SurModics, Inc. CEO Discusses F1Q12 Results - Earnings Call Transcript

Feb. 6.12 | About: SurModics, Inc. (SRDX)

SurModics, Inc. (NASDAQ:SRDX)

F1Q12 Earnings Call

February 06, 2012 10:00 AM ET

Executives

Tim Arens - Interim CFO

Gary Maharaj - President & CEO

Analysts

Ernie Andberg - Feltl and Company

Ross Taylor - CL King

Gregory Macosko - Lord Abbett

Charley Jones - Barrington Research

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the SurModics First Quarter 2012 Earnings Conference Call. (Operator Instructions). Today's conference is being recorded, February 6, 2012.

I would now like to turn the conference over to Tim Arens, Interim Chief Financial Officer. Please go ahead.

Tim Arens

Thank you, Alicia. Good morning and welcome to SurModics' Fiscal 2012 First Quarter Conference Call. Also with me on the call is Gary Maharaj, our Chief Executive Officer.

Our press release report and our full first quarter results was issued earlier this morning and is available on our website at 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 2011 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.

On today's call, I will comment on our restatement for fiscal 2011 and will highlight select financial results for the quarter. Gary will then discuss our key achievements for the quarter and provide an update on our strategy and growth drivers. Following this discussion, we will open the call to take your questions.

Before probably begin with our financial highlights, let me take a moment to explain the delay in issuing our results for the first quarter and the postponement of our earnings conference call last week.

During the preparation of our first quarter earnings results, our accounting team discovered that the fourth 2011 Pharmaceuticals related asset impairment charge was calculated incorrectly. Our internal team moved quickly to address the issue and management determined that a restatement was necessary for our full year and fourth quarter 2011 financial results.

However, this particular restatement was unique in that it involved complex non-routine accounting issues around the asset impairment charge. We felt that we could reach a conclusion on this matter prior to the originally scheduled earnings call, however, we determined shortly before the call that further analysis was necessary to ensure the accuracy of the asset impairment charge. We apologize for any inconvenience this may have caused and thank you all for your patience and understanding.

Accordingly, we will be restating our fiscal 2011 financials in an amended 10K filling, which should be available within the next two weeks. Before I provide you with additional details on the restatement I want to make three points very clear.

First, this is a non-cash impairment charge and pertains to a non-routine accounting event associated with our former Pharmaceuticals business. Second, the restatement has no effect on continuing operations and third we do not believe the restatement is systemic in anyway.

Let me now describe the issue leading to the restatement. As you likely remember on November 17, 2011 we announced the completion of the previously announced sale of substantially all our SurModics Pharmaceuticals assets to Evonik Industries.

Under the terms of the sale, the entire portfolio of products and services of SurModics Pharmaceuticals including the Company's cGMP development and manufacturing facility located in Birmingham, Alabama was acquired by Evonik for $30 million in cash.

In the fourth quarter of fiscal 2011, $17.9 a million asset impairment charge related to the Pharma assets was taken. We have now determined that the Pharma carry-in value utilized in Q4 fiscal 2011 to determine the amount of the asset impairment charge should have excluded certain deferred revenue, deferred taxes and other liabilities totaling $10.2 million.

As a result, the asset impairment charge should have been $28.1 million. Therefore the restated net loss for Q4 fiscal 2011 and the full year fiscal 2011 are $18.7 million and $18.5 million respectively.

The diluted loss per share for Q4 fiscal 2011 and the full-year fiscal 2011 are $1.07 and $1.06 respectively. Importantly this issue was spotted internally by our accounting team and we have moved quickly and in accordance with SEC guidelines to address the issue.

Let me now continue on where our first quarter financial highlights. Unless otherwise noted, first quarter financial results discussed today exclude discontinued operations. I'll address to results from our discontinued operations in more detail a bit later in my comments.

Our efforts to strengthen our core business continue to yield positive results, as our hydrophilic coatings have delivered their 10th consecutive quarter of revenue growth and our In Vitro Diagnostic products have delivered their third consecutive quarter of revenue growth.

Revenue for the first quarter totaled $11.9 million, a 5% decline from the $12.5 million reported in the first quarter of last year. Our first quarter revenue was impacted by a $2 million decline in revenue associated with Cypher and Cypher Select Plus drug eluting stents. Excluding the impact of Cypher, revenue increased 14% from the year ago period.

Growth in our core hydrophilic coatings and IVD products have made meaningful contribution towards offsetting the impact of the lost revenue associated with Cypher. Together, these core product offerings generated nearly $1 million of revenue growth in the quarter that partially offset the declines in Cypher related revenue as I noted earlier.

