Surmodics Inc (SRDX) 2016 Q1 法說會逐字稿

Good day, everyone, and welcome to the SurModics first-quarter 2016 conference call. Today's conference is being recorded.

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

Thank you, Anthony. Good morning and welcome to SurModics' 2016 first-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.

We will also refer to non-GAAP measures because we believe they provide useful information for our investors. Today's news release contains a reconciliation table to GAAP results.

This conference is being webcast and is accessible through the Investor Relations section of the SurModics website, where the audio recording of the website will also be archived for future reference. A press release disclosing our quarterly results was issued earlier this morning and is available on our website at www.surmodics.com.

On today's call, I will provide an overview of our first-quarter financial results. Gary will then cover our key achievements, provide an update on the integration of Creagh Medical and NorMedix acquisitions, and discuss our growth drivers and strategies. Finally, we will open up the call to take your questions.

I will start with the financials. We are pleased to report that revenue for the first quarter of fiscal 2016 rose 16% to $16.5 million compared with $14.2 million in the first quarter of last year. First-quarter revenue included $0.5 million from our recent acquisition of Creagh Medical.

On a GAAP basis, our diluted earnings totaled $0.19 per share compared to $0.27 per share in the prior-year quarter. Both the first quarter of fiscal 2016 and 2015 included a $0.02-per-share discrete income tax benefit from the renewal of the federal research and development tax credit. Fiscal 2016 first-quarter earnings also reflected a $0.20-per-share reduction from acquisition-related transaction costs, including investment banker fees, integration, contingent consideration accretion, amortization, foreign currency transaction, and other expenses.

We had indicated in our January 8 release and call that these items would be factored into our fiscal 2016 financial results. So the $0.20 is within our expectations.

On a non-GAAP comparative basis, quarterly earnings per share were $0.38 per share in the first quarter of fiscal 2016 compared to $0.26 per share last year, an increase of 46%. We delivered operating income of $3.9 million in the first quarter of fiscal 2016, down from $5 million in the prior-year period.

Operating margin decreased from 35.4% to 23.8% in the current-year quarter. The decline in operating income and margin reflect higher revenue, offset by acquisition-related expenses and intangible asset amortization.

Turning now to our two business units, in our medical device segment, revenues derived from our hydrophilic coatings, device drug delivery coatings, and balloon catheter products, revenue rose to $12.2 million, increasing 15% from the year-ago period. Excluding the Creagh Medical acquisition, the medical device segment revenue increased 10%.

First-quarter hydrophilic coating royalty revenue totaled $7.5 million, up 6% from last year. Reagent sales increased 3 million -- $0.3 million. The medical device customer research and development revenue rose $0.3 million for the quarter as a result of Creagh Medical acquisition and higher demand for contract coating services to support customer clinical trials and select product launches.

This segment generated $3.8 million of operating income in the first quarter as compared to $5.5 million in the prior-year quarter. Higher gross margin from revenue increases was more than offset by $2.8 million of acquisition-related expenses, amortization accretion, and foreign currency transaction costs.

For our in vitro diagnostics segment, first-quarter fiscal revenue totaled $4.3 million, an increase of 20% from a year ago. This year, the IVD business segment has realized exceptional revenue growth from sales of ours stabilization reagents, antigens, as well as BioFX-branded products.

Product gross margin for IVD was 65.4% in the first quarter compared with 65.7% in the prior-year quarter. This slight decrease mainly related to sales mix, as antigens, a product that we distribute, comprised a higher percentage of current-year quarter sales mix versus last year.

IVD operating income was $1.6 million compared to $1.1 million in the first quarter of fiscal 2015. Operating margin increased to 38.3% versus 30.8% in the prior-year quarter due to improved operating leverage from higher revenue and lower legal costs.

Now I would like to discuss our first-quarter fiscal 2016 revenue summary by category. First, our royalty and license fees, which are generated primarily in our medical device segment. This revenue category was $7.9 million, an increase of 9% from last year.

Second, product sales in the first quarter of fiscal 2016 totaled $7.2 million, up 23% from the year-ago period. This reflects higher reagent sales in our medical device segment and product sales in our in vitro diagnostic segment.

And third, R&D revenue was $1.4 million, up from $1.1 million a year ago. So all three categories posted solid gains.

As a percent of revenue, first-quarter R&D expenses were 22% versus 25.2% in the year-ago period. R&D expenses of $3.6 million for the quarter were up slightly from last year.

