Good day and welcome to the Surmodics' First Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Tim Arens. Please go ahead, sir..

Thank you, Todd. Good morning and welcome to Surmodics' fiscal 2019 first quarter earnings call. Before we begin, I would like to remind you that during this call, we may 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'll 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 our 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 afternoon and is available on our website at surmodics.com.

I will now turn the call over to Gary Maharaj.

Gary?.

Thanks, Tim, and good afternoon, and thank you for joining us from Minnesota where the temperature outside is negative 15 degrees. We are off to a great start in the execution of our fiscal 2019 strategic initiatives, including substantial progress in our drug-coated balloon programs as well as our Medical Device coatings and IVD offerings.

Our results reflect excellent top and bottom line performance and we are quite proud of the accomplishments of our entire team at Surmodics. They have been and continued to be instrumental in our growing momentum and success. In the first quarter, we generated revenue of $22.2 million, growing 31% over the first quarter of fiscal 2018.

This included 2.4 million of revenue from our SurVeil agreement with Abbott. We also reported diluted GAAP earnings of $0.09 per share and non-GAAP earnings of positive $0.12 per share in the first quarter.

Looking ahead, we are well positioned to building our momentum and have updated our fiscal 2019 revenue expectations which Tim will discuss later in the call. In the first quarter of our fiscal year, we were very pleased with the progress made in each of our three major strategic objectives that we previously described for fiscal 2019.

As a reminder, these are first to ensure the success of SurVeil, specifically to complete the TRANSCEND pivotal study enrollment and to make substantial progress towards achieving CE mark.

Second, we continue to make meaningful advances with our drug-coated balloon pipeline and our non-drug delivery service device portfolio, including the acceleration of our thrombectomy platform development. And finally, to continue to drive revenue growth and cash flow from our existing Medical Device coatings and IVD offerings.

These offerings provide significant and ongoing return on invested capital and cash flow to fuel our strategic growth initiatives. Let me provide some color on each of these core objectives. Starting with SurVeil. We are pleased with the enrollment progress in TRANSCEND, our pivotal trial for SurVeil.

The acceleration seat enrollment this quarter takes us well beyond the halfway point for total enrollment. All the U.S. and almost all of outside of the United States clinical sites have been initiated. As planned, we expect to complete TRANSCEND enrollment by the end of fiscal 2019.

Further, we have submitted key elements of our regulatory filing to our European notified body as part of our efforts to obtain the CE mark for SurVeil. While the timing of receiving the CE mark is difficult to predict given the changing European regulations, we are targeting no later than the end of calendar 2019.

Many of you are aware of the recent clinical debate on the safety of intravascular devices that use paclitaxel as the active pharmaceutical agent. This was triggered by a publication in December by Dr. Konstantinos Katsanos of Greece. The paper described a meta-analysis of vascular devices including drug-coated balloons and drug-eluting stents.

It highlighted a signal of increased mortality in devices containing paclitaxel versus nondrug controls after three to five years. This has created much debate in industry and we are following it closely.

Much of the feedback in the paper involved the significant limitations of such analysis as a category and specific limitations as applied to this particular study. Meta-analysis requires significant sophisticated assumptions and how to treat and pull data from multiple disparate sources and device categories.

There is some disagreement on whether the correct statistical methods and assumptions were made in the analysis. In addition, patient level data was not available to Dr. Katsanos and his colleagues. These data contained specific and relevant information relating to mortality.

At last week's LINC Conference in Germany, the patient's level data were presented on each of the devices in question and demonstrated no significant increase, nor difference in mortality rates.

The clinical discussion continued at the ISET Meeting earlier this week in Florida and will again be vigorously discussed at the upcoming Vascular Leaders Forum sponsored by the VIVA Physicians Group at the end of February where Surmodics has been invited to participate.

In addition, the FDA recently issued a notice that included a statement that the current benefit to risk data supports the use of these devices and encourage continued surveillance and reporting of any adverse events, as they continue to reduce and look at these data.

It is important to note that the steering committee of the TRANSCEND trial has recommended continuing with the trial. Our steering committee is comprised of the world's leading clinicians with expertise in this specific area.

