Gary Maharaj - CEO Andy LaFrence - CFO.

Ben Haynor - Feltl & Company James Sidoti - Sidoti Company Betty Lilly - Gamco Investors Gregory Macosko - Montrose Advisors Jan Wald - Benchmark.

Good day, and welcome to the SurModics' Second Quarter 2016 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Andy LaFrence, Vice President of Finance and Chief Financial Officer. Please go ahead, sir..

Thank you, Tunisia. Good afternoon and welcome to SurModics' 2016 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 statements resulting from certain risks and uncertainties including those described in our SEC filings.

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

This conference 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 first quarter financial results. Gary, will then review our key achievements, provide an update on the integration of Creagh Medical and NorMedix and discuss our growth drivers and strategies. Finally, we will open up the call to take your questions. Let’s start with the income statement.

We’re pleased to announce our revenue for the second quarter of fiscal 2016, grew 16% to $16.7 million compared with $14.4 million in the second quarter of last year. Second quarter revenue included $1.1 million from our fiscal 2016, acquisitions of Creagh Medical in NorMedix.

So disclosing these acquisitions revenues grows 8% over the last year’s levels, very nice growth for the Company. There are number of factors impacting EPS this quarter, let me take you though that and I’ll start with GAAP earnings, which totals $0.06 per share versus $0.23 per share in the prior year of quarter.

Revenue for the second quarter of fiscal 2016 as includes an estimated $1.1 million or $0.05 per share out of period adjustment to correct accumulative over statement of royalty revenue of which $1 million related to years prior to fiscal 2016. Your statement with not material to any prior periods.

Non-GAAP earnings totaled $0.20 per share in the second quarter of fiscal 2016 compared with -- comparable with the prior year period. As we have mentioned before our non-GAAP earnings exclude acquisition related transaction cost i.e. integration, continued consideration accretion, amortization and foreign currency loss.

Together these items totaled $0.16 per share in the current quarter. Our non-GAAP numbers adjust for a $0.03 per share benefit from a strategic asset gain in the current quarter as well as $0.04 per share, strategic asset gain in the prior year quarter.

We delivered operating income of $2.2 million the second quarter of fiscal 2016 down from $3.9 million in the prior year period. Operating margin was 13.4% in the current year quarter, versus 27.3% year ago, this change includes transaction related costs and increased incentive compensation.

Turning now to our two segments, we saw a strong performance in both Medical Device and In Vitro Diagnostics. In our Medical Device segment revenues derived from our hydrophilic coating, device drug delivery coatings and balloon catheter products. Revenue rose to $11.6 million increasing 10% from a year ago period.

Second quarter hydrophilic coating royalty revenue and license fees totaled $6.7 million, down 9% from last year. Second quarter hydrophilic royalties were negatively impacted by the previously discussed revenue correction.

Product sales increased $1.3 million or 70% to $3.1 million as a result of revenue from our recent acquisitions and strong reagents order volume. In Medical Device customer research development and other revenue rose $0.4 million to $1.8 million for the quarter again due to the Creagh Medical and NorMedix acquisitions.

This segment generated $2.3 million of operating income in the second quarter compared to $4.7 million in the prior year quarter. Acquisition related expenses of $2.1 million and sales mix accounted for the change in operating margin.

For our In Vitro Diagnostic segment second quarter fiscal 2016 revenue grew to $5.1 million an increase of 32% from a year ago. This year the IVD business segment has realized exceptional revenue growth across all of its major product lines encompassing protein stabilizer, BioFX branded products, micro array slides and antigens.

Product gross margins for IVD was 63.1% in the second quarter compared with 64.4% in the prior year quarter. This decrease stemmed from a change in sales mix as antigens, a product that we distribute comprised a higher percentage of the current year's quarter sales mix versus last year.

Improved operating leverage from higher product volumes partially offset the unfavorable sales mix. IVD operating income more than doubled to $2 million from $0.9 million in the second quarter of fiscal 2015.

