Surmodics, Inc.
Q1 2009 Earnings Call Transcript

Published: 29 Jan 2009

[Operator:]

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the SurModics’ first quarter 2009 earnings conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator instructions) As a reminder this conference is being recorded today Wednesday, January 28, 2009. I would now like to turn the conference over to Mr. Phil Ankeny, Senior Vice President and Chief Financial Officer. Please go ahead, sir.

[Philip Ankeny:]

Thank you very much. Good afternoon and welcome to SurModics’ fiscal 2009 first quarter conference call. Thanks for joining us today. I’m Phil Ankeny, and our press release reporting quarterly results was issued earlier this afternoon and is available on our website at www.surmodics.com. Joining me on the call today is Bruce Barclay, our President and Chief Executive 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. I will remind you that some of the statements made during this call may be considered forward looking. The 10-K for fiscal year 2008 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. In today’s call, I will cover the Company’s quarterly financial results. Bruce will then highlight quarterly achievements and update you on pipeline opportunities and finally we will open the call to your questions. I will begin with an overview of the first quarter financial results and follow that with specifics on discreet line items. Next I will discuss significant revenue drivers and breakdown revenue by component and market. Finally, I will cover expenses and review our balance sheet and cash flow. First quarter revenue was a record $63.2 million, a significant increase from $23.8 million in the year earlier period. Revenue from Merck had a significant impact on quarterly results, as a result of the termination of our collaborative research and license agreement, which became effective in mid-December. Upon termination, we recognized $34.8 million of revenue, which was previously being deferred. In addition, as previously disclosed, Merck’s decision to terminate the agreement triggered an additional $9 million payment to SurModics, which was received and recognized in the quarter. Moving down the income statement, the Company reported operating income of $42.7 million, compared with $7.6 million in the prior year period. Net income was $27.1 million, during the period compared with $5.6 million in the same period last year. Diluted earnings per share was $1.53, compared with $0.31 in the first quarter of fiscal 2008. These are all record figures but again the Merck termination was the principal driver in making them so. In addition, included in the first quarter GAAP results were two event-specific charges. We recorded restructuring charges of $1.8 million relating to our previously announced organizational changes and downsizing. We also recorded an in-process research and development charge of $3.2 million, in connection with the acquisition of drug delivery technology and collaborative programs from PR Pharmaceuticals in November. Also in connection with the PR Pharmaceuticals acquisition, we recorded amortization of intangibles of approximately $34,000. Going forward, the intangibles amortization will be approximately $50,000 per quarter. I will now provide a brief review of the quarter on a non-GAAP basis, which we’ve often said provides a better indicator of our results. Please refer to the supplemental non-GAAP tables in our press release for further details. We adjust for the accounting related to Merck by backing out the amounts recognized during the quarter, which had previously been deferred, or $34.8 million. The $9 million milestone payment, which was billed and collected in the quarter, is reflected in both GAAP revenue and in the non-GAAP results. We also adjust for the event-specific charges we incurred during the quarter, including the restructuring charges and IPR&D charge for the PR Pharmaceuticals’ acquisition

[Bruce Barclay:]

Thank you, Phil, and welcome everyone to the call. My comments today will briefly highlight quarterly achievements, review some of our key opportunities and bring you up to-date on the product pipeline and our progress against fiscal 2009 goals. First a word about the quarter. While we are pleased to announce a record quarter, we acknowledge it was the cancellation of the Merck agreement that made it so. Looking at the quarter on a non-GAAP basis, receiving $9 million in cash for Merck in this economy was definitely a positive event. However, we understand that absent the Merck payment, it was a down quarter. Product sales were soft and our R&D revenue engine has not yet replaced all the build activity we previously were doing for Merck. However, the first quarter results in no way diminish our optimism and excitement about SurModics’ future and our management team and our employees are committed to returning to growth. In addition, we believe SurModics’ business model strikes an excellent balance between safety and growth especially over the long-term. We participate with our customers and many large markets in healthcare, where our technology is used to create sophisticated diagnostic tools and to solve a variety of unmet clinical needs. The demographics of healthcare was strong growth in the over 60 population, help drive the opportunity we see. Further within healthcare, we are very well diversified. In fact we view the diversification of our portfolio as a significant asset, as we offer both diagnostic and therapeutic solutions with nearly 300 products and projects spanning multiple technologies and more than 10 different clinical areas. Additionally, we believe we have a highly profitable business model and while many companies our size are struggling to survive in the current environment, we have a solid foundation and a long history of delivering positive earnings and cash flow. Our strong balance sheet with no debt, is the result of a disciplined approach to capital allocation, which creates a margin of the safety today that many other companies do not enjoy and allows us to pursue value enhancing opportunities such as share buybacks, business development opportunities and facilities investments. We believe our growth prospects were enhanced by our recent reorganization into clinically and market focussed business units and by centralizing our R&D function within our legacy business. These changes will enable us to better understand and help solve the needs of patients within specific clinical indications and more effectively leverage existing and new technologies across multiple clinical applications. Going forward, SurModics will have four business units

[Operator:]

Thank you, sir. Ladies and gentlemen we will now begin the question-and-answer session. (Operator instructions). Our first question comes from the line of Ross Taylor with C.L. King, please go ahead.