TRANSCEND is a highly independently monitored trial with five-year follow-up and will important rigorously reviewed clinical efficacy and safety data to this field. We have not seen an impact on enrollment fleet as a result of this clinical debate and we will continue to monitor it and can put into it where relevant.

Turning to some other products that are promising in our pipeline, we received approval to initiate the first in-human study for our AVess, arteriovenous access drug-coated balloon. This is exciting and we have already treated successfully the first patient. We are on track to complete the first in-man trial of AVess by the end of calendar 2019.

Moving on to our innovated below-the-knee sirolimus drug-coated balloon, we are in the process of refining the coating and drug delivery formulations based on the results from our earlier preclinical evaluations.

In short, we were not satisfied with some of the data we observed in the last set of preclinical studies and believe that we can improve on this.

Below-the-knee disease is complex and multi-factorial and we intend to evolve the device that has the most significant favorable impact for these patients and that further optimization will help us achieve this. We anticipate submitting for regulatory approval to initiate first in-human trial by the end of fiscal 2019.

We also continue to make progress in our nondrug delivery pipeline and we are committed to work in the next wave of product of innovations that solve unmet clinical needs. These innovations will help us to build highly differentiated platforms and create additional shareholder value.

During fiscal 2019 we remained on track to file submissions for regulatory approval on 3 to 4 new devices. As part of these assets, we are committed to accelerate the development of the thrombectomy platform. Physician evaluation of our first design iteration for arterial thrombosis has been excellent.

Device is capable of removing organized thrombus in a simulated arterial model. Organized thrombus is a very difficult to remove often requiring surgery and resulting in significant blood loss and patient hospitalization.

We believe our design represents an on the table solution without requiring the use of capital equipment while potential minimizing patient blood loss and reducing the likelihood of hospitalization.

As a reminder, our thrombectomy platform has brought potential to treat thrombosis in multiple muscular beds including arterial and venous thrombosis, pulmonary embolism and neurovascular applications.

We're targeting completion of design activities by the end of fiscal 2019, and to submit our first application for regulatory approval for vascular thrombosis sometime in the first quarter fiscal 2020.

In December, we convened a group of the world's top radialists for a discussion of device needs for radial access to the peripheral arteries and to seek feedback on all early ideas and prototypes of this area.

Radialists are intervention physicians, cardiologists, vascular surgeons and interventional radiologist who prefer practice interventions by the radial artery versus the femoral artery for access. It is well known that radial access to the coronary vessels generally results in better safety outcomes for patients.

Radial access to coronary vessels is used more than 70% of the time in Europe and we believe approximately 35% to 40% of the time in the U.S. Radial access to the peripheral vasculature however is in its infancy. The lack of devices for both access and treatment is a limiting factor.

This physician group was able to test drive some of those early prototypes for peripheral radial access in simulated anatomical models and were to a prison visibly impressed.

We intend to seek and develop -- develop and seek regulatory approval for multiple devices that are able to access and treat peripheral vascular disease using a regular approach within the next 18 months.

The benefits will not only to be patients but also to healthcare economics given the potential for low risk of bleeding complications and much faster patient discharged following the procedure.

Finally, superb execution by our Medical Device and IVD businesses has continued to produce strong performance with growth seen across all product revenue categories.

We expect our Medical Device business segment to continue to contribute significantly to our expected double-digit revenue growth in fiscal 2019 including modest growth in our coatings derived revenue compared with the prior year.

It is a credit to the strength of our coatings team that have managed such excellent execution in continued to grow the coatings business in the mid single digits in spite of recent patent expiration. Our IVD team also delivered exceptional performance this past quarter, growing revenue by over 70%.

This performance is a result of strength across the customer base although against the weaker comparison quarter relative to the second half performance last year. Nevertheless, the business continues to handily outperform the immunoassay market growth rates of 2% to 3%.

In sum, we are encouraged by the significant accomplishments this quarter which continued to enhance the foundational elements needed to drive our near and long term growth. And looking at our current trajectory, our fundamentals and business outlook are stronger than they've ever been before.

