Surmodics, Inc.
Q4 2012 Earnings Call Transcript

Published: 7 Nov 2012

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the SurModics Fourth Quarter 2012 Earnings Conference Call. During today’s presentation all parties will be in a listen only mode. Following the presentation the conference will be opened for questions. (Operator Instructions). This conference is being recorded today, November 6, 2012. I would now like to turn the conference over to Tim Arens, Vice President of Finance and Interim CEO. Please go ahead.

[Tim Arens:]

Thank you, Douglas. Good afternoon and welcome to SurModics' fiscal 2012 fourth quarter and full year earnings call. Also with me on the call is Gary Maharaj, our Chief Executive Officer. Our Press Release reporting our quarterly and full year results was issued earlier this afternoon and is available on our website at surmodics.com. Before we begin, it is my duty to inform you that this conference call is being webcast and is accessible through the Investor Relation section of the SurModics website, where the audio recording of the webcast will be also achieved for future reference. I will remind you that some of the statements made during this call may be considered forward-looking. The 10-K for fiscal year 2011 identified certain factors that could cause the Company's actual results to differ materially from those projected in any forward-looking statements made during this call. The company does not undertake any duty to update any forward-looking statements as a result of new information or future events or developments. On today's call, I will provide an overview of our financial results for the quarter and the year, as well as discuss our outlook for fiscal 2013. Gary will then discuss our strategy and growth drivers moving forward. Following this discussion we will open the call to take your questions. As we look back at our fiscal 2012 performance, let us begin our discussion with a few highlights related to the year. We achieved record Hydrophilic Coating revenue and record In Vitro Diagnostic Product revenue during the year. We came in at the upper end of our full year revenue and earnings per share outlook. As a remainder, our guidance called for revenue to be in the range of $51 million to $52 million and earnings to be in the range of $0.56 to $0.59 per share, and we also announced and completed our $55 million share repurchase. Before I fully discuss our results from continuing operations for the fourth quarter and full year, let me first address a few items that will lend some clarity to our results. The items that affect our non-GAAP results include our fourth quarter share repurchase, our second quarter impairment loss and the discontinuation of Cordis' Cypher and Cypher Select Plus drug-eluting stents. In early September, the company completed its Modified “Dutch Auction” Tender and repurchased more than 16% of the Company’s outstanding common stock at a price of $19 per share. Following our purchase of nearly 2.9 million shares, the company has 14.65 million shares of common stock outstanding. As our repurchase was completed well into the fourth quarter of fiscal 2012, our weighted average diluted share account in the quarter is 16.9 million shares outstanding, compared with 17.6 million at the end of the third quarter. The full effect of our repurchase will be reflected in fiscal 2013 and in future years. For the quarter and the year, our non-GAAP results which can be seen in the supplemental tables found in today's earnings release, reflect adjustments related to two GAAP expenses, stock repurchase costs and the second quarter impairment loss related to our equity investment in OctoPus. Our GAAP results include approximately $500,000 of fourth quarter expense associated with our tender offer and the $800,000 second quarter impairment loss related to our equity investment in OctoPus. Turning to Cypher, during our fourth quarter fiscal 2012, we generated less than $100,000 of revenue associated with Cordis’s Cypher and Cypher Select Plus drug eluting stents. By comparison, in the fourth quarter of 2011, we generated $1.6 million of Cypher revenue. For the full year, we generated approximately $400,000 of revenue from Cypher, compared with $6.6 million in fiscal 2011. Beginning with our first quarter of fiscal 2013, the discontinuation of these Cypher products will no longer have a meaningful impact in our comparative numbers. Going forward the growth generated by our business will be much clearer. We believe that these non-GAAP adjustments provide meaningful insight into the performance of our continuing operations and an alternative perspective of our operating results. Moving onto our fiscal 2012 fourth quarter results, our financial performance, excluding Cypher resulted in solid revenue growth, while our core business generated strong non-GAAP operating income growth. Revenue for the fourth quarter totaled $13.8 million, which is a slight decline from the $13.9 million reported in the fourth quarter of last year. On a comparative basis, our fourth quarter revenue growth when adjusting for the net change of $1.5 million in revenue associated with Cypher increased 12% from the year ago period. We delivered fourth quarter operating income of $4.6 million. On a non-GAAP basis operating income was $5.1 million, an increase of 116% from the prior year. Non-GAAP operating margin was 37%, up 1800 basis points compared with the prior year period, driven by the strength of the quarter's revenue performance and strong contributions from last year's productivity and cost actions related to the strategic realignment of our business. On a GAAP basis, our diluted earnings per share from continuing operations was $0.17 for the fourth quarter, compared with diluted earnings share of $0.13 from the year ago period. On a non-GAAP basis, diluted earnings per share grew 111% and was $0.19, compared with non-GAAP diluted earnings per share of $0.09 from the fourth quarter of last year. Turning to the full year 2012, GAAP revenue was $51.9 million, a decline of 2% from fiscal 2011. On a comparative basis, our fiscal 2012 full year revenue growth when adjusting for the net change of $6.2 million in revenue associated with Cypher increased 12% from the year ago period. We delivered operating income of $16.3 million in fiscal 2012, an increase of 11% from fiscal 2011. On a non-GAAP basis, fiscal 2012 operating income was $16.5 million, up 68% from fiscal 2011. Our non-GAAP operating margin for the full year 2012 was 32%, an increase of 1,100 basis points from last year. On a GAAP basis, our fiscal 2012 diluted earnings per share from continuing operations was $0.58, compared with diluted earnings share of $0.63 in fiscal 2011. On a non-GAAP basis, diluted earnings per share from continuing operations increased 61% and was $0.61, compared