Surmodics, Inc.
Q2 2008 Earnings Call Transcript

Published: 28 Apr 2008

[Operator:]

Ladies and gentlemen, thank you very much for standing by, and welcome to the SurModics Second Quarter 2008 Earnings Call. At this time all participants are in a listen-only mode, and later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). As a reminder, this call is being recorded Wednesday, April 23, 2008. I would now like to turn the conference over to Maggie Knack. Please go ahead ma'am.

[Maggie Knack:]

Thank you, operator. Good afternoon, and welcome to SurModics fiscal 2008 second quarter conference call. Thank you for joining us today. This is Maggie Knack, SurModics' Director of Investor Relations. Our fiscal 2008 second quarter results press release was issued earlier this afternoon, and is also available on our company website at www.surmodics.com. Joining me on the call today is Bruce Barclay, President and Chief Executive Officer; and Phil Ankeny, Senior Vice President and Chief Financial Officer. 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. We expect the total call today to last approximately one hour. I will remind you that some of the statements made during this call may be considered forward-looking. The 10-K for fiscal year 2007 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. Please be advised that during the call, non-GAAP financial measures will be used to provide information pertinent to ongoing business performance. These measures are reconciled to the GAAP measures and are available in today's earnings press release. Now I would like to give a brief overview of the topics that will be addressed during today's call. First, Phil will cover the company's quarterly financial results. Bruce will then highlight quarterly achievements, discuss pipeline opportunities and other business matters, and update you on the status of our fiscal 2008 corporate goals. And finally, we will open the call to your questions. With that, I'll turn the call over to Phil.

[Phil Ankeny:]

