Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
☐
No
☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes
☐
No
☒
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
☒
No
☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes
☒
No
☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
☒
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
If an emerging growth company, indicated by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 1(a) of the Exchange Act.
☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
☐
No
☒
The aggregate market value of the Common Stock held by shareholders other than officers, directors or holders of more than 5% of the outstanding stock of the registrant as of March 31, 2017 was approximately $176 million (based upon the closing sale price of the registrant’s Common Stock on such date).
The number of shares of the registrant’s Common Stock outstanding as of November 25, 2017 was 13,098,716.
Portions of the Registrant’s Proxy Statement for the Registrant’s 2018 Annual Meeting of Shareholders are incorporated by reference into Part III.
PART I
ITEM 1. BUSINESS.
Overview – General
Surmodics, Inc. and subsidiaries (referred to as “Surmodics,” the “Company,” “we,” “us,” “our” and other like terms) is a leading provider of medical device and
in vitro
diagnostic technologies to the healthcare industry. Our mission is to improve the treatment and detection of disease by using our technology to provide solutions to difficult medical device and diagnostic challenges. Our business segments partner with many of the world’s leading and emerging medical device, diagnostic and life science companies to develop and commercialize innovative products designed to improve patient diagnosis and treatment.
In fiscal 2017, our business performance continued to be driven by growth in our core Medical Device and In Vitro Diagnostics (“IVD”) businesses, while we continued medical device product and platform development leveraging the technologies and manufacturing capabilities acquired with the fiscal 2016 acquisitions of Creagh Medical Ltd. (“Creagh Medical”) and NorMedix, Inc. (“NorMedix”) (together the “Fiscal 2016 Acquisitions”) in our Medical Device business unit.
The Company was organized as a Minnesota corporation in June 1979. We make available, free of charge, copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) on our website,
www.surmodics.com
, as soon as reasonably practicable after filing such material electronically or otherwise furnishing it to the SEC. We are not including the information on our website as a part of, or incorporating it by reference into, our Form 10-K.
The information below provides an overview of the principal products, services and markets for each of our two business units. For more information regarding domestic and foreign revenue and revenue by our business units, also known as our operating segments, for each of our last three fiscal years, see Note 12 to the consolidated financial statements in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. The discussion of other aspects of our business including research and development (“R&D”), intellectual property, marketing and sales, future acquisition strategy, significant customers, competition, manufacturing, government regulation and our employees applies to our business in general and we describe material segment information within these sections where relevant.
Medical Device Segment
Advances in medical device technology have helped drive improved device efficacy and patient outcomes. The convergence of the pharmaceutical, biotechnology and medical device industries, often made possible by surface coatings and device drug delivery technologies, (together, “surface modification coating technologies”) presents an opportunity for major advancements in the healthcare industry. We believe the benefits of combining drugs and biologics with implantable and minimally invasive devices are becoming increasingly valuable in applications in cardiology, peripheral vascular disease, ophthalmology, orthopedics and other large markets.
In an effort to improve their existing products or develop entirely new devices, a growing number of medical device manufacturers are exploring or using surface modification and device drug delivery technologies as product differentiators or device enablers. The continuing trend toward minimally invasive surgical procedures, which often employ catheter-based delivery technologies, has increased the demand for hydrophilic (i.e., lubricious or slippery) coatings and other coating technologies. For example, stents, particularly drug-eluting stents, have significantly reduced the need for repeat intravascular procedures, and they have diminished the need for more invasive cardiac bypass surgery. Drug-coated balloons have further transformed intravascular therapies by enhancing patient outcomes while not leaving stents in the vascular system. Transcatheter heart valve repair or replacement via a minimally invasive catheter-based system has enabled the treatment of patients suffering from heart valve disease who are too ill to undergo open-heart surgery. Positive clinical outcomes and acceptance of these and other similar innovations by patients, physicians and insurance companies has helped certain segments of the United States (“U.S.”) medical device industry grow at a faster pace than the economy as a whole. The attractiveness of the industry has drawn intense competition among the companies participating in this area.
Our Medical Device segment provides surface modification coating technologies that impart lubricity, prohealing or biocompatibility characteristics, or drug delivery capabilities, as well as vascular device, catheter and balloon design, development and manufacturing capabilities. Historically, we have provided surface modification technologies to enhance our customers’ medical devices and delivery systems. Since fiscal 2013, with our investment in our drug-coated balloon (“DCB”) platform, we have been focused on a strategy to develop and manufacture proprietary medical device products that combine our surface modification
3
coatings with medical devices or delivery systems (“whole-product solutions”). This strategy does not change our focus on our core surface modification technologies, however we believe it will greatly increase our relevance in the indust
ry and is key to our future growth and profitability, given the prospect of capturing more revenue and operating margin with whole-product solutions. Our aim is to provide customers earlier access to highly differentiated whole-product solutions that addre
ss unmet clinical needs, and partner with them on successful commercialization.
During fiscal 2017, we continued investing in our whole-product solutions strategy and achieved meaningful strategic milestones, including the initiation of the TRANSCEND SurVeil® DCB pivotal clinical trial, as well as U.S. Food and Drug Administration (“FDA”) and Conformité Européenne (“CE Mark”) clearance for our .014” low-profile percutaneous transluminal angioplasty balloon dilation catheter (“.014” PTA balloon catheter”), designed for peripheral angioplasty procedures.
Overview of Interventional Peripheral Market and Whole-Products Solutions Strategy
Peripheral artery disease (“PAD”) is a condition that causes a narrowing of the blood vessels supplying the extremities, most often due to plaque buildup in the arterial walls. Left untreated, PAD may lead to symptoms such as large non-healing ulcers, infections, or gangrene, and may require limb amputation or, in extreme cases, result in death.
The American Heart Association has reported that an estimated 8.5 million Americans and 202 million people worldwide are living with PAD. The number of people affected by PAD is expected to increase as a result of an aging population, coupled with increasing prevalence of conditions linked to PAD, such as diabetes and obesity. The interventional PAD market utilizes a variety of access and therapy catheters to treat PAD. These technologies are delivered through a number of access points into the vascular system including femoral (leg), radial (wrist or arm) and pedal (foot).
Our business model for our whole-product solutions strategy is to design, develop and manufacture products incorporating our proprietary catheter, balloon and surface modification coating technologies. Our whole-product solutions strategy has been built on the acquisition of state-of-the-art medical device design, development and manufacturing capabilities to complement our leadership in surface modification coating technologies to develop whole-product solutions for treatment of PAD and other vascular diseases. The Creagh Medical acquisition brought a state-of-the-art R&D and manufacturing facility offering robust extrusion, balloon-forming, top-assembly, packaging and regulatory capabilities focused on balloon catheters. The NorMedix acquisition provided ultra-thin-walled, minimally invasive catheter technologies. We have integrated our balloon catheter, ultra-thin-walled catheter and surface modification technologies to design, develop and manufacture proprietary products. We are currently seeking third-party companies to distribute our products to end users.
During fiscal 2017 we received FDA 510(k) clearance and CE Mark for our first whole-product solution, a .014” PTA balloon catheter, and expect to receive regulatory approval for several additional catheter and balloon-based products throughout calendar 2018. We are currently in discussions with potential partners to distribute our .014” PTA balloon catheter.
Surmodics is focused on the development of drug coated balloons to treat PAD. The development of the
SurVeil
DCB is a major step forward in our strategy to offer whole-product solutions for the medical device industry. During fiscal 2016, we initiated PREVEIL, an early feasibility clinical trial of the
SurVeil
DCB, which is intended to treat PAD in the leg above the knee. Enrollment in PREVEIL was completed in the second quarter of fiscal 2017. We began enrollment in the TRANSCEND
SurVeil
DCB pivotal clinical study in the fourth quarter of fiscal 2017, with the objective of obtaining data necessary to support regulatory approvals and reimbursement for this device in the U.S. We also plan to initiate
SurVeil
DCB clinical trials in Europe to support CE Mark approval. Until regulatory approvals have been obtained, our
SurVeil
DCB is not approved for commercial sale.
In addition to our
SurVeil
DCB program, we are developing other DCB’s for treatment of PAD below-the-knee (“BTK”) and arteriovenous (“AV”) fistulae, commonly associated with hemodialysis.
Overview of Surmodics’ Surface Modification and Device Drug Delivery Technologies
We believe Surmodics is positioned to take advantage of the continuing trend of incorporating surface modification and device drug delivery technologies into the design of combination products, potentially leading to more efficient and effective products as well as new product applications. We have a growing proprietary technology portfolio that incorporates our market expertise and insight, as well as unique collaborative research, development and manufacturing capabilities — key ingredients to bring innovation together to benefit patients, us, and the healthcare industry.
4
Coatings for Surface Modification and Device Drug Delivery
Key differentiating characteristics of our coating platforms are their flexibility, durability and ease of use. In terms of flexibility, coatings can be applied to many different kinds of surfaces and can immobilize a variety of chemical, pharmaceutical and biological agents. Additionally, the surface modification process can be tailored to provide customers with the ability to improve their devices’ performance by choosing the specific coating properties desired for particular applications. Our surface modification technologies also can be combined to deliver multiple surface-enhancing characteristics on the same device.
Our proprietary PhotoLink® coating technology is a versatile, easily applied, coating technology that modifies medical device surfaces by creating covalent bonds between device surfaces and a variety of chemical agents.
PhotoLink
coatings can impart many performance enhancing characteristics, such as advanced lubricity (slippery) and hemocompatibility (preventing blood clot formation), when bound onto surfaces of medical devices or other biological materials without materially changing the dimensions or other physical properties of devices.
PhotoLink
reagents can be applied to a variety of substrates. The coating formulations are easily applied to the material surface by a variety of methods including, but not limited to, dipping, spraying, roll-coating or ink-jetting. We continue to expand our proprietary reagent portfolio for use by our customers. These reagents enable our customers to develop novel surface features for their devices, satisfying the expanding healthcare industry requirements. We are also continually working to expand the list of materials that are compatible with our surface modification and device drug delivery reagents. Additionally, we develop coating processes and coating equipment to meet the device quality, manufacturing throughput and cost requirements of our customers.
The
PhotoLink
coating process is relatively simple to use and is easily integrated into the customer’s manufacturing process. In addition, the process does not subject the coated products to harsh chemical or temperature conditions, produces no hazardous byproducts, and does not require lengthy processing or curing time. Further, our
PhotoLink
coatings are generally compatible with accepted sterilization processes, so the surface attributes are not lost when the medical device is sterilized.
We launched our Serene® hydrophilic coating platform in fiscal 2013, which optimizes lubricity and durability while significantly reducing particulates generation. This next-generation coating has demonstrated excellent lubricity on a wide range of substrates, and has been used on FDA-cleared coronary, peripheral and structural heart devices.
Serene
coatings are applied using our
PhotoLink
process.
Our device drug delivery coating technologies allow therapeutic drugs to be incorporated within our proprietary polymer matrices to provide controlled, site-specific release of the drug into the surrounding environment. The drug release can be tuned to elute quickly (within minutes to a few days) or slowly (from several months to over a year), illustrating the wide range of release profiles that can be achieved with our coating systems. On a wide range of devices, drug-eluting coatings can help improve device performance, increase patient safety and enable innovative new treatments. Examples of short term use drug delivery devices would include drug coated balloons and examples of longer-term drug delivery devices would include drug eluting stents. We work with companies in the medical device and biotechnology industries to develop specialized coatings that allow for the controlled release of drugs from device surfaces. We see at least three primary areas with strong future potential: (1) improving the function of a device which itself is necessary to treat the medical condition; (2) enabling site-specific drug delivery while limiting systemic exposure; and (3) enhancing the biocompatibility of a medical device to ensure that it continues to function over a long period of time.
Licensing Arrangements
We commercialize our surface modification and device drug delivery technologies primarily through licensing arrangements with medical device manufacturers. We believe this approach allows us to focus our resources on further developing new technologies and expanding our licensing activities. Many of our technologies have been designed to allow manufacturers to implement them easily into their own manufacturing processes so customers can control production and quality internally without the need to send their products to a contract manufacturer.
We generate the largest portion of our revenue through licensing arrangements. Royalties and license fees represented 43.5%, 46.5% and 51.3% of our total revenue in fiscal 2017, 2016 and 2015, respectively. Greater than 96% of our royalties and license fees revenue in this three-year period were generated from hydrophilic coating licenses. Revenue from these licensing arrangements typically includes license fees and milestone payments, minimum royalties, and royalties based on a percentage of licensees’ product sales. We also generate revenue from reagent chemical sales to licensees for use in their coating processes.
5
The licensing process begins with the customer specifying a desired product feature to be created such as lubricity or drug delivery. Because each device and coating application is unique, we routinel
y conduct a feasibility study to qualify each new potential product application, often generating commercial development revenue. Feasibility studies can range in duration from several months to a year. After we complete a feasibility study, our customers
cannot market their product until they receive regulatory approval. As further described under the caption “Government Regulation,” the regulatory approval process varies in each country and ranges from several months to four or more years. At any time pr
ior to a customer’s commercial launch, a license agreement may be executed granting the licensee rights to use our technology. We often support our customers by providing coating assistance for parts required in animal tests and human clinical trials. Typi
cally, we complete a technology transfer to most customers which enables those customers to apply the coating at their own facilities.
License agreement terms are generally for a specified number of years or our patent’s life, whichever is longer, although a license generally may be terminated by the licensee for any reason upon 90 days’ advance written notice. In cases where the royalty obligation extends beyond the life of the applicable patent, it is because the license also includes rights to our know-how or other proprietary rights. Under these circumstances, the royalty obligation typically continues at a reduced royalty rate for a specified number of years generally following the date on which the customer’s product was first sold.