with non-GAAP diluted earnings per share of $0.38 in fiscal 2011. Turning our attention to our Medical Device Business Unit, fourth quarter Medical Device sales, which include revenue from both our hydrophilic coatings and device drug delivery coatings totaled $10 million, a slight decline from the $10.2 million reported in the year ago period. During the quarter we nearly offset the $1.6 million of Cypher revenue generated in the fourth quarter of fiscal 2011. As a result of our strong hydrophilic coating performance, our Medical Device non-GAAP revenue increased 15% compared with the prior year period. During the quarter, hydrophilic coating revenue increased 13% from last year to $9.9 million. Device drug delivery coating revenue of approximately $80,000 declined 94%, compared with the $1.4 million in the fourth quarter of fiscal 2011. For the year, we achieved record hydrophilic coating revenue of $36.8 million, representing 10% growth compared with fiscal 2011. Adjusting for Cypher, our hydrophilic coatings revenue increased 13%. Device drug delivery coating revenue of $1.1 million declined 82% from last year’s $6 million. This decline was attributable to Cypher. During the fourth quarter and during fiscal 2012, we saw double digit hydrophilic coating royalty revenue growth in all key medical device markets segments, including neurovascular, peripheral and transcatheter heart valve replacement. The past year has seen these three market segments, increase in importance as they have grown to represent half of our total hydrophilic coating royalty revenue. Medical device generated $5.2 million of GAAP operating income during the quarter, representing a 5% increase from a year ago period. Adjusting for Cypher, medical device operating income increased greater than 50% to $5.2 million from the year ago period, driven by higher revenue. Looking at our In Vitro Diagnostics business unit, our IVD sales for the fourth quarter totaled $3.8 million, an increase of 5% compared with the year ago period. Our IVD business unit has generated eight consecutive quarters of year-on-year product revenue growth and for the second consecutive quarter achieved record diagnostic product revenue. For the full year, In Vitro Diagnostic sales totaled $14 million, an increase of 7% from the $13.2 million generated in fiscal 2011. For the full year, we achieved record diagnostic product revenue. Among the bright spots during the year, and one that aligns with our core expansion activities was the growing impact of molecular diagnostics in our business performance. We saw strong double digit growth in our product sales to this growing diagnostic market. You will recall that our third quarter performance saw pressure on the IVD operating income line as product costs increased, which impacted our third quarter diagnostic product gross margins. Our fourth quarter, product gross margin of 63% saw a 200 basis point improvement from the third quarter. In part, because of the improved product gross margin, our fourth quarter IVD operating income increased 35%, compared with a year ago period to $1.3 million. Now, let's discuss our fourth quarter 2012 revenue summary by category. Royalty and license fees, which are generated primarily in our medical device business unit, were $7.4 million, a decline of 4% from the $7.7 million reported last year. Excluding the impact of Cypher, royalty and license fees increased 11% in the fourth quarter of fiscal 2012. Fourth quarter product sales of $5.3 million declined 6% from the year ago period. Impacting the quarter's product sales performance was a 20% decline in medical device reagent sales, principally from the Cypher impact. Excluding Cypher, product sales increased 3% in the fourth quarter of fiscal 2012. Lastly, R&D revenue in the fourth quarter was $1.1 million, a doubling from the $547,000 reported last year. Coating services support for certain of our hydrophilic customers was a primary driver of the increase in the R&D revenue. SG&A expenses in the fourth quarter fiscal 2012 were 27% of revenue, compared with 30% in the year ago period. SG&A expenses declined 9% from last year, mainly as a result of last year's cost reduction efforts and our on-going efficiency improvements. Research and development expenses in the fourth quarter of 2012 were 25% of revenue, compared with 27% in the year ago period. R&D expenses declined 8% from last year. Taking a quick review of our balance sheet, our cash and investments totaled $58.1 million. Our cash and investment balance reflects the use of $55 million for our share repurchase that was completed in the fourth quarter. We continue to generate solid cash flow during the quarter. Cash flow from operations was $5.6 million during the fourth quarter. Finally, I want to address our expectations for fiscal year 2013. For the full year we expect GAAP revenue to be in the range of $55 million to $58 million and diluted GAAP EPS to be in the range of $0.75 to $0.87. I would like to offer some comments regarding this revenue and earnings per share outlook for fiscal 2013. First, our earnings per share outlook reflects an increase in our investment and technology innovation and funding of our organic growth strategies to drive growth across the business. Backend, our outlook reflects a tax rate of 38% and third and last, our share account consists of 14,650,000 shares. At this point, I would like to turn the call over to our Chief Executive Officer, Gary Maharaj. Gary? Gary Maharaj Thank you, Tim. I'm very pleased with our most recent results and the momentum we have generated over the course of this fiscal year. I’m particularly pleased looking back at fiscal 2012, that we accomplished the objectives and goals we established at the beginning of this year. We began the year by completing the sale of the pharmaceuticals business, which was outside of our core area of focus and expertise. Importantly, this allowed us to increase our focus and driving performance in our core Medical Device and IVD businesses, leading to improved results in fiscal 2012 over the prior year and at the top end of all financial guidance. I’m especially proud of our ability to cover almost 90% of the loss of the Cypher revenues and profits within four quarters. I believe that this demonstrates not only the resiliency of SurModics, but it also highlights the strength of our core hydrophilic coatings business and our efforts to diversify and expand our product portfolio, our customer base and ultimately our revenue streams. Finally, we applied a balanced approach to putting our cash position and healthy balance sheet to work by investing in our pipeline for future growth, as well as executing a major share buyback during the fourth quarter. The key effect of (ph) execution of our plans for fiscal 2012 enabled us to return to profitable growth. In