As we progress throughout the fiscal year, we anticipate that growth in our core businesses will continue to offset the quarterly Cypher impact. For your information, Cypher fiscal 2011 revenue was $1.6 million in Q2, $1.3 million in Q3 and $1.6 million in Q4.

On a GAAP basis, our diluted earnings per share was $0.12 for the first quarter compared to diluted earnings per share of $0.16 from a year ago period. Excluding the impact of Cypher, qualified therapeutic grant income and one time charges, diluted earnings per share in the first quarter was $0.11 compared to diluted earnings per share of $0.08 from the year ago period.

I will now turn the discussion to performance by business unit. For the first quarter, total medical device sales, which includes revenue from both our hydrophilic coatings and device drug delivery technologies were $8.9 million, down 10% from the $9.8 million reported in the year ago period.

First quarter results included hydrophilic coatings revenue of $8.2 million, representing 8% growth compared with the year ago period. Device drug delivery revenue of 700,000 declined 69% compared with the year ago period. As a reminder, a significant portion of the Cypher revenue is reported in device drug delivery.

Driving our first quarter hydrophilic coatings performance was strong royalty revenue growth from key customers. Device drug delivery revenue was largely comprised of milestone revenue earned from OrbusNeich as this customer continues to make progress towards the commercialization of its combo dual therapy spend, which incorporates our SynBiosys biodegradable polymer. Excluding the impact of Cypher, medical device revenue grew 14% from the year ago period.

Medical Device generated $3.9 million of operating income during the quarter, a 32% decline from the year ago period. Excluding Cypher and the $800,000 of Q1 2011 therapeutic grant income, Medical Device operating income grew 24% from the year ago period.

For the first quarter, In Vitro Diagnostic sales of $3 million grew 13% compared with the $2.7 million reported in Q1 of fiscal 2011. In Vitro Diagnostic's performance continues to benefit from a growing diagnostic test kit customer base and increasing demand for our dry and liquid protein stabilizers and colorimetric substrates especially among our key customers. IVD generated $900,000 of operating income during the quarter, a 23% increase from last year.

Now, let's discuss our revenue summary by category. Royalty and license fees which are generated primarily in our Medical Device business unit were $6.6 million, down 12% from the $7.5 million reported last year. Excluding the impact of Cypher, royalty and license fees grew 10% in the first quarter of fiscal 2012.

Product sales of $4.6 million in the first quarter of fiscal 2012 were up 4% compared to last year. When excluding the Q1 fiscal 2011 Cypher product revenue of approximately $500,000, product sales grew 18%.

Lastly, R&D revenue in the first quarter was $700,000, an increase of 21% from the $550,000 reported last year. Commercial coding support for certain of our hydrophilic coding customers drove the increase in R&D revenue.

Reviewing our product gross margins, we generated gross margins of 66% in the first quarter of fiscal 2012 compared with 65% last year. Our IVD business saw improvement in gross margins from the consolidation of our BioFX manufacturing operations into our Eden Prairie, Minnesota facility.

Moving onto a review of our operating cost, SG&A expenses in the first quarter of fiscal year 2012 were 29% of revenue compared with 30% in the year ago period. Excluding Cypher revenue, SG&A during the first quarter of fiscal 2011 was approximately 32% of revenue. SG&A expenses declined 7% from last year mainly as a result of efforts undertaken over the past year to align the company's cost structure with our core businesses.

Research and development expenses were 31% in the first quarter revenue compared with 20% in the first quarter of fiscal 2011. Excluding the $800,000 qualified therapeutic grant income, R&D expenses as a percentage of first quarter fiscal 2011 revenue was 27%. R&D expense grew 9% from the year ago period when excluding the qualified therapeutic grant income. Our R&D expense growth was a result of increased product development activities in both of our business units.

Taking a quick review of our balance sheet, I would note that at the end of December we had cash in investments of $94.4 million. This balance includes $27.1 million of cash proceeds from the Pharma asset sale. Not included in this balance is the additional $2.9 million recently released from escrow establishing connection with the $30 million sale of our Pharma related assets.

All amounts associated with that transaction that were held in escrow have now been released. Operating cash flow was $1.9 million during the first quarter. This quarter's operating cash flow is lower than recent periods mainly because of the cash payments associated with that variable compensation plan and other accrued liabilities.

