the feasibility has been
completed in a manner satisfactory to the customer, the customer funds a development project to optimize the coating formulation to meet the
customer’s specific technical needs. At any time prior to commercialization, a license agreement may be executed granting the licensee rights to
use our technology. We also manufacture and sell the chemical reagents used by licensees in the coating process, generating another source of recurring
revenue. We often support our customers by providing coating assistance for parts required in animal tests and human clinical trials. However, most
customers perform the coating work internally once a product has received regulatory approval and is being actively marketed.
The term of a license agreement
is generally for a specified number of years or the life of our patents, whichever is longer, although a license generally may be terminated by the
licensee for any reason upon 90 days advance written notice. Our license agreements may include certain license fees and/or milestone payments. The
license can be either exclusive or nonexclusive, but a significant majority of our licensed applications are nonexclusive, allowing us to license
technology to multiple customers. The royalty rate on a substantial number of the agreements has traditionally been in the 2% to 3% range, but there
are certain contracts with lower or higher rates. Royalty rates in certain more recent agreements have been trending higher, especially where the
relevant SurModics technology is an enabling component of the customer’s device (i.e., the device could not perform as desired without our
technology). The amount of the license fees, milestone payments, and the royalty rate are based on various factors including whether the arrangement is
exclusive or nonexclusive, the perceived expected value of the coating application to the device, the size of the potential market, and customer
preferences. Most of our agreements also incorporate a minimum royalty to be paid by the licensee. Royalties are generally paid on a quarter-lag basis,
and are based on the customer’s actual sales of coated products in the prior quarter.
We currently have 80 licensed
products (customer products utilizing SurModics technology) already on the market generating royalties and 72 customer products incorporating our
technology pending regulatory approval. These 152 products are being sold or developed by 76 licensed customers. We signed a record 20 new licenses in
fiscal year 2005.
Licensed customers include Abbott
Laboratories, Boston Scientific Corporation, CardioMind, Inc., Cordis Corporation (a Johnson & Johnson company), ev3 Inc., FoxHollow Technologies,
Inc., GE Healthcare, Guidant Corporation, Medtronic, Inc., Novocell, Inc., Rubicon Medical, Spectranetics Corporation, St. Jude Medical, Inc., and
ThermopeutiX, among others. Under most of our licensing agreements, we are required to keep confidential the identity of our customers unless they
approve such disclosure.
Genomics Products
During fiscal year 1999, we
launched our 3D-Link® Activated Slide to the genomics market. Coated glass slides are used by genomics researchers to prepare microarrays for DNA
analysis. General Electric Company, through GE Healthcare, has an exclusive license to our coated glass slide technology. In addition to license fees,
we generate revenue under this license from the manufacture and sale of coated glass slides to GE Healthcare, who markets the slides under their
CodeLink brand.
Diagnostic/Stabilization Products
We sell stabilization products
for use by manufacturers of immunoassay diagnostic tests. Our StabilCoat®, StabilGuard® and StabilZyme® Stabilizers are designed to
maintain the activity of biological components of immunoassays, and other bioanalytical techniques, resulting in longer shelf life and improved
performance. These products offer our customers the benefit of product differentiation and improvement while providing the ultimate end users the
benefit of a faster test with fewer steps and fewer errors. In the past two years, we have introduced new products to improve the stability and
performance of protein microarrays, and bead-based assays, a rapidly growing area in the diagnostics and drug discovery. We also introduced
StabilZyme® Noble, a BSA-free biomolecule stabilizer, which improves stabilization without the complications of bovine proteins.
Diagnostic Royalties
We have also licensed patent
rights to Abbott Laboratories involving a format for in vitro diagnostic tests. This format was developed during the early years of the Company and has
found broad application in the area of rapid point-of-care diagnostic testing, such as pregnancy and strep tests. At the end of fiscal year 2004, we
expanded
9
our agreement with Abbott by
purchasing the future royalty streams under certain of Abbott’s sublicenses until the expiration of our patents in fiscal year 2009. Prior to such
expansion, we were receiving only a portion of the royalties under such sublicenses.
Research and Development
Our research and development
personnel work to enhance and expand our technology offerings in the area of surface modification and drug delivery through internal scientific
investigation. These scientists and engineers also evaluate external technologies in support of our business development activities. All of these
efforts are directed by an assessment of the needs of the markets in which we do business. Additionally, the R&D staff support the sales staff and
business units in performing feasibility studies, providing technical assistance to potential customers, optimizing the coating methodologies for
specific customer applications, supporting clinical trials, training customers, and integrating our technologies and know-how into customer
manufacturing operations.
We work together with our
customers to integrate the best possible surface modification and drug delivery technologies with their devices, not only to meet their performance
requirements, but also to perform services quickly so that the product may reach the market ahead of the competition. To quickly solve problems that
might arise during the development process and optimization of the coating formulation and process, we have developed comprehensive capabilities in
analytical chemistry and surface characterization within our R&D organization. Our state-of-the-art instrumentation and extensive experience allow
us to test the purity of coating reagents, to monitor the elution rate of drug from coatings, to measure coating thickness and smoothness, and to map
the distribution of chemicals at the surface and within the coating. We believe our capabilities far exceed those of our direct competitors, and
sometimes even exceed those of our large-company customers.
As medical devices become more
sophisticated and complex, we believe the need for surface modification and drug delivery will continue to grow. We intend to continue our development
efforts to expand our surface modification and drug delivery technologies to provide additional optimized surface properties to meet these needs across
multiple medical markets. In addition, we are expanding our drug delivery and surface modification technology expertise to capture more of the final
product value. We are doing this by, in selected cases, developing or acquiring pharmaceuticals or devices to develop from feasibility, up to and
including animal and human clinical tests. There can be no assurance that we will be successful in developing or acquiring additional pharmaceuticals
or devices.
After thorough consideration of
each market opportunity, our technical strategy is to target selected coating characteristics for further development, to facilitate and shorten the
license cycle. We continue to perform research into applications for future products both on our own and in conjunction with some of our customers.
Some of the research and development projects currently being worked on include additional polymer systems for site specific drug delivery, including
biodegradable technologies, as well as technologies to improve endothelialization of implantable devices and to improve long-term blood compatibility,
nanofiber cell culture technologies and drug delivery platforms for ophthalmic applications.
In fiscal years 2005, 2004, and
2003, our research and development expense was $16.1 million, $12.6 million, and $12.0 million, respectively. A portion of this expense is billed to
customers for coating optimization and other development work on customer product applications. Research and development revenue in fiscal years 2005,
2004, and 2003 was approximately $5.4 million, $4.4 million, and $5.6 million, respectively. We intend to continue investing in research and
development to advance our surface modification and drug delivery technologies and to expand uses for our technology bases. In addition, we continue to
pursue access to products and technologies developed outside the Company as appropriate to complement our internal research and development
efforts.
Patents and Proprietary Rights
Patents and other forms of
proprietary rights are an essential part of the SurModics business model. We protect our extensive portfolio of technologies through a number of U.S.
patents covering a variety of coating methods, reagents, and formulations, as well as particular clinical device applications. We generally file
international patent applications in the locations matching the major markets of our customers (primarily in North America, Europe, and Japan) in
parallel with U.S. applications. In fiscal year 2005, we filed 51 United States patent applications,
10
expanding the portfolio
protection around our current technologies as well as enabling pursuit of new technology concepts, innovations, and directions. At fiscal year end, we
had 94 pending United States patent applications, 10 of which were exclusively licensed from others, and 169 foreign patent applications, of which 22
were exclusively licensed from others. We own 52 issued United States patents, and are the exclusive licensee on 13 additional patents.
Internationally, we own 107 patents and are exclusively licensed under 10 additional patents. Extensive in-licensing rights of a more limited nature
are available to us from other third party patents, enabling efficient use of such intellectual property in various ways favorable to the
Company.
We also rely upon trade secrets
and other unpatented proprietary technologies. We seek to maintain the confidentiality of such information by requiring employees, consultants and
other parties to sign confidentiality agreements and by limiting access by parties outside the Company to such information. There can be no assurance,
however, that these measures will prevent the unauthorized disclosure or use of this information or that others will not be able to independently
develop such information. Additionally, there can be no assurance that any agreements regarding confidentiality and non-disclosure will not be
breached, or, in the event of any breach, that adequate remedies would be available to us.
Marketing and Sales
We market our core technologies
and products throughout the world using a direct sales force consisting of five sales professionals who focus on specific markets and companies. These
sales professionals work in concert with business unit personnel to coordinate customer activities. Business unit general managers are also integrally
involved in sales and marketing activities. The specialization of our sales professionals fosters an in-depth knowledge of the issues faced by our
customers within these markets such as industry trends, technology changes, biomaterial changes and the regulatory environment. Internationally, we
have a marketing agreement with JVS Sales & Technical Consultants, GmbH to help us pursue customer opportunities in Europe while also providing
increased service and support to existing customers in the region. In addition, we are pursuing additional sales and marketing relationships in other
geographies around the world.
In general, we license our
technologies on a non-exclusive basis to customers for use on specific products. This strategy enables us to license our technologies to multiple
customers in the same market. We also target new product applications with existing customers.
To support our marketing and
sales activities, we publish technical literature on our various surface modification technologies (e.g., lubricity, hemocompatibility, drug delivery,
etc.). In addition, we exhibit at major trade shows and technical meetings, advertise in selected trade journals and through our website, and conduct
direct mailings to appropriate target markets.
We also offer ongoing customer
service and technical support throughout our licensees’ relationships with us. This service and support begins with a coating feasibility study,
and includes additional services such as assistance in the transfer of the technology to the licensee, further coating optimization, process control
and trouble shooting, coating of product for clinical studies, and assistance with regulatory submissions for coated product approval. Most of these
services are billable to customers.
Significant Customers
We have two customers that each
provided more than 10% of our revenue in fiscal year 2005. Revenue from Cordis Corporation and Abbott Laboratories represented approximately 46% and
14%, respectively, of our total revenue for the year ended September 30, 2005. The loss of one or more of our largest customers could have a material
adverse effect on our business, financial condition, results of operations, and cash flow as discussed in more detail below.
Competition
The ability for surface
modification and drug delivery technologies to improve the performance of medical devices and to enable new product categories has resulted in
increased competition in these markets. Our surface modification and drug delivery technologies compete with technologies developed by AST,
Biocompatibles
11
International plc,
BioSensors, Carmeda (recently acquired by W.L. Gore), Control Delivery Systems (recently acquired by pSivida Limited), Hydromer, MediVas, Oculex
Pharmaceuticals, Inc. (acquired by Allergan, Inc.), Specialty Coatings Systems, and STS Biopolymers Inc., a division of Angiotech Pharmaceuticals,
Inc., among others. Some of these companies offer drug delivery technologies, while others specialize in lubricious or hemocompatible coating
technology. Some of these companies target ophthalmology applications, while others target cardiovascular medical device applications. In addition, due
to the many product possibilities afforded by surface modification technologies, many of the large medical device manufacturers have developed or are
engaged in efforts to develop internal competency in the area of surface modification and drug delivery. Some of our existing and potential competitors
(especially medical device manufacturers pursuing coating solutions through their own research and development efforts) have greater financial,
technical and marketing resources than we have.
We attempt to differentiate
ourselves from our competitors by providing what we believe is a high value added approach to surface modification and drug delivery technology. We
believe that the primary factors customers consider in choosing a particular technology include performance (e.g., flexibility, ability to fine tune
drug elution profiles, biocompatibility, etc.), ease of manufacturing, time-to-market, ability to produce multiple properties from a single process,
compliance with manufacturing regulations, customer service and total cost of goods (including manufacturing process labor). We believe our
technologies deliver exceptional performance in these areas, allowing us to compete favorably with respect to these factors. We believe that the cost
and time required to obtain the necessary regulatory approvals significantly reduces the likelihood of a manufacturer changing the coating process it
uses once a device has been approved for sale.
Because a significant portion of
our revenue is dependent on the receipt of royalties based on sales of medical devices incorporating our technologies, we are also affected by
competition within the markets for such devices. We believe that the intense competition within the medical device market creates opportunities for our
technologies as medical device manufacturers seek to differentiate their products through new enhancements or to remain competitive with enhancements
offered by other manufacturers. Because we seek to license our technologies on a non-exclusive basis, we may further benefit from competition within
the medical device markets by offering our technologies to multiple competing manufacturers of a device. However, competition in the medical device
market could also have an adverse effect on us. While we seek to license our products to established manufacturers, in certain cases our licensees may
compete directly with larger, dominant manufacturers with extensive product lines and greater sales, marketing and distribution capabilities. We also
are unable to control other factors that may impact commercialization of coated devices, such as regulatory approval, marketing and sales efforts of
our licensees or competitive pricing pressures within the particular device market. There can be no assurance that products employing our technologies
will be successfully commercialized by our licensees or that such licensees will otherwise be able to compete effectively.
Manufacturing
In accordance with our licensing
strategy, we generally do not coat medical devices to be sold by our customers following regulatory approval. However, we often support our customers
by coating products for human clinical trials. We also manufacture most of the reagent chemicals used by our customers in the coating process, allowing
us to control the quality of the reagents and maintain their proprietary nature, while providing an additional source of revenue. Reagents are polymer
chemicals that are prepared using a proprietary formula in relatively small batch processes (as contrasted with commodity chemicals prepared by large
continuous methods). The reagents are sold in dry form, requiring the licensee, in most cases, to simply add water, a water/isopropyl alcohol mix, or
other solvent to put them into solution before application. We have developed proprietary testing and quality assurance standards for manufacturing our
reagents and do not disclose the reagent formulas or manufacturing methods.
We also manufacture our
proprietary line of activated coated glass slides for sale by GE Healthcare under the CodeLink® brand. Standard glass slides are cleaned
and pretreated in a multiple-step process. We apply our proprietary PhotoLink coating in a clean room environment, test the slides to assure they meet
quality standards, package slides in specialized containers and seal them in moisture-proof packaging. Marketed and sold as either blank slides or
pre-arrayed with up to 40,000 genes, these products are a core technology of GE Healthcare.
We also manufacture stabilization
products employing a three-step production process. First, component chemicals are mixed in high purity water; next, these liquids are sterile-filtered
into specific container sizes under aseptic conditions; and finally, the resultant finished goods are sealed and labeled.
12
We attempt to maintain multiple
sources of supply for the key raw materials used to manufacture our products. We do, however, purchase some raw materials from single sources, but we
believe that additional sources of supply are readily available. Further, to the extent additional sources of supply are not readily available, we
believe that we could manufacture such raw materials.
Although not regulated by Good
Manufacturing Practices (GMP), we do follow quality management procedures in part to respond to requests of customers to establish compliance with
their individual criteria. In an effort to better meet our customers’ needs in this area, we received ISO 13485:2003 and ISO 9001:2000
certification in fiscal year 2004.
Government Regulation
Although our coating technologies
themselves are not directly regulated by the U.S. Food and Drug Administration (“FDA”), the medical devices incorporating our technologies
are subject to FDA regulation. New medical products utilizing our coating technologies can only be marketed in the United States after a 510(k)
application has been cleared, or PMA application approved, by the FDA. This process can take anywhere from three months for a 510(k) application, to
two or three years or more for a PMA application. The burden of demonstrating to the FDA that a new device is either equivalent to a previously
marketed device (510k process), or in the case implantable devices, safe and effective, (PMA process) rests with our customers as the medical device
manufacturers. If the primary mode of action for a product is as a drug, customers are typically required to submit an Investigational New Drug (IND)
application to initiate clinical studies that will support their marketing application, which is called a New Drug Application (NDA) or Biologics
License Application (BLA). These applications contain the results of design verification and validation testing, biocompatibility testing, and clinical
evaluations conducted with the device.
In support of our customers’
regulatory filings, we maintain confidential Device Master Files at the FDA regarding the nature, chemical structure and biocompatibility of our
reagents. Although our licensees do not have direct access to these files, they may, with our permission, reference these files in their medical device
submission to the FDA. This approach allows the FDA to understand in confidence the details of the coating technologies without us having to share this
highly confidential information with our customers.
U.S. legislation allows device
manufacturers, prior to obtaining FDA approval, to manufacture devices in the U.S. and export them for sale in international markets. This generally
allows us to realize earned royalties sooner. However, sales of medical devices outside the U.S. are subject to international requirements that vary
from country to country. The time required to obtain approval for sale internationally may be longer or shorter than that required by the
FDA.
SurModics is currently conducting
a Phase I safety trial for the I-vation implant. The study is being conducted at five clinical sites under an IND according to Good Clinical Practices.
The Phase I trial plans to enroll 30 patients who will be subject to follow-up monitoring for three years.
Employees
As of December 1, 2005, we had
135 employees, of whom 85 were engaged in product development, quality, and manufacturing positions, with the remainder in sales, marketing, or
administrative positions. Post-graduate degrees are held by 23 of our employees, 10 of whom hold Ph.D. degrees. We are not a party to any collective
bargaining agreements and we believe that our employee relations are good.
We believe that future success
will depend in part on our ability to attract and retain qualified technical, management and marketing personnel. Such experienced personnel are in
high demand, and we must compete for their services with other firms that may be able to offer more favorable benefits.
Forward-Looking Statements
Certain statements contained in
this Form 10-K, in the Company’s annual report to shareholders or in other reports of the Company and other written and oral statements made from
time to time by the Company do not relate strictly to historical or current facts. As such, they are considered “forward-looking statements”
that provide current
13
expectations or forecasts of
future events. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Such statements can be identified by the use of terminology such as “anticipate,” “believe,” “could,”
“estimate,” “expect,” “forecast,” “intend,” “may,” “plan,” “possible,”
“project,” “will” and similar words or expressions. Any statement that is not an historical fact, including estimates, projections,
future trends and the outcome of events that have not yet occurred, are forward-looking statements. The Company’s forward-looking statements
generally relate to its growth strategy, financial results, product development programs, sales efforts, and the impact of the Cordis agreement and
other significant customer agreements. You should carefully consider forward-looking statements and understand that such statements involve a variety
of risks and uncertainties, known and unknown, and may be affected by inaccurate assumptions. Consequently, no forward-looking statement can be
guaranteed and actual results may vary materially. The Company undertakes no obligation to update any forward-looking statement.
