Andrew LaFrence - CFO Gary Maharaj - CEO, President and Director.

Brooks O'Neil - Lake Street Capital Markets Jim Sidoti - Sidoti & Company.

Good day. And welcome to the Surmodics Fourth Quarter and Fiscal Year 2017 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, Mandy. Good morning and welcome to Surmodics 2017 Fourth Quarter Earnings Call. Before we begin, I would like to remind you that during 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 for our investors. Today's news release contains a reconciliation table to GAAP results.

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 morning and is available on our website at www.surmodics.com.

I'll now turn the call over to Gary Maharaj.

Gary?.

Thank you, Andy. Good morning, everyone and thank you for joining. We had a busy and productive year and our fourth quarter results reflects strong top line performance and our continued focus in maintaining solid operational results even as we invest in our new product pipeline.

On today's call, I'll provide an overview for our key achievements and our strategy going into the fiscal 2018. Then I will turn the call over to Andy to provide a review of our fourth quarter financial results and our fiscal 2018 guidance. We'll then open the call to take your questions.

In the fourth quarter as we reflect in our fiscal 2017 results, we demonstrated excellent progress in each of our three major objectives.

As a reminder these were, one, to meet our overall revenue and profitability goals in our core businesses while managing the oUS expiration of significant royalty generating patents in our medical coatings business.

Two, to invest in and achieve significant milestones in our drug-coated balloon program and secure regulatory approval in our catheter and balloon R&D pipeline. And third to expand our capacity of high quality and cost efficient manufacturing. Let's step through the Q4 results for each of these.

Revenue grew by 10.5% versus the year ago period and we achieved GAAP diluted earnings of $0.03 per share. We are pleased with this performance especially considering the royalty headwinds we face this quarter because of the expiration of our third generation hydrophilic patents and our accelerated investments in our new product pipeline.

As you may recall from earlier press releases, as a result of these investments we accomplished several important milestones. We secured FDA, IDE approval to start the TRANSCEND trial. The pivotal trial of our SurVeil Drug-Coated Balloon which is head-to-head comparison versus the market leading Medtronic admiral IN.PACT drug-coated balloon.

We've recently enrolled the first patient in TRANSCEND and intent to run a rigorous high quality trial with a world class team of principal investigators that we have engaged. Next the results of our prevailed early feasibility clinical study on the SurVeil Drug-Coated Balloon represented by Dr. Gary Ansel at the VIVA meeting recently in September.

The data demonstrated that the absence of any safety signals, good device performance and excellent clinical improvement in the 13 patients followed up through six months. We also received FDA clearance and CE Mark follow unique hydrophilic coated 014 balloon catheter for below the knee angioplasty. This uses our serene hydrophilic coating.

We are confident that this highly deliverable, low profile PTA catheter will provide clinicians an effective tool for accessing and crossing even the most complex peripheral lesion. Finally, our design and manufacturing facility fit out in Ireland is nearly complete.

We are now capable of making both drug delivery and non drug delivery devices in Ireland. We've doubled our manufacturing footprint and have ability to quickly ramp up production in line with our whole product solution strategy. Our target is to be able to manufacture all our approved medical devices at large scale by Q2 of fiscal 2018.

Our hard work and investment throughout the year culminated in this strong fourth quarter accomplishments. We set up SurModics right way we wanted be as we enter fiscal 2018, namely to be in a position to invest and clear R&D and clinical programs that will drive consistent long-term shareholder value.

In fiscal 2018, we intend to accomplish three major goals. These are, execute the TRANSCEND trial in a high quality rigorous and efficient manner. To that end we are planning to have the full complement of clinical sites up and running by the end of fiscal of 2018.

Two, advanced R&D whole product solutions pipeline by securing regulatory approval for at least four new products in fiscal 2018 and filing for the first human use of at least one of the following our below-the-knee drug-coated balloon program, our AV fistula drug-coated balloon depending on the quality of the preclinical results.

And three finalize and further delineate our commercialization strategy with our potential distribution partners for medical device sale. Our long-term goals of generating double digit top line growth by 2019 and generating EBITDA margin at or above 30% by 2021 in our sites and we believe very attainable. Moving to our clinical programs.