addition our efforts helped us set up for success over the long term, as we pursue a goal on building a great organization that is the industry leader, delivers consistently strong results and has high impact in the markets we serve. I'm excited about fiscal 2013. Our strategy relentlessly focusing in our core business has created a platform for profitable growth. In fiscal year 2013 we'll continue this focus on driving and strengthening the core, while starting the process of methodically expanding our core. Now we recognize and are prepared for the inherent challenge in balancing the tension of core growth with core expansion. However, our expansion strategy to go beyond hydrophilic coatings for minimal invasive devices and diagnostic reagents for amino acids is important and timely. By starting now, we can take a more methodical approach towards managing the risk and opportunities intrinsic to core expansion. This measured approach also ensures that we are allocating our resources efficiently, in a way that maximizes successful contributions from our product pipeline. For me and most importantly, it represents a return to the passion of SurModics as a technology based company engaged in the disciplined exploration, discovery and application of technology to solve meaningful problems and the diagnosis for treatment of disease. In this uncertain global and economic and industry environment, we will remain focused on developing and commercializing products that are first and foremost best in class when it comes to patient safety, clinical relevance and cost effectiveness. These attributes will help us to remain competitive and at the forefront of this challenging environment. Let me now spend a few minutes discussing our business units and what we expect for fiscal 2013. Our medical device business had a good year of double digit growth, net of Cypher based on the strength of core customer sales and the double digit growth in the transcatheter valve peripheral vascular market segments. We are well positioned with our Generation 5 hydrophilic coating platform to continue this growth. We continue feasibility and commercialization activities with Gen 5. In fact, the majority of new feasibilities are conducted on Gen 5. We continue also to make progress on qualifying Gen 5 on a full range of substrates and representative catheter designs used by our customers. These activities and focus will continue into fiscal 2013, and we are committed to seeing this product successfully through to its completion as we believe it will be a significant contributor to our future growth. Our core expansion activities in this segment involved a return to device drug delivery, as demonstrated by our preclinical research efforts on our drug coated balloon project. Importantly, we have already started experiments in other forms of surface modification that improved the performance of actual devices as opposed to delivery systems. We will consider providing more information on these experiments only after they have progressed to full blown projects internally. However, this migration back to the device is an important guiding strategy for our future. Our preclinical results from the drug coated balloon project continue to be very positive. We believe that our technology, if it continues to prove successful, actually has the potential to set a new standard in maximizing targeted tissue uptake of the drug while minimizing unintended drug loses in the blood stream. We will continue to invest in making progress on this drug coated balloon in fiscal 2013, since it fulfills an important need with a large market opportunity, upwards of $1 billion. In the IVD business we continue to focus in our core activities. As an example, in R&D we have applied some of our project development experiments to what’s custom formulations of core products, specific to the needs of key customers. Other resources have been focusing on experiments involving core products intentionally designed for emerging markets where they have different value propositions. As far as co-expansion activities are focused, we’re focusing on the fast growing field of molecular diagnostics, specifically in area of cancer, infectious disease and inherited disease. Our leverage in this molecular diagnostic market is based on two current core capabilities. First, our surface chemistry that is currently used to immobilize nucleic assets, such DNA and RNA for analysis. Second, our unique creation capabilities in stabilizing the conformation of proteins so that they remain active to binding in molecular diagnostic applications. While these activities are early and exploratory, we’re seeking ways to apply and develop our core technology in a large and growing segment, such as Molecular Diagnostics and this will essential to our core expansion of IVD in fiscal 2013. So, the key issues at the Waterfront for us this year are commercialization of Gen 5 hydrophilic coating platform, completing the preclinical assessment of our drug coated balloon technology, conducting meaningful experiments on surface modifications that improve the performance of implantable medical devices, and finally, assessing the opportunity for core expansion into molecular diagnostics with our existing IVD technology. We believe that these objectives are most relevant and represent an optimal balance of driving the core, while beginning the process of expanding the core. We have dedicated substantial amount of our resources to these key projects with excellent results to date. The critical part of our success during the last seven quarters can be attributed to the focus, clarity and simplicity of our strategy. These efforts to reinvigorate our pipeline have been enabled by the healthy balance sheet and strong cash generation capabilities of our business model. The appropriate deployment of our cash to maximize shareholder value is also an important area of strategic focus that we are constantly evaluating. Our overriding objective is to strike the balance between continuing to fund organic growth through investing in our pipeline and future growth, while maintaining the financial flexibility to be both opportunistic and to manage risk, while returning excess cash to shareholders. As you have seen recently and as I mentioned earlier, during the fourth quarter, we purchased over 16% of the company's outstanding shares which demonstrates our commitment to returning excess cash to shareholders. In conjunction with our Board, we'll continue to carefully evaluate the appropriate deployment of our cash going forward. Our team is excited about this year and is confident in our ability to make progress against our stated strategic, operational and financial goals in fiscal 2013. Operator, this concludes our preparatory remarks and we’d like now like to open the call now for questions.