Thank you, Maggie. I will begin by providing an overview of second quarter financial results and follow that with specifics on discrete line items. Next, I will discuss significant revenue drivers and breakdown revenue by component and business segment. Finally, I will cover expenses and review our balance sheet and cash flow. Second quarter revenue was a record $25.7 million, a 48% increase from $17.4 million in the year earlier period. All aspects of our business continue to report strong results. These results include a record $5.2 million in revenue from Brookwood Pharmaceuticals, and another $1.1 million from BioFX Laboratories, both of which we acquired in the fourth quarter of fiscal 2007. Excluding the revenue from Brookwood and BioFX, our Legacy business generated record revenue of $19.4 million. We will continue to break out the revenue contributions from these recently acquired companies for the remainder of fiscal 2008. Moving down the income statement, the company reported operating income of $7.2 million, down 11% from $8.1 million in the prior year period. Net income was $5.1 million for the quarter, down 10% from $5.7 million in the same period last year. Diluted earnings per share was $0.28, down 10% from $0.31 in the second quarter of fiscal 2007. In an effort to give investors a more transparent picture of ongoing operations here at SurModics, we are providing supplemental non-GAAP disclosure related to the Merck agreement accounting treatment. We believe that this supplemental non-GAAP disclosure complements our GAAP reporting and allows the investment community to better understand current performance by showing what our results would have looked like had we fully recognized as revenue all of the items related to our collaboration with Merck, compared to amortizing the amounts as we do under the EITF 00-21 accounting. Because the Merck agreement is so significant to our business, and because of the effect the associated accounting treatment has on our reported results, we are presenting this new non-GAAP disclosure to help investors understand the impact of that single agreement. To help you follow along with my upcoming comments, please refer to the supplemental tables in our press release. To provide more of a cash view of the accounting for Merck, we back out the revenue recognized from licensees and cumulative R&D work, which are typically Non-cash items in the quarter. We then add in the amounts that were billed during the quarter, both the $1.8 million of R&D activity for the quarter, and the $2 million license fee we received when Merck elected to expand their rights and pursue development of an additional investigational compound. With the addition of these significant amounts during the quarter, our deferred revenue balance related to Merck grew to $24.9 million at March 31, 2008. Our supplemental non-GAAP tables also illustrate the growth in the deferred revenue from Merck. With this growing deferred revenue balance, we are building a stream of recurring revenue and earnings for the future. As you can see in the supplemental tables, total non-GAAP revenue for the second quarter was $28.5 million. Following this level of revenue through the P&L and taxing resultant pre-tax income at our effective tax rate of 39%, results in non-GAAP diluted earnings per share of $0.37. So, you can see how the accounting treatment for the Merck agreement results in a difference of $0.09 in earnings per share for the quarter, an impact of 32% over the GAAP results, and $0.14 for the first six months of the fiscal year, an impact of 24% over the GAAP results. We encourage investors to consider SurModics results on a GAAP, non-GAAP and cash flow basis, as we believe that this combination provides the most appropriate and comprehensive view of our past and ongoing performance. Shifting gears a bit, I will now discuss the CYPHER Sirolimus-eluting coronary stent. Johnson & Johnson, the parent company of Cordis Corporation, reported worldwide sales of approximately $400 million for CYPHER, down 25% year-over-year. Despite the decrease in sales, J&J estimates that the CYPHER stent has retained 43% market share in the United States, and 39% market share outside the US during the second quarter. Multiple headwinds including lower penetration rates, reduced prices, and increased competition year-over-year continue to drive softness in the DES market. On a more optimistic note, many experts believe we are beginning to experience some stabilization in this market. Going forward, we also expect increased competition in the US market with the anticipated approval of XIENCE drug-eluting stent from Abbott later this year. In addition, we were pleased to see that during the quarter, Medtronic received FDA approval for their Endeavor Zotarolimus-Eluting Coronary Stent System, and that they launched that product in the United States. We want to remind investors that the SurModics hydrophilic coating is a component of the delivery system for this stent. And our third quarter results will include royalties from the first sales of Endeavor in the US We are already receiving royalties on sales of Endeavor outside the US While total SurModics revenue associated with CYPHER decreased 28% compared with the prior year period, our remaining businesses continued their strong growth with record non-CYPHER related revenue increasing 90% from the year earlier period. Even if you exclude revenue from Brookwood and BioFX, the rest of our business grew 34% year-over-year. Our track record of generating robust revenues despite declining contributions from CYPHER sales underscores the success of our evolving business model and the value of our broad and growing portfolio of products. Moving on to SurModics mix of revenue in the second quarter. Our results break down as follows. 54% generated from royalties and license fees, 18% from product sales, and 28% from R&D revenue. In contrast, in the year earlier period, royalties and license fees accounted for 75%. Product sales were 19%, and R&D revenue was 6%. As we have discussed in prior conference calls, the acquisitions of Brookwood Pharmaceuticals and BioFX Laboratories have shifted our revenue mix in the near term towards higher contributions from product sales and R&D revenue, which has had an adverse impact on our operating margin. However, we believe this near-term effect is more than offset by the benefit of a stronger, more diversified business, and we fully expected Brookwood's robust pipeline to generate royalties and license fees. Accordingly, the long-term mix may trend toward a higher percentage of royalties and license fees. Next, let's discuss revenue components for the quarter. Royalties and license fees were $13.8 million during the period, up 6% from the year-ago quarter, even though CYPHER sales were down substantially as gains in non-CYPHER-related royalties and license fees more than offset the significant decline in CYPHER-related royalties and license fees. Again, these results underscore the value of our diversified portfolio of royalty generating license