Our biggest priority is TRANSCEND which is our pivotal trial for SurVeil, our paclitaxel drug-coated balloon. We announced enrollment of our first patient last month marking a major milestone for the company as we work towards our goal of improving clinical outcome for peripheral artery disease patients.

We look forward to ramping up enrollment for the additional sites through the upcoming year and as a reminder TRANSCEND is expected to enroll approximately 446 patients and up to 60 clinical sites in the US and 18 sites in Europe.

The randomized trial will evaluate SurVeil Drug-Coated Balloon for the treatment of peripheral artery disease in upper leg compared to the Medtronic IN.PACT Admiral drug-coated balloon. This trial is among the first level one study to compare a next generation drug-coated balloon with one that is currently commercially available.

In Europe, we are evaluating our strategy and timing assumptions for our study to obtain the CE Mark taking into consideration evolving European regulations. To provide some background SurVeil design reflects our long standing leadership in the development of drug delivery and service technology for vascular devices.

The device includes a proprietary drug-excipient formulation for the balloon coating and is manufactured using a proprietary process to improve coating uniformity and distribution.

Preclinical data have demonstrated 3x to 5x higher target tissue concentration, more evenly distributed and durable drug effect and importantly a lower incidence of downstream drug concentrations as compared with other commercially available first generation drug-coated balloons.

As mentioned earlier, the results of our early feasibility study that prevailed trial demonstrated an absence of safety signal and clinical improvement in the 13 patients at six months follow up. These real evidences have demonstrated by their walking scores.

There was also 100% binary patentcy and freedom from target lesion revascularization and a six months late lumen loss which is a measure of how much a vessel diameter have decreased with 0.27 millimeter which is on lower end of published data from other drug-coated balloon studies.

Moving on to our SurVeil base below the knee DCB program, we are continuing to make excellent progress using our own internally developed 014 balloon platform as a carrier. We are working through all of the detailed preclinical data and studies requiring the package that we will use to submit our first human clinical trial.

Expect that this data will take much of 2018 to compile and finalize. We've also made progress in developing our AV fistula drug-coated balloon.

As discussed previously, we have the technology to address, and maintain access of fistula patentcy which are major frustrations for patients undergoing renal dialysis and that can add dramatically to the cost of care.

We are continuing to evaluate our emerging preclinical data set and will determine the possible to even further accelerate this program in fiscal 2018. Here again our goal is to obtain the clinical data and clarity to file for regulatory approval to conduct a first in human study.

The decision of which of the studies will go forward first depends on the quality of the preclinical data that we develop in each of this program. In total, we plan to invest $13 million to $16 million externally on our drug-coated balloon platform in fiscal 2018.

This represents up to 67% increase in external R&D spending on these programs compared to fiscal 2017 and we estimate that we will spend up to several million dollars on both the below the knee and AV fistula drug-coated development programs to glean clarity for their reflective regulatory approvals.

Now given the large market opportunities for both of these indications, we believe that these are worthwhile investments for our shareholders. Now turning our focus to our non drug delivery R&D pipeline. We are making headway with the products and development using advanced versions of our coating chemistry of catheter and balloon technology.

Although regulatory timings remains a bit unpredictable. This in some cases is translating into integrative process which we incorporate feedback from the US FDA as we optimize our design. While we are confident this is the right strategy to be successful, it is in some cases lengthening the development time for these products.

Our microcatheter development and regulatory approval has been delayed from the timeline noted in our third quarter call. This unique device uses our Surmodics PRISTYNE hydrophilic coating. While we submitted our application to the FDA early in the third quarter of 2017, the agency has requested more data.

We have in our view completed this testing and generated the data required and plan to resubmit this filing in November. For the 018 peripheral balloon catheter incorporating our Serene hydrophilic coating, we are continuing to work through all these final designs specifications and testing.

Once we have internal confirmation that we are able to achieve our rigorous design specifications, we'll then submit this to agency for 510 (k) clearances. Recall that we are developing best in class differentiated devices in each category.

And as a result we do not freeze our designs until they exceed our internal exceedingly rigorous competitive performance benchmark. While the ultimate timing is beyond our control, we are confident that we'll receive clearances for these products in first part of fiscal 2018.