With a great team assembled as well as the breadth of intellectual property, we are well positioned to continue top line growth and operation performance. I'll now turn the call over to Tim to provide more details on the first quarter fiscal 2019 results as well as our outlook for fiscal 2019. Tim..

Thank you, Gary. Revenue for the first quarter of fiscal 2019 saw growth as Gary mentioned, across all revenue categories in both of our business segments. Total revenue for the quarter was $22.2 million. as compared with 17 million in the first quarter of 2018.

Looking at our two business units, Medical Device delivered an impressive 35% revenue growth, increasing 4.6 million to 17.3 million in the first quarter. For In Vitro Diagnostics business, first quarter fiscal 2019 revenue which is predominantly comprised of product sales, totaled $5 million, up nearly 18% compared with the year ago period.

Looking at specific areas within Medical Device, first quarter royalty and license fee revenue totaled $10.1 million, up $3 million from the comparable prior year quarter. The increase in royalty and license fee revenue reflects $2.4 million of license fee revenue recognized from the SurVeil distribution and development agreement with Abbott.

Product sales increased $900,000 or 24%. Medical Device product sales benefits from an increase in balloon catheter unit volume as a result of recent customer product launches. R&D revenue associated with customer feasibility projects in coating services, increased $500,000 from the prior year quarter.

The Medical Device business unit reported $357,000 of operating income in the first quarter versus an operating loss of $389,000 in the prior year quarter.

Medical device operating results benefited from our strong revenue performance and were impacted by 3.7 million of increased R&D spend, reflecting continued progress with our drug-coated balloon programs including the TRANSCEND clinical study and continued investment in our innovative product development pipeline to support our future growth.

IVD revenue in the first quarter reflected strong growth in sales of our clinical components used in diagnostic tests and microarray slides slide. IVD operating income of $2.5 million in the first quarter increased $785,000 or 47% compared to the year ago period.

Operating margin in the first quarter of fiscal 2019 was 49% compared to 39% in the prior year quarter. Impacting IVD operating margin was product revenue mix which is skewed toward higher margin products. Product gross margin for the quarter was 63.9% of product sales as compared with 64.3% in the prior year quarter.

Impacting our first quarter product gross margins was product mix as we continue to see an increase in balloon catheter product sales and continued scale up costs in our Irish facility as we prepare for future growth.

As a percentage of revenue first quarter of fiscal 2019 R&D expenses, including costs of clinical and regulatory activities totaled 51.6% compared with 46% in the year ago period. Our Q1 R&D spend as a percentage of revenue was in line with our full year R&D expense guidance range, which I remind you remains in the low to mid 50s.

Although the full year is expected to fall within this range we may see some quarters outside of this range. R&D expense was 11.5 million for the quarter up 3.7 million from the first quarter of fiscal 2018.

The increase in R&D expense was driven by increased spending associated with our TRANSCEND clinical study as well as continued progress on the development of our whole product solutions pipeline, including spending to support AV access and below-the-knee drug-coated balloon programs.

SG&A expenses in the first quarter of fiscal 2019 were 26.7% of revenue versus 30.4% in the prior year period. On a dollar basis, SG&A in the first quarter of fiscal 2019 totaled 5.9 million, as compared with 5.2 million one year ago.

Impacting the increase in SG&A expense during the quarter were higher compensation and benefits expenses associated with staffing to support our strategic initiatives. We recorded an income tax benefit of $176,000 in the first quarter fiscal 2019 as compared with income tax expense of $1 million in the prior year period.

If you recall, the prior year period included a $1.2 million charge associated with the impact of tax reform. On a GAAP basis, our diluted earnings total of $0.09 per share in the current year quarter as compared with the loss of $0.12 per share in the first quarter fiscal 2018.

On a non-GAAP basis, quarterly earnings per share were $0.12 in the first quarter of fiscal 2019 versus $0.10 in the prior year quarter. We continue to maintain a strong balance sheet. Cash and investments totaled $45.9 million at the quarter end.