agreements. Product sales were strong in the second quarter, increasing 39% year-over-year to $4.7 million from $3.4 million in the prior year period. Growth was particularly strong in in vitro products. Continuing now with our final revenue component, we generated a record $7.2 million in R&D revenue in the second quarter of 2008, a significant increase from $1 million in the year-ago quarter. The increase reflects the addition of Brookwood to our business, as well as increased R&D activity with Legacy SurModics customers. Importantly, this record level of R&D revenue was achieved despite the bulk of roughly $1.8 million billed for our people's efforts in support of Merck being recorded as deferred revenue. As our supplemental non-GAAP table illustrates, R&D revenue would have been $8.4 million if we did not amortize the amounts under EIPF 00-21. Now I will review results across business segments. The drug delivery segment generated revenue of $12 million in the quarter, a 93% increase year-over-year, and up 11% sequentially. The increase from the year earlier period reflects strong R&D revenue from Ophthalmology and other drug delivery customers, which offset the impact of the 25% year-over-year decrease in CYPHER sales. In addition, Brookwood contributed approximately $5.2 million, which is a record for that business to drug delivery segment revenue. Brookwood's strong performance has also triggered the first revenue-based milestone payment under the acquisition agreement. Accordingly, we will be making a $2 million payment to Southern Research Institute soon. Moving on to hydrophilic and other operating segments. We generated record revenue of $8.3 million during the period, up 26% year-over-year, and up 9% sequentially, driven by strong growth in royalties and R&D revenue. Our significant growth in this segment illustrates the substantial customer traction that exists for SurModics technologies and the Company's broad and growing portfolio of license customers. Again, no revenue is included yet from the US launch of the Endeavor drug-eluting stent by Medtronic. And, lastly, revenue for the in vitro segment was $5.5 million for the quarter, up 19% year-over-year and flat sequentially. Growth in product sales including BioFX offset a decrease in royalties. Next, I will comment on the Abbott Diagnostics royalties, which roll up into the in vitro technologies operating segment. Our most recent 10-K reported that 16% of fiscal year 2007 revenue derived from Abbott Laboratories. Included in this figure are several customers under the Abbott corporate umbrella, including Abbott Diagnostics, and several products within Abbott Vascular. While diagnostics royalties are the largest single revenue item from Abbott, they are certainly not the only one. As we have disclosed in the past, the US patents underlying the Abbott diagnostics royalties will expire in fiscal 2009. Specifically, the patents expire in December 2008, but remember that we report royalties on a lag, essentially when the sales and associated royalties are reported to us. Typically, this is a one quarter lag, but some customers report even more slowly than that, since there are so many sublicensees under these patents. As a result, we expect that some royalties may spill into the second half of fiscal 2009. You should also keep in mind that our current results include the amortization expense associated with our Abbott sublicense purchase. This amortization of approximately $400,000 per quarter will stop after the first quarter of fiscal 2009, in line with the patent expiration, even though royalty revenue will continue at least through the second quarter of fiscal 2009, as I just discussed. Let me also remind you of another patent expiration we have discussed in the past. One of our earliest patents covering our PhotoLink technology expired in March 2008. It is important to remind investors how our intellectual property strategy typically plays out. Our scientists and engineers are constantly creating inventions to improve our technologies, and we file patents on man of these new inventions. On the customer front, most of our customers migrate to these improved technologies and, accordingly, the patent life is effectively extended and we continue to collect royalties from these customers. In the case of PhotoLink, we have successfully migrated the vast majority of our customers to later generation and substantially better PhotoLink technology. However, we do have one customer that has elected for operational reasons to stay with our older technology. The associated royalties with this customer are not material. Next, I will return to a review of operating expenses. We continue to invest heavily in R&D as we expand our technology leadership and culture of innovation. In the second quarter we dedicated 41% of revenue to R&D. Overall, R&D expense constituted 63% of total operating expenses excluding product costs. I am pleased to report that we are continuing to grow our technical team adding capabilities to better support our customers today and in the future. With the addition of Brookwood and BioFX, combined with the organic hires we continue to make in our Legacy organization, total R&D expense was $10.4 million, up 81% from last year. SG&A expense more than doubled compared to last year, with much of the uptick associated with the addition of Brookwood and BioFX, as well as expansion of our organization to support our growing business. Also included in this quarter's expenses was amortization of intangibles from Brookwood and BioFX totaling approximately $300,000. Expenses also include an accrual for bonuses that may be paid for fiscal 2008 performance under our bonus plan. Non-cash stock-based corporation was approximately $3.4 million for the quarter, sequentially up from $2 million in the first quarter. Most of this increase was related to one time Non-cash stock-based comp charges in connection with the recent transitions on our board. Now let's turn to the balance sheet. As of March 31, SurModics had a cash and investments balance totaling $80.9 million, sequentially up from $72.5 million as of December 31. Cash flow from operations was $4.5 million during the quarter, compared with $4.7 million in the year-ago quarter. Our second quarter operating cash flow is typically the lowest on a quarterly basis, all else being equal, because we make two quarterly estimated federal tax payments during the period, in January and March. Also, Brookwood had a $1.9 million increase in accounts receivable this quarter in connection with their significant revenue growth. Our strong financial position has allowed us to return capital to our shareholders. Since announcing the new share repurchase program in November, and once our trading window opened at the end of January, we bought approximately 65,000 shares of SurModics stock for $2.6 million. Our share repurchase program reflects our strong confidence in our near- and long-term prospects, and our belief that SurModics stock is undervalued. With that, I will now turn the call over to Bruce.

