Surmodics Inc (SRDX) 2013 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the SurModics second quarter 2013 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). This conference is being recorded today, Tuesday, May 7, 2013.

And at this time I would like to turn the conference over to Gary Maharaj, President and CEO. Please go ahead, sir.

Thank you, Vince. Good afternoon, everyone. First, allow me to introduce Andy LaFrence, our Vice President of Finance and Chief Financial Officer. Andy joined SurModics on February 12th, and he has a strong background in public accounting, having spent 26 years at KPMG, including a decade leading the Twin Cities Life Science practice at KPMG. Most recently, Andy was the CFO of CNS Therapeutics, which was acquired by Covidien in October of 2012.

Some of you have already met Andy in several investor roadshows within the last two months. Andy has in a very short time become an integral member of our leadership team and a trusted partner for me. Welcome, Andy.

Gary, thank you for your warm introduction. And good afternoon, and welcome to SurModics' fiscal 2013 second quarter earnings call.

Before I begin, I would like to remind you that during the course of this call we will make forward-looking statements. These forward-looking statements are covered under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include statements regarding SurModics' future financial and operating results or other statements that are not historical facts.

Please be advised that actual results could differ materially from those stated or implied by the forward-looking statements, due to certain risks and uncertainties, including those described in our SEC filings. SurModics disclaims any duty to update or revise our forward-looking statements as a result of new information, future events, developments, or otherwise.

Finally, 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. A press release disclosing our quarterly results was issued earlier this afternoon and is available on our website at www.surmodics.com.

On today's call, I will provide an overview of our financial results, highlights for the quarter, and our outlook for fiscal 2013. Gary will then cover our key achievements for the quarter and discuss our growth drivers and strategy. Finally, we will open the call to take your questions.

I'll start with the financials. We are pleased with the Company's performance. Revenue for the second quarter totaled $13.7 million, a 12% increase from $12.2 million reported in the second quarter of last year. We've delivered quarterly operating income of $4.1 million, also a 12% increase from the prior year.

Operating margin was 30%, which is comparable with last year. On a GAAP basis, our diluted earnings from continuing operations totaled $0.23 per share for the second quarter versus $0.11 per share in the year-ago period. The fiscal 2013 quarter increase included discrete income tax benefits of $0.03 per share.

The prior year second quarter was negatively impacted by a $0.05 per share other-than-temporary impairment charge. On a non-GAAP basis, diluted earnings from continuing operations totaled $0.20 per share for the second quarter, compared to $0.16 per share in the prior year period.

Turning now to our two business units. In Medical Device, which includes revenue from both our hydrophilic coatings and device drug delivery coatings, sales totaled $9.7 million. This represented an increase of 11% from $8.8 million reported in the year-ago period.

Second quarter hydrophilic coating royalty revenue increased 10% to $9.6 million. During the quarter, we achieved double-digit hydrophilic coating royalty revenue growth in our key medical device market segments, including neurovascular and transcatheter heart valve replacement. Our Medical Device unit generated $4.8 million of operating income in the second quarter, a 16% increase from fiscal 2012.

As we noted in our first quarter 2013 conference call, research and development expenses in the first half have been lower than anticipated as a result of the timing of R&D activities. We expect consolidated R&D expenditures -- that is, encompassing both business units -- to increase for the full fiscal year of 2013 by at least 8%.

For our In Vitro Diagnostics unit, second quarter revenue totaled $4.0 million, a 15% increase from a year ago. Of note, our IVD business has generated ten consecutive quarters of year-over-year revenue growth.

Sales for the quarter benefited from strong demand in stabilization and BioFX products as well as slides, a component of our molecular diagnostic business. Product gross margin for IVD was 64%, 230 basis points lower than a year ago. Gross margin was impacted by increased allocation of indirect cost. IVD operating income of $1.3 million was flat with the second quarter of 2012.

The gross margin gain did not offset the higher operating expenses that stem from increased allocation of corporate expenses as well as additional hiring needed to support growth. It is worth noting that our diagnostics operating margin for the quarter was 32%. Going forward, we expect it will be in the high 20% to low 30% range.

Now, I'd like to discuss our second quarter 2013 revenue by category. Royalty and license fees, which are generated primarily by our Medical Device business unit, were $7 million, an 11% increase from $6.3 million last year.

Second quarter product sales of $5.8 million increased 14% from the year-ago period. The Company generated solid growth in both hydrophilic reagent sales and diagnostic product sales.

Lastly, R&D revenue in the second quarter was approximately $1.0 million, an increase of 15% from $0.9 million reported last year. Coating services support for key hydrophilic customers was the primary driver of the increase.

