SurModics' (SRDX) CEO Gary Maharaj on Q1 2016 Results - Earnings Call Transcript

| About: SurModics, Inc. (SRDX)

SurModics, Inc. (NASDAQ:SRDX)

Q1 2016 Results Earnings Conference Call

January 28, 2016 08:30 AM ET

Executives

Gary Maharaj - President and CEO

Andy LaFrence - VP, Finance and CFO

Analysts

James Sidoti - Sidoti & Company

Ben Haynor - Feltl & Company

Charley Jones - Dougherty Markets

Jan Wald - Benchmark Company

Operator

Good day, everyone, and welcome to the SurModics' First Quarter 2016 Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Andy LaFrence, Vice President of Finance and Chief Financial Officer. Please go ahead, sir.

Andy LaFrence

Thank you, Anthony. Good morning and welcome to SurModics' 2016 first quarter earnings call. Before we begin, I would like to remind you that during the course of this call we will make forward-looking statements. These forward-looking statements are covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and include statements regarding SurModics' future financial and operating results or other statements that are not historical facts. Please be advised that actual results could differ materially from those stated or implied by our forward-looking statements resulting from certain risks and uncertainties including those described in our SEC filings. SurModics disclaims any duty to update or revise our forward-looking statements as a result of new information, future events, developments or otherwise.

We will also refer to non-GAAP measures because we believe they provide useful information to our investors. Today’s news release contains a reconciliation table to GAAP results. This conference is being webcast and is accessible through the Investor Relations section of the SurModics website where the audio recording of the webcast will also be archived for future reference. A press release disclosing our quarterly results was issued earlier this morning and is available on our website at www.surmodics.com. On today's call I'll provide an overview of our first quarter financial results. Gary, will then cover our key achievements, provide an update on the integration of Creagh Medical and NorMedix acquisitions and discuss our growth drivers and strategies. Finally, we will open up the call to take your questions.

I’ll start with the financials. We are pleased to report that revenue for the first quarter of fiscal 2016 rose $16% to $16.5 million compared with $14.2 million in the first quarter of last year. First quarter revenue included $0.5 million from our recent acquisition of Creagh Medical. On a GAAP basis, our diluted earnings totaled $0.19 per share compared to $0.27 per share in the prior year quarter. Both the first quarter of fiscal 2016 and 2015 included $0.02 per share discreet income tax benefit from the renewal of the federal research and development tax credit.

Fiscal 2016 first quarter earnings also reflected a $0.20 per share reduction from acquisition related transaction costs including investment banker fees, integration, contingent consideration accretion, amortization, foreign currency transaction and other expenses. We had indicated in our January 8th release and call that these items will be factored into our fiscal 2016 financial results. So the $0.20 is within our expectations.

On a non-GAAP comparative basis, quarterly earnings per share were $0.38 per share in the first quarter of fiscal 2016 compared to $0.26 per share last year an increase of 46%. We delivered operating income of $3.9 million in the first quarter of fiscal 2016, down from $5 million in the prior year period. Operating margin decreased from 35.4% to 23.8% in the current year quarter. The decline in operating income and margin reflects higher revenue offset by acquisition related expenses and intangible asset amortization.

Turning now to our two business units. In our Medical Device segment revenues derived from our hydrophilic coatings, device drug delivery coatings and balloon capital products, revenue rose to $12.2 million increasing 15% from the year ago period, excluding the Creagh Medical acquisition the Medical Device segment revenue increased 10%. First quarter hydrophilic coating royalty revenue totaled $7.5 million up 6% from last year. Region sales increased $0.3 million. The Medical Device customer research and development revenue rose $0.3 million for the quarter as a result of Creagh Medical acquisition and higher demand for contract cleaning services to support customer clinical trials and select product launches.

