SurModics Management Discusses F1Q 2011 Results - Earnings Call Transcript

SurModics, Inc. (NASDAQ:SRDX) F1Q 2011 (Qtr End December 31, 2010) Earnings Call January 26, 2011 5:00 PM ET

Management

Phil Ankeny - SVP, CFO
Gary Maharaj - CEO

Analysts

Ross Taylor - C.L. King & Associates
Ernie Andberg - Feltl & Company
Suraj Kalia - Rodman & Renshaw
Beth Lilly - Gabelli Funds
Daniel Owczarski - Avondale Partners

Operator

Good day, ladies and gentlemen, thank you for standing by. Welcome to the SurModics First Quarter 2011 Earnings Conference Call.

During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. If you have a question, please press star followed by the 1 on your touchtone phone. If you'd like to withdraw your question, please press the star followed by the 2. And if you're using speaker equipment, please lift the handset before making your selection.

This conference is being recorded today, Wednesday, January 26, 2011.

I would now like to turn the conference over to Mr. Phil Ankeny, Senior Vice President and Chief Financial Officer. Please go ahead, sir.

Phil Ankeny

Thank you, Camille [ph]. Good afternoon and welcome to SurModics fiscal first quarter 2011 conference call. Thank you for joining us today.

Our press release reporting quarterly results was issued earlier this afternoon and is available on our website at www.surmodics.com. Before we begin, it is my duty to inform you that this conference call is being webcast and is accessible through the Investor Relations section of the SurModics website where the audio recording of the webcast will also be archived for future reference.

I will remind you that some of the statements made during this call may be considered forward-looking. The 10-K for fiscal year 2010 identifies certain factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made during this call. The company does not undertake any duty to update any forward-looking statements as a result of new information or future events or developments.

Joining me on the call today is Gary Maharaj, our new Chief Executive Officer. As you know, Gary officially took the helm as CEO on December 27, 2010. He comes to us with 23 years experience in the medical device industry, most recently as CEO of Arizant, Inc.

During his tenure at Arizant, he helped to refocus and refine its core business which ultimately resulted in improved operating and financial results. In fact, under Gary's leadership, Arizant nearly doubled annual revenues to over $200 million in less than five years. Additionally, Gary brings a strong background in R&D leadership to SurModics from his earlier years as the head of R&D at Arizant and in various management and research positions for the orthopedic implant and rehabilitation divisions of Smith & Nephew.

As you listen to Gary's comments today, I believe the parallel between his accomplishments over his career and the opportunities here at SurModics will be quite evident. We are thrilled to have Gary onboard at SurModics and are excited to be able to leverage his expertise and leadership.

On today's call Gary will discuss his reasons for joining SurModics and provide his initial observations and a broad overview of his outlook for the company. Afterwards I will highlight financial results and key achievements for the quarter. I will also comment on our financial outlook for fiscal 2011. And finally we will open the call to take your questions.

With that, let me turn the call over to Gary.

Gary Maharaj

Thank you, Phil. It's my pleasure to join all today for my first earnings conference call with SurModics.

There are two things that I want to talk about today, first, why am I here? And second, I'll provide a high-level perspective of SurModics based on my initial observation. So let's talk about why I'm here.

When I first became aware of the opportunity to become the CEO at SurModics, I immediately became excited at the prospect of leading the company for several compelling reasons. I believe that the ability to improve a medical device by surface modification is an important and ever-growing need in healthcare and that SurModics has the leadership position in this technology.

Furthermore, I believe that a company with a competitive edge in cost-effective and clinically-relevant surface modification can have a major positive impact in healthcare. Finally, working with high-impact medical technology, seeing them help patients and in the process becoming commercially successful is personally important and rewarding to me.

After further diligence and discussions with the board and management, my interest grew because I felt a fit with the team and their keen interest in improving the financial and competitive strength of the company. Bottom line, I saw an opportunity to build upon SurModics' leadership position, its broad technology platform, and to work with its talented employees, all with the goal of having a positive impact in patient outcomes and creating value for our shareholders and customers both current and future.

Now it's been just over four weeks since I joined SurModics, and while I'm still getting acclimated, I've learned a great deal already from my interactions with employees and customers. My first order of business as CEO was to begin establishing trust and confidence with our employees, especially given the changes in the company during the past year.