Moving on to discontinued operations, as a result of the sale of Pharmaceutical assets which were completed on November 17, the company reported $2.5 million of pre-tax income from discontinued operations in the first quarter of 2012. In addition, the company has reported a $1.7 million pre-tax loss in the sale of pharmaceutical assets primarily related to transaction costs.

We are reaffirming our revenue and earnings per share outlook for the full year fiscal 2012. As a reminder, our full year revenue outlook remains unchanged and is expected to be in the range of $47 million to $51 million.

GAAP diluted earnings per share from continuing operations also remains unchanged and is expected to be in the range of $0.45 to $0.53 per share. Our outlook is based upon the diluted share count of 17.6 million shares.

At this point, I would like to turn the call over to our Chief Executive Officer, Gary Maharaj. Gary?

Gary Maharaj

Thank you, Tim. The completion of the CLFO formal assets was one big step towards returning SurModics to profitability and focus revenue growth in our core businesses. In fact in this first year, year one as I call it of the transformation of SurModics, our team accomplished a following goals.

We exceeded our operating plan, we sold the Pharma assets, we put in place the management team for the future, we adjusted a cost structure to align with our future business needs, and we implemented a strategic focus in our core businesses to improve our execution and to maximize our returns. All of these were intended to set the stage for growth entering year two.

As you can see from the reported results, the organic growth without Cypher in our core hydrophilic coatings and IVD businesses is strong. Year two will be defined by three areas, first, our ability to execute on and expand our higher margin core businesses to generate profitable growth and cash flow. Second, our investment in internal R&D to drive organic growth and optimize long term returns from this pipeline. And third our strategy for you use of cash on the balance sheet on our ongoing cash generation.

Let's review each of these in more detail. In both the Medical Device and IVD businesses, our customers face increasing headwinds in terms of healthcare cost, increasing regulatory scrutiny and single digit overall market growth. Our demonstrated ability to deeply understand these issues and provide solutions that help our customers reduce their costs and mitigate regulatory risk, make SurModics an important strategic partner. As a result, we believe that we can consistently exceed this intrinsic market growth rate.

With respect to medical devices, our key growth initiatives are focused on expanding our leadership in Hydrophilic Coatings and developing new drug delivery platforms.

Today, we are well positioned and higher growth transcatheter valve and neurovascular applications with the hydrophilic coatings. We are excited about more products in these categories where we are being selected as a coating technology of choice in both the U.S. and Europe, the high values vastly delivered devices.

In addition we are a component of the drugs delivery stent coating of OrbusNeich's Combo Dual Therapy Stent, which demonstrated positive clinical trial results as presented in November of 2011 at the Transcatheter Cardiovascular Therapeutics Conference in San Francisco.

We are pleased to report SurModics' next generation hydrophilic reagents are now available for purchase by licensed customer base. This next generation platform, as I have described earlier, provide a compelling value proposition, eliminating the trade-off between lubricity and the durability. In fact, repeated internal catheter testing confirms our ability to provide significant reduction in particulates coupled with best-in-class lubricity and ease of application in the manufacturing environment.

As part of our commercialization process, we have initiated broader pilot feasibility studies with our customers in selected applications. The results are very encouraging. As a reminder, the targeted segments for growth with this new coding platform, our core market segments of angioplasty, stent delivery, neurovascular and other specialty catheters seeking advanced lubricity with reduced particulates. We also see an opportunity to help customers who currently use proprietary in-house codings by demonstrating that we can meaningfully improve their product performance.

We've also taken several important steps to accelerate sales and grow profitability in our IVD business. Our change towards the customer focused sale structure, where historically we have been focused on products has been positive. This new structure in combination with our market leading product performance, quality and service and support continue to increase our base of customers. Later this month, we anticipate launching an updated website with e-commerce capabilities that will support our customers with valuable content and simple options to purchase our products online.

Finally, the integration of the, BioFX product line into our Eden Prairie operations has improved both our customer focus and operational efficiency which contribute to an increased gross margin in IVD.

Let's talk now about R&D. As I've said before, R&D is at the heart of value creation and organic growth for SurModics. We have overhauled and reframed the R&D pipeline in both Medical Devices and IVD to optimize long-term return. Our pipeline consists of the three portfolios I've described in past calls, ideas, experiments and projects. We're been very careful to invest appropriate amount of diligence to our R&D ideas and experiments before committing the full funding to full-fledged projects.