Although it is not possible to
create a comprehensive list of all factors that may cause actual results to differ from the Company’s forward-looking statements, such factors
include, among others:
• |
|
the Company’s significant dependence upon Cordis, which
causes our financial results and stock price to be subject to factors affecting Cordis and its Cypher stent program, including among others, the rate
of market penetration by Cordis, the timing of market introduction of competing products, product safety or efficacy concerns and intellectual property
litigation generally and specifically the litigation involving Boston Scientific Scimed, Inc. and Cordis in the U.S. District Court for the District of
Delaware in which each was reported in June and July 2005 to have infringed the patent rights of the other; |
• |
|
frequent intellectual property litigation in the medical device
industry that may directly or indirectly adversely affect our customers’ ability to market their products incorporating our
technologies; |
• |
|
our ability to protect our own intellectual
property; |
• |
|
healthcare reform efforts and reimbursement rates for medical
device products that may adversely affect our customers’ ability to cost effectively market and sell devices incorporating our
technologies; |
• |
|
the Company’s ability to attract new licensees and to enter
into agreements for additional product applications with existing licensees, the willingness of potential licensees to sign license agreements under
the terms offered by the Company, and the Company’s ability to maintain satisfactory relationships with its licensees; |
• |
|
the Company’s ability to increase the number of market
segments and applications that use its coating technologies through its sales and marketing and research and development efforts; |
• |
|
the Company’s ability to facilitate through strategic
investment and research and development support the creation of new medical device market segments and applications that incorporate its coating
technologies; |
• |
|
market acceptance of products sold by customers incorporating
our technologies and the timing of new product introductions by licensees; |
• |
|
market acceptance of products sold by customers’
competitors and the timing and pricing of new product introductions by customers’ competitors; |
• |
|
the difficulties and uncertainties associated with the lengthy
and costly new product development and foreign and domestic regulatory approval processes, such as delays, difficulties or failures in achieving
acceptable clinical results or obtaining foreign or FDA marketing clearances, which may result in lost market opportunities or postpone or preclude
product commercialization by licensees; |
• |
|
efficacy or safety concerns with respect to products marketed by
us and our licensees, whether scientifically justified or not, that may lead to product recalls, withdrawals or declining sales; |
• |
|
the ability to secure raw materials for reagents the Company
sells; |
• |
|
the Company’s ability to manage successfully clinical
trials and related foreign and domestic regulatory processes for the I-vation intravitreal implant or other acquired products from InnoRx under
development by the Company’s ophthalmology division, whether delays, difficulties or failures in achieving acceptable |
14
|
|
clinical results or obtaining foreign or FDA marketing
clearances postpone or preclude product commercialization of the intravitreal implant or other acquired products, and whether the intravitreal implant
and any other acquired products remain viable commercial prospects; |
• |
|
product liability claims not covered by insurance; |
• |
|
the development of new products or technologies by competitors,
technological obsolescence and other changes in competitive factors; |
• |
|
the trend of consolidation in the medical device industry,
resulting in more significant, complex and long term contracts than in the past and potentially greater pricing pressures; |
• |
|
the Company’s ability to identify suitable businesses to
acquire or with whom to form strategic relationships to expand its technology development and commercialization, its ability to successfully integrate
the operations of companies it may acquire from time to time and its ability to create synergies from acquisitions and other strategic
relationships; |
• |
|
the Company’s ability to successfully internally perform
certain product development activities and governmental and regulatory compliance activities with respect to acquired technology, including InnoRx
technology, which activities the Company has not previously undertaken in any significant manner; |
• |
|
economic and other factors over which the Company has no
control, including changes in inflation and consumer confidence; |
• |
|
acts of God or terrorism which impact the Company’s
personnel or facilities; and |
• |
|
other factors described below in “Risk
Factors.” |
Many of these factors are outside
the control and knowledge of the Company, and could result in increased volatility in period-to-period results. Investors are advised not to place
undue reliance upon the Company’s forward-looking statements and to consult any further disclosures by the Company on this subject in its filings
with the Securities and Exchange Commission. Many of the factors identified above are discussed in more detail below under “Risk
Factors.”
Risk Factors
The loss of one or more of our major customers could
significantly reduce our revenue and earnings.
We have two customers that each
provided more than 10% of our revenue in fiscal year 2005. Revenue from Cordis Corporation and Abbott Laboratories represented approximately 46% and
14%, respectively, of our total revenue for the year ended September 30, 2005. The loss of one or more of our largest customers could have a material
adverse effect on our business, financial condition, results of operations, and cash flow. There can be no assurance that revenue from any customer
will continue at their historical levels. Loss of one or more of our current customers, particularly Cordis, Abbott, or other large customers, could
have a material adverse effect on our business, financial condition and results of operations. If we cannot broaden our customer base, we will continue
to depend on a few customers for the majority of our revenue.
We rely on third parties to market, distribute and sell
the products incorporating our technologies and those third parties may not perform or agreements with those parties could be
terminated.
The principal element of our
business strategy is to enter into licensing arrangements with medical device companies that manufacture products incorporating our technologies. For
the fiscal years ended September 30, 2005, 2004 and 2003, we derived approximately 76%, 70% and 60% of our revenue, respectively, from royalties and
license fees. We do not currently manufacture, market or sell our own medical devices nor do we intend to do so in the foreseeable future. (Assuming
completion of successful clinical trials with the I-vation intravitreal implant, we believe we could commence commercial sale of the implant no sooner
than 2010.) Thus, our prospects are substantially dependent on the receipt of royalties from licensees of our technologies. The amount and timing of
such royalties are, in turn, dependent on the ability of our licensees to gain successful regulatory approval for, market
15
and sell products
incorporating our technologies. Failure of certain licensees to gain regulatory approval or market acceptance for such products could have a material
adverse effect on our business, financial condition and results of operations.
Our customers manufacture, market
and sell the products incorporating our licensed technologies. If one or more of our licensees fails to pursue the development or marketing of these
products as planned, our revenue and profits may not reach our expectations, or may decline. We do not control the timing and other aspects of the
development or commercialization of products incorporating our licensed technologies because our customers may have priorities that differ from ours or
their development or marketing efforts may be unsuccessful, resulting in delayed or discontinued products. Hence, the amount and timing of royalty
payments received by us will fluctuate, and such fluctuations could have a material adverse effect on our business, financial condition and results of
operations.
Under our standard license
agreements, licensees can terminate the license for any reason upon 90 days’ prior written notice. Existing and potential licensees have no
obligation to deal exclusively with the Company in obtaining surface modification or drug delivery technologies and may pursue parallel development or
licensing of competing technological solutions on their own or with third parties. A decision by a licensee to terminate its relationship with us could
materially adversely affect our business, financial condition and results of operations.
We need to expand our licensing base to reduce our
reliance upon several major customers.
A significant portion of our
revenue is derived from a relatively small number of customer products. We intend to continue pursuing a strategy of licensing our technologies to a
diversified base of medical device manufacturers and other customers, thereby expanding the licensing base for our coating technologies. Success will
depend, in part, on our ability to attract new licensees, to enter into agreements for additional applications with existing licensees and to develop
and market new applications. There can be no assurance that we will be able to identify, develop and adapt our technologies for new applications in a
timely and cost effective manner; that new license agreements will be executed on terms favorable to us; that new applications will be accepted by
manufacturers in our target markets; or that products incorporating newly licensed technology, including new applications, will gain regulatory
approval, be commercialized or gain market acceptance. Delays or failures in these efforts could have an adverse effect on our business, financial
condition and results of operations.
Surface modification is a competitive market and carries
the risk of technological obsolescence.
We operate in a competitive and
evolving field and new developments are expected to continue at a rapid pace. Our success depends, in part, upon our ability to maintain a competitive
position in the development of technologies and products in the field of surface modification and drug delivery. Our technologies compete with
technologies developed by AST, Biocompatibles International plc, BioSensors, Carmeda (recently acquired by W.L. Gore), Control Delivery Systems
(recently acquired by pSivida Limited), Hydromer, MediVas, Oculex Pharmaceuticals, Inc. (acquired by Allergan, Inc.), Specialty Coatings Systems, and
STS Biopolymers Inc., a division of Angiotech Pharmaceuticals, Inc., among others. In addition, many medical device manufacturers have developed or are
engaged in efforts to develop surface modification or drug delivery technologies for use on their own devices. Some of our existing and potential
competitors (especially medical device manufacturers pursuing coating solutions through their own research and development efforts) have greater
financial and technical resources and production and marketing capabilities than us. Competitors may succeed in developing competing technologies or
obtaining governmental approval for products before us. Products incorporating our competitors’ technologies may gain market acceptance more
rapidly than products using ours. Developments by competitors may render our existing and potential products noncompetitive or obsolete. Furthermore,
there can be no assurance that new products or technologies developed by others, or the emergence of new industry standards, will not render our
products or technologies or licensees’ products incorporating our technologies noncompetitive or obsolete. Any new technologies which make our
coating technologies less competitive or obsolete would have a material adverse effect on our business, financial condition and results of
operations.
If we cannot adequately protect our technologies and
proprietary information, we may be unable to sustain a competitive advantage.
Our success depends, in large
part, on our ability to obtain and maintain patents, maintain trade secret protection, operate without infringing on the proprietary rights of third
parties and protect our proprietary rights
16
against infringement by third
parties. We have been granted U.S. and foreign patents and have U.S. and foreign patent applications pending related to our coating technologies. There
can be no assurance that any pending patent application will be approved; that we will develop additional proprietary technologies that are patentable,
that any patents issued will provide us with competitive advantages or will not be challenged or invalidated by third parties, or that the patents of
others will not prevent the commercialization of products incorporating our technologies. Furthermore, there can be no assurance that others will not
independently develop similar technologies, duplicate any of our technologies or design around our patents. There can be no assurance that our trade
secrets or confidentiality agreements with employees, potential licensees or other parties will provide meaningful protection for our unpatented
proprietary information.
Our commercial success also will
depend, in part, on our ability to avoid infringing patent or other intellectual property rights of third parties. There has been substantial
litigation regarding patent and other intellectual property rights in the medical device industry, and intellectual property litigation may be used
against us as a means of gaining a competitive advantage. Intellectual property litigation is complex, time consuming and expensive, and the outcome of
such litigation is difficult to predict. If we were found to be infringing any third party patent or other intellectual property right, we could be
required to pay significant damages, alter our products or processes, obtain licenses from others, which we may not be able to do on commercially
reasonable terms, if at all, or cease commercialization of our products and processes. Any of these outcomes could have a material adverse effect on
our business, financial condition and results of operations.
Patent litigation or U.S. Patent
and Trademark Office interference proceedings may also be necessary to enforce any patents issued or licensed to us or to determine the scope and
validity of third party proprietary rights. These activities could result in substantial cost to us, even if the eventual outcome is favorable to us.
An adverse outcome of any such litigation or interference proceeding could subject us to significant liabilities to third parties, require disputed
rights to be licensed from third parties or require us to cease using our technology. Any action to defend or prosecute intellectual property would be
costly and result in significant diversion of the efforts of our management and technical personnel, regardless of outcome, and could have a material
adverse effect on our business, financial condition and results of operations.
We may face product liability claims related to
participation in clinical trials or the use or misuse of our products.
The development and sale of
medical devices and component products involves an inherent risk of product liability claims. Although we expect that devices incorporating our
technologies will be manufactured by others and sold under their own labels, and in most cases our customer agreements provide indemnification against
such claims, there can be no assurance that product liability claims will not be filed against us for such devices or that such manufacturers will not
seek indemnification or other relief from us for any such claims. In addition, there can be no assurance that product liability claims will not be
filed directly against us with respect to our own products. There can be no assurance that our current product liability insurance will continue to be
available to us on acceptable terms, if at all, or that, if available, the coverages will be adequate to protect us against any future product
liability claims. Furthermore, we do not expect to be able to obtain insurance covering our costs and losses as a result of any recall of products or
devices incorporating our technologies because of alleged defects, whether such recall is instituted by a device manufacturer or us or required by a
regulatory agency. A product liability claim, recall or other claim with respect to uninsured liabilities or for amounts in excess of insured
liabilities could have a material adverse effect on our business, financial condition and results of operations.
Any adverse results in our Phase I trials for our
I-vation intravitreal implant could harm our ability to commercialize the implant in a timely, cost-effective manner, if at all.
We are currently conducting a
Phase I safety trial for our I-vation intravitreal implant. Our Phase I trial is intended to help assess the safety and tolerability of the implant in
patients with diabetic macular edema, and is being conducted under an investigational new drug application with the U.S. Food and Drug Administration.
The Phase I trial plans to enroll 30 patients who will be subject to follow-up monitoring for three years. The first human implant in the trials
occurred in June 2005.
Our ability to commercialize the
implant by 2010 will depend on the success of our Phase I testing efforts and the performance of the implant in patients that participate in the trial
and the successful enrollment and results
17
from other clinical trials
that will be required before we or a partner can seek approval for commercial sale of the implant. Although the preliminary results of the Phase I
trial have not presented any material problems, we cannot be certain the implant will perform as expected in additional clinical tests. Problems in
connection with our Phase I trials or in any subsequent phases of required clinical trials may prevent or delay us or a partner obtaining necessary
regulatory approvals and threaten our ability to timely or cost-effectively commercialize the implant, if at all.
Our Phase I trial is being
conducted on a statistically insignificant number of human patients and is not intended to evaluate aspects of the effectiveness of the implant.
Because the initial number of tests performed in humans will be relatively small, there is no assurance that the Phase I trials will identify problems
that may become evident from a larger base of tests or after a longer period of observation of the patients. We will be able to accurately evaluate the
performance of the implant in humans only after extensive testing in large numbers of patients over a period of years.
We have a single manufacturing facility and we may lose
revenue and be unable to maintain our customer relationships if we lose our production capacity.
We manufacture all of the
products we sell in our existing production labs in our Eden Prairie, Minnesota facility. If our existing production facility becomes incapable of
manufacturing products for any reason, we may be unable to meet production requirements, we may lose revenue and we may not be able to maintain our
relationships with our licensees. Without our existing production facility, we would have no other means of manufacturing products incorporating our
coating technologies until we were able to restore the manufacturing capability at our facility or develop an alternative manufacturing facility.
Although we carry business interruption insurance to cover lost revenue and profits in an amount we consider adequate, this insurance does not cover
all possible situations. In addition, our business interruption insurance would not compensate us for the loss of opportunity and potential adverse
impact on relations with our existing customers resulting from our inability to produce products for them.
Our revenue will be harmed if we cannot purchase
sufficient reagent components we use in our manufacture of reagents.
We currently purchase some of the
components we use to manufacture coating reagents from sole suppliers. If any of our sole suppliers becomes unwilling to supply components to us,
incurs an interruption in its production or is otherwise unable to provide us with sufficient material to manufacture our reagents, we will experience
production interruptions. If we lose our sole supplier of any particular reagent component or are otherwise unable to procure all components required
for our reagent manufacturing for an extended period of time, we may lose the ability to manufacture the reagents our customers require to
commercialize our coating technology. This could result in lost royalties and product sales, which would harm our financial results. Adding suppliers
to our approved vendor list may require significant time and resources since we typically thoroughly review a supplier’s business and operations
to become comfortable with the quality and integrity of the materials we purchase for use with our technology, including reviewing a supplier’s
manufacturing processes and evaluating the suitability of materials and packaging procedures the supplier uses. We routinely attempt to maintain
multiple suppliers of each of our significant materials, so we have alternative suppliers if necessary. However, if the number of suppliers of a
material is reduced, or if we are otherwise unable to obtain our material requirements on a timely basis and on favorable terms, our operations may be
harmed.
We are dependent upon key personnel and may not be able
to attract qualified personnel in the future.
Our success is dependent upon our
ability to retain and attract highly qualified management and technical personnel. We face intense competition for such qualified personnel. We do not
maintain key person insurance nor do we have employment agreements with any of our employees. Although we have non-compete agreements with most
employees, there can be no assurance that such agreements will be enforceable. The loss of the services of one or more key employees or the failure to
attract and retain additional qualified personnel could have a material adverse effect on our business, financial condition and results of
operations.
18
Our products are subject to continuing regulations and
we may be subject to adverse consequences if we fail to comply with applicable regulations.
Although coating technologies
themselves are not directly regulated by the FDA, the medical devices incorporating the technologies are subject to FDA regulation. The burden of
securing FDA approval for these medical devices rests with our licensees (the medical device manufacturers). However, we have prepared Device Master
Files which may be accessed by the FDA to assist it in its review of the applications filed by our licensees. Historically, most medical devices
incorporating a coating have been subject to the FDA’s 510(k) marketing approval process, which typically lasts from six to nine months.
Supplemental or full pre-market approval (“PMA”) reviews require a significantly longer period, delaying commercialization. Furthermore,
sales of medical devices outside the U.S. are subject to international regulatory requirements that vary from country to country. The time required to
obtain approval for sale internationally may be longer or shorter than that required for FDA approval. There can be no assurance that our licensees
will be able to obtain regulatory approval for their coated medical devices on a timely basis, or at all. Regulatory approvals, if granted, may include
significant limitations on the indicated uses for which the product may be marketed. In addition, product approval could be withdrawn for failure to
comply with regulatory standards or the occurrence of unforeseen problems following initial marketing. Changes in existing regulations or adoption of
new governmental regulations or policies could prevent or delay regulatory approval of products incorporating our technologies or subject us to
additional regulation. Failure or delay of our licensees in obtaining FDA and other necessary regulatory approval or clearance or the loss of
previously obtained approvals could have a material adverse effect on our business, financial condition and results of operations.
Certain of our activities are
regulated by federal and state agencies in addition to the FDA. For example, activities in connection with disposal of certain chemical waste are
subject to regulation by the U.S. Environmental Protection Agency. Some of our reagent chemicals must be registered with the agency with basic
information filed related to toxicity during the manufacturing process as well as the toxicity of the final product. Failure to comply with existing or
future regulatory requirements could have a material adverse effect on our business, financial condition and results of operations.
We use hazardous materials in some of our research,
development and manufacturing processes.
Our research, development and
manufacturing activities sometimes involve the controlled use of various hazardous materials. Although we believe that our safety procedures for
handling and disposing of such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or
injury from these materials cannot be completely eliminated. While we currently maintain insurance in amounts which we believe are appropriate in light
of the risk of accident, we could be held liable for any damages that might result from any such event. Any such liability could exceed our insurance
and available resources and could have a material adverse effect on our business, financial condition and results of operations.
Our stock price has been volatile and may continue to be
volatile
The trading price of our common
stock has been, and is likely to continue to be, highly volatile, in large part attributable to developments and circumstances related to factors
identified in “Forward-Looking Statements” and “Risk Factors.” The market value of your investment in our common stock may rise or
fall sharply at any time because of this volatility, and also because of significant short positions taken by investors from time to time in our stock.
In the year ended September 30, 2005, the closing sale price for our common stock ranged from $23.80 to $46.13 per share. As of December 9, 2005, the
last reported sale price of our stock was $38.43 per share. The market prices for securities of medical technology, drug delivery and biotechnology
companies historically have been highly volatile, and the market has experienced significant price and volume fluctuations that are unrelated to the
operating performance of particular companies.