[Operator:]

(Operator Instructions). Our first question is from the line of Charley Jones with Barrington Research. Please go ahead.

[Charley Jones:]

I wanted to start a little bit on Gen 5 and just in general your coatings business. I was hoping you could talk to us a little bit about the conversations you're having with companies that have in-house coatings and where you’re at in that process, whether or not you can maybe set some expectations for 2013 there and in-house coatings?

[Gary Maharaj:]

Certainly. As a reminder to everyone, companies that use the majority of the coatings in-house are also in large part of customers of SurModics and use our coatings on different products. And so we’re always in conversations with them. I think our strategy in Gen 5 is to really ensure that we have satisfied our key customers first and help them get it across the go line on their devices but we continue to be in strategic conversations with the companies you mentioned, Charley. We’re certainly not planning or telegraphing or plan to commercialize these customers quite yet.

[Charley Jones:]

Maybe you have a quarter there, but hopefully we can talk about that a little bit more going forward, I was also hoping that you could talk a little bit more about Gen 5 and the royalty rate expectation you have there and do you think there is an opportunity for a tiered strategy here for say neuro or is that too difficult to achieve?

[Gary Maharaj:]

Certainly we certainly look at Gen 5 as an upgraded technology in terms of what we’re able to go to deliver to our customers and by that I mean the fact that there is no tradeoff between durability and diversity and so they can, in particular optimize the lubricity values that they desire with this coating. A lot of this is depending on the application. Gen 5 represents actually a family of recipes to be precise and that family has different cost value propositions and cost propositions around it. So we really try to rate it to the needs of that customer, most of them the application.

[Charley Jones:]

And then, I was wondering if you could give us an update on where you are at with coating new surfaces, intraluminal, PTFE grafts et cetera. Will we see some product development there or do you think that’s really more of a 2014 situation?

[Gary Maharaj:]

Well, as we look at those areas and those are certainly rich areas for us to mine, some of those we have identified may take actually a different chemistry or different approach versus the approach we are taking now. So I would consider that really exploration at this point; since it may require a different chemistry approach to the entire process.