Operating margin increased to 38.9% versus 24.2% in the prior year quarter due to improved operating leverage from higher revenue and lower legal cost. Now I'd like to discuss our second quarter fiscal 2016 revenue summary by category.

First and quite positively product sales in the second quarter of fiscal 2016 rose to $8.1 million up 44% from the year ago period. This increase reflects acquisition related product sales and higher reagent sales in our Medical Device segment as well as stronger sales in our In Vitro Diagnostics segment.

Second, our royalty and license fees which are generate primarily in our medical device segment. This revenue category totaled $6.7 million, an increase of -- a decrease I should say of 9% from last year. The decline was a result of previously discussed revenue correction into a lesser extent the impacts of the expiration of our third generation U.S.

patent in the first quarter of fiscal 2016. And third, research, development and other revenue was $1.8 million up from 1.4 million a year ago due to our recent acquisitions. As a percent of revenue second quarter R&D expenses were 29.2% versus 30.5% in the year ago period.

On a dollar basis R&D expenses of 4.9 million rose by $0.5 million from last year. SG&A expenses in the second quarter fiscal 2016 were 29.1% of revenue versus 27.6% in the prior year period.

On a dollar basis SG&A in the second quarter of fiscal 2016 totaled $4.9 million compared with $4 million a year ago, a dollar increase reflects incentive compensation resulting from an improved revenue and a better performance from our historical medical device and IVD businesses as well as the inclusion of Creagh Medical and NorMedix revenue in our consolidated results.

Income tax expense was 62.2% of pre-tax income in the second quarter up from 32.7% in the prior year period.

The increase in the effective tax rate for the second quarter of fiscal 2016 was expected and resulted from the non-deductible acquisition related cost including transaction cost, contingency duration accretion expense and the related foreign currency losses.

Looking at our balance sheet it continues to be strong, our cash and investments totaled $39 million at March 31st, 2016, we continue to generate solid operating cash flow. Cash flow from operations was $9.4 million in the first half of fiscal 2016.

In the first half of fiscal '16 we invested $1 million in profit planning and equipment and used net cash of $25.1 million to acquire Creagh Medical and NorMedix. Our current cash and investment balances and operating cash flows combined with SurModics $20 million loan credit provides adequate capacity to support our corporate strategic initiatives.

This afternoon we filed an 8-K describing our material weakness in our internal controls over the financial reporting relating to controls over royalty revenue associated with expired patent.

While these weaknesses created a reasonable possibility of an error in financial reporting may go undetected after exhaustive review and analysis for recorded the previously mentioned $1.1 million correction [ph] in current quarter royalty revenue of which $1 million related to periods from fiscal 2012 to fiscal 2015.

No revisions to previously issued financial statements were required furthermore we're committed to implement additional measures to re-immediate this material weakness by implementing changes in our internal control over financial reporting. Turning next to our guidance, we've posted revenue growth of 16% in the first half of fiscal 2016.

I am pleased to say that we now expect full year revenue to be in the range of $63 million to $66 million up from the previous range of $62 million to $66 million. We are reaffirming our diluted gap earnings in the range of $0.30 to $0.35 per share.

Non-GAAP earnings per share are expected to rise to a range of $0.75 to $0.85 per share up from a range of $0.66 to $0.75 per share.

The fiscal 2016 revenue GAAP earnings and non-GAAP earnings per share guidance all these ranges exclude the impact of a $2.9 million or $0.14 per share after tax royalty payment from a customer for the period from the 2009 through 2016 that was reported to the company subsequent to March 31, 2016.

This royalty revenue will be recognized in the third quarter of fiscal 2016 when collectability is originally assured and completion of their [Indiscernible] process occurs consistent with the Company's revenue mechanism policy.

We estimate capital expenditures to be in the range of $8 million to $9 million, an increase from 4.5 million to 5 million driven largely by investments in Ireland in the second half of fiscal 2016. Let me update the assumptions that underline these ranges, they are no substantial changes in the U.S.

dollars and euro exchange rates for fiscal 2016 from current rates. Research and development to be approximately low to mid 30% of revenue. Selling, general and administrative expenses including business combination related amortization, accretion and transaction expenses are projected to be approximately in the mid 20% of revenue.