Turning to expenses, SG&A expense in both the second quarters of fiscal 2013 and the year earlier, were 28% of revenue. SG&A in 2013 totaled $3.8 million, an increase of 13% from last year on a dollar basis. The $453,000 increase in SG&A expense is the result of increased staffing and compensation expense.

As percentage of total revenue, second quarter R&D expenses were 28% versus 29% in the year-ago period. R&D expense of $3.8 million for the quarter increased 7% from last year, resulting from investment in clinical experiment in drug-coated balloon development initiatives. As I noted earlier, we anticipate increased acceleration of R&D expenditures in the second half of fiscal 2013.

To clarify, we expect our third quarter R&D investment to support future growth initiatives will increase to the point where year-to-date and full-year R&D will grow by at least 8%.

Income tax expense from continuing operations was 21.2% of pre-tax income in the second quarter, compared to 39% in the prior period. We realized discrete income tax benefits of $0.01 per share from the retroactively reinstated R&D tax credit, as well as a benefit of $0.02 per share related to the capital loss carrybacks from the [Vesic] strategic asset capital loss.

We anticipate our continuing operations effective tax rate to be approximately 33% in the third and fourth quarters of fiscal 2013.

During 2013 fiscal second quarter, the Company realized, net of tax, income from discontinued operation of $0.7 million, primarily as a result of settlement of a job incentive obligations with the City of Birmingham, Alabama.

Let's turn to the six-month results. We are also -- the Company has also performed well in our six-month results. Revenue for the first half totaled $27.5 million, a 14% increase from $24.1 million reported in the prior year period.

We delivered operating income of $9 million in the first half of 2013, a 30% increase from the prior year total of $6.9 million. Operating margin in the 2013 six-month period was 33%, a 400 basis point improvement over the same period last year.

On a GAAP basis, our diluted earnings from continuing operations totaled $0.52 per share for the current year period compared with $0.23 per share in the year-ago period.

The fiscal 2013 increase included discrete income tax benefits of $0.03 per share. Changes in net strategic investment gains and losses between the periods accounted for an additional [$0.13] per share change in EPS. On a non-GAAP basis, diluted earnings per share from continuing operations increased 46% to $0.41 per share for the current year six-month period, compared to $0.28 per share in the prior period.

Looking at our balance sheet, it continues to be strong. Our cash and investments totaled $63.2 million at March 31st, 2013. We continue to generate solid cash flow during the quarter. Cash from operations was $6.8 million during the first six months of fiscal 2013.

We also received $2.3 million from the sale of strategic investments in the first six months of 2013, and we repurchased approximately 106,000 shares for $2.7 million in the second quarter. Approximately $7.6 million remains outstanding under our share repurchase program. This repurchase program reflects our commitment to enhancing shareholder value.

We also note in our press release the disclosure of a correction of an error from the September 30th, 2010 financial statement, to reduce by $1.2 million an other-than-temporary impairment charge on the strategic investment. The impairment -- the impact of this adjustment was not deemed to be material to the results of operations, total assets, or stockholders' equity for the previously reported periods.

Finally, I want to comment on our expectations for fiscal year 2013. For the full year, we are reaffirming our revenue outlook in the range of $55 million to $58 million. This is an increase from $51.9 million for fiscal 2012.

We are also reaffirming our EPS outlook from continuing operations of $0.86 to $0.99 per share. Our fiscal 2012 EPS totaled $0.58 per share. It is important to note that our earnings per share outlook excludes any potential share account reduction that could occur as a result of share repurchase we may make.

At this point, I would like to turn the call back to Gary for his perspective on our operations.

Thank you, Andy. SurModics' strategy to focus on growth in our core business units is showing consistent results. I am pleased with our 12% revenue growth and 30% operating margin in the second quarter, for two reasons.

First, we are transforming SurModics into a consistently profitable and growth-oriented company, in the midst of a challenging economic environment.

Second, we continue to improve what is in our control -- that is, our internal teams executing against our strategic objectives. SurModics' dedicated employees deserve the credit for these results. We are aware, just as you are, of recent industry earnings reports, which have raised our awareness of more headwinds in certain market segments. However, our EPS and revenue guidance remains unchanged.

Fiscal 2013 continues to be transformative for SurModics. This year is about balance -- the balance of continuing to focus on core growth even as we lay the foundation for core expansion. Our focus on the core goal for the Medical Devices unit is to drive adoption of SurModics Serene low particulate coatings into the next wave of devices currently under development by our customers.

SurModics Serene, as you may recall, represents our next generation of hydrophilic lubricious coatings. It is the first hydrophilic coating that breaks the tradeoff between lubricity and durability. Finally, our customers can have the benefits of low friction and low particulates.