[Charley Jones:]

If I could just sneak one more in and I’ll jump back in queue here. Can you give us a little bit more detail on where you’re out with drug eluting blue (ph), and I think most of us have heard you say something to the extent of, you never know if the next set of pigs are going to come back and there is going to be some issue. And I think a lot of us really kind of; maybe roll our eyes a little bit because you seem so confident. So I'm just curious, are you at an de-risking stage you can kind of share with us and where you're at in kind of being able to commercialize this, whether it's figuring out how to do it in manufacturing or whatever.

[Gary Maharaj:]

Sure. That's a good point and you remember well, Charley. For me from an R&D viewpoint, it's all about thinning down the variability and we feel really good, we've always seen, through all the quarters I've been seeing that. I think the things for our team and for me is really putting the statistics behind it to demonstrate repeatability of the results, we're seeing and so when I talk about the next five clinical, pre-clinical studies and how they come back, is really is adding to our statistical database which increases our confidence. The second thing our team is really focused on over the summer, is really ensuring that a process is validated, anytime you go from lab scale to doing dozens or even potentially hundreds of catheters, you want to make sure that you have that repeatability and that is golden for us that we can not only get it work once but we can get it to work multiple times and get it to work on larger patches. And so, coming out of this summer's efforts, my sense of confidence has grown since we've been able to demonstrate that. So while we're less susceptible for the next five preclinical studies coming back because of the substantial data we've generated, I want to keep everybody reminded it's really preclinical work we're doing so.

[Operator:]

Our next question is from the line of Ross Taylor with C.L. King. Please go ahead.

[Ross Taylor:]

Hi. I'll start up with just a couple of modelling questions. I wonder if you can make any comments about where you expect R&D expense to be in fiscal year '13 or just, maybe if you can just, any indication as to how much that expense line may grow next year, if at all.

[Gary Maharaj:]

Yes. I'll Tim dive into some more detail but we’re committed to funding our organic growth while maintaining the appropriate and communicated operating margins, that we have historically delivered. And so when we look at our revenue growth and our incremental margins, we actually are funding, incremental R&D out of our operating plan at this point. Tim I expect spending to go up but not to really take margins down.

[Tim Arens:]

That's right. Gary it's a great way to answer that. Ross, this is Tim. How I would articulate this is, as you take a look at the earnings outlook that we've provided, you ought to be thinking about really two things, there will be an increase in operating expenses to fund R&D and R&D is probably going to be looking at growth of somewhere mid-single digits to low high single digits, say 5% to 8% for 2013 to fund ideas, experiments and projects. What I’ll tell is we don’t typically provide a lot of insight around where we’re at in terms of ideas, experiments and projects, but probably one way to think about this is the mix of ideas, experiments and projects are going to have a significant influence on the rate of expense growth for R&D and hence the range. So hopefully that provides people of some insight and how to model operating expenses in R&D are going forward.

[Ross Taylor:]

Okay. That’s good. And also with your CapEx, they were very low in 2012. I just wondered, if you can get any rough guidance as to whether they kind of stay down on that range next year. And also looking at the quarterly numbers for royalty revenues in 2012, the first half of the year was much lower in terms of absolute dollars than the second half of the year. And I wondered if that, primarily due to the seasonality in the business or whether there is some new product launches that really caused that increase from H1 to H2.

[Gary Maharaj:]

Right. So, let’s start with the CapEx question. Yes, this year was abnormally low, some of the CapEx expenses really more of a timing issue and will start to flow into Q1 for things that were begin in late fiscal 2012. Probably the best way to be thinking about CapEx for 2013 is we’ll probably be somewhere in the close to $2 to $2.5 million range. Now, with the regard to the royalty rate question, there is a whole lot in there. There is seasonality of course, but as we’ve been seeing over the several quarters, we’ve seen really nice significant double digit growth in some in these important market segments within medical device and we’ve been benefited trans catheter valves peripheral neural. We’ve just seen a nice revenue growth in those segments each quarter, both year-on-year as well as we’re seeing nice growth on a sequential basis within these segments as well. And that’s really what’s helping to drive the distribution of royalty revenue over the back half of 2012.

[Ross Taylor:]

My last question, looking at some of your R&D projects particularly in device drug delivery, some of the projects you’re doing outside of drug-coating balloons. You say that one could have the potential of the important contributors to revenues. Would you expect the timeframe in terms of getting those products to market as about the same as the drug dealing balloon or some of those shorter or should we think about some of them actually even longer time to market?