SG&A expenses in the first quarter of fiscal 2016 were 21.8% of revenue versus 24.9% in the prior-year period. On a dollar basis, SG&A in the first quarter of fiscal 2016 totaled $3.6 million compared with $3.5 million a year ago. The dollar increase reflects higher SG&A as a result of the inclusion of six weeks of Creagh Medical in our consolidated results, offset partially by lower spend in professional services.

Income tax expense was 34% of pretax income in the first quarter, up from 28.9% in the prior-year period. The increase in the effective tax rate for the quarter -- in the first quarter of fiscal 2016 resulted from nondeductible acquisition-related costs and contingent consideration accretion expense, offset by discrete tax items, including the renewal of the R&D tax credit in the first quarter of fiscal 2016. Without the discrete tax items in the first quarter, the effective rate would have been 40.8%.

Looking at our balance sheet, it continues to be strong. Our cash investments totaled $42.7 million at December 31, 2015. We continued to generate solid operating cash flow. Cash flow from operations was $6.1 million in the first quarter of fiscal 2016. Cash flow from operations was positively impacted by $2.4 million from the timing of a past-due customer payment that was paid in October.

We invested $0.4 million in property, plant, and equipment, and used net cash of $18.2 million to acquire Creagh Medical in the first quarter of fiscal 2016. Our current cash and investment balances, operating cash flows, combined with SurModics' $20 million line of credit provide adequate capacity to support our corporate strategic growth initiatives.

We are reaffirming our previously stated guidance for fiscal 2016. We expect revenue to range from $62 million to $66 million. Further, we expect diluted earnings to be in the range of $0.30 to $0.35 per share and non-GAAP earnings of $0.66 to $0.75 per share.

Let me repeat the assumptions that underlie these ranges. They are no substantial changes in the US dollar and euro exchange rate in fiscal 2016 from current rates; research and development expenses to be approximately in the mid-30% of revenue; SG&A expenses, excluding business combination-related amortization accretion and transaction expenses, are projected to be approximately in the mid-20% of revenues; and the income tax rate is now expected to be between 50% and 53%. This estimate has been revised from 39% to 42% of pretax income, as we have updated our estimate of nontax benefited items, including contingent consideration accretion and transaction costs related to the Creagh Medical and NorMedix transactions.

We estimate capital expenditures to be between $4.5 million and $5 million, including investments in the Creagh Medical's Iris facility. The operational and financial results from the first quarter were remarkable in the midst of two significant transformation acquisitions. Thank you to the entire team for your hard work and outstanding results.

And now I will ask Gary to share his perspective. Gary?

Thank you, Andy. I'm delighted at our SurModics' team performance in the first quarter. I want to thank them for the huge positive accomplishments in multiple areas. We hit our stride on all aspects of our strategic trifecta.

As you may recall from SurModics' last quarterly earnings call, I described our trifecta as, first, to transform SurModics into a whole products solutions provider of differentiated medical devices via organic R&D and corporate development initiatives. We successfully achieved major goals in this area. Organically, our R&D team reached a critical milestone in securing the IDE approval for an early feasibility study of the SurVeil drug-coated balloon to be conducted in the United States.

From a corporate development viewpoint, we acquired two best-in-class companies within two months, namely Creagh Medical and NorMedix, which we completed shortly after the conclusion of our first quarter. We believe that both of these acquisitions dramatically accelerate our transformation to become a whole product solution provider for our medical device customers.

The second pillar of our trifecta is to continue to generate maximum revenue growth from our core medical device coatings and in vitro diagnostic businesses. our scorecard here speaks for itself. We were able to drive significant double-digit growth in both of our core businesses, as Andy has just described.

And finally, our third pillar is to continuously optimize investments required for strategic transformation and long-term value creation, with the short-term generation of earnings. I call this balance. It is an essential element to successfully execute a strategy that aspires to both grow profitably, even while investing in transformation.

To achieve this balance at SurModics, we continuously adapt our investment of management focus, time, and resources based on evolving opportunities and risks to ensure a maximum return to our shareholders. Simply put, I am proud of our efforts in this optimization during this first quarter. It is a critical element that I believe really differentiates SurModics, and it is evident in our ability to invest in and accelerate transformation while at the same time delivering profitable growth.

Let's talk about our business unit performance. In the first quarter, our medical device, as Andy said, excluding Creagh, grew 10% versus the same quarter last year. This is because of the gains in royalty revenue, R&D revenue, and reagent revenue, as Andy noted.

