Surmodics Inc (SRDX) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to SurModics' second-quarter 2014 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).

I would now like to turn the conference over to Andy LaFrence, Vice President of Finance and Chief Financial Officer. Please go ahead, sir.

Thank you, Kadya. Good afternoon and welcome to SurModics' fiscal 2014 second-quarter earnings call.

Before we 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 our forward-looking statements resulting from 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 at our website at www.surmodics.com.

On today's call I will provide an overview of our financial results, highlights for the second quarter and update our outlook for fiscal year 2014. Gary will then cover our key achievements and discuss our growth drivers and strategies. Finally we will open the call to take your questions.

I'll start with the financials. On a GAAP basis our diluted earnings per share totaled $0.18 per share for the second quarter compared with $0.23 per share in the year-ago period. Earnings in the second quarter of fiscal 2014 were impacted by a previously announced $0.04 per share non-cash charge related to amendments to the Board of Directors' equity compensation.

On a pro forma basis second-quarter fiscal 2014 diluted earnings increased 10% to $0.22 per share compared with $0.20 per share a year ago. We are pleased with this growth in earnings per share.

Revenue for the second quarter of fiscal 2014 totaled $13.6 million in line with the second quarter of last year. In the second quarter of 2014 we delivered operating income of $3.5 million, a 16% decrease from the prior year.

Operating margin was 26% compared with 30% in the prior-year quarter. On a pro forma basis operating margin was 32% in the current-year quarter excluding the impact of the one-time non-cash charge.

Turning now to our two business units. Medical device is the larger business and contributed approximately three-quarters of our total revenue.

Revenue from this business, which is derived from both hydrophilic coatings and device drug delivering coatings, rose to $10.5 million, increasing 8% from the year ago period. We are impressed with the performance of the medical device business given the current market conditions.

Second-quarter hydrophilic coatings royalty revenue increased 3% to $7.1 million compared with last year. The medical device business also benefited from a 10% increase in research and development revenue associated with contract coating services.

Our medical device unit generated $5.3 million of operating income in the second quarter, up 10% from a year ago. Medical device operating income was positively impacted by increased revenue from royalties and R&D which was partially offset by higher planned drug-coated balloon research and development expenditures.

For in vitro diagnostics units second-quarter fiscal 2014 revenue totaled $3.1 million, a $0.8 million decrease compared to the prior-year quarter. The lower revenue was primarily driven by a shift in order patterns by a few key customers who initiated inventory rebalancing programs related to SurModics' stabilization and antigen products combined with lower BioFX branded substrate revenue and a slowdown in sales in Europe.

After 13 consecutive quarters of year-over-year revenue growth we were surprised by the drought. Let me mention that just a few orders can make a sizable difference in IVD performance in a given quarter. Importantly, we expect improvement in this business in the second half of fiscal 2014.

Product gross margin for IVD was 63% in the second quarter, down slightly from 64% in the prior-year quarter. IVD operating income decreased 50% to $0.6 million compared with the second quarter of fiscal 2013. Our diagnostics operating margin for the quarter declined 20% versus 32% in the prior-year quarter primarily resulting from lower revenue.

Now I'd like to discuss our second quarter 2014 revenue summary by category. Royalty and license fees, which are generated primarily in our medical device business unit, were $7.3 million, up 5% from last year.

Second-quarter product sales of $5.2 million declined 10% from the year-ago period reflecting increased reagent sales in our medical device business unit offset by lower sales of our diagnostic products including IVD, BioFX branded substrates, stabilization and antigen shipments. Lastly, R&D revenue in the second quarter was $1.1 million, an increase of 10% from the prior quarter.

SG&A expenses in the second quarter of fiscal 2014 were 32% of revenue compared with 30% a year earlier. SG&A in the second quarter of 2014 totaled $4.2 million and increased 12% from last year.

The increase stems from the previously noted $0.9 million non-cash charge related to amendments to Board of Director equity compensation offset partially by lower professional service costs. Excluding stock-based compensation for both periods SG&A expenses decreased 10% in the second quarter of fiscal 2014 compared with the prior-year period. This decrease is driven by our disciplined and focused approach to managing SG&A expenditures.