The income tax rate is expected to in range between 50% to 53% in fiscal 2016, and this includes our estimate of non-tax benefit items including contingent consideration accretion and transaction costs from the Creagh and NorMedix acquisition as well as Creagh Medical generated operating losses in fiscal 2016.

The operational and financial results in the first half of 2016 were remarkable in the midst of two significant acquisitions and related integration activities. Thank you to the team in both Ireland and the U.S. for their hard work and outstanding results. And now, I'll ask Gary to share his perspective.

Gary?.

Thank you, Andy. I am delighted with all the SurModics' team performance in the second quarter. I want to thank them for the huge positive accomplishments in multiple areas.

This marks the third consecutive quarter of double digit growth for us and it was not an easy quarter by any measure given the sheer effort required to integrate two acquisitions while continuing to drive core business performance and advanced measured R&D programs including our drug-coated balloon platform.

Our team demonstrated disciplined balance and coordinated team willing to deliver these results. We hit our stride on all aspects of our strategic tri-facta.

As you may recall from SurModics' last quarterly earnings call, the first element in our tri-facta is to transform SurModics into a whole product solutions provider Medical Devices by organic R&D and corporate development initiatives. We achieved major milestones here.

We started the enrollment of the nearly feasibility study for the SurModics SurVeil drug-coated balloon in March and commenced enrollment at early [indiscernible] first patient treated.

This is exciting not only for SurModics but for Medical Device Clinical Research in the United States, since the very first patient treated are actually in this country. Moreover we acquired NorMedix in our second quarter and have met excellent program in derating [ph] both Creagh Medical and NorMedix in a very short time.

These two acquisitions dramatically accelerate our growth strategy to become a differentiated whole product solution provider for our Medical Device customers. The second pillar of our tri-facta is to continue to generate maximum revenue growth from our core Medical Device coatings and In Vitro Diagnostics businesses.

For yet another quarter our score card here speaks for itself. We were able to drive significant double digit growth in both of our core businesses as Andy has just described. Our base is performing well as we continue to maximize our opportunity there.

And finally our third pillar is to continuously optimize investments required for strategic transformation and the long-term value creation with the short term generation of earnings and I call this balance.

We adapt our investment of management focus, time and resources based on the continuously evolving opportunities and risks ahead to ensure a maximum return.

Simply put, I’m proud of our efforts in optimization during the second quarter, this is an critical element that really sets SurModics apart and it is evident and our ability to invest and accelerate our long term strategy, while at the same time delivering profitable growth.

Let’s talk about our business unit performance, in the second quarter our co-medical device segment including, excluding Creagh Medical and NorMedix acquisitions, grew 7% on a GAAP basis versus the same quarter last year. This was due to gains and reagent revenue that Andy noted.

Royalty revenue was impacted by that $1.1 million adjustment to royalty revenue during the second quarter, but without this clean royalty still grew 5% for the second quarter.

Our reagent revenue grew in line with our pre-clean royalty revenues was an additional increase we believe driven by some customers, stocking up inventories to some extent as their respect to the areas. Creagh Medical and NorMedix contributes additional revenue to help us grow 15% overall in our key medical device business segment.

This is excellent performance. Our IVD business had an amazing quarter of profitable growth, increasing revenues by 32% versus the same quarter last year and achieving an operating margin greater than 38%. We expanded revenues in our core product lines of protein stabilizers, BioFX substrates Microv Slices as well as antigens.

This growth stand from the combination of organic customer growth, revenue from new acquired IVD customers and successfully cross selling current customers the continuation of what we saw in the first quarter. Let’s now move to the integration activities in Creagh Medical and NorMedix.

Starting with the people, Creagh Medical and NorMedix both have exceptional depth and breadth of incredibly count to the navigated people, this is you can image, fits nicely with our similarly talented team at SurModics.

These acquisitions have already attracted and we’ve hired additional peoples with specific experience and skill that add to capabilities and fit our pioneering and informal culture.