During the quarter, we paid $11 million to satisfy all remaining contingent earn our obligations associated with our November 2015 acquisition of Creagh Medical as well as $7 million of net impact from plan changes in operating assets and liabilities in the quarter.

In addition, we invested $2.1 million in productive plant equipment during our first fiscal quarter of 2019. Our current cash and investment balances and expected operating cash flows provide adequate capacity to support our corporate strategic growth initiatives.

As far as 2019 revenue and earnings performance guidance, we are increasing the lower end of our fiscal 2019 revenue expectations to $94 million from $92 million while maintaining the upper end of our fiscal 2019 revenue expectations of $97 million, representing an increase ranging from 16% to 19% as compared with fiscal 2018 revenue.

We now expect the fiscal 2019 diluted loss in the range of $0.22 to a loss of $0.02 per share compared with our previous expectation of a loss of at the lower end range of $0.32 per share.

We now expect non-GAAP diluted arrange for share to range from $0.02 to $0.22 per share compared with their previous expectations of a loss at the lower end of our range of $0.07 per share to a non-GAAP earnings of $0.23 per share.

Non-GAAP EPS was impacted by $0.01 per share related to the foreign currency exchange rate effect on our contingent consideration obligations which were paid in the first quarter. Operator, this concludes our prepared remarks. We'd now like to open the call to questions..

Thank you. [Operator Instructions] We'll take our first question from Mike Matson with Needham & Company..

Hi, this is David Saxon on for Mike this afternoon. I've been hopping between some calls, so apologize if you've answered some of these questions. First, just wanted to start off with the paclitaxel meta-analysis, I know there's been a lot of buzz.

Just wanted to get your thoughts on that?.

Yes, first of all, I've been impressed with all the stakeholders in this debate where patient safety is prime move for everyone. I know Dr. Katsanos personally and spoke with him as recently as last week. He has a step through the limitations in any of these.

Meta-analysis is very difficult analysis to conduct because you are pulling multiple data sources that may or may not have the same type of distributions, and you are pulling separate categories of devices and Dr. Katsanos acknowledges the limitations of. He is pointing to a signal.

The other thing is -- and there are some debates whether the right assumptions were used. And that was over my head, so I will limit just to this I'm observing the debate on a statistical method.

On the other hand, patient level data is often and in this case missing because the authors and the publications authors don’t have access to patient level data. So I was quite impressed with the industry and the physicians at the LINC Meeting. Every device -- they must have been scrambling as Dr.

Schneider said this is how we spend the Christmas Holidays where they actually scrubbed the patient level data which does exist to search for a signal of statistical significance in mortality. And indeed did not find that.

This was presented for the Medtronic device, the Bard Lutonix device, I believe, Stellarex has some presentation as well as for PTX and one of the drug [indiscernible]. And clearly the patient level data where you can actually see, what was the cause of mortality for the patient, indicated no statistical difference.

The debate isn’t over because the test for mortality these trials including TRANSCEND designed for binary patency significance at one year. Test for mortality is a specific safety outcome, literally requires thousands of patients over five years.

So I believe I don't know this, but I believe there will now potentially be a pulling of the patient level data in independent meta-analytical method to see, if there's any further signal from this. This is not a small endeavor and I think this could take -- from the layperson's viewpoint, I think I the will take several months.

The FDA is also weighing in our best and I think you're seeing that they adopt a letter where in some forum, it was mischaracterizes a warning. It was I believe good judgment by the FDA to reinforce the systematic surveillance of any adverse events and reporting.

The appropriate consenting of patients who are being treated on these and also the potential that the FDA was going to be following up and doing I believe their own analysis. But they have reminded everyone that thus far the benefits to risks of these devices remained in favor of using the devices.

And so I believe the FDA will have a major part play in the ongoing debate. The next set up for this will be the VIVA leadership forum in DC at the end of February. And I think I said we have been invited to participate in that as well.

So it's hard to make a decision on whether it's true, I think no one wants to make what I call it, what is known as a Type I error which is basically concluding that there is a safety signal when in fact there is none given the dramatic efficacy of these devices.

