SurModics' CEO Discusses F2Q2014 Results - Earnings Call Transcript

May. 1.14 | About: SurModics, Inc. (SRDX)

SurModics, Inc. (NASDAQ:SRDX)

F2Q2014 Earnings Conference Call

May 1, 2014 5:00 PM ET


Andrew D. C. LaFrence – Vice President -Finance and Chief Financial Officer

Gary R. Maharaj – President and Chief Executive Officer


Jan Wald – Benchmark Company

Ross Taylor – C.L. King & Associates, Inc.


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 parties will be in a listen-only mode. Following the presentation, the conference will be open for question. (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.

Andrew D. C. LaFrence

Thank you, Katia. 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 on our website at

On today’s call, I will provide an overview of our financial results, highlights for the second quarter and update our outlook for the 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 please 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 or 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 a larger business and contributed approximately three quarters of our total revenue. Revenue from this business which is drive from both hydrophilic coatings and device drug delivery coatings rose to $10.5 million, increase in 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 coating royalty revenue increased 3% to $7.1 million, compared with the 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 in R&D, which was partially offset by higher plan drug coated balloon research and development expenditures.

For our In Vitro Diagnostics unit, 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 thirteen consecutive quarters of year-over-year revenue growth we were surprised by the drop. Let me mentioned I 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 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 units, offset by a lower sales of our diagnostics products, including IVD BioFx branded substrate stabilization enhanced in shipment. 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, an increase 12% from last year. The increased stems from previously noted $0.9 million in non-cash charge related to amendments to Board of Director equity compensation, offset partially by a lower professional service cost. Excluding stock-based compensation for both periods SG&A expense is decreased 10% in the second quarter of fiscal 2014, compared with a prior year period. This decrease is driven by discipline in focus supports 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 up $4.1 million for the quarter rose 10% from last year, resulting from planned investment 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’ve 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 pre-tax income in the second quarter, compared with 21.2% in the prior-year period. The second quarter of fiscal 2013 includes one-time discrete income tax benefits by totaled $0.4 million.

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

Let’s now turn to the six months results; revenue for the first six months of fiscal 2014 totaled $27.5 million, unchanged from last year, which included one-time $0.6 million catch-up royalty payment. Excluding this payment revenue under 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 deliver 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 31% in the first six months of fiscal 2014 compared with the prior year period excluding the fiscal 2014 one-time director of compensation charge and this fiscal 2013 one-time royalty payment. Earnings in the first six months of fiscal 2014 and 2013 will also impacted by a gain and one SurModics strategic investments.

The Company realizes a $0.7 million benefit for $0.05 per share in the first six months of fiscal 2014 resulting from a clinical milestone earnout associated with a fiscal 2013 sales Vessix Vascular to Boston Scientific. In the first six month of fiscal 2013 the Company recognizes $1.2 million gain or $0.08 per share under Vessix sale.

Pro forma earnings per share gross $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 continued to generate solid operating cash flow. Cash flow from operations was $5.9 million during the first quarter of fiscal 2014. We also received $0.7 million milestone payment related to Vessix, and we invested $28 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've 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 of 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 in 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 guide 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 activity 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 would like to turn the call over to Gary for his perspective on our operations. Gary.

Gary R. Maharaj

Thank you Andy. Our second quarter results can be characterized in three grouping. The satisfying, the challenging and the promising. Let’s talk about each of these, first the satisfying. Our medical devise 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 all our particular sector of the industry.

Off 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 coding services provided in support of a pre-launch inventory build for our customers 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 sites.

On a consolidated basis quarter-over-quarter, our pro forma operating income was actually slightly higher, this despite is slight overall decline in revenue and an increased R&D investment. This represents continued disciplined expense management even as we choose 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. All IVD business experience significant quarter-over-quarter revenue decline. The major drivers of this appear to be reduction in order patents from several major U.S. customer and European customers. In addition, in the comparable quarter last year, we experienced a robust 15% growth held impart by an active influenza season in 2013.

We believe that some of decline in U.S. 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 in the second half of fiscal 2014. Even with this stabilization however and as I indicated in our Q1’s earnings call we will continue face below single-digit growth pressures of our IVD customer base for the remainder of this fiscal year.