We’ve made excellent headwind leveraging in Creagh Medical facility in Ireland to begin the process of suing our non-US based customers with hydrophilic coatings capabilities and a world class production facilities.

Our activities included the purchase and installation of the equipment, the treating of the create team and the initial costs of sub validations. These and similar initiatives will continue to grow the next two quarters at Creagh Medical.

At NorMedix we’ve started the upfront scoping activities as which determined the best targets for our product development initiatives using combined NorMedix and SurModics technologies.

We in tend to have this assessment wrapped up in the fiscal quarter and then will start ramping up the product development project or projects in the fourth quarter, we call it NorMedixes patterned ultra-thin graded castle platform and proprietary manufacturing processes.

Along with some of SurModics new lubricious coding platforms create a new and exciting capability to change the standard of capital performance in all areas of vascular access. Our aim is to attend at least one 510-k clearance of a unique capsule based per year starting in fiscal 2017.

Finally, let me update you on the no including progress in the SurModics of the real drug-coated balloon program. We’ve three clinical sites up in running each of which already at least in rolled, at least one patient, and we’re on track to complete this enrolment in our fiscal third quarter.

While we cannot confirm this, we’re not aware of any other drug-coated balloon technology that has conducted in the early feasibility study in the United States. We’re continuing our discussions with the FDA, as we move to complete this study and contemplate further clinical evolution of the serial drug-coated balloon.

We’re also advancing our Sirolimus drug-coated balloon program. Our goal in the third quarter is to kick off project levels to focus one specific anatomical target.

Our intension in this program is to use to the balloon design and development expertise at Creagh Medical to develop the device that will carry our unique proprietary Sirolimus drug-delivery coding technology. I recently comment described our longer term outlook for SurModics.

Our objective is to recall as to generate consistent revenue growth in the mid-teams on a constant currency basis and EBITDA margins greater than 30% by fiscal 2020. We’ll meet these goals by the successful of the execution in the three following areas.

First, we got the fully hall as the potential of our drug delivery capabilities , starting with the SurModics of the real drug coded balloon platform and expanding to the other relevant anatomical targets.

Second, we have to develop a well start and predictive medical device, R&D pipeline that leads to multiple differentiating new product productions and up take by all customers. Both Creagh Medical and NorMedix have haven us a head start with their current portfolio products. Together we’ve significantly more opportunities for R&D pipeline development.

As specially the 510k type of regulatory products to offset in tyrannically higher risk in our device drug delivery platforms and third as we demonstrated in the big way this quarter, we must continue to develop and grow SurModics’ core medical device coding and diagnostics reagent businesses.

We believe that natural per patent expiration, intrinsic growth of both of these business is in the mid-single digits with greater than 30% operating margin.

I'm increasingly excited about our future at SurModics, we're off to a strong start in the first half of fiscal 2016, we're already making substantial progress on our whole product solution agenda with integration of Creagh Medical and NorMedix.

We are encouraged by our drug quarter balloon program and we continue to execute our growth strategies in our full medical coatings and In Vitro Diagnostics.

I believe we face unique prospects, I don’t know if another company our size that has best in class capabilities in device technology such as drug delivery and coatings, peripheral balloon catheters, world class manufacturing and all aspects of vascular catheter technology.

And even chemical reagents and surface technology to be used in our In Vitro Diagnostics. We've put together all of the right ingredients for an agile company with technology, balloons, catheters and manufacturing. I'm confident in our ability to use these for a long term advantage to generate consistently attractive financial results.

In other words now we have the right pieces, our job is to put them together to continue to generate superior shareholder returns in the not too distant future. Operator this concludes our prepared remarks, we'd now like to open the call to questions..

Certainly, [Operator Instructions] and we'll go out and take our first question from Ben Haynor with Feltl & Company, please go ahead your line is open..

On the targets that you're considering with NorMedix the 510K type product, can you give us a sense of how many you're looking at and are there any of that would be complementary or kind of fit together real well for a certain type of procedure or treatment that might make them more attractive to a licensor?.

