Andy LaFrence - VP of Finance and Chief Financial Officer Gary Maharaj - President and Chief Executive Officer.

Charley Jones - Dougherty Markets Ben Haynor - Feltl & Company.

Good day, and welcome to the SurModics’ Second Quarter 2015 Conference Call. Today’s conference is being recorded. And at this time, I would like to turn the conference over to Mr. Andy LaFrence, Vice President of Finance and Chief Financial Officer. Please go ahead, sir..

Thank you, Tom. Good afternoon and welcome to SurModics’ 2015 second quarter earnings call. Before we begin, I would like to remind you that during the course of this call we will make forward-looking statements.

These forward-looking statements are covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and include statements regarding SurModics’ future financial and operating results or other statements that are not historical facts.

Please be advised that actual results could differ materially from those stated or implied by our forward-looking comments resulting from certain risks and uncertainties including those described in our SEC filings.

SurModics disclaims any duty to update or revise our forward-looking statements as well as a result of new information, future events, developments or otherwise. We also refer to non-GAAP measures because we believe they provide useful information for our investors. Today’s news release contains a reconciliation table to GAAP results.

Finally, this conference call is being webcast and is accessible through the Investor Relations section of the SurModics website where the audio recording of the webcast will also be archived for future reference. A press release disclosing our quarterly results was issued earlier this afternoon and is available on our website at www.surmodics.com.

On today’s call I’ll provide an overview of our second quarter financial results. I will not go through the fiscal first half numbers as they’re included in the table on the press release. Gary, will then cover our key achievements and discuss our growth drivers and strategies.

Finally, we will open the call to take any questions including questions on the first half results. I’ll start with the financials. Revenue for the second quarter of fiscal 2015 rose 6% to $14.4 million compared with $13.6 million in the second quarter of last year.

On a GAAP basis our diluted earnings from operations totaled $0.23 per share compared with $0.18 per share in the year-ago period. Non-GAAP earnings per share from operations were $0.19 in the current quarter compared with $0.22 per share in the prior-year quarter. The fiscal 2015 quarter included a $0.04 per share investment gain.

The 2014 second quarter included a $0.04 per share one-time non-cash charge related to amendment to Board of Directors after the compensation. We delivered operating income of $3.9 million in the second quarter of fiscal 2015, up from $3.5 million in the prior-year period. Operating margin increased from 26% to 27% in the current year quarter.

Operating margin benefited from increased revenue and reduced board stock-based compensation partially offset by higher planned expenditures associated with our SurVeil Drug Coated Balloon product as well as professional service related cost. Turning now to our two business units.

Medical Device is the larger business unit, it contributes approximately three-quarters of our total revenue. Revenue is derived from both our hydrophilic coatings and device drug delivery coatings. Revenue rose to $10.6 million, increasing 1% from the year-ago period.

Second quarter hydrophilic coating royalty revenue totaled $7.2 million, up 2% from last year. We continue to diversify our hydrophilic coatings portfolio. For the second consecutive quarter, peripheral applications were the leading royalty segment.

Reagent product sales declined during the second quarter as the number of our customers’ implemented inventory rebalancing initiatives.

And Medical Device business unit also posted higher customer research and development revenue, this is primarily associated with contract coating services to support customer clinical trials in select product launches. This unit generated $4.7 million of operating income in the second quarter down 11% from a year ago.

The planned increase of drug coated balloon R&D investment accounted for this segment’s change in operating income. For In Vitro Diagnostics unit, second half fiscal 2015 revenue totaled $3.9 million, an increase of 23% from a year ago, which was a weaker quarter for this business.

This year the IVD business realized exceptional broad-based growth from our immunoassay reagents as well as molecular diagnostics product line. Product gross margin for IVD was 64% in the second quarter compared with 63% in the prior-year quarter. This increase mainly related to improved manufacturing leverage resulting from stronger volumes.

