UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to ___________ Commission File Number 0-23837 SurModics, Inc. (Exact name of registrant as specified in its Charter) MINNESOTA 41-1356149 (State of incorporation) (I.R.S. Employer Identification No.) 9924 West 74th Street Eden Prairie, Minnesota 55344 (Address of principal executive offices) Registrant's telephone number, including area code: (612) 829-2700 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __ The number of shares of the registrant's Common Stock, $.05 par value per share, outstanding as of January 31, 2000 was 7,778,295.
PART I - FINANCIAL INFORMATION Item 1. Financial Statements SURMODICS, INC. Condensed Balance Sheets (In thousands, except share data) <TABLE> <CAPTION> December 31, September 30, 1999 1999 -------- -------- ASSETS (Unaudited) CURRENT ASSETS: <S> <C> <C> Cash & cash equivalents $ 1,777 $ 1,975 Short-term investments 4,390 3,947 Accounts receivable, net 1,211 1,433 Inventories 473 459 Prepaids and other 410 260 -------- -------- Total current assets 8,261 8,074 -------- -------- PROPERTY AND EQUIPMENT, net 6,384 5,275 LONG-TERM INVESTMENTS 15,478 15,917 DEFERRED TAX ASSETS 1,910 2,465 OTHER ASSETS, net 221 227 -------- -------- $ 32,254 $ 31,958 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 307 $ 710 Accrued liabilities 899 1,261 Deferred revenues 255 268 -------- -------- Total liabilities 1,461 2,239 -------- -------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Series A Preferred stock- $.05 par value, 150,000 shares authorized; no shares issued or outstanding -- -- Common stock- $.05 par value, 15,000,000 shares authorized; 7,746,236 and 7,701,921 shares issued and outstanding 387 385 Additional paid-in capital 32,191 32,009 Unearned compensation (245) (267) Stock purchase notes receivable (38) (58) Accumulated other comprehensive income (283) (187) Accumulated deficit (1,219) (2,163) -------- -------- Total stockholders' equity 30,793 29,719 -------- -------- $ 32,254 $ 31,958 ======== ======== </TABLE> The accompanying notes are an integral part of these condensed balance sheets.
SURMODICS, INC. Condensed Statements of Income (In thousands, except per share data) (Unaudited) <TABLE> <CAPTION> Three Months Ended December 31, 1999 1998 ------- ------- REVENUES: <S> <C> <C> Royalties $ 2,350 $ 1,306 License fees 100 265 Product sales 1,234 630 Research and development 465 438 ------- ------- Total revenues 4,149 2,639 ------- ------- OPERATING COSTS AND EXPENSES: Product 396 283 Research and development 1,608 1,165 Sales and marketing 377 398 General and administrative 562 528 ------- ------- Total operating costs and expenses 2,943 2,374 ------- ------- INCOME FROM OPERATIONS 1,206 265 ------- ------- OTHER INCOME: Investment income, net 293 269 Gain on sale of investments 1 99 ------- ------- Other income, net 294 368 ------- ------- INCOME BEFORE PROVISION FOR INCOME TAXES 1,500 633 INCOME TAX BENEFIT (PROVISION) (556) 292 ------- ------- NET INCOME $ 944 $ 925 ======= ======= NET INCOME PER SHARE: Basic $ 0.12 $ 0.13 Diluted $ 0.11 $ 0.12 WEIGHTED AVERAGE SHARES OUTSTANDING: Basic weighted average common shares outstanding 7,718 7,230 Dilutive effect of outstanding stock options 523 602 ------- ------- Diluted weighted average common shares outstanding 8,241 7,832 </TABLE> The accompanying notes are an integral part of these condensed financial statements.