Failure to identify strategic investment and acquisition
opportunities and integrate acquired businesses into our operations successfully may limit our growth.
An important part of our growth
in the future may involve strategic investments and the acquisition of complementary businesses or technologies. Our identification of suitable
investment opportunities and acquisition candidates involves risks inherent in assessing the technology, value, strengths, weaknesses, overall
risks
19
and profitability, if any, of
investment and acquisition candidates. We may not be able to identify suitable investment and acquisition candidates. If we do not make suitable
investment and acquisitions, we may find it more difficult to realize our growth objectives.
The process of integrating new
businesses into our operations poses numerous risks, including:
• |
|
an inability to assimilate acquired operations, personnel,
technology, information systems, and internal control systems and products; |
• |
|
diversion of management’s attention; |
• |
|
difficulties and uncertainties in transitioning the business
relationships from the acquired entity to us; and |
• |
|
the loss of key employees of acquired companies. |
In addition, future acquisitions
by us may be dilutive to our shareholders, and cause large one-time expenses or create goodwill or other intangible assets that could result in
significant asset impairment charges in the future. Strategic investments may result in impairment charges if the value of any such investment declines
significantly. In addition, if we acquire entities that have not yet commercialized products but rather are developing technologies for future
commercialization, our earnings per share may fluctuate as we expend significant funds for continued research and development efforts for acquired
technology necessary to commercialize such technology. We cannot guarantee that we will be able to complete successfully any investments or
acquisitions or that we will realize any anticipated benefits from investments or acquisitions that we complete.
ITEM
2. PROPERTIES.
We conduct our operations in two
facilities located in suburban Minneapolis-St. Paul, Minnesota. In May 1999, we purchased the land and building we currently occupy in Eden Prairie,
Minnesota. The building has approximately 64,000 square feet of space. Most of our operations take place at the Eden Prairie location. In October 2001,
we purchased a facility in Bloomington, Minnesota, situated on 27 acres of land. In fiscal year 2004, we announced that after careful examination of
our redefined business goals, we believed that the Bloomington contract manufacturing facility was no longer necessary for the execution of our
strategic plan. Accordingly, we recorded a non-cash asset impairment charge of $16.5 million in the third quarter of fiscal year 2004 and an additional
$2.5 million charge in the fourth quarter of fiscal year 2005. In September 2005, we entered an agreement to sell the Bloomington property and
facility. During our fiscal third quarter, we began construction to improve the research and development activities of our Eden Prairie facility. We
intend to occupy portions of the Bloomington facility until modifications to our Eden Prairie facility are complete, at which time we will consolidate
operations at our Eden Prairie headquarters. We expect to vacate the Bloomington facility by the end of the third quarter of fiscal year 2006. The
purchases of these two properties were internally funded and remain unencumbered. We believe that projected capacity of our Eden Prairie facility is
adequate to service the needs of our customers for the foreseeable future. In addition, we lease approximately 3,000 square feet of office space in
Irvine, California for use by our ophthalmology division.
ITEM 3. LEGAL
PROCEEDINGS.
We are not a party to nor is any
of our property subject to any material pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO
A VOTE OF SECURITY HOLDERS.
There were no matters submitted
to a vote of security holders during the fourth quarter of fiscal year 2005.
20
EXECUTIVE OFFICERS OF THE
REGISTRANT
The names, ages and positions of
the Company’s executive officers are as follows:
Name
|
|
|
|
Age
|
|
Position
|
Bruce J
Barclay |
|
|
|
|
49 |
|
|
President and Chief Executive Officer |
Aron B.
Anderson, Ph.D |
|
|
|
|
42 |
|
|
Vice President and Chief Scientific Officer |
Philip D.
Ankeny |
|
|
|
|
42 |
|
|
Chief Financial Officer, and Vice President, Business Development |
Douglas P.
Astry |
|
|
|
|
53 |
|
|
General Manager, Diagnostics and Drug Discovery |
Lise W.
Duran, Ph.D |
|
|
|
|
50 |
|
|
Vice President and General Manager, Regenerative Technologies |
Steven J.
Keough |
|
|
|
|
50 |
|
|
Vice President and Chief Intellectual Property Counsel and General Manager, Orthopedics |
Paul A.
Lopez |
|
|
|
|
49 |
|
|
Vice President, and President, Ophthalmology Division |
Loren R.
Miller |
|
|
|
|
40 |
|
|
Vice President and Controller |
Dale R.
Olseth |
|
|
|
|
75 |
|
|
Executive Chairman |
Charles W.
Olson |
|
|
|
|
41 |
|
|
Vice President U.S. Sales, and General Manager, Hydrophilic Technologies |
David S.
Wood |
|
|
|
|
49 |
|
|
Vice President and General Manager, Drug Delivery |
Gregory T.
Yung |
|
|
|
|
56 |
|
|
Vice President, Worldwide Marketing and International Sales |
Bruce J
Barclay joined the Company as its President and Chief Operating Officer in December 2003. He became a director of the Company in July 2004 and
Chief Executive Officer of the Company in July 2005. Mr. Barclay has more than 25 years of experience in the health care industry. Prior to joining
SurModics, he served as President and Chief Executive Officer of Vascular Architects, Inc., a medical device company that develops, manufactures and
sells products to treat peripheral vascular disease, from 2000 to 2003. Prior to Vascular Architects, he served at Guidant Corporation, most recently
as an officer and Senior Vice President from 1998 to 2000. Previously, he was a Vice President of Guidant’s Interventional Cardiology division
with responsibility for the law division, a new therapies technical development team and business development, charged with the acquisition of new
products and technologies for the division. Mr. Barclay also has considerable experience in the pharmaceutical area serving in several positions at Eli
Lilly and Company. Mr. Barclay also serves on the Board of Directors of Cardiac Science, Inc., which develops, manufactures and markets diagnostic and
therapeutic cardiology products and services. Mr. Barclay received a B.S. in chemistry and a B.A. in biology from Purdue University in 1980 and a J.D.
from the Indiana University School of Law in 1984. He is also a registered patent attorney.
Aron B. Anderson, Ph.D.,
joined the Company as an Associate Scientist in 1991. In 1994, he was named Director, Hemocompatibility R&D, in 2001, named Director, Drug
Delivery, and in January 2005, Vice President and Chief Scientific Officer. Dr. Anderson serves on the Board of Directors of University Enterprise
Laboratories, a partnership between the University of Minnesota and the city of St. Paul that functions as a technology company incubator. Dr. Anderson
received a B.S. in Chemical Engineering from the University of Minnesota in 1985, and received an M.S. in 1987 and Ph.D. in 1991, both in Chemical
Engineering, from Stanford University.
Philip D. Ankeny joined
the Company as its Vice President and Chief Financial Officer in April 2003 with the additional responsibilities of Vice President, Business
Development added in April 2004. Prior to joining SurModics, he served as Chief Financial Officer for Cognicity, Inc. from 1999 to 2002. Prior to that,
Mr. Ankeny served as a Partner at Sherpa Partners, LLC, a venture capital and venture development firm, from 1998 to 1999. He also spent five years in
investment banking with Robertson Stephens and Morgan Stanley. In addition, his operating experience includes over five years with IBM and Shiva in
sales, marketing and business development roles. Mr. Ankeny also serves on the Board of Directors of Innovex, Inc., which designs and manufactures
flexible
21
circuit interconnect
solutions to original equipment manufacturers in the electronics industry. Mr. Ankeny received an A.B. degree in economics and engineering from
Dartmouth College in 1985 and an M.B.A. from Harvard Business School in 1989.
Douglas P. Astry joined
SurModics in June 2003 as Manager, Array Business, and was promoted to General Manager, Diagnostics and Drug Discovery in April 2004. Prior to joining
SurModics, from 2002 to 2003, he was Vice President of Marketing and Business Development at HTS Biosystems, and from 1980 through 2001, he held
various research and business management positions at 3M, most recently Business Development manager of 3M’s Bioanalytical Technologies Group. Mr.
Astry received his B.A. degree in Biology from Williams College, an M.S. in Physiology from the University of Connecticut, and an M.B.A. from the
University of Minnesota.
Lise W. Duran, Ph.D.,
became Vice President and General Manager of the Regenerative Technologies business unit in April 2004. Dr. Duran came to SurModics in 1990, serving as
Director of Microbiology until she was promoted to Vice President of Product Development in 1998. From 1988 to 1990, Dr. Duran served as a Study
Director for Microbiological Associates, Inc., in the Biotechnology Services Division. She also did a research fellowship in Immunology at the Mayo
Clinic and was a postdoctoral associate in Laboratory Medicine and Pathology at the University of Minnesota. Dr. Duran serves on the Board of Directors
as Treasurer of the Surfaces in Biomaterials Foundation. Dr. Duran received her B.S. in microbiology from the University of Maryland and a Ph.D. in
microbiology from the Uniformed Services University of the Health Sciences
Steven J. Keough joined
SurModics as its Senior Vice President and Chief Intellectual Property Counsel in January 2004 and added the duties of Vice President and General
Manager of the New Ventures business unit in April of that year. The current Orthopedics business unit emerged in October 2005 from New Ventures, and
is led by Mr. Keough. Before joining SurModics, Mr. Keough practiced law at Minneapolis-based Fredrikson & Byron, P.A. from 2000–2003, where
he was a senior member and past chairman of the intellectual property department. He previously served as president and co-founder of the intellectual
property law firm Patterson & Keough, P.A. from 1991–2000. He was also Manager of Asia-Pacific at the Minneapolis law firm of Merchant &
Gould, from 1987–1991. Mr. Keough has extensive business and legal experience involving medical technologies, technology transfer, strategic
planning, licensing and high technology business management. Mr. Keough earned a J.D. from Boston College, an M.A. from the Catholic University of
America, and a Bachelor of Science degree from the United States Naval Academy.
Paul A. Lopez joined
SurModics in July 2005 as Vice President and President of the Company’s Ophthalmology division. Before joining SurModics, Mr. Lopez was President
and CEO of Valley Forge Pharmaceuticals, an early stage pharmaceutical company. Prior to Valley Forge, Mr. Lopez served in various senior level
positions at Bausch & Lomb, including President, North America Surgical; Vice President, Commercial Operations, Americas and Asia Pacific Regions;
and Vice President, Business Integration. Mr. Lopez has also held roles at Monsanto Company, Pharmacia and Upjohn, Inc. and Iolab Corporation. Mr.
Lopez serves on the Boards of Directors of Alliance Medical Products and Valley Forge Pharmaceuticals, both private companies located in Irvine,
California. Mr. Lopez received an M.B.A. from California State Polytechnic University and a B.S. in Business Administration from California State
University.
Loren R. Miller joined the
Company in 1999 and served as Controller before being promoted to Vice President and Controller in March 2003. Prior to SurModics, Mr. Miller served as
Controller of Northwest Athletic Clubs (owned by The Wellbridge Company). From 1996 to 1998 he was the Controller for Executive Aviation Inc. In
addition he held various positions at Mesaba Aviation Inc. from 1988 until 1995, most recently as Controller. Mr. Miller is a CPA and received a B.S.
degree in Business Administration & Finance and a B.S. degree in Accounting from Minnesota State University in 1988.
Dale R. Olseth joined the
Company in 1986 as its President, Chief Executive Officer and a director of the Company. Mr. Olseth served as the Company’s President and Chief
Executive Officer until July 2005. Mr. Olseth continues to serve as the Company’s Executive Chairman. Mr. Olseth has been Chairman since 1988. Mr.
Olseth also serves on the Board of Directors of The Toro Company and the boards of Otologics LLC and the University of Minnesota Foundation. He served
as Chairman or President and Chief Executive Officer of Medtronic, Inc. from 1976 to 1986. From 1971 to 1976, Mr. Olseth served as President and Chief
Executive Officer of Tonka Corporation. Mr. Olseth received a B.B.A. degree from the University of Minnesota in 1952 and an M.B.A. degree from
Dartmouth College in 1956.
22
Charles W. Olson joined
the Company in 2001 as Market Development Manager, was promoted in December 2002 to Director, Business Development, named General Manager of the
Hydrophilic Technologies business unit in April 2004, and promoted to Vice President and General Manager, Hydrophilic Technologies in October 2004. In
April 2005, the position of Vice President, U.S. Sales was added to his responsibilities. Prior to joining SurModics, Mr. Olson was employed as General
Manager at Minnesota Extrusion from 1998 to 2001 and at Lake Region Manufacturing in project management and technical sales from 1993 to 1998. Mr.
Olson received a BS degree in Marketing from Winona State University in 1987.
David S. Wood joined the
Company as its Vice President and General Manager of the Drug Delivery business unit in November 2004. Prior to joining SurModics, he was a Director of
Product Development at Guidant Corporation’s Cardiac Rhythm Management Division from 1994 to 2004. Prior to Guidant’s formation in 1994 as a
spin off from Eli Lilly and Company, Mr. Wood held several management positions between 1989 and 1994 in marketing and product development at
Lilly’s Cardiac Pacemakers, Inc. subsidiary. Mr. Wood joined Eli Lilly and Company in 1978 as a Chemical Engineer. Between 1978 and 1980 and again
from 1982 to 1989 he served in a variety of engineering, financial and medical device business development positions at Lilly. Mr. Wood received his
undergraduate degree in Chemical Engineering from Vanderbilt University in 1978 and an M.B.A. from The Wharton School at the University of Pennsylvania
in 1981.
Gregory T. Yung joined
SurModics in 2000 as Director of Sales and Market Development, was named Vice President, Sales and Business Development in 2002 and Vice President,
Sales and Marketing in April 2004. In April 2005, he was named Vice President, Worldwide Marketing and International Sales. Mr. Yung has over 20 years
of experience in the medical device industry, having held management positions at Medtronic, Inc. from 1988 to 2000 and at Boston Scientific, Inc. from
1984 to 1988. Mr. Yung received a B.S. degree in business administration and marketing from the University of Akron in 1979.
The executive officers of the
Company are elected by and serve at the discretion of the Board of Directors.
23
PART II
ITEM
5. |
|
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED
STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. |
Our stock is traded on the Nasdaq
National Market under the symbol “SRDX.” The table below sets forth the range of high and low closing sale prices, by quarter, for our Common
Stock, as reported by Nasdaq, in each of the last two fiscal years.
Fiscal Quarter ended:
|
|
|
|
High
|
|
Low
|
September 30,
2005 |
|
|
|
|
45.50 |
|
|
|
35.40 |
|
June 30,
2005 |
|
|
|
|
46.13 |
|
|
|
31.85 |
|
March 31,
2005 |
|
|
|
|
34.75 |
|
|
|
28.08 |
|
December 31,
2004 |
|
|
|
|
32.90 |
|
|
|
23.80 |
|
| |
September 30,
2004 |
|
|
|
|
24.94 |
|
|
|
21.32 |
|
June 30,
2004 |
|
|
|
|
25.20 |
|
|
|
19.00 |
|
March 31,
2004 |
|
|
|
|
24.08 |
|
|
|
18.60 |
|
December 31,
2003 |
|
|
|
|
28.30 |
|
|
|
20.10 |
|
Our transfer agent
is:
American Stock Transfer & Trust Company
59 Maiden Lane, Plaza Level
New York, New York
10038
(800) 937-5449
According to the records of our
transfer agent, as of November 10, 2005, there were 278 holders of record of our Common Stock and approximately 13,261 beneficial owners of shares
registered in nominee or street name.
We have never paid any cash
dividends on our Common Stock and do not anticipate doing so in the foreseeable future.
We made no sales of unregistered
securities, and made no repurchases of our equity securities, during the quarter ended September 30, 2005.
In July 2005, we issued 60,002
additional shares of common stock to former shareholders of InnoRx pursuant to the terms of and as a result of our January 2005 acquisition of InnoRx
and successful completion of a milestone established in the acquisition. (See Liquidity and Capital Resources for more information related to our
InnoRx acquisition.) Such shares were issued only to the 15 stockholders of InnoRx, and exemption from registration therefore was claimed at the time
of the acquisition under Section 4(2) of such Securities Act.
24
ITEM 6. SELECTED FINANCIAL
DATA.
The data presented below as of
and for the years ended September 30, 2005, 2004, and 2003 are derived from our audited financial statements included elsewhere in this report. The
financial data as of and for the years ended September 30, 2002 and 2001 are derived from our audited financial statements that are not included in
this report. The information set forth below should be read in conjunction with the Company’s financial statements and “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 7 of this report and our financial statements and
related notes beginning in page F-1 and other financial information included in this report.
|
|
|
|
Fiscal Year
|
|
(Dollars in thousands, except per share data)
|
|
|
|
2005
|
|
2004**
|
|
2003
|
|
2002
|
|
2001
|
Income
Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenue |
|
|
|
$ |
62,381 |
|
|
$ |
49,738 |
|
|
$ |
43,232 |
|
|
$ |
29,488 |
|
|
$ |
22,693 |
|
Operating
income |
|
|
|
|
2,985 |
|
|
|
10,474 |
|
|
|
20,640 |
|
|
|
10,709 |
|
|
|
7,566 |
|
Net income
(loss) |
|
|
|
|
(8,246 |
) |
|
|
7,242 |
|
|
|
13,936 |
|
|
|
7,796 |
|
|
|
5,109 |
|
| |
Diluted net
income (loss) per share |
|
|
|
|
(.45 |
) |
|
|
.41 |
|
|
|
.78 |
|
|
|
.44 |
|
|
|
.29 |
|
| |
Pro forma
amounts assuming the accounting change* was applied retroactively:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
(loss) |
|
|
|
|
(8,246 |
) |
|
|
7,242 |
|
|
|
13,936 |
|
|
|
7,796 |
|
|
|
6,814 |
|
Diluted net
income (loss) per share |
|
|
|
|
(.45 |
) |
|
|
.41 |
|
|
|
.78 |
|
|
|
.44 |
|
|
|
.38 |
|
| |
Balance Sheet
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and
short-term investments |
|
|
|
$ |
24,445 |
|
|
$ |
19,215 |
|
|
$ |
6,647 |
|
|
$ |
13,149 |
|
|
$ |
14,840 |
|
Total
assets |
|
|
|
|
124,225 |
|
|
|
109,587 |
|
|
|
97,808 |
|
|
|
77,248 |
|
|
|
60,583 |
|
Retained
earnings |
|
|
|
|
27,915 |
|
|
|
36,161 |
|
|
|
28,918 |
|
|
|
14,982 |
|
|
|
7,186 |
|
Total
stockholders’ equity |
|
|
|
|
115,581 |
|
|
|
94,310 |
|
|
|
86,114 |
|
|
|
69,995 |
|
|
|
55,700 |
|
| |
Pro forma
amounts assuming the accounting change* was applied retroactively:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained
earnings |
|
|
|
|
27,915 |
|
|
|
36,161 |
|
|
|
28,918 |
|
|
|
14,982 |
|
|
|
7,186 |
|
Total
stockholders’ equity |
|
|
|
|
115,581 |
|
|
|
94,310 |
|
|
|
86,114 |
|
|
|
69,995 |
|
|
|
55,700 |
|
* |
|
Effective October 1, 2000, we adopted Staff Accounting Bulletin
No. 101 (“SAB 101”), “Revenue Recognition in Financial Statements.” As a result of adopting SAB 101, we recorded a cumulative
effect of a change in accounting principle related to license fees recognized in prior years in the amount of $1,705,000, net of tax of $1,000,000, or
$.09 per diluted share. |
** |
|
In connection with our InnoRx acquisition, we retroactively
adjusted our previously reported results to show the impact of accounting for InnoRx under the equity method. The net impact was an approximate
$194,000 reduction in net income for fiscal year 2004. |
ITEM
7. |
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND
RESULTS OF OPERATION. |
The following discussion and
analysis of our financial condition, results of operations and trends for the future should be read together with Selected Financial Data and our
audited financial statements and related notes appearing elsewhere in this report. Any discussion and analysis regarding trends in our future financial
condition and results of operations are forward-looking statements that involve risks, uncertainties and assumptions, as more fully identified in
“Forward-looking Statements” and “Risk Factors.” Our actual future financial condition and results of operations may differ
materially from those anticipated in the forward-looking statements.
