Surmodics, Inc.
Q3 2020 Earnings Call Transcript

Published: 10 Aug 2020

[Operator:]

Good day, and welcome to the Surmodics Third Quarter Fiscal 2020 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Tim Arens, Senior Vice President of Finance and Chief Financial Officer. Please go ahead, sir.

[Tim Arens:]

Thank you, Dan. Good afternoon, and welcome to Surmodics fiscal 2020 third quarter earnings call. Before we begin, I would like to remind you that during 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'll also refer to non-GAAP measures because we believe they provide useful information for our investors. Today's news release contains reconciliation tables to GAAP results. This conference call is being webcast and is accessible through the Investor Relations section of the Surmodics website, where the audio recording of the webcast will also be archived for future reference. A press release disclosing our quarterly results was issued this afternoon and is available on our website at surmodics.com. I will now turn the call over to Gary Maharaj. Gary?

[Gary Maharaj:]

Thank you, Tim. Good afternoon, and thank you for joining us. We hope you are staying safe and healthy during this challenging time. I'm quite pleased by our performance this quarter despite the difficulties posed by COVID-19. As we navigate through this pandemic, we continue our commitment to our strategic objectives for fiscal 2020, notably achieving a number of critical milestones and continuing to ensure that we remain well positioned financially. Before we dive into an update on our progress, I'll provide a summary of our top line, and Tim will also cover in more detail later. First, total revenue for the third quarter of fiscal 2020 grew by 10.4% to $26.9 million as compared to $24.3 million in the third quarter of fiscal 2019. Looking at our 2 business units. Medical Device grew 8% to $20.5 million, and In Vitro Diagnostics grew 18% to $6.4 million in the third quarter as compared with the prior year quarter. Our Medical Devices business revenue growth was positively affected by increased license fee revenue from our SurVeil drug-coated balloon agreement with Abbott Vascular, as a result of the CE Mark for our SurVeil DCB. This license fee revenue more than offset a meaningful decline in coatings royalty revenue, which resulted from the impact of COVID-19 and the expiration of our fourth generation hydrophilic coating patents. As a reminder, a key component of our Medical Device business revenue is derived from royalty revenue and therefore, dependent on our customers' sales of devices that use our technology. The procedures using our coatings and products range from urgent to elective procedures, and as a result, remain largely variable and dependent on the recovery of vascular procedures from this pandemic. Medical Device revenue in Q3 was impacted to a significant degree by coronavirus procedure deferrals. However, we were encouraged to hear the resumption of elective procedures and the easing of these restrictions in certain geographies as the third quarter progressed. Turning to our IVD business. The 18% growth we generated in Q3 over last year was a result of continued momentum in key chemical components and the DNA microarray slides, with a small positive impact from COVID-19 diagnostic and serology tests that are in development by our customers, where we are a provider of technology. Tim will discuss Q3 revenue performance in greater detail. But needless to say, we are happy to support our customers who are involved in COVID-related research that can result in better diagnostic and serology tests. Our performance in Q3 exemplifies our team's dedication to our mission in the diagnosis and treatment of disease despite the challenges brought forth by this pandemic. We're committed to making meaningful progress on our initiatives for this fiscal year. As a reminder, this year, we set out to accomplish the following

[Tim Arens:]

Thank you, Gary. During today's call, I will provide an overview of our third quarter operating performance. As we communicated last quarter, due to the uncertainty created by the COVID-19 pandemic, our full year guidance is suspended. However, I will provide some commentary to help provide insight into the impact of COVID-19 on our company as we head into our fourth quarter. These comments are based on circumstances that exist today, which we acknowledge are fluid and subject to change. First, let me speak to the impacts of COVID-19 through our third quarter. During the quarter, our operating results were impacted by the coronavirus pandemic in 4 primary areas

[Operator:]

[Operator Instructions] We'll take our first question in queue, comes from Jim Sidoti, Sidoti & Company.

[Jim Sidoti:]

Can you hear me?

[Gary Maharaj:]

Jim, we hear you well.

[Jim Sidoti:]

All right. Great, great. Glad everybody's well there. I just want to be clear, the $10.8 million payment from Abbott, was that recorded as $10.8 million in the quarter or something less than that into -- on the income statement?

[Tim Arens:]

Yes. It's recorded less on the income statement. We recorded $6.7 million of the $10.8 million on the Q3 income statement.

[Jim Sidoti:]

Okay. And then the rest will be spread out over the next couple of quarters?

[Tim Arens:]

Yes. It will go out through the 5-year follow-up period of the TRANSCEND study. So it will be treated in the same manner that the upfront license fee is being treated as well as the first milestone payment, the completion of the 446 patient enrollment in the study.

[Jim Sidoti:]

And has Abbott indicated to you when they plan to launch the device in Europe?