I am pleased that we generated increased royalty revenue in our peripheral and structural health market segments from customer programs that we have worked hard to secure and support during these past several years.

Our coating services, or R&D revenue, benefited from high utilization by key customers of our short-run manufacturing programs to support either product launches or clinical trials. Our reagent revenue grew in conjunction with our royalty revenue, both an additional increase, we believe, by customers stocking up on inventories to some extent at their respective year ends. Creagh Medical contributed additional and very important revenue to help us grow 15% overall in the medical device business.

Our IVD business had an excellent quarter and grew revenues 20% versus the same quarter last year. We expanded revenues in our core product lines of protein stabilizers and BioFX substrates, as well as antigens. This growth stemmed from the combination of organic customer growth, revenue from new IVD customers, and successfully cross-selling current customers on our full suite of products. In addition, there was a change in order cadence from some customers who did not order within the same period last year. Importantly, IVD operating income grew by 49% due to this improved operating leverage.

I've not had the opportunity to discuss our acquisition of NorMedix on an investor call, so let's spend a few minutes on the strategic fit of NorMedix and its impact on where we are heading.

NorMedix fits our strategy for acquiring and integrating the assets and capabilities to become a world-class medical device innovator and product developer with its strong emphasis on independent and innovative device design and development in the area of vascular catheters. NorMedix's patented ultra-thin-walled braided catheter platforms and proprietary manufacturing processes, along with SurModics' new generation of lubricious coating platforms, creates a new and exciting capability to change the standard of catheter performance in all areas of vascular access.

In addition, there are multiple synergies between NorMedix and Creagh Medical. Creagh, as you recall, is our November acquisition of a balloon catheter design, development and manufacturing base in Ireland. Creagh will be also the scale-up facility to manufacture NorMedix's and SurModics' innovations and other specific programs. Creagh Medical will become our center of excellence for medical device manufacturing while SurModics' Eden Prairie, Minnesota, location will become a center of excellence to manufacture chemical reagents for both coatings and diagnostics.

A quick reminder on how the pieces fit together. We have four basic ingredients to access vascular anatomy and interventional medicine. These are guide wires, catheters, and balloon catheters, and a technology component, such as the hydrophilic coating. At SurModics' scale and size, we are unique because we now have best-in-class capabilities in three of these critical areas -- namely, coating technology, catheters, and balloons. While there may be others, I'm not aware of a company of our size that has this unique combination of skills and the ability to act with agility.

Our integration priorities for NorMedix are straightforward. We plan to combined NorMedix's capabilities in thin-walled catheters with SurModics' most advanced coatings to develop a portfolio of catheter-based products to enable access, support, and guidance to devices targeting the most difficult anatomical areas. Our aim is to attain at least one 510(k) product clearance per year of a very unique catheter-based product starting in fiscal 2017.

Our integration program is off to an excellent start. We are thoroughly pleased with how Creagh and SurModics are coming together culturally. While NorMedix has just closed, I expect the same. Both of these companies have incredibly talented teams up and down the organizations. In addition, with Tom Greaney, previously CEO of Creagh Medical, as our Vice President of Operations, and Gregg Sutton, previously CEO of NorMedix, as our Vice President of Research and Development, we have added two seasoned executives with excellent track records at the leadership level to complement our team. Tom and Greg and their excellent teams are a welcome addition to the SurModics family. We look forward to updating you on our integration progress in future quarters.

Finally, our SurModics SurVeil drug-coated balloon program continues with clinical trial preparations. We are on plan for the first patient enrollment by the end of March 2016. we have been working with the clinical sites and the lead investigators and their teams to obtain the site-specific approvals and agreements. We conducted clinical trial and product training at our first site in January. In the meantime, the viability and the magnitude of the opportunity for drug-coated balloons continues to increase.

In addition, we completed some seminal preclinical studies on our Sirolimus-based drug-coated balloon program in December that encourages us that the same excipient platform which looks at our paclitaxel drug appears to be quite viable with Sirolimus as well. We were able to maintain sufficient Sirolimus drug in the tissue to observe positive biologic effects of the drug on the arterial wall.

If this is true -- and we do have a ways to go before we can demonstrate that -- we may have the only balloon drug delivery platform that can work with multiple drugs. Sirolimus, as you know, may have unique potential in different anatomies compared with paclitaxel, such as coronary and below-the-knee arteries. We intend to continue our R&D efforts to assess the viability of our Sirolimus drug-coated balloon program throughout fiscal 2016.