Looking ahead, we've also begun work on the next wave of product innovations for which we are targeting regulatory filing and clearance in calendar 2018 which will help us further build out our platform to achieve top line growth. We'll discuss more about these R&D programs in future calls as we get closer to the actual regulatory filing.

As for the whole products commercialization we are currently evaluating a number of partners for our approved devices. At this time, it would be premature to provide any detail commentary on these discussions. We are looking forward to providing more clarity in the next two quarters. It is an exciting time at SurModics.

We are investing and making a good progress in R&D program. We are on track to becoming leading and enduring medical device innovator by combing our key technology assets with our medical device customer relationship to develop world class market leading creating product for vascular disease.

We are encouraged of our clinical regulatory and development achievement, coupled with our ongoing top line performance and operational progress. I'll now turn the call over to Andy to provide more details on our fourth quarter fiscal 2017 results as well as our outlook for 2018.

Andy?.

Thank you, Gary. We're happy to report that revenue for the fourth quarter of fiscal 2017 was $20.1 million as compared with $18.2 million in the fourth quarter last year. Revenue in the fourth quarter of fiscal 2017 included $1.1 million of license fee.

On a GAAP basis, our diluted earnings totaled $0.03 per share as compared with $0.20 per share in the prior year quarter. We delivered operating income of $0.4 million in the fourth quarter of fiscal 2017, down from $4.1 million in the prior year period.

Operating margin decreased to 2.2% in the current year quarter as compared with 22.5% in the fourth quarter of fiscal 2016.

The declines in GAAP earnings per share, operating income and margin in the current year quarter as compared with the prior year quarter reflect previously disclosed increases in R&D spend to support our whole-product solutions, product development and regulatory submissions.

On a non-GAAP basis, quarterly earnings per share were $0.18 per share in the fourth quarter of fiscal 2017 versus $0.26 per share in the prior year quarter. Turning now to our two business units. Medical Device reported revenue of $14.7 million, an increase of $1 million as compared with the year-ago period.

Looking at specific areas within Medical Device, fourth quarter royalty and license fee revenue totaled $9.2 million, up $1.2 million from the prior year quarter. The increase in royalty and license fee revenue is attributable to the previously noted $1.1 million license fees.

Product sales decrease $0.2 million from the prior year quarter due to lower shipments. Medical Device customer research and development revenue were essentially flat in the current quarter as compared with the fourth quarter of fiscal 2016.

This unit generated $0.3 million of operating income in the fourth quarter versus $4.2 million in the prior year quarter.

The Medical Device operating income change was impacted by the previously described planned increased investments related to our whole-products solution strategy and $0.4 million impairment charge related to Creagh Medical intangible assets and was partially offset by the $1.1 million license fees.

For our In Vitro Diagnostics segment, fourth quarter fiscal 2017 revenue which consists of product sales, totaled $5.3 million, as compared with $4.5 million in the prior year period, an increase of 19.8%.

IVD revenue in the fourth quarter reflected strong growth and stabilization, BioFX, microarray and antigen product sales which more than offset the previously disclosed decline from a significant microarray customer that was acquired by one of its competitors.

IVD operating income was $2.4 million as compared with $1.8 million in the fourth quarter of 2016. Operating margin increased to 44.4% versus 40.8% in the prior year quarter due to improved gross margin resulting from favorable product mix and increased operating leverage from higher revenue.

Product gross margins for the quarter were 62.4% of product sales as compared with 65.1% in the prior year quarter. The change in gross margin percentage resulted from unfavorable product mix primarily lower reagent sales and higher revenue from antigens, a product we distribute from our German partner.

As a percentage of revenue, fourth quarter R&D expenses were 48.4% versus 29.2% in the year-ago period. R&D expense of $9.7 million from the quarter was up $4.4 million from last year.

As we have stated before, we anticipate R&D expense will increase in the second half of fiscal 2017 as we accelerate our whole-product solutions strategy, including advancing our SurVeil drug-coated balloon human clinical trials and other proprietary products.

SG&A expenses in the fourth quarter of fiscal 2017 were 26.5% of revenue versus 27.6% in the prior year period. On a dollar basis, SG&A in the fourth quarter of fiscal 2017 totaled $5.3 million as compared with $5 million a year ago. During the quarter, the U.S. dollar continued to weaken as compared with the euro.