Our license agreements may include certain license fees and/or milestone payments. Substantially all our licensed applications are nonexclusive, allowing us to license technology to multiple customers. Moreover, even exclusive licenses generally are limited to a specific “field of use,” allowing us the opportunity to further license technology to other 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. In certain agreements, our royalty is based on an agreed-upon amount per unit. License fees, milestone payments, and the royalty rates are based on various factors, including the licensed product’s or technology’s stage of development, the perceived value of our technology to the customer’s product, the size of the potential market, and whether the arrangement is exclusive or nonexclusive. Our agreements generally incorporate a minimum royalty to be paid by the licensee. Royalty payments generally commence one quarter after the customer’s actual product sales occur because of the delay in reporting sales by our licensees. As such, we currently recognize royalty revenue in the quarter customer royalty payments are due to us. Commencing in fiscal 2019 we are required to adopt a new revenue recognition accounting standard that will require us to recognize and accrue royalty revenue in the same quarter that the underlying customer product sale occurs.
We have over 150 licensed product classes (customer products utilizing Surmodics technology) already in the market generating royalties and greater than 100 customer product classes incorporating our technology in various stages of pre-commercialization. We signed 17, 18 and 22 new licenses in fiscal 2017, 2016 and 2015, respectively.
Under our customer license agreements, the responsibility for securing regulatory approval for and ultimately commercializing these products rests with our customers. Our reliance on our customers in this regard and the potential risks to our operations as a result are discussed in Item 1A “Risk Factors” of this Form 10-K. Moreover, we are often contractually obligated to keep the details concerning our customers’ R&D efforts (including the timing of expected regulatory filings, approvals and market introductions) confidential. Given the significant uncertainty inherent in product development and regulatory approval processes, the expected timing for regulatory approval and commercialization for the product classes pending regulatory approval is can vary greatly.
Our licensing agreements generally require us to keep our customers’ identities confidential, unless they approve of such disclosure. Licensed customers who allow the use of their name include: Abbott Laboratories (“Abbott”), Boston Scientific Corporation (“Boston Scientific”), Cook Medical, Cordis Corporation (a subsidiary of Cardinal Health, Inc.) (“Cordis”), Covidien PLC (a subsidiary of Medtronic), Edwards Lifesciences Corporation, Evalve, Inc. (a subsidiary of Abbott), ev3 Inc. (a subsidiary of Medtronic), Medtronic, OrbusNeich Medical, Inc., and Spectranetics Corporation (a subsidiary of Koninklijke Philips N.V.).
In Vitro
Diagnostics Segment
Our In Vitro Diagnostics (“IVD”) business unit sells stabilization products, substrates, antigens and surface coatings to diagnostics customers. We manufacture or sell components for
in vitro
diagnostic immunoassay and molecular tests and we manufacture and sell surface coatings to the diagnostic, biomedical research, and life science markets.
Immunoassay Diagnostics.
An immunoassay is a biochemical test that measures the presence or concentration of a target molecule, or “analyte”, in a biological fluid or sample. Analyte levels are correlated to the patient’s disease state or medical condition of a patient to diagnose the presence, absence or severity of disease. Analytes can range from large molecules such as proteins to small molecules such as hormones. Immunoassays are developed and produced using multiple components. The component’s selection and optimization confer the assay quality and performance of the assay in terms of sensitivity and
6
specificity. IVD companies select these critical biochemical and reagent components to meet the assay’s diagnostic specifications. We develop, ma
nufacture and sell high-performing, consistent-quality and stable immunoassay component products to enable our customers’ diagnostic tests to detect the absence or presence of disease.
Molecular Diagnostics - DNA and Protein Immobilization.
Both DNA and protein microarrays are useful tools for the pharmaceutical, diagnostic and research industries. During a DNA gene analysis, typically thousands of different probes need to be placed in a pattern on a surface, called a DNA microarray. These microarrays are used by the pharmaceutical industry to screen for new drugs, by genome mappers to sequence human, animal or plant genomes, or by diagnostic companies to search a patient sample for disease causing bacteria or viruses. However, DNA does not readily adhere to most surfaces. We have developed various surface chemistries for both DNA and protein immobilization. Protein microarrays are used as diagnostic and research tools to determine the presence and/or quantity of proteins in a biological sample. The most common type of protein microarray is the antibody microarray, where antibodies are spotted onto a surface and used as capture molecules for protein detection.
The sales cycle for our IVD products generally begins when an IVD company initiates the process to develop a new, or improve a current, diagnostic test. During product development, these companies will look to source the test’s critical components with reagents it produces internally or with reagents from a supplier, such as Surmodics.
As IVD tests are developed and various reagents are tested, companies will generally seek to optimize the sensitivity (false negative reductions), specificity (false positive reductions), speed (time from sample to results), convenience (ideally as few steps as possible) and cost effectiveness. Upon regulatory approval or clearance, the customer’s diagnostic test can be sold in the marketplace. It may take several years after approval or clearance for the test to achieve peak market share and optimize Surmodics’ revenue.
Overview of
In Vitro
Diagnostics Products
Protein Stabilizers.
We offer a full line of stabilization products for the IVD market. These products increase sensitivity, reduce false positive and false negative results, while extending the diagnostic test’s shelf life, thereby producing more consistent assay results. Our stabilization products are ready-to-use, eliminating the in-house manufacturing preparation time and cost of producing stabilization and blocking reagents.
Substrates.
We also provide colorimetric and chemiluminescent substrates to the IVD market under our BioFX trademark. A substrate is the diagnostic test kit component that detects and signals that a reaction has taken place so that a result can be recorded. Colorimetric substrates signal a positive diagnostic result through a color change. Chemiluminescent substrates signal a positive diagnostic result by emitting light. We believe that our substrates offer a high level of stability, sensitivity and consistency.
Antigens.
We are the exclusive distributor
in the United States, Canada and Puerto Rico (and non-exclusive distributor in Japan) of DIARECT AG’s line of antigens. Because of the lack of high-quality antigens from natural sources, DIARECT produces the majority of these antigens and other components using recombinant technology.
Surface Coatings for Molecular Diagnostic Applications.
We offer custom coatings for molecular diagnostic applications, including DNA, RNA and protein microarrays. Our TRIDIA™ surface coatings bind molecules to a variety of surfaces and geometries and may be customized for selectivity using passivating polymers and reactive groups. This proprietary technology immobilizes DNA and protein to adhere to testing surfaces. We offer other surface coatings that improve flow characteristics through membranes and microfluidic channels on diagnostic devices including point-of-care components.
Research and Development
Our R&D personnel work to enhance and expand our technology and product offerings in the area of whole-product solutions, drug delivery, surface modification, and
in vitro
diagnostics through internal scientific investigation and proprietary product development. These scientists and engineers also evaluate external technologies in support of our corporate development activities. Our R&D efforts are all guided by the needs of the markets in which we do business. Additionally, the R&D staff support the business development staff and business units in performing feasibility studies, providing technical assistance to existing and potential customers. These services, which generate our research, development and other revenue, include optimizing the relevant technologies for specific customer applications, supporting clinical trials, training customers, and integrating our technologies and know-how into customer manufacturing operations and developing whole-product solutions that meet customers’ needs by integrating our coating, medical device and medical device delivery technologies.
7
In fiscal 2017, 2016 and 2015, our R&D expenses were $31.8 million, $18.5 million and $16.2 million, respectively. Included in R&D expenses are the costs associated with our research, develo
pment and other revenue. We intend to continue significantly investing in R&D to advance our whole-product solutions, surface modification coatings, device drug delivery and
in vitro
diagnostic technologies and to expand uses for our technology platforms.
We anticipate an increase in R&D expenses in fiscal 2018 primarily related to whole-product solutions product development, including our DCB development and clinical study activities. In addition, we continue to pursue access to products and technologies d
eveloped outside the Company to complement our internal R&D efforts.
Medical Device Segment
As treatment technologies become more sophisticated and increasingly leverage minimally invasive techniques, we believe the need for improved medical devices that benefit from surface modification and device drug delivery will continue to grow. We intend to continue our development efforts to expand our whole-product solutions offerings including advancing our surface modification and device drug delivery technologies to better meet these needs across multiple medical markets and to capture more of the final product value. Our whole-products solutions R&D activities are primarily focused on the peripheral vascular market, where we believe the integration of our surface modification, balloon catheter and ultra-thin-walled catheter technologies will result in unique devices capable of producing better patient outcomes in complex, difficult-to-treat arterial disease cases. We are doing this by developing or acquiring technologies and funding development activities that may include pre-clinical and clinical studies.
With the Fiscal 2016 Acquisitions and subsequent investments in our R&D infrastructure and facilities, we have strengthened our capabilities and broadened our capacity for R&D activities. Our facility in Ballinasloe, Ireland is fully equipped for R&D and manufacturing and is focused on design and manufacture of peripheral vascular devices. This facility’s capabilities include balloon forming, extrusion, coating, braiding and assembly of finished products. The facility is equipped for medical device R&D and manufacturing with space for future growth. In the first quarter of fiscal 2017, we completed an expansion of R&D and manufacturing clean rooms as well as an analytical lab to support our whole-product solutions strategy. With the NorMedix acquisition, we obtained a differentiated catheter-technology platform and additional design and development expertise that have enhanced the value we offer our medical device customers and accelerated our development of proprietary medical device products. We have continued to develop surface modification coating and DCB chemistry technologies in our Eden Prairie, Minnesota facilities. Our proprietary, whole-product solutions integrate our surface modification coatings, catheter and balloon technologies and are being developed with a combined team from our U.S. and Irish facilities. In addition to our DCB-platform products, we are executing on our plan to develop and commercialize 12-15 medical device products over the next 5 years. Additional planned activities include initiation of surface modification experiments that improve medical device performance, as well as incorporation of our catheter technology platform into various other devices intended for the emerging peripheral vascular treatment market.
We received FDA clearance and CE Mark for the .014” PTA balloon catheter in the fourth quarter of fiscal 2017 and we expect to receive regulatory clearance for several additional, newly-developed products during calendar 2018.
In addition to proprietary medical device product development, we work with our customers to integrate the best possible surface modification and device drug delivery technologies with their products, 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 and optimization process, we have developed extensive 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 throughout coatings. We believe our capabilities in this area exceed those of our direct competitors.
In Vitro Diagnostics Segment
Our R&D efforts to grow our IVD business unit include identifying and addressing unmet needs that exist in the global IVD market place. Our pipeline of IVD products includes components for immunoassay and molecular diagnostic applications, such as, new protein stabilizers, detection technologies, accessory reagents and surface coatings that have the potential to add greater sensitivity, specificity, speed, convenience and lower cost for IVD test manufacturers. In fiscal 2016 we launched
StabilBlock®
Immunoassay Stabilizer, our most advanced stabilizer product.
Clinical Trials
Our PREVEIL first in-human early feasibility study using the
SurVeil
DCB completed enrollment in the second quarter of fiscal 2017. In PREVEIL, six-month results indicated that acute success measures of safety were achieved in all patients, as well as 100 percent primary patency and encouraging late lumen loss at six months post-procedure.
In July 2017, we received an investigational device exemption (“IDE”) from the FDA to initiate a pivotal clinical trial of the
SurVeil
DCB. The randomized clinical trial, TRANSCEND,
8
will evaluate the
SurVeil
DCB for treatment for PAD in the upper leg compared with the Medtronic IN.PACT® Admiral® DCB. The objective of the TRANSCEND
clinical trial is to evaluate the safety and
effectiveness of the
SurVeil
DCB device for treatment of subjects with symptomatic PAD due to stenosis of the femoral and/or popliteal arteries. If successful, the TRANSCEND
clinical trial will be used to support regulatory approvals and reimbursement
(U.S. and Europe). The trial will enroll up to 446 subjects at up to 60 sites in the U.S. and 18 outside the U.S. Study participants will be randomized to receive either treatment with
SurVeil
DCB or
IN.PACT Admiral
DCB. The trial’s primary efficacy endpoi
nt is primary patency, defined as a composite of freedom from restenosis and clinically-driven target lesion revascularization through 12 months post-index procedure. All randomized subjects will be followed through 60 months post-index procedure. We initi
ated enrollment in the TRANSCEND clinical trial in October 2017 and have engaged a clinical research organization to assist us with the administration of the clinical trial. There is no assurance that the TRANSCEND clinical trial will support regulatory ap
proval, or that any anticipated time frame will be met. We estimate that the cost of the TRANSCEND clinical trial will range between $32 million to $40 million over the next several years.
In connection with our whole-product solutions strategy, we plan to continue to sponsor and support clinical investigations to evaluate patient safety and clinical efficacy when necessary to support regulatory approval or clearance for new product initiatives. We will generate the clinical data necessary to seek regulatory approval or clearance for our existing and emerging products.
Patents and Proprietary Rights
Patents and other forms of proprietary rights are an essential part of Surmodics’ business. The Company aggressively pursues patent protection covering the proprietary technologies that we consider strategically important to our business. In addition to seeking patent protection in the U.S., we also generally file patent applications in European countries and, on a selective basis, other foreign countries. We strategically manage our patent portfolio so as to ensure that we have valid and enforceable patent rights protecting our technological innovations.
We protect our extensive portfolio of technologies through filing and maintaining patent rights covering a variety of coatings, drug delivery methods, reagents, and formulations, as well as particular clinical device applications. During fiscal 2017, Surmodics filed 4 original U.S. patent applications, as well as 9 international patent applications. As of September 30, 2017, Surmodics owned or had exclusive rights to 55 pending U.S. patent applications and 135 foreign patent applications. Likewise, as of the same date, Surmodics owned or had exclusive rights to 147 issued U.S. patents and 198 international patents.