[Gary Maharaj:]

As a partner, they're assessing the situation with the COVID pandemic and also, as you know, the paclitaxel issue. One thing to keep in mind, Jim, is the TRANSCEND data could be seen as right around the corner potentially later in this calendar year. So in terms of marketing against a very crowded European field that may be a relevant data set that they may need as well. So we'll continue to work with them. Our job is to make sure we're able to supply them on the decision to go with a full launch.

[Jim Sidoti:]

Okay. And you indicated that because the COVID, follow-up has become a little more challenging. Do you think that delays the release of this data?

[Gary Maharaj:]

Well, we've been in continuous discussions with the FDA, and the agency has been eminently practical about this. Clearly, the cohort of patients we're treating are also the cohort of patients who suffer much worse consequences of catching COVID. So there's been -- in some of the cases, there's been a reluctance to go into the hospital or the clinic. And in some cases, the hospital clinic was not able to accommodate them within window. So yes, so we have lost some, but we're continuing to follow. As I said, I think we're over 70% of the entire cohort that have had an in-window follow-up. It's the remainder of that 30%, we're doing everything we can, including the ones that we still have left within window, and that will be through the middle of September. So, there is a possibility we may wait for some late comers out of window. Just because in discussions with the agency, they're going to look at the completed cases, those are the ones that are done according to protocol, but they're also interested as we are in the totality of the data. So the question is if there are some straggling cases that have come in outside of September, October or November. We'll have to make that decision as we go forward. We don't envision that right now, but it's not out of the realm of possibility. Nonetheless, the work to lock the database, clean it and all that stuff is ongoing. So we're not waiting for everything to line up to do that. The team will be actively scrubbing and locking, so that if we do wait for some late follow-up, it's not as much on the critical path.

[Jim Sidoti:]

Okay. And with regards to Sublime, now you have the balloon and the guide sheath approved, I assume that those will go to the same partner?

[Gary Maharaj:]

Yes. Well, first, we want to do -- we started in a bit wrong side, right? We have the guide to be able to access the guide sheaths. And in many respects, it's a road to nowhere because our guide sheath, I believe we still have the smallest sheath compatible in the 5-French version that's on the market or that has clearance. And now we have -- I think our team fact-checked this simply the longest balloon that's ever been created. This is a 2.5 meter working length device. As I always joke, we could treat people of Tim's height with it. It's a long, long balloon obviously. So, now we have the sort of critical mass, complementary devices to evaluate them. It's no sense of like evaluating the sheath without a therapeutic device. And without a therapeutic device -- without the sheath, the therapeutic device wouldn't have as many legs. So the first step as usual is we want to make sure that those devices perform clinically as expected. And we're going to take our time to do that because they're quite unique devices, and it's a quite unique approach for radial to the periphery. So partners may be interested at this time, but we want to get our -- this part of the job done first before we talk to them about it.

[Jim Sidoti:]

Okay. And then, last one for me on Avess. It sounds like since Abbott passed, you'll look for other options. Is one of those options to start the trial on your own?

[Gary Maharaj:]

Yes. So recall during the contract negotiations with SurVeil, Abbott had wanted to have the value of an option. And we -- so in negotiation, there was some value assigned to the option, and they got the option. I would characterize it as allowing the option to expire is not unexpected from our viewpoint. Keep in mind, again, the TRANSCEND study results are probably a few months off, right? 3 to 5 months, let's say, off. And if -- it's the same technology in a vest that's in SurVeil. imagine if it's a comparison with Medtronic, and Medtronic has good results in the AV space. So you could see if the TRANSCEND data looks good, favorable for SurVeil with respect to Medtronic, you could somehow translate that to different vascular that of AV. It's not identical. It's not totally scientific, but you can make a much less risky bet of that point. And so I think at that time, we will continue just as we did in SurVeil, the clinical and product development behind Avess. We have to fill out the matrix. There's big balloon diameters and substance. There's a lot of work to do before we contemplate doing the next stage of clinical. And by the time we finish that work, we'll also have the TRANSCEND data available. I think that will help us understand the value -- the residual risk and the value of what we have to base the next clinical development. But as usual, when we believe in something, partners may come, partners may go, but as we continue to fill this out, we believe it could create more value for a better deal down the road.

[Jim Sidoti:]

Okay. And I guess I do have one more. The In Vitro Diagnostics business, it sounds like you saw actually uptick in that business because of COVID. Is that a trend you expect to continue through the rest of fiscal...

[Gary Maharaj:]

Yes. I'll let Tim talk to that. But we want to be very careful about -- I mean, that was a nice small benefit, I mean, intrinsic momentum. The businesses has really drove it. But it's really hard to predict in early research stage. Tim, you want to add?

