, and those are the factors that really helped to drive our 2012 growth. I would look at bringing those into 2013, and extrapolating those into 2013 for us to get to the high end of our outlook.

Okay, great. And then assuming the drug-coated balloon continues to progress like you think it will, do you anticipate going to Europe first with that, or would that be something you'd start out here?

As you know, a business model is really finding a key partner to take it to the channel where we haven't brought products to market ourselves, and then that continues to be our strong preference. So really at the end of the pre-clinical project stage where we have a data package and we've probably conducted a GLP study, at that time, there will be much more interest and viewable data by some or multiple strategic partners who would then want to develop a relationship to commercially license the product or the technology. For their balloon platforms. So that's -- then there's the regulatory decisions and [pathways] are really up to the partner themselves of how they'd like to proceed.

That makes perfect sense. That's all I had. Thank you gentlemen.

Thanks Ben.

(Operator Instructions)

Gregory Macosko with Lord Abbett.

Yes, thank you. Just with regard to the revenue growth, I note that adjusted in fiscal '12, your growth was 12% and the high end of your growth is now -- is at -- is point of your projected '13 growth is 12%. Is there any suggestion that customers are holding back from the development? I mean, relative to Gen 5 or anything else that would slow the growth because they're waiting for new products?

Greg, this is Tim. No, I would not characterize that. In fact, just to maybe put a little finer point to it, I think we've mentioned in the past that in regard to Gen 5, we expect to see royalty revenue from Gen 5 Q4 of fiscal 2013. As I think we've described in the past with regard to our business model, our customers for the most part as they consider leveraging Gen 5 are going to leverage it on a -- either a next generation product or a new product. And so that will take time for them to work through their product development pipeline. So please don't take a similar growth level in 2013 as a thought that perhaps customers are delaying, putting next generation technology on their products.

Okay. Very good. Then, just -- I would assume then conservatism would be a definition of in terms of historic growth versus future growth?

Yes. We also -- as many of our customers are doing the same and they have informed us, there's a sort of watchful waiting for the macroeconomic conditions in health care over the next 12 months. And so, part of it is we are so deeply connected to the heads of our customers, one of things that Tim had mentioned we're getting to the top of the range. We also even the coronary segment has become less important, it's still important that performs as a baseline for the powerful neurovascular trans catheter. And so, it sort of reflects the weighted average of the probabilities we see primarily from a macroeconomic viewpoint.

And when you say funding or expanding, you talked about in your summary sort of expanding your opportunities and outlook. The point being that is would acquisitions or anything like that be part of that expansion?

We haven't really gone on record and stated our acquisition M&A strategy. Needless to say, that anything that can help us strengthen the core business and provide a platform for expansion certainly is not out of the question. But we haven't put a set strategy in terms of our cash and balance sheet specifically towards M&A at this point. That's an ongoing conversation with the Board.

And Gregory, this is Tim. I'd just like to expand on Gary's comment here. Just to be perfectly clear, our outlook is reflective only of organic growth initiatives, it does not reflect any M&A activities.

Okay. And I assume then at this point you really haven't looked at anything or had any considerations with regard to an acquisition?

Well, you've probably -- my words were carefully chosen earlier. We -- our balance sheet is also for opportunistic investments, and so we remain in this market and opportunistic invested. If the right M&A or the right strategic fit and the right core strengthening or expansion capabilities came along we'd certainly look at it.

Okay. You speak carefully. Thank you very much.

Thanks.

Thank you Gregory.

Charley Jones with Barrington Research.

Hello. Thanks again. Sorry if you answered this, what was your operating cash flow for the quarter excluding -- for the year excluding share repurchase?

Our operating cash flow was, let's see here, I think it was $5.6 million Charley.

For the quarter? How about for the year?

For the year it was -- and this is in the press release here, it was $17.6 million.

All right. Sorry, I missed that. Are you -- could you tell us whether or not you're on both the major commercial trans catheter heart valve programs? I think you are, but I just want to be crystal clear about this.