[Bruce Barclay:]

Thank you, Phil, and welcome, everyone. Today I will update you on the quarterly achievements and update you on the product pipeline and other business matters. I'll also revisit the progress we've made against SurModics fiscal 2008 corporate goals. This quarter's results are evident that SurModics is a well diversified company with multiple high-value opportunities in front of us. We know that our continued success is predicated on executing against three key pillars that have driven our performance to this point. First is our ability to continue to grow and diversify revenue. Second is our capability in leveraging our innovation and technology leadership to solve multiple customer problems. And third is our record of strong financial results and effective capital allocations which allows us to generate increasing value to our shareholders on multiple fronts. SurModics generated strong financial results in the second quarter. We announced record total revenue, up 48% year-over-year and 8% sequentially, and also had record revenue in our Legacy business for the second consecutive quarter. In addition, we again achieved double-digit revenue growth in all three of our operating segments. Finally, we congratulate Dr. Art Tipton and all of our exceptional Brookwood employees, as Brookwood generated record revenue and 43% growth year-over-year, compared with their results as an independent company. We are particularly pleased to have realized these high-quality results despite the continuing decline in CYPHER stent sales year-over-year, although sequential CYPHER sales were a better than some industry experts expected. And while we are disappointed that our GAAP earnings have not kept pace with revenue growth, it's important to remember that the continued growth of R&D work in our collaboration with Merck has actually diluted the GAAP earnings due to the accounting treatment for that agreement. In fact, as Phil discussed, for the first six months of fiscal 2008, our pro forma EPS is $0.14, or 24% higher than reported GAAP EPS as a result of the substantial benefits we are deriving from our relationship with Merck. SurModics continues to make significant progress in our relationship with Merck. We built a record number of hours on the Merck projects in the second quarter, which was roughly $1.8 million. Further, our value of this partner was underscored in January, when Merck exercised an option to license, develop and commercialize an additional Merck proprietary investigational compound using our I-vation sustained drug delivery system. This agreement highlights our strong and expanding relationship and provides further validation for the I-vation drug delivery system as a platform for delivering drugs to treat retinal disease. In addition to our development programs with Merck, SurModics scientists and engineers are also busy in other ophthalmology development projects for back of the eye and front of the eye diseases with numerous customers. These projects leverage our drug delivery platforms and polymer matrix technologies for sustained delivery of customers' proprietary drugs to the eye including both large and small molecule compounds. The customer demand for our research and development services reinforces the opportunity we see in sustained drug delivery applications in ophthalmology. SurModics has a total of 10 paid development programs in process for both large and small molecules, both posterior and anterior segment applications across multiple SurModics technology platforms. We're also pleased to mention that SurModics will be presenting data at the upcoming 2008 association for Research in Vision and Ophthalmology meeting, also known as RVO, which will be held at the end of this month. All of the SurModics is related to the drug delivery platform technologies currently under development in our Drug Delivery and Ophthalmology business units. Our Brookwood pharmaceuticals unit continues to perform very well. As a reminder, Brookwood's proprietary polymer-based technologies provide site-specific and systemic drug delivery solutions to companies developing improved pharmaceutical products. Customer interest has never been stronger, as evidenced by the record level of revenue generated in the quarter. Brookwood continues to generate impressive, profitable growth from customer supported R&D, product manufacturing for clinical trials, and polymer sales. And, as customers move along in the development cycle, there remains significant upside from royalties and licensees. Brookwood is positioned to continue its growth following the signing in the March quarter of an additional development contract valued in the millions of dollars with a top 10 pharma company. No license has yet been signed with this customer. Additionally, Brookwood has multiple later stage opportunities with some in Phase III clinical trials. We believe that some of these could enter the market and begin generating royalty flow within the next two to three years. In addition, similar to the SurModics Legacy business, there is the potential for deals to be structured to include milestone payments in advance of these royalty flows. To support that growth and consistent with the strategy we articulated when we announced the acquisition in August 2007, SurModics announced today in the second press release after the market closed that we had completed the purchase of a new facility in Birmingham, Alabama. We will soon begin to renovate the property, and when completed we expect it to provide SurModics and Brookwood a world-class facility capable of manufacturing and developing pharmaceutical products to treat patients around the world. Today the announcement reflects the confidence we have in Art Tipton and all of our colleagues in Alabama, as well as the strength of our business and the optimism we have in its future. Expanding Brookwood's capacity was contemplated at the time of the acquisition, and today's announcement is wholly consistent with our business strategy. This new facility is designed to support the growing customer interest in both R&D and manufacturing services from Brookwood. In addition, at the time of the acquisition, we discussed how Brookwood manufacturing capabilities would be helpful in serving Merck, since we are the exclusive final product manufacturer for them with I-vation. Along these lines, we're happy to announce today that this new facility today will be the manufacturing site for the late-stage clinical trial and commercial product for the I-vation TA drug delivery system currently in development. Also, when the expansion of the facility is complete, we will be fully equipped to help customers in product development and supply at every stage, from early feasibility to production of marketed products. Our pharma and biotech customers work with Brookwood specifically because of our drug delivery technologies and capabilities, as well as our commitment to manufacture clinical and commercial product on their behalf. This larger facility is a key building block in our continued advancement to more fully support and service our customers. The preexisting facility has approximately 286,000 square feet of office and warehouse space and sits on 42 acres. It's less than a half mile from Brookwood's current headquarters in Birmingham. We expect the total investment to be approximately $30 million including the cost of the building and the initial renovation. Importantly, this amount excludes the anticipated financial assistance we are receiving from the state, city, and local government in Alabama, which will total several million dollars. The building's pre-existing warehouse shell allows us to populate clean rooms and interior walls much more easily, quickly and inexpensively than constructing a building from the ground up. If customer projects continue to progress as expected, and we maintain our execution against the business plan, Brookwood's employee population could reach roughly 300 employees, rather, over the next three to five years. Let me offer some additional insight into how our customers view facilities. Medical device customers typically prefer to manage all final product manufacturing in-house. By contrast, pharma and biotech customers are far less interested in the manufacturing of microparticles or other drug formulation activities such as the type of work that Brookwood performs. The inclination by pharma customers to outsource manufacturing to the extent possible is pervasive. While feasibility, preclinical and sometimes even Phase I and Phase II trials can be performed at our current facilities, pharma and biotech customers require a much larger scale facility before they launch a Phase III trial, because the FDA prefers to see the manufacturing process finalized before initiating Phase III. In order to continue advancing toward our goal of becoming a leading player in this business, we need to have the capability in facilities that places our customers, and particularly our pharma customers, in a premier position. We're pursuing the development of a manufacturing facility based on our expectation that one or more additional Brookwood customer projects will be moving into Phase III trials. We have existing customers ready to take this step now, and prospective customers expressing interest in the capability. Having a facility in place will greatly increase our win rate relative to competitors who don't possess this type of infrastructure. As we communicated at the time of our Brookwood acquisition, SurModics continues to support its customers as they move forward into a major campaign. This new facility is large enough in terms of capacity with the ability to handle multiple client manufacturing programs. It further retains expansion potential to accommodate much of our existing and anticipated needs. Another brought spot emerging is our project in diversifying and participating in next generation technologies in the