IVD operating income increased to $09 million compared with $0.6 million in the second quarter of fiscal 2014. Our diagnostics operating margin for the quarter rose to 24% versus 20% in the prior-year quarter, due to stronger operating leverage from higher sales, partially offset by increased SG&A costs.

Now, I’d like to discuss our second quarter 2015 revenue summary by category. First, royalty and license fees, which are generated primarily in our Medical Device business unit, were $7.4 million, an increase of 1% from last year, stemming from increased hydrophilic coating royalties.

Second, product sales in the second quarter of fiscal 2015 totaled $5.7 million, an increase of 9% from the year-ago period. This reflects higher product shipments in our In Vitro Diagnostics business unit offset by the previously mentioned lower reagent revenue in our Medical Device segment.

And third, R&D revenue was $1.4 million, up from $1.1 million a year ago. SG&A expenses in the second quarter of fiscal 2015 were 29% of revenue compared with 32% a year earlier. On a dollar basis, SG&A in the second quarter of fiscal 2015 was down, totaling $4.1 million versus $4.3 million a year ago.

The decline reflects a $0.9 million expense reduction from the fiscal 2014 acceleration of Board of Directors stock based compensation offset by increased legal and professional services expenses including corporate development costs. As a percentage of revenue, second quarter R&D expenses were 31% versus 30% in the year-ago period.

R&D expense of $4.4 million for the quarter increased 7% from last year, resulting from timing of a drug coated balloon development program. As expected, we are experiencing higher research and development spending from the remainder of fiscal 2015 consistent with our previously provided financial guidance.

Income tax expense was 33% of pre-tax income in the second quarter, essentially flat with the prior-year period. Looking at our balance sheet, it continues to be strong. Our cash and investments totaled $49.1 million and we had no debt outstanding at March 31, 2015. We continue to generate solid operating cash flow.

Cash flow from operations was $6.8 million for first half of fiscal 2015. We invested $0.2 million in property, plant and equipment and returned $20 million to our shareholders through the accelerated share repurchase program announced in November 2014.

Our current cash and investment balances, and operating cash flows, combined with SurModics’ $20 million line of credit and $175 million shelf registration, provide adequate capacity to support our corporate strategic initiatives. We are reaffirming our previously stated revenue, earnings per share and operating cash flow guidance for fiscal 2015.

We estimate revenue for fiscal 2015 to be in the range of $57 million to $60 million and GAAP diluted earnings to be in the range of $0.85 per share to $0.95 per share.

As a reminder, the fiscal 2015 earnings per share guidance includes an increase of approximately 5% to 7% in research and development expenses over fiscal 2014 levels primarily related to the drug coated balloon program and assumed $13.3 million diluted shares outstanding in the 33% to 35% income tax rate.

The company’s earnings per share and income tax rate guidance exclude the impact of any strategic investment or short-term investment gains and losses. Cash flow from operating activities is expected to range between $16.5 million and $18 million and we project capital expenditures for fiscal 2015 to range between $1.7 million and $2.2 million.

This range is down from our previous guidance of $2.2 million to $2.5 million. We continue to be impressed with the dedicated of the SurModics’ team to focus on our core markets while pivoting on our transformation strategy.

We’re very pleased with the great first half and thank you to the entire SurModics’ team for your efforts in the first six months of fiscal 2015. And now, I’ll ask Gary to share his perspective.

Gary?.

to generate maximum revenue growth in our core hydrophilic coatings and In Vitro Diagnostics businesses. To transform SurModics into a whole product solution provider of medical devices via organic R&D and corporate development initiatives, and finally to accomplish these while continuously optimizing our operating margins.

First let’s discuss operating margin optimization. Our operating margin in the second quarter was 27% compared to 35% in the first quarter, primarily as a result of increasing R&D spending by an additional $800,000.

As you may recall, we explained last quarter that as we intentionally ramp up planned R&D expenditures most notably in our SurModics SurVeil Drug Coated Balloon program that we expect to intentionally reduce our operating margin for the remainder of fiscal 2015 to support this investment.