We have licensed our
PhotoLink
hydrophilic technology on a non-exclusive basis to a number of our customers for use in a variety of medical device surface applications, including those described above. In particular, we have 30 issued U.S. patents, 10 pending U.S. patent applications, 34 issued international patents, and 32 pending international patent applications protecting various aspects of these technologies, including compositions, methods of manufacture and methods of coating devices. The expiration dates for these patents and anticipated expiration dates of the patent applications range from fiscal 2020 to 2035. Moreover, these patents and patent applications represent distinct families, with each family generally covering a successive generation of the technology, including improvements that enhance coating performance, manufacturability, or other important features desired by our customers. Among these, our third-generation
PhotoLink
technology is protected by a family of patents that expired in November 2015 (in the U.S.) and October 2016 (in certain other countries). In addition, our fourth-generation of our
PhotoLink
technology is protected by a family of patents that is expected to expire in early fiscal 2020. As noted above in “Licensing Arrangements,” the royalty obligation in our typical license agreement is generally for a specified number of years or the patent life, whichever is longer. In cases where the royalty obligation extends beyond the life of the applicable patent, it is because the license also includes rights to our know-how or other proprietary rights. Under these circumstances, the royalty obligation will continue at a reduced royalty rate for a specified number of years, as determined based on the specific terms and conditions of the applicable customer agreement, generally tied to the date on which the customer’s product was first sold. In recent years, we have successfully converted a number of our customer’s products utilizing this early generation technology to our advanced generation technologies.
The royalty revenue associated with our third-generation technology which has not yet converted, or is not in the process of converting, to our advanced generation technologies was approximately 12% of our fiscal 2017 revenue.
Approximately 21% of our total revenue in fiscal 2017 was generated from the fourth generation of our
PhotoLink
technology, which are protected by a family of patents that will begin to expire in fiscal 2020. Of the license agreements using our early generation technologies, most will continue to generate royalty revenue at a reduced royalty rate beyond patent expiration.
We also rely upon trade secrets, trademarks 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
9
prevent the un
authorized 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
Our aim is to use our design, development, manufacturing and commercialization capabilities to provide our customers earlier access to highly differentiated products that address important unmet clinical needs, and partner with them on successful commercialization of these products. While whole-product solutions development and manufacturing capability and capacity scale-up have been a significant focus, it does not change our business model to provide world-class surface modification coating technologies to our medical device customers.
Sales professionals working within our Medical Device business work in concert with our R&D personnel to coordinate customer activities. Our sales professionals’ specialization 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. As we complete development of our whole-product solutions medical devices, we are seeking third-parties to sell these products. With respect to our diagnostics products, our sales professionals sell directly to IVD kit manufacturers and we enter into sales and marketing relationships with third parties to distribute those products around the world. We also offer those products for sale through our website. See Note 12 to the consolidated financial statements in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for information regarding domestic and foreign revenue.
To support our marketing and sales activities, we publish technical literature on our various surface modification, drug delivery, and
in vitro
diagnostics technologies and products. 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 to our customers. This service and support may begin with a feasibility study, and also may include additional services such as assistance in the transfer of the technology to the customer, further optimization, process control and troubleshooting, preparation of product for clinical studies, and assistance with regulatory submissions for product approval. Some of these services are billable to customers, mainly feasibility and optimization activities.
Acquisitions
To further our strategic objectives and strengthen our existing businesses, we intend to continue to explore acquisitions and strategic collaborations to diversify and grow our business. As a result, we expect to make future acquisitions where we believe that we can broaden or enhance our technology offerings and expand our revenue sources and the markets in which we participate. Mergers and acquisitions of medical and diagnostic technology companies are inherently risky, and no assurance can be given that any of our previous or future acquisitions will be successful or will not materially adversely affect our consolidated results of operations, financial condition, or cash flows.
Significant Customers
Revenue from Medtronic represented approximately 18% of our consolidated revenue for the year ended September 30, 2017 and was generated from multiple products and fields of use, substantially all of which were recognized in our Medical Device segment. The percentage of revenue from Medtronic decreased in fiscal 2017 as our customer base was diversified with the Fiscal 2016 Acquisitions. No other customer provided more than 6% of our consolidated revenue in fiscal 2017. Two customers in our IVD business accounted for 13% and 10%, respectively, of our IVD operating segment revenue.
Competition
Medical Device Segment
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. Upon receiving regulatory clearance for our proprietary products, we plan to seek third parties to sell these whole-product solutions products. Our core balloon and catheter capabilities compete with larger original equipment manufacturer (OEM) suppliers, as well as some of our largest medical device partners that have in-house resources to produce balloons and catheters. We provide differentiated whole-product solutions that integrate our surface modification, catheter, balloon and other proprietary technologies.
10
Because a significant portion of our revenue depends on royalties derived from our customers’ medical device product sales incorporating our surface modification coating technologies, we are also affec
ted by competition within the markets for such devices. As we typically license our surface modification coating technologies on a non-exclusive basis, we benefit by offering our technologies to multiple competing manufacturers of a device. However, compet
ition 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 surface modification licensees may compete directly with larger, dominant manufacturers wi
th extensive product lines and greater sales, marketing and distribution capabilities. We also are unable to control other factors that may impact commercialization of our whole-product solutions and licensees with medical devices that utilize our surface
modification coatings, such as regulatory approval, marketing and sales efforts of our customers and licensees or competitive pricing pressures within the particular market. Many of our existing and potential competitors have greater financial, technical
and marketing resources than we have.
The ability for surface modification coating technologies to improve the performance of medical devices and drugs and to enable new product categories has resulted in increased competition in these markets. Some of our competitors offer device drug delivery technologies, while others specialize in lubricious or hemocompatible coating technology. Some of these companies target cardiovascular, peripheral or other medical device applications. In addition, because of 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 device drug delivery.
We attempt to differentiate ourselves from our competitors by providing what we believe is a high value-added approach to drug delivery and surface modification 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), ease of manufacturing, time-to-market, intellectual property protection, ability to produce multiple products from a single process, compliance with manufacturing regulations, ability to manufacture clinical and commercial products, 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. With respect to our licensed surface modification technologies, we believe that the cost and time required to obtain the necessary regulatory approvals significantly reduces the likelihood of a customer changing the manufacturing process it uses once a device or drug has been approved for sale.
In Vitro Diagnostics Segment
Competition in the diagnostics market is highly fragmented. In the product lines in which we compete (protein stabilization reagents, substrates, recombinant autoimmune antigens and surface chemistry technologies), we face an array of competitors ranging from large manufacturers with multiple business lines to small manufacturers that offer a limited selection of products. Some of our competitors have substantially more capital resources, marketing experience, R&D resources and production facilities than we do. We believe that our products compete on performance, stability (shelf life), sensitivity (lower levels detected, faster results), consistency and price. We believe that our continued competitive success will depend on our ability to
gain market share, to develop or acquire new proprietary products, obtain patent or other protection for our products and successfully market our products directly or through partners.
Manufacturing
We manufacture our surface modification and drug delivery reagents, and our IVD products in our Eden Prairie, Minnesota facility. In certain limited circumstances, we also provide contract manufacturing services for our customers, including, for example, coating their medical devices that are intended for pre-clinical and clinical development (including human clinical trials), and products that are sold for commercial use by our customers. We manufacture balloon catheters in our Ballinasloe, Ireland facility, which offers a suite of capabilities, including balloon forming, extrusion, coating, braiding and assembly of finished products. We plan to manufacture substantially all of our whole-product solutions devices in our Irish facility by the end of fiscal 2018.
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.
We follow quality management procedures in accordance with applicable regulations and guidance for the development and manufacture of materials and device, biotechnology or combination products that support clinical trials and commercialization. In an effort to better meet our customers’ needs in this area, our Eden Prairie, Minnesota facility is certified to ISO 13485 and ISO 9001. Our facility in Ballinasloe, Ireland is certified to ISO 13485. Each of these facilities is registered with the U.S. FDA as a “Contract Manufacturer.”
11
Government Regulation
The medical devices, IVD and biotechnology products incorporating our technologies are required to undergo long, expensive and uncertain regulatory review processes that are governed by the U.S. FDA and other international regulatory authorities. New medical devices utilizing our surface modification coating technologies can only be marketed in the U.S. after a 510(k) application has been cleared or a PMA application has been approved by the FDA. This process can take anywhere from several months (e.g., for medical device products seeking regulatory approval under the 510(k) approval process) to several years (e.g., for medical device products seeking regulatory approval under the PMA application process). With respect to our customers’ products that incorporate our surface modification coating and IVD technologies, the burden of securing regulatory approval typically rests with our customers as the medical device manufacturers. During fiscal 2017, 2016 and 2015, Surmodics had multiple customers obtain regulatory clearance on medical devices incorporating our
Serene
coating platform. With respect to our whole-product solutions, including the
SurVeil
DCB and any additional medical device products that we develop, the burden of securing regulatory approval will rest on us unless we partner with other organizations to pursue such approval.
In support of our customers’ regulatory filings, we maintain various confidential Device Master Files with the FDA and provide technical information to other regulatory agencies outside the U.S. regarding the nature, chemical structure and biocompatibility of our reagents. Our licensees generally do not have direct access to these files. However, they may, with our permission, reference these files in their various regulatory submissions to these agencies. This approach allows regulatory agencies to understand in confidence the details of our technologies without us having to share this highly confidential information with our customers.
U.S. legislation allows companies, prior to obtaining FDA clearance or approval to market a medical product in the U.S., to manufacture medical products 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 products 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.
Employees
As of November 30, 2017, we had 257 employees. Of these employees we employ 101 outside the U.S., primarily in R&D and manufacturing operations functions. We are not a party to any collective bargaining agreements.
We believe that our future success will depend in part on our ability to attract and retain qualified technical, management and marketing personnel. We are committed to developing and providing our employees opportunities to contribute to our growth and success.
12
EXECUTIVE OFFICERS
OF THE REGISTRANT
As of December 1, 2017, the names, ages and positions of the Company’s executive officers are as follows:
Name
|
|
Age
|
|
Position
|
Gary R. Maharaj
|
|
54
|
|
President and Chief Executive Officer
|
Timothy J. Arens
|
|
50
|
|
Vice President of Corporate Development and Strategy
|
Thomas A. Greaney
|
|
51
|
|
Chief Operating Officer, Medical Devices
|
Andrew D. C. LaFrence
|
|
54
|
|
Vice President of Finance and Information Systems and Chief Financial Officer
|
Charles W. Olson
|
|
53
|
|
Senior Vice President of Commercial and Business Development, Medical Devices
|
Bryan K. Phillips
|
|
46
|
|
Senior Vice President, Legal and Human Resources, General Counsel and Secretary
|
Joseph J. Stich
|
|
52
|
|
Vice President and General Manager, In Vitro Diagnostics
|
Gregg S. Sutton
|
|
58
|
|
Vice President of Research and Development, Medical Devices
|
Gary R. Maharaj
joined the Company in December 2010 as President and Chief Executive Officer and was also appointed to the Surmodics Board of Directors at such time. Prior to joining Surmodics, Mr. Maharaj served as President and Chief Executive Officer of Arizant Inc., a provider of patient temperature management systems in hospital operating rooms, from 2006 to 2010. Previously, Mr. Maharaj served in several senior level management positions for Augustine Medical, Inc. (predecessor to Arizant Inc.) from 1996 to 2006, including Vice President of Marketing, and Vice President of Research and Development. During his approximately 30 years in the medical device industry, Mr. Maharaj has also served in various management and research positions for the orthopedic implant and rehabilitation divisions of Smith & Nephew, PLC. Mr. Maharaj holds an M.B.A. from the University of Minnesota’s Carlson School of Management, an M.S. in biomedical engineering from the University of Texas at Arlington and the University of Texas Southwestern Medical Center at Dallas, and a B.Sc. in Physics from the University of the West Indies.
Timothy J. Arens
joined the Company in February 2007 as Director, Business Development and became Senior Director of Financial Planning and Analysis and General Manager, In Vitro Diagnostics in October 2010. He was promoted to Vice President of Finance and Interim Chief Financial Officer in August 2011 and in February 2013 became Vice President Corporate Development and Strategy. Prior to joining Surmodics, Mr. Arens was employed at St. Jude Medical, Inc., a medical technology company, from 2003 to 2007, in positions of increasing responsibility related to business development and strategic planning functions. Mr. Arens received a B.S. degree in Finance from the University of Wisconsin Eau Claire in 1989 and an M.B.A. degree from the University of Minnesota’s Carlson School of Management in 1996.
Thomas A. Greaney
joined the Company in November 2015 as Vice President of Operations and General Manager of Creagh Medical, after we acquired it. In August 2017, Mr. Greaney was promoted to Chief Operating Officer, Medical Devices. Prior to joining Surmodics, he served as Chief Executive Officer for Creagh Medical, from September 2005 to November 2015. Prior to his tenure in Creagh Medical, Mr. Greaney served in a variety of roles with Boston Scientific for 10 years including the world-wide operations responsibility for the Taxus Stent commercialization. From 1989 to 1995 he worked for a number of Electronics companies in a variety of engineering and management roles. Mr. Greaney received a B.E in Industrial Engineering in 1988 and a post grad Diploma in Quality Assurance in 1989, both from the National University of Ireland Galway.