drug-eluting stent space. While SurModics' current stent-related revenue continues to be impacted by multiple market headwinds, DES remains an important revenue generator for SurModics. We continue to believe in the opportunities DES market provides. Development relating to our collaboration with CardioMind serves as a great example of how we are diversifying our business within the existing $4 billion plus drug-eluting stent market. As you saw in our March 31 press release, the SynBiosys biodegradable drug delivery polymer system was incorporated in a first in human trial using a new small vessel drug-eluting stent developed by CardioMind. SurModics continues to leverage its strong drug delivery technology base to help increase the addressable market for drug-eluting stents. Our leadership in the development of biomaterials, surface modification, and drug delivery technologies, and the breadth and flexibility of our model and offerings provide the company with a significant number of opportunities to create shareholder value. While some of these have achieved tremendous results and many more are making notable and gratifying progress, it is inevitable that others, particularly those announced at a very early stage of development, may face additional challenges and hurdles that extend their timeline for reaching full potential. We're very pleased with the condition and status of our pipeline, and we'll continue to leverage our unique business model to maximize our number of premium (inaudible). One example of this slower progression relates to our cell culture labware products. As we have stated previously, SurModics along with our two exceptional partners in the Donaldson Company and Corning Life Sciences, are developing and distributing ECM products that provide cell growth conditions that more closely resemble those found in the body. A year ago, Corning launched four initial products including both 96-well microplate of 100 mm research dish products. While they consider the technology a significant upgrade relative to comparable products currently being utilized by the research and pharmaceutical markets for cell culture and drug discovery applications, we acknowledge that sales to date have been disappointing. While sales have been small, they are growing, but we are taking steps to address circumstances that have delayed these products' adoption on a larger scale. For example, we are in the process of redefining our relationships with Corning and Donaldson. We expect that these new relationships will provide SurModics with expanded outlook for commercialization of new ECM products. Let me be clear, though, that Corning remains committed to growing the sales of the current ECM products. We will update you going forward as relates to the redefined relationship with Corning and Donaldson. And now I'd like to update you on personnel changes in the quarter. We're pleased to have recently added Mark Lehman as our new corporate controller at SurModics. Mark brings substantial experience to this position, and we look forward to his contributions at the Company. In addition, as we previously announced through an 8-K filing, Steve Keil left the company in March. While his position is not being replaced, we are backfilling those responsibilities in Orthopedics and Intellectual Property with existing senior talent, and are confident that we can move forward successfully under this new leadership. We remain committed to Orthopedics, which now reports to Charlie Olson, who has assumed responsibility for these customer relationships. Remember, also, that the technology for Orthopedics application has been driven by our Drug Delivery hydrophilic technologies and Regenerative Technologies business units. And importantly, no change in leadership has occurred there. The Intellectual Property group is now reporting to Bryan Phillips, our secretary to the board, and deputy general counsel. Bryan is a patent attorney, and this transition is also expected to be relatively seamless. Additionally, we have an update on the agreement SurModics signed with a major orthopedics company in October 2007. While we have not been at liberty to disclose details of the agreement previously, including the name of the customer, we can tell you now that this agreement covered our trauma, wound spacer product designed to release an antibiotic for 72 hours or less. A critical assumption underlying the agreement and its financial terms was that we would be able to secure regulatory clearance from the FDA without a clinical trial. We have reported in the past on a few occasions that we have been talking with FDA on the appropriate clinical regulatory path going forward. These discussions have concluded and FDA has decided that a human clinical trial is required to support the approval of such a product. Accordingly, we have terminated our agreement with this orthopedics customers and are reviewing our options on this particular project going forward. It's important to reiterate that we continue to have active interest from other customers in this arena and on our longer release wound spacer products. As I said earlier, orthopedics remains a strong area of interest for us, and we continue to explore opportunities for our participation. At this stage I'll turn your attention to the status of our product pipeline as of March 31. We had a total of 97 licensed customers, several with multiple licenses, compared with 87 in the prior year period. SurModics had 100 licensed product classes on the market generating royalty revenue compared with 95 a year ago. The total number of licensed products not yet launched was 103, up from 91 in the prior year period. Major non-licensed opportunity stood at 90, compared with 77 a year ago. In total the company had 193 potential commercial products in development on March 31. All of these numbers include Brookwood's customers and projects. And as these numbers in our paid R&D for the quarter suggest, the magnitude of R&D work we are doing on behalf of customers is a testament to the significant value of our pipeline. Let me conclude by reviewing our progress against selected fiscal 2008 goals. We provide this information so that investors can more easily track our progress as we implement the Company's stated strategic initiatives. These objectives also offer insight into how we manage our business and provide a view of the Company's future opportunities. Let's begin with our corporate goals. We expect to launch 10 new product classes by our customers in fiscal 2008. In the second quarter, customers launched four new product classes into the marketplace including Medtronic's AneuRx AAA stent brass delivery system in the US, which features our hydrophilic coating technology, and Medtronic's Talent Abdominal Stent Graft Delivery System in Europe, also featuring SurModics hydrophilic coating. Our product total for the first six months of the year is six in pace to reach our 2008 projection. We also anticipate signing 18 new licenses for our customers in fiscal '08. SurModics had another good quarter signing four new license agreements with customers and bringing our fiscal year-to-date total to 13. The final will be laid out in our corporate category well to exceed $10 million in cash for paid R&D. For the first half of fiscal 2008, we generated total cash R&D of $15.6 million, already surpassing that goal. This significant number is reflective of how busy our development teams are at SurModics with multiple customers. One of our fiscal 2008 goals for Brookwood Pharmaceuticals is to generate $17.5 million in revenue, and the second quarter came in at $5.2 million, bringing our total year-to-date of $9.4 million. Our goal for IVT is to exceed $4 million in revenue from BioFX products. In the first two quarters of fiscal 2008, BioFX has generated $2.2 million in revenue, so we're on track to meet both of these goals. We have several significant goals in Ophthalmology and at Brookwood, and although we haven't fully achieved these goals to date, we remain on track to meet them in this fiscal year. Another goal I want to comment on is our fiscal 2008 cardiovascular objective to have a customer conduct a first-in-man procedure with a next generation drug-eluting device incorporating our technology. We achieved this when this biodegradable drug delivery polymer system was incorporated in a first-in-human trial evaluating a new small vessel stent developed by CardioMind. As mentioned earlier, in this quarter we also saw Medtronic launch the Endeavor DES in the US Thus, we achieved another one of our stated fiscal 2008 goals. We're pleased with the progress we're making against our ambitious goals, and we believe we can achieve most or all of them just as we did in fiscal 2007. Before concluding, I want to take a moment to welcome two new members to our Board of Directors. Bob Buhrmaster and Sue Knight. Bob is the retired chairman, president and CEO of Jostens, Inc., and also starred in various roles at Corning for 18 years. Sue was vice president and chief financial officer at MTS Systems and previously served in various management and executive positions at Honeywell for 24 years. Both will serve as members of our audit committee. We are very pleased to have these two seasoned executives join the board and look forward to their contribution. In conclusion, I'll reiterate that SurModics is a well diversified company with multiple high value opportunities in front of us. We recognize that our continued success is predicated on our ability to execute against our three key pillars, first growing and diversifying revenue; second, leveraging our innovation and technology; and third, continuing to deliver strong financial results and effective capital allocation. We're confident that these pillars will continue to drive our performance now and into the future. Michael, that concludes our prepared remarks. We would now like to open up the call to any questions.