Let me clarify the process of adoption of SurModics Serene low particulate coating, so that you have a clear understanding of the efforts and the timing involved.

First, of course, we have to improve the awareness of our current and potential customers, that there is now a dramatically better solution for their lubricious coating needs. As we do that, they can incorporate SurModics Serene into the product life cycle of their next-generation devices.

Second, our application engineering teams must work with these customers to assess the capability of SurModics Serene on each individual device platform. This occurs during development, and within the constraints of the customers' usually aggressive timelines. It requires then shop testing and sometimes preclinical evaluation to generate sufficient data to satisfy both customer specifications and regulatory requirements. Please note that, at SurModics, this is also part of our R&D expenditure.

Third, our licensing team then jumps in to negotiate and sign license agreements for the use of SurModics Serenes on the particular devices involved.

Fourth, our coating services team supports the customer through their clinical trials, regulatory filing, and the US -- or US approval process.

Finally, our tech support engineers transfer the technology to our customers' manufacturing location global; or, we continue to coat their devices through our in-house coating services.

I'm emphasizing this adoption process because it demonstrates a couple of things. First, SurModics is not merely a supplier, but a solution provider with a very high service component of the Company.

Secondly, the rate of adoption of SurModics Serene depends on the throughput of several serial processes, including regulatory clearances for customers' products, prior to our ability to generate worldwide royalties.

I am happy to report that today we are currently performing the vast majority of our feasibility programs with the Serene platform. Several SurModics Serene customers are currently in the initial stages of the regulatory review process, and we anticipate this number will grow as we continue to help customers advance these through the regulatory channels, in coronary, peripheral, neuro, and structural heart market segments.

Now, turning to In Vitro Diagnostics. Our focus on the core goal there is to drive new customer acquisition and current customer utilization by improving our commercial operations.

Our IVD team is focusing on three main initiatives to accomplish this goal -- new customer acquisition; cross-selling our current suite of products to existing customers; and new product introduction, including the development of custom formulations for certain key customers.

We continue to make progress, implementing all of these. Specifically, we have added 29 new diagnostic kit customers to our growing list of customers year-to-date, and we have cross-sold SurModics products -- IVD products, into an additional 74 customers -- in some cases, multiple IVD products.

Moreover, sales from our new products launched within the last 24 months continue to build steadily, and these products will add over $200,000 in IVD revenue for this fiscal year. As a result of these initiatives, our revenues continue to grow faster than overall diagnostics market.

Now, let's talk about core expansion. Our core expansion activities in Medical Devices are focused on our drug-coated balloon project. Our aim is to offer a highly valued proprietary coating platform which is capable of treating diseased vessels in the peripheral vasculature. We have accelerated our R&D spending, as Andy mentioned earlier, to continue to generate preclinical data on the performance of this coating platform.

Even though R&D spending was lower than planned during the first two quarters, we are forecasting that we will spend at a minimum the full budgeted amount for fiscal 2013. There is a possibility that we may decide to accelerate the spending even further. This will depend on the amount and type of data that we want to generate, and the preclinical testing pathway that we choose to pursue.

I continue to be pleased with our progress. Internally, our R&D team is excited to further refine and test the capability of our coating platform for drug-coated balloons.

In IVD, our core expansion relates investigating the application of our technology in the molecular devices market segment, and testing the viability of establishing a beachhead in this fast-growing market.

With our existing technology, we have interviewed over 30 key opinion leaders in molecular diagnostics, and users, and customers in the field, to have a much more thorough grounding on the unique challenges for them in these applications.

While we have not landed on a particular technology approach to the molecular diagnostics segment, we do have a list of experiments to conduct as a result. We're still in learning mode, so conducting experiments will generate data that informs us on the early viability of our potential technology solutions.

Finally, we're developing our strategy to deploy cash on our balance sheet in order to create growth, earnings, and future cash flow. Tim Arens, our newly-appointed Vice President of Corporate Development and Strategy, is leading the early efforts in his new role. While still early, we are formulating our strategy for corporate development that is in line with our overall Company strategy.

I want to emphasize that our team continues to execute on clear goals based on our strategy. We're off to a solid start in fiscal 2013 and, despite recent industry headwinds, remain confident in our ability to make progress on our stated strategic, operational, and financial goals for the fully. In addition, we remain committed to our investments in R&D to further expand our profitable core.

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

(Operator Instructions). Ross Taylor, CL King & Associates.

My first question relates to the IVD business. I just wanted to clarify -- did I hear you say your objective for the operating profit margin for that business over the long term was high 30% to low 40% range? And if I heard that correctly, what does it take to get you to that kind of level?

No. Let me clarify. No. It was the high 20s to low 30s.

Okay. So, that's the objective for the IVD business. Okay.