I recently described our longer-term outlook for SurModics. Our objective is to generate consistent revenue growth in the midteens on a constant currency basis and EBITDA margins greater than 30% within three years. We will meet these goals by successful execution in the following three areas.

First, we need to fully harness the potential of our drug delivery capabilities, starting with the SurModics SurVeil drug-coated balloon platform and expanding to other relevant anatomical targets.

Second, we're going to develop a well-stocked and productive medical device research and development pipeline that leads to multiple differentiated new product introductions and uptakes by our strategic customers. Both Creagh Medical and NorMedix have given us a huge head start with their current portfolio of products and provide significantly more opportunities for the R&D pipeline development, especially in 510(k)-type regulatory products, to offset the intrinsically higher risk in our device drug delivery platform.

Third, as we demonstrated in a big way this quarter, we must continue to grow and develop our SurModics' core medical coatings business and diagnostics reagents businesses. We believe that net of the patent expirations, the intrinsic growth of these businesses is consistently in the mid-single digits with greater than 30% operating margins.

I'm excited about our future at SurModics for several reasons. We're off to a strong start in the first quarter of fiscal 2016. Our acquisitions of Creagh Medical and NorMedix positions us ideally to make substantial progress on our transformation agenda in fiscal 2016 with real-world and actionable tactics. We are making important progress on our drug-coated balloon program, and we continue to exceed our growth strategies in our core medical coatings and in vitro diagnostics businesses.

We have put together all of the right ingredients for an agile company, with technology, balloon design, catheter design, and the manufacturing. And I am confident in our ability to use these for our long-term advantage to generate consistently attractive financial results.

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

(Operator Instructions) James Sidoti, Sidoti & Company.

So, very impressive quarter. It seems like, based on the guidance, about half of the earnings for the year came in the first quarter. Is that accurate?

Well, Jim, if you look at the first quarter and pull the pieces apart here, one of the things we provide in our guidance is that we are expecting R&D to be mid-30% of revenue for the year, and we are at 22% for the first quarter. So if you look at that run rate, we were at somewhat of a deficit of about $2.2 million in the first quarter. So you add it onto that, we also have the third-generation patents that expired in November. We will start to feel those impacts here in the next quarter, in the second quarter and more in the third quarter. We think that we have quantitatively and qualitatively gotten our arms around those numbers.

But that, combined with the deal costs and accretion that's expected, amortization expenses will probably be close to $2.6 million accretion, probably $1.4 million. We've got a lot of pieces that are now coming online in terms of expenditures that we had provided in our guidance on the 8th of January. So that provides you some perspective in terms of the EPS numbers and what they mean for the rest of the year.

Okay. So that amortization, $2.6 million for the year -- that includes both acquisitions?

That is our current estimate of that. We are still completing the NorMedix purchase price allocation, but our preliminary estimates would suggest we are in about the $2.6 million range.

Okay. Okay, so roughly $900,000 a quarter for the next three quarters?

Yes. I would say that it would probably be closer to about $750,000 to $800,000.

Okay. All right, and can you repeat what you said about the tax rate going forward?

The tax rate for the entire year will be in the 50% to 53% category. And the reason it's that high is that we have a couple pieces. The accretion of the contingent consideration is not a deductible expense. And the second piece is that in Ireland we have an NOL. And as we amortize the intangibles, we don't get a tax benefit at this point in time. So, those are a couple of the big drivers.

In addition, we will have some incremental deal costs in the next couple quarters as we wrap up these acquisitions and some of the integration work. Some of that will be deductible and other parts will not be deductible.

But in the aggregate, as we look at that, our current estimate is 50% to 53%. And we will be doing some additional work here over the next quarter to further refine that.

All right. So if we look at R&D, and you said that was lower than it's going to be for the rest of the year, it was also lower than it was in the fourth quarter of fiscal 2015. Is that just the timing of the trial and that type of thing?

Some of it is the timing of the trial. Some of it is, as I said, Sirolimus program is a very active program. And sometimes you converge quicker than you thought you were going to converge on the data that you need. I think some of it is we had hoped to have probably had some of these acquisitions on board maybe a little bit earlier in terms of our searching. And so, turning on the tap to actually get the synergies between our technology and the device capabilities of these both companies, we are getting to that now in our second quarter going forward.

And then similarly for SG&A, that also was lower in the fourth quarter than it was -- I mean, lower in the first quarter than it was in the fourth quarter, despite the acquisition, which surprised me. Is that the legal expense that was a big factor there?