Overview
SurModics is a leading provider
of surface modification and drug delivery technologies to the healthcare industry. The Company is organized into three operating segments composed of
six technology-centered and industry-focused business units. The “Drug Delivery” operating segment contains: (1) the Drug Delivery
business
25
unit, which is responsible
for technologies dedicated to site specific delivery of drugs, and (2) the Ophthalmology division, which is dedicated to the advancement of treatments
for eye diseases, such as age-related macular degeneration (AMD) and diabetic macular edema (DME), two of the leading causes of blindness. The
“Hydrophilic and Other” operating segment consists of three business units: (1) Hydrophilic Technologies business unit, which focuses on
enhancing medical devices with advanced lubricious coatings that facilitate their placement and maneuverability in the body; (2) Regenerative
Technologies business unit, which is developing platforms intended to augment or replace tissue/organ function (e.g., cell encapsulation applications),
or to modify medical devices to facilitate tissue/organ recovery through natural repair mechanisms (e.g., hemo/biocompatible coatings); and (3)
Orthopedics business unit, which is committed to innovative solutions for orthopedics patients using proven SurModics technologies, and creating new
technology solutions to existing patient care gaps in the orthopedics field. The “Diagnostics” operating segment contains the Diagnostics and
Drug Discovery business unit, which includes our genomics slide technologies, our stabilization products for immunoassay diagnostics tests, our in
vitro diagnostic format technology and the work being performed to develop synthetic cell culture products.
Revenue in each of our operating
segments is derived from three primary sources: (1) royalties and license fees from licensing our patented surface modification and drug delivery
technologies and in vitro diagnostic formats to customers; (2) the sale of reagent chemicals to licensees of our technologies, stabilization products
to the diagnostics industry and coated glass slides to the genomics market; and (3) research and development fees generated customer projects. Revenue
should be expected to fluctuate from quarter to quarter depending on, among other factors: our customers’ success in selling products
incorporating our technologies; the timing of introductions of coated products by customers; the timing of introductions of products that compete with
our customers’ products; the number and size of development projects that are entered into; the number and terms of new license agreements that
are finalized; the value of reagent chemicals and other products sold to licensees; and the timing of future acquisitions we complete, if
any.
For financial accounting and
reporting purposes, we treat our three operating segments as one reportable segment. We made this determination because our operating segments
currently share the same facilities; a significant percentage of our employees provide support services (including research and development) to each
operating segment; technology and products from each operating segment are marketed to the same or similar customers; each operating segment uses the
same sales and marketing resources; and each operating segment operates in the same regulatory environment.
On January 18, 2005, we acquired
all of the assets of InnoRx, Inc. by paying cash and issuing shares of SurModics common stock to InnoRx stockholders. InnoRx was an early-stage company
developing drug delivery implants and therapies for the ophthalmology market. The assets we acquired were folded into our newly-created Ophthalmology
division. Prior to the acquisition, SurModics held an ownership interest in InnoRx of less than 20% and accounted for the investment under the cost
method. Upon completion of the InnoRx acquisition, we retroactively adjusted our previously reported results to show the impact of accounting for
InnoRx under the equity method. The net impact was an approximate $194,000 reduction in net income for fiscal year 2004 from previously reported
results.
Critical Accounting Policies
Our financial statements are
based in part on the application of significant accounting policies, many of which require management to make estimates and assumptions (see Note 2 to
the financial statements). Management believes the following are the critical areas in the application of our accounting policies that currently affect
our financial condition and results of operations.
Revenue
recognition. Royalty revenue is generated when a licensed customer sells products incorporating our technologies. Royalty revenue is recognized
as our licensees report it to us, and payment is typically submitted concurrently with the report. We recognize initial license fees over the term of
the related agreement. Revenue related to a performance milestone is recognized upon the achievement of the milestone, as defined in the respective
agreements. Revenue on sales of products is recognized when persuasive evidence of an agreement exists, delivery has occurred, the fee is fixed and
determinable and collectibility is probable. Generally, these criteria are met at the time our product is shipped. Revenue for research and development
is recorded as performance progresses under the applicable contract.
26
Valuation of long-lived
assets. We periodically evaluate whether events and circumstances have occurred that may affect the estimated useful life or the recoverability
of the remaining balance of long-lived assets, such as property and equipment. If such events or circumstances were to indicate that the carrying
amount of these assets would not be recoverable, we would estimate the future cash flows expected to result from the use of the assets and their
eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) or other measure of fair value was less
than the carrying amount of the assets, we would recognize an impairment charge. Results in the third quarter of fiscal year 2004 include a non-cash
asset impairment charge of $16.5 million against our Bloomington, Minnesota contract manufacturing facility. Management determined the fair value using
this real estate market data. In September 2005, we entered into an agreement to sell the Bloomington facility. Results in the fourth quarter of fiscal
year 2005 include an additional non-cash asset impairment charge of $2.5 million to reflect the fair value based on the agreed selling price. We intend
to consolidate operations at our Eden Prairie, Minnesota headquarters by the end of the third quarter of fiscal year 2006.
Investments.
Investments consist principally of U.S. government and government agency obligations and mortgage-backed securities. Our investment policy calls for no
more than 5% of investments be held in any one credit issue, excluding U.S. government and government agency obligations. Investments are classified as
available-for-sale, that is, investments are reported at fair value with unrealized gains and losses excluded from operations and reported as a
separate component of stockholders’ equity, except for other-than-temporary impairments, which are reported as a charge to current operations and
result in a new cost basis for the investment.
Results of Operations
Years Ended September 30, 2005 and
2004
(Dollars in thousands)
|
|
|
|
Fiscal Year
2005
|
|
Fiscal Year
2004
|
|
Increase
|
|
% Increase
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Drug
Delivery |
|
|
|
$ |
29,678 |
|
|
$ |
25,690 |
|
|
$ |
3,988 |
|
|
|
16 |
% |
Hydrophilic
and Other |
|
|
|
|
19,065 |
|
|
|
15,527 |
|
|
|
3,538 |
|
|
|
23 |
% |
Diagnostics |
|
|
|
|
13,638 |
|
|
|
8,521 |
|
|
|
5,117 |
|
|
|
60 |
% |
Total
revenue |
|
|
|
$ |
62,381 |
|
|
$ |
49,738 |
|
|
$ |
12,643 |
|
|
|
25 |
% |
Revenue. Fiscal year 2005
revenue was $62.4 million, an increase of $12.6 million or 25% from fiscal year 2004. We experienced double digit revenue growth in all three operating
segments as detailed in the table above and further explained in the narrative in the paragraphs that follow.
Drug Delivery. Revenue in
the Drug Delivery segment increased 16% to $29.7 million from $25.7 million in fiscal year 2004. Significant growth in royalties and license fees
offset a decrease in sales of reagent chemical products (chemicals that we manufacture and sell to licensees for coating their medical devices). Drug
Delivery derives a substantial majority of its revenue from royalties and license fees and product sales attributable to Cordis Corporation, a Johnson
& Johnson company, on its Cypher Sirolimus-eluting Coronary Stent. The Cypher stent incorporates a proprietary SurModics coating that delivers a
therapeutic drug designed to reduce the occurrence of restenosis in coronary artery lesions.
Revenue from sales of reagents to
Cordis decreased in fiscal year 2005 because of lower unit prices resulting from a contractual reduction in reagent pricing. Unit volume was little
changed from fiscal year 2004. There are no further contractual price reductions and management does not anticipate further reductions in reagent
prices to Cordis. Management believes the sales volume of reagents sold to Cordis will be directly impacted by anticipated continued improvements in
manufacturing efficiencies by Cordis in addition to relative market share positions of drug-eluting stent players.
Drug Delivery research and
development revenue in fiscal year 2005 was about the same as the prior year, with increased revenue from customers other than Cordis offsetting lower
revenue from Cordis. In addition, prior to our January 2005 acquisition of InnoRx, a portion of our research and development revenue was attributable
to InnoRx as a customer. Following the acquisition, we no longer record revenue for research and development activities in connection with the InnoRx
technology.
27
Future royalty revenue could
decrease because of lower Cypher stent sales as a result of continuing competition from Boston Scientific Corporation’s Taxus drug-eluting stent.
Boston Scientific was granted approval by the FDA to begin marketing in the U.S. its Taxus drug-eluting stent in our second fiscal quarter of 2004. The
Taxus stent competes directly with the Cypher stent. While the overall market for drug-eluting stents is expected to continue growing, we anticipate
that quarterly royalty revenue from the Cypher stent will continue to be volatile as the various marketers of drug-eluting stents continue competing in
the marketplace and as others enter the marketplace. Management expects royalties from the Cypher stent to constitute a significant portion of our
revenue in fiscal year 2006. However, whether and the extent to which royalties from the Cypher stent continue to constitute a significant source of
revenue is subject to a number of risks, including intellectual property litigation generally and specifically the damages, settlements and mutual
agreements that may result from various infringement suits between Boston Scientific and Cordis in which each has reported to have recently been found
to have violated certain intellectual property rights of the other.
Hydrophilic and Other.
Hydrophilic and Other revenue increased 23% to $19.1 million, because of increased royalties and license fees and research and development fees.
Whereas a significant percentage of revenue in Drug Delivery is attributable to Cordis, in Hydrophilic and Other there are several dozen licensees and
an even larger number of coated products generating royalties. The growth in royalties reflects both newly introduced licensed products and increased
sales of coated products already on the market. While management anticipates continued revenue growth in fiscal year 2006, it likely will not be as
strong as growth in fiscal year 2005.
Diagnostics. Diagnostics
revenue increased 60% to $13.6 million. A substantial majority of the growth resulted from increased royalty revenue under certain sublicenses, whose
royalty streams we purchased from Abbott in September 2004. While revenue from these royalty streams from Abbott are anticipated to continue into the
future, we anticipate the growth in Diagnostics revenue in fiscal year 2006 will not be as high in percentage terms as 2005 results. Diagnostics
derives a significant percentage of its revenue from GE Healthcare and Abbott Laboratories.
Revenue from product sales
increased resulting from higher sales of stabilization products used for immunoassay diagnostic tests. Effective February 2005, we terminated our
stabilization product distribution agreement with SeraCare and began selling directly to the U.S. diagnostics industry. Management believes revenue
from stabilization products will continue to increase when compared to prior year comparable periods because of the impact of selling directly to the
U.S. diagnostics industry, rather than through a distributor.
Product costs. Product
costs were $2.9 million for the fiscal year, a 6% decrease from $3.0 million in the prior year. Overall product margins averaged 70% compared with 71%
for the comparable period last year. Management anticipates overall product margins will be about the same in fiscal year 2006.
Research and development
expenses. Research and development expenses were $16.1 million, an increase of 27% compared with fiscal year 2004. A majority of the increase
reflects legal costs associated with intellectual property processing and applications. In addition, we incurred costs associated with the clinical
trial of our I-vation intravitreal implant and increased personnel costs related to establishing our new Ophthalmology division. Management believes
research and development expense will continue to increase in fiscal year 2006 as a result of anticipated expenses for development activities and
clinical trials associated with the intravitreal implant.
Sales and marketing expenses.
Sales and marketing expenses were $1.2 million in fiscal year 2005, a 28% decrease from the prior year. A substantial portion of the decrease
resulted from lower payroll costs related to a reduction in senior marketing personnel in connection with a company-wide reorganization in 2004.
Management anticipates sales and marketing expense to increase modestly in fiscal year 2006.
General and administrative
expenses. General and administrative expenses were $6.5 million in fiscal year 2005, a 20% increase compared with fiscal year 2004, primarily
reflecting increased compensation, legal and utility costs. Management anticipates general and administrative expense to increase modestly in fiscal
year 2006.
Purchased in-process research
and development. On January 18, 2005, we acquired all of the assets of InnoRx, Inc. by paying cash and issuing shares of SurModics common stock to
InnoRx stockholders. Results in fiscal year 2005 included a non-cash in-process research and development charge of $30.3 million. The fair value of the
in-process research and development was determined by an outside valuation consultant.
Asset impairment charge.
Results in fiscal year 2005 included a non-cash asset impairment charge of $2.5 million against our Bloomington, Minnesota contract manufacturing
facility. Results in the fiscal year 2004 included
28
a non-cash asset impairment
charge of $16.5 million against the facility. In September 2005, we entered into an agreement to sell the Bloomington facility and plan to consolidate
operations at our Eden Prairie, Minnesota headquarters.
Other income, net. Other
income was $1.4 million in fiscal year 2005, an increase of 16% compared to the prior year. The increase reflects higher levels of investable cash and
higher yields generated from our investment portfolio. Previously reported fiscal year 2004 results have been retroactively adjusted to show the impact
of accounting for InnoRx under the equity method. Prior to completing the acquisition of InnoRx in January 2005, we accounted for our investment in
InnoRx under the cost method.
Income tax provision. Our
income tax provision was $12.6 million in fiscal year 2005 compared with $4.4 million in fiscal year 2004. Excluding the impact of the $30.3 million
in-process research and development charge, which is not tax deductible, the effective tax rate was 36.8% in fiscal year 2005, compared with 37.2% for
the same period last year.
Years Ended September 30, 2004 and
2003
(Dollars in thousands)
|
|
|
|
Fiscal year
2004
|
|
Fiscal year
2003
|
|
Increase
(Decrease)
|
|
% Increase
(Decrease)
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Drug
Delivery |
|
|
|
$ |
25,690 |
|
|
$ |
20,168 |
|
|
$ |
5,522 |
|
|
|
27 |
% |
Hydrophilic
and Other |
|
|
|
|
15,527 |
|
|
|
12,380 |
|
|
|
3,147 |
|
|
|
25 |
% |
Diagnostics |
|
|
|
|
8,521 |
|
|
|
10,684 |
|
|
|
(2,163 |
) |
|
|
(20 |
%) |
Total
revenue |
|
|
|
$ |
49,738 |
|
|
$ |
43,232 |
|
|
$ |
6,506 |
|
|
|
15 |
% |
Revenue. Fiscal
year 2004 revenue was $49.7 million, an increase of 15% over fiscal year 2003. The growth in total revenue was attributable to growth in our Drug
Delivery and Hydrophilic and Other segments as detailed in the table above. We provide a narrative of revenue for each of our three operating segments
in the paragraphs that follow.
Drug Delivery. Drug
Delivery revenue increased 27% to $25.7 million in fiscal year 2004. Drug Delivery derives a substantial majority of its revenue from all three primary
sources (royalties and license fees, product sales and research and development fees) from Cordis Corporation (a Johnson & Johnson company) on its
Cypher stent. Fiscal year 2004 Drug Delivery revenue growth was attributable to a significant increase in royalties and license fees compared with the
prior year. Cordis’ Cypher stent received U.S. FDA approval in April 2003 (the third quarter of fiscal year 2003). Accordingly, 2004 results
reflect a full year of Cypher sales in the United States, whereas fiscal year 2003 results include U.S. sales of Cypher for slightly less than 6
months. This increase in royalties and license fees more than offset a significant reduction in research and development revenue and a decrease in
sales of reagent chemicals (chemicals that we manufacture and sell to licensees for coating their medical devices). Research and development revenue
decreased in 2004 principally as a result of the lower level of clinical coating work following FDA approval of Cypher. Although Cordis purchased a
substantial majority of reagents sold in fiscal year 2004, reagent chemical sales to Cordis decreased in 2004 as both volume and unit prices
decreased.
Hydrophilic and Other. In
fiscal year 2004, Hydrophilic and Other revenue increased 25% to $15.5 million, with growth contributed from all three primary revenue sources.
Royalties and license fees increased modestly compared with fiscal year 2003. Sales of reagent chemicals increased substantially compared with fiscal
year 2003.
Diagnostics. Overall
fiscal year 2004 revenue decreased about 20% to $8.5 million with nearly all of the decrease caused by lower royalties from GE Healthcare stemming from
scheduled contractual royalty decreases. In addition, fiscal year 2003 results include a $500,000 payment related to the achievement of a technical
milestone while 2004 results include a similar milestone payment of $250,000.
Product costs. Product
costs were $3.0 million for fiscal year 2004, an increase of 15%, from the $2.6 million recorded in fiscal year 2003. Overall product margins averaged
71%, a decrease from 78% in fiscal year 2003. Higher cost non-Cordis products made up a higher percentage of total product sales in fiscal year
2004.
Research and development
expenses. Research and development expenses for fiscal year 2004 were $12.6 million, an increase of $633,000, or 5%, compared with the same period
in fiscal year 2003.
29
Sales and marketing
expenses. Sales and marketing expenses were $1.7 million for fiscal year 2004, a decrease of $331,000, or 16%, from fiscal year 2003. A substantial
portion of the decrease resulted from lower payroll costs related to a reduction in senior marketing personnel in connection with a company-wide
reorganization.
General and administrative
expenses. General and administrative expenses were $5.4 million for fiscal year 2004, a decrease of $513,000, or 9%, compared with fiscal year
2003. The decrease reflects efficiencies gained in the reorganization as well as lower legal costs.
Asset impairment charge.
Results in fiscal year 2004 included a non-cash asset impairment charge of $16.5 million against our Bloomington, Minnesota contract manufacturing
facility
Other income, net. Other
income was $1.2 million for fiscal year 2004, a decrease of 37%, from fiscal year 2003. Investment income decreased as a result of lower investment
yields and the early payoff of a $1.9 million note receivable. In addition, much of the decrease reflects lower capital gains generated from our
investment portfolio. In fiscal year 2003, our investment advisor sold and reinvested a portion of our bond portfolio generating gains of $461,000.