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

For In Vitro Diagnostics segment, first quarter fiscal revenue totaled $4.3 million, an increase of 20% from a year ago. This year the IVD business segment has realized exceptional revenue growth from sales of our stabilization reagents, antigens as well as BioFX branded products. Product gross margin for IVD was 65.4% in the first quarter, compared with 65.7% in the prior year quarter. The slight decrease mainly related to sales mix as antigens, a product that we distribute, comprised a higher percentage of current year quarter sales mix versus last year.

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

Now I would like to discuss our first quarter fiscal 2016 revenue summary by category. First, our royalty and license fees which are generated primarily in our Medical Device segment. This revenue category was $7.9 million, an increase of 19% last year. Second, product sales in the first quarter of fiscal 2016 totaled $7.2 million up 23% from the year ago period. This reflects higher reagent sales in our Medical Device segment and product sales in our In Vitro Diagnostics segment. And third, R&D revenue was $1.4 million up from $1.1 million a year ago. So all three categories posted solid gains.

As a percent of revenue, first quarter R&D expenses were 22% versus 25.2% in the year ago period. R&D expenses of $3.6 million for the quarter were up slightly from last year. SG&A expenses in the first quarter of fiscal 2016 were 21.8% of revenue versus 24.9% in the prior year period. On a dollar basis, SG&A in the first quarter of fiscal 2016 totaled $3.6 million compared with $3.5 million a year ago. The dollar increase reflects higher SG&A as result of the inclusion of six weeks of Creagh Medical in our consolidated results, offset partially by lower spend in professional services.

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

Looking at our balance sheet, it continues to be very strong. Our cash investments totaled $42.7 million at December 31, 2015. We continue to generate solid operating cash flow. Cash flow from operations was $6.1 million in the first quarter of fiscal 2016. Cash flow from operations was positively impacted by $2.4 million from the timing of a past few customer payment that was paid in October. We invested $0.4 million in property, plant and equipment and used net cash of $18.2 million to acquire Creagh Medical in the first quarter of fiscal 2016. Our current cash and investment balances, operating cash flows combined with SurModics' $20 million line of credit, provide adequate capacity to support our corporate strategic growth initiatives.

We are reaffirming our previously stated guidance for fiscal 2016. We expect revenue to range from $62 million to $66 million. Further we expect diluted earnings to be in the range of $0.30 to $0.35 per share, and non-GAAP earnings of $0.66 to $0.75 per share. Let me repeat the assumptions that underlie these ranges. They are no substantial changes in the U.S. dollar and euro exchange rates in fiscal 2016 from current rates. Research and development expenses to be approximately in the mid 30% of revenue.

SG&A expenses excluding business combination related amortization accretion and transaction expenses are projected to be approximately in the mid 20% of revenue. And income tax rate is now expected to be between 50% and 53%. This estimate has been revised from 39% to 42% of free tax income as we have updated our estimate of non-tax benefited items including contingent consideration accretion and transaction costs related to the Creagh Medical and NorMedix transactions. We estimate capital expenditures to be between $4.5 million and $5 million including investments in the Creagh Medicals' Iris facility.

The operational and financial results from the first quarter were remarkable in the midst of two significant transformational acquisitions. Thank you to the entire team for your hard work and outstanding result.

And now, I'll ask Gary to share his perspective. Gary?

Gary Maharaj

Thank you, Andy. I am delighted with all the SurModics' team performance in the first quarter. I want to thank everybody for the huge positive accomplishments in multiple areas. We hit our stride on all aspects of our strategic tri-factor. As you may recall from SurModics' last quarterly earnings call, I described our tri-factor as, first to transform SurModics into a whole product solutions provider of differentiated Medical Devices by organic R&D and corporate development initiatives.

We successfully achieved major goals in this area. Organically our R&D team reached a critical milestone in securing the IDE approval for an early feasibility study of the survey of drug-coated balloon to be conducted in the United States. From a corporate development view point we acquired two best in class companies within two months namely Creagh Medical and NorMedix which we completed shortly after the conclusion of our first quarter. We believe that both of these acquisitions dramatically accelerate our transformation to become a whole product solution provider for our Medical Device customers.