Third the promising. All commercial development and coating services teams in medical device have been very busy helping our customers conduct feasibility trials with our SurModics Serene next generation lubricity platform. As you recall Serene offers significant advantages providing both lubricity and low particulates for interventional devices. The vast majority of the feasibility evaluation that we are conducting are with Serene, while most of these customer assessment still have to secure regulatory clearances and approval, 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 devices. We aim to build on modest success such of this to demonstrate Serene’s benefits of increased lubricity and reduced particulates to customer who thus far still use their older generations of the in-housing coating formulations.

Continuing in the vein of promising, lets 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. Reveal with peripheral artery disease in the SFA, experienced significantly better outcomes of 12 months, also treatment with In.Pact Admiral drug coated balloon. VAM patients with standard balloon angioplasty. Most noteworthy are these to 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.

Second, primary tendency 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 balloon to treat atherosclerosis in peripheral artery disease patients. These data clearly position DCBs as a better alternative to balloon angioplasty in the Superficial-femoral artery and a viable contented to be consider through suspect.

Here at SurModics one of our internal benchmark has been in the Medtronic 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 this efficiency of drug delivery to tissue in pre-clinical testing. Of course, additional clinical testing is needed to compete at a clinical performance of these devices.

During quarter two, we continued to devoted substantial efforts to characterizing and developing to 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 the drug delivery capability in preclinical confirmatory study. So, that the previously characterize coating technology continued to perform as expected as we drive to the narrow process window.

This work will continue into Q3, and our goal 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 GLP safety study. First human use of appears more likely to be in early calendar 2015. As you know we have previously had targeted the end of calendar 2014 and characterize these aggressive to achievable target that represents key milestones in this major value creating program.

Our planned R&D budget for fiscal 2014 included a contingency for investing in the early thought of clinical trial preparation for the drug coated balloon program. If we could accelerate into 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 into 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 is nothing more to share at this point, we assure that it is a high priority with a high internal spending.

Let me reiterate what I had said previously, 2014 will be both a challenging and exciting year for the company. Challenging of the phase continued industry head wins in our respective core businesses and exciting as we would through both opportunity and a risks to put SurModics front incent in providing a solution to huge and now even more acknowledged clinical need.

Although drug coated balloon project is a difficult and complex technology endower, 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 for questions.

Question-and-Answer Session


Thank you, sir. (Operator Instructions) And our first question comes from the line of Jan Wald with Benchmark Company. Please go ahead.

Jan Wald – Benchmark Company

Hi, good afternoon, everyone. I guess I had 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 strategic partner and when do you think you are going to come on board. Is it going to be the first remain is done or before that, during that, help us understand when that’s going to happen?

Gary R. Maharaj

Jan, thanks for the question. Some of that we certainly continuing close discussions with the multiple partners and some of that depends on some – both the partner and SurModics, from all of the point 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 toward a first in human use.

Jan Wald – Benchmark Company

Do you feel that there is a prudent time where – lets you get to the first I mean you get through or close to being to the first in man, if you don’t have a strategic partner. Do you think that somebody can come in and low goal and offer at that point in time, because they know that you are not going to want to take it further than that. How do you deal with it?

Gary R. Maharaj

Its interesting, given the recent clinical data, I heard one – the CEO of one very large and well-known in their earnings call last week say, it is no longer an option, not to have a drug coated balloon. And I’m adding the path in yours you know. And so in treatment of SFA disease, those are dramatic reduction in target lesion revascularization, clinical driven target lesion revascularization now observe.

And even more so I guess the economic analysis, 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 a map at something here to speak or anyone who wants to compete peripheral vascular device in the future. So well you never say never, we believe it’s very opaque

Jan Wald – Benchmark Company

Okay and I guess just one more question on this related to drug coated balloon. The idea of doing a drug coated balloon I thought was an exceptionally good idea, but unless a one trip pony, there is other thing that you are going to wanted do to create a value proposition that you have with drug coated balloons. What are the areas are you thinking about in terms of…

Gary R. Maharaj

We see drug coated balloon project as the first child of many and in fact its probably one that’s 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 – mediated drug delivery and this platform I may mentioned in the last call we actually are making nice progress on our sirolimus version of the drug coated balloon and its unique to have the same platform be able to deliver the multiple drugs.