[Gary Maharaj:]

Sure. It depends on the, we have a mix of intended device applications that these experiments are targeting, Drug dealing balloons, in my opinion is at the high time end of the range, just because of substantial clinical work that needs to be done will foresee marking and for U.S. FDA approval and so I would say that would probably represent an outer bound. The things that we are experimenting with as well while not much shorter, my opinion would be shorter than the drug coated balloon itself.

[Operator:]

Our next question is from the line of Ben Haynor with Feltl and Company, please go ahead.

[Ben Haynor:]

Great just had a few here. What needs to happen to get you to the higher range of your revenue guidance and then what do you anticipate the mix looking like between the Vitro Diagnostics and other revenue?

[Gary Maharaj:]

Thank you for the question. The way that I would have people characterize or think about what it will take for us to get to our higher end of our range is, really continued success in this growth segments that we've seen. I would tell you that we would also be looking to have no real risks or impacts from a global economic perspective or downturns and procedures within healthcare environment. And its continued success in capturing new customers and bringing new products to market and those are the factors that really helped to drive our 2012 growth, I would look at bringing those into 2013 and extrapolate those in to 2013, for us to get to the high-end of our outlook.

[Ben Haynor:]

Okay. Great. And then assuming the drug coated balloon continues to progress like you think it will, do you anticipate going to Europe first with that or would that be something you’d start off here?

[Gary Maharaj:]

Well as you know business model is really finding a key partner to take it to the channel, where we haven’t brought products to market ourselves and that continues to be a strong preference. So really at the end of the preclinical project stage where we have a data package and we've probably conducted a GLP study, that time, there'll be much more interest and viewable data by some or multiple strategic partners who would then want to develop a relationship that commercially license the product or the technology for their balloon platforms. So then there is the regulatory decisions and approximately they are really up to the partner themselves of how they like to proceed.

[Operator:]

(Operator Instructions) Our next question is from the line of Gregory Macosko with Lord Abbett, please go ahead.

[Gregory Macosko:]

Yes, thank you. Just with regard to the revenue growth, my note that, adjusted in fiscal ‘12, your growth was 12% in your high end of your growth at this point, the projected ‘13 growth as 12%. Is there any suggestion that customers are holding back from the development, I mean related to Gen 5 or anything else that would slow the growth because they are waiting for new products?

[Tim Arens:]

Greg, this is Tim. No, I would not characterize that. in fact this could maybe put a little finer point to it, I think we’ve mentioned in the past that in regard to Gen 5 we expect to see royalty revenue from Gen 5, Q4 fiscal 2013. As I think we've described in the past with regard to our business model, our customers for the most part they consider leveraging Gen 5 are going to leverage it on either a next generation product or a new product. And so that will take time for them to work through their product development pipeline, so please don’t take a similar growth level in 2013 as a thought that perhaps customers are delaying putting next generation technology on their products.

[Gregory Macosko:]

Okay, very good. Then, I mean, just I will assume then, conservatism would be a definition in terms of historic growth versus future growth.

[Tim Arens:]

Yes, we also, as many of our customers are doing the same when they have informed as such, there is a sort of logical waiting for the macroeconomic condition in healthcare over the next 12 months. And so part of it is we are so deeply connected to the health of our customers. You know one thing Tim had mentioned, we are getting to the top of the range, we also, even though coronary segment has become less important, it is still important that that performs as a baseline for the peripheral neurovascular trans catheter and so it sort of reflects the weighted average of the probabilities we see, primarily from a microeconomic viewpoint.

[Gregory Macosko:]

And when you say funding or expanding, you talked about in your summary sort of expanding your opportunities and outlook, the point being that, would acquisitions or anything like that be part of that expansion.

[Gary Maharaj:]

You know we haven't, really gone on record and stated an acquisition, M&A strategy. Needless to say that anything that can help us strengthen the core business and provide a platform for expansion certainly is not out of the question but we haven't put a set strategy in terms of our cash and balance sheet specifically towards M&A at this point, that's an on-going conversation with the board.

[Tim Arens:]

Gregory, this is Tim. I'd just like to expand on Gary's comment here, just to be perfectly clear, our outlook is reflective only of organic growth initiatives, does not reflect any M&A activities.

[Gregory Macosko:]

Okay. And I assume then at this point, you really haven't looked at anything or have had any considerations with regard to an acquisition?

[Gary Maharaj:]

Well, you know, you probably, my words were carefully chosen early. Our balance sheet is also for opportunistic investments and so we remain in this market an opportunistic investment, if the right M&A with a right strategic fit in the right core strengthening our expansion capable is came along, we'd certainly look at it.

[Operator:]

Our next question is a follow up from the line of Charley Jones with Barrington Research.