Yes, you know I'll comment on the general category because the team is still narrowing their focus there and I don’t want to let that out yet, but when you think of anything that's really requires ultrathin walled access and still with a very thin wall be able to torque, push, maneuver the catheter.

That's a pretty wide hunting ground, but that's where we intend to start.

There are quite a lot of opportunities where there are wide spaces that we don't see as completely filled by the current product offerings of our customers and you know a wide space in vascular medicine, they're not small numbers they're $50 million to a $100 million types of products.

So just think of the platform a very thin wall, the flexibility of a rope with the torque ability of a broomstick [ph]..

Okay and suppose in the -- on the IVD business, awfully good quarter you put up, do you think that that's something that's sustainable I mean it sounds like it was across the board, so I would think that it would be but just kind of wanted to hear any color that you might have there..

Ben we look at business as really having long term growth in the mid-single digits and we've had and three of the last four quarters with an exceptional in terms of double digit growth so we have some high comps that are going to be coming in against series starting in Q3 and our viewpoint is that there has been some situational components to the growth over the last nine quarters or nine months or so we did expect that to go to more of a normal mid-single digits growth.

But the team I will tell you, they have performed exceptionally well in terms of executing, in terms of sales, business development as well as manufacturing..

And I’ll say, we -- we're not benefiting from some external tailwind there necessarily and these were just execution over the last three plus years, some of which is now paying the dividend..

Okay that makes sense. And then on the interest guidance particularly on EPS, you know I know you don't guide to the quarterly, but was that more outperformance versus what you were thinking in Q2 that led to the bump up or is that the improved performance that you see going forward..

Ben to be clear we've had two pieces here, one is the -- and one of the reasons we talked about in terms of higher incentive compensation is that general line business is performing very well right now, to offset that we did have an increase in terms of transaction related cost and many of those are non-deductible, so you kind of get a double hit from those because you don't get a tax effects for that.

So those are kind of pieces really ruling, or really driving I should say the non-GAAP numbers and the other thing I would say is that as we talked about in the script and options in the release, we did receive notification from a customer regarding a $2.9 million payment that we expect to receive in this quarter and we haven't completed our analysis of that payment.

But that is not included our current guidance given that we have completed thought was appropriate to disclose the given the magnitude of payment..

And then lastly for me on the tax rate, do you anticipate that it will stay kind of similar to these levels to get to 50% to 53% for remainder of the year or could it be higher in one quarter and more in the other?.

Well, I think what will happen we'll start to see a comedown a little bit because some of these is due to the transaction cost that also with this $2.9 million, we'll have reassess the rate in terms of we're going to be directionally we think we'll be going down.

But we have to get through the hurdles of revenue recognition on this item and then we'll work our way through all various cascades of calculation to term that amount with seven times at the time..

Thank you. [Operator Instructions] We will go ahead and take our next question from James Sidoti with Sidoti Company. Please go ahead. Your line is open..

You've talked about having at least one product for NorMedix each fiscal year starting fiscal ’17, once that product in the market, where you would manufacture it at, which facility?.

The drug-coated balloon..

No..

[Multiple Speakers] NorMedix really -- they will be certainly the initial skill but our intention is to really use the Creagh Medical manufacturing facility in Ireland to actually make -- anything that's touching the Medical Device will be coming out of that facility.

So the R&D could be done but the initial process consolidations and manufacturing will be accretive..

And is that the -- is that where the some of the capital expenditures and expenses in fiscal ’16 are going to step up capacity there?.

There is a couple of thinks we're looking at ramping up for the drug-coated balloon program and we have next that manufacturing done and we're also looking the contract coding business over there and having that completely.

But really I would say setting the rest of infrastructure of the facility there being at that facility or enough facility, we're looking a couple of alterative, so we really look at this as being the catalyst to executed on this strategy as a whole product solution..

I think in ’17 you will see some additional investments so things like breathing machine, the NorMedix type of manufacturing being put in place at Creagh..