Well, Charley, we've communicated one partner that we have the ability to communicate and that's Edward [Zathient] valve. What we've said in the past is that we're well-positioned. There are several players in the trans catheter valve space. We're happy to say that we're well-positioned in that space, and unfortunately we really can't say more at this point.

Okay. That's helpful. On diagnostics, you've talked about singles and doubles here and a conservative strategy and getting new growth. Are there triples or home runs, and can we expect a chance for you to hit one of those in 2013, or is that a longer term goal?

For me it is a long -- we will actually be looking for the triples and home runs, and really being very proactive on that. My assessment is while it could happen, we don't want to plan the Company that it has to happen. But certainly our strategy, especially in the area of molecular diagnostics where we believe some of our existing core platforms have playing power, we'll certainly try to amplify that. So, I know I'm dodging the question. It could happen, and we are working to make it happen but it's not part of our plan at this point.

And then --

In terms of 2013.

In terms of 2013 financials, yes.

Okay. But longer term it sounds like you're confident. And shorter term might not fall in '13?

That's right. And the outlook reflects more of those singles and doubles, Charley, that you described.

And really it's been more singles, right? Are chances of some doubles here better?

Yes, yes.

Okay. Quick question about Gen 5. I was curious if you could prognosticate for us, bring out your crystal ball and give us an expectation of the percentage of customers that will probably use Gen 5 on their next generation program say I don't know, out in 2014. Do you think it's over half, or are there reasons why it's not?

Our intention is that the majority of customers in terms of our commercialization strategy would be porting over to Gen 5, primarily because we believe it's the best Hydrophilic coating, including our own, for their next generation of devices. And these next generation devices actually have in some cases more difficult requirements. It's not just commercialization for commercialization's sake, we see it bringing real value to their platform. So my answer is by 2014, really is the majority of our customers. Now, the cash flows from that given the product development and the regulatory timelines may not reflect that in 2014, but the licenses signed should.

Is there anything about this where it is going to be more difficult to get products through, or is it going to be seamless as the other generations have been in the past for companies?

As always it depends on the specific device. We -- sometimes a very small component of the overall submission. So a lot of this depends on the FDA review of the device it claims in a safety profile. And so unfortunately we tag along with that. Our intention is a Gen 5 is to make it actually easier from what we bring to the table for our customers.

A question on your drug alluding balloon drug delivery technology. So if you're able to enable better uptake by the vessel, why wouldn't that be valuable for the drug-eluting stent programs? And then as part of that answer, if you could kind of give us an update where your drug-eluting stent partner is, and their rollout or approvals in Europe?

Yes, we don't have any other insights -- I'll answer the second one first and always [neesha]. We would expect it to be any time soon, but really we are also waiting word from them on their regulatory approvals. And so that's as much as I can say to that. We will also look to the public disclosure of their regulatory approval. As far as for the drug-eluting stent, we called it in many respects, the drug-eluting stent is an easy application, because you have stent's trust and the polymer on it to be continuously present to the tissue there. And so the with the drug-coated balloon, there's no physical device. You're really requiring the stickiness of the coating to stick to the vascular wall and continue to deliver drugs for up to 28 days. So that's the big difference.

Are there any milestones or incorporated in your 2013 guidance? And again, looking for to you bring out your crystal ball and maybe move a little bit away from the last management strategy understanding that you don't want to tip your hand too much. But can you give us a little bit better understanding of what your thought process is about an exclusive non-exclusive relationship for DEB and the likelihood we could see some milestones in 2013 whether it is or isn't contemplated in guidance?

Our philosophy has been to when things are still in R&D, we ourselves deeply discount the probabilities of four financial plans. That's not to say that it could not happen, it just means that when we put it in if it is in there it's a very deeply discounted amount. The other thing is, in terms of the type of licensee we're looking for from my perspective, it's important that we have partner or partners who are really going to fully develop the market with such a terrific technology when we get to that point, and so that's very critical. By choosing the right partner who is aggressive and wants to change the world as well, we believe that we can have a little more latitude on the type of deal. But it's really the selection, and the type of partner is more important to us. The milestones and royalties and stuff are really negotiated at that time.

So there's really not anything of any major significance in your guidance?