[Tim Arens:]

Absolutely, Jim. It's a very good question. And so just to remind folks, IVD, the Diagnostics business grew 18% to about $1 million year-on-year. And just on that growth, we're talking a pretty modest amount of that growth, well less than 50% and probably maybe, say, you wouldn't be wrong thinking it might be closer to the 25% of that growth was coming from COVID-related activities. As Gary mentioned, it's way too early. I mean we have multiple partners that are working on things. And you just don't know how long it will take to get into markets and get adoption but we're pleased with what we're seeing. And clearly, at this point here, we're happy to provide our customers who are working on COVID-related activities with our chemical components to help them develop the best possible serology tests and help us with the pandemic.

[Operator:]

We'll take our next question in queue, comes from Brooks O'Neil, Lake Street Capital Markets.

[Brooks O'Neil:]

I'm going to try to ask as many questions as Jim did, see if I can get answers there. But my first one is, you talked quite a bit about the patent expiration on Gen 4. And just curious if you could share with us sort of your outlook for that business going forward? And how you stand with Gen 5? And what's going on there and whatnot?

[Tim Arens:]

Sure. It's a great question. Brooks, we've characterized Gen 4 previously, in fact, back in November as we're entering into fiscal 2020 kind of what we expected the impact to be. And at that point, we highlighted a $5 million to $5.5 million headwind. And I'll tell you, we continue to think that's the case. So I would suspect that Q4 is probably going to be slightly larger headwind than what we saw here in Q3, the $1.8 million. And then I did articulate previously that with regard to fiscal 2021, we'll continue to see some impact from patent expirations. But it will probably be about half of the amount that we're anticipating here for fiscal 2020. So somewhere $2.5 million to $3 million is probably what one should probably think the impact will be in fiscal 2021. Gen 5 actually was probably the best performing of our hydrophilic coating generations. It came in flat for the quarter. Unfortunately, other generations were impacted not only by COVID, which I think overall reduced our portfolio by about 30% versus what we would have seen without it. So we're pleased with Gen 5. And I think once we get out of this environment with COVID, we're going to see some robust growth from Gen 5.

[Brooks O'Neil:]

Great. And then Jim asked you about the Avess product. I'm not sure I understand sort of what the commercial outlook is for Sundance. So could you just talk a little bit about that?

[Gary Maharaj:]

Yes. We were really pleased to get that trial up and running and start enrolling patients. I guess I could say this, now, we had hoped -- we actually had a teed-up for March. And then some of the Western European countries that we're about to start on actually had really massive COVID, including one of the principal investigators at the sequester. So by the time she was able to get back, we couldn't really start the trial. So it was a really spectacular execution on our team to get it started in -- at least in Western Europe. We have 7 sites that we are targeting to get this trial enrolling. And this is on our 0.014" below-the-knee platform where we're using sirolimus with the similar technology and the excipient that we use. So we're quite excited about this because it will tell us how well this device and the technology itself can perform. The idea is to be able to finish enrolling this trial sometime into fiscal '21. And it's a 6-month follow-up. So then we'll be able to, after that follow up, assess the viability of that device. The -- it's really a safety study, but it will get some directional efficacy data as well. Abbott also has the option right remaining with respect to the Sundance product as well. So -- but we don't know -- I don't believe there's any U.S.-approved BTK device at this point. But keep in mind, we also got the breakthrough technology designation from the FDA of this product. I thought it was last year, we're able to get that. So quite excited, but the job is to really enroll this trial with high quality even in the light of COVID and follow-up those patients within the next year.

[Brooks O'Neil:]

Great. And then my last one, I was only joking about Jim. My last question is, obviously, you're spending 50% plus of revenue on R&D today. And it's very tremendous fruit. We're really excited about it. But I'm curious if you could share sort of your early thinking about how you might handle the R&D spending as we get into that period where the revenue growth starts to take off as some of these whole products launch.

[Gary Maharaj:]

Sure. Tim can comment a little bit more on the details. But when we talk about our R&D right now, it's really -- we're doing pipeline development. And pipeline development means you have to have a pipeline, intrinsic value of what we have with that pipeline. So we're still building a pipeline, and we're not in steady state or what I call product development yet. And that steady state really comes by where the returns from things coming out of the pipeline start offsetting the investments going into the pipeline. Right now, that is completely out of balance because we have to invest in the pipeline for a long-term future. The other thing to consider is that the combination products like DCB and Avess are pretty heavy hitter, right? So we're committed to SurVeil until we see this data. The TRANSCEND data will also help us how to think about Avess. And then we have, in the next 6-plus quarters, we'll see how Sundance does. So really, if you're in for this, you have to be in for that time period. The non-drug products like the Sublime and Pounce, thrombectomy and stuff like that, those will start returning probably earlier than the second two DCBs. So sometime in the '23 to '24 period -- I would say, hopefully closer to '23, you'll start to see what I call dynamic equilibrium where the investments in the pipeline are now being somewhat offset by the returns from them. I want to be clear, our R&D as a 50% of revenue is not going to be like that forever. But the thing we want to make sure is we wanted there because the denominator of revenue is going up. So that's what's really going to change that ratio.

