1 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, 2000 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: (952) 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, 2001 was 16,684,686.
2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SURMODICS, INC. Condensed Balance Sheets (In thousands, except share data) <TABLE> <CAPTION> December 31, September 30, 2000 2000 ------------ -------------- ASSETS (Unaudited) <S> <C> <C> CURRENT ASSETS: Cash & cash equivalents $ 1,461 $ 1,510 Short-term investments 16,531 15,847 Accounts receivable, net 1,735 1,406 Inventories 573 500 Deferred tax asset 232 912 Prepaids and other 1,015 911 -------- -------- Total current assets 21,547 21,086 -------- -------- PROPERTY AND EQUIPMENT, net 7,280 7,166 LONG-TERM INVESTMENTS 22,999 22,293 OTHER ASSETS, net 222 204 -------- -------- $ 52,048 $ 50,749 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 224 $ 379 Accrued liabilities 1,243 1,584 Deferred revenues 456 433 -------- -------- Total current liabilities 1,923 2,396 DEFERRED REVENUES, less current portion -- 50 -------- -------- Total liabilities 1,923 2,446 -------- -------- COMMITMENTS AND CONTINGENCIES 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; 16,620,986 and 16,556,002 shares issued and outstanding 831 828 Additional paid-in capital 45,942 45,740 Unearned compensation (262) (289) Stock purchase notes receivable (7) (7) Accumulated other comprehensive income (loss) 179 (46) Retained earnings 3,442 2,077 -------- -------- Total stockholders' equity 50,125 48,303 -------- -------- $ 52,048 $ 50,749 ======== ======== </TABLE> The accompanying notes are an integral part of these condensed balance sheets. 2
3 SURMODICS, INC. Condensed Statements of Income (In thousands, except per share data) (Unaudited) <TABLE> <CAPTION> Three Months Ended December 31, --------------------------- 2000 1999 -------- -------- <S> <C> <C> REVENUES: Royalties $ 2,058 $ 2,350 License fees 435 100 Product sales 1,557 1,234 Research and development 782 465 -------- -------- Total revenues 4,832 4,149 -------- -------- OPERATING COSTS AND EXPENSES: Product 608 396 Research and development 1,775 1,608 Sales and marketing 414 377 General and administrative 713 562 -------- -------- Total operating costs and expenses 3,510 2,943 -------- -------- INCOME FROM OPERATIONS 1,322 1,206 -------- -------- OTHER INCOME: Investment income, net 631 293 Gain on sale of investments 150 1 -------- -------- Other income, net 781 294 -------- -------- INCOME BEFORE PROVISION FOR INCOME TAXES 2,103 1,500 INCOME TAX PROVISION (737) (556) -------- -------- NET INCOME $ 1,366 $ 944 ======== ======== NET INCOME PER SHARE: Basic $ 0.08 $ 0.06 Diluted $ 0.08 $ 0.06 WEIGHTED AVERAGE SHARES OUTSTANDING: Basic weighted average common shares outstanding 16,590 15,436 Dilutive effect of outstanding stock options 1,106 1,046 -------- -------- Diluted weighted average common shares outstanding 17,696 16,482 </TABLE> The accompanying notes are an integral part of these condensed financial statements. 3
4 SURMODICS, INC. Condensed Statements of Cash Flows (In thousands) (Unaudited) <TABLE> <CAPTION> Three Months Ended December 31, ----------------------------- 2000 1999 -------- -------- <S> <C> <C> OPERATING ACTIVITIES: Net income $ 1,366 $ 944 Adjustments to reconcile net income to net cash provided by operating activities- Depreciation and amortization 361 210 Amortization of unearned compensation, net 27 22 Change in deferred tax 680 555 Change in assets and liabilities: Accounts receivable (329) 222 Inventories (73) (14) Prepaids and other (128) (150) Accounts payable and accrued liabilities (496) (765) Deferred revenues (27) (13) -------- -------- Net cash provided by operating activities 1,381 1,011 -------- -------- INVESTING ACTIVITIES: Purchases of property and equipment, net (470) (1,313) Purchases of available-for-sale investments (14,046) (3,943) Sales/maturities available-for-sale investments 12,881 3,843 Repayment of stock purchase notes receivable -- 20 -------- -------- Net cash used in investing activities (1,635) (1,393) -------- -------- FINANCING ACTIVITIES: Issuance of common stock 205 184 -------- -------- Net decrease in cash and cash equivalents (49) (198) CASH AND CASH EQUIVALENTS: Beginning of period 1,510 1,975 -------- -------- End of period $ 1,461 $ 1,777 ======== ======== </TABLE> The accompanying notes are an integral part of these condensed financial statements. 4