Yes, Charley, it's a fair way to characterize it. As far as expenses are concerned, we do, in fact, our guidance reflects expenses associated with pre-clinical activities associated with the drug-coated balloon project.

And the last one, I saved it for last because I'm going to push you a little bit. You did a great job obviously returning cash to shareholders, but just wondering if you could help us out in your thought process around acquisitions. Can you strengthen the core by $5 million, $10 million, $15 million acquisitions, or do you think there's opportunities for something bigger? And if you could at least share us your thoughts, maybe not the board's but your thoughts, on what level of cash is appropriate or could be appropriate given that your got a $15 million to $20 million operating cash flow?

Yes. It's a good question. I'll say first that we are, the Board, we are in conversations about our continuing to evaluate that. My feeling is, we went down the middle of the fairway and demonstrated we said we'd do what we said in terms of returning cash, and we were happy to do that. As you said, we wake up and we have generated more cash on our balance sheet, and our plans certainly reflect that.

This year really is incumbent upon management with the Board to develop a strategic use of that cash for growth of the Company or increase in value of the Company. And subsequently look at the excess cash portion of that as either certainly risk mitigation, also keeping some still for opportunistic investment, but also importantly understanding that our shareholders may have a need for some return of cash. In this case it would probably be more in the excess cash bucket as we have determined the best uses, strategic uses of cash. And so the lineup or the queue is a little bit different as we look at this here.

So on acquisitions, let's push a little bit more. Are we still thinking $5 million, $10 million, $15 million -ish, I don't think you even talked that much about acquisitions at the most, or are there maybe some opportunities for something bigger in your opinion?

I would say my feeling on the big is we better have a very good investment hypothesis, very good reason to have done a lot of diligence to do large acquisitions. We're looking for things that strengthen and expand the core, nothing that's too adjacency's away. We're not necessarily looking to buy revenues, but we're looking to expand our capabilities especially. So the big ones while not out of the question, certainly have a nonlinearly higher burden to get over here to SurModics.

Thanks for all the answers.

Thanks.

Jeffrey Warshauer with Sidoti & Company.

Hello. Thanks for taking my question. Just quickly on R&D revenue, we saw increases throughout the year, maybe if you could provide a little more color on what type of customers are increasing the testing of their devices to customers, existing customers, customers previously used, in-house? And then with a month into the most recent quarter how you feel about that category going forward?

Jeff, this is Tim. Thank you for the questions. Really the R&D revenue can probably be classified into really two key buckets. One is, as you described, doing work where we get paid to help optimize our coating technologies for our customers' products. And that has been fairly modestly growing over the last year. What I will tell you is that the most significant source of growth is coming from what we call coating services, and we may have described this in the past. This is customers that are using our Hydrophilic coating technology and are going into animal studies or human clinical studies for the most part where they will send us their parts to coat, and they'll do assembly and then use those products for their clinical or pre-clinical work.

So just to be a little bit more eye -- put a finer point on that, that's really where the growth is coming from in R&D. In terms of how we think of that going forward, as you can imagine, customers do work and then they submit to the FDA or a regulatory body and they don't need to have products coated. And so you're always getting customers that come in and go out of that equation. I would anticipate that as you look at our outlook, I would assume that the growth rate to be thinking about with regard to R&D isn't much different than the growth rate that we provided overall for the revenue outlook.

Okay. Thanks. That's helpful.

And at this time, there are no further questions in queue. I'd like to turn the call back over for closing remarks.

Thank you. Our success in 2012 has given us strong momentum as we head into the new year. We'll remain laser focused on executing against these strategic objectives that will enable us to return SurModics to profitability and focused revenue growth in our core businesses. At the same, our strong operating model and healthy balance sheet have created an opportunity to continue investment in R&D and new product introduction to expand the core, while maintaining the financial flexibility to be both opportunistic and to return value to shareholders. I want to thank everyone again today for participating in this quarter's conference call. And we look forward to providing further updates on our next quarter's call. Thank you everybody.

Thank you ladies and gentlemen, that does conclude our conference for today. We'd like to thank you for your participation again, and you may now disconnect.