As a percent of total revenue second-quarter R&D expenses were 30% versus 28% in the year-ago period. R&D expenses of $4.1 million for the quarter rose 10% from last year resulting from planned investments to support our drug-coated balloon development initiatives.

We anticipate R&D expense will increase in the range of 7% to 9% for the full fiscal year 2014. As Gary will discuss, we have reduced our estimate for fiscal 2014 research and development investment due to changes in the timing of drug-coated balloon expenditures.

Income tax expense was 33% of pretax income in the second quarter compared with 21.2% in the prior-year period. The second quarter of fiscal 2013 included one-time discrete income tax benefits that totaled $0.4 million.

Adjusted for these two items income tax expense was 31.7% of pretax income in the second quarter of fiscal 2013. For the full fiscal year 2014 year we continue to anticipate a 31% to 33% tax rate as stated in last quarter's conference call.

Let's now turn to the six-month results. Revenue for the first six months of fiscal 2014 totaled $27.5 million, unchanged from last year which included a one-time $0.6 million catch-up royalty payment. Excluding this payment revenue in the first six months of fiscal 2014 increased 2% from a very strong prior-period result.

Medical device revenue increased by 4% in the first half of fiscal 2014 on a GAAP basis and 7% excluding this payment. We delivered an operating income of $7.8 million in the first six months of fiscal 2014 versus the prior-year total of $9 million.

Operating margin in the fiscal 2014 six-month period was 28% compared with 33% last year. Pro forma operating margin increased 1% to 32% in the first six months of fiscal 2014 compared with the prior-year period excluding this fiscal 2014 one-time director compensation charge and the fiscal 2013 one-time royalty payment.

Earnings in the first six months of fiscal 2014 and 2013 were also impacted by a gain on one of SurModics' strategic investments. The Company realized a $0.7 million benefit, or $0.05 per share in the first six months of fiscal 2014 resulting from a clinical milestone earnout associated with the fiscal 2013 sale of Vessix Vascular to Boston Scientific.

In the first six months of fiscal 2013 the Company recognized a $2.1 million gain, or $0.08 per share from the Vessix sale. Pro forma earnings per share rose to $0.43 per share in the first six months of fiscal 2014 from $0.39 per share in the prior-year period. Schedules of pro forma adjustments are included in our second-quarter earnings release.

Looking at our balance sheet it continues to be strong. Our cash and investments totaled $51.3 million and we had no debt outstanding at March 31, 2014.

We continue to generate solid operating cash flow. Cash flow from operations was $5.9 million during the first half of fiscal 2014. We also received a $0.7 million milestone payment related to Vessix and we invested $0.8 million in property, plant and equipment in the first half of fiscal 2014.

Reflecting our commitment to enhancing shareholder value under the $20 million repurchase authorization announced in July of 2013, we bought back 106,000 shares of common stock totaling $2.6 million in the second quarter of fiscal 2014. We bought back 486,000 shares of common stock for $11.5 million in fiscal 2014 prior to completing our share repurchase authorization in January 2014.

I now want to comment on our expectations for the full fiscal year. We are reaffirming our previous stated earnings-per-share outlook for fiscal 2014.

Including an increase in research and development expenses primarily to support drug-coated balloon initiatives and the second quarter 2014 $0.04 per share Board of Director equity compensation charge, the Company continues to estimate dilutive GAAP earnings to be in the range of $0.85 to $0.97 per share. This guidance also assumes R&D expense will increase in the range of 7% to 9% in fiscal 2014, down from a 20% rise included in our previous guidance.

We are adjusting our full-year revenue guidance to be in the range of $56 million to $58.5 million to reflect the changes in customer order patterns in the IVD business unit. Our previous guidance for revenue was in the range of $58 million to $62 million.

The Company also affirmed for fiscal 2014 net cash flow from operating activities should range from $17.6 million to $18.6 million and capital expenditures are expected to range from $2.2 million to $2.5 million. At this point I'd like to turn the call over to Gary for his perspective on our operations. Gary?

Thank you, Andy. Our second-quarter results can be characterized in three groupings -- the satisfying, the challenging and the promising. Let's talk about each of these.