SURMODICS, INC. Condensed Statements of Cash Flows (In thousands) (Unaudited) <TABLE> <CAPTION> Three Months Ended December 31, --------------------- 1999 1998 ------- ------- OPERATING ACTIVITIES: <S> <C> <C> Net income $ 944 $ 925 Adjustments to reconcile net income to net cash provided by operating activities- Depreciation and amortization 210 176 Amortization of unearned compensation, net 22 15 Change in deferred rent -- (6) Change in deferred tax 555 (292) Change in assets and liabilities: Accounts receivable 222 111 Inventories (14) (51) Prepaids and other (150) (99) Accounts payable and accrued liabilities (765) (492) Deferred revenues (13) (31) ------- ------- Net cash provided by operating activities 1,011 256 ------- ------- INVESTING ACTIVITIES: Purchases of property and equipment, net (1,313) (361) Purchases of available-for-sale investments (3,943) (8,972) Sales/maturities available-for-sale investments 3,843 8,556 Repayment of stock purchase notes receivable 20 65 ------- ------- Net cash used in investing activities (1,393) (712) ------- ------- FINANCING ACTIVITIES: Issuance of common stock 184 131 ------- ------- Net decrease in cash and cash equivalents (198) (325) CASH AND CASH EQUIVALENTS: Beginning of period 1,975 1,344 ======= ======= End of period $ 1,777 $ 1,019 ======= ======= </TABLE> The accompanying notes are an integral part of these condensed financial statements.
SURMODICS, INC. Notes to Condensed Financial Statements (Unaudited) (1) Basis of Presentation: In the opinion of management, the accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles and reflect all adjustments, consisting solely of normal recurring adjustments, needed to fairly present the financial results for these interim periods. These financial statements include some amounts that are based on management's best estimates and judgments. These estimates may be adjusted as more information becomes available, and any adjustment could be significant. The results of operations for the three months ended December 31, 1999 are not necessarily indicative of the results that may be expected for the entire fiscal year. According to the rules and regulations of the Securities and Exchange Commission, the Company has omitted footnote disclosures that would substantially duplicate the disclosures contained in the audited financial statements of the Company. Read together with the disclosures below, management believes the interim financial statements are presented fairly. However, these unaudited condensed financial statements should be read together with the financial statements for the year ended September 30, 1999 and footnotes thereto included in the Company's form 10-KSB as filed with the Securities and Exchange Commission. (2) New Accounting Pronouncements The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. Based on current operations, the Company anticipates that the adoption of SFAS No. 133 in fiscal 2002 will not have a significant impact on its results of operations. (3) Comprehensive Income The components of comprehensive income for the three-month periods are as follows: <TABLE> <CAPTION> Three months ended December 31, 1999 1998 -------------- ------------- (dollars in thousands) <S> <C> <C> Net income $944 $925 Other comprehensive income: Change in unrealized loss on available-for-sale securities (96) (196) -------------- ------------- Total comprehensive income $848 $729 ============== ============= </TABLE>
(4) Operating Segments <TABLE> <CAPTION> Research & (dollars in thousands) Licensing Manufacturing Development Corporate Consolidated --------- ------------- ----------- --------- ------------ Three Months Ended December 31, 1999 <S> <C> <C> <C> <C> <C> Revenues: PhotoLink $ 1,744 $ 605 $ 272 $ -- $ 2,621 Diagnostic 705 -- -- -- 705 Stabilization & other -- 630 -- -- 630 Government -- -- 193 -- 193 ------- ------- ------- ------- ------- Total Revenues 2,449 1,235 465 -- 4,149 Expenses -- 396 1,608 939 2,943 ------- ------- ------- ------- ------- Operating income (loss) 2,449 839 (1,143) (939) 1,206 Other income 294 294 Income tax provision (556) (556) ------- Net income $ 944 ======= <CAPTION> Three Months Ended December 31, 1998 Revenues: <S> <C> <C> <C> <C> <C> PhotoLink $ 960 $ 245 $ 209 $ -- $ 1,414 Diagnostic 611 -- -- -- 611 Stabilization & other -- 385 -- -- 385 Government -- -- 229 -- 229 ------- ------- ------- ------- ------- Total Revenues 1,571 630 438 -- 2,639 Expenses -- 283 1,165 926 2,374 ------- ------- ------- ------- ------- Operating income (loss) 1,571 347 (727) (926) 265 Other income 368 368 Income tax benefit 292 292 ------- Net income $ 925 ======= </TABLE> (5) 1999 Employee Stock Purchase Plan On November 15, 1999 the Board of Directors adopted, and on January 24, 2000 shareholders approved, the Company's 1999 Employee Stock Purchase Plan (the "Stock Purchase Plan"). The Stock Purchase Plan permits all full-time and part-time employees (including officers) of the Company to purchase stock of the Company. The Stock Purchase Plan does not allow an employee to purchase stock through the Stock Purchase Plan if immediately after the grant of an option, he or she would own stock representing 5% or more of the total combined voting power or value of all classes of the stock of the Company. The Stock Purchase Plan will terminate on February 28, 2010, unless the Board of Directors extends the term of the Plan.