5 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, 2000 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, 2000 and footnotes thereto included in the Company's form 10-K as filed with the Securities and Exchange Commission. (2) NEW ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 requires that license and other up-front fees be recognized over the term of the agreement unless the fee is in exchange for products delivered or services performed that represent the culmination of a separate earnings process. The Company will adopt SAB 101 when required, which is currently expected to be in the fourth quarter of fiscal 2001. The Company is currently evaluating SAB 101 to determine whether its implementation will have any material impact on the Company's financial position or results of operations with respect to the license fees earned by SurModics. Any adjustment would result in a charge to earnings for the cumulative effect of the change. This amount would then be deferred and be recognized as revenue in future periods. (3) COMPREHENSIVE INCOME The components of comprehensive income for the three-month periods are as follows: <TABLE> <CAPTION> Three months ended December 31, 2000 1999 -------------- ------------- (dollars in thousands) <S> <C> <C> Net income $ 1,366 $ 944 Other comprehensive income: Change in unrealized gain (loss) on available-for-sale securities 225 (96) -------- -------- Total comprehensive income $ 1,591 $ 848 ======== ======== </TABLE> 5
6 (4) OPERATING SEGMENTS (dollars in thousands) <TABLE> <CAPTION> Research & Licensing Manufacturing Development Corporate Consolidated ----------- ---------------- ------------- ----------- -------------- <S> <C> <C> <C> <C> <C> Three Months Ended December 31, 2000 Revenues: PhotoLink $ 1,861 $ 723 $ 709 $ -- $ 3,293 Diagnostic 632 -- -- -- 632 Stabilization & other -- 834 -- -- 834 Government -- -- 73 -- 73 ------- ------- ------- ------- ------- Total Revenues 2,493 1,557 782 -- 4,832 Expenses -- 608 1,775 1,127 3,510 ------- ------- ------- ------- ------- Operating income (loss) 2,493 949 (993) (1,127) 1,322 Other income 781 781 Income tax provision (737) (737) ------- Net income $ 1,366 ======= Three Months Ended December 31, 1999 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 ======= </TABLE> (5) 2-FOR-1 STOCK SPLIT On November 13, 2000, the Board of Directors declared a 2-for-1 stock split of the Company's Common Stock, payable on December 6, 2000, to shareholders of record on November 27, 2000. All share, per share and weighted average share information has been restated to reflect the split. 6
7 (6) STOCKHOLDERS' EQUITY On November 13, 2000, the Board of Directors adopted a resolution that designated an additional 300,000 of the then 4,850,000 undesignated shares as Series A Preferred Stock. The total number of authorized shares of the Company are now 50,000,000 consisting of 45,000,000 shares of Common Stock, $0.05 par value per share, 450,000 of Series A Preferred Stock, $.05 par value per share, and 4,550,000 undesignated shares. 7
8 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, stabilization products to the diagnostics industry, and coated slides to the genomics market; and research and development fees generated on projects for commercial customers and pursuant to government grants. RESULTS OF OPERATIONS THREE MONTHS ENDED DECEMBER 31, 2000 AND 1999 Revenues. The Company's revenues were $4.8 million for the first quarter of fiscal 2001, an increase of $683,000, or 16%, over the same period of fiscal 2000. The revenue components were as follows (in thousands): <TABLE> <CAPTION> $ Increase % Increase 2000 1999 (Decrease) (Decrease) ---- ---- ----------- ----------- <S> <C> <C> <C> <C> PhotoLink(R)revenue: Royalties $1,426 $1,644 $ (218) (13%) License fees 435 100 335 335% Reagent chemical sales 723 605 118 20% Commercial development 709 272 437 161% ------ ------ ------ Total PhotoLink revenue 3,293 2,621 672 26% Other revenue: Diagnostic royalties 632 705 (73) (10%) Stabilization & other products 834 630 204 32% Government research 73 193 (120) (62%) ------ ------ ------ Total revenues $4,832 $4,149 $ 683 16% ====== ====== ====== </TABLE> First quarter revenue growth of 16% was primarily due to a 26% increase in PhotoLink-related revenue. Commercial development revenue increased 161% to $709,000. Much of this increase was due to a high level of effort on two projects: genomics work with Motorola and the continued development of a drug delivery stent with Johnson & Johnson's Cordis division. PhotoLink royalties fell $218,000 to $1.4 million. The bulk of the difference was due to a one-time royalty payment of $225,000 recorded in last year's first quarter. Excluding this one-time payment, PhotoLink royalty growth was essentially flat with last year. Reagent chemical sales (those chemicals used by licensees in the PhotoLink coating process) increased 20% to $723,000. A single client purchased a little more than half of the reagents sold during the quarter. Reagent sales to all other clients more than doubled between years. SurModics signed two new PhotoLink license agreements during the first quarter. Fees from the two new licenses and milestone payments on several previously executed licenses combined for total license revenue of $435,000, a significant increase over last year. The Company now has license agreements with 49 companies covering over 100 different product applications. A 32% increase in 8