[Operator:]

Thank you, sir. (Operator Instructions). Our first question comes from the line of Richard Rinkoff with Craig-Hallum. Please go ahead.

[Richard Rinkoff:]

Thank you. On the orthopedic product, did any money change hands when you terminated the agreement, and are you considering doing clinical trials yourself, or are you looking for another orthopedic partner?

[Bruce Barclay:]

There was a small built-in money to our favor, but material as a result of an initial payment and then a refund at the end. For the 72-hour product, no, we're not considering clinical trial. We do expect some savings going forward from that, but that will be relatively small compared to the rest of our R&D program.

[Richard Rinkoff:]

So, you're pursuing other partners presumably. Should we assume that it could be several years before this turns into anything significant?

[Bruce Barclay:]

No, I would say that the regulatory pathway on other applications is still open. Those are reviewed and decided upon on a product-by-product basis. And so if there is no clinical trial, obviously that would happen sooner. If there is clinical trial, then we would hopefully structure those relationships like we do many of them, including paid R&D, maybe meet milestones and fees upfront before royalties begin.

[Richard Rinkoff:]

Okay. One more question. Did you get any milestone payments from CardioMind or Medtronic as a result of the launch of their products?

[Bruce Barclay:]

We did from CardioMind, yes.

[Richard Rinkoff:]

Care to tell us how much?

[Bruce Barclay:]

They were non-material in the quarter.

[Richard Rinkoff:]

Thank you.

[Bruce Barclay:]

Thank you.

[Operator:]

Thank you, sir. The next question comes from the line of Daniel Owczarski with Avondale Partners. Please go ahead.

[Daniel Owczarski:]

Thanks. Hi, Bruce. Hi, Phil. Can you talk a little bit about Brookwood? You saw the nice sequential growth and the big year-over-year growth. Are we talking about increasing the number of projects or are they accelerating or both, or can you give us any color or any examples of success there?