As a result, we realized a $0.3 million foreign exchange loss on our euro-denominated contingent consideration obligation related to the Creagh Medical acquisition.

We recorded an income tax benefit of $0.2 million in the fourth quarter of fiscal 2017 as compared with income tax expense of $1.5 million, or 35.5% of pretax income in the prior year period. The current quarter income tax benefit reflects the impact of inner company development activities performed by our Irish subsidiary.

Both periods reflects an impact of non tax-benefited amortization, contingent consideration, accretion, foreign currency losses and operating losses in Ireland. Looking at our balance sheet which continues to be strong, cash investments totaled $48.3 million at year end. We generated cash from operating activities of $14.1 million in fiscal 2017.

We also repurchased 196,190 common shares for $4.7 million during the fiscal 2017 under the company's share repurchase program. We invested $6.4 million in plant and equipment during fiscal 2017. Our current cash and investment balances and operating cash flows provide adequate capacity for us to support our corporate strategy growth initiatives.

Gary noted in his remarks that we expect to accelerate our investments in our drug-coated balloon platform in fiscal 2018 and to a lesser extent our 510(k) product in CE Mark pipeline. Drug-coated balloon investments include enrollment in the TRANSCEND clinical trial and continued development of both our below the knee and AV fistula program.

As a result, we expect research and development expenses to range between 55% and 60% of fiscal 2018 revenue. We expect revenue to range from $72 million to $75 million for fiscal 2018. GAAP diluted loss is expected to be in the range of $0.50 to $0.75 per share and we expect non-GAAP loss of $0.16 to $0.41 per share.

The loss per share guidance includes a $3 million, or $0.15 per share estimated R&D expense variability as a result of our estimated range of patient enrollment rate for our TRANSCEND study. Gary and I thrilled with the operational execution performance by the entire SurModics team in fiscal 2017. Thank you for your hard work and outstanding results.

Operator, this concludes our prepared remarks. We like now to open the call to take questions. .

[Operator Instructions] We will go to Brooks O'Neil with Lake Street Capital Markets. .

Good morning. Can you hear me okay? Okay, great. I am in a cab on the way to the airport so I apologize if there is any background noise. Congratulations on strong fourth quarter.

I understand that Gary mentioned that it was premature to discuss your dialogue with strategic partners and I am not asking for any specifics but I was hoping you could give us a little color in terms of the responsiveness or lack thereof that you are finding in the marketplace as you begin to engage with potential strategic partners. .

Yes, Brooks, we just came back from the TCT conference in Denver last week. And the meetings with the strategics for 014 for example the product that we have regulatory approvals worldwide currently, great reception on that.

The next step typically with the strategics they like to get into the hands of their clinical evaluation so recall until we have regulatory approvals. These are preclinical studies and bench up testing so now we can actually with 014 treat the tibial artery of patients below the knee diseases. So that's been a good reception.

We are also moving forward with some of the world's top curve below the knee interventionist to get that product into their hands now that we have approval. So reception is quite favorable.

On the products that are not yet approved, clearly the strategics can't really assess the clinical effectiveness of those products in patients but clearly the benchmark performance that they are looking at has also met the favorable reception. And I would include the microcatheter and 018.

So we believe these are products it will plug some portfolio hole in some of these strategics and it's given the benchmark performance we have the interest is high.

I want to caution everyone though that we are not just rushing to sign -- if you want to get the best meal and so the clinically evaluation that these products which we are confident that we will allow us then to get strategics understand the real value in these products over the next quarter or so. .

Sure. All of that is very helpful and I appreciate that color very much. So the second question I have is you commented -- I am very excited about the TRANSCEND trial, I know you are spending a lot of time and dollars on it.

You commented that you are competing -- you are comparing to the first generation DCB and I know that an advanced over what some of the competitors have done in terms of comparing the DCB with the plain balloon.

So you would comment on the state of the market in terms of are we in the first generation competitive profile or are some of the competitors out there with second or third generation DCB now in your opinion. .

Sure. I'll give you my opinion. I see that it's my opinion because we clearly don't -- many of these companies are our customers as well and we love the fact that the technology has kick up progressing but I see many of the devices in Europe they are probably 10 plus devices in Europe where this technology feel really initiated.