In IVD, we continue to accelerate our development and launch of new products. As a follow-on to the two new products introduced last year, we have several new development projects underway. We expect to launch these new diagnostic products in the next quarter. These products will further differentiate our offerings because of the effect on improving the accuracy of diagnostic test kit. In addition to these upcoming launches, our R&D pipeline continues to be scaled with other experiments and projects that will satisfy key market needs.

In Medical Devices, we have started initial scoping work in our experiment portfolio involving unsolved large problems on medical devices with a surface interaction and play a role. While I will not comment on ideas and experiment, I can share news about the projects currently underway. We've already discussed our next generation hydrophilic coatings platform called PRO 5 and there is ongoing qualification of multiple medical device application.

I'd like to spend some more time on our drug coated balloon project. Drug coated balloons may offer better alternative than current therapies in the areas of the vasculature where placing a stent is not ideal. Examples of this, interventions in the peripheral vessel such as in the superficial femoral artery and the coronary vessel to treat infantry stenosis. The worldwide market for drug coated balloon is predicted to be over $1 billion annually.

Several first generation products are already in the market outside of the U.S. and one product currently has an investigational device exemption in the U.S. We actually continue to be excited with the results of our ongoing preclinical studies, which demonstrate a high degree of control of drug release and retention on the vessel to be treated. We are aggressively supporting this project in R&D in order to further understand the value of our solution and the needs of our customers who may want the license this technology from us.

During the last 12 months, our technical team has completed greater than 60 formulation experiments to rapidly extract the best formulations for preclinical testing. This focused effort of our talented team of scientists and engineers along with our continued investment in preclinical studies has yielded several potential options.

Most recently, we've completed a series of 28-day experiments including histology. These data have provided very encouraging results related of controlled drug uptake in both coronary and peripheral tissue when compared to other commercially available drug coated balloon. SurModics is now positioned to have deeper value added client conversation on this unique platform for licensing in the near future.

Let's turn to the third item to the use of cash in our balance sheet. We are executing a disciplined and strategic process to determine how best we can best deploy this capital, the process that continues today. However, there are two points that I need to emphasize upfront. First, we are evaluating all options to use our balance sheet, the best of our interest of our business and our shareholders. Second, we do not expect to deploy a significant portion of our cash reserves on acquisitions. Along with our board, we are carefully evaluating the sources and potential uses of cash based on our strategy to create that is growth value for our shareholders. This will help guide as to the appropriate balance of the three uses of cash that I see. Cash deployment to create value, cash returns to shareholders to redistribute value, and cash reserves for both opportunistic investment and to mitigate risk.

In summary, we are excited about our opportunities going forward. These include growth from core products, our R&D opportunities that are catalyst for future growth, and finally the strategic and disciplined use of cash to create, return and to protect value for all shareholders.

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

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now begin the question and answer session. (Operator Instructions). And our first question comes from the line of Ernie Andberg with Feltl and Company. Please go ahead.

Ernie Andberg - Feltl and Company

How can we on the outside judge let's say the medical device business and where the growth might look like two to three years down the road with your new hikes for the coatings technology endeavors in drug-coated balloons?

Gary Maharaj

It's difficult to speculate, but two to three years down the road, we certainly will be the major player in hydrophilic coatings for minimally invasive devices. Added onto that, we'll be exercising this drug delivery capability that the company has always had and the drug-coated balloon is really our first foray into that type of drug delivery product, so I would expect if we are successful with the drug-coated balloon, certainly these things would take time for our customers to get through the regulatory channel, it may not be contributing maximum cash flow given the regulatory environment, but in addition we would have queued up our things that we have in our experiment platform now that will contribute to delivery of some ingredient of the surface to prevent problems such as infection as one example. So, the cash flows will be weighted over time, not because of the shrinking of hydrophilic revenues, but because of the addition of revenues in cash flows from other platforms.

Ernie Andberg - Feltl and Company

Tim, you were good enough to give us the breakdown of the J&J Cypher stent related revenues in the next three quarters. It's difficult again I hear on the outside to understand how the other three quarters went, when as you described into as X discontinued operations and X the stent business, sort of a double question here. One, can you break down those revenue numbers by royalties and product sales, or we can get a feel there and can you give us restated numbers for the other three quarters of the year?

Tim Arens

Right, so Ernie let me refer you to the earnings release from earlier this morning. There is I think the final two pages of the release provide some supplemental information that pertain to the first quarter 2011 and first quarter 2012.

You will see the Cypher royalty and license fees revenue as well as the Cypher product sales. The information that it provided, the Cypher revenue impact in 2011 for quarters two, three, four, I haven't provided any detail breakout in terms of what portion came from product sales and what amount came from royalties. We probably be providing that. I don't have that in front of me Ernie, but we will be providing that as we go through the year.