Andrew D. C. LaFrence
joined the Company in February 2013 as Vice President of Finance and Chief Financial Officer and was also named Vice President of Information Systems in August 2016. Prior to joining Surmodics, he served as Chief Financial Officer for CNS Therapeutics, which developed and marketed pharmaceuticals for site-specific drug delivery to the central nervous system, from January 2011 to January 2013. Prior to joining CNS, Mr. LaFrence served as interim Chief Financial Officer of International Green Power from July 2010 to January 2011. Mr. LaFrence has over 30 years of financial and management experience including 26 years at KPMG LLP where, from 1996 to 2010, he was an audit partner focusing on supporting venture-backed, high-growth medical technology, pharmaceutical, biotech and clean tech private and public companies. Mr. LaFrence is a certified public accountant and received a bachelor's degree in accounting and a minor in business administration from Illinois State University in 1984.
Charles W. Olson
joined the Company in July 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, Sales was added to his responsibilities. In November 2008, Mr. Olson was named Vice President of our Cardiovascular business unit,
13
in October 2010, he was named Senior Vice President and Ge
neral Manager, Medical Device, and in August 2016 he was named Senior Vice President of Commercial and Business Development, Medical Devices. 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 B.S. degree in Marketing from Winona State University in 1987.
Bryan K. Phillips
joined the Company in July 2005 as Patent Counsel and Assistant General Counsel. In January 2006, Mr. Phillips was appointed Corporate Secretary, and he was promoted to Deputy General Counsel in October 2007. He was promoted to Vice President, General Counsel and Corporate Secretary in September 2008 and was promoted to Senior Vice President in October 2010. In August 2011, he became Senior Vice President, Legal and Human Resources, General Counsel and Secretary. Prior to joining Surmodics, Mr. Phillips served as patent counsel at Guidant Corporation’s Cardiac Rhythm Management Group where he was responsible for developing and implementing intellectual property strategies and also for supporting the company’s business development function. He also practiced law at the Minneapolis-based law firm of Merchant & Gould P.C. Mr. Phillips received a B.S. degree in Mechanical Engineering from the University of Kansas in 1993 and a law degree from the University of Minnesota Law School in 1999. He is admitted to the Minnesota bar and is registered to practice before the U.S. Patent and Trademark Office.
Joseph J. Stich
joined the Company in March 2010 as Vice President of Marketing, Corporate Development and Strategy. In August 2011, he became Vice President, Business Operations and General Manager, In Vitro Diagnostics and in September 2013 his role was adjusted to Vice President and General Manager, In Vitro Diagnostics. Before joining Surmodics, Mr. Stich was Vice President of Corporate Development for Abraxis BioScience, LLC, a biotechnology company focused on oncology therapeutics, from 2009 to 2010. Prior to joining Abraxis, he was a Vice President for MGI Pharma, Inc., a biopharmaceutical company, from 2005 to 2009. Mr. Stich’s prior experience also includes serving as President/COO of Pharmaceutical Corp. of America (a subsidiary of Publicis Healthcare Specialty Group), and positions of increasing responsibility in sales and marketing at Sanofi-Aventis Pharmaceuticals. He received a B.B.A. degree from the University of Wisconsin — Whitewater in 1988, and an M.B.A. degree from Rockhurst University in Kansas City, Missouri in 1996.
Gregg S. Sutton
joined the Company in January 2016 as Vice President of Research and Development, Medical Devices. Prior to joining Surmodics, he served as President and CEO of NorMedix, Inc., which we acquired in fiscal 2016, since June 2009. Mr. Sutton is a veteran medical device designer and developer with over 25 years of engineering experience in the medical device industry. He co-founded and held executive positions at several highly successful, early-stage development device companies, including Atritech, Angioguard, Vascular Solutions, and Navarre Biomedical, leading teams in development and launch of high-profile, first-of-their-kind devices. With a degree in mechanical engineering and over 50 patents granted, he has substantial experience in all aspects of medical device development, including intellectual property, design, product development, and manufacturing.
The executive officers of the Company are elected by and serve at the discretion of the Board of Directors. None of our executive officers are related to any other executive officer or any of our directors.
14
ITEM 1A.
RI
SK FACTORS
.
RISKS RELATING TO OUR BUSINESS, STRATEGY AND INDUSTRY
The loss of, or significant reduction in business from, one or more of our major customers could significantly reduce our revenue, earnings or other operating results.
A significant portion of our revenue is derived from a relatively small number of customers. We have one customer that provided more than 10% of our revenue in fiscal 2017. Revenue from Medtronic represented approximately 18% of our total revenue for the fiscal year ended September 30, 2017 and was generated from multiple products and fields of use. The loss of Medtronic or any of our largest customers, or reductions in business from them, 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. If we cannot broaden our customer base, we will continue to depend on a small number of customers for a significant portion of our revenue.
The long-term success of our business may suffer if we are unable to expand our licensing base.
We intend to continue pursuing a strategy of licensing our coatings technologies to a diverse array base of medical device companies, thereby expanding the commercialization opportunities for our technologies. A significant portion of our revenue is derived from customer devices used in connection with procedures in cardiovascular, peripheral vascular and other applications. As a result, our business is susceptible to adverse trends in procedures. Further, we may also be subject to adverse trends in specific markets such as the cardiovascular industry, including declines in procedures using our customers’ products as well as declines in average selling prices from which we earn royalties. Our 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 technologies for use in applications outside of cardiovascular. 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 customers 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 operating results.
Surface modification, device drug delivery and medical device products are competitive markets and carry the risk of technological obsolescence and we face increased competition in our In Vitro Diagnostics segment.
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 device drug delivery. Our surface modification and device drug delivery technologies compete with technologies developed by a number of other companies. In addition, many medical device manufacturers have developed, or are engaged in efforts to develop, drug delivery or surface modification technologies for use on their own products. With respect to commercialization of our whole-product solutions, we expect to face competitive pricing pressures from larger OEM suppliers, as well as some of our largest medical device partners that have in-house resources that produce similar products. Some of our existing and potential competitors (especially medical device manufacturers pursuing coating solutions through their own R&D efforts) have greater financial and technical resources as well as production and marketing capabilities than us. Further, even if we are successful with respect to our plan to develop 12-15 medical device products over the next five years, we will be competing with companies that may be better able to leverage existing sales forces. 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 uncompetitive 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 uncompetitive or obsolete. Any new technologies that make our drug delivery, surface modification or In Vitro Diagnostics technologies less competitive or obsolete would have a material adverse effect on our business, financial condition and results of operations.
We may not be successful in implementing our whole-products solutions strategy and related important strategic initiatives
Since fiscal 2013, with our investment in our DCB platform, we have been focused on a key growth strategy for our medical device business by expanding to offer whole-product solutions to our medical device customers. Our aim is to provide customers earlier access to highly differentiated products that address unmet clinical needs, and partner with them on successful commercialization. If we are unable to identify and enter into arrangements with our medical device customers for the
15
commercialization of our products, we may seek to market and sell these products throug
h third-party distributors or via direct sales.
Successfully implementing our whole-products solutions strategy and related strategic initiatives will place substantial demands on our resources and management’s time, and require, among other things:
|
•
|
continued enhancement of our medical device R&D capabilities, including those needed to support the clinical evaluation and regulatory approval for our whole-product solutions;
|
|
•
|
effective coordination and integration of our research facilities and teams, particularly those located in different facilities;
|
|
•
|
successful hiring and training of personnel;
|
|
•
|
effective management of a business geographically located both in the United States and Ireland;
|
|
•
|
commercialization of our products, including through strategic partnerships with our medical device customers, third-party distributors, or via direct sales;
|
|
•
|
sufficient liquidity to support substantial investments in R&D required to make our strategy successful; and
|
|
•
|
increased marketing and sales-support activities.
|
There is no assurance that we will be able to successfully implement our whole-products strategy and related strategic initiatives in accordance with our expectations, which could impact our ability to realize an acceptable return on the investments we are making in connection with this strategy, and may result in an adverse impact on our business and financial results.
Failure to identify acquisition opportunities or to integrate acquired businesses into our operations successfully may limit our growth.
An important part of our growth in the future may involve the acquisition of complementary businesses or technologies. Our identification of suitable acquisition candidates involves risks inherent in assessing the technology, value, strengths, weaknesses, overall risks and profitability, if any, of acquisition candidates. We may not be able to identify suitable acquisition candidates, or we may be unable to execute acquisitions due to competition from buyers with more resources. If we do not make suitable investments and acquisitions, we may find it more difficult to realize our growth objectives.
The process of integrating acquired businesses into our operations, including our Fiscal 2016 Acquisitions, poses numerous risks, including:
|
•
|
an inability to integrate acquired operations, personnel, technology, information systems, and internal control systems and products;
|
|
•
|
a lack of understanding of tax, legal and cultural differences;
|
|
•
|
diversion of management’s attention, including the need to manage several remote locations with a limited management team;
|
|
•
|
difficulties and uncertainties in transitioning the customers or other 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’ ownership, and cause large one-time expenses or create goodwill or other intangible assets that could result in future significant asset impairment charges. 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 R&D efforts necessary to commercialize such acquired technology. We cannot guarantee that we will be able to successfully complete any acquisitions or that we will realize any anticipated benefits from acquisitions that we complete.
16
Our failure to expand our management systems and controls to support anticipated growth or integrate acquisitio
ns could seriously harm our operating results and business.
Our operations are expanding, and we expect this trend to continue as we execute our business strategy. Executing our business strategy has placed significant demands on management and our administrative, development, operational, information technology, manufacturing, financial and personnel resources. Accordingly, our future operating results will depend on the ability of our officers and other key employees to continue to implement and improve our operational, development, customer support and financial control systems, and effectively expand, train and manage our employee base. Otherwise, we may not be able to manage our growth successfully.
Goodwill or other assets on our balance sheet may become impaired, which could have a material adverse effect on our operating results.
We have a significant amount of goodwill and intangible assets on our balance sheet in connection with our acquisitions. As of September 30, 2017, we had $27.3 million of goodwill and indefinite-lived intangible assets on our consolidated balance sheet related to our Medical Device and IVD segments, of which $19.3 million related to our Fiscal 2016 Acquisitions in our Medical Device reporting unit. As required by the accounting guidance for non-amortizing intangible assets, we evaluate at least annually the potential impairment of the goodwill and trademark. Testing for impairment of non-amortizing intangible assets involves the determination of the fair value of our reporting units. The estimation of fair values involves a high degree of judgment and subjectivity in the assumptions used. We also evaluate other assets on our balance sheet, including strategic investments and intangible assets, whenever events or changes in circumstances indicate that their carrying value may not be recoverable. Our estimate of the fair value of the assets may be based on fair value appraisals or discounted cash flow models using various inputs. During fiscal 2017 and 2016, we recorded impairment charges on our indefinite-lived intangible assets of $0.4 million and $0.1 million, respectively, related to non-amortizing intangible assets arising from the Creagh Medical acquisition. Future impairment of the goodwill or other assets on our balance sheet could materially adversely affect our results of operations.
Research and development costs may adversely affect our operating results.
The success of our business depends on a number of factors, including our continued research and development of new technologies for future commercialization. In recent years, we have expended considerable resources researching and developing our DCB platform. In fiscal 2018, we expect to continue the clinical evaluation of the
SurVeil
DCB and will conduct additional development activities for the below-the-knee, AV fistula and other whole-product solutions products, which will result in significant expenses that will adversely affect our operating results, including our profitability, in fiscal 2018 and future periods. Additionally, these activities are subject to risks of failure that are inherent in the development of new medical technologies or products. There can be no assurance that we will be successful in developing new technologies or products, or that any such technology will be commercialized.
We recognize revenue in accordance with various complex accounting standards, and changes in circumstances or interpretations may lead to accounting adjustments.
Our revenue recognition policies involve application of various complex accounting standards, including accounting guidance associated with revenue arrangements with multiple deliverables. Our compliance with such accounting standards often involves management’s judgment regarding whether the criteria set forth in the standards have been met such that we can recognize as revenue the amounts that we receive as payment for our products or services. We base our judgments on assumptions that we believe to be reasonable under the circumstances. However, these judgments, or the assumptions underlying them, may change over time. In addition, the SEC or the Financial Accounting Standards Board (“FASB”) may issue new positions or revised guidance on the treatment of complex accounting matters. Changes in circumstances or third-party guidance could cause our judgments to change with respect to our interpretations of these complex standards, and transactions recorded, including revenue recognized, for one or more prior reporting periods, could be adversely affected.
As described below in “Part II, Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations.”, the FASB issued new revenue recognition guidance for recognizing revenue from contracts with customers in May 2014. This accounting standard will be effective for us beginning in the first quarter of fiscal 2019. We are currently evaluating the impact that the adoption of this standard will have on our business model and consolidated results of operations, cash flows and financial position. We currently believe the impact will be material due to the risks associated with implementing the new standards and ensuring accuracy in our reporting during the transition, the acceleration of minimum license fees and a one-quarter acceleration of royalty revenue pursuant to our hydrophilic license agreements, as well as requiring several additional financial
17
statement footnote disclosures. We will also need to update and enhance our internal accounting systems, processes and our internal controls ove
r financial reporting. This has required, and will continue to require, additional investments by us, and may require incremental resources and system configurations that could increase our operating costs in future periods. If we are not able to properly
implement the new revenue recognition standards in a timely manner, the revenue that we recognize and the related disclosures that we provide under the new standards may not be complete or accurate, and we could fail to meet our financial reporting obligat
ions in a timely manner, which could result in, among other things, regulatory discipline and adversely affect our stock price.
With our fiscal 2016 acquisition of Creagh Medical, our business includes foreign operations which exposes us to certain risks related to fluctuations in U.S. dollar and foreign currency exchange rates.