Results in fiscal year 2004 reflect approximately $187,000 in gains from such sales. Previously reported fiscal year 2004 results have been
retroactively adjusted to show the impact of accounting for InnoRx under the equity method. Prior to completing the acquisition of InnoRx in January
2005, we accounted for our investment in InnoRx under the cost method.
Income tax provision. Our
income tax provision was $4.4 million in fiscal year 2004 compared to $8.6 million in fiscal year 2003. The effective tax rate was 37.2% in fiscal year
2004, a decrease from 38.0% in fiscal year 2003.
Liquidity and Capital Resources
As of September 30, 2005, we had
working capital of $36.5 million and cash, cash equivalents and investments totaling $73.3 million. Our investments principally consist of U.S.
government and government agency obligations and investment grade, interest-bearing corporate debt securities with varying maturity dates, the majority
of which are five years or less. Our investment policy requires that no more than 5% of investments be held in any one credit issue, excluding U.S.
government and government agency obligations. The primary investment objective of the portfolio is to provide for the safety of principal and
appropriate liquidity while generating an above benchmark (Lehman Brothers 1-3 Year Government Index) total rate of return. Management plans to
continue to direct our investment advisors to manage our investments primarily for the safety of principal for the foreseeable future. We had positive
cash flows from operating activities of approximately $26.0 million in fiscal year 2005, compared with $23.2 million in fiscal year
2004.
We conduct a significant majority
of our operations at our Eden Prairie, Minnesota headquarters. In addition, we own a facility in Bloomington, Minnesota. We believe we have adequate
office space and manufacturing capacity in our Eden Prairie headquarters to support our business and strategic plan. As such, in September 2005, we
entered into an agreement to sell the Bloomington facility and plan to consolidate operations in Eden Prairie. During our fiscal third quarter,
construction began to improve the research and development capabilities at the Eden Prairie facility. Management estimates expending a total of
approximately $8 million. The capital improvements are expected to be completed during the second quarter of fiscal year 2006.
In February 2004, we invested
$2.1 million in InnoRx, Inc., an Alabama-based, early-stage company developing drug delivery devices and therapies for the ophthalmology market. We
made an additional investment of approximately $1.6 million in the first quarter of fiscal year 2005. On January 18, 2005, we entered into a merger
agreement whereby SurModics acquired all of the assets of InnoRx, Inc. by paying approximately $4.1 million in cash and issuing 600,064 shares of
SurModics common stock to InnoRx stockholders. On July 1, 2005, we issued 60,002 shares of SurModics’ common stock to the shareholders of InnoRx
upon the successful completion of the first milestone involving the InnoRx technology acquired in the purchase of InnoRx. Upon the successful
completion of the remaining development and commercial milestones involving InnoRx technology acquired in the transaction, we will be required to issue
up to an aggregate 540,062 additional shares of our common stock to the stockholders of InnoRx. As the transaction was accounted for as a purchase of
assets, SurModics was required to determine the fair value of the assets acquired and the total consideration given. The fair value was determined by
an outside valuation consultant. The assets of InnoRx we acquired consisted almost exclusively of in-process research and development assets. In our
second fiscal quarter of 2005, we
30
recorded a charge of $30.3
million to write-off the value of these in-process research and development assets. In connection with the purchase, we recorded an $8.1 million credit
to additional paid-in capital to record the aggregate estimated value of the contingent payment obligations. Since the contingent payment obligations
are recorded as additional paid-in capital, the obligations will not have any impact on future results of operations.
In January 2005, we made an
equity investment of approximately $3.9 million in OctoPlus, a privately owned company based in the Netherlands active in the development of
pharmaceutical formulations incorporating novel biodegradable polymers. The $3.9 million investment, which is accounted for under the cost method,
represents an ownership interest of less than 20%.
We have invested a total of $5.2
million in Novocell, Inc., a privately-held Irvine, California-based biotech firm that is developing a unique treatment for diabetes. Working with
Novocell, our researchers have created a coating that encapsulates pancreatic islet cells, the cells that produce insulin in the human body. If
successful, this treatment using coated islet cells could dramatically change the treatment of diabetes. While we anticipate that our investment in
Novocell will help facilitate the commercialization of our technology and result in revenue for the Company in the future, there can be no assurance
that this will occur. Novocell’s primary technology is in its development stage, and we anticipate that it will be years before commercialization
may be realized. The $5.2 million investment, which is accounted for under the cost method, is included in other assets and represents an ownership
interest of less than 5%.
In May 2005, we invested $1.0
million in ThermopeutiX, an early stage company developing novel medical devices for the treatment of vascular and neurovascular diseases, including
stroke. In addition to the investment, we have licensed our hydrophilic and hemocompatible coating technologies to ThermopeutiX for use with its
devices. The $1.0 million investment, which is accounted for under the cost method, represents an ownership interest of less than 20%.
Risks and uncertainties
surrounding a development-stage company’s ability to obtain on a timely and frequent basis financing needed to continue its development activities
currently affect, and will continually affect, the prospects of our investments in Novocell, OctoPlus and ThermopeutiX and the revenue they may
ultimately generate. There is no assurance that the development stage companies listed above will successfully meet their immediate or future financing
needs or that their financing needs will be met when required. If adverse results occur in the development of their respective technology, or if their
respective financing needs are not continually met, the viability of such companies, the value of our investment and their ability to be future sources
of revenue for the Company will be in jeopardy, and our investment in such companies would likely be considered impaired and charged against earnings
at such time.
In September 2004, we made a
commitment to purchase for $7 million certain additional sublicense rights and the accompanying future royalty revenue streams under certain
sublicenses through an amendment to our diagnostic format patent license with Abbott Laboratories. Prior to such amendment, we were receiving only a
portion of the royalties under such sublicenses. The first $5 million installment was paid in November 2004. The remaining installments are reflected
in other long-term liabilities.
As of September 30, 2005, we had
no debt, nor did we have any credit agreements. We believe that our existing capital resources will be adequate to fund our operations into the
foreseeable future.
Off-Balance Sheet Arrangements
We did not have any material
off-balance sheet arrangements at September 30, 2005 or during the year then ended.
Contractual Obligations
Presented below is a summary of
contractual obligations and other minimum commercial commitments. We do not have any long-term debt or any capital or material operating leases. See
Notes to Financial Statements for additional information regarding the below obligations and commitments.
31
|
|
|
|
Maturity by Fiscal Year
|
|
Contractual obligations
|
|
|
|
Total
|
|
2006
|
|
2007
|
|
2008
|
|
2009
|
2010
|
|
Thereafter
|
|
|
|
|
|
(in
millions)
|
Other
long-term liabilities reflected on balance sheet under GAAP |
|
|
|
$ |
2.0 |
|
|
|
— |
|
|
$ |
1.0 |
|
|
$ |
1.0 |
|
|
|
— |
|
— |
|
— |
|
Total |
|
|
|
$ |
2.0 |
|
|
|
— |
|
|
$ |
1.0 |
|
|
$ |
1.0 |
|
|
|
— |
|
— |
|
— |
|
New Accounting Pronouncements
In May 2005, FASB issued
Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB
Statement No. 3 (“SFAS 154”). This statement applies to all voluntary changes in accounting principle and changes required by an accounting
pronouncement where no specific transition provisions are included. SFAS 154 requires retrospective application to prior periods’ financial
statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of
the change. The provisions of SFAS 154 are effective for the Company for accounting changes and correction of errors made in fiscal year 2007. The
Company does not anticipate that the implementation of this standard will have a material impact on its financial position, results of operations or
cash flows.
In December 2004, the Financial
Accounting Standards Board issued a revision to Statement of Financial Accounting Standards 123 (SFAS 123(R)), Share-Based Payment. The revision
requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments granted to employees. The
statement eliminates the alternative method of accounting for employee share-based payments previously available under Accounting Principles Board
(APB) Opinion No. 25. The Statement is effective for the Company beginning in the first quarter of fiscal year 2006.
In March 2005, the Securities and
Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”), which provides guidance on the interaction
between SFAS 123(R) and certain SEC rules and regulations. SAB 107 was issued to assist issuers in their initial implementation of SFAS 123(R) and
enhance the information received by investors and other users of the financial statements. The Company will consider the guidance provided by SAB 107
as it implements SFAS 123(R) in the first quarter of fiscal year 2006.
In December 2004, the FASB staff
issued FSP FASB 109-1 that provides guidance on the application of FASB Statement No. 109, Accounting for Income Taxes, to the provision within the
American Jobs Creations Act of 2004 that provides a tax deduction on qualified production activities. This FSP is effective upon issuance. The adoption
of this FSP did not have a material impact on our results of operations or financial position for fiscal year 2005. The Company has not determined the
impact for fiscal year 2006.
In March 2004, the Emerging
Issues Task Force (“EITF”) released Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments” (“EITF 03-1”) regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for
under the FASB Statements No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“FAS 115”). The effective
date for evaluating whether an investment is other-than-temporarily impaired was delayed by FASB Staff Position (FSP) EITF Issue 03-1-1. In November
2005, the FASB issued FSP FAS 115-1 to clarify these rules. Effectively, the FSP issued in November 2005 reverts to the other-than-temporary guidance
that predated the original effective date of EITF 03-1; however, it maintains certain guidance in EITF 03-1 relative to testing of cost-method equity
securities and the disclosure requirements which have been effective since 2003. The FSP issued in November 2005 is effective for reporting periods
beginning after December 15, 2005. The adoption of the FSP issued in November 2005 is not anticipated to have a material effect on our balance sheet or
results of operations. The additional disclosures required by EITF 03-1 and maintained by the FSP issued in November 2005 have been considered for
inclusion in the notes to our audited fiscal 2005 financial statements
ITEM 7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company’s investment
policy requires investments with high credit quality issuers and limits the amount of credit exposure to any one issuer. The Company’s investments
principally consist of U.S. government and government agency obligations and investment-grade, interest-bearing corporate debt securities with
varying
32
maturity dates, the majority
of which are five years or less. Because of the credit criteria of the Company’s investment policies, the primary market risk associated with
these investments is interest rate risk. SurModics does not use derivative financial instruments to manage interest rate risk or to speculate on future
changes in interest rates. A one percentage point increase in interest rates would result in an approximate $1.0 million decrease in the fair value of
the Company’s available-for-sale securities as of September 30, 2005, but no material impact on the results of operations or cash flows.
Management believes that a reasonable change in raw material prices would not have a material impact on future earnings or cash flows because the
Company’s inventory exposure is not material.
Although we conduct business in
foreign countries, our international operations consist primarily of sales of reagent and stabilization chemicals. Additionally, all sales transactions
are denominated in U.S. dollars. Accordingly, we do not expect to be subject to material foreign currency risk with respect to future costs or cash
flows from our foreign sales. To date, we have not entered into any foreign currency forward exchange contracts or other derivative financial
instruments to hedge the effects of adverse fluctuations in foreign currency exchange.
ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA.
The balance sheets as of
September 30, 2005 and 2004 and the statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended
September 30, 2005, together with the independent auditors’ report thereon and related footnotes (including selected unaudited quarterly financial
data), begin on page F-1 of this Form 10-K.
ITEM
9. |
|
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE. |
None.
ITEM 9A. CONTROLS AND
PROCEDURES.
1. Disclosure Controls and Procedures.
As of the end of the period
covered by this report, the Company conducted an evaluation under the supervision and with the participation of the Company’s management,
including the Company’s Chief Executive Officer and Chief Financial Officer regarding the effectiveness of the design and operation of the
Company’s disclosure controls and procedures pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”).
Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and
procedures are effective to ensure that information that is required to be disclosed by the Company in reports that it files under the Exchange Act is
recorded, processed, summarized and reported within the time period specified in the rules of the Securities Exchange Commission.
2. Internal Control over Financial Reporting.
(a) |
|
Management’s Report on Internal Control Over Financial
Reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company.
Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control
— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation,
management concluded that the Company’s internal control over financial reporting was effective as of September 30, 2005. Management’s
assessment of the effectiveness of the Company’s internal control over financial reporting as of September 30, 2005 has been audited by Deloitte
& Touche LLP, an independent registered public accounting firm, as stated in their report below. |
(b) |
|
Attestation Report of the Independent Registered Public
Accounting Firm. |
33
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
Board of Directors and Stockholders
SurModics, Inc.
Eden Prairie, Minnesota
We have audited management’s
assessment, included in the accompanying Management’s Report on Internal Control over Financial Report, that SurModics, Inc. (the
“Company”) maintained effective internal control over financial reporting as of September 30, 2005, based on criteria established in
Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s
management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of
the Company’s internal control over financial reporting based on our audit.
We conducted our audit in
accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our
audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinions.
A company’s internal control
over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial
officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that
(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of
the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent
limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material
misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the
internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s
assessment that the Company maintained effective internal control over financial reporting as of September 30, 2005, is fairly stated, in all material
respects, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting
as of September 30, 2005, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission.
We have also audited, in
accordance with the standards of the Public Company Accounting Oversight Board (United States), the financial statements as of and for the year ended
September 30, 2005 of the Company and our report dated December 8, 2005 expressed an unqualified opinion on those financial
statements.
Minneapolis, Minnesota
December 8,
2005
34
3. |
|
Changes in Internal Controls |
There were no changes in the
Company’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are
reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B. OTHER
INFORMATION.
All information required to be
disclosed in a report on Form 8-K during the fourth quarter of the year covered by this Form 10-K has been reported.
35
PART III
ITEM 10. DIRECTORS AND EXECUTIVE
OFFICERS OF THE REGISTRANT.
The information required by Item
10 relating to directors, our audit committee, the nature of changes, if any, to procedures by which our shareholders may recommend nominees for
directors, codes of ethics and compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated herein by reference to the sections
entitled “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Code of Ethics and Business
Conduct” that appear in the Company’s definitive Proxy Statement for its 2006 Annual Meeting of Shareholders.
ITEM 11. EXECUTIVE
COMPENSATION.
The information required by Item
11 is incorporated herein by reference to the section entitled “Executive Compensation and Other Information” that appears in the
Company’s definitive Proxy Statement for its 2006 Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by Item
12 is incorporated herein by reference to the sections entitled “Principal Shareholders,” “Management Shareholdings” and
“Equity Compensation Plan Information” which appear in the Company’s definitive Proxy Statement for its 2006 Annual Meeting of
Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS.
None.
ITEM 14. PRINCIPAL ACCOUNTING
FEES AND SERVICES.
The information required by Item
14 is incorporated herein by reference to the section entitled “Independent Registered Public Accounting Firm” which appears in the
Company’s definitive Proxy Statement for its 2006 Annual Meeting of Shareholders.
36
PART IV
ITEM 15. EXHIBITS, FINANCIAL
STATEMENT SCHEDULES.
(a) |
|
1. Financial statements
The following statements
are included in this report on the pages indicated: |
|
|
|
|
Page (s)
|
Report of
Independent Registered Public Accounting Firm |
|
|
|
|
F-1 |
|
Balance
Sheets |
|
|
|
|
F-2 |
|
Statements of
Operations |
|
|
|
|
F-3 |
|
Statements of
Stockholders’ Equity |
|
|
|
|
F-4 |
|
Statements of
Cash Flows |
|
|
|
|
F-5 |
|
Notes to
Financial Statements |
|
|
|
|
F-6–F-15 |
|
2. Financial Statement Schedules. All schedules for which provision is made in the applicable accounting regulations of the
Securities and Exchange Commission other than the ones listed above are not required under the related instructions or are not applicable, and,
therefore, have been omitted.
3. Listing of
Exhibits. The exhibits which are filed with this report or which are incorporated herein by reference are set forth in the Exhibit Index following
the signature page.
37
SIGNATURES
Pursuant to the requirements of
Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized.
SURMODICS, INC.
(“Registrant”)
Dated: December 14,
2005By: |
|
/s/ Bruce J Barclay
Bruce J Barclay
Chief
Executive Officer |
Pursuant to the requirements of
the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant, in the capacities, and on
the dates indicated.
(Power of Attorney)
Each person whose signature
appears below authorizes BRUCE J BARCLAY and PHILIP D. ANKENY, and constitutes and appoints said persons as his true and lawful attorneys-in-fact and
agents, each acting alone, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to
sign any or all amendments to this Annual Report on Form 10-K and to file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, authorizing said persons and granting unto said attorneys-in-fact and agents, each acting
alone, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully
to all intents and purposes as he might or could do in person, hereby ratifying and confirming all said attorneys-in-fact and agents, each acting
alone, or his substitute or substitutes, may lawfully do or cause to be done by virtue thereof.
Signature
|
|
|
|
Title
|
|
Date
|
/s/ Bruce J
Barclay
Bruce J Barclay |
|
|
|
President and Chief Executive Officer (principal executive officer) |
|
December
14, 2005 |
| |
/s/ Philip D.
Ankeny
Philip D. Ankeny |
|
|
|
Chief Financial Officer (principal financial officer) and Vice President |
|
December
14, 2005 |
| |
/s/ Loren R.
Miller
Loren R. Miller |
|
|
|
Vice
President and Controller (principal accounting officer) |
|
December
14, 2005 |
| |
/s/ Dale R.
Olseth
Dale R. Olseth |
|
|
|
Executive Chairman, Director |
|
December
14, 2005 |
| |
/s/ Jose H.
Bedoya
Jose H. Bedoya |
|
|
|
Director |
|
December
14, 2005 |
| |
/s/ John W.
Benson
John W. Benson |
|
|
|
Director |
|
December
14, 2005 |
| |
/s/ Gerald B.
Fischer
Gerald B. Fischer |
|
|
|
Director |
|
December
14, 2005 |
| |
/s/ Kenneth H.
Keller
Kenneth H. Keller |
|
|
|
Director |
|
December
14, 2005 |
| |
/s/ David A.
Koch
David A. Koch |
|
|
|
Director |
|
December
14, 2005 |
| |
/s/ Kendrick
B. Melrose
Kendrick B. Melrose |
|
|
|
Director |
|
December
14, 2005 |
| |
/s/ John A.
Meslow
John A. Meslow |
|
|
|
Director |
|
December
14, 2005 |
38
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
Board of Directors and Stockholders
SurModics, Inc.
Eden Prairie, Minnesota
We have audited
the accompanying balance sheets of SurModics, Inc. (the “Company”) as of September 30, 2005 and 2004, and the related statements of
operations, stockholders’ equity, and cash flows for each of the three years in the period ended September 30, 2005. These financial statements
are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our
audits.
We conducted our audits in
accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such financial
statements present fairly, in all material respects, the financial position of SurModics, Inc. as of September 30, 2005 and 2004, and the results of
their operations and their cash flows for each of the three years in the period ended September 30, 2005, in conformity with accounting principles
generally accepted in the United States of America.