First, the satisfying. Our medical device business unit delivered strong quarter-over-quarter revenue growth of 8% and an increase in operating income of 10%. These two especially in conjunction are remarkable even in light of continued growth challenges for our particular sector of the industry.

Of note, year-over-year coronary sector revenue rose 3% for the second consecutive quarter. We are satisfied and encouraged by this performance.

Our R&D revenue grew by 10% primarily as a result of coatings services provided in support of the prelaunch inventory build for a customer's commercial launch of their peripheral vascular device. SurModics, as you may recall, typically coats more than 10,000 devices per month as a bridge to manufacturing service for customers until they grow to a level where it makes sense for us to help them transfer these operations to their specified high-volume manufacturing site.

On a consolidated basis quarter over quarter our pro forma operating income was actually slightly higher, this despite a slight overall decline in revenue and an increased R&D investment. This represents continued disciplined expense management even as we choose to invest in areas of strategic interest. As Andy mentioned, SG&A without stock-based comp actually decreased 10% versus Q2 of 2013 and has dropped 13% in the first half of fiscal 2014 compared with last year.

Second, let's talk about the challenging. Our IVD business experienced a significant quarter-over-quarter revenue decline. The major drivers of this appear to be a reduction in order patterns from several major US customers and European customers. In addition, in the comparable quarter last year we experienced a robust 15% growth helped in part by an active influenza season in 2013.

We believe that some of the decline in US orders stems from inventory reduction initiatives by certain customers as they try to more tightly manage working capital. As a result of this timing issue we expect to see a new cadence of orders that should stabilize the second half of fiscal 2014. Even with this stabilization, however, and as I indicated in our Q1 earnings call, we will continue to face the low single-digit growth pressures of our IVD customer base for the remainder of this fiscal year.

Third, the promising. Our commercial development and coatings services teams in medical device have been very busy helping our customers conduct feasibility trials with our SurModics Serene next-generation diversity platform. As you recall, Serene offers significant advantages in providing both lubricity and low particulates for interventional devices.

The vast majority of the feasibility evaluations that we are conducting are with Serene. While most of these customer assessments still have to secure regulatory clearances and approvals we are encouraged by the ongoing adoption of Serene.

On a small but pivotal note, Serene was recently selected for use in a product application by a customer who uses their own in-house lubricious coating on the majority of their other devices. We aim to build on modest successes such as this to demonstrate Serene's benefits of increased lubricity and reduced particulates to customers who thus far still use their older generations of the in-house coating formulation.

Continuing in the vein of promising, let's discuss our drug-coated balloon project. Recent developments have made this an even more significant and realizable market opportunity.

The recent results of the Medtronic IN.PACT SFA trial study revealed that patients with peripheral artery disease in the SFA experienced significantly better outcomes at 12 months after treatment with IN.PACT Admiral drug-coated balloon than patients with standard balloon angioplasty.

Most noteworthy are these two findings. Clinically driven target lesion revascularization, or the rates of clinically driven reintervention at 12 months were only 2.4% for the drug-coated balloon treatment group and 20.6% for the PTA group.

The Second, primary patency rates, or the restoration of adequate blood flow, were 82.2% for the DCB treatment group and markedly above the 52.4% for the standard balloon angioplasty group. These dramatic and clinically significant results are likely to enhance the value of the emerging drug-coated balloon market by lending additional credibility to the efficacy of drug-coated balloons to treat atherosclerosis in peripheral artery disease patients. These data clearly position DCBs as a better alternative than balloon angioplasty in the superficial femoral artery and a viable contender to be considered versus stents.

Here at SurModics, one of our internal benchmarks has been the SurModics IN. PACT Admiral drug-coated balloon. And so far in bench and preclinical testing we continue to be very encouraged by the performance of our paclitaxel drug-coated balloon with respect to the efficiency of drug delivery to tissue in preclinical testing. Of course additional clinical testing is needed to compare the clinical performance of these devices.

During quarter two we continue to devote substantial efforts to characterizing and developing the coating process parameters on our balloon catheter platform. This involves, as you recall, testing and characterization on multiple balloon catheter sizes, diameters and lengths.