[Charley Jones:]

Thank, again. Sorry if you answered this, what was your operating cash flow for the quarter, for the year excluding share repurchase?

[Gary Maharaj:]

Our operating cash flow was 5.6 million Charley.

[Charley Jones:]

For the quarter, how about for the year?

[Gary Maharaj:]

For the year it was and this is in the press release here, it was 17.6 million.

[Charley Jones:]

Right. Sorry I missed that. Can you tell us whether or not you're on both the major commercial trans catheter heart valve programs? I think you are, but I just want to be crystal clear about this.

[Gary Maharaj:]

Well, Charley we've communicated one partner that we have the ability to communicate and that's (inaudible) what we've said in the past is that we're well positioned. There are several players in the trans catheter valve space. We're happy to say that we're well positioned in that space and unfortunately we really can't say more at this point.

[Charley Jones:]

Okay. That’s helpful. On diagnostics, you talked about singles and doubles here on conservative strategy in getting the growth. Are there triples or home runs and can we expect a chance for you to have one of those in 2013 or is that a longer term goal?

[Gary Maharaj:]

We will be actually be looking for the triples and home runs done and really being very proactive on that. My assessment is while it could happen, we don’t want to plan the company that it has to happen. But certainly our strategy, especially in the area of molecular diagnostics where we believe some of our existing core platforms have plain power. We’ll certainly try to amplify that. So, I’m know I’m dodging the question, it could happen and we are working to make it happen but it’s not part of our plan at this point. In terms of 2013 yes.

[Charley Jones:]

Okay. But longer term sounds like you’re confident, shorter term might not fall in ‘13.

[Gary Maharaj:]

That’s right. And the outlook reflects more of those singles and doubles Charley that you described.

[Charley Jones:]

And really it’s been more singles, right? I mean, our chances of some doubles here are better?

[Gary Maharaj:]

Yes. Yes.

[Charley Jones:]

Okay. Quick question about Gen 5, I was curious if you could prognosticate for us, bring out your crystal ball and give us an expectation of the percentage of customers that will probably use Gen 5 under next generation program say out in 2014. Do you think it’s over half or there are reasons why it’s not?

[Gary Maharaj:]

Our intention is that the majority of customers in term of our commercialization strategy would be porting over the Gen 5, primarily because we believe it’s a best hydrophilic coating including our own for their next generation of devices and these next generation devices actually have, in some cases more difficult requirements. So, it’s not just commercialization or commercialization state, we see it bringing real value to their platform. So my answer is by 2014, we really see majority of our customers. Now, the cash flows from that given the product development and regulatory timeline may not reflect that in 2014 but the license assigned should.

[Charley Jones:]

Is there anything about this where it is going to be more difficult to get products through or is going to be seamless as the other generations have been in the past for companies?

[Gary Maharaj:]

As always it depends on the specific device, sometimes a very small component of the overall submissions. So, a lot of this depends on the FD review of the device that claims in a safety profile and so unfortunately we tagged along with that. Our intention is a Gen 5 is to make it actually easier from what we bring to the table for our customers.

[Charley Jones:]

A question on your drug-eluting balloon, drug delivering technology, so if you're able to enable better uptake by the vessel, why won't that be available for the drug eluting stent programs and then as part of that answer, if you could give us an update where your drug eluting stent partner is and their role out of approvals in Europe.

[Gary Maharaj:]

Yes. We don’t have any other insights in to the second one first of all was niche, we would expect it to be anytime soon but really we are also awaiting word from them on their regulatory approvals. And so that's as much as I can say to that, we will also look to the public disclosure of their regulatory approval. As far as for the drug eluting stent, we call it in many respects, the drug eluting stent is an easy application because you have the stents trust in the Palomar on it to be continuously present to do so, the tissue there and so over the drug coated balloon, there is no physical device, you really requiring the stickiness of the coating to stick to the vascular wall and continue to deliver drug up to 28 days. So, that’s the big difference.

[Charley Jones:]

Are there any milestones incorporated in your 2013 guidance and again, looking for you to kind of bring out your crystal ball, may be move a little bit away from last management strategy, understanding that you don’t want to dip your hand too much but can you kind of give us a little bit better understanding of what your thought process is about, exclusive, non-exclusive relationship for DEB and the likelihood, we could see some milestones in 2013, whether it is or isn't contemplated in guidance.