So, I think the industry and the clinical community will be very busy cranking this data to find out what whether there is a signal..

And then just can you touch on the status of any just sort of distribution agreements for your 510(K) products you may have signed this quarter?.

Yes, we are, Tim and I keep saying, we won the right agreement for shareholders. And yes, we, if you talk to the parties who we negotiate with, they would say we are tough.

And that, and so the issue isn't a lack of interest, it really is we believe in these devices and our team is I would say fairly sophisticated financial models of what we need from our distribution partners. And so we continue to filter that out.

I do want to say we've never been closer but I think patient is key here as we continue to be very active in these..

And then just a quick one for Tim.

How much from the Abbott milestones did you recognize this quarter?.

David, it was $2.4 million..

Thank you. We'll take our next question from Brooks O'Neil with Lake Street Capital Markets..

I too was jumping a little bit between calls. So if I ask a question that you've already addressed, just say so and I'll read the transcript. But my sense is SurVeil is a device that uses paclitaxel, Medtronic Admiral does as well.

Do you see the discussion, the ongoing, let's call it, minor uncertainty related to having any impact on that trial?.

No, we have seen the same rate of enrollment between Thanksgiving and New Year's Day. We had an expected dropped enrollment just because patient senses a number of procedures for this site were down. But it rebounded back in January where we are at the levels that we predicted in January. So I have not seen an impact enrollment.

We've had several webinars with the clinician and research coordinator community who conduct this trial. And they continue to be very active. We have had one site withdrawal off the 69 sites just saying, they want to wait this out and see how it comes out. But that's that being said, that site has not had a negative influence on us.

So clearly, we feel confident. We're on track for September, end of September completion of the trial..

Secondly, I'm curious as you think about your core business, device business let's say.

Do you see this having a potentially positive effect as device manufacturers think about other drugs, other ways to put them into the body and use them to treat patients?.

It's hard to tell and I think it's quite early. The first thing that has to resolve it, it's very difficult to find a mortality signal with limited number of patients. And in fact, the Dr. Schneider and this team recently published the Medtronic data. I think was last week it was published. But I believe it almost 2,000 patients in the Medtronic arm.

And when they looked at it's in every which way from the amount of -- the size of the balloon the patient got in terms of the dose of paclitaxel, could not find any signal relative to dose or mortality versus the PTA controlled group.

And in fact on an absolute basis, the PTA controlled group was actually higher, but on the statistical basis there was no difference.

So hard to predict, we use sirolimus for below-the-knee for different reasons because we have a hypothesis that it’s a better drug for smaller friable vessels in the tibial artery area, just much like in the coronary, [indiscernible] really the prevalent drug of choice.

So I hate the comp out but don’t know and I actually don’t believe there will be much impact one way or another..

And Gary just you mentioned the sirolimus, do you see that as a drug that has wide application beyond the BTK work you're doing right now? Or how are you viewing it today?.

Right now, we are really focused BTK. Is there a role played in superficial femoral artery in the popliteal. Possibly, that's not really been well demonstrated yet. The thing that’s hot is and we have talked to all experts, and I don’t know if anyone really knows whether vascular biology acts the same in different vascular beds.

Clearly, sirolimus can be made to work. There may be some advantages to that in other tissue bed as well. So whatever we learned in our BTK program even though it's taking a little bit longer will be very good learnings for us to that same question you are asking in the future..

[Operator Instructions] We will take our next question from Jim Sidoti with Sidoti and Company..

The Medical Device revenue even if you exclude the 2.4 million you got from Abbott your royalty revenue was up about $500,000.

Is that related to new product launches?.

Well, no, it's really a portfolio effect. We have certain customers who have -- and I'm looking at Gary here, but -- and talking with the BD team really its broad based. We are seeing customers outperform. It's not just one product its not just one customer so just real strong performance by our customer here this past quarter..

And do you still have a headwind from patent expirations?.

Yes, Jim, I think we have talked about this back in the November call. It's really maybe about a 0.5 million is what kind we are expecting this year in terms of the patent headwinds from the Gen3 coating which really suggest that the other coating families and generations are really picking up the pace..