Ernie Andberg - Feltl and Company

It would be helpful to us on the outside judging the prospects if you could do that now in an 8K rather than as you go through the year?

Tim Arens

Right, I fully appreciate that. Let me say this, what you are seeing here I can – if you want to 2011, we are you are seeing about 25% of the revenue come from product sales from Cypher. I'd say using that as a proxy probably isn't going to be too far off, in some quarters it's less, but that would be a general rule of thumb to provide you with little guidance at this point.

Operator

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

Ross Taylor - CL King

Hi. I just have a couple of questions. I just first of all with your new Hydrophilic Coating technology, it seems like it's available a little bit earlier than I expected. But can you comment it all as to whether you think that could actually cause your Hydrophilic revenues to accelerate in your fiscal year '13 for example or we just kind of just expect steady straight growth compared to fiscal year '12 in that product category?

Gary Maharaj

Sure. It depends on the uptake and we – I think we've said before the first calendar quarter, we would be doing the pre-commercialization. So, it's available, just to describe the commercialization process, we allow currently licensed customers on select applications in sub-street to start validating it on their products. So, it doesn't imply that we have cash flow coming in from it at this time, but we will go through that pre-commercialization or commercialization process if the customer is tested.

As far as what it would mean in terms of acceleration 2013, again I'll talk to speculate, but this is better than the previous generations. And so, I'm confident that as customers run it through their rigorous testing they will see the value and want to port over to this certainly on their new device application.

As far as the submarket for it, anything where you want durability and lubricity at the same time, ideal target markets for this in different parts of the vasculature. So part of it Ross will depend on how many licenses we sign where this is the ideal coating for new to the world device application looking for more durability. I expect it to accelerate over the next, over the three quarters from the time it first being still bringing in cash flow.

Ross Taylor - CL King

And another question related to hydrophilic, I think today is the first time you've really disclosed that your technologies on the spacing and value, and can you help us quantify at all, I mean, how much that may contribute to growth in fiscal year '12 or just kind of any clarity to help us provide estimate as to how much revenue that may contribute?

Tim Arens

Ross, this is Tim and my response is probably something you can appreciate. We don't provide guidance on customer specific programs. What I might suggest is taking a look at what Edwards might be saying about their expected revenue from that particular product and I think it's been pretty well characterized what our average royalty rates are. You can see that in our 10-K. You might want to disuse that as a basis for formulating some initial thoughts.

Ross Taylor - CL King

Okay, all right. Again that is, couple other questions. Can you just...

Gary Maharaj

Ross just I'd would make sure, Tim and I discussed with each other, the royalty is not on the value itself. We would call at that, but it's under delivery system.

Ross Taylor - CL King

Yes, and I guess that the challenge is just trying to assess the value of the delivery system versus the value of the valve as it relates to the ASP on the valve. Anyway, okay and just two other questions. Gary, can your repeat some of your statements, you broke up just a little bit at least on my end about your comments about how willing you are to deploy some of the cash towards acquisition?

Gary Maharaj

Well, in conjunction with the board, we are looking at all options for deployment of cash. All that probably broke up on is just to show investors we are not looking to deploy a significant portion of that cash on single acquisition. We are compelled to look at acquisitions that would strength the core, but I don't want to have people think we're going to go out and spend the bulk or even a large part of our balance sheet on a single acquisition.

The biggest thing for us is really as you know Ross cash is a strategic asset, so deployment should be based on the sources and uses of cash, the strategy requires; and then we look at our capital structure, and also look at the reserves that we have in terms of mitigating risks, having some cash on hand, and frankly even having some cash on hand to be opportunistic in the future and then the component of that is the return of cash or redistribution of value to shareholder. So, I don't know if that covered what you probably missed when I was speaking.

Ross Taylor - CL King

No, that's good. Thank. And my last question just relates to the drug eluting balloon project, I mean how likely is it that that maybe get licensed to multiple potential partners versus one partner bidding for an exclusive license?

Tim Arens

I can't comment on where we are, but there certainly are interested partners and that the way we approach is what's best for the partner or partners and also trying to add to what's best for SurModic. It also depends on the data and how strong if we continue to see strong preclinical and animal results in terms of control of the drug on the balloon that could have an impact on those negotiations as well.

Operator

Thank you. Our next question comes from the line of Gregory Macosko with Lord Abbett. Please go ahead.