[Bruce Barclay:]

Sure, be glad to. We view that situation as absolutely running on all cylinders. The team is very busy, lots of customer activity and lots of interest in working with them now and in the future. Relative to the facility expansion, since that was announced today as well as the earnings, it's a situation, Dan, where the facilities we have today is literally getting in the way of growing the business, not only from a development standpoint, because the interest is strong and the projects are growing, but also from a commercialization standpoint. It's been, I'd say, a real learning experience for us. We knew this going in, but it's been certainly proven true that pharmaceutical customers are different than medical device customers in large part because of this interest in Phase III in commercial product manufacturing being done outside of the pharmaceutical customers' own four walls. And what we're finding is that many of those customers actually make their choices in partnering not only on technology that a customer might have and as part of the development expertise, but also its ability to do that late-stage commercial manufacturing for these final drug release products. So, we've had lots of customer interest in exploring our ability to expand, and they're happy to see this announcement, I'm sure. And also customers that we have in-house today that are actually going to be using the facilities. Additionally, there is great expertise in Birmingham already in manufacturing products under CG&P conditions. And so as we mentioned with the acquisition back in August, the ability to leverage that knowledge and facility capabilities to assist us with Merck, where we've got exclusive manufacturing rights I think is an added bonus to this entire situation. Lastly, while we can't disclose a lot of detail, we did mention in the release and we're extremely excited that one of Brookwood's existing customers, when we acquired the business, has in the quarter signed a very significant multiple million-dollar order for additional R&D work. And, again, they're not licensed, but we expect them to be with us for a long time and hopefully we'll be able to convert that into a license. They're a top 10 pharma company and a name that everybody would recognize. So, very active business, a lot of, again, customer interest, and running on all cylinders.

[Daniel Owczarski:]

So, with that top 10 account, that last one that you just talked about, would we see that in Brookwood's numbers or is that all going to be incremental?

[Bruce Barclay:]

Some of that was in this quarter, but most of that will be incremental going forward.

[Daniel Owczarski:]

And if we could switch to ARVO. You talked about that you're going to be presenting. Could you give us some ideas on posters that you're going to be presenting or additional I-vation data? And is Merck, I guess, going to be presenting anything on I-vation?

[Bruce Barclay:]

There will be two posters and one paper, so three separate disclosures. And there is a book of abstracts that's been published already by ARVO, to give you some details. But essentially what it's on is our R&D activities internally. So, there will be a presentation on our 15 to 18 month clinical data from our Phase I clinical trial. Another one on large molecule delivery. And a third on our Eureka platform, our internally developed biodegradable polymer platform implant. Again, the details of those are in published abstracts and will be presented next week. So, it's the biggest research meeting in the year for retinal researchers and companies interested in that area. We'll be very busy. We'll have a number of people there from both Birmingham, Minnesota and California, and we expect to be, again, busy.

[Daniel Owczarski:]

And just a couple of quick ones for Phil. For Endeavor, how does the payment from Medtronic work? They've got their fiscal year ending at the end of this month, and then do they write you a check right after that, or how does the timing work there?

[Phil Ankeny:]

Yes, like the vast majority of our licensed customers, we receive a report following the close of their quarter on what the sales were, and calculation of the associated royalties, and they typically attach a check to that report. And so what Medtronic, as an existing customer does, is for the April quarter, because they're not on our quarters, obviously, they get a report to us with associated payment somewhere in our June quarter here. And so that's when we'll have the ability then to book the associated royalties from the Endeavor US sales in this quarter.

[Daniel Owczarski:]

Okay. And then to go back to Merck. You talked about the $2.8 million that was not recognized. Did you receive that as cash during the quarter?

[Phil Ankeny:]

Well, the way it works with Merck, the $2 million license fee, we have received the cash already. The $1.8 million of R&D work has been invoiced but not yet paid.

[Daniel Owczarski:]

Okay. Thank you.

[Phil Ankeny:]

Thanks, Dan.

[Operator:]

Thank you. The next question comes from the line of Ross Taylor with C. L. King. Please go ahead.

[Ross Taylor:]

I have a couple of questions. The first of these Bruce might have already answered, but I might have missed it. But the new facility for Brookwood, when do you all think that will be complete and operating?

[Bruce Barclay:]

No, I don't think I did address that. Thanks, Ross, for the question. As we noted in the press release, we actually just closed on the building this week. In order to meet our timelines for customers and especially the need for manufacture of the I-vation TA product, we're going to be moving as quickly as we can to complete the construction. We hope to make significant progress by the end of calendar 2008, and we'll probably continue to build out into 2009. So, it's aggressive, but we think that's realistic and attainable, but it is driven by customer needs going forward.

[Ross Taylor:]

Okay. And with the orthopedic beads, would the regulatory pathway outside of the US maybe be easier than it is in the US, or is that outside the US market just not significant enough that that factors into your decision-making?

[Bruce Barclay:]

Potentially it would be easier, but clearly that's the primary market for that product would have been in the United States.