And then on R&D spending, you are down about 1 million in the quarter that ended in September.

Is that timing of enrollment or anything else there?.

I'm sorry, Jim, we are up on the year-over-year basis.

Are you asking me about sequential?.

Sequential right, compared to the quarter that ended in September..

No, it basically, it’s a lot of the timing related aspects of running multiple programs, clinical studies. As we've discussed here, over the last couple of calls, we anticipate the R&D expenditures as a percentage of revenue will fall between that 50 to 55 low to mid 50s. We're right in that range this quarter.

We'll see some quarters really might be below or above that. I wouldn't read anything into it on the sequential basis..

And then on the balance sheet, you have new entry for our contract assets.

Is that related, what is that related to?.

Yes, the great catch on it. Yes, it's a -- it's related to the new accounting standards and how we have to recognize the royalty revenue and the period in which our customers actually selling. So that's our estimate of what the other royalty revenues would be from the coatings business for the most part. So that's what that is..

And then, last thing for me is cash flow. You've invested a lot this quarter. You did some capital expenditure in Ireland. You also paid off the, I guess, contingency payments for the acquisition you did couple of years ago.

What should we think about free cash flow for the year?.

Yes, so for the year, it will be positive. This is how we're thinking about it. Q1 had a couple of unique things as you've described here. Going forward, Q2, Q3 and Q4, one should be expect that we're going to be positive from an operating cash flow perspective..

How about for free cash?.

Over the course of the year, free cash, I think we're going to be -- it's going to be pretty good. I'd say we're probably looking at something that's going to be just slightly a slight increase here..

Thank you. We'll take our next question from Mike Petusky with Barrington Research..

A couple of questions, Gary, just want to clarify though. The one site that dropped out that was U.S.

site, is that right?.

Yes, yes..

And then you also said that most of the U.S.

sites have at this point been activated that, did I hear that correctly?.

Yes, we have a -- we got German approval I think was late last quarter. And so, all these sites are in Germany, so we're just matching through -- I believe there's one in Austria and one in Germany, that's left. So, it's probably all but two..

And then just moving on to the 510(K) products, obviously, you commented about ongoing negotiations and hopefully, your closed. Is there any backing away from I think you guys had said, hey, look we, while we're not putting a lot of revenue into our guidance for '19 associated with 510(K) products that are approved.

We do think that will generate revenue from I believe you said from all three products in fiscal '19.

Any backing off that or maybe just a note of caution around that at this point or now?.

Yes, we as far as commercial, getting commercial agreements here, the one thing we are considering, and Tim, I don't believe we're backing off the revenues from the 510(K) product..

We're not here..

Oh, yes. But the -- in this, we believe we have to also do our part to set the tone with our strategic partners. And if we don't find the right agreements in the first close up of these agreements, it sets us up negatively for the products to file. So, yes, we are not backing off and we believe we can get the right agreement signed..

And there is still an expectation that you guys will file for another three or four like 10-K clearances in fiscal '19?.

Yes, our nondrug delivery teams are very busy as well and we believe we can get those three or four filed in this fiscal year again..

And then just last one and forgive, if you mentioned this and I just never quite caught on, but how many patients were in the AV trial?.

It's up to 50 patients in the first in-human and given these are -- especially first in-human trial is a little -- there is difference in enrollment criteria for them. So, we are targeting to be finished with enrollment in that by the end of our fiscal year.

We are very excited to get to be with the quickly get into the first patient and we have several more untapped. So, 50 patients, up to 50 patients..

Thank you. At this time, we have no further questions. I'll turn it back to management for closing remarks..

Well, thank you all for your questions. We are excited as we are making progress in our SurVeil program with the TRANSCEND trial. We are very excited to have started our AV fistula drug coated balloon first in-human trial, and just hats off to our core business execution that continues to perform incredibly well even as we transformed this business.

Thanks everyone and have a great afternoon..

Thank you, ladies and gentlemen. This concludes today's conference. You may now disconnect..