We have also audited, in
accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal
control over financial reporting as of September 30, 2005, based on the criteria established in Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated December 8, 2005 expressed an unqualified opinion
on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the
effectiveness of the Company’s internal control over financial reporting.
Minneapolis, Minnesota
December 8,
2005
F-1
SurModics, Inc.
Balance Sheets
As of
September 30
(thousands, except share data)
|
|
|
|
2005
|
|
2004
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
Current
Assets
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents |
|
|
|
$ |
3,921 |
|
|
$ |
2,709 |
|
Short-term
investments |
|
|
|
|
20,524 |
|
|
|
16,506 |
|
Accounts
receivable, net of allowance for doubtful accounts of $40 as of September 30, 2005 and 2004 |
|
|
|
|
10,996 |
|
|
|
8,130 |
|
Income taxes
receivable |
|
|
|
|
3,640 |
|
|
|
— |
|
Inventories |
|
|
|
|
1,091 |
|
|
|
1,040 |
|
Deferred tax
asset |
|
|
|
|
353 |
|
|
|
379 |
|
Prepaids and
other |
|
|
|
|
1,079 |
|
|
|
805 |
|
Total current
assets |
|
|
|
|
41,604 |
|
|
|
29,569 |
|
| |
Property and
Equipment, net |
|
|
|
|
14,832 |
|
|
|
15,738 |
|
Long-Term
Investments |
|
|
|
|
48,874 |
|
|
|
44,088 |
|
Deferred Tax
Asset |
|
|
|
|
2,868 |
|
|
|
5,579 |
|
Other Assets,
net |
|
|
|
|
16,047 |
|
|
|
14,613 |
|
Total
Assets |
|
|
|
$ |
124,225 |
|
|
$ |
109,587 |
|
| |
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
|
Current
Liabilities
|
|
|
|
|
|
|
|
|
|
|
Accounts
payable |
|
|
|
$ |
1,163 |
|
|
$ |
683 |
|
Accrued
liabilities —
|
|
|
|
|
|
|
|
|
|
|
Compensation |
|
|
|
|
1,629 |
|
|
|
894 |
|
Accrued
income taxes payable |
|
|
|
|
— |
|
|
|
3,827 |
|
Accrued
other |
|
|
|
|
1,917 |
|
|
|
5,857 |
|
Deferred
revenue |
|
|
|
|
414 |
|
|
|
528 |
|
Total current
liabilities |
|
|
|
|
5,123 |
|
|
|
11,789 |
|
| |
Deferred
Revenue, less current portion |
|
|
|
|
1,521 |
|
|
|
1,488 |
|
Other Long-Term
Liabilities |
|
|
|
|
2,000 |
|
|
|
2,000 |
|
Total
liabilities |
|
|
|
|
8,644 |
|
|
|
15,277 |
|
Commitments and
Contingencies (Note 6)
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ Equity
|
|
|
|
|
|
|
|
|
|
|
Series A
preferred stock — $.05 par value, 450,000 shares authorized, no shares issued and outstanding |
|
|
|
|
— |
|
|
|
— |
|
Common stock
— $.05 par value, 45,000,000 shares authorized 18,535,761 and 17,536,656 shares issued and outstanding |
|
|
|
|
927 |
|
|
|
877 |
|
Additional
paid-in capital |
|
|
|
|
89,721 |
|
|
|
57,849 |
|
Unearned
compensation |
|
|
|
|
(2,621 |
) |
|
|
(632 |
) |
Accumulated
other comprehensive income (loss) |
|
|
|
|
(360 |
) |
|
|
56 |
|
Retained
earnings |
|
|
|
|
27,914 |
|
|
|
36,160 |
|
Total
stockholders’ equity |
|
|
|
|
115,581 |
|
|
|
94,310 |
|
Total
Liabilities and Stockholders’ Equity |
|
|
|
$ |
124,225 |
|
|
$ |
109,587 |
|
The accompanying notes are an integral part of these
financial statements.
F-2
SurModics, Inc.
Statements of Operations
For the
Years Ended September 30
(thousands, except net income per share)
|
|
|
|
2005
|
|
2004
|
|
2003
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalties and
license fees |
|
|
|
$ |
47,582 |
|
|
$ |
34,836 |
|
|
$ |
25,833 |
|
Product
sales |
|
|
|
|
9,403 |
|
|
|
10,478 |
|
|
|
11,804 |
|
Research and
development |
|
|
|
|
5,396 |
|
|
|
4,424 |
|
|
|
5,595 |
|
Total
revenue |
|
|
|
|
62,381 |
|
|
|
49,738 |
|
|
|
43,232 |
|
Operating
Costs and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product |
|
|
|
|
2,855 |
|
|
|
3,035 |
|
|
|
2,649 |
|
Research and
development |
|
|
|
|
16,072 |
|
|
|
12,633 |
|
|
|
12,000 |
|
Sales and
marketing |
|
|
|
|
1,209 |
|
|
|
1,683 |
|
|
|
2,014 |
|
General and
administrative |
|
|
|
|
6,496 |
|
|
|
5,416 |
|
|
|
5,929 |
|
Asset
impairment charge |
|
|
|
|
2,487 |
|
|
|
16,497 |
|
|
|
— |
|
Purchased
in-process research & development |
|
|
|
|
30,277 |
|
|
|
— |
|
|
|
— |
|
Total
operating costs and expenses |
|
|
|
|
59,396 |
|
|
|
39,264 |
|
|
|
22,592 |
|
Income from
Operations |
|
|
|
|
2,985 |
|
|
|
10,474 |
|
|
|
20,640 |
|
Other Income,
net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
income |
|
|
|
|
1,967 |
|
|
|
1,185 |
|
|
|
1,398 |
|
Other income
(loss) |
|
|
|
|
(602 |
) |
|
|
(7 |
) |
|
|
461 |
|
Other income,
net |
|
|
|
|
1,365 |
|
|
|
1,178 |
|
|
|
1,859 |
|
Income Before
Income Taxes |
|
|
|
|
4,350 |
|
|
|
11,652 |
|
|
|
22,499 |
|
Income Tax
Provision |
|
|
|
|
(12,596 |
) |
|
|
(4,410 |
) |
|
|
(8,563 |
) |
Net income
(loss) |
|
|
|
|
($8,246 |
) |
|
$ |
7,242 |
|
|
$ |
13,936 |
|
| |
Basic net
income (loss) per share |
|
|
|
|
($0.45 |
) |
|
$ |
0.41 |
|
|
$ |
0.80 |
|
Diluted net
income (loss) per share |
|
|
|
|
($0.45 |
) |
|
$ |
0.41 |
|
|
$ |
0.78 |
|
| |
Weighted
Average Shares Outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
|
|
18,131 |
|
|
|
17,501 |
|
|
|
17,363 |
|
Dilutive
effect of outstanding stock options |
|
|
|
|
— |
|
|
|
299 |
|
|
|
474 |
|
Diluted |
|
|
|
|
18,131 |
|
|
|
17,800 |
|
|
|
17,837 |
|
The accompanying notes are an integral part of these
financial statements.
F-3
SurModics, Inc.
Statements of Stockholders’
Equity
For the Years Ended September 30, 2005, 2004 and 2003
|
|
|
|
Common Stock
|
|
(in thousands)
|
|
|
|
Shares
|
|
Amount
|
|
Additional
Paid-In
Capital
|
|
Unearned
Compensation
|
|
Accumulated
Other
Comprehensive
Income
(Loss)
|
|
Retained
Earnings
|
|
Total
Stockholders’
Equity
|
Balance,
September 30, 2002 |
|
|
|
|
17,272 |
|
|
$ |
864 |
|
|
$ |
53,936 |
|
|
$ |
(460 |
) |
|
$ |
673 |
|
|
$ |
14,982 |
|
|
$ |
69,995 |
|
Components of
comprehensive income, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
13,936 |
|
|
|
13,936 |
|
Unrealized
holding losses on available-for-sale securities arising during the period |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(51 |
) |
|
|
— |
|
|
|
(51 |
) |
Less
reclassification for gains included in net income,
net of tax |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(285 |
) |
|
|
— |
|
|
|
(285 |
) |
Comprehensive
income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13,600 |
|
Issuance of
common stock |
|
|
|
|
17 |
|
|
|
1 |
|
|
|
404 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
405 |
|
Common stock
options
exercised, net |
|
|
|
|
149 |
|
|
|
7 |
|
|
|
765 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
772 |
|
Tax benefit
from exercise of stock options |
|
|
|
|
— |
|
|
|
— |
|
|
|
1,186 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1,186 |
|
Restricted
stock activity |
|
|
|
|
1 |
|
|
|
— |
|
|
|
162 |
|
|
|
(162 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
Amortization
of unearned compensation |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
156 |
|
|
|
— |
|
|
|
— |
|
|
|
156 |
|
Balance,
September 30, 2003 |
|
|
|
|
17,439 |
|
|
|
872 |
|
|
|
56,453 |
|
|
|
(466 |
) |
|
|
337 |
|
|
|
28,918 |
|
|
|
86,114 |
|
Components of
comprehensive income, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
7,242 |
|
|
|
7,242 |
|
Unrealized
holding losses on available-for-sale securities arising during the period |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(164 |
) |
|
|
— |
|
|
|
(164 |
) |
Less
reclassification for gains included in net income, net of tax |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(117 |
) |
|
|
— |
|
|
|
(117 |
) |
Comprehensive
income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,961 |
|
Issuance of
common stock |
|
|
|
|
19 |
|
|
|
1 |
|
|
|
344 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
345 |
|
Common stock
options
exercised, net |
|
|
|
|
63 |
|
|
|
3 |
|
|
|
350 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
353 |
|
Tax benefit
from exercise of stock options |
|
|
|
|
— |
|
|
|
— |
|
|
|
325 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
325 |
|
Restricted
stock activity |
|
|
|
|
16 |
|
|
|
1 |
|
|
|
377 |
|
|
|
(378 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
Amortization
of unearned compensation |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
212 |
|
|
|
— |
|
|
|
— |
|
|
|
212 |
|
Balance,
September 30, 2004 |
|
|
|
|
17,537 |
|
|
|
877 |
|
|
|
57,849 |
|
|
|
(632 |
) |
|
|
56 |
|
|
|
36,160 |
|
|
|
94,310 |
|
Components of
comprehensive loss, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(8,246 |
) |
|
|
(8,246 |
) |
Unrealized
holding losses on available-for-sale securities arising during the period |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(481 |
) |
|
|
— |
|
|
|
(481 |
) |
Less
reclassification for losses included in net income, net of tax |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
65 |
|
|
|
— |
|
|
|
65 |
|
Comprehensive
loss |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(8,662 |
) |
Issuance of
common stock |
|
|
|
|
682 |
|
|
|
34 |
|
|
|
25,731 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
25,765 |
|
Common stock
options
exercised, net |
|
|
|
|
244 |
|
|
|
12 |
|
|
|
2,310 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
2,322 |
|
Tax benefit
from exercise of stock options |
|
|
|
|
— |
|
|
|
— |
|
|
|
1,258 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1,258 |
|
Restricted
stock activity |
|
|
|
|
73 |
|
|
|
4 |
|
|
|
2,573 |
|
|
|
(2,577 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
Amortization
of unearned compensation |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
588 |
|
|
|
— |
|
|
|
— |
|
|
|
588 |
|
Balance,
September 30, 2005 |
|
|
|
|
18,536 |
|
|
$ |
927 |
|
|
$ |
89,721 |
|
|
|
($2,621 |
) |
|
|
($360 |
) |
|
$ |
27,914 |
|
|
$ |
115,581 |
|
The accompanying notes are an integral part of these
financial statements.
F-4
SurModics, Inc.
Statements of Cash
Flows
For the Years Ended September 30 (in
thousands)
|
|
|
|
2005
|
|
2004
|
|
2003
|
Operating
Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
(loss) |
|
|
|
|
($8,246 |
) |
|
$ |
7,242 |
|
|
$ |
13,936 |
|
Adjustments
to reconcile net income (loss) to net cash provided by operating activities —
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization |
|
|
|
|
3,733 |
|
|
|
3,125 |
|
|
|
2,583 |
|
Loss (gain)
on InnoRx equity method and sales
of investments |
|
|
|
|
602 |
|
|
|
7 |
|
|
|
(461 |
) |
Asset
impairment charge |
|
|
|
|
2,487 |
|
|
|
16,497 |
|
|
|
— |
|
Noncash
compensation |
|
|
|
|
588 |
|
|
|
212 |
|
|
|
156 |
|
Purchased
in-process research & development |
|
|
|
|
30,277 |
|
|
|
— |
|
|
|
— |
|
Deferred
tax |
|
|
|
|
5,143 |
|
|
|
(5,640 |
) |
|
|
839 |
|
Tax benefit
from exercise of stock options |
|
|
|
|
1,258 |
|
|
|
325 |
|
|
|
1,186 |
|
Loss (gain)
on disposals of property and equipment |
|
|
|
|
(65 |
) |
|
|
22 |
|
|
|
1 |
|
Change in
operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable |
|
|
|
|
(2,866 |
) |
|
|
1,015 |
|
|
|
(3,639 |
) |
Inventories |
|
|
|
|
(51 |
) |
|
|
(177 |
) |
|
|
(117 |
) |
Accounts
payable and accrued liabilities |
|
|
|
|
912 |
|
|
|
(966 |
) |
|
|
447 |
|
Income
taxes |
|
|
|
|
(7,467 |
) |
|
|
2,269 |
|
|
|
2,043 |
|
Deferred
revenue |
|
|
|
|
(81 |
) |
|
|
(663 |
) |
|
|
202 |
|
Prepaids and
other |
|
|
|
|
(274 |
) |
|
|
(78 |
) |
|
|
(124 |
) |
Net cash
provided by operating activities |
|
|
|
|
25,950 |
|
|
|
23,190 |
|
|
|
17,052 |
|
Investing
Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of
property and equipment |
|
|
|
|
(2,109 |
) |
|
|
(5,474 |
) |
|
|
(15,454 |
) |
Purchases of
available-for-sale investments |
|
|
|
|
(98,716 |
) |
|
|
(45,976 |
) |
|
|
(42,896 |
) |
Sales/maturities of available-for-sale investments |
|
|
|
|
88,955 |
|
|
|
27,092 |
|
|
|
35,885 |
|
Purchase of
equity in OctoPlus, Novocell and other |
|
|
|
|
(5,133 |
) |
|
|
(302 |
) |
|
|
(925 |
) |
Purchase of
licenses |
|
|
|
|
(5,238 |
) |
|
|
(64 |
) |
|
|
(10 |
) |
Investment in
and acquisition costs for InnoRx |
|
|
|
|
(5,181 |
) |
|
|
(2,331 |
) |
|
|
— |
|
Repayment of
notes receivable |
|
|
|
|
— |
|
|
|
1,869 |
|
|
|
(30 |
) |
Net cash used
in investing activities |
|
|
|
|
(27,422 |
) |
|
|
(25,186 |
) |
|
|
(23,430 |
) |
Financing
Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of
common stock |
|
|
|
|
2,684 |
|
|
|
698 |
|
|
|
1,178 |
|
Net cash
provided by financing activities |
|
|
|
|
2,684 |
|
|
|
698 |
|
|
|
1,178 |
|
Net increase
(decrease) in cash and
cash equivalents |
|
|
|
|
1,212 |
|
|
|
(1,298 |
) |
|
|
(5,200 |
) |
Cash and Cash
Equivalents
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of
year |
|
|
|
|
2,709 |
|
|
|
4,007 |
|
|
|
9,207 |
|
End of
year |
|
|
|
$ |
3,921 |
|
|
$ |
2,709 |
|
|
$ |
4,007 |
|
Supplemental
Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for
taxes |
|
|
|
$ |
13,780 |
|
|
$ |
7,265 |
|
|
$ |
4,327 |
|
Noncash
transaction-purchase Abbott
Laboratories sublicense |
|
|
|
|
— |
|
|
$ |
7,020 |
|
|
|
— |
|
Noncash
transaction-acquisition of property, plant, and equipment on account |
|
|
|
$ |
1,268 |
|
|
$ |
248 |
|
|
$ |
4,298 |
|
The accompanying notes are an integral part of these
financial statements.
F-5
SurModics, Inc.
Notes to Financial Statements
September 30, 2005 and 2004
1. Description
SurModics, Inc. (the Company)
develops, manufactures and markets innovative surface modification and drug delivery technologies for the healthcare industry. The Company’s
revenue is derived from three primary sources: (1) royalties and license fees from licensing its patented surface modification and drug delivery
technologies and in vitro diagnostic formats to customers; (2) the sale of reagent chemicals to licensees of our technologies, stabilization products
to the diagnostics industry, and coated slides to the genomics market; and (3) research and development fees generated on projects for
customers.
2. Summary of Significant
Accounting Policies
Cash and Cash Equivalents
Cash and cash equivalents consist
principally of money market instruments with original maturities of three months or less and are stated at cost which approximates fair
value.
Investments
Investments consist principally
of U.S. government and government agency obligations and mortgage-backed securities and are classified as available-for-sale as of September 30, 2005
and 2004. Available-for-sale investments are reported at fair value with unrealized gains and losses excluded from operations and reported as a
separate component of stockholders’ equity, except for other-than-temporary impairments, which are reported as a charge to current operations and
result in a new cost basis for the investment.