Gregory Macosko - Lord Abbett

Thank You. Yes, just a follow-up on Ross's question regarding exclusivity. The point being is that that is part of the negotiations with the customers?

Gary Maharaj

Yes, yes.

Gregory Macosko - Lord Abbett

Okay. And, then with regard to those different the licensing of various kinds of coatings et cetera, how does this affect the customer in getting products through the FDA? I assume that obviously if it's a good coating it makes it better and easier et cetera, but is there any advantage relative to just FDA approval as opposed to internal development that helps them by using one of your coatings?

Gary Maharaj

Right, we don't have FDA approval per se or clearances. We do maintain a dossier on file with the FDA of our products. Our customers refer to that dossier in seeking the regulatory approvals required for their products. So, by maintaining that file it certainly helps customers in different parts of the world as well refer to that and then the FDA can then look at those files on file and then help our customers get the approvals that they require. Certainly if customers are looking at highly acute applications where durability is critical, we believe this coating will give them an advantage in seeking that approval, but certainly that's between the customer and the FDA

Tim Arens

Gregory, this is Tim. I just might add to Gary's comments that customers make a decision on hydrophilic coatings for a number of reasons. Obviously, one being performance and obviously there is a price or value equation to this, but there is other buying criteria and a very important one is SurModics has a long history of used medical devices that takes away risk for customers and their ability to get their technologies, their products to regulatory approval given that we have had that long history of using, Gary referenced to fact that device master file exists and our customers are allowed to utilize that in there submission. So, we look at it as being able to provide them with a lot of value around a lot of different points to help them get approval and de-risk their process.

Gregory Macosko - Lloyd Abbot

Could you give us a little color just on what the customers internally are doing? I know we've talked in the past about some likelihood that customers may look more towards you or others to supply them externally with coatings in the like. Have you seen, just generally speaking, additional reduction in their internal resources used in the coating area such that in effect over longer time they might look towards to you?

Gary Maharaj

What's unique about SurModics is the customer base fee service, everything from garage start-ups to mid-size companies, to very large multinational medical device firms....

Gregory Macosko - Lloyd Abbot

You know I'm not talking about garages.

Gary Maharaj

Right, right, but certainly for the early companies and start-ups, we have been providing more what we call bridge to manufacturing coating services and in fact we have scaled up that part of our service offering. But in terms of the large customers what they are looking for, I think coatings are clearly on their mind as they develop new products. It certainly is not the only thing given the higher risk of any Medical Device and I have not seen a negative change in terms of how they approach SurModics and especially the response we have gotten to the next generation coatings as we have made it available to select customers. Their own device is coated and they conduct their own internal rigorous testing of how the coating performs on the device.

Tim Arens

So, Gregory, I'll offer a few additional comments that might be useful. First there is a relatively small number of device manufactures that are utilizing in-house coatings as we refer to them on their Medical Device applications or products and those few that are doing that they are in fact SurModics' customers in utilizing our Hydrophilic Coatings on certain of their products. Certainly, I can tell you that we're not hearing much in the way of these particular customers investing significant resources in developing next generation coating platforms for their products. In fact, I can tell you that at least one of these companies that utilize in-house coatings has been talking to us about our new hydrophilic coating platform, which I think speaks volumes about our platform and also gives you some perspective on maybe how those companies that are using in-house coatings are thinking about their own technology.

So, we feel real strong about what we have with our PRO our new hydrophilic coatings platform and it gets back to an earlier question about how do we think about this platform over the next several years? We're really excited about it and we're excited in part because we think it provides us with opportunities to expand our market reach if you will, specifically as it relates to in-house coatings and so, time will help us with that, but again we are pretty excited in generally here about what we have.

Gregory Macosko - Lloyd Abbot

Good, good answer. And then finally with regard to In Vitro, you've mentioned some new products coming, I guess, that's in fiscal third quarter?

Tim Arens

No, we didn't provide specific quarter…

Gary Maharaj

I think it's the next quarter we are going to launch them.

Tim Arens

Right, and really it pertains to this quarter, yes, that's a good point Gary. Gregory, you can expect that you'll see us launch new In Vitro diagnostic chemical components this quarter.

Gregory Macosko - Lloyd Abbot

And are we talking about something totally new or is it kind of variations obviously differences, you mentioned the Assay Diluent and the BioFX etcetera membrane, is it products along that line as well as diagnostic kits?