No. I think that was primarily just true-ups at the end of the year based upon the results for stock-based and other incentive compensation.

Okay. And then more of a big picture -- can you just help explain how these two deals fit? I understand how Creagh fits with the current drug eluting balloon platform you are working on. Now, will NorMedix help with the delivery system for the balloon? Or will that be a separate product launch?

NorMedix can certainly help with those things. I think NorMedix is -- the first priority is they have some really unique catheter technology platforms, separated catheters. And so they can go with very ultra thin-walled, kink-free catheters that give you almost a 1-for-1 talk even when they are very flexible. So that's a big trade-off in the industry. I think I may have said in the past that you want the talkability of a broomstick. So when you turn one end of a broomstick the other end turns. But you want the flexibility of a rope, and those trade-offs are very difficult to achieve at the same time.

NorMedix -- we believe, in our diligence and looking at their technology, has that capability better than any other catheter company we clearly are aware of. Now, when you take that and some of our uncommercialized next-generation molecules that SurModics is working on [in coatings], you combine those two, then you have the ability to actually remove one of the other trade-offs of these catheters, which is the lubriciousness to be able to slide and for access and the tightness of the fit in the vessel. And, in some [torturous] vessels, retrieval of these catheters like in the iliac is very difficult as well.

So now what we are excited about is being able to put the best-in-class lubricious technology with a pretty unique catheter platform to get a range of catheter devices throughout the body. If you start with just introduces, start with access sheets, guide sheets to support catheters or the catheters that are required for CTU support. And the way it fits together is, because we work so tightly with our over 100 interventional vascular customers, we have a keen awareness of the holes in their portfolio and the trade-offs that they have to make and do their device design.

So with some a priori knowledge we -- and I wouldn't be giving full clarity on this until later in the fiscal year, partly for competitive reasons but partly I want our team to take some time to digest what the first product opportunities should be. But NorMedix is very clear. With our technology, this is a combination that could create some very differentiated catheters.

Creagh has a couple plays. And in fact both these companies ended up knowing generically about each other during the diligence, and they actually got very excited. In fact, if we had not closed the NorMedix deal, I believe Creagh was still going to work with NorMedix to actually get some innovative products out.

Creagh has two purposes. Creagh, as an independent peripheral balloon innovator, is astounding. Then you also have the quality systems and then the manufacturing facility there.

So as we look at Creagh in terms of with the NorMedix interaction, NorMedix can't really scale their devices up beyond very, very short-run manufacturing. So the Creagh-NorMedix team even today, even actually as I'm speaking right now -- some of our team from Ireland are here -- are working to see how -- when we are successful with the NorMedix devices, how do we scale that up in Ireland? So there's a big interaction there.

When it comes to device innovation, and I'll give you some of the holy grails that are still left in vascular medicine. Someday, someone is going to want to treat below the knee with radial access in the arm. And that's going to put a lot of stress on the delivery systems, the catheters, the guide sheets, the access sheets, the supports. It will put a lot of stress on the catheter part of the balloon catheter.

So recall, a balloon catheter is a balloon at the end. (technical difficulty) What connects it to the hub -- it's actually a catheter. So we actually see having those pieces and, then, the technology component to snake your way through and potentially have an actual lubricious coating, low particulate, very durable and then potentially have a drug on it.

And so, some of these things, while some of the big strategics have these capabilities, what I like about SurModics is we're small enough to have all of the capabilities and also quick enough to move very quickly in those innovations. So that's how it plays together.

The last thing I'd say is SurModics has a deep competency in research and in reagent and wet manufacturing. Neither of those are going to go away. That's what helped bring us to this dance here.

And so, our research teams have continued to innovate on drug delivery, new molecules, anything where there is a surface interaction in the human body, which is every device that's put in the body, will remain a core part of our R&D. So we're not just going to what's pure D. The R part of our R&D is going to be very vital, plus the center of excellence for manufacturing on the reagent side.

So it really hangs together very well for us. Now we have got to go execute.

All right. And the last question is, in general, what will the strategy be going forward? Will you decide what device you want to build and then go out and try and sell it? Or are you going to start working with your customers now to figure out what they need and then work on those specific projects?

We always, always will be working with our customers. I think what we have to offer our customers now -- recall, any of our customers have had to retrench their R&D to focus on some really core therapeutic areas like valves, like drug-coated balloons. And a lot of white space is left in interventional medicine that they are saying to us, look, bring us products that are clinically, technically and regulatorily derisked. Bring us a whole product solution. Ideally, that's sterilized, packaged, labeled and doc to stock.