've been impressed by not just the strength and quality of our employees, but their tenacity and desire to create a better future. I believe that our employees are proud of the work they do and are loyal to this organization. Importantly, they share my sense of urgency in restoring the 30-plus-year legacy of SurModics and returning our business to profitable growth. I'm enjoying working closely with them as we draw [ph] the future.

I've also had the opportunity to meet some of our customers, and as I discuss the business with them, I began to see some common themes that will align with my own point of view. Today, as we all know, our customers are faced with difficult decisions as they navigate an evolving regulatory environment, manage R&D with fewer resources and tighter budgets. Heightened competitive pressures and longer product cycle times have only compounded the situation.

So to compete effectively in this environment, our customers are looking for technology solutions to differentiate their product offering and to demonstrate a compelling clinical benefit. But equally important in the current economy, they need to justify the cost of product enhancement and new technology more so than ever before. Risk balancing act is having a profound impact on innovation as a whole for our customers and our business as a result.

However, I choose to look at these challenges of our customers as actual opportunities for innovation by SurModics. I also believe that difficult periods like this allow the best companies to distance themselves from their competitors, especially with innovative cost-effective new products.

So let me now share with you my initial observations about the future of SurModics that will help position this business for long-term success. I firmly believe in the thesis that sustained and profitable growth requires a well-defined and strong core as the foundation of the business. Our first task therefore is to tightly define SurModics' core business and its boundaries in terms of our customers, products and technology.

Now we will have to shape this based both on the areas where we have the greatest competitive advantages and the areas of highest growth potential for the company. Second, we're going to have to realistically assess the current strength of this core, once defined, by answering questions such as -- do we have competitive advantages within the current market segments for sustained profitable growth? Are there underserved segments within this core and the customers within the core that need our technology solutions? Are we going to require investment in our core technologies to strengthen our position? And is the cost and capital structure of the company in the best position to create profitable growth based on this core?

Now these are just a flavor of the questions that the board, the rest of the management team and I will need to carefully consider in the coming months to make sure we set the proper course for the company and its return to growth. That said, our business model is one where the growth issues are not going to be solved overnight. Our goal is to build a business that is capable of sustainable long-term profitable growth and shareholder value creation.

Prior to joining SurModics, my views of this business was just a few key decisions away from getting back on the right track. The board and the management team have already made the first decision which is to seek strategic alternatives for the pharmaceuticals business. I believe that the pharma business has sound long-term growth and profitability prospects in an appropriate strategic setting and financial structure. It is the aim of this process to unlock that value.

SurModics is ultimately a technology company whose strength is providing easy to implement technology and product solutions for specific customer needs. R&D is the critical path for our growth engine and will be a key area of focus for me personally. We will need to drive a deeper level of focus in our customers' problems and ensure that our R&D resources are properly deployed in solving meaningful problems in a manner that is profitable for both our customers and SurModics. As a result, I'll be working with our R&D teams to understand the opportunities and risks in the current portfolio of projects and to develop a plan for the future pipeline.

In summary, SurModics is at an important crossroads and I'm excited to be leading the organization and our talented team at such a critical time. By refocusing our efforts within a well-defined core, we have an opportunity, an opportunity to build upon our strengths that create sustainable long-term growth and shareholder value. During the coming months, I'll be working diligently with the management team and the board to develop the strategic plan, and I look forward to sharing this as more details emerge.

Now I'd like to turn the call over to Phil for a review of our financial results. Thanks.

Phil Ankeny

Thanks, Gary. I'd like to begin with some financial highlights.

For the first quarter of fiscal '11, revenue was $15.2 million, 2% lower sequentially. On a GAAP basis, diluted loss per share was $0.02. Non-GAAP diluted earnings per share was $0.05 per share. And cash flow from operations was $5.3 million. Please refer to our earnings press release including the supplemental tables for an explanation of our non-GAAP accounting.

Now let me return to our revenue lines. Royalties and license fees for the first quarter were $7.6 million, a decrease of 5% on a sequential basis. Recently, Johnson & Johnson reported its sales of the Cypher sirolimus-eluting coronary stent, were approximately $134 in the quarter, down 1% sequentially and down 40% year-over-year.