Tim Arens

That's exactly right. These are chemical component products that help to improve the accuracy of diagnostic testing and the thing that's really exciting for us is that there's just a lot of different diagnostic test formats that can benefit from having chemical components that are developed to optimize the results for that format. And so, what you're going to be seeing from us are new technologies or new products that help our customers improve the accuracy of their diagnostic test or it help support different customer segments, whether it would be diagnostic testing customer or a researcher.

Gary Maharaj

And, yes, and in the first years we're focusing on the core, Tim and I using a baseball analogy call these singles and doubles. As we plan for the longer-term aspect of R&D what we're going to experiment on, then we'll be looking for the triples and home runs. But really this is the base hit strategy in terms of getting some products out there that we actually have had requests and demand for and now we're trying to fulfill that by launching them.

Operator

Thank you. Our next question comes from the line of Charley Jones with Barrington Research. Please go ahead.

Charley Jones - Barrington Research

Good morning. Thanks for taking my question. My first one is a clarification on some comments earlier about your transcatheter valve participation. I guess we've always been told in the past that on these hydrophilic coatings you gain somewhere around, and I'm just going to say, have to agree with that, 1% on the total ASP of the device. Now in the case of site, for Select, for example you guys have the biomaterial on part of it, they kept a drug on the stent and you got that little piece too. But you guys just described it a little bit differently for the transcatheter valve. Now I can appreciate how that's a much more expensive device, but help us understand a little bit how that royalty rates fluctuates with that and what you are actually getting the royalty on. And then secondly for drug coating balloons, what does that mean? Are we all of a sudden just getting the 1% on the delivery system or again because the stents were all one big piece are these transcatheter valves 1% on the total ASP?

Gary Maharaj

Yeah, first of all the cycle was...

Charley Jones - Barrington Research

It's a big clarification.

Gary Maharaj

Right, cycle was like this as well. I mean there were different components of that revenue stream. There were certainly, the product we sold for the hydrophilic coating, there was the royalty for the hydrophilic coatings, there was a product polymer that we sold for the drug delivery components of the stent and then the fourth thing, it was a royalty bid for the drug coating on the stent. So if you look at those four revenue streams and so what we are saying is...

Charley Jones - Barrington Research

Let's exclude that one actually. Let's look at Fox Hound a little, let's look at whatever, you have a $3,000 device, you are getting roughly a 1% out of it. You are getting a 1% on the catheter delivery system. It's just a couple of hundred bucks. So forget about Cypher. Let's go back to the trans-catheter valve and the balloon I guess.

Tim Arens

All right this is Tim, let me help you a bit on this, so you probably appreciate that we provide hydrophilic coatings for CRM application.

Charley Jones - Barrington Research

Sure.

Tim Arens

We don't receive a percent of the royalty against the entire product ASP, so if you think about an ICD…

Charley Jones - Barrington Research

That's a very different thing, but okay.

Tim Arens

So it's the same thing with a percutaneous valve. In these higher priced applications, when you are talking about a hydrophilic coatings and how they enable the delivery...

Charley Jones - Barrington Research

Preventative care in the future...

Tim Arens

To the chemical locations, we're going to get paid on the basis of the delivery system. Now, every customer is a bit different so it's difficult for me to give you a lot of specificity, but probably what I might help you understand is think about it from the perspective, if you think about the stent delivery system and what stents sell for $1200, $2000 depending on where they're sold worldwide, there is a percentage on that. That might not be a bad way to help you think about it, but every customer is a little bit different Charlie and it's hard to take an example and use that example across…

Charley Jones - Barrington Research

I just think you got to be careful then about how you describe the transcatheter valve market in that case if it's a replacement for the stent market. One, it's a very different, okay....

Tim Arens

We are not doing that, what Gary was trying to articulate was, you are using an example where we are generating royalty from two different coatings, one being for the delivery of drug off of Cypher product.

Charley Jones - Barrington Research

I understand.

Tim Arens

So, we wanted to provide clarity on that.

Charley Jones - Barrington Research

Yeah, I got it.

Tim Arens

So, hopefully that eliminates the confusion. Now drug-coated balloons is a little bit different animal.

Charley Jones - Barrington Research

Okay.

Tim Arens

I want to make sure that you appreciate this as well. In a drug-coated balloon application, there could be the potential for SurModics to generate multiple royalty streams.

Charley Jones - Barrington Research

Sure.

Tim Arens

One would be on the hydrophilic coatings that enable the delivery of that therapeutic benefit for a patient, but also there is a device drug delivery coating....

Charley Jones - Barrington Research

The polymer.