Creagh actually does sterilize batch-labeled products that don't have their brand in it but have strategic brand names on it. So they are already leading the way on that. So the short answer is yes, identifying with our customers their wants and needs and the holes in their portfolio.

But the other thing we have an advantage now is we can look beyond just asking our customers what they need. We can actually look for the clinical solutions, continue to work with our customers and potentially solve some of the problems that they didn't think are solvable. And so, that will always be a hallmark of how we work with our customers.

All right, thank you.

Ben Haynor, Feltl and Company.

You mentioned looking at getting one or more 510(k) approvals annually starting next fiscal year. As we look at towards let's call it 2020, could that be a half a dozen or a dozen? And should we expect any PMAs potentially mixed in there?

One a month? Is that what you want?

No, that would be great.

Clearly, it's a flywheel we are setting in motion. Right? And as you know the old saying goes, the first turn you put your shoulder into it, and the first turn is going to take some time. But clearly, my objective is to have a continuous series of 510(k) products with smooth product launches to our customers.

12 -- one per month is -- now we're probably going to set a new goal for our R&D team after hearing that. But clearly, we will start with one per year because we are starting somewhat from Ground Zero right now. And so we'd like to get our first one out as quickly as possible in calendar 2017.

But as we build that flywheel momentum, I don't see any reason that two to three per year are not within our wheelhouse. And keep in mind, even small white spaces in vascular medicine are $50 million to $150 million to $250 million markets. So we are not talking about something that's going to play in a market that's $5 million.

So that the amount that we get is going to be that optimization, Ben, of say we want midteens growth and we want greater than 30% EBITDA margin. And so the reinvestment strategy and our success in that -- if it takes more talented engineers and R&D people together so that, and that reinvestment makes sense, you will absolutely see us do it.

Okay, great. And that answered my second question as well. These aren't going to be $20 million of sales for the customer. Now, are there any circumstances where you might have a customer who has a vascular product that is inferior, for whatever reason, to their other competitors that you would go and try and develop a product in that category? Or is it solely going after these white spaces you talk about?

I think our nature is to really go create and break new ground. Certainly, as customers have requests -- and as our key customers, if they come to us and say, you know, we really want to get more competitive in this line, we are clearly going to consider it. But the thing about SurModics R&D and just for me personally is I don't want to see us doing things that are slightly better than. As some of the members of our Clinical Advisory Board have told us, look, there are 12 sales reps in the hallway outside a Cath Lab saying they are slightly better than the other person.

And the view of SurModics is, get us something that clearly is a step above. And I know those sound like fighting words, but that's at least going to be our goal and our target.

Will we ever do something that's slightly better than, for a key customer? I can't say no to that. It depends on the deal. But I think our bias is to really go create a new standard in some of these products that were previously unachievable. And as I said, towards the end of this fiscal year I could start laying out more clarity on that. I'd like to tell you what I think now but I know our R&D teams want me to shut up and give them time to percolate properly.

Okay, that makes sense. These products sound like they can be the triples and home runs that you've talked about on past calls, as they get approved and (multiple speakers) --

Yes, and especially without needing to do the long-term PMA investment. Right?

Yes, that makes sense. And then lastly, for Andy, the tax rate being higher this year -- that's understandable. But how does that look as we get into fiscal 2017 and beyond? Are there advantages that you can take, due to the Irish location of Creagh?

Right. Well, I think there's a couple pieces there, then. One, we won't have any transaction-related costs that are nondeductible. So, we will get some benefits there. And then you start to think about Ireland; they do have net operating loss carryforward. So in the GAAP financials we most likely will not have any benefit if they -- no matter what sort of expenses or profits they may have, for a year or two, until they get ramped up with the investment we are going to put in there.

So, you are not going to see any, I would say, GAAP sort of benefits coming through in Ireland for at least a couple years. Probably from a cash standpoint we won't be paying taxes there for quite some time.

Okay, great. That's all I had, gentlemen. Thank you very much.

Charlie Jones with Dougherty Markets.

I'll just ask you one question, hopefully. Is the product in 2017 not a balloon catheter?

The product we are contemplating with NorMedix would be more of a vascular catheter. Keep in mind, Creagh -- we haven't given a lot of headlines for that. Creagh is a balloon catheter developer, so they are continuously developing balloon catheters. Part of what Creagh will be doing with us is developing some balloon catheters for us as well as, in a sense, as an internal customer.