Product sales were $4.8 million in the quarter, up 4% sequentially. We continue to generate broad-based customer demand for our component in vitro diagnostic products as well as our polymers and reagent -- coating reagents.

Lastly, R&D revenue in the first quarter was $2.8 million, down 7% sequentially, reflecting continued softness in R&D spending by our customers. However, we have signed several new customer R&D programs in the past few months and they are starting to build momentum.

In October 2010, we announced a new organizational structure that reflects our three complementary but distinct business units -- medical device, in vitro diagnostics and pharmaceuticals. Accordingly, going forward, we will also break out revenue by business unit.

Let me start with our medical device business unit. Broad-based demand for our coating technologies has fueled substantial licensing activity in the medical device space. In the past five years, SurModics has signed more than 150 license agreements and more than 90% of them have been in medical device. We had a strong quarter of signing new licenses in the first quarter with nine new licenses, eight of which were in medical device.

We were also pleased to have five new product class introductions by our customers during the quarter. Our portfolio of licensed customer product opportunities both on the market and in our pipeline includes many exciting new medical device product categories including percutaneous heart valves, stent graphs, prohealing stents and many other minimally-invasive products in the coronary, peripheral and neurovascular markets.

Revenue in medical device was $9.8 million in the first quarter, essentially flat compared with the fourth quarter of fiscal 2010. Strong reagent sales were offset by a modest decrease in royalties and license fees.

Next let's turn to in vitro diagnostics. Our IVD business represents another source of stability and growth potential. Today this business derives virtually all of its revenue from sales of our component IVD products. Revenue in the in vitro diagnostics business unit was $2.7 million in the quarter, down 7% sequentially. This decrease was not unexpected and mostly reflects timing of customer orders. We are pleased with the broad-based customer interest in our product portfolio and we are gearing up for some new product introductions later in the year.

Lastly, our pharmaceuticals business generated revenue of $2.7 million in the first quarter, down 6% sequentially. Results for this business continued to be impacted by the challenging R&D environment. As I mentioned earlier, we have signed several new customer R&D programs in the past few months and we look forward to the favorable impact that these programs may have on R&D revenue in the future.

In addition, as we disclosed in December, reached the decision to explore strategic alternatives for our pharmaceuticals business, and we have retained Piper Jaffray & Company as our financial adviser in connection with the process.

On the expense front, R&D expenses for the quarter were favorably impacted by therapeutic tax credits we earned of approximately $800,000 or roughly $0.03 per share. SG&A expenses included approximately $0.5 million in expenses for certain non-recurring advisory services. Both of these items have been excluded from our non-GAAP earnings per share numbers which, as we stated earlier, came in at $0.05 per share for the first quarter. This compares sequentially to a non-GAAP loss in the fourth quarter of $0.05.

With respect to our full-year 2011 guidance, we expect to generate revenue in the range of $55 million to $63 million and non-GAAP diluted earnings per share ranging from a loss of $0.15 per share to positive earnings of $0.05 per share. Including anticipated non-recurring or event-specific charges such as restructuring charges and goodwill impairment charges, GAAP diluted earnings per share is expected to be in the range of a loss of $0.53 to a loss of $0.33.

Our performance in the first quarter was as expected and we reaffirm the guidance the company provided in November 2010. Moving forward, we are committed to driving improved results and staying on pace to fulfill our fiscal 2011 projections. Our medical device and in vitro diagnostics businesses continue to be steady performers both from a revenue and cash flow perspective.

We remain excited about the long-term potential of this company. Our balance sheet is strong and provides the company ample financial flexibility. Our cash and investments at the end of the first quarter totaled $59.7 million.

Lastly, before we open up the call to your questions, I'd like to ask to briefly discuss the agreement we reached with Ramius LLC.

As most of you are aware, during the first quarter we began discussions with our largest shareholder and reached an agreement regarding director nominations for the 2011 annual meeting of shareholders and other matters. As a result of that agreement, we welcomed two new members, Jeffrey Smith and Dr. David Dantzker to our board of directors. Additionally, we announced that John Meslow and -- excuse me -- Ken Keller will retire from the board effective at the conclusion of the 2011 annual meeting. On behalf of the board, the management team and the entire company, I would like to thank John and Ken for their many years of dedicated service to SurModics.