9 stabilization and other product (DNA slides) sales contributed to the bulk of revenue growth outside of PhotoLink. Product costs. The Company's product costs were $608,000 for the first quarter of fiscal 2001, an increase of $212,000, or 54%, over the same period of fiscal 2000. Overall product margins decreased to 61% in the first quarter of fiscal 2001 from 68% in the same period of fiscal 2000. While the margin is down from last year, margins have been consistently running at 61% for the last four quarters. Research and development expenses. Research and development expenses were $1.8 million for the first quarter of fiscal 2001, an increase of $167,000, or 10%, over the same period of fiscal 2000. The change was primarily due to compensation and benefits associated with technical personnel added by the Company over the last year, foreign patent filing fees and increased depreciation and facilities costs due to last year's construction of additional laboratory facilities. Sales and marketing expenses. Sales and marketing expenses were $414,000 for the first quarter of fiscal 2001, a $37,000 or 10% increase from the same period of fiscal 2000. Increased compensation and benefits costs and additional business travel offset a decrease in promotional expenses. General and administrative expenses. General and administrative expenses were $713,000 for the first quarter of fiscal 2001, an increase of $151,000, or 27%, over the same period of fiscal 2000. The increase was the result of additional facilities costs related to building additions added in the previous year, and rising compensation and benefit costs. Income from operations. The Company's income from operations was $1.3 million for the first quarter of fiscal 2001, an increase of $116,000, or 10%, over the same period of fiscal 2000. Other income, net. The Company's other income was $781,000 for the first quarter of fiscal 2001, an increase of $487,000, or 166%, over the same period of fiscal 2000. The increase in investment income was a direct result of the 90% increase in investment balances from last year's first quarter. In addition, the Company sold a portion of its bond portfolio to take advantage of a tax capital loss carryforward, generating a realized gain of $150,000. Income tax expense. The Company's income tax provision was $737,000 for the first quarter of fiscal 2001 versus a $556,000 in the same period of fiscal 2000. Other comprehensive income. The Company had $225,000 of other comprehensive income for the first quarter of fiscal 2001. This income was generated by an increase in the fair value of the Company's long-term available-for-sale investments. As of December 31, 2000, the Company had a net $179,000 unrealized gain related to those investments. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2000, the Company had working capital of $19.6 million and cash, cash equivalents and investments totaling approximately $41.0 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 five years or less. The Company generated positive cash flows from operating activities of $1.4 million in the first quarter, which was an increase of 37% for the same period of last year, primarily due to the increase in net income and the change in the deferred tax asset. 9
10 As of December 31, 2000, 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 five 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 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 $400,000 decrease in the fair value of the Company's available-for-sale securities as of December 31, 2000, but no material impact on the results of operations or cash flows. 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. Investors should consider these risks and other risks identified in the Company's filings with the SEC when making investment decisions. Shareholders and other readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. SurModics undertakes no obligation to update publicly or revise any forward-looking statements. 10
11 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. None. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. <TABLE> <CAPTION> Use of Proceeds through the period ending December 31, 2000. <S> <C> <C> (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 $ 3,110,000 Sales and marketing $ 1,728,000 Property and equipment upgrades $ 8,565,000 Patent protection $ 334,000 Working capital and general corporate purposes $ 1,150,000 Administration $ 240,000 Money market funds $ 394,102 All the above items represented direct or indirect payments to others. </TABLE> 11
12 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 22, 2001. (b) Proxies were solicited pursuant to Regulation 14A under the Securities Act of 1934. The shareholders voted on two matters: (i) to set the number of directors at eight (8) and (ii) to elect Class II directors. The shareholders approved both 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 eight (8) 13,512,880 5,780 22,210 0 <CAPTION> Votes Broker Votes For Withheld Non-Votes ------------- ------------ ----------- <S> <C> <C> <C> (ii) Elect Class II directors James J. Grierson 13,469,070 71,800 0 Kendrick B. Melrose 13,471,270 69,600 0 </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 (b) Reports on Form 8-K - None 12
13 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 12, 2001 By: /s/ Stephen C. Hathaway -------------------------------- Stephen C. Hathaway Vice President & CFO (Principal Financial Officer) 13
14 EXHIBIT INDEX Exhibit Number Description - -------------- ----------- 3.1 Articles of Incorporation, as amended to date 14