The Company reports its consolidated financial statements in U. S. dollars. In a period where the U.S. dollar is strengthening or weakening as compared with the Euro, our revenue and expenses denominated in the Euro are translated into U.S. dollars at a lower or higher value than they would be in an otherwise constant currency exchange rate environment. In addition, we have Euro-denominated contingent consideration liabilities that are subject to exchange rate fluctuations, which are scheduled to be paid in the first quarter of our fiscal 2019 and we have not hedged this foreign currency exposure. During fiscal 2017 and 2016, we recorded foreign currency exchange losses of $0.5 million and $0.4 million, respectively. The losses were primarily related to these Euro-denominated liabilities. As our foreign operations expand, the effects may become material to our consolidated financial statements.
We have previously identified material weaknesses in our internal control over financial reporting. While these particular material weaknesses have been remediated, if we do not maintain effective internal control over financial reporting, our operating results could require material modification and our financial reports may not be reliable.
A material weakness was identified in a prior year related to the design and operating effectiveness of our transactional and review controls related to recognition of royalty revenue. We have since remediated the material weakness by taking the steps described below in “Part II, Item 9A. Controls and Procedures.”. 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 Exchange Act. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2017.
Although we are committed to continuing to improve our
internal control processes to ensure the adequacy of the internal controls over financial reporting, any control system, regardless of how well designed, operated and evaluated, can provide only reasonable, not absolute, assurance that its objectives will be met. Therefore, we cannot be certain that, in the future, additional material weaknesses or significant deficiencies will not exist or otherwise be discovered. If other deficiencies or material weaknesses exist, it could result in misstatements of our results of operations, a restatement of our financial statements for one or more prior periods, a decline in our stock price and investor confidence or other material effects on our business, reputation, results of operations, financial condition or liquidity.
RISKS RELATING TO OUR OPERATIONS AND RELIANCE ON THIRD PARTIES
We rely on third parties to market, distribute and sell most products incorporating our coating technologies.
A principal element of our business strategy is to enter into licensing arrangements with medical device and other companies that manufacture products incorporating our technologies. For the fiscal years ended September 30, 2017, 2016 and 2015, we have derived 44%, 47%, and 51%, respectively, of our revenue from royalties and license fees derived from such licensing arrangements. The revenue that we derive from such arrangements is dependent on our licensees’ ability to successfully develop, obtain successful regulatory approval for, manufacture (if applicable), market and sell products incorporating our technologies.
Additionally, a licensee could modify their product in such a way that it no longer incorporates our technology. Many of these factors are outside of our control and the failure on the part of our licensees to successfully meet these requirements could have a material adverse effect on our business, financial condition and results of operations.
Moreover, 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 us and may pursue parallel development
18
or licensing of competing technologies 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 co
ndition and results of operations.
Failure on the part of our licensees to successfully meet these requirements could have a material adverse effect on our business, financial condition and results of operations.
A portion of our IVD business relies on distribution agreements and relationships with various third parties and any adverse change in those relationships could result in a loss of revenue and harm that business.
We sell many of our IVD products outside of the United States through distributors. Some of our distributors also sell our competitors’ products, and if they favor our competitors’ products for any reason, they may fail to market our products as effectively or to devote resources necessary to provide effective sales, which would cause our results to suffer. Additionally, we serve as the exclusive distributor in the United States, Canada and Puerto Rico for DIARECT AG for its recombinant and native antigens. The success of these arrangements with these third parties depends, in part, on the continued adherence to the terms of our agreements with them. Any disruption in these arrangements will adversely affect our financial condition and results of operations.
We rely on our customers to accurately report and make payments under our agreements with them.
We rely on our customers to determine whether the products that they sell are royalty-bearing and, if so, report and pay the amount of royalties owed to us under our agreements with them. The majority of our license agreements with our customers give us the right to audit their records to verify the accuracy of their reports to us. However, these audits can be expensive, time-consuming and possibly detrimental to our ongoing business relationships with our customers. While we have undertaken audits of certain of our customers in the past, we generally rely on the accuracy of the reports that they provide to us.
Inaccuracies in these reports has resulted in, and could result in additional overpayments or underpayments of royalties, which could have a material adverse effect on our business, financial condition and results of operations.
We have limited or no redundancy in our manufacturing facilities, and we may lose revenue and be unable to maintain our customer relationships if we lose our production capacity.
We manufacture all of our Medical Device coating reagents (and provide coating manufacturing services for certain customers) and our IVD products at our Eden Prairie, Minnesota facility. We also manufacture balloon catheter products at our facility in Ballinasloe, Ireland and catheter-based medical devices in limited quantities in Plymouth, Minnesota. If our existing production facilities 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 customers, including certain of our licensees. In particular, because most of our customers use our coating reagents to manufacture their own products that generate royalty revenue for us, failure by us to supply these reagents could result in decreased royalty revenue, as well as decreased revenue from our surface modification coating technologies product sales. Without our existing production facilities, we would have no other means of manufacturing products until we were able to restore the manufacturing capability at these facilities or develop one or more alternative manufacturing facilities. 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.
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. For medical device products that incorporate our coating technology, most of the license provide us with indemnification against such claims. However, there can be no guarantee that product liability claims will not be filed against us for such products, or for medical device products that we manufacture as part of our whole-product solutions strategy, that parties indemnifying us will have the financial ability to honor their indemnification obligations or that such manufacturers will not seek indemnification or other relief from us for any such claims. Any product liability claims, with or without merit, could result in costly litigation, reduced sales, significant liabilities and diversion of our management’s time, attention and resources. We have obtained a level of liability insurance coverage that we believe is appropriate to our activities, however, we cannot be sure that our product liability insurance coverage is adequate or that it will continue to be available to us on acceptable terms, if at all. 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
19
because of alleged defects, whether such recall is instituted by us, by a customer, or is 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 liabilit
ies could have a material adverse effect on our business, financial condition and results of operations.
Our revenue will be harmed if we cannot purchase sufficient components that we use in our manufacture of reagents.
We currently purchase some of the components we use to manufacture reagents from sole suppliers. If any of our sole suppliers becomes unwilling to supply components to us, experiences 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 products incorporating our 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. 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, and we generally do not enter into employment agreements, except with certain executive officers. 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.
Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer.
We collect and store sensitive data, including intellectual property, our proprietary business information and that of our customers, suppliers and business partners, and personally identifiable information of our customers and employees, on our networks. The secure maintenance of this information is critical to our operations and business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers resulting from employee error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, and regulatory penalties, disrupt our operations and the services that we provide to our customers, damage our reputation and cause a loss of confidence in our products and services, any of which could adversely affect our business and competitive position.
RISKS RELATING TO OUR INTELLECTUAL PROPERTY
We may not be able to obtain, maintain or protect proprietary rights necessary for the commercialization of our technologies.
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 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 proprietary 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, that the patents of others will not prevent the commercialization of products incorporating our technologies, or that others will not independently develop similar technologies or design around our patents. Furthermore, because we generate a significant amount of our revenue through licensing arrangements, the loss or expiration of patent protection for our licensed technologies will result in a reduction of the revenue derived from these arrangements which may have a material adverse effect on our business, cash flow, results of operations, financial position and prospects.
20
We may become involved in expensive and unpredicta
ble patent litigation or other intellectual property proceedings which could result in liability for damages, or impair our development and commercialization efforts.
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 and pharmaceutical industries, 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 certain other administrative proceedings may also be necessary to enforce our patents 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.
If we are unable to keep our trade secrets confidential, our technology and proprietary information may be used by others to compete against us.
We rely significantly upon proprietary technology, information, processes and know-how that are not subject to patent protection. We seek to protect this information through trade secret or confidentiality agreements with our employees, consultants, potential licensees, or other parties as well as through other security measures. There can be no assurance that these agreements or any security measure will provide meaningful protection for our unpatented proprietary information. In addition, our trade secrets may otherwise become known or be independently developed by competitors. If we determine that our proprietary rights have been misappropriated, we may seek to enforce our rights which would draw upon our financial resources and divert the time and efforts of our management, and could have a material adverse effect on our business, financial condition and results of operations.
If we are unable to convert our customers to our advanced generation of hydrophilic coating technology, our royalty revenue may decrease.
In our Medical Device business unit, we have licensed our
PhotoLink
hydrophilic technology to a number of our customers for use in a variety of medical device surface applications. We have several U.S. and international issued patents and pending international patent applications protecting various aspects of these technologies, including compositions, methods of manufacture and methods of coating devices. The expiration dates for these patents and the anticipated expiration dates of the patent applications range from fiscal 2020 to 2035. These patents and patent applications represent distinct families, with each family generally covering a successive generation of the technology, including improvements that enhance coating performance, manufacturability, or other important features desired by our customers. Among these, our third-generation
PhotoLink
hydrophilic technology is protected by a family of patents that expired in November 2015 (in the U.S.) and October 2016 (in certain other countries). The royalty revenue associated with our third-generation technology was approximately 12% of our fiscal 2017 revenue.
Approximately 21% of our total revenue in fiscal 2017 was generated from our fourth-generation
PhotoLink
technology, which are protected by a family of patents that will begin to expire in fiscal 2020. Of the license agreements using our early generation technologies, most will continue to generate royalty revenue at a reduced royalty rate beyond patent expiration.
In recent years, we have successfully converted a number of our customers’ products utilizing these early generation technologies to one of our advanced generation technologies. While we are actively seeking to convert our customers to one of our advanced generations of our hydrophilic coating technology, there can be no assurance that we will be successful in doing so, or that those customers that have converted, or will convert, will sell products utilizing our technology which will generate earned royalty revenue for us.
21
If we or any of our licensees breach any of the agreements under which we have in-licensed intellectual property from others, we could be deprived of important intellectual property ri
ghts and future revenue.
We are a party to various agreements through which we have in-licensed or otherwise acquired rights to certain technologies that are important to our business. In exchange for the rights granted to us under these agreements, we have agreed to meet certain research, development, commercialization, sublicensing, royalty, indemnification, insurance or other obligations. If we or one of our licensees fails to comply with these obligations set forth in the relevant agreement through which we have acquired rights, we may be unable to effectively use, license, or otherwise exploit the relevant intellectual property rights and may be deprived of current or future revenue that is associated with such intellectual property.
RISKS RELATING TO CLINICAL AND REGULATORY MATTERS
The development of new products and enhancement of existing products requires significant research and development, clinical trials and regulatory approvals, all of which may be very expensive and time-consuming and may not result in commercially viable products.
The development of new products and enhancement of existing products requires significant investment in research and development, clinical trials and regulatory approvals. During fiscal 2017, we continued the development of the
SurVeil
DCB, including investigating additional clinical applications and uses of the platform. In October 2017, commenced enrollment of patients in TRANSCEND, the pivotal clinical trial for the
SurVeil
DCB.
There can be no assurance that any products now in development, or that we may seek to develop in the future, will achieve technological feasibility, obtain regulatory approval or gain market acceptance. If we are unable to obtain regulatory approval for new products or enhanced products, our ability to successfully compete in the markets in which we participate may be materially adversely impacted. A delay in the development or approval of new products and technologies may also adversely impact the timing of when these products contribute to our future revenue and earnings growth.
Healthcare policy changes may have a material adverse effect on us.
Healthcare costs have risen significantly during the past decade. There have been and continue to be proposals by legislators, regulators and third-party payers to keep these costs down. Certain proposals, if implemented, would impose limitations on the prices our customers will be able to charge for our products, or the amounts of reimbursement available for their products from governmental agencies or third-party payers, or otherwise negatively impact pricing and reimbursement. Because a significant portion of our revenue is currently derived from royalties on products which constitute a percentage of our customer’s product’s selling price, these limitations could have an adverse effect on our revenue.
The Patient Protection and Affordable Care Act (the “ACA”) imposes significant new taxes on medical device makers who make up a significant portion of our customers. Although significant components of these taxes have been suspended for calendar 2016 and 2017, their status is unclear for 2018 and subsequent years, as is the future of the ACA itself. The legislation has resulted in a significant total cost increase to the medical device and diagnostic industries, which could have a material, negative impact on both the financial condition of our customers as well as on our customers’ ability to attract financing, their willingness to commit capital to development projects or their ability to commercialize their products utilizing our technology, any of which could have a material adverse effect on our business, financial condition and results of operations. There continues to be substantial risk to our customers, and therefore us, from the uncertainty which continues to surround the future of health care delivery and reimbursement both in the U.S. and abroad.
In particular, we cannot predict what other healthcare programs and regulations will ultimately be implemented at the federal or state level or the effect of any future legislation or regulation in the United States or abroad may have on our business.
Whole-product solutions medical devices and other products incorporating our technologies are subject to increasing scrutiny and regulations, including extensive approval/ clearance processes and manufacturing requirements. Any adverse regulatory and/ or enforcement action (for us or our licensees) may materially affect our financial condition and business operations.
Our products and our business activities are subject to a complex regime of regulations. Additionally, certain state governments and the federal government have enacted legislation aimed at increasing transparency of industry interactions with health care providers. Any failure to comply with these legal and regulatory requirements could impact our business. In addition, we will continue to devote substantial additional time and financial resources to further develop and implement policies, systems, and
22
processes to comply with enhanced leg
al and regulatory requirements, which may also impact our business. We anticipate that governmental authorities will continue to scrutinize our industry closely, and that additional regulation may increase compliance and legal costs, exposure to litigation
, and other adverse effects to our operations.
To varying degrees, the FDA and comparable agencies outside the US require us to comply with laws and regulations governing the development, testing, manufacturing, labeling, marketing, and distribution of our products. Our compliance with these laws and regulations takes significant time/ resources, involves stringent testing/ surveillance, involves attention to any needed product improvements (such as modifications, repairs, or replacements), and may include significant limitations of the uses of our products.
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 by us or 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.