The second pillar of our tri-factor is to continue to generate maximum revenue growth from our core Medical Device coatings and In Vitro Diagnostics businesses. Our score card here speaks for itself. We were able to drive significant double digit growth in both of our core businesses as Andy has just described. And finally our third pillar is to continuously optimize investments required for strategic transformation and the long-term value creation with the short term generation of earnings. I call this balance. It is an essential element of successfully executed strategy that aspires to both grow profits heavily even while investing in transformation.

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

Let's talk about our business unit performance. In the first quarter our Medical Device as Andy said excluding Creagh grew 10% versus the same quarter last year. This was because of the gains and royalty revenue, R&D revenue and reagent revenue that Andy noted. I'm pleased that we generated increased royalty revenue in our peripheral and structural half market segments, on customer programs that we worked hard to secure and support during these past several years. Our coatings services or R&D revenue benefitted from high utilization by key customers of our short run manufacturing programs to support other product launches of clinical trials. Our reagent revenue grew in conjunction with our royalty revenue both an additional increase we believe by customers stocking up in inventories to some extent at their respective year ends.

Creagh Medical contributed additional and very important revenue to help us grow 15% overall in the Medical Device business. Our IVD business had an excellent quarter and grew revenues 20% for a sustained quarter last year. We expanded revenues in our core product lines of protein stabilizers and BioFX substrates as well as antigens. This growth stemmed from the combination of organic customer growth, revenue from new IVD customers and successfully cross selling current customers on our full suite of products. In addition, there was a change in order cadence from some customers who did not order within the same period last year. Importantly IVD operating income grew by 49% due to the said improved operating leverage.

I've not had yet the opportunity to discuss our acquisition of NorMedix on an investment call. So let's spend a few minutes on the strategic fit of NorMedix and its impact and where we are heading. NorMedix fits our strategy of acquiring and integrating the assets and capabilities to become a world class Medical Device innovator and a product developer with its strong emphasis on independent and innovative device design and development in the area of vascular catheters. NorMedix's patented ultra-thin wall braided catheter platforms and proprietary manufacturing processes along with SurModics' new generation of lubricious coating platforms created a new and exciting capability to change the standard of catheter performance in all areas of vascular access.

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

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

Our integration priorities for NorMedix are straight forward. We plan to combine NorMedix's capabilities and thin wall catheters with SurModics' most advance coatings to develop a portfolio of catheter based products to enable access, support and guidance to devices targeting the most difficult anatomical areas. Our aim is to obtain at least one 510k product clearance per year of a very unique catheter based product starting in fiscal 2017.

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

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

In addition, we completed some seminal preclinical studies on our sirolimus based drug-coated balloon program in December that encourages us that the same excipient platform which would suit our paclitaxel drug appears to be quite viable with sirolimus as well. We were able to maintain sufficient sirolimus drug in the tissue to observe positive biological effects of the drug on the arterial wall. If this is true and we do have a ways to go before we can demonstrate that, we may have the only balloon drug delivery platform that can work with multiple drugs. Sirolimus as you know may have unique potential and different anatomies compared to paclitaxel such as coronary and below the knee arteries. We intend to continue our R&D efforts to assess the viability of our sirolimus drug coated balloon program throughout fiscal 2016.

I recently described our longer term outlook for SurModics. Our objective is to generate consistent revenue growth in the mid-teens on a constant currency basis and EBITDA margins greater than 30% within three years. We will meet these goals via successful execution in the following three years. First we need to fully harness the potential of our drug delivery capabilities, starting with the SurModics SurVeil drug-coated balloon platform and expanding to other relevant anatomical targets.