It also means substantial retesting at each step of the way to ensure our drug delivery capability in preclinical confirmatory studies so that the previously characterized coating technology continues to perform as expected as we drive to a narrow process window. This work will continue into Q3. Our goal here is to freeze the design, the formulation and the process specifications in our fiscal fourth quarter.

By the end of our calendar year 2014, we aim to start a GLP safety study. First human use appears more likely to be in early calendar 2015. As you know we had previously had targeted the end of calendar 2014 and characterized these as aggressive though achievable targets that represents key milestones in this major value creating program.

Our planned R&D budget for fiscal 2014 included the contingency for investing in the early part of clinical trial preparation for the drug-coated balloon program if we could accelerate into the first human use of the device in calendar 2014. We do not believe that this investment will occur in fiscal 2014 but instead will be pushed into fiscal 2015.

As a result we have reduced the forecast range of R&D expenditure to be between 7% and 9% growth over fiscal 2013. In addition, the SurModics team continues to be very efficient and effective in our investment in the new product development part of R&D.

Our corporate development activity remains robust. We are actively scouting for the best opportunities that fit our strategy for both core business growth and core expansion. While there's nothing more to share at this point, be assured that this is a high priority with a high internal standard.

Let me reiterate what I have said previously. 2014 will be both a challenging and exciting year for the Company, challenging as we face continued industry headwinds in our respective core businesses and exciting as we work through both the opportunities and the risks to put SurModics front and center in providing a solution to a huge and now even more acknowledged clinical need.

Although drug-coated balloon the project is a difficult and complex technology endeavor it is one where we believe we can create the best product and technology combination with the potential to be the market leader with the right strategic partner. Operator, this concludes our prepared remarks. We would now like to open the call to questions.

(Operator Instructions). Jan Wald, Benchmark Company.

Good afternoon, everyone. I guess I have a couple of questions.

One of them on the drug-coated balloon. I guess in terms of thinking about your strategic partner and the likelihood that you will find one and the likelihood that you will find one in time, could you give us a little sense of how things are going in terms of finding a strategic partner and when you think they're going to come onboard? Is it going to be when the first in man is done, or before that, during that? Help me understand when that's going to happen.

Some of that, Jan -- thanks for the question -- some of that we certainly are continuing close discussions with multiple partners. Some of that depends on both the partner and SurModics.

From our viewpoint it depends on the value and the return at different points in the project for our shareholders and in addition it depends on what evidence the strategic partner will need to provide that value. Currently, we are very comfortable as a company funding our way through the first in human trial. And certainly if there is more interest that meets our value curve earlier we certainly will entertain that, but our plan is to keep going and driving this program towards a first-in-human use.

Do you feel that there is a point in time where you get through the first in man, you get through or close to being through the first in man, you don't have a strategic partner, do you think that somebody can come in and lowball an offer at that point in time because they know that you're not going to want to take it further than that? How do you deal with that?

It's interesting. Given the recent clinical data, I heard the CEO of one very large and well-known company in their earnings call last week say it is no longer an option not to have a drug-coated balloon and I am adding the part in your arsenal.

In treatment of SFA disease those are dramatic reductions in target lesion revascularization, clinical driven target lesion revascularization that were observed. And even more so I guess the economic analyses, which are yet to come, will actually even, in my opinion, further position drug-coated balloons as a viable, economically advantageous improved clinical outcome.

And I think that really puts it on the map as something here to stay for anyone who wants to compete in peripheral vascular disease in the future. So we while you never say never, we believe it's the real thing.

Okay. I guess just one more question related to the drug-coated balloon.

The idea of doing a drug-coated balloon I thought was an exceptionally good idea but unless this is a one-trick pony there's other things that you're going to want to do to create a value proposition like you have with drug-coated balloons. What other areas are you thinking about down the road?

So we see the drug coated balloon at the project as the first child of many. And in fact it is probably one of the on the more difficult part of the spectrum of things that we could try.

But it really is a platform for us. And so when we say drug-coated balloon we are actually talking about a particular product application of a platform that we have developed which we call [exitin] mediated drug delivery.

And this platform, I may have mentioned it in the last call, we're actually making nice progress on our sirolimus version of the drug-coated balloon. It is unique to have the same platform be able to deliver multiple drugs.