Our facilities and procedures are subject to periodic inspections by the FDA to determine compliance with the FDA’s requirements. The results of these inspections can include inspectional observations on FDA’s Form-483, warning letters, or other forms of enforcement. The FDA has significantly increased its oversight of companies subject to its regulations, including medical device companies. If the FDA were to conclude that we are not in compliance with applicable laws or regulations, or that any of our medical devices are ineffective or pose an unreasonable health risk, the FDA could ban such medical devices, detain or seize adulterated or misbranded medical devices, order a recall, repair, replacement, or refund of such devices, refuse to grant pending pre-market approval applications or require certificates of non-U.S governments for exports, and/or require us to notify health professionals and others that the devices present unreasonable risks of substantial harm to the public health. The FDA may also assess civil or criminal penalties against us, our officers or employees and impose operating restrictions on a company-wide basis, or enjoin and/or restrain certain conduct resulting in violations of applicable law. The FDA may also recommend prosecution to the U. S. Department of Justice. Any adverse regulatory action, depending on its magnitude, may restrict us from effectively marketing and selling our products and limit our ability to obtain future pre-market clearances or approvals, and could result in a substantial modification to our business practices and operations.
We may face liability if we mishandle or improperly dispose of the hazardous materials used 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 that we believe are appropriate, 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.
Additionally, 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. We could be held liable in the event of improper disposal of such materials, even if these acts were done by third parties. 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.
RISKS RELATING TO OUR SECURITIES
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.” Our common stock price may rise or fall sharply at any time because of this volatility, as a result of sales executed by significant holders of our stock, and also because of short positions taken by investors from time to time in our stock. In the fiscal year ended September 30, 2017, the sale price for our common stock ranged from $21.90 to $31.80 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 may be unrelated to the operating performance of particular companies.
23
ITEM 1B.
UNRESOLVE
D STAFF COMMENTS
.
None.
ITEM 2.
PROPERTIES
.
Our principal operations are located in Eden Prairie, a suburb of Minneapolis, Minnesota, where we own a building that has approximately 64,000 square feet of space. We also own a 30,000 square foot building in Ballinasloe, Ireland dedicated to our Medical Device operating segment. We lease a warehouse near our Eden Prairie facility through 2021 and a R&D-focused facility in Plymouth, Minnesota through May 2018. Upon termination of the Plymouth lease in May 2018, we plan to move substantially all of our U.S. Medical Device whole-product solutions R&D operations into a 36,000 square foot leased facility in Eden Prairie Minnesota. We also own an undeveloped parcel of land adjacent to our principal facility, which we intend to use to accommodate our growth needs.
ITEM 3.
LEGAL PROCEEDINGS
.
See the discussion of “Litigation” in Note 11 to the consolidated financial statements in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.
ITEM 4.
MINE SAFETY DISCLOSURES
.
Not Applicable.
24
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
Notes to Consolidated Financial Statements
1. Description
Surmodics, Inc. and subsidiaries (“Surmodics” or the “Company”) is a leading provider of medical device and
in vitro
diagnostic technologies to the healthcare industry. The Company derives its revenue from three primary sources: (1) royalties and license fees from licensing our proprietary surface modification and device drug delivery technologies to customers; the vast majority (typically in excess of 90%) of revenue in the “royalties and license fees” category is in the form of royalties; (2) product revenue generated from reagent chemical sales to licensees; stabilization chemical, antigen, substrate and surface coating chemical sales to the diagnostic and biomedical research markets as well as medical device and related products (such as balloons and catheters) sales to original equipment manufacturer (OEM) suppliers and distributors; and (3) research and commercial development fees generated on customer projects.
Basis of Presentation
The consolidated financial statements include all accounts and wholly-owned subsidiaries, and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”) (“GAAP”). All inter-company transactions have been eliminated.
2. Summary of Significant Accounting Policies and Select Balance Sheet Information
Cash and Cash Equivalents
Cash and cash equivalents consist of financial instruments with maturities of three months or less at the Company’s acquisition date of the security and are stated at cost which approximates fair value and may include money market instruments, certificates of deposit, repurchase agreements and commercial paper instruments.
Investments
Investments consisted principally of commercial paper and corporate bond securities and are classified as available-for-sale as of September 30, 2017. Available-for-sale securities are reported at fair value with unrealized gains and losses, net of tax, excluded from the consolidated statements of income and reported in the consolidated statements of comprehensive income as well as a separate component of stockholders’ equity in the consolidated balance sheets, except for other-than-temporary impairments, which are reported as a charge to current earnings. A loss would be recognized when there is an other-than-temporary impairment in the fair value of any individual security classified as available-for-sale, with the associated net unrealized loss reclassified out of accumulated other comprehensive income with a corresponding adjustment to other income (loss). This adjustment would result in a new cost basis for the investment. No such adjustments occurred during the fiscal years ended September 30, 2017, 2016 or 2015. Interest earned on debt securities, including amortization of premiums and accretion of discounts, is included in other income (loss). Realized gains and losses from the sales of available-for-sale debt securities, which are included in other income (loss), are determined using the specific identification method.
The amortized cost, unrealized holding gains and losses, and fair value of available-for-sale securities as of
September 30, 2017 and 2016
were as follows
(in thousands):
|
|
September 30, 2017
|
|
(Dollars in thousands)
|
|
Amortized Cost
|
|
|
Unrealized Gains
|
|
|
Unrealized Losses
|
|
|
Fair Value
|
|
Commercial paper and corporate bonds
|
|
$
|
31,817
|
|
|
$
|
—
|
|
|
$
|
(15
|
)
|
|
$
|
31,802
|
|
Total
|
|
$
|
31,817
|
|
|
$
|
—
|
|
|
$
|
(15
|
)
|
|
$
|
31,802
|
|
|
|
September 30, 2016
|
|
(Dollars in thousands)
|
|
Amortized Cost
|
|
|
Unrealized Gains
|
|
|
Unrealized Losses
|
|
|
Fair Value
|
|
Commercial paper and corporate bonds
|
|
$
|
22,019
|
|
|
$
|
—
|
|
|
$
|
(65
|
)
|
|
$
|
21,954
|
|
Total
|
|
$
|
22,019
|
|
|
$
|
—
|
|
|
$
|
(65
|
)
|
|
$
|
21,954
|
|
F-9
There were no held-to-maturity debt securities as of September 30, 2017 or 2016 and no realized gains or losses on sales of available-for-sale securities for the fiscal years then ended. Realized gains and losses on sales of available-for-sale securities totaled $0.5 million and $(0.1) million, respectively, for the fiscal year ended September 30, 2015.
Inventories
Inventories are principally 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 components as of September 30
(in thousands):
|
|
2017
|
|
|
2016
|
|
Raw materials
|
|
$
|
1,603
|
|
|
$
|
1,766
|
|
Work in-process
|
|
|
659
|
|
|
|
492
|
|
Finished products
|
|
|
1,254
|
|
|
|
1,321
|
|
Total
|
|
$
|
3,516
|
|
|
$
|
3,579
|
|
Property and Equipment
Property and equipment are stated at cost, less any impairment, and are depreciated using the straight-line method over the estimated useful lives of the assets. The Company recorded depreciation expense of $3.0 million, $2.3 million and $2.0 million for the fiscal years ended September 30, 2017, 2016 and 2015, respectively.
The September 30, 2017 and 2016 balances in construction-in-progress include the cost of enhancing the capabilities of the Company’s Ballinasloe, Ireland and Eden Prairie, Minnesota facilities. As assets are 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):
|
|
Useful Life
|
|
2017
|
|
|
2016
|
|
|
|
(In years)
|
|
|
|
|
|
|
|
|
Land
|
|
N/A
|
|
$
|
4,420
|
|
|
$
|
4,359
|
|
Laboratory fixtures and equipment
|
|
3 to 10
|
|
|
19,491
|
|
|
|
15,243
|
|
Buildings and improvements
|
|
3 to 20
|
|
|
21,924
|
|
|
|
19,589
|
|
Office furniture and equipment
|
|
3 to 10
|
|
|
4,541
|
|
|
|
3,948
|
|
Construction-in-progress
|
|
|
|
|
2,493
|
|
|
|
3,441
|
|
Less accumulated depreciation
|
|
|
|
|
(29,927
|
)
|
|
|
(26,979
|
)
|
Property and equipment, net
|
|
|
|
$
|
22,942
|
|
|
$
|
19,601
|
|
Other Assets
Other assets consist principally of the following as of September 30
(in thousands):
|
|
2017
|
|
|
2016
|
|
ViaCyte, Inc.
|
|
$
|
479
|
|
|
$
|
479
|
|
Other noncurrent assets
|
|
|
418
|
|
|
|
149
|
|
Other assets, net
|
|
$
|
897
|
|
|
$
|
628
|
|
In February 2011, the stent technology of Nexeon MedSystems, Inc. (“Nexeon”) was acquired by CeloNova BioSciences, Inc. (“CeloNova”). Prior to the acquisition by CeloNova, Nexeon created a wholly-owned subsidiary, Nexeon Stent, to hold the company’s stent-related assets. Nexeon distributed to its stockholders the Nexeon Stent stock which was exchanged for Series B-1 preferred shares of CeloNova. CeloNova is a privately-held Texas-based medical technology company that is marketing a variety of medical products. The Company’s investment in CeloNova, which was accounted for under the cost method, represented less than a 2% ownership interest. The Company does not exert significant influence over CeloNova’s operating or financial activities.
F-10
On November 10, 2015 Boston Scientific C
orporation announced its intent to acquire CeloNova’s interventional radiology portfolio for $70 million, plus potential milestone payments. The Company recognized an other-than-temporary impairment loss of $1.5 million related to its investment in CeloNov
a in the fourth quarter fiscal 2015 based on the indicated value of this transaction. As of September 30, 2017 and 2016, the carrying value of this investment is $0.
The Company has invested a total of $5.3 million in ViaCyte, Inc. (“ViaCyte”), a privately-held California-based biotechnology firm that is developing a unique treatment for diabetes using coated islet cells, the cells that produce insulin in the human body. In fiscal 2006, the Company determined that its investment in ViaCyte was impaired and that the impairment was other-than-temporary. Accordingly, the Company recorded an impairment loss of $4.7 million. In the second quarter of fiscal 2013, the Company recorded an additional other-than-temporary impairment loss on this investment totaling $0.1 million based on a financing round and market valuations. The balance of the investment of $0.5 million, which is accounted for under the cost method, represents less than a 1% ownership interest. The Company does not exert significant influence over ViaCyte’s operating or financial activities.
The Company transferred its original investment of $2,000 in Intersect ENT, Inc. (“Intersect ENT”) out of other assets to short-term available-for-sale investments upon completion of Intersect ENT’s initial public offering (“IPO”) in July 2014. The Company recognized a gain on this investment in other income of $0.5 million during the year ended September 30, 2015 as the investment was sold.
The total carrying value of cost method investments is reviewed quarterly for changes in circumstances or the occurrence of events that suggest the Company’s investment may not be recoverable. The carrying value of cost method investments is not adjusted if there are no identified events or changes in circumstances that may have a material adverse effect on the fair value of the investment.
In the fiscal years ended September 30, 2017, 2016 and 2015, the Company recognized revenue of less than $0.1 million in each period from activity with companies in which it had a strategic investment.
Intangible Assets
Intangible assets consist principally of acquired patents and technology, customer lists and relationships, licenses and trademarks. The Company recorded amortization expense of $2.6 million, $2.4 million and $0.8 million for the years ended September 30, 2017, 2016 and 2015, respectively. During the year ended September 30, 2016, the Company acquired 100% of the shares of both Creagh Medical Ltd. (“Creagh Medical”) and NorMedix, Inc. (“NorMedix”). These acquisitions (collectively, “Fiscal 2016 Acquisitions”) resulted in an increase in customer lists and relationships, developed technology and in-process research and development (“IPR&D”) of $12.6 million, $8.7 million and $1.0 million, respectively. During the year ended September 30, 2015, the Company acquired certain assets from ImmunO4, LLC resulting in an increase in customer lists, non-compete and other intangible assets of $0.3 million, $0.2 million and $0.1 million, respectively.