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

Third, as we demonstrated in a big way this quarter we must continue to grow and develop our SurModics' core medical coatings business and Diagnostics reagents businesses. We believe that net of the patent expirations the intrinsic growth of these businesses is consistently in the mid-single digits with greater than 30% operating margins. I am excited about our future at SurModics for several reasons. For after a strong start in the first quarter of fiscal 2016, our acquisitions of Creagh Medical and NorMedix positions us ideally to make substantial process -- progress on our transformation agenda in fiscal 2016, with real world and actionable tactics.

We are making important progress on our drug-coated balloon program and we continue to exceed our growth strategies in our core medical coatings and In Vitro Diagnostics businesses. We have put together all of the right ingredients for an agile company with technology, balloon design, catheter design and manufacturing. And I am confident in our ability to use these for our long term advantage to generate consistently attractive financial results.

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

Question-and-Answer Session

Operator

Thank you. [Operator instruction]. And our first question comes from James Sidoti with Sidoti & Company.

James Sidoti

Very impressive quarter. It seems like based on the guidance about half of the year into the year came in the first quarter. Is that accurate?

Andy LaFrence

Well, Jim if you look at the first quarter and pull the pieces apart here, one of the things that we provided in our guidance is that we are expecting R&D to be in the mid 30% of revenue for the year and we are at 22% for the first quarter. If you look at that run rate we are at -- somehow we have gotten about $2.2 million in the first quarter. So you add it on to that, we also have the third generation patents that expired in November, we will start to feel those impact here in the next quarter, in second quarter and more in the third quarter. We think we have qualitative and quantitatively gotten around to those numbers, but that combined with the deal costs and accretion that's expected, amortization expenses will probably be close to $2.6 million accretion, probably $1.4 million. We have had a lot of pieces that are now coming online in terms of expenditures that we had provided in our guidance on the [indiscernible]. So that provides you I think in some perspective in terms of the EPS numbers and what they mean for the rest of the year.

James Sidoti

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

Andy LaFrence

That's our current estimate that we are still completing the NorMedix purchase price allocation but preliminary estimates would suggest we are about the $2.6 million range.

James Sidoti

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

Andy LaFrence

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

James Sidoti

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

Andy LaFrence

Yes. The tax rate for the entire year will be in the 50% to 53% category and the reason it's that high is that we have a couple of pieces. The accretion of the continued consideration is not a deductible expense and the second piece is that in Ireland we had an NOL and as we amortize the intangibles we don’t get a tax benefit at this point in time. So those are couple of the big drivers and in addition we will have some of the incremental deal costs in the next just couple of quarters as we ramp up these acquisitions and some of the integration work. Some of that will be deductible and other parts will be not deductible. But in the [indiscernible] we look at that, our current estimate is 50% to 53% will be doing some additional work here over the next quarter to further refine that.

James Sidoti

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

Andy LaFrence

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

James Sidoti

And then similarly for SG&A that also was lower in the fourth quarter than it was in the -- I mean in the -- lower in the first quarter than it was in the fourth quarter despite the acquisition which slightly -- is that with the legal expense factor was a big factor there?

Andy LaFrence

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

James Sidoti

Okay. And then more of a big picture. Can you just help us explain how these two deals fit. I understand how Creagh fits with the current drug over the balloon pipeline you are working on. Now will NorMedix help with the delivery systems at the balloon or will that be separate product lines?

Gary Maharaj

Yes. NorMedix can certainly help with those. In fact NorMedix's first priority is they have some really unique catheter technology platforms, a breed of catheters and so they can go with very ultra-thin walls, so the [pink three] catheters that give you almost a one for one talk even when they are very flexible and so that's a big trade off in the industry. I think I may have said in the past you want to talk ability of our balloons tech, so you take one of the balloons tech [indiscernible] but you want the flexibility of [indiscernible] and those trade-offs are very difficult to achieve at the same time. NorMedix we believe in our diligence and looking at their technology has that capability better than any other catheter company we clearly are aware of.