But you won’t see that sort of run rate, we haven't finished their operating plans into ’17, but the run rate for CapEx will be significant less than this year ongoing..

And my manufacturing over there, do you think your overall tax rate in fiscal ’18, ’19 and going forward?.

Yes, there is a couple of pieces related to that Jim and it's really had more to do with accounting and they do what cash tax because we do have a net operating loss carried forward there right now we’re receiving a -- we're not getting benefits for losses there because we have evaluation allowance.

Going forward at point in time we will remove that evaluation allowance as we execute on our new business plan and that point in time we will go ahead and start to see some changes in the rate but.

We’re really focused on cash and cash returns and we will at the end of ’16 going ’17 provide more guidance around the tax rate for ’17 once you've finished the plan..

And then bookkeeping question, on the pro forma adjustment table, you've excluded $361,000 gain on a strategy investments in the quarter?.

That's correct Jim..

That's below the operating volume I assume..

Yes, it is..

So where is that though I am on the P&L?.

It’s in the -- there is a category, I think it's down below, it’s in other-to-net number somewhere at least $40,000 or something like that $57,000 [ph] or something like that.

It's embedded in there, so in there you guys a couple of pieces there, Jim, you got one piece is relegated to the foreign exchange lots for the quarter related to the contingent consolidation and the other piece is related to that $360,000 gain related to strategic investment which was sold..

Thank you and we'll go-ahead hut and take our next question from Betty Lilly with Gamco Investors, please go ahead your line is open?.

I have three questions one is -- okay can you explain a little bit more about this 2.8% million royalty payment that you're going to get in the third quarter and it seems to be very so off and you get the lump sum pigment from a customer, so can you give a little bit detail on it?.

Beth we’ve just recently received this report from this customer, so we don’t have the ability to provide a now, we're still going through the analysis of the annoying data associated with it.

So, we really won't provide a lot more other than, it was such of such a magnitude we thought it was appropriate to disclose that given that we weren't adjusting the ranges until we actually receive that.

So, we still need to go through those filters, we do through, but it is very similar to some of these other adjustments from time to time we receive and those really a result of us as we look at royalty reporting and see fluctuations and make inquiries with customers.

From time to time we see that there is some adjustments through historical reporting and this obviously goes back a number of years. So that's the content that we can really put around this report at this time..

So, basically you sold -- the customer sold more product over a course of a couple of quarters and as a result they owe you more and you inquired about it, is that kind of how this came about?.

It simply came about just using our analytical skills that we have, our tools I should say as we look at fluctuations from quarter-to-quarter and this goes back a number of years as we mentioned in our script, it goes back, so I think the first royalty is going back to 2009 in which they have some catch up components to their royalty payments, so it really is a result of the controls we have in place related to quarter viewing customer payments..

And then seems to be about the accounting questions today, so can you talk about this $1.1 million auto period adjustment and so the correction of an error..

Yes, this relates to some of our previously expired technology and as we’ve looked at the potential error related to these payments that were made by our customers, we determine that the potential of the error was material enough, if this had continued to go on for a number of years that that's the result and a significant adjustments in financials and as we stated in our 8-K as well as in the materials we went through on the call today that none of the amounts were deemed immaterial for any of the periods presented and these go back for periods for 2012 through 2015 in the first quarter.

So, if we think about 1.1 million of which a 1 million is out of period in -- its $250,000 per year sort of number, so it wasn’t material period and we -- Gary and I sat down and looked at the processes controls in place and took responsibility for the fact that we need to mitigate potential of an error in financial statements and we will need to do some additional work on the design and operating effectiveness of the controls in the third quarter..

And so when it happens, you've to pay this money back to the customers?.

We believe we may have to yes..

Okay I just wanted to get a better understanding.

And you probably will have what, better understanding a bit as we go through the year?.

Yes, we will hope that we gain clarity throughout the next couple of quarters to finalize that amount..

And now, I want to just talk a little bit about the surveyor [ph] and the sites up in line.

So you've got three sites up and running and you hope to complete the enrollment it this quarter, correct?.

That's our target yes..