(6) Stockholders' Equity On January 24, 2000 shareholders approved an amendment to the Articles of Incorporation to eliminate all references in the Articles to a class of Convertible Preferred Stock, shares of which were automatically converted as part of the Company's initial public offering in 1998. Additionally, the Amendment increased the total number of authorized shares of the Company to 50,000,000 consisting of 45,000,000 shares of Common Stock, $0.05 par value per share, 150,000 of Series A Preferred Stock, $.05 par value per share, and 4,850,000 undesignated shares.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. General SurModics is a leading provider of surface modification solutions to medical device manufacturers. The Company's revenues are derived from four primary sources: fees from licensing its patented technology to customers; royalties received from licensees; the sale of photoreactive chemical compounds to licensees and stabilization products to the diagnostics industry; and research and development fees generated on projects for commercial customers and pursuant to government grants. Results of Operations Three Months Ended December 31, 1999 and 1998 Revenues. The Company's revenues were $4.1 million for the first quarter of fiscal 2000, an increase of $1.5 million, or 57%, over the same period of fiscal 1999. The revenue components were as follows (in thousands): <TABLE> <CAPTION> $ Increase % Increase 1999 1998 (Decrease) (Decrease) <S> <C> <C> <C> <C> PhotoLink(R) revenue: Royalties $1,644 $695 $949 137% License fees 100 265 (165) (62%) Reagent chemical sales 605 245 360 147% Commercial development 272 209 63 30% --- --- -- Total PhotoLink revenue 2,621 1,414 1,207 85% Other revenue: Diagnostic royalties 705 611 94 15% Stabilization products 630 385 245 64% Government research 193 229 (36) (16%) --- --- ---- Total revenues $4,149 $2,639 $1,510 57% ====== ====== ===== </TABLE> First quarter revenue growth of 57% was distributed across several operating segments but resulted primarily from an 85% increase in PhotoLink-related revenue. The 137% growth in PhotoLink royalties was due primarily to increased sales of coated products sold by the Company's licensees. In addition, the first quarter royalties included a one-time royalty payment of $225,000 from a client as the result of a license renegotiation. Several products have been bundled in this contract and the client will pay a tiered royalty based on sales volume. If this one-time payment were excluded, royalties would still have more than doubled between years. During the quarter, approximately 86% of the PhotoLink royalties received were earned royalties based on the clients' sale of coated products. The remaining royalties were minimum payments made to SurModics prior to a medical device reaching the market. The 147% increase in reagent chemical sales (those chemicals used by licensees in the PhotoLink coating process) was due to growing production of PhotoLink-coated devices by SurModics' clients. While a single client purchased more than half of the reagents sold during the quarter, reagents purchased by this customer are expected to decrease in the last half of the year as a result of collaborative efforts to improve processing efficiencies.