Now when you take that in some of our un-commercialized next generation molecules that SurModics is working on coatings and you combine those two then you have the ability to actually remove one of the other trade offs in these catheters which is the lubriciousness to be able to slide and for access and the tightness of the fit in the vessel. And in some [indiscernible] vessels retrieval of these catheters like in the [indiscernible] are very difficult as well. So now we were excited about this being able to put the best in class lubricious technology with a pre-unique catheter platform to get a range of catheter devices throughout the body and if you start with just introducers, start with access sheets, guide sheets, support catheters that are catheters that are required for seek yield support.

And the way it fits together is because we work so tightly with our over a 100 interventional vascular customers we have a keen awareness of the holes in their portfolio and the trade-offs that they have to make [indiscernible] these lines. So with some [indiscernible] knowledge I wouldn't be giving full clarity on this until later in the fiscal year probably for competitive reasons and probably I want our teams to take some time to digest what the first product opportunities should be. But NorMedix is very clear, with our technologies as a combination that creates some -- very differentiated catheters. Creagh has a couple of plays and in fact both these companies ended up knowing generically about each other during the [indiscernible] and they actually got very excited.

In fact if we had not closed the NorMedix deal, I believe Creagh was still going to work with NorMedix to actually get some innovative products out. Creagh has two purposes, Creagh is an independent peripheral balloon innovator is astounding. Then you also have the quality systems and then the manufacturing facility there. So as we look at Creagh in terms of with the NorMedix interaction, NorMedix can't really scale their devices up beyond very, very short run manufacturing. So the Creagh and NorMedix team even today, even actually as I am speaking right now [indiscernible] from Ireland and here, working to see how when we are successful with the NorMedix devices how do we scale that up in Ireland. So there is a big interaction there.

When it comes to device innovation and I’ll give you some of the Holy Grails are still left in vascular medicine. I mean some day someone is going to want to treat globally with radial access in the arm. And that’s going to put a lot of stress on the delivery systems, the catheters, the guide sheets, the access sheets, the support. It will put a lot of stress on the catheter part of the balloon catheters. So we call a balloon catheter as a balloon that both connects it to the hub, it's actually a catheter. So we actually see having those pieces. And then the technology component to snake your way through and potentially have an extra lubricous coating, low particulate very durable and then potentially have a drug on it. And so some of these things while -- some of the big strategics have these capabilities.

What I like about SurModics is we are small enough to have all of the capabilities and also quick enough to move very quickly in those innovations. So that’s not [indiscernible] to get us. The last thing I would say SurModics has a deep competency in research and in reagent and wet manufacturing. Neither of those are going to go away. I mean that’s what helped bring us to the stance here. And so our research teams have continued to innovate on drug delivery, new molecules, anything where there is surface interaction in the human body which is every device that's put in the body will remain a core part of our R&D. So we are not just going towards pure D, the R part of our R&D can be very vital, plus the center of excellence for manufacturing on the reagent side. So it really hangs together very well for us. Now we have got to go and execute.

James Sidoti

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

Gary Maharaj

We always will be working with our customers. I think what we have to offer our customers now, recall many of our customers have had to re-trench their R&D to focus on some really core therapeutic areas, like valves, like drug-coated balloons and a lot of white space is left in interventional medicine that they saying to us look bring us products that are clinically, technically and regulatory derisked, bring us the whole product solution. Ideally that's sterilized package labeled and doctor stock. Creagh actually does sterilized package labeled products that don’t have their brand but have strategic brand names on it. And so they are already leading the way on that. So the short answer is yes, identifying with our customers their wants and needs and the holes in their portfolio. But the other thing we have an advantage now is we can look beyond just asking our customers what they need, we can actually look for the clinical solutions, continue to work with our customers and potentially solve some of the problems that they didn’t think are solvable. And so that will always be a hallmark of how we work with our customers.

James Sidoti

Thank you.

Operator

Our next question comes from Ben Haynor with Feltl & Company.