The original cost, unrealized
holding gains and losses, and fair value of investments as of September 30 were as follows (in thousands):
|
|
|
|
2005
|
|
|
|
|
|
Original Cost
|
|
Unrealized Gains
|
|
Unrealized Losses
|
|
Fair Value
|
U.S.
government obligations |
|
|
|
$ |
32,392 |
|
|
$ |
36 |
|
|
|
($256 |
) |
|
$ |
32,172 |
|
Mortgage-backed securities |
|
|
|
|
15,782 |
|
|
|
37 |
|
|
|
(157 |
) |
|
|
15,662 |
|
Asset-backed
securities |
|
|
|
|
10,744 |
|
|
|
3 |
|
|
|
(81 |
) |
|
|
10,666 |
|
Municipal
bonds |
|
|
|
|
10,127 |
|
|
|
1 |
|
|
|
(154 |
) |
|
|
9,974 |
|
Corporate
bonds |
|
|
|
|
927 |
|
|
|
1 |
|
|
|
(4 |
) |
|
|
924 |
|
Total |
|
|
|
$ |
69,972 |
|
|
$ |
78 |
|
|
|
($652 |
) |
|
$ |
69,398 |
|
|
|
|
|
2004
|
|
|
|
|
|
Original Cost
|
|
Unrealized Gains
|
|
Unrealized Losses
|
|
Fair Value
|
Mortgage-backed securities |
|
|
|
$ |
28,035 |
|
|
$ |
82 |
|
|
|
($ 56 |
) |
|
$ |
28,061 |
|
U.S.
government obligations |
|
|
|
|
15,172 |
|
|
|
95 |
|
|
|
(64 |
) |
|
|
15,203 |
|
Asset-backed
securities |
|
|
|
|
6,015 |
|
|
|
6 |
|
|
|
(16 |
) |
|
|
6,005 |
|
Municipal
bonds |
|
|
|
|
9,949 |
|
|
|
57 |
|
|
|
(31 |
) |
|
|
9,975 |
|
Corporate
bonds |
|
|
|
|
1,350 |
|
|
|
— |
|
|
|
— |
|
|
|
1,350 |
|
Total |
|
|
|
$ |
60,521 |
|
|
$ |
240 |
|
|
|
($167 |
) |
|
$ |
60,594 |
|
F-6
The original cost and fair value
of investments by contractual maturity at September 30, 2005, were as follows (in thousands):
|
|
|
|
Original Cost
|
|
Fair Value
|
Debt securities
due within:
|
|
|
|
|
|
|
|
|
|
|
One
year |
|
|
|
$ |
20,504 |
|
|
$ |
20,524 |
|
One to five
years |
|
|
|
|
33,765 |
|
|
|
33,260 |
|
Five years or
more |
|
|
|
|
15,703 |
|
|
|
15,614 |
|
Total |
|
|
|
$ |
69,972 |
|
|
$ |
69,398 |
|
The following table summarizes
sales of available-for-sale securities for the years ended September 30, 2005, 2004, and 2003 (in thousands):
|
|
|
|
2005
|
|
2004
|
|
2003
|
Proceeds from
sales |
|
|
|
$88,955 |
|
$27,092 |
|
$35,885 |
Gross realized
gains |
|
|
|
$17 |
|
$187 |
|
$506 |
Gross realized
losses |
|
|
|
($119) |
|
$0 |
|
($45) |
Inventories
Inventories are stated at the
lower of cost or market using the specific identification method and include direct labor, materials and overhead. Inventories consisted of the
following as of September 30 (in thousands):
|
|
|
|
2005
|
|
2004
|
Raw
materials |
|
|
|
$ |
512 |
|
|
$ |
634 |
|
Finished
products |
|
|
|
|
579 |
|
|
|
406 |
|
Total |
|
|
|
$ |
1,091 |
|
|
$ |
1,040 |
|
Property and Equipment
Property and equipment are stated
at cost and are depreciated using the straight-line method over 3 to 30 years, the estimated useful lives of the assets. The Company recorded
depreciation expense of approximately $2.0 million in 2005, $3.1 million in 2004, and $2.6 million in 2003.
In September 2005, the Company
entered an agreement to sell a building and 27 acres of land located in Bloomington, Minnesota. SurModics intends to occupy portions of the building
until modifications to the Company’s Eden Prairie, Minnesota facility are complete, at which time the Company will consolidate operations at its
Eden Prairie headquarters. The Company will continue to record depreciation expense on the facility until completion of the sale. The Company expects
to vacate the Bloomington facility by the end of the third quarter of fiscal 2006.
The 2005 and 2004 balances in
construction-in-progress include the cost of enhancing the capabilities of our facilities. Once placed in service, construction-in-progress is
transferred to the specific property and equipment categories and depreciated over the estimated useful lives of the assets.
Property and equipment consisted
of the following components as of September 30 (in thousands):
|
|
|
|
2005
|
|
2004
|
|
Useful life
(in years)
|
Laboratory
fixtures and equipment |
|
|
|
$ |
9,550 |
|
|
$ |
9,954 |
|
|
|
3 to 5 |
|
Building and
improvements |
|
|
|
|
7,306 |
|
|
|
7,411 |
|
|
|
5 to 30 |
|
Building
subject to sale agreement |
|
|
|
|
6,650 |
|
|
|
8,955 |
|
|
|
5 to 30 |
|
Office
furniture and equipment |
|
|
|
|
2,718 |
|
|
|
3,152 |
|
|
|
3 to 5 |
|
Construction-in-progress |
|
|
|
|
2,456 |
|
|
|
127 |
|
|
|
|
|
Less
accumulated depreciation and amortization |
|
|
|
|
(13,848 |
) |
|
|
(13,861 |
) |
|
|
|
|
Property and
equipment, net |
|
|
|
$ |
14,832 |
|
|
$ |
15,738 |
|
|
|
|
|
F-7
Other Assets
Other assets consist principally
of investments, acquired patents, and licenses. The cost of patents is amortized over 4 to 19 years. The Company recorded amortization expense of $1.7
million in 2005, $22,000 in 2004, and $23,000 in 2003.
In September 2004, we made a
commitment to purchase for $7 million certain additional sublicense rights and the accompanying future royalty revenue streams under certain
sublicenses through an amendment to our diagnostic format patent license with Abbott Laboratories. Prior to such amendment, we were receiving only a
portion of the royalties under such sublicenses. The first $5 million installment was paid in November 2004. The remaining installments are reflected
in other long-term liabilities.
In February 2004, the Company
invested $2.1 million in InnoRx, Inc., an Alabama-based, early-stage company developing drug delivery devices and therapies for the ophthalmology
market. SurModics made an additional investment of approximately $1.6 million in the first quarter of fiscal year 2005. On January 18, 2005, SurModics
acquired via a merger all of InnoRx’s assets by paying approximately $4.1 million in cash, issuing 600,064 shares of SurModics common stock to
InnoRx stockholders and agreeing to issue up to an additional 600,064 shares if certain development and commercial milestones are met. On July 1, 2005,
the Company issued 60,002 shares of SurModics common stock to the shareholders of InnoRx upon the successful completion of the first milestone
involving the InnoRx technology acquired in the purchase of InnoRx. Upon the successful completion of the remaining development and commercial
milestones involving InnoRx technology acquired in the transaction, the Company will be required to issue up to an aggregate 540,062 additional shares
of our common stock to the stockholders of InnoRx. As the transaction was accounted for as a purchase of assets, SurModics was required to determine
the fair value of the assets acquired and the total consideration given. The assets of InnoRx we acquired consisted almost exclusively of in-process
research and development assets. In the second fiscal quarter of 2005, we recorded a charge of $30.3 million to write-off the value of these in-process
research and development assets. In connection with the purchase, the Company recorded an $8.1 million credit to additional paid-in capital to record
the aggregate estimated value of the contingent payment obligations. Since the contingent payment obligations are recorded as additional paid-in
capital, the obligations will not have any impact on future results of operations.
SurModics has invested a total of
$5.2 million in Novocell, Inc., a privately-held Irvine, California-based biotech firm that is developing a unique treatment for diabetes using coated
islet cells, the cells that produce insulin in the human body. The $5.2 million investment, which is accounted for under the cost method, is included
in other assets and represents an ownership interest of less than 5%. In January 2005, the Company made an equity investment of approximately $3.9
million in OctoPlus, a privately owned company based in the Netherlands active in the development of pharmaceutical formulations incorporating novel
biodegradable polymers. The $3.9 million investment, which is accounted for under the cost method, represents an ownership interest of less than 20%.
In May 2005, the Company invested $1.0 million in ThermopeutiX, an early stage company developing novel medical devices for the treatment of vascular
and neurovascular diseases, including stroke. In addition to the investment, SurModics has licensed its hydrophilic and hemocompatible coating
technologies to ThermopeutiX for use with its devices. The $1.0 million investment, which is accounted for under the cost method, represents an
ownership interest of less than 20%.
The Company expects to incur
approximately $1.7 million of amortization expense in fiscal 2006 through 2008, $436,000 in fiscal 2009, and $18,000 in fiscal 2010 related to all of
its licenses and patents.
Other assets consisted of the
following as of September 30 (in thousands):
|
|
|
|
2005
|
|
2004
|
Abbott
license |
|
|
|
$ |
7,037 |
|
|
$ |
7,020 |
|
Investment in
Novocell |
|
|
|
|
5,210 |
|
|
|
5,210 |
|
Investment in
InnoRx |
|
|
|
|
— |
|
|
|
1,968 |
|
Investment in
OctoPlus |
|
|
|
|
3,935 |
|
|
|
— |
|
Investment in
ThermopeutiX |
|
|
|
|
1,000 |
|
|
|
— |
|
Patents and
other |
|
|
|
|
732 |
|
|
|
599 |
|
Less accumulated
amortization |
|
|
|
|
(1,867 |
) |
|
|
(184 |
) |
Other assets,
net |
|
|
|
$ |
16,047 |
|
|
$ |
14,613 |
|
F-8
Stock-Based Compensation
The Company accounts for stock
options under the intrinsic value method as described in APB Opinion No. 25, “Accounting for Stock Issued to Employees”, under which no
compensation expense has been recognized. Had compensation expense for the options been determined using the fair value method described in Statements
of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for
Stock-Based Compensation-Transition and Disclosure”, the Company’s net income (loss) and earnings per share would have changed to the
following pro forma amounts for the years ended September 30 (in thousands, except per share data):
|
|
|
|
2005
|
|
2004
|
|
2003
|
Net income
(loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
reported |
|
|
|
|
($8,246 |
) |
|
$ |
7,242 |
|
|
$ |
13,936 |
|
Fair value
compensation expense, net of tax |
|
|
|
|
(2,746 |
) |
|
|
(1,742 |
) |
|
|
(1,574 |
) |
Pro
forma |
|
|
|
|
($10,992 |
) |
|
$ |
5,500 |
|
|
$ |
12,362 |
|
Basic net
income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
reported |
|
|
|
|
($0.45 |
) |
|
$ |
0.41 |
|
|
$ |
0.80 |
|
Fair value
compensation expense, net of tax |
|
|
|
|
(0.16 |
) |
|
|
(0.10 |
) |
|
|
(0.09 |
) |
Pro
forma |
|
|
|
|
($0.61 |
) |
|
$ |
0.31 |
|
|
$ |
0.71 |
|
Diluted net
income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
reported |
|
|
|
|
($0.45 |
) |
|
$ |
0.41 |
|
|
$ |
0.78 |
|
Fair value
compensation expense, net of tax |
|
|
|
|
(0.16 |
) |
|
|
(0.10 |
) |
|
|
(0.09 |
) |
Pro
forma |
|
|
|
|
($0.61 |
) |
|
$ |
0.31 |
|
|
$ |
0.69 |
|
The fair value of each option is
estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 2005,
2004, and 2003 respectively: risk-free interest rates of 3.77%, 3.56%, and 3.05%; expected lives of 7.0, 7.4, and 7.4; and expected volatility of 63%,
66%, and 69%. See Note 4 for a detailed description of the Company’s 2003 Equity Incentive Plan.
Impairment of Long-Lived Assets
The Company periodically
evaluates whether events and circumstances have occurred that may affect the estimated useful life or the recoverability of the remaining balance of
long-lived assets, such as property and equipment and investments. If such events or circumstances were to indicate that the carrying amount of these
assets would not be recoverable, the Company would estimate the future cash flows expected to result from the use of the assets and their eventual
disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) or other measure of fair value was less than the
carrying amount of the assets, the Company would recognize an impairment loss. In fiscal 2004, the Company announced that after careful examination of
its redefined business goals, the Company believed its Bloomington contract manufacturing facility was no longer necessary for the execution of its
strategic plan. Accordingly, results in the third quarter of fiscal year 2004 included a non-cash asset impairment charge of $16.5 million. In
September 2005, the Company signed an agreement to sell the Bloomington property and facility and based on the selling price recorded an additional
$2.5 million impairment charge in the fourth quarter of fiscal year 2005.
Revenue Recognition
Royalty revenue is generated when
a licensed customer sells products incorporating the Company’s technologies. Royalty revenue is recognized as the Company’s licensees report
it to the Company, and payment is typically submitted concurrently with the report. The Company recognizes initial license fees over the term of the
related agreement. Revenue related to a performance milestone is recognized upon the achievement of the milestone, as defined in the respective
agreements. Revenue on sales of the Company’s products is recognized when persuasive evidence of an agreement exists, delivery has occurred, the
fee is fixed and determinable and collectibility is probable. Generally, these criteria are met at the time the Company’s product is shipped.
Revenue for research and development is recorded as performance progresses under the applicable contract.
F-9
Use of Estimates
The preparation of financial
statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Ultimate results could differ from those estimates.
Reclassifications and Retroactive
Adjustments
Certain reclassifications have
been made to the prior year’s financial statements in order to conform to the 2005 presentation. Fiscal year 2004 results have been retroactively
adjusted to show the impact of accounting for InnoRx under the equity method. The net impact reduced net income an approximate $194,000 from previously
reported results.
New Accounting Pronouncements
In May 2005, the Financial
Accounting Standards Board (FASB) issued SFAS No. 154, Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB
Statement No. 3 (“SFAS 154”). This statement applies to all voluntary changes in accounting principle and changes required by an accounting
pronouncement where no specific transition provisions are included. SFAS 154 requires retrospective application to prior periods’ financial
statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of
the change. The provisions of SFAS 154 are effective for the Company for accounting changes and correction of errors made in fiscal year 2007. The
Company does not anticipate that the implementation of this standard will have a material impact on its financial position, results of operations or
cash flows.
In December 2004, the FASB issued
SFAS 123(R), Share-Based Payment. The revision requires all entities to recognize compensation expense in an amount equal to the fair value of
share-based payments granted to employees. The statement eliminates the alternative method of accounting for employee share-based payments previously
available under APB Opinion No. 25. The Statement is effective for the Company beginning in the first quarter of fiscal year 2006.
In March 2005, the Securities and
Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”), which provides guidance on the interaction
between SFAS 123(R) and certain SEC rules and regulations. SAB 107 was issued to assist issuers in their initial implementation of SFAS 123(R) and
enhance the information received by investors and other users of the financial statements. The Company will consider the guidance provided by SAB 107
as it implements SFAS 123(R) in the first quarter of fiscal year 2006.
In March 2004, the Emerging
Issues Task Force (“EITF”) released Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments” (“EITF 03-1”) regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for
under the FASB Statements No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“FAS 115”). The effective
date for evaluating whether an investment is other-than-temporarily impaired was delayed by FASB Staff Position (FSP) EITF Issue 03-1-1. In November
2005, the FASB issued FSP FAS 115-1 to clarify these rules. Effectively, the FSP issued in November 2005 reverts to the other-than-temporary guidance
that predated the original effective date of EITF 03-1; however, it maintains certain guidance in EITF 03-1 relative to testing of cost-method equity
securities and the disclosure requirements which have been effective since 2003. The FSP issued in November 2005 is effective for reporting periods
beginning after December 15, 2005. The adoption of the FSP issued in November 2005 is not anticipated to have a material effect on our balance sheet or
results of operations. The additional disclosures required by EITF 03-1 and maintained by the FSP issued in November 2005 have been considered for
inclusion in the notes to our audited fiscal year 2005 financial statements.
In December 2004, the FASB staff
issued FSP FASB 109-1 that provides guidance on the application of SFAS No. 109, Accounting for Income Taxes, to the provision within the American Jobs
Creations Act of 2004 that provides a tax deduction on qualified production activities. This FSP is effective upon issuance. The adoption of this FSP
did not have a material impact on our results of operations or financial position for fiscal year 2005.
F-10
3. Stockholders’
Equity
1999 Employee Stock Purchase Plan
Under the 1999 Employee Stock
Purchase Plan (“Stock Purchase Plan”) the Company is authorized to issue up to 200,000 shares of Common Stock. All full-time and part-time
employees can choose to have up to 10% of their annual compensation withheld to purchase the Company’s Common Stock at purchase prices defined
within the provisions of the Stock Purchase Plan. The Company issued 21,556, 19,169, and 17,179 shares under the Stock Purchase Plan during fiscal
2005, 2004, and 2003, respectively. As of September 30, 2005 and 2004, there was approximately $233,000 and $255,000, respectively, of employee
contributions included in accrued liabilities in the accompanying balance sheets.
Restricted Stock Awards
The Company has entered into
restricted stock agreements with certain key employees, covering the issuance of Common Stock (“Restricted Stock”). The Restricted Stock will
be released to the key employees if they are employed by the Company at the end of the vesting period. Unearned compensation has been recognized for
the estimated fair value of the applicable common shares, reflected as a reduction of stockholders’ equity, and is being charged to income over
the five-year vesting term.
Transactions in restricted stock
were as follows:
Outstanding
at September 30, 2002 |
|
|
|
|
55,000 |
|
Granted |
|
|
|
|
5,000 |
|
Canceled |
|
|
|
|
(4,000 |
) |
Vested |
|
|
|
|
(8,000 |
) |
Outstanding
at September 30, 2003 |
|
|
|
|
48,000 |
|
Granted |
|
|
|
|
20,000 |
|
Canceled |
|
|
|
|
(4,000 |
) |
Vested |
|
|
|
|
(22,500 |
) |
Outstanding
at September 30, 2004 |
|
|
|
|
41,500 |
|
Granted |
|
|
|
|
73,500 |
|
Canceled |
|
|
|
|
— |
|
Vested |
|
|
|
|
(7,000 |
) |
| |
Outstanding
at September 30, 2005 |
|
|
|
|
108,000 |
|
4. Stock-Based Compensation
Plan
In fiscal year 2003, the Company
adopted and shareholders approved the SurModics, Inc. 2003 Equity Incentive Plan (the “2003 Plan”).
The 2003 Plan replaced the 1997
Incentive Stock Option Plan, which the shareholders had previously approved, and the Nonqualified Stock Option Plan and Restricted Stock Plan
previously adopted by the Board (collectively referred to as the “Prior Plans”). Upon shareholder approval of the 2003 Plan, no further stock
options or restricted stock awards were granted under the Prior Plans, it being the Board’s intention that all future options should be granted
under the 2003 Plan; however, any options and restricted stock awards outstanding under the Prior Plans shall remain subject to their terms and
conditions.
Under the Company’s 2003
Plan, the Board or the Compensation Committee may award nonqualified or incentive stock options and restricted stock awards (collectively referred to
as an “Award” or “Awards”) to officers, directors, consultants and employees (the “Participants”) of the Company. The
2003 Plan called for 600,000 shares of the Company’s common stock be made available for grants of Awards to Participants. If any Awards granted
under the Plan expire or terminate prior to exercise or otherwise lapse, the shares subject to such portion of the Award are available for subsequent
grants of Awards. In January 2005, shareholders approved an amendment to increase the shares reserved under the 2003 Plan by 1,800,000 shares to
2,400,000 shares.