[Tim Arens:]

Yes. Let me provide a little bit more context and color for you as well, Brooks. I think it's a little bit probably early and premature to fully appreciate what the clinical study funding might be and who it might be coming from as it pertains to our below-the-knee drug-coated balloon as well as the AV access drug-coated balloon. But what I would tell you is even if Surmodics were to fund pivotal studies for both of those technologies, I don't see our overall aggregate dollar spend being much different than what we've spent last year or perhaps even this year, which is, to remind you, somewhere in that low 50s kind of range. If we're not funding that, and it's going to be significantly lower. And I'll -- just to put it in context. I think last year, we spent -- it could have been somewhere right around $11 million, maybe a little bit north of $11 million on TRANSCEND and the AV first in-human studies. So it gives you a little sense of the context of what we're spending annually on that. And put it into context here, if you think about the remaining spend for TRANSCEND, it's coming down, like, I think this year, it's maybe going to be $7 million-ish relative to what we spent last year. So as you kind of go through the gestation period of these clinical studies, you actually do see lower spend. But it depends on when the other things are going to be coming online. But without providing any long-term guidance, I just want to frame up, I think it would be -- there would have to be something extraordinary in terms of interest and excitement for us to go above the kind of level that we've been spending over the last two years. And as Gary was describing as the revenue streams come online, you're going to be looking at R&D as a percentage of revenue, it's going to be dropping significantly from where we're at. I would probably direct you to think back to the pre whole-product solutions there where we're spending somewhere around 30%, 35% on R&D as a percentage of revenue. So probably not a bad place to think longer term. But when we have a few more things solidified, we'll be able to provide a lot more clarity and color for you.

[Operator:]

[Operator Instructions] We'll make our -- next question in queue comes from Mike Matson, Needham.

[David Saxon:]

It's David on for Mike. And I guess I'll see how many questions I can ask. I'm just kidding. No, but I've been hopping between calls, so I apologize if you got any of this in your scripts. But I guess just on -- first on the IVD business. Understand that it's between 20% and -- 25% and 50% is from COVID-related project. But if those do really take off, do you have any capacity constraints at all?

[Tim Arens:]

Yes. No, it's something that we talked about a lot around here. I mean if it really, really took off, it would be a good problem to have, but one that I think we could probably solve but we do have capacity, and we can always look at adding shifts or lines. So at the present time, I feel we've got that covered. And I think our team wouldn't be overly shy about having to tackle that "problem," if it were to take off, and we had an opportunity to provide a lot of chemical components to support these tests.

[David Saxon:]

Okay. I appreciate that color. And then just on the thrombectomy project. I forget the name of it now. But I think it will be an arterial indication. Is that right? And then can you talk about the pathway to other indications and making it a venous product? I'll just leave at it there.

[Gary Maharaj:]

Sure. We -- yes, it is going to be initially an arterial indication that's called Pounce. And we're in front of the agency right now. Quite a lot of learning in the arterial indication with the back and forth with the FDA. So that will be very helpful as we choose the next indication. I think the first thing is Pounce, as we get it out there, devices like this, as you well know, are heavy hitters. I mean if there's complete therapeutic solutions that we're providing here, so we want to make sure the concept works well. We're very confident it will work well on arterial. The issue of where we go next. In fact, we've been discussing that. Clearly, the venous indication is on adjacency, you can go from arteries to veins and then there's PE and stroke. I highly doubt we'll go straight into stroke. That's a pretty a longer-term potentially PMA type. And we've got our hands full of fair amount of PMA-type devices right now. But clearly, between DVT and PE, we believe it has legs. We've got to decide where is the best, not just market opportunity, but one of the things we want to optimize is the learnings from the arterial may play easy into the venous side. It's very different. Veins move around. They're soft, the blood flowing, I will say in the wrong direction, but blood's flowing in back to the heart and lungs. So the extensibility of the platform, what we learn from our arterial experience and the market size. So it's a multifactorial thing. It's -- this just use market size to determine these, but I think we want to move quickly into the next indication. So I get one vote on the team, but my vote would be get to the indication that's easiest to extend and get into play. So I know I haven't answered your question, but I think it's going to come down between venous and PE.

[Operator:]

This concludes the Q&A. I will now turn it over to management for any closing remarks.

[Gary Maharaj:]

Thank you. We want to close by expressing our sincere appreciation to those on the front line who remain dedicated to supporting patients and to keeping our communities running. Please stay safe, and everyone be well until our next quarter earnings call. Thanks, everybody.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's presentation. You may now disconnect.