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

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session.

As a reminder, if you have a question, please press the star followed by the 1 on your touchtone phone. If you would like to withdraw your question, please press star followed by the 2. And if you're using speaker equipment, you will need to lift the handset before making your selection. One moment please.

And our first question is from the line of Ross Taylor with C.L. King. Please go ahead.

Ross Taylor - C.L. King & Associates

Hi. Just two or three questions. I guess, first of all, with regards to the strategic alternatives for the pharma business, can you give us any update in terms of how far you've gotten down that process or anything you've learned at this point in time?

Phil Ankeny

Ross, this is Phil. I'll give you just a brief update.

There's really not a lot we can share at this point. The process has been initiated very well with our investment bankers, and we've been pleased with how the process is unfolding. But it's really too early to give any indications on where we are and exactly how much time we expect it to take.

Ross Taylor - C.L. King & Associates

Okay. And then my two other questions are financial-related. The royalty revenue ticked down just a little bit sequentially and I just wondered if there's any one product or kind of milestone payments that are resulting in that kind of sequential decline? Or is it really just more a matter of soft industry environment causing your portfolio of royalty-generating products kind of soften?

And second question is, on the R&D expense line, I mean it looks like if I adjust for that R&D tax credits, your R&D spend was about $8 million in the quarter, and is that probably a reasonable run rate to use for the rest of the year?

Phil Ankeny

So your first question related to the sequential royalties and license fees, and essentially it's pretty typical that from Q4 to Q1 we do experience some modest decrease in the royalty line, and that's really related to some of our agreements that have some tiering in that we see the impact of on a sequential basis Q4 to Q1. We've discussed in the past that our hydrophilic portfolio has actually been increasing nicely on a year-over-year basis and typically sequentially as well. This is the one quarter of the year where we tend to experience sequential modest decrease. But again we are up on a year-over-year basis on the hydrophilic in the hydrophilic royalties. So we're not at all concerned about the trend and pleased to see continued strength in that portfolio.

As it relates to the R&D expenses, Ross, I think the way that you laid it out is a fair way to contemplate it because of the R&D therapeutic tax credits we did earn.

Ross Taylor - C.L. King & Associates

Okay. So kind of assuming about $8 million in expenses going forward. I know you don't always like to give much in the way of guidance, but is that a reasonable expectation then for the balance of the year?

Phil Ankeny

Yeah, it's at a reasonable neighborhood. It obviously depends on any expenses we need to incur on behalf of customers to continue to drive their programs, but in terms of a neighborhood, yes.

Ross Taylor - C.L. King & Associates

Okay. All right, that's all I have at the moment. Thank you.

Phil Ankeny

Okay, thanks, Ross.

Operator

Thank you. And our next question is from the line of Ernie Andberg with Feltl & Company. Please go ahead.

Ernie Andberg - Feltl & Company

Hello, Phil.

Phil Ankeny

Hi, Ernie.

Ernie Andberg - Feltl & Company

Hey. I'm doing some back of the math envelope here, so bear with me. But you said in the release and in your comments, you were about positive $0.05 non-GAAP. If you're maintaining your minus $0.15 to plus $0.05 non-GAAP, that suggests your breakeven -- you're expecting a breakeven to a loss over the rest of the fiscal year? Is that the implication -- that's the implication, is that what you're really saying?

Phil Ankeny

Well, our guidance is intended to be full-year guidance and not so much a quarterly view of the world. Given the uncertainty we continue to see in the balance of the fiscal year, we don't see a reason to be changing our full-year guidance. So that's essentially the answer, it's really not directionally intended to tell you what the other quarters are.

Ernie Andberg - Feltl & Company

Okay. Your comments seem to suggest, Phil, that you might start to see an improvement in that license and royalties line over the balance of the year if the contracts you signed come through on a reasonable basis. Is that what you were suggesting?

Phil Ankeny

Well, the specific piece that I was speaking to was the hydrophilic portfolio…

Ernie Andberg - Feltl & Company

Just hydrophilic as opposed to the whole seven, eight.

Phil Ankeny

Correct, because there are other components in there. Clearly Cypher is one component that is challenging to predict obviously and has continued to experience year-over-year as well as sequential decreases in sales. And so it will just depend on how that unfolds.