Intangible assets consisted of the following as of September 30
(in thousands):
|
|
2017
|
|
|
|
Weighted Average
Original Life (Years)
|
|
|
Gross Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Net
|
|
Definite-lived intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer lists and relationships
|
|
|
8.9
|
|
|
$
|
18,293
|
|
|
$
|
(7,834
|
)
|
|
$
|
10,459
|
|
Developed technology
|
|
|
11.7
|
|
|
|
9,297
|
|
|
|
(1,478
|
)
|
|
|
7,819
|
|
Non-compete
|
|
|
5.0
|
|
|
|
230
|
|
|
|
(103
|
)
|
|
|
127
|
|
Patents and other
|
|
|
16.5
|
|
|
|
2,321
|
|
|
|
(1,423
|
)
|
|
|
898
|
|
Subtotal
|
|
|
|
|
|
|
30,141
|
|
|
|
(10,838
|
)
|
|
|
19,303
|
|
Unamortized intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In-process research and development
|
|
|
|
|
|
|
679
|
|
|
|
—
|
|
|
|
679
|
|
Trademarks and trade names
|
|
|
|
|
|
|
580
|
|
|
|
—
|
|
|
|
580
|
|
Total
|
|
|
|
|
|
$
|
31,400
|
|
|
$
|
(10,838
|
)
|
|
$
|
20,562
|
|
F-11
|
|
2016
|
|
|
|
Weighted Average
Original Life (Years)
|
|
|
Gross Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Net
|
|
Definite-lived intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer lists and relationships
|
|
|
8.9
|
|
|
$
|
17,692
|
|
|
$
|
(6,123
|
)
|
|
$
|
11,569
|
|
Core technology
|
|
|
8.0
|
|
|
|
530
|
|
|
|
(530
|
)
|
|
|
—
|
|
Developed technology
|
|
|
11.8
|
|
|
|
8,724
|
|
|
|
(618
|
)
|
|
|
8,106
|
|
Non-compete
|
|
|
5.0
|
|
|
|
230
|
|
|
|
(58
|
)
|
|
|
172
|
|
Patents and other
|
|
|
16.5
|
|
|
|
2,321
|
|
|
|
(1,275
|
)
|
|
|
1,046
|
|
Subtotal
|
|
|
|
|
|
|
29,497
|
|
|
|
(8,604
|
)
|
|
|
20,893
|
|
Unamortized intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In-process research and development
|
|
|
|
|
|
|
987
|
|
|
|
—
|
|
|
|
987
|
|
Trademarks and trade names
|
|
|
|
|
|
|
645
|
|
|
|
—
|
|
|
|
645
|
|
Total
|
|
|
|
|
|
$
|
31,129
|
|
|
$
|
(8,604
|
)
|
|
$
|
22,525
|
|
Based on the intangible assets in service, excluding any possible future amortization associated with acquired IPR&D, which has not met technological feasibility as of September 30, 2017, estimated amortization expense for each of the next five fiscal years is as follows
(in thousands):
2018
|
|
$
|
2,661
|
|
2019
|
|
|
2,661
|
|
2020
|
|
|
2,486
|
|
2021
|
|
|
2,347
|
|
2022
|
|
|
2,307
|
|
Future amortization amounts presented above are estimates. Actual future amortization expense may be different as a result of future acquisitions, impairments, completion or abandonment of IPR&D intangible assets, changes in amortization periods, foreign currency exchange rates or other factors.
The Company defines IPR&D as the value of technology acquired for which the related projects have substance and are incomplete. IPR&D acquired in a business acquisition is recognized at fair value and is capitalized as an indefinite-lived intangible asset until completion of the IPR&D project or abandonment. Upon completion of the development project (generally when regulatory approval to market the product is obtained), an impairment assessment is performed prior to amortizing the asset over its estimated useful life. If the IPR&D projects are abandoned, the related IPR&D assets would be written off. The Company assesses indefinite-lived assets for impairment annually in the fourth quarter and whenever an event occurs or circumstances change that would indicate that the carrying amount may be impaired. Similar to the goodwill impairment test, the
indefinite-lived assets impairment test requires the Company to make several estimates about fair value, most of which are based on projected future cash flows.
The Company performed its annual impairment analysis as of August 31, 2017 and
the fair value of certain IPR&D and trade name assets were deemed to be less than their carrying value, due to decreases in estimated future revenue associated with the assets. As a result, impairment losses of $0.3 million and $0.1 million were recorded
in research and development
and
selling, general and administrative expenses, respectively, in the consolidated statements of income for
the year ended September 30, 2017
.
The Company performed its annual impairment analysis as of August 31, 2016 and
the fair value of a trade name asset was deemed to be less than its carrying value. As a result, an impairment loss of less than $0.1 million was recorded in selling, general and administrative in the consolidated statements of income for the year ended September 30, 2016. No other impairment losses were identified during the annual impairment analyses.
The valuation methodology for determining the decline in value of these indefinite-lived intangible assets was based on inputs that require management judgment and are Level 3 inputs, as discussed in Note 4 to the consolidated financial statements.
Goodwill
Goodwill represents the excess of the cost of an acquired entity over the fair value assigned to the assets purchased and liabilities assumed in connection with a company’s acquisition. Goodwill is not amortized but is subject, at a minimum, to annual tests for impairment in accordance with accounting guidance for goodwill. The carrying amount of goodwill is evaluated annually, and between annual evaluations if events occur or circumstances change indicating that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.
F-12
The Company’s reporting units are the In Vitro Diagnostics operations known as its In Vitro Diagnostics unit which contains its BioFX branded products and the Surmodics device drug delivery, hydrophilic coatings and medical device manufacturing operations known as the Medical Device unit. Inherent in the determination of fair value of the reporting units are certain estimates and judgments, including the interpretation of current economic indicators and market valuations as well as the Company’s strategic plans with regard to its operations.
The Company performed its annual impairment tests of goodwill as of August 31, 2017 and 2016, elected to perform the quantitative assessment described above for each of its reporting units. The Company did not record any goodwill impairment charges as it was determined that the reporting units’ fair values were greater than their carrying values. This impairment assessment is reliant on forecasted cash flows, as well as the selected discount rate, which are inherently subjective and require significant estimates. Differences in the reporting units’ actual future operating results as compared with these forecasts estimates could materially affect the estimation of the fair value of the reporting units.
In accordance with ASU 2017-04, which was prospectively adopted effective July 1, 2017, an impairment charge is recorded for the amount by which the carrying value of the reporting unit exceeds the fair value of the reporting unit, as calculated in the quantitative analysis described above. The Company did not record any goodwill impairment charges using the newly adopted accounting principal in the fiscal year ended September 30, 2017. Prior to the adoption of ASU 2017-04, the measurement of an impairment (Step 2 of the impairment test) would have been calculated by determining the implied fair value of a reporting unit’s goodwill by allocating the fair value of the reporting unit to all other assets and liabilities of that unit based on their relative fair values. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities would have been the implied fair value of goodwill. The Company did not record any goodwill impairment charges using Step 2 of the impairment test in the fiscal years ended September 30, 2016 or 2015.
Goodwill as of September 30, 2017 and 2016 totaled $27.3 million and $26.6 million, respectively.
Goodwill related to the In Vitro Diagnostics reporting unit represents the gross value from the acquisition of BioFX Laboratories, Inc. in 2007. As part of the Fiscal 2016 Acquisitions, the Medical Device reporting segment added $17.9 million of goodwill during fiscal 2016, $13.4 million of which was denominated in Euros and subject to revaluation due to fluctuations in exchange rates.
The change in the carrying amount of goodwill by segment for the years ended September 30, 2017 and 2016 was as follows
(in thousands)
:
(Dollars in thousands)
|
|
In Vitro Diagnostics
|
|
|
Medical Device
|
|
|
Total
|
|
Balance as of September 30, 2015
|
|
$
|
8,010
|
|
|
$
|
—
|
|
|
$
|
8,010
|
|
Additions (See Note 3)
|
|
|
—
|
|
|
|
17,892
|
|
|
|
17,892
|
|
Foreign currency translation adjustment
|
|
|
—
|
|
|
|
653
|
|
|
|
653
|
|
Balance as of September 30, 2016
|
|
|
8,010
|
|
|
|
18,545
|
|
|
|
26,555
|
|
Foreign currency translation adjustment
|
|
|
—
|
|
|
|
727
|
|
|
|
727
|
|
Balance as of September 30, 2017
|
|
$
|
8,010
|
|
|
$
|
19,272
|
|
|
$
|
27,282
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Valuation of Long-Lived Assets
Accounting guidance requires the Company to evaluate periodically 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 intangibles with finite lives. If such events or circumstances were to indicate that the carrying amount of these assets may 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) were less than the carrying amount of the assets, the Company would recognize an impairment charge to reduce such assets to their fair value. In fiscal 2017, 2016 and 2015, there were no impairment charges relating to the Company’s long-lived assets as there were no events or circumstances that occurred that affected the recoverability of such assets.
F-13
Accrued Liabilities
Other accrued liabilities consisted of the following as of September 30
(in thousands):
|
|
2017
|
|
|
2016
|
|
Accrued professional fees
|
|
$
|
501
|
|
|
$
|
262
|
|
Accrued clinical study expense
|
|
|
411
|
|
|
|
283
|
|
Accrued inventory purchases
|
|
|
596
|
|
|
|
315
|
|
Due to customers
|
|
|
41
|
|
|
|
881
|
|
Deferred revenue
|
|
|
62
|
|
|
|
180
|
|
Other
|
|
|
224
|
|
|
|
249
|
|
Total
|
|
$
|
1,835
|
|
|
$
|
2,170
|
|
Revenue Recognition
The Company recognizes revenue when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) shipment has occurred or delivery has occurred if the terms specify destination; (3) the sales price is fixed or determinable; and (4) collectability is reasonably assured. When there are additional performance requirements, revenue is recognized when all such requirements have been satisfied. Under revenue arrangements with multiple deliverables, the Company recognizes each separable deliverable as it is earned.
The Company derives its revenue from three primary sources: (1) royalties and license fees from licensing our proprietary surface modification and device drug delivery technologies to customers; the vast majority (typically in excess of 90%) of revenue in the “royalties and license fees” category is in the form of royalties; (2) product revenue from the sale of reagent chemicals to licensees, the sale of stabilization products, antigens, substrates and surface coatings to the diagnostic and biomedical research markets as well as the sale of medical devices and related products (such as balloons and catheters) to original equipment manufacturer (OEM) suppliers and distributors; and (3) research and commercial development fees generated on customer projects.
Taxes collected from customers and remitted to governmental authorities are excluded from revenue and amounted to $0.1 million for each of the years ended September 30, 2017, 2016 and 2015.
Royalties and license fees
. The Company licenses technology to third parties and collects royalties. Royalty revenue is generated when a customer sells products incorporating the Company’s licensed technologies. Royalty revenue is recognized as licensees report it to the Company, and payment is typically submitted concurrently with the report. For stand-alone license agreements, up-front license fees are recognized based on the terms of the related licensing agreement, either over the term of the agreement or at the point in time when the earnings process is complete. Minimum royalty fees are recognized in the period earned.
Revenue related to a performance milestone is recognized upon the achievement of the milestone, as defined in the respective agreements and provided the following conditions have been met:
|
•
|
The milestone payment is non-refundable;
|
|
•
|
The milestone involved a significant degree of risk, and was not reasonably assured at the inception of the arrangement;
|
|
•
|
Accomplishment of the milestone involved substantial effort;
|
|
•
|
The amount of the milestone payment is commensurate with the related effort and risk; and
|
|
•
|
A reasonable amount of time passed between the initial license payment and the first and subsequent milestone payments.
|
If these conditions have not been met, the milestone payment is deferred and recognized over the term of the agreement.
Product sales.
Product sales to third parties consist of original equipment manufacturer (OEM) and distributor sales and are recognized at the time of shipment. The Company’s sales terms provide no right of return outside of the standard warranty policy. Payment terms are generally set at 30-45 days.
F-14
Research and development.
The Company performs third-party research and development activities, which are typically provided on a time and materials
basis. Generally, revenue for research and development is recorded as performance progresses under the applicable contract, which corresponds with the period the related costs are incurred.
Arrangements with multiple deliverables.
Revenue arrangements with multiple deliverables require the Company to:
(i) disclose whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;
(ii) allocate revenue in an arrangement using estimated selling prices (“ESP”) of deliverables if a vendor does not have vendor-specific objective evidence of selling price (“VSOE”) or third-party evidence of selling price (“TPE”); and
(iii) allocate revenue using the relative selling price method.
The Company accounts for revenue using a multiple attribution model in which consideration allocated to research and development activities is recognized as performed, and milestone payments are recognized when the milestone events are achieved, when such activities and milestones are deemed substantive. Accordingly, in situations where a unit of accounting includes both a license and research and development activities, and when a license does not have stand-alone value, the Company applies a multiple attribution model in which consideration allocated to the license is recognized ratably, consideration allocated to research and development activities is recognized as performed and milestone payments are recognized when the milestone events are achieved, when such activities and milestones are deemed substantive.
The Company enters into license and development arrangements that may consist of multiple deliverables which could include a license(s) to Surmodics’ technology, research and development activities, manufacturing services, and product sales based on the needs of its customers. For example, a customer may enter into an arrangement to obtain a license to Surmodics’ intellectual property which may also include research and development activities, and supply of products manufactured by Surmodics. For these services provided, Surmodics could receive upfront license fees upon signing of an agreement and granting the license, fees for research and development activities as such activities are performed, milestone payments contingent upon advancement of the product through development and clinical stages to successful commercialization, fees for manufacturing services and supply of product, and royalty payments based on customer sales of product incorporating Surmodics’ technology. The Company’s license and development arrangements generally do not have refund provisions if the customer cancels or terminates the agreement. Typically all payments made are non-refundable.
The Company is required to evaluate each deliverable in a multiple element arrangement for separability. The Company is then required to allocate revenue to each separate deliverable using a hierarchy of VSOE, TPE, or ESP. In many instances, the Company is not able to establish VSOE for all deliverables in an arrangement with multiple elements. This may be a result of the Company infrequently selling each element separately or having a limited history with multiple element arrangements. When VSOE cannot be established, the Company attempts to establish a selling price of each element based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately.
When the Company is unable to establish a selling price using VSOE or TPE, the Company uses ESP in its allocation of arrangement consideration. The objective of ESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. ESP is generally used for highly customized offerings.
The Company determines ESP for undelivered elements by considering multiple factors including, but not limited to, market conditions, competitive landscape and past pricing arrangements with similar features. The determination of ESP is made through consultation with the Company’s management, taking into consideration the marketing strategies for each business unit.
Deferred Revenue
Amounts received prior to satisfying the above revenue recognition criteria are recorded as deferred revenue in the accompanying consolidated balance sheets, with deferred revenue to be recognized beyond one year being classified as non-current deferred revenue. The Company had current and non-current deferred revenue of $0.3 million and $0.4 million as of September 30, 2017 and 2016, respectively included in other accrued liabilities (current) and other long-term liabilities (long-term).
Customer overpayments are accounted for as a liability until all criteria for revenue recognition have been met. As of September 30, 2017, and 2016 the Company has recorded a liability of less than $0.1 million and $0.9 million, respectively, for customer royalty overpayments, which are included in other accrued liabilities.