[Ross Taylor:]

Okay. And do you have any internal goals you can share with us in terms of how quickly you relicense that or find another partner?

[Bruce Barclay:]

For the 72-hour product, no. I would say that's not working with the company that we had signed up on in October did set us back on the 72-hour product. As I said, for the same product but able to release drug over an extended period of time, we actually have strong interest today. We've got a proposal outstanding and waiting to see if we can get that one in the barn, so to speak. So, there is strong interest on the longer-term product, if not the shorter term.

[Ross Taylor:]

Okay. And final question relates to the revenues from Abbott. Your Abbott revenues did increase quite a bit during fiscal '07, and I wonder, was most of that driven by the in vitro segment, or did some of that come from Abbott Vascular or somewhere in R&D payments?

[Bruce Barclay:]

It was both. Those have been growing royalty streams.

[Ross Taylor:]

Okay. All right. That's very helpful. Thanks very much.

[Bruce Barclay:]

Thank you.

[Operator:]

Thank you. The next question comes from the line of Aaron Lindberg with William Smith & Company. Please go ahead.

[Aaron Lindberg:]

Thanks. Can you just help us understand broadly what's going on in the pipeline related to products dropping out, and is that mainly from products coming off of a patent or next generation products coming out? As an example, you've had product classes generating revenue at 100, which is the same number it's been after the last two quarters, but there were four products launched in this quarter, so presuming that implies the floor dropped off and a similar kind of a situation with licensed product classes not yet launched. Can you just kind of walk us through that and help us understand?

[Phil Ankeny:]

Absolutely. Very good question, by the way, Aaron, because there is a lot of movement that can happen in some of those buckets, and so let's just walk you through a little bit about some of the things that cause those changes to happen. Obviously, as we sign new licenses, that's going to cause increases in those buckets as products get on the market. That increases the products on the market category. We do have some fallout, though, that will happen for a number of reasons in those buckets as well, where a customer may go out of business, may decide to cancel a license because they are no longer pursuing a product. A customer may get acquired and sometimes, the company that acquires them may already be a customer of SurModics. And depending on the license definitions, the product definitions in the license of the now parent company, they can cover the products that are being sold, then acquired, through their existing license. And so for lots of those reasons, we net down to what are really active license attachments, essentially.

[Aaron Lindberg:]

And so, like, for example, a quarter ago, Endeavor and AneuRx would have been in the major non-licensed opportunities and now dropped into product classes generating revenue?

[Phil Ankeny:]

That's exactly right.

[Aaron Lindberg:]

Okay. Unrelated, given the investment in the Birmingham facility and the build out down there, do you anticipate additional expansion in Minnesota, or does moving I-vation down there cover you for a while?

[Bruce Barclay:]

No, actually, we do expect some expansion in Minnesota as we've mentioned in RK and I think mentioned before on these calls. We have entered into an agreement to acquire the land next-door to our building that we're in right now on 74th Street and Eden Prairie. And also we are leasing a facility very close to us right now for some expansion as well. Those plans are not finalized, although there are many people working very hard to help us finalize those plans. And we would expect that we would have that done, that plan done and then being able to announce that as well at some point in the near future. But very similar to Birmingham, I would say that, again, I think the facility is hampering our ability to continue to grow our business and also to do it in a way that supports the strategy. And so that's what's behind the work being done up here in Minnesota.

[Aaron Lindberg:]

Okay. But certainly there's the possibility for breaking ground on additional facilities in Minnesota yet this year?

[Bruce Barclay:]

Why don't we wait until we've got something announced. It's still a little bit too early, because the team isn't quite done with its recommendations, and then we will talk about that.

[Aaron Lindberg:]

Excellent. Thank you.

[Bruce Barclay:]

Thank you.

[Operator:]

Thank you. (Operator Instructions). We do have a follow-up question from the line of Daniel Owczarski with Avondale Partners. Please go ahead.

[Daniel Owczarski:]

Yes, just a quick follow-up on the stock compensation impact. You talked about there was a one-time hit in this quarter for the transition in the board, so the third quarter, does it look more like the first quarter or the second quarter, or how do we model that?

[Phil Ankeny:]

It would probably be better to think about it more in line with the first quarter. That's all caveated against how the board chooses to think about kind of the go-forward incentive for all employees. But based on what we know today, yeah, the first quarter is probably a more typical figure to think about.

[Daniel Owczarski:]

Okay. Thank you.

[Operator:]

Thank you, sir. At this time there are no further questions. I'd like to turn it back over to Mr. Barclay. Please go ahead.

[Bruce Barclay:]

Good. Thanks, Mike, very much. We want to thank everybody again for participating in this quarter's conference call. We look forward to speaking with you again in July, when we announce our third quarter results.

[Operator:]

Thank you. Ladies and gentlemen, this does conclude the SurModics second quarter 2008 earnings conference call. You may now disconnect. Thank you for using ATT Teleconferencing.