Ben Haynor

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

Gary Maharaj

One a month is that you want. Clearly it's a fly wheel we are studying in motion right. And so, the old saying goes, the first two and you put your shoulder and the first two is going to take some time. But clearly my objective is to have a continuous series of [fighting wear] products with smooth product launches to our customers. Once a month -- now we know we are probably going to set a new goal for our R&D team after hearing that, but clearly we will start one per year because we are starting somewhat from ground zero right now and so would like to get our first one out as quickly as possible in calendar 2017. But as we build that trivial momentum I don’t see any reason that two to three per year are not within [indiscernible]. And keep in mind even small white pieces in vascular medicine are $50 million to $200 million market. So we are not talking about something that's going to play in a market that is $5 million. So that's the amount we get is going to be that optimization then we say we won mid-teens growth or we won rate of 30% EBITDA margin. And so the reinvestment strategy and our success in that if it takes more talented engineers and R&D people together for that then that reinvestment makes sense, you will absolutely see us do it.

Ben Haynor

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

Gary Maharaj

I think we -- our nature is to really go create and break new ground. If certainly as customers have requested and as our key customers if they come to us and say we really want to get more competitive in this line we clearly are going to consider it. The thing I want to remind is R&D and just for me personally is I don’t want to see us doing things that are slightly better than. As some of our members of our Clinical Advisory Board have told us, look there are 12 sales reps in the hallway outside the cath lab saying they are slightly better than the other person and the view of SurModics is get us something that clearly is a step above. I know that sounds like fighting with you, that's at least going to be our own goal and our target. What we do will be as it do something that's slightly better than for a key customer, I can't say no to that. I mean it depends on the deal but I think our bias is to really go, create a new standard in some of these products that were previously unachievable. And as I said towards the end of this fiscal year I could start laying out more clarity on that. I'd like to tell you what I think now but I now our R&D teams want me to shut up and give them time to percolate properly.

Ben Haynor

Okay, that makes sense. So these product sounds like they can be the triples and home runs that you've talked about on past calls, as they get approved and come out.

Gary Maharaj

Yes. And then especially without needing to do the long-term PMA investment.

Ben Haynor

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

Andy LaFrence

Well I think the couple of pieces there Ben. One, we won't have any transaction related costs that are nondeductible so we will get some benefits there. And then you start to think about Ireland they do have net operating loss carry forwards, so in the GAAP financials we most likely will not have any benefit if any no matter what sort of expenses or profits it may have for a year or two until they get ramped up with the investment we are going to put in there. So you are not going to see any I would say GAAP sort of benefits coming through in Ireland for at least a couple of years coming from a cash standpoint. We won't be paying taxes there for quite some time.

Ben Haynor

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

Operator

[Operator Instructions]. Our next question comes from Charley Jones with Dougherty Markets.

Charley Jones

Good morning. Thanks for the time. I will just ask the one question hopefully. Is the product in 2017 not a balloon catheter?

Gary Maharaj

The product we are contemplating with NorMedix would be more of a vascular catheter. Keep in mind Creagh we haven’t given a lot of headlines to that. Creagh is a balloon catheter development, so they are continuously developing balloon catheters. Part of what Creagh will be doing with us is developing some balloon catheters for us as well in the sense of an internal customer. So Creagh has regulatory approvals independently and I have said this in the previous call, in the U.S. and in Japan and in the EU markets. So we going to continue driving that innovation for [indiscernible] of customers and so that’s beat into our deal diligence and their revenue growth plan. So I was speaking to more what the SurModics, NorMedix type contribution would be. Creagh will also be taking advantage of SurModics SurVeil for example on their offerings to those customers as well. I could count those as new but I feel like I’d be cheating because Creagh has those plans already. But we are giving them the best in class coatings so. It is new but it's not that we are working with Creagh from ground zero to develop a new balloon with them at this point.

Charley Jones

And there again more than I bargained for there, it's sounds like they were already working on through all investment and you started on it and then did even have something that could add to their balloon even better, is that the reason?