So, can you remind us about how many sites and I think I remember 15 to 16 patients and then at what point during, Andy, will you be able to talk about what you're seeing in terms of results?.

Well, it's -- we allowed up to 15 patients and up to three sites, so we've got three sites. They've all enrolled patients and really it's a 30 day follow-up, certainly these patients are followed up for several years, for three years, but the safety and points we're looking at are focused on 30 day follow-up of the patients.

So, when -- it takes even in a small clinical you still have to crank the data and keep the data integrity and statistics we're seeing. So, add 30 days to the last patient treated and then add another six to seven weeks beyond that actually we get the data scrubbing from the sides.

So, we're looking at several months off before we feel qualified to talk about the outcomes there..

And then once you -- remind us then what the next step is after suppose you get through the safety side and everything is fine and then how long do we wait till you start the next process of enrollment?.

Well, as I said we are in discussions with the DFA, I mean early discussions about -- they are multiple viable steps for us both in the U.S.

and both in EU and so what we're trying to do is work closely to find us out which of these steps accelerate getting more data on the device and also which of these steps weight to appetite of the strategic who were in close contact with as they’re looking at our drug coated balloon program so you know we're trying to optimize what we want to do trying to optimize what strategic partner may prefer to do and along with optimizer riding three pathway.

Clearly the next step after this would be to get a broader clinical data set of patients using the serving product including some idea of the efficacy of the device..

Thank you and we'll go out and take our next question from Gregory Macosko with Montrose Advisors, please go ahead, your line is open..

Yes, thank you, yes nice quarter. With regard to the two acquisitions I just wanted to get an understanding of the manufacturing. Was there any manufacturing that came along with or assembly that came along with the two acquisitions and is -- sounds as if most of the manufacturing will be done in Ireland is that correct..

Both of these sites both NorMedix and Creagh have manufacturing capabilities, but you know as we look at the NorMedix facility they're really optimized for short run manufacturing and as we with them are successful as we start scaling that up very quickly you need to leverage the footprint of the Creagh facility in Ireland, and so they both have Tea rooms, they both have operatives, they both have really good quality systems and so, Creagh just has more expansion capability for us, they have a very nicely designed clean room and extrusion capability, so what we're investing in is adding within the built confines of the building adding to some footprint to be able to take on more manufacturing of our proprietary devices.

.

Does that mean then that you'll perhaps close some of the NorMedix facilities or?.

In fact no, we're investing all time but in the NorMedix area we're investing more in hiring R&D team member. We have a very-very small crew of people in the clean room there so that'll feel good for a very long time to come as we meet the prototypes and we meet the very initial short runs.

Both of these areas and at SurModics we've been hiring in the last quarter. .

And then just with respect to the manufacturing that was done in the past, which you're going to do in the future, will that be a part of helping the gross margins or improving the margins as you shall we say integrate forward at all?.

You know as we look it depends because the mix of products that we're contemplating in the future we’ll probably do more to the gross margin curve than actually the current product.

So if you look at the drug coated balloons that will have its own gross margin curve which might wash everything out but it’s a gross margin so we haven't given any signal or guidance of what to expect from gross margins except there's a normal range of healthy medical device industry gross margin that we expect to command as well..

And then finally, just to help me understand the several sites et cetera, there's three sites and there's 15 patients in total to start with that correct?.

Yes..

Okay. And once that has gone been done through then there will be 50 to 60 at a later point..

Well I said, we have options typically if you want to do a traditional feasibility it's probably close to the 70 to 90 patients to get efficacy but that's what we're working through right now both in our data sets and then looking at alternatives of next step, if we do decide to stay primarily in the U.S.

it certainly would need at least 10 sites up and running..

I see so 10, and that was my next question, if when you go to that 70 or 90 or whatever you'll need 10 sites in total..

And as soon as I finish this call our clinical trial design team will tell me that I was wrong. But just [Multiple Speakers]..

Alright, very good, thanks for the explanation..

Thank you and we'll go ahead and take our next question from Jan Wald with Benchmark, please go ahead your line is open..