F-11
The 2003 Plan requires that the
option price of Incentive Stock Options (“ISO”) be at least 100% of the fair market value of the Common Stock on the date of the grant or
110% with respect to optionees who own more than 10% of the total combined voting power of all classes of stock. Options expire in seven years or upon
termination of employment and are exercisable at a rate of 20% per year from the date of grant or 20% per year commencing one year after the date of
grant.
Nonqualified stock options issued
under the 2003 Plan are granted at fair market value on the date of grant. Options expire in 7 to 10 years and are exercisable at a rate of 20% per
year from the date of grant or 20% per year commencing two years after the date of grant.
As of September 30, 2005, there
were 1,216,450 additional shares available for grant under the 2003 Plan. Information regarding stock options under all plans is summarized as
follows:
Exercise Price Range
|
|
|
|
Shares
Outstanding at
September 30, 2005
|
|
Weighted Average
Exercise Price
|
|
Weighted Average
Remaining
Contractual
Life
(in years)
|
|
Shares
Exercisable at
September 30, 2005
|
|
Weighted Average
Exercise Price
|
| $2.50–$ 8.44 |
|
|
|
|
151,575 |
|
|
$ |
7.00 |
|
|
|
1.68 |
|
|
|
151,575 |
|
|
$ |
7.00 |
|
| $10.25–$21.82 |
|
|
|
|
311,240 |
|
|
|
21.19 |
|
|
|
5.69 |
|
|
|
81,400 |
|
|
|
20.26 |
|
| $22.46–$25.09 |
|
|
|
|
117,000 |
|
|
|
24.95 |
|
|
|
2.58 |
|
|
|
103,368 |
|
|
|
25.07 |
|
| $27.00–$29.89 |
|
|
|
|
669,950 |
|
|
|
29.38 |
|
|
|
6.03 |
|
|
|
60,020 |
|
|
|
29.32 |
|
| $30.13–$53.00 |
|
|
|
|
280,170 |
|
|
|
37.24 |
|
|
|
5.42 |
|
|
|
72,260 |
|
|
|
36.02 |
|
| |
|
|
|
|
1,529,935 |
|
|
$ |
26.60 |
|
|
|
5.16 |
|
|
|
468,623 |
|
|
$ |
20.62 |
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
|
Options
|
|
|
|
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Shares
|
|
Weighted
Average
Exercise
Price
|
Outstanding,
beginning of year |
|
|
|
|
1,147,563 |
|
|
$ |
20.12 |
|
|
|
982,965 |
|
|
$ |
19.57 |
|
|
|
964,215 |
|
|
$ |
14.86 |
|
Granted |
|
|
|
|
698,100 |
|
|
|
31.38 |
|
|
|
352,700 |
|
|
|
21.54 |
|
|
|
241,100 |
|
|
|
30.01 |
|
Exercised |
|
|
|
|
(244,418 |
) |
|
|
9.58 |
|
|
|
(62,052 |
) |
|
|
5.69 |
|
|
|
(155,418 |
) |
|
|
6.30 |
|
Canceled |
|
|
|
|
(71,310 |
) |
|
|
27.54 |
|
|
|
(126,050 |
) |
|
|
26.90 |
|
|
|
(66,932 |
) |
|
|
20.26 |
|
Outstanding,
end of year |
|
|
|
|
1,529,935 |
|
|
$ |
26.60 |
|
|
|
1,147,563 |
|
|
$ |
20.12 |
|
|
|
982,965 |
|
|
$ |
19.57 |
|
Exercisable,
end of year |
|
|
|
|
468,623 |
|
|
$ |
20.62 |
|
|
|
568,367 |
|
|
$ |
14.52 |
|
|
|
505,025 |
|
|
$ |
11.61 |
|
Weighted
average fair value of options granted |
|
|
|
$ |
20.26 |
|
|
|
|
|
|
$ |
14.57 |
|
|
|
|
|
|
$ |
20.69 |
|
|
|
|
|
F-12
5. Income
Taxes
The Company utilizes the
liability method to account for income taxes. Deferred taxes are based on the estimated future tax effects of differences between the financial
statement and tax basis of assets and liabilities given the provisions of the enacted tax laws.
The deferred income tax provision
reflects the net change during the year in deferred tax assets and liabilities. Income taxes in the accompanying statements of operations for the years
ended September 30 were as follows (in thousands):
|
|
|
|
2005
|
|
2004
|
|
2003
|
Current
provision:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
|
|
$ |
7,059 |
|
|
$ |
8,697 |
|
|
$ |
6,524 |
|
State and
foreign |
|
|
|
|
371 |
|
|
|
1,179 |
|
|
|
1,032 |
|
Total current
provision |
|
|
|
|
7,430 |
|
|
|
9,876 |
|
|
|
7,556 |
|
| |
Deferred
provision (benefit):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
|
|
|
4,592 |
|
|
|
(4,827 |
) |
|
|
981 |
|
State |
|
|
|
|
574 |
|
|
|
(639 |
) |
|
|
26 |
|
Total
deferred provision (benefit) |
|
|
|
|
5,166 |
|
|
|
(5,466 |
) |
|
|
1,007 |
|
Total
provision |
|
|
|
$ |
12,596 |
|
|
$ |
4,410 |
|
|
$ |
8,563 |
|
The
reconciliation of the difference between amounts calculated at the statutory federal tax rate and the Company’s effective tax rate was as follows
(in thousands):
|
|
|
|
2005
|
|
2004
|
|
2003
|
Amount at
statutory federal income tax rate |
|
|
|
$ |
1,513 |
|
|
$ |
4,146 |
|
|
$ |
7,870 |
|
Change due
to:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
State
taxes |
|
|
|
|
496 |
|
|
|
351 |
|
|
|
676 |
|
Other |
|
|
|
|
(10 |
) |
|
|
(87 |
) |
|
|
17 |
|
Write-off of
in-process R&D |
|
|
|
|
10,597 |
|
|
|
— |
|
|
|
— |
|
Income tax
provision |
|
|
|
$ |
12,596 |
|
|
$ |
4,410 |
|
|
$ |
8,563 |
|
The components
of deferred income taxes consisted of the following as of September 30 and result from differences in the recognition of transactions for income tax
and financial reporting purposes (in thousands):
|
|
|
|
2005
|
|
2004
|
Depreciable
assets |
|
|
|
$ |
1,584 |
|
|
$ |
4,851 |
|
Deferred
revenue |
|
|
|
|
611 |
|
|
|
625 |
|
Accruals and
reserves |
|
|
|
|
362 |
|
|
|
379 |
|
Restricted stock
amortization |
|
|
|
|
273 |
|
|
|
149 |
|
Equity
items |
|
|
|
|
(33 |
) |
|
|
(33 |
) |
Other |
|
|
|
|
— |
|
|
|
(13 |
) |
Net operating
loss |
|
|
|
|
424 |
|
|
|
— |
|
Total
deferred tax asset |
|
|
|
|
3,221 |
|
|
|
5,958 |
|
Current deferred
tax asset |
|
|
|
|
353 |
|
|
|
379 |
|
Noncurrent
deferred tax asset |
|
|
|
$ |
2,868 |
|
|
$ |
5,579 |
|
6. Commitments and
Contingencies
The Company is involved from time
to time in routine legal matters and other claims incidental to the business. The Company believes that the resolution of such routine matters and
other incidental claims, taking into account established reserves and insurance will not have a material adverse impact on its financial position,
results of operations, or cash flows.
F-13
7. Defined Contribution
Plan
The Company has a 401(k)
retirement and savings plan for the benefit of qualified employees. The Company matches 50% of each dollar of the first 6% of the tax deferral elected
by each employee. Company contributions totaling $223,000, $210,000, and $204,000 have been charged to income for the years ended September 30, 2005,
2004, and 2003.
8. Operating
Segments
Operating segments are defined as
components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker,
or decision making group, in deciding how to allocate resources and in assessing performance.
SurModics manages its business on
the basis of the operating segments noted in the table below, which are comprised of the Company’s six business units. The three operating
segments are aggregated into one reportable segment. The “Drug Delivery” operating segment contains the Drug Delivery business unit, which is
responsible for technologies dedicated to site specific delivery of drugs, and the Ophthalmology division, which is dedicated to the advancement of
treatments for eye diseases, such as age-related macular degeneration (AMD) and diabetic macular edema (DME), two of the leading causes of blindness.
The “Hydrophilic and Other” operating segment consists of three business units: (1) Hydrophilic Technologies business unit, which focuses on
enhancing medical devices with advanced lubricious coatings that facilitate their placement and maneuverability in the body; (2) Regenerative
Technologies business unit, which is developing platforms intended to augment or replace tissue/organ function (e.g., cell encapsulation applications),
or to modify medical devices to facilitate tissue/organ recovery through natural repair mechanisms (e.g., hemo/biocompatible coatings); and (3)
Orthopedics business unit, which is committed to innovative solutions for orthopedics patients using proven SurModics technologies, and creating new
technology solutions to existing patient care gaps in the orthopedics field. The “Diagnostics” operating segment contains the Diagnostics and
Drug Discovery business unit, which includes our genomics slide technologies, our stabilization products for immunoassay diagnostics tests, our in
vitro diagnostic format technology and the work being performed to develop synthetic cell culture products.
Each operating segment has
similar economic characteristics, technology, manufacturing processes, customers, regulatory environments, and shared infrastructures. The Company
manages its expenses on a company-wide basis, as many costs and activities are shared among the business units and a majority of the Company’s
employees reside in shared resource units. The focus of the business units is providing solutions to customers and maximizing revenue over the
long-term. The accounting policies for segment reporting are the same as for the Company as a whole. Revenue for each operating segment for the years
ended September 30 was as follows (in thousands):
|
|
|
|
2005
|
|
2004
|
|
2003
|
Operating
segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Drug
Delivery |
|
|
|
$ |
29,678 |
|
|
$ |
25,690 |
|
|
$ |
20,168 |
|
Hydrophilic
and Other |
|
|
|
|
19,065 |
|
|
|
15,527 |
|
|
|
12,380 |
|
Diagnostics |
|
|
|
|
13,638 |
|
|
|
8,521 |
|
|
|
10,684 |
|
Total
Revenue |
|
|
|
$ |
62,381 |
|
|
$ |
49,738 |
|
|
$ |
43,232 |
|
Major Customers
Revenue from customers that
exceed 10% of total revenue was as follows for the years ended September 30:
|
|
|
|
2005
|
|
2004
|
|
2003
|
Cordis
Corporation |
|
|
|
|
46 |
% |
|
|
52 |
% |
|
|
48 |
% |
Abbott
Laboratories |
|
|
|
|
14 |
% |
|
|
8 |
% |
|
|
10 |
% |
GE Healthcare
(formerly Amersham plc) |
|
|
|
|
6 |
% |
|
|
7 |
% |
|
|
13 |
% |
The revenues
from each of the customers are derived from all three primary sources: licensing, product sales, and research and development.
F-14
Geographic Revenue
Geographic revenues were as
follows for the years ended September 30:
|
|
|
|
2005
|
|
2004
|
|
2003
|
Domestic |
|
|
|
|
85 |
% |
|
|
79 |
% |
|
|
66 |
% |
Foreign |
|
|
|
|
15 |
% |
|
|
21 |
% |
|
|
34 |
% |
9. Quarterly Financial
Data
The following is a summary of the
unaudited quarterly results for the years ended September 30, 2005, 2004 and 2003 (in thousands, except per share data).
|
|
|
|
First Quarter
|
|
Second Quarter
|
|
Third Quarter
|
|
Fourth Quarter
|
Fiscal
Year 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
|
|
$ |
14,069 |
|
|
$ |
15,705 |
|
|
$ |
16,518 |
|
|
$ |
16,090 |
|
Income (loss)
from operations |
|
|
|
|
8,638 |
|
|
|
(21,148 |
) |
|
|
9,148 |
|
|
|
6,346 |
|
Net income
(loss) |
|
|
|
|
5,682 |
|
|
|
(24,371 |
) |
|
|
6,095 |
|
|
|
4,793 |
|
Net income
(loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
|
|
0.32 |
|
|
|
(1.34 |
) |
|
|
0.33 |
|
|
|
0.26 |
|
Diluted |
|
|
|
|
0.32 |
|
|
|
(1.34 |
) |
|
|
0.32 |
|
|
|
0.25 |
|
| |
Fiscal
Year 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
|
|
$ |
12,087 |
|
|
$ |
12,738 |
|
|
$ |
11,444 |
|
|
$ |
13,469 |
|
Income (loss)
from operations |
|
|
|
|
6,287 |
|
|
|
6,678 |
|
|
|
(10,787 |
) |
|
|
8,295 |
|
Net income
(loss) |
|
|
|
|
4,111 |
|
|
|
4,305 |
|
|
|
(6,551 |
) |
|
|
5,378 |
|
Net income
(loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
|
|
0.24 |
|
|
|
0.25 |
|
|
|
(0.37 |
) |
|
|
0.31 |
|
Diluted |
|
|
|
|
0.23 |
|
|
|
0.24 |
|
|
|
(0.37 |
) |
|
|
0.30 |
|
| |
Fiscal
Year 2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
|
|
$ |
8,048 |
|
|
$ |
9,742 |
|
|
$ |
12,819 |
|
|
$ |
12,623 |
|
Income from
operations |
|
|
|
|
2,856 |
|
|
|
3,992 |
|
|
|
6,958 |
|
|
|
6,834 |
|
Net
income |
|
|
|
|
2,171 |
|
|
|
2,750 |
|
|
|
4,572 |
|
|
|
4,443 |
|
Net income
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
|
|
0.13 |
|
|
|
0.16 |
|
|
|
0.26 |
|
|
|
0.25 |
|
Diluted |
|
|
|
|
0.12 |
|
|
|
0.15 |
|
|
|
0.26 |
|
|
|
0.25 |
|
In the second
quarter of fiscal year 2005, we recorded a charge of $30.3 million to write-off the value of in-process research and development assets acquired in the
purchase of InnoRx. In addition, fiscal year 2005 fourth quarter results include a $2.5 million impairment charge recorded against our Bloomington,
Minnesota contract manufacturing facility.
Fiscal year 2004 results have
been retroactively adjusted to show the impact of accounting for InnoRx under the equity method. The net impact reduced net income an approximate
$67,000 in the second quarter, $61,000 in the third quarter and $66,000 in the fourth quarter from previously reported results. Fiscal year 2004 third
quarter results include an impairment charge recorded against our Bloomington contract manufacturing facility. The $16.5 million impairment charge was
included in loss from operations.
F-15
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
20549
EXHIBIT INDEX TO FORM 10-K
For the Fiscal Year Ended September 30,
2005
SURMODICS, INC.
Exhibit
|
|
|
|
2.1 |
|
|
|
Agreement of Merger, dated January 18, 2005, with InnoRx, Inc. — incorporated by reference to Exhibit 2.1 to the Company’s Current
Report on Form 8-K dated January 18, 2005, SEC File No. 0-23837. |
3.1 |
|
|
|
Restated Articles of Incorporation, as amended — incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form
10-QSB for the quarter ended December 31, 1999, SEC File No. 0-23837. |
3.2 |
|
|
|
Bylaws, as amended to date — incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-QSB for the
quarter ended December 31, 1998, SEC File No. 0-23837. |
4.1 |
|
|
|
Rights Agreement, dated as of April 5, 1999, between the Company and Firstar Bank Milwaukee, NA., as Rights Agent, including as: Exhibit A
Statement of Designation of Series A Preferred Stock of the Company; Exhibit B Summary of Rights to Purchase Shares of Series A Preferred Stock; and
Exhibit C Form of Right Certificate — incorporated by reference to Exhibit 1 to the Company’s Registration of Securities on Form 8-A, SEC
File No. 0-23837. |
10.1* |
|
|
|
Company’s Incentive 1987 Stock Option Plan, including specimen of Incentive Stock Option Agreement — incorporated by reference to
Exhibit 10.2 to the Company’s Registration Statement on form SB-2, Reg. No. 333-43217. |
10.2* |
|
|
|
Company’s Incentive 1997 Stock Option Plan, including specimen of Incentive Stock Option Agreement — incorporated by reference to
Exhibit 10.3 to the Company’s Registration Statement on form SB-2, Reg. No. 333-43217. |
10.3* |
|
|
|
Form
of Restricted Stock Agreement under 1997 Plan — incorporated by reference to Exhibit 10.4 to the Company’s Registration Statement on form
SB-2, Reg. No. 333-43217. |
10.4* |
|
|
|
Form
of Non-qualified Stock Option Agreement under 1997 Plan — incorporated by reference to Exhibit 10.5 to the Company’s Registration Statement
on form SB-2, Reg. No. 333-43217. |
10.5 |
|
|
|
Form
of License Agreement — incorporated by reference to Exhibit 10.6 to the Company’s Registration Statement on form SB-2, Reg. No.
333-43217. |
10.6* |
|
|
|
SurModics, Inc. Executive Income Continuation Plan — incorporated by reference to Exhibit 10 to the Company’s Quarterly Report on
Form 10-QSB for the quarter ended June 30, 1999, SEC File No. 0-23837. |
10.7 |
|
|
|
Adjusted License Agreement by and between the Company and Cordis Corporation effective as of January 1, 2003 — incorporated by reference
to Exhibit 10.11 to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002, SEC File No. 0-23837. |
10.8 |
|
|
|
Reagent Supply Agreement by and between the Company and Cordis Corporation effective as of January 1, 2003 — incorporated by reference to
Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002, SEC File No. 0-23837. |
10.9* |
|
|
|
Form
of officer acceptance regarding employment/compensation.** |
10.10* |
|
|
|
The
Company’s 2003 Equity Incentive Plan, including forms of incentive stock option, non-qualified stock option and restricted stock
agreements.** |
Exhibit
|
|
|
|
10.11* |
|
|
|
Amendment (adopted November 15, 2005 by the board of directors and approved January 31, 2005, by shareholders) to the Company’s 2003
Equity Incentive Plan — incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March
31, 2005, SEC File No. 0-23837. |
10.12* |
|
|
|
The
Company’s 2005 Bonus Plan — incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended December 31, 2004, SEC File No. 0-23837. |
10.13* |
|
|
|
The
Company’s Board Compensation Policy effective January 31, 2005, as modified November 14, 2005.** |
10.14* |
|
|
|
Summary of Compensation Arrangements for Named Executive Officers of the Company.** |
10.15* |
|
|
|
The
Company’s 2006 Bonus Plan — Executive Officers** |
23.1. |
|
|
|
Consent of Deloitte & Touche LLP.** |
24 |
|
|
|
Power of Attorney (included on signature page of this Form 10-K).** |
31.1 |
|
|
|
Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.** |
31.2 |
|
|
|
Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.** |
32.1 |
|
|
|
Certification of Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.** |
32.2 |
|
|
|
Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.** |
* |
|
Management contract or compensatory plan or
arrangement |