SurModics signed five new PhotoLink license agreements during the first quarter, which resulted in license fee revenue of $100,000. The Company has license agreements with 46 companies covering over 100 different products. A 64% increase in stabilization sales contributed to the bulk of revenue growth outside of PhotoLink. This rate of growth is not expected to continue during the rest of the year since the level of stabilization sales has been fairly flat over the last four quarters. Product costs. The Company's product costs were $396,000 for the first quarter of fiscal 2000, an increase of $113,000, or 40%, over the same period of fiscal 1999. Overall product margins increased to 68% in the first quarter of fiscal 2000 from 55% in the same period of fiscal 1999. The continued margin improvement was the result of efficiencies achieved in manufacturing reagent chemicals and stabilization products based on increased production volumes. Research and development expenses. Research and development expenses were $1.6 million for the first quarter of fiscal 2000, an increase of $443,000, or 38%, over the same period of fiscal 1999. The change was primarily due to compensation and benefits associated with technical personnel added by the Company over the last year, increased patent and legal fees, and supplies cost to equip the newly completed laboratory space. Sales and marketing expenses. Sales and marketing expenses were $377,000 for the first quarter of fiscal 2000, a $21,000 or 5% decrease from the same period of fiscal 1999. Increased promotional expenses were more than offset by decreased compensation and benefit costs due to open positions. It is expected that these positions will be filled in the second quarter. General and administrative expenses. General and administrative expenses were $562,000 for the first quarter of fiscal 2000, an increase of $34,000, or 6%, over the same period of fiscal 1999. The increase was the result of compensation and benefit costs of employees hired in the last half of the previous fiscal year. Income from operations. The Company's income from operations was $1.2 million for the first quarter of fiscal 2000, an increase of $941,000, or 355%, over the same period of fiscal 1999. Other income, net. The Company's other income was $294,000 for the first quarter of fiscal 2000, a decrease of $74,000, or 20%, over the same period of fiscal 1999. An increase in investment income in the current period was offset by a decrease in realized gains on the sale of investments. The first quarter of fiscal 1999 included a $99,000 realized gain from the sale of investments. Income tax expense. The Company's income tax provision was $556,000 for the first quarter of fiscal 2000 versus a $292,000 income tax benefit recorded in the same period of fiscal 1999. Net income for the first quarter of fiscal 1999 included the reversal of income tax valuation reserves of approximately $525,000 reducing the Company's tax provision at statutory rates to a net credit of $292,000. Excluding the effect of the reversal of income tax valuation reserves, the Company's net income and diluted income per share would have been as follows on a proforma basis: Proforma Three Months Ended December 31, 1999 1998 ---- ---- Net income before provision for income taxes $ 1,500,000 $ 633,000 Income tax provision (556,000) (231,000) ----------- ----------- Net income $ 944,000 $ 402,000 =========== =========== Diluted net income per share $ 0.11 $ 0.05 =========== ===========
Other comprehensive loss. The Company's other comprehensive loss was $96,000 for the first quarter of fiscal 2000. This loss was due to a reduction in the market value of the Company's long-term investments available for sale due to continued increases in interest rates. As of December 31, 1999, the Company had a net $283,000 unrealized loss related to those investments. Liquidity and Capital Resources As of December 31, 1999, the Company had working capital of approximately $6.8 million and cash, cash equivalents and investments totaling approximately $21.6 million. The Company's investments principally consist of U.S. government agency obligations and investment grade, interest-bearing corporate debt securities with varying maturity dates, the majority of which are three years or less. The Company generated positive cash flows from operating activities of $1.0 million in the first three months, which was an increase of 295% for the same period of last year, primarily due to the change in the deferred tax asset as described above. Approximately $1.4 million of cash was used for investing activities during the first three months compared to $712,000 last year. The significant change in investing activities between years was due to approximately $600,000 in progress payments made on the construction of additional laboratory and office space. The Company gained occupancy of the additional space in early December 1999. The total cost of the additional space is approximately $1.0 million. Finally, $184,000 of cash was generated from financing activities due to the exercise of stock options during the first three months of the year. As of December 31, 1999, the Company had no debt, nor did it have any credit agreements. The Company believes that its existing capital resources will be adequate to fund the Company's operations into the foreseeable future. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company maintains an investment portfolio in accordance with its investment policy. The primary objectives of the Company's investment policy are to preserve principal, maintain proper liquidity to meet operating needs and maximize yields. 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 maturity dates, the majority of which are three years or less. All of the Company's cash equivalents and marketable securities are classified as available-for-sale securities. The securities held in the company's investment portfolio are subject to interest rate risk. Changes in interest rates affect the fair market value of the available-for-sale securities. The Company has determined that a hypothetical ten percent increase in interest rates would result in an approximate $150,000 decrease in the fair value of the Company's available-for-sale securities as of December 31, 1999, but no material impact on the results of operations or cash flows. SurModics does not use derivative instruments in its investment portfolio.