That's correct, Ross.

Okay. And then you mentioned you hired some additional people in that division to help support future growth. And what functions or departments is that occurring in?

Well, you know, we have invested in some marketing help. We also have the general manager, Joe Stich, who's fully allocated to the -- driving the activities in that division as well. So, it really relates to marketing activities, new product targeting, and product launches.

Okay. And the final questions relate to R&D, and Gary, maybe you alluded to this in some of your remarks. But I just wondered, what specific areas are driving the ramp-up in R&D over the back half of the year. Is it all related to the drug-eluting balloon? And I guess, is there any incremental acceleration we might see in R&D revenues as well?

Yes. You know, there's a couple of dynamics. The big one really is the preclinical data package generation for the drug-coated balloon. As you know, there's a substantial amount of data and statistics that are required to demonstrate the viability of the approach -- things such as dosing studies -- a fair amount of data and process development.

As mentioned earlier on Serene as well, that -- recall that SurModics application development team for customers is also viewed as R&D expenditure. Sometimes we get paid to do R&D as R&D revenues there; but a lot of the time, for the adoption of Serene, that's part of our R&D revenue as well.

The third component really is the experiments that we want to conduct. We have a choice of, do we cut back a little bit on the experiment portfolio, to drive on on the drug-coated balloon?

Our feeling right now is, we need to continue to do both. The experiments represent cash flows a ways out, and I prefer not to cut those seminal data generation to just look for the short-term gains on current projects. So, that's our philosophy going forward, and we really want to get back to being that R&D-based company, even as we see headwinds in the industry.

Okay. And my final question -- and I apologize if I misheard some of the remarks here as well, but it sounded like you mentioned you were refining the drug-eluting balloon platform a little bit. And if I heard that correctly, what's driving that decision? Does that represent a lot more time involved in getting this program up to speed or further along?

I think one of the things we've recognized, certainly in drug-coated balloons, is the need for really high quality process control. And if this is going to have the SurModics brand on it, one of the things we'd like to offer to our customers is that it doesn't just work in the lab; we actually have a very refined process for making these.

Another key thing is that we believe our platform is transposable to just about any balloon catheter platform. It should be a very unique capability that we can offer. And so, we're actually generating a lot of statistics, so that when we're ready, and certainly that -- the preclinic animal testing, we can demonstrate a very high-valued technology platform to our potential customers.

Okay. That's very helpful. Thank you.

Ben Haynor, Feltl and Company.

So, you mentioned that several of your customers are -- have the Serene coating before regulators. Would that be several products as well, or is it more than several products?

Ben, this is Andy. We currently have -- a number of products are in front of various regulatory agencies worldwide. So, it's not one or two; it's several. And we would anticipate to start seeing some additional approvals here in the next quarter or two.

Okay. Great. And then, any chance you can discuss what segments of the market those might be targeting?

No, we really don't disclose that. I mean, our current product that's been approved out there is both peripheral and coronary. So, we would anticipate that it's going to continue to be a very broad-based applications that will be approved, and it will be amongst all of our different market segments.

Okay. Great. And then, is there any more color that you can provide on the preclinical assessment of the drug-coated balloon? You know, how are the pigs coming back these days?

You know, the one thing -- I think, before, we were communicating that we'd be able to fully complete the preclinical animal testing in this calendar year. Depending on the pathway, some of these studies are three- versus six-month studies. It could drift into our Q2 of fiscal '14. And so, that's what I have to offer.

But what's exciting, though, is that the data we're getting and the stability of our platform is something we want to keep hammering on. So, as I said earlier to Ross, you know, in the industry there's a lot of optionality of people who are acquiring drug-coated balloons for future competition. We want to have the best. And we want to have what I would call a third-generation technology that's very robust from the get-go. So, that'll take a little more data collection to demonstrate that fact.

So, you're saying you're not too worried about CV Ingenuity?

Oh, yes, I think (inaudible) about it. No, I actually -- you know, my -- to be honest, I like to see the whole category do well, because I think whoever's trying to solve this problem will have a dramatic impact. So, I -- the more, the better, to help patients.

Great. That's all I have.

(Operator Instructions). And I'm showing no further questions at this time. I'd like to turn the conference back over to Mr. Maharaj for any closing remarks.

Thank you. Let me reiterate that SurModics reported strong revenue and EPS growth in the 2013 second quarter. Going forward, we are focused on core growth and simultaneously expanding the core. I want to thank everyone today for participating in this quarter's conference call, and we'll look forward to providing updates on our third quarter call. Thank you, everyone.

Thank you, sir. Ladies and gentlemen, this does conclude the SurModics second quarter 2013 earnings conference call. Thank you very much for your participation. You may now disconnect.