The optimization that I mentioned is ongoing assessment of the investment needed to generate future cash flows while continuing to generate current earnings. In addition, we aim to drive operating efficiency so that we can offset some of the expense associated with investment required for transformation.

Turning to our core business revenue growth, I’m pleased with the continued growth in our In Vitro Diagnostics or IVD business unit. As Andy mentioned, we achieved growth across the broad range of our IVD product line. While the easy revenue comparable with the second quarter of fiscal 2014 accounted for the large 23% growth.

We do expect continued real growth in IVD in the third quarter of fiscal 2015. Our Medical Device business unit continued positive and profitable growth, despite reduced order patterns of reagents from some customers. We believe the law order levels are due to reduction in inventory and working capital management at these customers.

However, we will be able to better confirm this after new order patterns have been established during the next two quarters. We’re working hard to reduce the financial impact for generation three hydrophilic technology patent expirations, starting in fiscal 2016.

We are finalizing a multi-pronged plan to address this in the next two quarters and remain confident that we can substantially overcome this headwind with our focus on core growth and our transformative strategy. Importantly, we remain busy with the evaluation feasibilities on new customer products with our Advanced Serene Hydrophilic Coatings.

I’m pleased to note that we signed five licensees that used Serene during this past second quarter. Now, let’s turn to our transformative activities. Our corporate development initiatives continue to screen many opportunities but some progressing to detailed due-diligence.

We have encountered more competition and higher multiples paid for targets that we have pursued. However, we remain disciplined at any deal pricing and structure has to have a strategic rationale and a vital path to long-term value creation for our shareholders.

We continue to scan for attractive companies with talented people, best-in-class engineering, manufacturing, design and technology, the right geographic and customer footprint and a complimentary business model that allows us to pursue our goals of developing whole product solutions.

Finally, let’s talk about SurModics SurVeil paclitaxel drug coated balloon program.

On a macro level, we noted in today’s news release that we are encouraged by the marketplace acceptance of drug coated balloons as a key therapeutic modality for the treatment of peripheral arterial disease in the superficial femoral artery and are particularly pleased that CMS has acknowledged us in the early reimbursement guidelines.

Specific to our situation, we continue to generate data that confirms SurVeil’s superior drug delivery efficiency. The extensive development and manufacturing activities required to prepare for regulatory submissions is on schedule. Further, we have started with and are receiving feedback from the respective regulatory body.

In addition, we have engaged a contract research organization for our clinical and had early conversations with clinical investigators and potential clinical sites. While there is no assurance of the regulatory timelines matching our anticipated project goals, we believe that our data of high quality, cogent and complete.

We are also investing in parallel activities to prepare clinical sites for when we have the regulatory approval to perceive with the first inhuman study. We have targeted to start patient enrollment by the end of fall of fiscal 2015.

In summary, our goals and outlook for the remainder of fiscal ‘15 are unchanged, to build our core business revenue, to optimize our operating income and earnings for long-term value creation, to proactively seek the right corporate development opportunities and to initiate early clinical assessment of the SurModics SurVeil Drug Coated Balloon.

We have an exciting finish to fiscal 2015 and we look forward to updating you on our progress during the next quarterly call in July. Operator, this concludes our prepared remarks. We’d now like to open the call to questions..

Good afternoon guys, how are you? Thanks for the time..

Hi Charley..

Maybe I’ll start with the customers that have been decreasing the reagent. I’m just wondering if they’re very, if it’s just a couple of customers here and that they have certain generation of product there.

And then, I guess, if you could talk a little bit more about some of these Serene wins that you’ve had, are they in really big product categories something that you’re extremely excited about or are they kind of still singles that are happening in the Serene area?.

I’ll take the first part of that, Charley, this is Andy I’ll take the first part of that question. In terms of the decreasing reagent, it’s just a number, handful of customers. And there have been couple of customers that have implemented lean and gone to new ordering patterns and they established that during the current quarter.