Gary Maharaj

No Charley. I am talking about of pure 510k type products, nothing with drug delivery.

Charley Jones

No. I meant when you were doing at your due diligence on Creagh and that’s what I was originally talking about as well. I was talking about the NorMedix transaction where you are talking about these 510k products. So I was just curious as far as 2017, it's a non-PMA product category. It sounds like it's non-balloon. You originally put this slide up to talk about being in three major vascular devices in the next -- I think three or four years. And so I think you are going to allow yourselves taking of about peripheral balloon there and maybe like another type of peripheral or coronary balloon that's two those. But can we expect at some point we will get a third category that is outside of balloon catheters that is a PMA type of device or 510k device that will be a top 10 device since non-balloon catheters, is the question? Thanks.

Gary Maharaj

When we go outside of balloon catheters especially in periphery and including drug-coated balloons there, I mean that there are other devices that are 510k build that I think are very high volume devices. And either -- internally the way I describe when I say three of the top 10 innovations in vascular medicine by 2020 no pun intended, this 2020 vision. But I think of it this way. I think of a valve, we may not do a valve, maybe do a really good valvuloplasty balloon, but potentially we have that capability in our technology that there is a major customer need we will. But when I think of vascular innovations I am not thinking of the high techie drug-coated balloons valves, [indiscernible] was neuro stroke from [indiscernible].

What I am talking about is devices that are used every day to treat tons of patients that actually are not well optimized and still getting below the knee is still difficult. Getting below the knee for example with radial access is presumably a lot better for patients, it could be a lot better for healthcare costs because you can treat bilaterally with these patients with diabetic diffuse disease. And so I would count something like that as an innovation. It may have a PMA but it's going to treat maximum amount of patients with minimizing healthcare costs dramatically and having better patient outcomes. So I believe first of all, three out of the top 10 is absolutely achievable. The trick is we are going to have to be working on more than three to be able to get three by 2020.

Charley Jones

I am asking another one, sorry everybody. So you were a leader early on in stent drug delivery and there is a lot of little companies there started over the years that probably got kind of scrapped over the years and as a result of different issues, funding issues. And I guess I am curious given your drug delivery technology why that wouldn't be kind of running, have any -- can you just remind us your agreements and your patents or your agreements mostly with Cordis or with others that may [indiscernible] that you and them being able to do something there? Thanks.

Gary Maharaj

Well yes, I’ll tell you when I first came here, clearly I looked at the drug-eluting stent world and that's where SurModics had it's one of the major innovations with Cordis. And then I quickly realized that drug-eluting stents had -- some [indiscernible] fastest commodity. I mean I wouldn’t call it a commodity but clearly some of the price pressures in some of those stents and for us to get back in there while we could have, I think we believed internally a drug-coated balloon being a new shelf. It's still early enough if you are in the top five or six to be able to re-write the rules. Drug-eluting stents we have to play according to the rules that have already been written just strategically speaking.

But as far as our drug delivery programs and that's what I was trying to emphasize, our research programs are not going away as it looks because we -- it may appear on a superficial level like we are shifting into purely device driven 510k products and that’s not the case because the research programs and new molecules for coatings and also for drug delivery can be a vital thought of our portfolio going forward. We are always looking -- you say some of these small start ups and how well they do. Tim Arens and the corporate development team are always scouting for things that we believe will have viability, new technologies that could come into our fold.

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

Charley Jones

Thanks Gary.

Operator

Our final questions comes from Jan Wald with Benchmark Company.

Jan Wald

Good morning, everyone. I guess most of my questions have been answered but just a couple of things maybe one like a follow up to mention those. In terms of the SurVeil platform, maybe even the whole are geared to those private solutions, people talk to you about how are you getting or ask questions but how you are getting ready to do it and what's your strategy is. But on the flipside are you feeling as if the strategics are interested in what you are doing and do you have anything that you could talk about in terms of progress or interest levels that would make people believe that the [indiscernible] will commence and the projects will commence, strategy is kind of working or will work?