And then the other component is the license fee line that tends to fluctuate depending on the quarter and which our customers achieve milestones or license fee payments.

Ernie Andberg - Feltl & Company

Okay. In your -- with no change in the guidance, and was it $2.7 million of pharma-related revenue, if memory serves me right, you suggested on your last call you expect about a $5 million loss in that business this year. Is my memory right, are you still in that range?

Phil Ankeny

Actually the operating loss that we discussed in the fourth quarter call in terms of our expectations for pharma was north of $10 million, and we're not changing our view on that at this point in time.

Ernie Andberg - Feltl & Company

Thank you for correcting me. Fair. Okay. I'll get back in line.

Phil Ankeny

Okay. Thank you, Ernie.

Operator

Thank you. And once again, ladies and gentlemen, if there are any additional questions, please press the star followed by the 1 at this time. As a reminder, if you're using speaker equipment, you'll need to lift the handset before making your selection.

And our next question is from the line of Suraj Kalia with Rodman & Renshaw. Please go ahead.

Suraj Kalia - Rodman & Renshaw

Good evening, gentlemen.

Phil Ankeny

Hi, Suraj.

Suraj Kalia - Rodman & Renshaw

Gary, congratulations on joining SurModics and wish you the very best in terms of navigating the headwinds with the landscape.

Gary Maharaj

Thank you.

Suraj Kalia - Rodman & Renshaw

And I do appreciate your honest assessment on this call, very much appreciated. Gary, specifically a question for you, and I know there are some things you can't say and you shouldn't say, I can appreciate that, but you and I both know, I mean we all know the industry-wide structural headwinds. SurModics has some really core competencies which are the best in the industry. Based on what you have seen so far in the month or so that you're there, how do you see over the next let's say couple of years in terms of capitalizing on this opportunity, essentially reducing the lumpiness of what you have lets you realize an ROI on that, how do you see it? Can you shed some additional color on what should we look at [ph]? We know about transcatheter valves, we know about -- I mean some of the programs that have been talked about. We also know, and again some of the companies that SurModics is working with, and these are long-term programs, and I'm more interested on the next two-year or six to eight-quarter timeframe.

Gary Maharaj

Understood. Some of this fall out of how we define the core in terms of the boundaries. As you know, the medical device space is pretty broad. As I look at what SurModics' core technologies are, I see from where I stand some broad applicability that are not necessarily only in the transcatheter type space. The ability to change, to modify a surface has a ubiquitous use I think in healthcare, and some of those uses are not necessarily two to three-year time to fruition.

Now I can't speak more than that because it'll sort of fall out of when we -- how we define the core because chasing other market segments, I'm a little weary of that too early because we need to understand what do we know and what value we're bringing to the table. So, minimally-invasive, as we know, is a big trend. Hospital-acquired infection is a big trend. So without limiting it, I think the trick will be defined easy uses for current core technologies that are able to generate medium-term cash flows versus purely catheter type sleeves [ph] which have -- many of them have a longer timeline because of the regulations involved.

So that's as much as I feel comfortable saying, not because I'm holding back but just because I want to give our team a chance to really go through this process and really shake it loose to see what we come up with as far as within the core and the segments we can go to.

I've been pleasantly surprised what we have in R&D from a capabilities viewpoint of the technology and the customer focus that the team has had. And I've been very surprised at the sheer number of customers we already have. I mean, SurModics technology is everywhere -- I can't say everywhere -- but more than meets the eye, having joined -- having been inside the company.

So I don’t know if that gives an answer for you.

Suraj Kalia - Rodman & Renshaw

No, fair enough.

Gary Maharaj

Okay.

Suraj Kalia - Rodman & Renshaw

I can appreciate that. Now, Gary, again, would it be a fair question to ask you, okay, you have looked at it from a bird's eye view just within a month or so, our impression is, look, the average royalty rate in the device business for what SurModics signs for licenses is going down. Please correct me if I'm wrong. And if not, again from what you have learned in the short timeframe, is there something specifically that stood out to you that says, you know what, guys, we got to rectify this and get back? Because you're right, SurModics is everywhere given the customer depth and breadth, the question is, what is the ROI per license? It has been, what, hundred-plus customers now and that you can see the revenue profile.