So, Creagh has regulatory approvals independently -- and we may have said this in the previous call -- in the US and in Japan and in the EU and CE Mark. So they are going to continue driving out innovation for their cadre of customers.

And so, that's baked into our deal diligence and their revenue growth plans. So I was speaking more of what the SurModics-NorMedix type contribution would be.

Creagh will also be taking advantage of SurModics Serene, for example, on their offerings to those customers as well. I could count those as new, but I feel like I'd be cheating because Creagh have those plans already but we are giving them the best-in-class coating. So it is new but it's not that we are working with Creagh from Ground Zero to develop a new balloon with them at this point.

Maybe I got more than I bargained for there. It sounds like they were already working on Sirolimus when you saw them and then you had something that could add to their balloon even better. Is that what you said?

No, Charlie. I am talking [IPO] of 510(k) type audits, nothing with drug delivery.

Yes. I meant when you were doing your due diligence on Creagh. And that's what I was originally talking about as well. I was talking about the NorMedix transaction, where you are talking about these 510(k) products.

So, I was just curious as far as 2017. It's a non-PMA product category. It sounds like it's non-balloon. You originally put this slide up that talked about being in three major vascular devices in the next, I think, three or four years.

Yes, 2020 [Vision].

Yes. And so I think you are going to allow yourselves, talking about a peripherals balloon there and maybe like another type of peripherals or coronary balloon, as two of those. But can we expect that at some point we will get a third category that is outside of balloon catheters that is a PMA type of device or a 510(k) device that will be a top 10 device that's non-balloon catheters, is the question?

Yes. When you go outside of balloon catheters, especially in the periphery and including drug-coated balloons there, there are other devices that are 510(k) capable that I think are very high-volume devices. And internally, the way I described when I say three of the top 10 innovations in vascular medicine by 2020, no pun intended -- 2020 Vision -- but I think of it this way. I think of a valve.

We may not do a valve. We do a really good valvuloplasty balloon, potentially. We have that capability in our technology that if there's a major customer need, we will. But when I think of vascular innovations I'm not only thinking of the high-techy drug-coated balloons, valves, clot retrievers and neuro -- stroke thrombectomy devices and stuff. What I'm talking about is devices that are used every day to treat tons of patients that actually are not well optimized. And still getting below the knee is still difficult. Getting below the knee, for example, with radial access is presumably a lot better for patients. It could be a lot better for healthcare costs because you can treat bilaterally with these patients with diabetic diffused disease.

And so I would count something like that as an innovation. It may not be a PMA, but it's going to treat maximum amounts of patients with minimizing healthcare costs dramatically and having better patient outcomes. So I believe, first of all, three out of the top 10 is absolutely achievable. The trick is, we're going to have to be working on more than three to be able to get three by 2020.

Right. I'm going to ask another one. Sorry, everybody. So, you were a leader early on in stent drug delivery. There's a lot of little companies that have started over the years that probably got scrapped over the years as a result of different issues, funding issues.

And I guess I'm curious, given your drug delivery technology why that wouldn't be kind of front -- can you just remind us of your agreements and your patents or your agreements mostly with Cordis or with others that may prohibit you in being able to do something there? Thanks; I leave it at that.

Yes. I'll tell you, when I first came here, clearly I looked at the drug-eluting stent world. And that's where SurModics had one of the major innovations with Cordis. And then I quickly realized that drug-eluting stents had, in some respects, passed us by. I wouldn't call it a commodity, but clearly some of the price pressures in some of those stents -- and first, it gets back in there. While we could have, I think we believed internally a drug-coated balloon being a new shelf, it's still early enough if you are in the top five or six, to be able to rewrite the rules. In drug-eluting stents we have to play according to the rules that have already been written, just strategically speaking.

But as far as our drug delivery programs go, and that's what I was trying to emphasize, our research programs are not going away. It may appear on a superficial level like we are shifting into purely device-driven 510(k) products. And that's not the case because the research programs of new molecules for coding and also for drug delivery are going to be a vital part of our portfolio going forward.

We are always looking -- as you say, some of these small startups and how well they do -- Tim Arens and the corporate development team are always counting for things that we believe will have viability, new technologies that could come into our fold.

So the short answer to your question is, it's going to be important. But as you all could tell, we wouldn't move until we find something that we feel very, very comfortable with, such as with Creagh and NorMedix. It may have taken two years, but we feel very happy for having the discipline to wait to find these two companies. The same is going to be true going forward.