Tim Arens

On the balloon. So, there is two different opportunities there for us.

Charley Jones - Barrington Research

Yeah. Okay, so back to the transcatheter valve though, we're talking about big devices here where your coating is very important on that causing dissection. So, you are getting a larger royalty rate on the delivery system? So, you are getting that value? Are you still getting this very small royalty rate on this much smaller dollar amount?

Tim Arens

I'm not today going to provide a lot of specifics around royalty rates on particular customers on product applications, but what I will tell you is the way I want you and others to think about this is it's not going to be much different from what our general portfolio looks like today.

Charley Jones - Barrington Research

Well, I think it's a lot different when you have a $3,000 SilverHawk that you are getting 1% on and a $400 catheter delivery system that you are taking a $20,000 valve in there with, but I'll move on.

Tim Arens

I like your thought right there and that's a good way to think about it, Charley.

Charley Jones - Barrington Research

Yeah, okay. So, I guess what kind of premium are you expecting with this new coating? And I'm curious what percentage of your customers do you expect to adopt? I know you've got some competition with some weaker hydrophilic coatings kind of at your heels over the next three years?

Gary Maharaj

Absolutely, certainly competition in coatings is something we see it all the time. We believe we will win those battles not just because of this next generation coating, I believe our customers are looking at the risks also of not using a SurModics that they currently use in terms of their manufacture ability, the service and support, and when things go wrong, it's really good that you have the reputation of SurModics behind you in terms of making and coating millions of these devices.

As far as the premium on this, I prefer not to speak about that because we are multiple, as we're negotiating this, it's best for us to do that one-on-one with our customers depending on application and depending on the acuity of the need for this type of coating. Certainly, we're intent on maintaining where we are with our prices and our royalties for these devices going forward.

Charley Jones - Barrington Research

I guess I got the impression from you that you expect the large vast majority of your customers to switch to this new product over the next couple of years, is that true? And then finally on this line, they have an existing product line out there SilverHawk or whatever, can they immediately change today if they want or do they have to submit new regulatory filing, so, that they can...

Gary Maharaj

You are right. I can't speculate on what they need to do regulatory wise, but I would expect that they would have to re-file. It depends on the product and the FDA rules in that regard.

Charley Jones - Barrington Research

It's more for new products?

Gary Maharaj

So, yes. So, one of the things that will help the acceleration of this is it being selected as new products are going through the regulatory channels, it will become part of the specification of those new products.

Charley Jones - Barrington Research

So, we shouldn't expect you to be putting this on an existing product. They are going to have to come out with a new generation before you start to generate a higher royalty rate.

Tim Arens

Yes. So, Charlie this is Tim and what you've described is really how it's worked for us in the past when we've introduced new hydrophilic coatings platforms. You will see more often than not that the customers who are adopting it on products immediately and development are the new products for next generation products. That's not to say that all customers do that. There have been occasions where some have gone back and to put the coating on existing products, but that's not typically the way it works.

Charley Jones - Barrington Research

I would like to just point out that for some of us who have watched this company for six years and just to watch other people come in and talk about acquisitions I think you guys are going to look really closely at how you're going to redeploy this cash and I think more of us should go back to the shareholders, but...

Tim Arens

I want to emphasize the reason I included even the word acquisition in there is to actually reassure people of exactly what you said, that we're not going to willy-nilly in...

Charley Jones - Barrington Research

And I mean not going willy-nilly, like no more than $5 million to $10 million over the next five years, let's just associate the strategy.

Tim Arens

Right. And to be clear we have no acquisition target now. So it's not like...

Charley Jones - Barrington Research

So then let's redeploy the cash. All right thanks a lot.

Operator

Thank you. And so that's all the time we have for questions today. I'd like to turn the conference back to management for any closing remarks.

Gary Maharaj

Thank you. I appreciate everyone's participation today and fiscal 2011 was a transformational year for the company and we've continued to build on that momentum in the first quarter 2012. We do remain steadfast in our commitment to return SurModics to profitability and focus revenue growth in these core businesses. I'll remind everyone as we enter year two of our transformation, we'll refocus on driving profitable growth, cash-flow in our higher margin core businesses, investing in R&D to drive organic growth, and then implementing and executing against the long-term strategic plan to spot the sustainable growth for these business. I believe that we are well in the path to achieving our 2012 guidance but also to sustain our double digit long-term growth.

Thanks everyone for participating in this quarter's call and we'll look forward providing further updates on the next quarter's call. Thank you.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.

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