[Gary Maharaj:]

Right. Our philosophy has been to, when things are still in R&D, we ourselves deeply discount the probabilities for financial plans. That’s not to say they could not happen; it just means that when we put it in, if its isn't there, it’s a very deeply discounted amount. The other thing is in terms of the type of licensee, we're looking for, from my perspective, it's important that we have partner or partners who really are going to fully develop the market with such a terrific technology, when we get to that point and so that’s very critical, by choosing the right partner who is aggressive and wants to change the world as well. We believe that we can have little more latitude and the type of the deal, but it’s really the selection of the type of partner is more important to us. The milestones and royalties and stuff are really negotiated at that time.

[Charley Jones:]

So there is really not anything of any major significance in your guidance.

[Gary Maharaj:]

Yes. Charley it’s a fair way to characterize it. As far as expenses are concerned we do, in fact our guidance reflects expenses associated with preclinical activities associated with the drug-coated balloon project.

[Charley Jones:]

And last one, I saved it for last because I want to push you a little bit, you did a great job obviously of returning cash to shareholders, but just wondered if you could help us out in your thought process around acquisitions, can you strengthen the core by you know, in $5, $10, $15 million acquisitions; or do you think there is opportunities for something bigger and if you could at least show us your thoughts, maybe not of that board’s but your thoughts on, what level of cash is appropriate or could be appropriate given that you got a $15 million $20 million operating cash flow?

[Gary Maharaj:]

Yes, it’s a good question. I will say first that we are in the board, we are in conversations what our continuity value is that. My feeling is we went down in the middle of this year, and demonstrated we said we do what we said in terms of returning cash and we were happy to do that. As you said, we wake up and we have generated more cash in our balance sheet and our plan certainly reflects that. This year, it really isn’t come up on management, with the board to develop a strategic use of that cash for growth of the company or increasing value of the company and subsequently look at the excess cash portion of that as either certainly risk mitigation also keeping some still for opportunistic investment but also importantly understanding that shareholders may have a need for some return of cash. In this case, it will probably more in to excess cash market as we have determined the best uses, strategic uses of cash and so the line-up, or the queue is a little bit different as we look at this year.

[Charley Jones:]

On acquisitions, let`s push a little more, are we still thinking 5, 10, 15, I don’t think, you’ve talked that much about acquisitions at the most or are there may be some opportunities for something bigger in your opinion.

[Gary Maharaj:]

I would say my feeling on the big is we better have a very good investment type hypothesis, very good reason have done a lot of diligence to do large acquisitions. We’re looking for things that strengthen and expand the core, nothing that’s two adjacencies away. We’re not necessarily look to buy revenues, but we’re looking to expand our capabilities especially. So the big ones while not out of the question; certainly have a non-linearly higher operating to get over here to SurModics .

[Operator:]

Our next question's from the line of Jeffery Waschau with Sidoti and Company. Please go ahead.

[Jeffery Waschau:]

Just quickly on R&D revenue we saw an increases throughout the year, maybe if you could provide a little more colour on what type of customers are increasing the testing of their devices, do customers, existing customers, customers previously in house and then with month into the most recent quarter how you feel about that category going forward?

[Tim Arens:]

Really the R&D revenue can probably be classified into really two key buckets. One is as you described, doing work where we get paid to help optimize our coating technologies for our customer’s products. And that has been fairly, modestly growing over the last year. What I will tell you is that most significant source of growth is coming from what we call coating services. And we may have described this in past, this is customers that are using our hydrophilic coating technology and are going into animal studies or human clinical studies for the most part where they will send to us their parts to coat and they'll do assembly and then use those products for their clinical and pre-clinical work. So just to be a little more, put a finer point on that, that's really where the growth is coming from in R&D. In terms of how we think of that going forward, as you can imagine, customers do work and then they submit to the FDA or to a regulatory body and they don't need to have products coated and so you're always getting customers that come in and go out of that equation. I would anticipate that as you look at our outlook, I would assume that the growth rate to be thinking about with regard to R&D isn't much different than the growth rates that we've provided overall for the revenue outlook.

[Operator:]

And at this time there are no further questions in queue. I'd like to turn the call back over for closing remarks.

[Tim Arens:]

Thank you.

[Gary Maharaj:]

Our success in 2012 has given us strong momentum as we head into the New Year. We'll remain laser focused in executing against these strategic objectives that will enable us to return SurModics to profitability and focus revenue growth in our core businesses. At the same time our strong operating model and healthy balance sheet have created an opportunity to continue investment in R&D and new product introduction to expand the core, while maintaining the financial flexibility to be both opportunistic and to return value to shareholders. I want to thank everyone again to participating in this quarter’s conference call. We look forward to providing further updates on our next conference call. Thank you everybody.

[Operator:]

Thank you ladies and gentlemen. That does conclude our conference for today. I would like to thank you for your participation again. And you may now disconnect.