[Ross Taylor:]

Hi. I got a couple of questions. First, I wondered if within you mean the royalty revenues or your diagnostic revenues, I mean how much you can give any information about how much you are getting from the Abbott royalties that expired in December?

[Bruce Barclay:]

We’re not breaking that number out. As we said the number was down year-over-year and so it definitely had an impact on the results, but it’s not our intent to break those out.

[Ross Taylor:]

Okay. And I mean is there any chance, can you say anything about - how it was sequentially versus the September quarter?

[Bruce Barclay:]

Sequentially it was up.

[Ross Taylor:]

Okay. And, another question would be, you said you still thought it was a reasonable chance to get your rough earnings guidance for the year-end. What would have to change versus the current quarter to make it more likely you could actually achieve that guidance because it looks like both your revenues would have to improve pretty materially from this quarter to get to that guidance?

[Bruce Barclay:]

We see several positive indicators for the rest of the year and Phil touched on them I think nicely in his prepared remarks. We see potential growth in our Brookwood business on the organic basis and also with the PR Pharma technology that we acquired. In the quarter we had a very small amount of customer projects that were transferred over from PR Pharma, hitting the top line in Q1, and we expect that to hit in mass in Q2 and beyond. We also have a number of activities going on within the ophthalmology space and in particular we signed one of the largest R&D agreements in our recent history in ophthalmology in the last quarter, even though, the license has not yet been signed by that particular customer. So we have a number of customers still working in that space and paying us to do the work and we are very much – very optimistic about that going forward.

[Ross Taylor:]

Okay, all right. That’s helps. Thanks very much.

[Bruce Barclay:]

Thank you.

[Operator:]

Thank you, sir. Our next question comes from line of Richard Rinkoff with Craig-Hallum. Please go ahead.

[Richard Rinkoff:]

Thanks. A couple of micro questions. On that ophthalmology agreement that you just signed, was that an R&D agreement and was there any of that in the quarter that we just saw?

[Bruce Barclay:]

Yes Rick, it was an R&D agreement and there was some in the quarter not by no means the majority.

[Richard Rinkoff:]

So should we expect R&D sequentially to move higher?

[Bruce Barclay:]

Yes, there are factors on both sides, yet an agreement is there and we do expect to increase the ramp on that particular project in Q2 here. We’ve also even talking to several customers here over the last few days and weeks. We are experiencing a little bit of the New Year, new budget kind of scenario if you will, so we will see how long that plays at. It’s too early in the quarter to put any – putting value on that and again PR Pharma I would say most of that will flow into the R&D line. On the other hand and again like it started well. R&D projects can be somewhat discretionary and though and therefore depending on the customer can be subject to reduction if a particular customer has an issue for whatever reason within their particular business. So little bit of pro and con, but again I would say we are optimistic about the R&D line for the rest of the year.

[Richard Rinkoff:]

You said that you are on track, you believe today to hit the rest of your goals for the year. One of them is signing an ophthalmology license agreement. Could you give us any more color and is the agreement that you just signed in first place to sign that license agreement?

[Bruce Barclay:]

I really can’t give anymore color than that other than we’ve had customers who and the one particularly we talked about last year, who have decided to spend more money on R&D to get – to continue to generate results before they enter into the - what we think would be the final license negotiation for rights going forward. So, I can’t say anything more than that other than there is lots of activity in ophthalmology. This recent agreement helped us substantially, but there are other companies as well that are paying R&D fees that we know we’re also talking to about – when the right time would be for the license discussion. So, and in fact that the number of customers who were supporting in ophthalmology continues to grow, so that business is very healthy.

[Richard Rinkoff:]

On the expense side, you said that the reductions were not fully felt in the quarter. Can you give us some idea of what the expense lines will look like for the rest of the year?

[Bruce Barclay:]

[We’re already] through that I would say that rolling forward expect some modest decrease in each of the R&D and SG&A lines, but in aggregate as we said we see a couple of million dollars of expense save, but it is pretty well balanced between the three quarters there that remain.