Gary Maharaj

Royalty rates may go down if you're not bringing anything new to the table and you're probably expanding customer base. In a sense it's like pricing. If you're not bringing any more value, prices do tend to go down.

The trick for SurModics, I mean this is a technology company, is what else do we have in our pipeline that's going to bring incremental value in terms of something as clinically relevant for our customers. And I actually am a little -- I'm cautiously optimistic, and the cautious thought is really based on how we invest in it, not cautious about technology, that the technology we have can, that we have in our harbor [ph], can bring additional value beyond what we have in our hydrophilic business at this point. And then that's going to be critical.

Phil Ankeny

And Suraj, to specifically address your question about, are the royalty rates going down for our agreements, the answer is no. No, we've been very stable, depending on the technology. They're different depending on the technology. But we've been able to more than hold our own and in fact generally do better as we've been rolling forward.

Suraj Kalia - Rodman & Renshaw

One last question for you, Phil. Forgive me, I'm brain-dead, jumping between all the conference calls, so just remind me. In terms of SG&A, obviously I look at your EPS guidance, is the $5 million, $5.5 million range approximately reasonable to look throughout the year? I'm just trying to reconcile this SG&A level with the revenues. I know I'm not asking for guidance, I'm just saying -- I'm just trying to understand the key things that'll drive your EPS guidance. And again forgive me if…

Phil Ankeny

Sure. Yeah, our SG&A was artificially high this quarter because of the advisory services we incurred. And so its run rate would be south of $5 million, but not as low as $4 million in all likelihood.

Suraj Kalia - Rodman & Renshaw

Not as low as $4 million, you said?

Phil Ankeny

Right. So it's probably somewhere between $4.5 and below $5 million.

Suraj Kalia - Rodman & Renshaw

And finally, Phil, in terms of let's say you'll sell the pharma business, I don’t know, in March for whatever, a buck, two bucks a share, whatever you get, should we expect additional repurchases or is it you'll want to pull it off at that stage?

Phil Ankeny

That's a great question, Suraj, and that's clearly something that we'll be planning to discuss with the board as the process unfolds and we find out exactly what the alternatives that are available and whether there's cash proceeds that we can then decide what the best use of really is for this company. And that's very much tied in to how the board is looking at things and how Gary is looking at coming to the company with a fresh perspective and working with the management team and the board to assess what are the best uses of capital going forward, what is the strategic direction, and once those are set, then, what's the best use of capital to align with that strategic direction.

Suraj Kalia - Rodman & Renshaw

Okay. Phil, I lied. And gross margins, are they still -- should we still look upon them in the 80-plus range?

Phil Ankeny

Well, so you're looking at a blended margin for the whole business. If you carve out just the margin for the products, this recent quarter, our product gross margin is more in the 62% range. So, somewhere in the high 50s to low 60s is generally a decent neighborhood to be thinking about for product gross margins.

Suraj Kalia - Rodman & Renshaw

Fair enough. Thanks, gentlemen.

Phil Ankeny

Thank you.

Operator

Thank you. And our next question is from the line of Beth Lilly with Gabelli Funds. Please go ahead.

Beth Lilly - Gabelli Funds

Good afternoon, Phil and Gary.

Gary Maharaj

Hi.

Phil Ankeny

Hi, Beth.

Beth Lilly - Gabelli Funds

I have several questions. Gary, can you -- can we just step back a minute, and you talked about tightly defining the core business is really critical in terms of defining the strategy. Let's even take a step back even before defining what it is, and can you in a minute define for us what the core business is?

Gary Maharaj

When you look at the markets and the segments SurModics as a company plays in, it's easier said than done. You can define it perhaps on business-specific viewpoint. What I will say is that SurModics has some chemistry and formulation capabilities that have applicability in different markets. Beyond that, in terms of the customers and the products, the baseline is really the technology. And so if were to really give my assessment of the core would be defining it more currently based on the technology.

That's not adequate to really build a business though, because you've got to know what products customers, market segments and perhaps channels that you play in, but I'm zeroing in very early on as what is the secret sauce at SurModics that we do that can impact the overall [ph] product line from the chemistry and formulations that we have.

And to be honest, I'm still in discovery mode. I don’t want to overstate what I think until I kind of more deeply embed myself with some of the brilliant scientists and engineers that we have here. So I'll have more to share about that at the next call. Needless to say, I'll start off defining it from a technology viewpoint.