That is much much more early stage. I don't want anybody to read much into that. But beyond that with a drug like sirolimus and paclitaxel, it gives us multiple anatomical sites that we can target this drug delivery with multiple types or genres of balloon catheters.

And certainly AV fistulas, small vessel bifurcations. Below the knee is a more challenging environment, it might actually be a slightly different disease. But we now have optionality to do expansion with this platform.

Our first SFA balloon catheters, and 0.35 catheters, certainly we believe they can be put on an 0.18 catheter to treat deeper into the popliteals and even an 0.14 catheter to go below the knee. So there's a range of expansion from this platform that can keep us busy for a very long time and they are all very large addressable markets.

Okay, I understand. One last question on the IVD business, I understand where order patterns can affect the results but in the longer term how do you get that business to grow faster than the low single digits?

We are somewhat open to the scale of that business as it stands currently where small difference in orders can have a big impact on revenue growth. And so one of the things we have to look at is we certainly have organic growth in product development as a viable part of our growth strategy.

It really is positioning that business to be more into the higher growth electrodiagnostics segment. As we listen to the earnings call the customers in the protein-based amino acid, they utilize the growth segment, 2%, 3% growth is a good day. So really positioning through A) organic product development and through B) potentially strategic acquisitions to both provide scale and positioning in a higher growth market is how we look at.

Okay, and do you see -- what is the timeline for getting growth of that business? It sounds like it's a longer-term proposition than a couple of quarters?

We expected to stabilize in Q3 and Q4.

That's correct.

But we still have to overcome the architecture of that low single-digit growth that we are seeing in that customer base. And so that will take a longer time beyond Q3 and Q4.

Okay, thank you very much.

(Operator Instructions). Ross Taylor, CL King.

Hi, I might have missed this in your prepared remarks but could you review what some of the causes were in the delay in putting the drug-coated balloon into a first in man clinical trial?

Yes, absolutely. The first one was we were very aggressive. And when we first started in Q1, as you recall, we had made the switch to say we are going beyond just a drug-coating technology and we were going to put on our own preparatory device.

And so what we didn't want to do is risk under funding this year if we were able to meet certain when I call greenlight milestones where we had green lights all the way and be trapped in Q3 and Q4 without the investment mechanism to prepare for a clinical trial. So some of it was just aggressiveness. If we wanted to have money on hand so that if we hit those green lights we can actually move into clinical trial.

I would characterize -- I wouldn't characterize all of it as a delay. The second thing is the share test matrix of work to freeze the product design and the process design and each time we make a change that makes the product more manufacturable in 10,000 to 50,000 quantities we have to go back and check that we haven't lost the drug signal along the way.

So every time we make changes we do a preclinical study. And we have done, I don't want to say how many preclinical studies, but we have done a substantial amount of preclinical studies.

So really what it amounts to is the clinical trial prep, the contracting with clinical trial sites, the building of the inventory for that, that is not going to be spent in fiscal 2014. And so that's the quarter difference that we see.

Okay. All right, that's really helpful. And also, I just wanted to make sure that changing your revenue guidance, that's all driven by the revised expectations for the IVD business, is that correct?

Ross, this is Andy, that's correct.

Okay. And my final question is, it seems like you had good performance in your cardiovascular division and your royalty revenues did pretty well. But I just wonder have you seen anything different or any changes in the performance of some of the end markets for the products that generate royalty revenues for you?

We are always open to the vagaries of the coronary segments and that is something we continue to watch. It seems to have stabilized in the last couple of quarters.

And there's always price competition and price reductions on any of our customer lines that we continue to watch, some of them in the Far East though, so in Japan. But we -- and so as we look at that -- this quarter's performance was nicely impacted although also by the launch of a pretty major peripheral vascular device that we actually had to help that customer in our coating services area. Though if that product continues to perform well we are happy for it.

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

I'd like to turn the conference back over to management for closing remarks. Please go ahead.

Let me reiterate that fiscal 2014 continues to represent an exciting opportunity for SurModics to continue our profitable growth even during a challenging market and while we increase our investment and opportunity for core expansion. I want to thank everyone again today for participating in this quarter's conference call. Thank you.

Thank you. Ladies and gentlemen this does conclude our conference for today.

Thank you for your participation. You may now disconnect.