Thanks, Gary.

Jan Wald, with Benchmark Company.

Most of my questions have already been answered. But just a couple of things, maybe more like a follow-up than anything else.

In terms of the SurVeil platform, and maybe even the whole idea of product solutions, people talked about how you are getting -- or asked questions about how you are getting ready to do it and what your strategy is. But on the flipside, are you feeling as if the strategics are interested in what you are doing? And do you have anything that you could talk about in terms of progress or interest levels that would make people believe that the build it as it comes -- build it and they will come strategy is working or will work?

Yes. First of all, the interest level has remained consistently high. A lot of the large and medium-sized strategics -- the development of drug-coated balloons continues to grow. Drug-coated balloons are taking share from other device categories.

And the one example, Jan, I may have mentioned to you is when the long lesion data, the impact long data came out in May of last -- at PCR, Euro PCR, the fact that on lesions of the 25 centimeters, plus or minus 9 centimeters -- those are lesions that are about a foot long that a drug-coated balloon as the single -- primary angioplasty followed by a drug-coated alone as the single treatment got rated the 90% freedom from target lesion revascularization. It really calls into question what are the devices that you need to treat the SFA? Certainly, for calcified lesions you may need oophorectomy or types of stents.

So, as a result of those type of things, the interest in drug-coated balloon continues to actually increase because of the market need and I would frankly say the competitive need among strategics. I think the issue that many of them have to deal with, without clearly naming names or anything like that, is that there's the optimum of saying I need something to grab and go, to get to market, versus I need the best-in-class product that's eventually in the right sales and marketing channel hands would actually win the market. And so that's always the ongoing tension.

We are clear in who we are with the strategics. We intend to be the best technology and demonstrate the best patient outcomes. And what we are offering to strategic as we finish these trials is a data package that clearly demonstrates that if they want to be the number-one drug-coated balloons, we are the only choice. If they want to be second or third in drug-coated balloons, we're not going to be able to do that. We are clearly not at that level right now. But we have an undying belief that in vascular medicine the best in market will win; and given the long-term viability of this market, that that sets us up nicely with a lot of the strategics.

Okay. And playing a bit of maybe a hedge fund manager or Carl Icahn here, the IVD business -- is that -- how long is that going to be a strategic fit for you guys? I guess that's the question.

Well, it is a strategic fit. Andy?

It actually does. It is a nice job of covering our corporate costs. But they grew 20% this last year -- this last quarter, I should say. And in the near term we see that it will continue to have nice growth. Later in the year we expect that growth to diminish, especially in the third quarter, after -- we have a 13% compound the prior year that we are dealing with.

But it's a nice business. And you've seen it grow well in the last really 18 months. And really it has to do with the management team there. We've got a great management team there. They are really focused on the market. They really have done a nice job of putting some niche products out there. And quite frankly, they are weighing share.

If you look at the overall market, it's growing at 3%. And they grew at 20%.

And we also expect this in the second quarter to see our slides business, our molecular diagnostics business, have a nice little boost as well. So, I think the business is still very core to who we are as a company. And keep in mind the fabric of the medical device segment really came from the diagnostics group many, many years ago. And it covers a lot of fixed overhead. And rightfully, by itself, with 38% operating margin, is doing very nicely for the company.

And one thing -- and this may sound counterintuitive. But as we look at our corporate development strategy, clearly we continue to look at opportunities in that space because, quite frankly, they could be easier to execute and get an actually could be probably -- I don't want to make a promise on it, but probably very quickly accretive as well. And in the interim, so -- it wouldn't be surprising to see us look to get that business, get a couple of small acquisitions done and get it to what I would call a more stable scale.

The IVD business is terrific. But if a customer misses an order in one quarter or, on the other side, if a customer has an extra order come in, you sort of want to smooth that out so that we are not being whipsawed around. And some strategic scale of products that are complementary there, given that we have an excellent management team, it's not out of the question.

Okay, thank you very much.

And we have no further questions in the queue at this time. I would like to turn the conference back over to management for any additional closing remarks.

Well, thank you for all of your questions. We are pleased with our recent acquisitions and initial integration moves. We expect fiscal 2016 to accelerate our transformation to delivering whole product solutions to our customers. It will be an exciting year for SurModics.

We look forward to speaking with you in our second-quarter earnings call. Thanks, everybody.

That does conclude today's conference. Thank you for your participation.