Beth Lilly - Gabelli Funds

Okay. Next question is, you talked about that one of the questions is -- is there going to be required investment to strengthen the core business? When you talk about investment, are you talking about multimillion-dollar type of investment? Are you talking about hiring more sales people, more engineers? Can you give us a sense?

Gary Maharaj

You're asking the exact questions we need to ask, and I'm glad you're asking that, because if it was simple at this point, we'd already be there. The answer is I don’t know the level of investment. It will depend on how -- well, firstly, we've got to get defining that core. Then part two, as I said earlier, was the step-up, realistically assessing where we're strong, where we're not, and whether we can get to the growth potential we desire. Whether that's in the channel, whether that's in the technology, and how much, I really can't address right now. But to give you some satisfaction, those are exactly the questions we need to ask.

I'm sorry, I wish I could tell you more at this point, but the process is exactly what you're describing.

Beth Lilly - Gabelli Funds

Yeah. It's trying to figure out, where do we want to be and what does it take to be there?

Gary Maharaj

Absolutely. And the investments have to be balanced to get a smooth stream of cash flows as well. So it's not just a couple of big ones obviously.

Beth Lilly - Gabelli Funds

Yeah. Okay. Does SurModics -- let's just assume for argument's sake that you get out of the pharmaceutical business -- does SurModics have the right cost structure going forward to support the level of business or do you anticipate that you can take out costs? How do you think about the overall cost structure of the corporation x pharmaceutical?

Gary Maharaj

Right now, just on a macro level, and I'll let Phil comment on some of the details, we have two profitable businesses and one that's currently unprofitable, and that's the pharmaceutical business. So as far as whatever tweaking we may have to do in the businesses, I don’t see that as being a lot because the businesses are generating cash and are profitable. The question comes on to growth. So, the unprofitability of SurModics as a whole has more to do with where the pharmaceutical business is at this point.

Beth Lilly - Gabelli Funds

Yeah. Okay. Phil, did you want to add anything?

Phil Ankeny

No, I think that's the right way to look at it. And again I think it all ties back to ultimately the strategic direction that Gary leads us toward in working with the rest of the management team and the board.

Beth Lilly - Gabelli Funds

Yeah. Okay. My final question is you have about $60 million in cash on the balance sheet and potentially more that will come in from the sale of pharma. How do you think about that, the allocation of the cash on the balance sheet as well as just overall allocation of cash flow?

Phil Ankeny

So generally the three areas that we have talked about with the board as areas that warrant potential investment of capital are in the areas of share repurchase, returning capital to the shareholders; secondly is corporate development through M&A or other investments in technology or other companies that can bring complementary things that support our strategy; and then third is capital investments in the business through, historically, we'd invested in the facility in Alabama, but then there's obviously a maintenance level of CapEx that we typically invest in the business each year.

So, really it's those three that we look at. And then it's ultimately a question of the balancing of those. And exactly where we fall on the balance depends on where we are strategically, where we are in the cycle relative to things, and obviously where the stock is relative to our views of its value.

Beth Lilly - Gabelli Funds

Well, I don’t know what it takes to -- Phil, what does it take to run the business? How much cash does it take to run the business?

Phil Ankeny

Well, the business is cash flowing.

Beth Lilly - Gabelli Funds

Yeah. So in essence, you're not -- I mean, if you -- you won't lose money -- let's suppose you break even this year, so that excess cash will only continue to build.

Phil Ankeny

Yeah. As we talked about in the fourth quarter, it is our expectation that we'll have positive operating cash flow for the year. So, absolutely.

Beth Lilly - Gabelli Funds

Okay. So in essence, you don't really -- I mean you maybe want to keep some of that cash on the balance sheet, but my sense is, is that you'll -- would you say that, Gary, one of your priorities is, in terms of these other things that you talked about, the strategic priorities of the company, one of the priorities is to figure out the best way to redeploy that cash on the balance sheet?

Gary Maharaj

Yeah, the capital structure of the company is critical. I came from a private equity highly-leveraged world, so I have a healthy respect for purity in the balance sheet. But the answer is absolutely.

Beth Lilly - Gabelli Funds

Okay.