Gary Maharaj

First of all the interest level has remained consistently high, a lot of this, the large and medium size strategic -- the market development of drug-coated balloon continues to grow. Drug-coated balloons are taking share from other device categories. The one example Jan and we have mentioned to you is when the long lesion data, the impact long data came out in May of last year at PCR, your PCR. The fact that on lesions of the 25 centimeters plus or minus 9 centimeters those are lesions that are about 1 foot long that a drug-coated balloon as the single -- primary angioplasty followed by a drug-coated balloon as the single treatment downgraded the 90% freedom from targeted lesion revascularization. It’s [really causing] the question what are the devices that you need to treat the SFA.

Certainly for calcified lesions you may need oophorectomy or types of stents. So as a result of those type of things the interest in drug-coated balloon continues to actually increase because of the upper market need and I would start to see the competitive need among strategics. I think the issue that many of them have to deal with without fairly naming names or anything like that is that there is the optimum of staying I need something to grabbing the go to get to the market versus I need the best in class product that's eventually in the right sales and marketing channel hence would actually win the market. And so that's always our ongoing intention. We play in who we are with the strategics. We intend to be the best technology and demonstrate the best patient outcomes and what we are offering to a strategic as we finish these trials is the date package that clearly demonstrate that if they want to be the number one drug-coated balloons we are the only choice.

If they want to be second or third in drug-coated balloons we are not going to able to do that, well clearly not at that level right now but we have a undying belief that in vascular medicine the best in market will win and given the long-term viability of this market that sets us up nicely with a lot of the strategics.

Jan Wald

Okay. And then I guess maybe a bit of maybe a hedge fund manager or color like on here, your IVD business. How long is that going to be a strategic fit for you guys? I guess that's the question?

Gary Maharaj

Well is it a strategic fit, Andy?

Andy LaFrence

Absolutely Gary. It does a nice job of covering our corporate costs. So you've gotten the good 20% this last year -- this past quarter I should say in the near term and we see that it will continue to have nice growth. Later in the year we expect that growth to diminish especially in third quarter after what we have our 13% comp from a prior year that we are dealing with. But it's a nice business. You've seen it grow well in the last really 18 months and really it has to do with the management team there, and we've got a great management team there. They are really focused on the market. They are really implementing on the their stock putting some niche products out there and quite frankly they are weighing share. As you look at the overall markets growing at 3% and they grew at 20% and we also expect this on the second quarter to see our Slides business, our [indiscernible] diagnostics business have a nice little boost as well. So I think the business is still very core to who we are as a company. And keep in mind the [Fabric] and the Medical Device segment really came from the diagnostics group many, many years ago and it covers a lot of fixed overhead and likely by itself with 38% operating margin is doing very nicely for the company.

Gary Maharaj

One thing and this may sound counterintuitive but as we look at our corporate development strategy, clearly we continue to look at opportunities in that space because quite frankly they could be easier to execute and get and actually could be -- probably I don’t want to make a promise of this but probably very quickly accretive as well in the near term. And so it wouldn’t be surprising to see us look to get that business, get a couple of small acquisitions done, to get it to what I’ll call a more stable scale. The IVD business is terrific but if a customer misses an order in one quarter, on the other side if a customer has an extra order come in, we sort of want to smooth that out so they are not being whipped sort of around and some strategic scale of products as complementary there, given that we have an excellent management team, it's not out of the question.

Jan Wald

Okay. Thank you very much.

Operator

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

Gary Maharaj

Well, thank you for all of your questions. We are pleased with our recent acquisitions and initial integration moves. We expect fiscal 2016 to accelerate our transformation to delivering whole product solutions to our customers. It will be an exciting year for SurModics. We look forward to speaking with you on our second quarter earnings call. Thanks everybody.

Operator

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

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