I really have two questions, lot of questions have already been asked but I just wanted to make sure I understood you know the reporting issue on the royalties, that's an internal matter that's not something that's been driven by some external force like the internal revenue or something like that, so this is something you're going to clean up internally and then I guess as a sub part of that question you are going to have to perform some kind of remediation, is that going to be over several quarters is that going to be a fairly large amount of resources or revenues targeted towards that or how should we think about that?.

Let me take a look sequentially, in terms of the process this is really a SurModics process, our process related to our internal control design and operating effectiveness, so this is something that we need to undertake within ourselves and remediate that material weakness we have out there.

In terms of the re-mediation process, we've already put in some controls we made for the example for our third generation coating technology that expire this year I would say a pretty robust process around the reporting around those controls and those revenues I should say and feel comfortable with that, we go and go back and revisit all of our controls in the royalty area and specifically these matters relate to the expression of patents and the underlying patents that we're talking about related to this correction expired quite frankly back in 2007.

So they go back aways, but nonetheless we've had several other generations and we scoured through those until comfortable with the revenues that have been reported under those patent expirations that recurred. So it's really I would say showing up.

Some controls are already put in place and then having some additional controls in place that need to be designed and then absolutely be operating effectively for a number of quarters before we can say that we remediated this material weakness..

And my second question is SurVeil, I noted in the press release that announced 1st of May and also on discussion, that you didn't talk about which sites are [accurate] and the names, and who might be leaving the first enhanced study or is there anything you can help us with here and then I have a follow-up to that?.

Yes, we have just chosen at this point not to disclose the sites, just to keep it quiet. I can't say the site that actually did the very first patient in the world, who was excited through the entire facility and they even want to be able to tell the world that we treated the first patient. So far we have not disclosed that.

And just our internal policy at this point. As we get little further into that I think we'll loosen that up and be happy to share more about the PIs and many of them are very excited that some of the clinical research is coming back to the United Sates, so that is happening in Western Europe typically.

So look from more information as we relax those disclosures a little bit later on..

Okay it's just unusual that you're not disclosing. And I guess from --..

I will say Jane [ph], each of these sub-bodies and the principle investigators are very well known in the field of drug-coated balloons, so their names will come as no surprise at the end today, but we wanted to just keep it little quite for now..

And then you've said typical [indiscernible] study -- feasibility study typically enrolls 70 to 90 patients which is the usual thing, your enrolment 15 is the hope that strategic partner comes on board and finishes up the study or are you just slowing methodical and how you’re approaching the study?.

This is our debut and I think for us, first of all doing feasibility ability of a combination -- drug device combination product in United States.

So I would say and if I am looking from the outside as the strategy it's a testament to the quality of the technology, the quality of the data we have done pre-clinically, our chemistry manufacturing and controlled integrality in the process, so by doing that it really tells a strategy that's to a very-very high standard.

As you know there are many drug-coated balloons currently commercialized in Europe. For many years that have not treated a patient in the United States yet. So that there we believe we’re setting a very high bar for our technology and for the transparency from a regulatory view point.

And as typical in first 15 patients it's really a safety study when we feel good about this safety study we'll continue to on into doing more of the efficacy type study. The strategics, certainly they are aware of it. Right now we certainly keep in contact with the several of them.

But we going this way they always have the options further the discussion and next salary to discussions that they’d like to at this point..

Thank you. And it does appear we have no further questions at this time. I will now hand it back over to our speakers for any additional of closing remarks..

Frankly all of your questions. To reiterate we are pleased with recent acquisition and the progress of our integration efforts. The generation of revenue growth from our core Medical Device and diagnostic, In Vitro-diagnostics business, and the progress we're making in our R&D pipeline.

We expect in fiscal 2016 to accelerate our transformation to delivering whole production solutions to our customers and we expect to build it on out fiscal 1st performance making for an existing second half for SurModics. Look forward to speaking with you on a fifth quarter earnings call..

And that concludes today's program I’d like to thank you for your participation. Have a wonderful day and you may disconnect at any time..