And we had one customer that actually was changing the manufacturing site. So, there was a pause as they go through and get that new site established. So, we are hopeful that the patterns will renew in the next two quarters to be consistent with historical levels. So, that’s why there was about $260,000 decrease in reagent sales..

Yes. And as far as the Serene licenses, they sort of spend the whole portfolio off nothing in the last quarter was something that was ordered back with the entire spectrum of feasibility. Some of them were vascular guidewires, protection devices, a couple of peripheral and neuro based catheters and micro-catheters as well.

So, the typical gametes of devices used in different organ systems. And Charley if you’re looking for a homerun type of new next generation stent and stuff, I think we already mentioned that the Medtronic program that’s already, we’re using Serene and that’s been a European approval.

I guess we’ll have to wait for Onyx in the approval of Onyx in the U.S. at whatever respective regulatory time..

I guess, one of the questions is maybe in the back of people’s mind is, is there going to be a quarter over the next two quarters where you’re going to see a drop-off before we see a deal next year mid-year assuming that we’re in the camp, but the way you said, something good is going to happen with the drug coated balloon.

But in between now and then, do you have a quarter in there where it’s kind of low operating margin and you’ve got some transition there.

Do you think you’d transition through that or do you think there will be at a quarter like that in there?.

Well, I think at least for the rest of this fiscal year, our guidance range is intact. I think as we approach fiscal ‘16, there is a confluence of a couple of things that could line up positively or potentially offset or potentially negatively.

For me, the one thing I wouldn’t want to do is to make a hasty decision with our drug coated balloon that could sub-optimize the value we could receive. So, if for example, there is - what you just asked is multiple permutations we have modeled.

I wouldn’t want us to see a potential quarter where operating income looks lower and hasting to take a lower value for our device. I would much prefer to go through a quarter of potentially two, so that our shareholders can get the better value for what we’ve invested in over the last few years.

So, I’m not answering it, we’ll give more clarity on fiscal ‘16 in a couple of months here. But certainly for the remainder of this fiscal year, we’re pretty squarely in our guidance range..

Your view point is reassuring, maybe if I could just ask a couple of quick ones and then jump back in the queue, on some of these other programs? Could you give us some update on the sirolimus program and just how far behind it is in the, from the paclitaxel and whether or not you have started other things there?.

Well, and I’m glad you asked this. So the sirolimus program we have is not, it’s actually, it’s still in the what we consider our experimental portfolio before we commit the full spending to the program level. But even at that point we are spending and we’re performing the required animal studies. I’ll say a couple of things.

One, we are experimenting with both a new drug and a new type of excipient and we’re seeing profound results.

We’re excited about that but I’m trying to keep myself restrained in a sense would believe we’re doing a third generation technology with our current DCB program, yet we’re seeing what I would consider fourth generation results in our sirolimus/new excipient program. So, very excited about that, have not chosen the anatomical target there..

Why not all of them?.

Why not all of them, yes, I know. We want to be able, one of the considerations is we want to be able to use what we’re learning on the superficial femoral artery program with paclitaxel so that we can use that to accelerate this sirolimus program at the appropriate time.

And so, below the knee is certainly an extension there that we can go with an additional program. But I don’t want to say we’ve made a choice on that yet. The type of devices as well will come into play..

I do want to make, I wanted to add one more question. So, in the last call you alluded to other excipients, other coatings that you would go to coat. I think there is a conversation around that at least that I have that, it was across the greater number of devices. And it sounded like they’re just drug coated balloons.

And so, I guess I was hoping you can maybe expand on that a little bit, and help us understand to whether or not your comments were really around drug coated balloons in just what you had just said or if you’ve had a number of different discoveries around coatings that really could enable you to transform your platform into dozens and hundreds of different devices?.

Dozens and hundreds, yes.

The two main prongs that we have that we’re working on, one is we certainly are working with some new molecules that are coating related, not necessarily drug delivery coating related but just coating related that we’re excited that could produce better optimized coating that can actually help in areas where they are difficult to cross lesions like chronic total occlusions, both in the coronary and the peripheral system.