Those are considered more the generation one devices. And we are happy to see those get to market. The devices that will approve in the United States so far, I see those as generation two devices. I think what we are working on is a generation three device.

And the market continues to grow the IMS data is certainly showing that the impact device is currently the US market leading product. But our device really takes it a notch further in terms of really being efficient in the drug transfer to the tissue.

It's not what you have on the delivery truck and it's what gets into the restaurant and people's belly at the end of the day. And that is where we really perform really well. And having a lot of drug that's really not getting to the target tissue potentially causing [dissemblali] we believe we have more elegant solution.

So that's the basis of the third generation device that we have. .

Thanks. And I appreciate and again I apologize for some background noise, Gary.

I am in the place where I can prevent it but I am just curious, the last question is, would you say that your expectations for spending on R&D in such for fiscal 2018 have increased substantially or they are largely in line with what you've been communicating in the recent past. And thanks a lot and again congratulations on the progress. .

Thank you. Brooks as we came out of the last quarter earnings call we talked about the fact that we anticipate an increase in spend and I think we evolved around the mid $30 million of spend for fiscal 2018 that we would be at least to that level.

And as we looked at the preclinical data and work through our fiscal 2018 plan, as Gary talked about they are both the below the knee and AV fistula programs. We decided that it was worth the additional several million dollars for each one of these program to get clarity in terms which will we would bring to the clinic.

So we have done some additional accelerated spending and I think we've received as well more clarity around the TRANSCEND study. As you well know a signed a [cero] agreement which was disclosed and as we work though the modeling there. We are able to get a better refinement in terms of what that spend might be.

These all the spending that we have right now once they were surprised by it, it's very conscious part of us in terms of efficient capital allocation to create a long-term shareholder value. .

And we will go next to Jim Sidoti with Sidoti & Company..

Good morning. Can you hear me? Right.

Can you just first give us a little more color on the $1.1 license fee in the quarter? What that was for?.

Without getting into lot of details we had a customer arrangement and the customer was sold and as a result of that we had some joint technology that we developed with this customer and they decided they want to own that technology. So it was really a license fee and technology acquisition fee with this customer and timer. .

Okay. And then in terms of the R&D spend for fiscal 2018, can you give us a sense how that's going to ramp first half year, second half of the year. I am assuming it takes time to get these sites up and running. So I mean should -- can you give us some sense how that all step up. .

Yes. We don't give generally give quarterly guidance but there will be I would say pretty steady state of spend in the first three quarters and then I'd say the fourth quarter will have probably 15% to 20% increase in spend over the first three quarters. So we kind of do the math and I can walk you through that.

It probably near $10 million for the first three quarters and then bump into maybe $12 million in the fourth quarter.

But again lot of that is going to be depended upon the variability of the ramp up of the clinical sites as well as the patients and that's why we commented that our EPS range includes a $3 million variant specifically related to the enrollment on the TRANSCEND study..

Okay. And then last question on the royalty in your -- will we continue to see the royalty revenues face that tougher comp in the first half of the year and when should that anniversary..

Yes, as we talked about, I'll walk you back little bit to 2017, we initially anticipated $5 million to $6 million headwind in 2017 as we gave the initial guidance.

And then we have walked down to more of $3.5 million - $4 million headwind later in the year as we saw better than expected performance from our customers and a lot of that had to do with customers that had already -- customers that had more sales outside of the US than what the mix in the model originally had in the beginning of the year.

So as you look into fiscal 2018, we do anticipate having another $2.5 million to $3 million, $3.5 million headwind in terms of the third generation coding technology. And lot of that is just a carryover from 2017 related to the good performance we had.

And just a little bit more color around on that, I'd say that headwind about two thirds of that will be in the beginning of the year, the first half of the year. And then it will taper down for the back end then. .

And that does concludes today's question-and-answer session. At this time, I'll turn the conference back to management for any additional or closing remarks. .

Thank you all for your questions. We are pleased with our fourth quarter results and our progress in our whole product solutions strategy. And we look forward to speaking with you in our first quarter earnings call soon. Thank you. .

This concludes today's call. Thank you for your participation. You may now disconnect..