[Richard Rinkoff:]

Its $2 million less than what you had budgeted, but we didn’t know what you originally budgeted?

[Bruce Barclay:]

Well, and since I’m saying that we didn’t - if you look at the current quarter there wasn’t a tremendous impact there. It should trend down from there and I think a couple of million is probably spread more through the back half of the year or back three quarters of the year.

[Richard Rinkoff:]

Do you envision making additional expense reductions?

[Bruce Barclay:]

No not at this point. Obviously it’s something we’ll keep a close eye on, but we continue to manage the business I think very well in terms of our discretionary spending in things you would imagine, R&D and travel and those types of things, we will continue to keep a close eye on that.

[Richard Rinkoff:]

Okay. One more macro question. If you take Merck out, which is when all of the expectations did, all the consensus expectations, you basically did about $19.5 million, let’s call it $20 million, multiply by four, you get $80 million, at Merck you get $89 million and your guidance was a $111 million, so do you still really believe that you can make up that difference between now and the end of September?

[Bruce Barclay:]

We’ve done the same math Rick and we are still standing by what Phil said in his prepared remarks, again not to repeat everything he said this is clearly more risk than when we said that originally three months ago because of the economy. But having talked with several customers, and understanding what they are going through and their particular issues, the reasons we’ve said we continue to see – we continue to standby what was said in the prepared remarks.

[Richard Rinkoff:]

Thank you.

[Bruce Barclay:]

Thank you.

[Richard Rinkoff:]

Okay.

[Operator:]

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

[Daniel Owczarski:]

Good afternoon.

[Bruce Barclay:]

Hi, Dan.

[Daniel Owczarski:]

Can you talk a little bit about what’s going on at the [facility] or the build out of Brookwood, as far as is that still on track, is that – do you take your foot off the gas there a little bit, or how does this, all this big economic changes impact your build out there?

[Bruce Barclay:]

That is still on track, and I think the comments we made in our 10-K it still stand, which is that we expect to spend between 20 to $25 million in fiscal 2009 on that building. We don’t expect it to come up until the fall of 2009 calendar, which would be Q1 of fiscal 2010. We continue to have strong customer interest in not only the expanded space, but also this expanded ability to manufacture project – products on a cGMP basis either for late-stage of clinical trial or for commercial capabilities. So, we continue to see that being an important part of our business long-term and it is continuing on.

[Daniel Owczarski:]

Okay, and then as far as number of projects that they are working on, is that number still consistent or are people dropping off there? I think you talked about some of the smaller customers trapped for cash. What about Brookwood's pipeline or partnership pipeline?

[Bruce Barclay:]

They have had a couple of drop-offs, some of the smaller ones. We don’t know whether that’s temporary or longer-term. At the same time, as you’ve seen from the R&D number we've had more revenue from some of the larger ones which help offset that, so it’s something that we’re watching closely and talking with our customers, but in the conversations we’ve had with customers over the last several weeks, their long-term plans are not changing. They continue to see significant upside in formulating new drugs especially drugs that are coming off-patent in the next three to five years and better sustained delivery vehicles and we think Brookwood offers a tremendous opportunity for them. And, again that’s been our long-term premise all along for the business and we are sticking by that.

[Daniel Owczarski:]

Okay and then just last on drug eluting stents, I think you mentioned maybe double-digit, projects there. Are those timelines been stretched out now that the FDA, is the FDA asking for more data or making things a little bit more difficult than those projects are slower to come to - into development?

[Bruce Barclay:]

I would say, I’m not that close to that to note precisely Dan, relative to the FDA. We – for a lot of our customers in the DES space, we’ve done early work with them and then we somewhat step out and they continue to process from there. So, given the fact we have as many as customers as we do, we said previously that in most, but not all of those we have better financial terms and what we had with CYPHER and it continues to be a large market with penetration rates increasing here in the U.S. at least we continue to see good upside in that business. Certainly, FDA is an issue for our customers. Funding for smaller customers is also an issue they need to deal with, but again we are continuing to be optimistic with what’s going on there.

[Daniel Owczarski:]

Okay, thank you.

[Bruce Barclay:]

Thanks for the call.

[Operator:]

Thank you, sir. Mr. Barclay, there are no further questions, please continue with any closing remarks.

[Bruce Barclay:]

Okay, thanks operator. We want to thank you again for participating in this quarter’s call. We look forward to speaking with you again at our Annual Meeting next Monday, February 2, and then in April, when we announce our second quarter results. Thank you very much.

[Operator:]

And thank you sir. Ladies and gentlemen, this does concludes the SurModics’ first quarter 2009 earnings conference call. You may now disconnect. Thank you for using ATT conferencing and have a pleasant day.