Gary Maharaj

Yes.

Beth Lilly - Gabelli Funds

All right. Yeah, because you didn't list that as one of your priorities, so I was just curious about whether or not that is priority.

Gary Maharaj

Yeah. I think one of the questions you may have missed that I said is, really, is the cost and capital structure of the company poised to take advantage of the strategy? And that -- but you're right, I mean we have to -- that is on the table as part of our strategy. Yeah.

Beth Lilly - Gabelli Funds

Okay, wonderful. All right, thank you very much, I appreciate all your time.

Gary Maharaj

Thanks.

Phil Ankeny

Thanks for your questions, Beth.

Operator

Thank you. And our next question is from the line of Daniel Owczarski with Avondale Partners. Please go ahead.

Daniel Owczarski - Avondale Partners

Yes, thanks. Hi, Gary; hi, Phil.

Gary Maharaj

Hi.

Phil Ankeny

Hi, Dan.

Daniel Owczarski - Avondale Partners

Could you talk a little bit about the in vitro diagnostics business? Is that considered core right now or is that -- could that be evaluated, and kind of what are the pros and cons of that business, keeping that business as it is today?

Gary Maharaj

When I look at the IVD business, first of all, it is -- the products we have there are marquee products and they're very differentiated. As I look at the connection, and this is a very early look again, the connection really is at a root [ph] technology level on formulation and chemistry, such as PhotoLink process and some of those products, which is applied also in medical device business.

So, is there a connection via technology to the core? Yes. Are there connections via the market segments and customers? Certainly there are different segments that we're operating in there. The question is, is the strength of that connection of the core give us leverage or operating advantage in the business? The business is solid, it's stable, it's cash flowing, and one of the things we again have to address is, can we get this business to grow if the core -- if it's within the boundaries of the core?

So that business is certainly not hurting the company but providing some stability as we go through the strategic plan about this [ph].

Daniel Owczarski - Avondale Partners

And Phil, you mentioned that there are a couple of new product introductions in that area. Is there anything you can add there?

Phil Ankeny

I'm sorry, what was your question? Is there anything what?

Daniel Owczarski - Avondale Partners

That you can add as far as what -- you referred to new product introductions in the in vitro diagnostics, any color you could add as to what that would be?

Phil Ankeny

There, we're not prepared to give the details of the products other than to let you know that they're in queue, and so we're making great progress on them and they'll be coming out later in the year, probably second half of the fiscal year. And there are some products we're really excited about, and absolutely they help the growth profile of the business.

Daniel Owczarski - Avondale Partners

So we should be thinking that they're more additive to the product line or were enhancements to the product line?

Phil Ankeny

They're not new categories, they're within the product families that we have, but significant enhancements to capabilities our customers want to leverage.

Daniel Owczarski - Avondale Partners

Okay. And then switching to R&D revenue-generating projects, and I think, Gary, you might have mentioned this a little bit. Are you starting to be more selective in some of those projects that you take on, or is it really any kind of project that can bring in revenue, you know, welcome at this time? I mean, is there any kind of change of focus or, let's stop and relook at what you're doing there?

Gary Maharaj

Well, not every dollar spent in R&D creates the same long-term potential. And the team already has a very capable pipeline embedded in it. What I believe is when we get through the strategic planning process, we're going to have to apply the test of strategic fit to what we're doing in R&D, because then we would have developed a strategic plan and deciding to not follow it. And so I think that'll come out of it later.

That said, I haven't seen anything in our R&D pipeline that is widely off-target in terms of what the company needs to be doing. I don’t know if that helps answer it.

Daniel Owczarski - Avondale Partners

Okay. Thank you.

Gary Maharaj

Yes.

Operator

Thank you. And at this time, I would now like to turn the call back over to Mr. Maharaj for closing remarks. Please go ahead.

Gary Maharaj

Thank you. Well, listen, I wanted to thank everyone for participating in this quarter conference call. I also hope that you can join us at our annual meeting which is on February 7 in Minneapolis. And I'm looking forward to speaking with you in our second quarter earnings call in April. Thanks, everybody.

Operator

Ladies and gentlemen, this concludes the SurModics first quarter 2011 earnings conference call. You may now disconnect. Thank you for using ACT Conferencing.