Forward Looking Statements The statements contained in this quarterly report relating to future revenue growth and expense levels are based on current expectations and involve a number of risks and uncertainties. These statements are forward looking and are made pursuant to the safe harbor provisions of the Private Securities Reform Act of 1995. The following factors could cause royalty revenue to materially and adversely differ from that anticipated: the ability of the Company's licensees to successfully gain regulatory approval for, market and sell products incorporating the Company's technology; the amount and timing of resources devoted by the Company's licensees to market and sell products incorporating the Company's technology; the Company's ability to attract new licensees and to enter into agreements for additional applications with existing licensees; the Company's ability to maintain a competitive position in the development of technologies and products in its areas of focus; and business and general economic conditions.
PART II - OTHER INFORMATION Item 1. Legal Proceedings. None. Item 2. Changes in Securities and Use of Proceeds. <TABLE> <S> <C> Use of Proceeds for the period ending December 31, 1999. (1) Effective Date: March 3, 1998 SEC File Number: 333-43217 (2) Offering Date: March 3, 1998 (4)(i) The offering has terminated; all securities registered were sold. (4)(ii) Managing Underwriter: John G. Kinnard and Company, Incorporated (4)(iii) Title of Securities: Common Stock (4)(iv) Amount Registered: 2,300,000 Aggregate Offering Price: $17,250,000 Amount Sold: 2,300,000 Aggregate Offering Price Sold: $17,250,000 (4)(v) Underwriting Discount and Commissions $ 1,293,750 Other Expenses $ 435,148 Total Expenses $ 1,728,898 All the above items represented direct or indirect payments to others. (4)(vi) Net Offering Proceeds $15,521,102 (4)(vii) Use of Net Offering Proceeds: Research and development $ 1,372,000 Sales and marketing $ 998,000 Property and equipment upgrades $ 6,416,000 Patent protection $ 123,000 Working capital and general corporate purposes $ 773,000 Administration $ 93,000 Money market funds $ 5,746,102 All the above items represented direct or indirect payments to others. </TABLE>
Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. (a) The Company held its Annual Meeting of shareholders on January 24, 2000. (b) Proxies were solicited pursuant to Regulation 14A under the Securities Act of 1934. The shareholders voted on four matters: (i) to set the number of directors at seven (7), (ii) to approve the Company's 1999 Employee Stock Purchase Plan, (iii) to amend the Articles of Incorporation to increase of the authorized Common Stock from 15,000,000 to 45,000,000, (iv) to elect Class I directors. The shareholders approved all four matters by the following votes: <TABLE> <CAPTION> Votes Votes Broker Votes For Against Abstained Non-Votes --------------- -------------- --------------- -------------- <S> <C> <C> <C> <C> (i) Set the number of directors at seven (7) 6,663,811 1,650 7,012 316,708 (ii) Approve the Company's 1999 Employee Stock Purchase Plan 6,618,086 25,895 28,492 316,708 (iii) Amend the Articles of Incorporation, including an increase of the authorized Common Stock form 15,000,000 to 45,000,000 shares 6,341,549 311,004 19,920 316,708 <CAPTION> Votes Broker Votes For Withheld Non-Votes --------------- -------------- --------------- <S> <C> <C> <C> (iv) Elect Class I directors Patrick E. Guire 6,656,555 15,918 316,708 Donald S. Fredrickson 6,649,555 22,918 316,708 </TABLE> Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits - 3.1 Articles of Incorporation, as amended to date 27 Financial Data Schedule (b) Reports on Form 8-K - None
SIGNATURES Pursuant to the requirements 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. February 14, 2000 By: /s/ Stephen C. Hathaway Stephen C. Hathaway Vice President & CFO (Principal Financial Officer)
Exhibit Index Exhibit Number Description 3.1 Articles of Incorporation, as amended to date 27 Financial Data Schedule