So, device like that could potentially be on a support catheter to the guidewire, a very small balloon to cross these lesions. So that’s one category of R&D we’re working on.

The other category is really about our class, what we call excipient mediated drug delivery, where we’re looking to get drugs off a device with very short-term contact, most of them balloon related but not necessarily only vascular related, is the other big prong we’re pushing on. So, we’re making progress on both of those areas.

The first one is more of the category of 510(k) type products, maybe 510(k) with some small clinicals. The second category of the excipient mediated platform of drug delivery working out might end up being more for the PMA type approval products, certainly with heavy clinical. So, we continue to make progress on both those categories..

Thanks for the extra time..

[Operator Instructions]. We’ll go next to Ben Haynor with Feltl and Company..

Good afternoon gentlemen..

Hi Ben..

Hi Ben..

Obviously you guys are following the DCB launch pretty closely.

Anything that you find particularly interesting there in early days beyond the prepared remarks you offered?.

Yes, I’ve been to some of these clinical sites and talked to a couple of the clinical investigators we’re dealing with. And many of them, at least I shouldn’t say many of them it’s not dozens of them. But those that we have, has been amongst the top enrollers in previous drug coated balloon trials. So they have a lot of experience.

I think what as observed in the conversations with them is that at least in these facilities, the practice is profoundly changing.

And again, if they’re able to do a good primary angioplasty and not have immediate elastic recoil or not have a flow limiting dissection, it appears to me that the 100% of those patients who, if the outcome is a good primary balloon angioplasty, those patients are getting DCBs.

And so, the question of the market breakdown comes down to how much potential, the allowed stenting do you have to do if you have a flow limiting dissection or if you have elastic recoil. And so, at least we’re encouraged that it is a bona fide therapeutic area.

With the recent I think the past two transitional, transitional pass-through payment for the outpatient market that CMS proposed, that actually is helpful in most cases. So, I - and this is again our opinion, we’re not in those markets, our customers are.

But I believe there are early readers, the DCBs are here and they’re already making an impact potentially on stenting in the SFE, both the metal and drug eluding stenting..

Excellent, very interesting. And then on, you kind of mentioned this that peripheral was bigger than - the biggest area.

Do you have kind of the breakdown, I think because of 35% last time around, has that increased or same as March?.

Right. Ben, last quarter peripheral I think was 37.4% and this quarter just 37.3% so it’s pretty consistent from quarter-to-quarter..

No big change there?.

But still bigger than….

It’s still bigger than current quarter..

And I know our general manager of Medical Device once or so reemphasized that it’s becoming increasingly difficult for us to trace the usage because some of these products, you think of a peripheral guidewire and neuro guidewire, coronary guidewire. And in some instances there could be substantial overlap.

So the edges of those market segments continued to blur a little bit of where we can see where the products actually are used..

Okay, that makes sense.

And then, lastly from me, any update on the geographies that you’re considering for connecting the SurVeil trials?.

The clinical trial SurVeil?.

Yes..

We haven’t, I want to hold that a little close to home yet. We certainly, the intention really is to do it in a highly branded fashion meaning terrific sites, well known DCB users, our Scientific Advisory Board clearly are filled with people who have a lot of expertise in the superficial femoral artery.

In fact, our Scientific Advisory Board pretty much bound the whole spectrum of anyone who has done a PMA approved device in the SFE over the last five years probably with one minor, one exception. So, I hope to be able to share more of that in the third quarter call.

And certainly if there is something that requires a notification or a press release that says where we are conducting, we will also consider that in between calls as well. Because it may be made public anyway, we get an approval to proceed..

Okay, great. Thanks for taking my questions gentlemen..

Thank you..

Thank you..

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

Thank you. Thank you for all of your questions. We’re pleased with our 2015 first half and look forward with optimism, focus on generating profitable growth in our core businesses as we progress towards providing whole product solutions to our customers. This ensures that SurModics is relevant to our valued customers. Thank you..

This does conclude today’s conference. We appreciate your participation..