Now that is much more early stage, I don’t want read much into that, but beyond that with drug like sirolimus and Paclitaxel, it gives us multiple anatomical sites that we can target this drug delivery with multiple types of balloon catheters certainly AV fistulas are small vessel bifurcations, below the knees is more a challenging environment, it might actually be a slightly different disease, but we now have optionally optionality to do expansion with this platform.

Our first SFA balloon catheters and 035 catheter certainly we believe it can be put on an 018 catheter deeper into the [indiscernible] and even an 014 catheter to go below the knee. So there is range of expansion from this platform that can keep us busy for a very long time and they are very large addressable markets.

Jan Wald – Benchmark Company

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

Gary R. Maharaj

we are somewhat open to the scale of that business as it stands currently where just 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 is a vital part of growth strategy, really its positioning that business to be more into the higher growth molecular diagnostics segment, where as we listen to the earnings calls of customers in the protein-based [indiscernible] growth segment 2% to 3% growth…

Andy D.C. LaFrence

It’s a good day.

Gary R. Maharaj

A good day and so really positioning through A organic product development and through B potentially strategic acquisition to both provide scale and positioning in a higher growth market is how we look at it.

Jan Wald – Benchmark Company

Okay. And do you see – what's the timeline for getting growth out of that business, so its sounds as it’s a longer term proposition than a couple of quarters?

Gary R. Maharaj

We expected it to stabilize in Q3 and Q4.

Andy D.C. LaFrence

That’s correct.

Gary R. Maharaj

But we still have to overcome to 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.

Jan Wald – Benchmark Company

Okay, thank you very much.

Andrew D. C. LaFrence

Thanks Jan.


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

Ross Taylor – C.L. King & Associates, Inc.

Hi, I missed that in your prepared remarks, but could you review what some of the causes where in the delay in putting the drug coated balloon into a first in man clinical trail?

Gary R. Maharaj

Yes, absolutely the first one was we were very aggressive and when we first saw that in Q1 as you recall, we had made the switch to say we’re going beyond just a drug coating technology and we were going to put it on own proprietary device. And so, what we didn’t want to do is risk under funding this year, if we were able to meet certain what I call green light milestones, where we had green lights all the way. And be trapped in Q3 and Q4 without the investment mechanism to prepare for clinical trials. So, some of it was just aggressiveness that if we wanted to do, have the money on hands so that if we hit those green lights, we can actually move into clinical trial.

So, I would characterize – so I wouldn’t characterize all of it as a delayed, the second thing is the share test metrics of would to freeze the product design and the process design and each time we make a change that makes the product more manufacturable 58,000 – 10,000 units to 15,000 unit quantity. 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 pre-clinical study and we’ve done I don’t want to say how many pre-clinical studies, but we’ve done a substantial amount of pre-clinical studies. So, really what it amounts to is the clinical trial tip, the contracting with clinical trial its like the building of the inventory for that. that is not going to be spent in fiscal 2014. And, so that’s the big – that’s the quarter difference that we see.

Ross Taylor – C.L. King & Associates, Inc.

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

Andrew D. C. LaFrence

Ross, this in Andy, that’s correct.

Ross Taylor – C.L. King & Associates, Inc.

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

Andrew D. C. LaFrence

Always open to bigger reset of coronary segment and that’s something we continue to watch it seems us stabilize in the last couple of quarters and as always price competition and price reductions on any of our customer lines that we continue to watch some of them in the far East so in Japan, but we – and so as we look at that this quarter’s performance was nicely impacted also by the launch of pretty major peripheral vascular device that we’ve actually had to help that customer in our coating services area. Sorry that product continues to perform well we were happy for it.

Ross Taylor – C.L. King & Associates, Inc.

Okay, right. That’s helpful, thank you very much.

Gary R. Maharaj

Thank a lot.


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

Gary R. Maharaj

Let me reiterate that fiscal 2014 continue to represent that exciting opportunity for SurModics. To continue our profitable growth even during a challenging market and while we increased 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.

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