F-15
Concentrations
The Company’s licensed technologies provide royalty revenue, which represents the largest revenue stream to the Company. The Company has licenses with a diverse base of customers and certain customers have multiple products using the Company’s technology. Medtronic plc (“Medtronic”) is the Company’s largest customer at approximately 18%, 25% and 26% of total consolidated revenue for the fiscal years ended September 30, 2017, 2016 and 2015, respectively. Medtronic has several separately-licensed products that generate royalty revenue for Surmodics, none of which represented more than 4% of Surmodics’ total revenue. No other individual customer using licensed technology constitutes more than 10% of the Company’s total revenue. The loss of Medtronic or any of our largest customers, or reductions in business from them, could have a material adverse effect on the Company’s business, financial condition, results of operations, and cash flows from operations.
The Company’s licensing agreements with many of its customers, including most of its significant customers, cover many licensed products that each separately generates royalty revenue. This structure reduces the potential risk to the Company’s operations that may result from reduced sales (or the termination of a license) of a single product for any specific customer.
The Company believes that the credit risk related to marketable securities is limited due to the adherence to an investment policy and that credit risk related to accounts receivable is limited due to a large customer base.
Income Taxes
The Company accounts for income taxes under the asset and liability method prescribed in accounting guidance. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the period in which related temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in this assessment. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date of such change.
Research and Development
Research and development (“R&D”) costs are expensed as incurred. Some R&D costs are related to third-party contracts, and the related revenue is recognized as described in “Revenue Recognition” above. Costs associated with customer-related R&D include specific project direct labor costs and material expenses as well as an allocation of overhead costs based on direct labor dollars.
Clinical trial costs.
The Company sponsors clinical trials intended to obtain the necessary clinical data required to obtain approval from various regulatory agencies to market medical devices developed by the Company. Costs associated with clinical trials are included within R&D expense and include trial design, clinical site reimbursement and third party fees.
The Company’s clinical trials are administered by third-party clinical research organizations (“CROs”). These CROs generally bill monthly for certain services performed as well as upon achievement of certain milestones. Milestone payments are amortized as the related services are performed, generally based upon the number of patients enrolled, “patient months” incurred and the duration of the study. The Company monitors patient enrollment, the progress of clinical studies and related activities through internal reviews of data reported to the Company by the CROs and correspondence with the CROs. The Company periodically evaluates its estimates to determine if adjustments are necessary or appropriate based on information it receives.
Government funding
. The Company is eligible to receive reimbursement for certain qualifying
R&D
expenditures under a grant from the Industrial Development Agency of Ireland (“IDA”). Reimbursements are recognized as a reduction of
R&D
expense when there is reasonable assurance that the funding will be received and conditions associated with the funding are met. The Company recorded reimbursements from IDA grants of $0.8 million during fiscal 2017 as a reduction of
R&D
expense. No reimbursements were recorded during fiscal 2016 or 2015.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP 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
F-16
date of the consolidated financial statements and
the reported amounts of revenue and expenses during the reporting period. Ultimate results could differ from those estimates.
Discontinued Operations
On November 1, 2011, the Company entered into a definitive agreement (the “Purchase Agreement”) to sell substantially all of the assets of its wholly-owned subsidiary, SurModics Pharmaceuticals, to Evonik Degussa Corporation (“Evonik”).
Pharmaceuticals discontinued operations used operating cash of less than $0.1 million in fiscal 2015. Cash generated from financing activities of less than $0.1 million in fiscal 2015 related to transfers of cash from continuing operations of Surmodics and consisted of cash used to make payments on accrual balances. There was no discontinued operations activity in fiscal 2017 or 2016.
Income Per Share Data
Basic income per common share is calculated based on the weighted average number of common shares outstanding during the period. Diluted income per common share is computed by dividing income by the weighted average number of common and common equivalent shares outstanding during the period. The Company’s only potentially dilutive common shares are those that result from dilutive common stock options and non-vested stock relating to restricted stock awards, restricted stock units and performance shares.
The following table sets forth the denominator for the computation of basic and diluted income per share for each of the fiscal years ended September 30
(in thousands):
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Net income from continuing operations available to common shareholders
|
|
$
|
3,926
|
|
|
$
|
9,985
|
|
|
$
|
11,947
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic weighted average shares outstanding
|
|
|
13,153
|
|
|
|
12,998
|
|
|
|
13,029
|
|
Dilutive effect of outstanding stock options, non-vested
restricted stock, restricted stock units and performance
shares
|
|
|
236
|
|
|
|
221
|
|
|
|
260
|
|
Diluted weighted average shares outstanding
|
|
|
13,389
|
|
|
|
13,219
|
|
|
|
13,289
|
|
The calculation of weighted average diluted shares outstanding excludes outstanding common stock options associated with the right to purchase 0.2 million, 0.7 million and 0.5 million shares for fiscal 2017, 2016 and 2015, respectively, as their inclusion would have had an antidilutive effect on diluted income per share.
Currency Translation
The Company’s reporting currency is the U.S. Dollar. Assets and liabilities of non-U.S. dollar functional currency subsidiaries are translated into U.S. dollars at the period-end exchange rates, and revenue and expenses are translated at the average quarterly exchange rates during the period. The net effect of these translation adjustments on the consolidated financial statements is recorded as a foreign currency translation adjustment, a component of accumulated other comprehensive income
on the consolidated balance sheets. Realized foreign currency transaction gains and losses are included in other, income (loss) net in the consolidated statements of income.
New Accounting Pronouncements
Accounting Standards to be Adopted
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) Update No. 2014-09,
Revenue from Contracts with Customers (ASC Topic 606)
. Principles of this guidance require entities to recognize revenue in a manner that depicts the transfer of goods or services to customers in amounts that reflect the consideration an entity expects to be entitled to in exchange for those goods or services. The guidance also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets
F-17
recognized from the costs to obtain or fulfill a contract.
This accounting standard will be effective for the Company beginning in the first quarter of fiscal year 2019 (
October 1, 2018) using one of two prescribed retrospective methods. The Company is currently evaluating the impact that the adoption of this standard will have on the Company’s business model and consolidated results of operations, cash flows and financial
position. The Company currently plans to adopt the standard using the modified retrospective approach and expects the impact will be material to the consolidated financial statements due to an anticipated one-quarter acceleration of minimum license fees a
nd royalty revenue earned under its hydrophilic license agreements, as well as require several additional financial statement footnote disclosures.
Under the modified retrospective approach, the Company will apply the new revenue standard to all new revenu
e contracts initiated on or after the effective date, and, for contracts which have remaining obligations as of the effective date, the Company will adjust the beginning balance of retained earnings.
In February 2016, the FASB issued Accounting Standards Update ASU 2016-02,
Leases (ASC Topic 842)
. The new guidance primarily affects lessee accounting, while accounting by lessors will not be significantly impacted by the update. The update maintains two classifications of leases: finance leases, which replace capital leases, and operating leases. Lessees will need to recognize a right-of-use asset and a lease liability on the statement of financial position for those leases previously classified as operating leases under the old guidance. The liability will be equal to the present value of lease payments. The asset will be based on the liability, subject to adjustment, such as for direct costs. The accounting standard will be effective for the Company beginning the first quarter of fiscal year 2020 (October 1, 2019) using a modified retrospective approach. The Company
believes the impact will be material due to the right-of-use assets and lease liabilities that will be recorded on the Company’s consolidated balance sheets upon adoption of the standard
.
In June 2016, the FASB issued ASU No 2016-13,
Financial Instruments – Credit Losses (ASC Topic 326), Measurement of Credit Losses on Financial Statements
. This ASU requires a financial asset (or a group of financial assets) measured at an amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The accounting standard will be effective for the Company beginning in the first quarter of fiscal 2020 (October 1, 2019), and early adoption is permitted. The Company is currently evaluating the impact that the adoption of this standard will have on the Company’s results of operations, cash flows and financial position.
Accounting Standards Implemented
In August 2016, the FASB issued ASU No. 2016-15,
Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments
. The new guidance clarifies requirements for presentation and classification of the following items within the statement of cash flows: debt prepayments, settlement of zero coupon debt instruments, contingent consideration payments, insurance proceeds, securitization transactions and distributions from equity method investees. The update also addresses classification of transactions that have characteristics of more than one class of cash flows.
The accounting standard will be effective for the Company beginning in the first quarter of fiscal 2018
. Early adoption is permitted, including adoption in an interim period.
The Company prospectively adopted this accounting standard on July 1, 2017 without any material impact on the Company’s consolidated statement of cash flows. Under the guidance, if and when our contingent consideration liabilities are paid, a portion of the payment will be classified as cash flows from operations, with the remainder classified as cash flows from financing activities.
In January 2017, the FASB issued ASU No. 2017-04,
Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment
. The new guidance removes Step 2 of the goodwill impairment test, which required a hypothetical purchase price allocation. A goodwill impairment will now be defined as the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The accounting standard is effective for the Company beginning in its fiscal 2020, with early, prospective adoption permitted. The Company early-adopted this accounting standard on July 1, 2017 with no impact on the Company’s consolidated financial statements, as the Company has not been required to complete Step 2 of the goodwill impairment test.
No other new accounting pronouncement issued or effective has had, or is expected to have, a material impact on the Company’s consolidated financial statements.
3. Business Combinations
For all business combinations, the Company records all assets and liabilities of the acquired business, including goodwill and other identified intangible assets, at their respective fair values as of the acquisition date. Contingent consideration, if any, is recognized at its fair value on the acquisition date and changes in fair value are recognized in earnings until settlement. Acquisition-related transaction costs are expensed as incurred.
F-18
Creagh Medical Ltd.
On November 20, 2015, the Company acquired 100% of the outstanding common shares and voting shares of Creagh Medical located in Ballinasloe, Ireland. The results of Creagh Medical’s operations have been included in the Company’s consolidated financial statements as of the Creagh Medical acquisition date. The acquisition was financed with cash on hand and contingent seller financing. The Company acquired Creagh Medical for up to €30 million (approximately $32 million as of the acquisition date), including an upfront payment of €18 million (approximately $19.3 million as of the acquisition date), and up to €12 million (approximately $12.8 million as of the acquisition date) based on achievement of revenue and value-creating operational milestones through September 30, 2018. The payment of the milestones, if any, will occur in the quarter ending December 31, 2018. As of September 30, 2017, the Company has paid $18.4 million in cash for this acquisition. Total transaction, integration and other costs associated with the Creagh Medical acquisition aggregated $2.7 million for the fiscal year ended September 30, 2016. Creagh Medical’s operating results have been included in the Medical Device segment
since the acquisition date
.
The Company realized $3.3 million of revenue and a loss of $2.7 million from Creagh Medical’s operations for the period from the acquisition date through September 30, 2016.
Creagh Medical designs and manufactures high-quality percutaneous transluminal angioplasty (“PTA”) balloon catheters. Since 2006, Creagh Medical has grown its technical and product capability with PTA products approved throughout the world, including Europe, the United States, and Japan. With these resources, the Company is uniquely positioned to offer a total solutions approach from product design and development through in-house extrusion, balloon forming, top-assembly and packaging and regulatory capabilities to approved products for exclusive distribution.
The purchase price of Creagh Medical consisted of the following
(in thousands)
:
Cash paid
|
|
$
|
18,449
|
|
Debt assumed
|
|
|
761
|
|
Contingent consideration
|
|
|
9,064
|
|
Total purchase price
|
|
|
28,274
|
|
Less cash and cash equivalents acquired
|
|
|
(251
|
)
|
Total purchase price, net of cash acquired
|
|
$
|
28,023
|
|
The purchase accounting allocation of assets acquired and liabilities assumed was finalized during the fourth quarter of fiscal 2016. During the measurement period, which ended September 30, 2016, certain insignificant adjustments were made from amounts previously reported to finalize Creagh’s preliminary fair value estimates related primarily to other current assets, intangible assets, goodwill, certain property value, contingent liabilities and the related deferred tax impacts.
The following table summarizes the final allocation of the purchase price to the fair values assigned to the assets acquired and the liabilities assumed at the date of the Creagh Medical acquisition:
|
|
Fair Value
(Dollars in thousands)
|
|
Estimated Useful Life
(In years)
|
Current assets
|
|
$
|
896
|
|
N/A
|
Property and equipment
|
|
|
634
|
|
1.0-10.0
|
Trade name
|
|
|
75
|
|
N/A
|
Developed technology
|
|
|
1,787
|
|
7.0
|
In-process research and development
|
|
|
942
|
|
N/A
|
Customer relationships
|
|
|
11,119
|
|
7.0-10.0
|
Other noncurrent assets
|
|
|
81
|
|
N/A
|
Current liabilities
|
|
|
(942
|
)
|
N/A
|
Deferred tax liabilities
|
|
|
(9
|
)
|
N/A
|
Net assets acquired
|
|
|
14,583
|
|
|
Goodwill
|
|
|
13,440
|
|
N/A
|
Total purchase price, net of cash acquired
|
|
$
|
28,023
|
|
|
F-19
The Creagh Medical goodwill, which is a result of acquiring and retaining the Creagh Medical existing workforce and expected synergies from integrating their business into the Company’s Medical Device segment, is not deductible for tax purposes.
NorMedix, Inc.
On January 8, 2016, the Company acquired 100% of the shares of NorMedix, a privately owned design and development company focused on ultra thin-walled, minimally invasive catheter technologies based in Plymouth, Minnesota. The acquisition was financed with cash on hand and contingent seller financing. The Company acquired NorMedix for up to $14.0 million, including an upfront payment of $7.0 million, and up to $7.0 million based on achievement of revenue and value-creating operational milestones through September 30, 2019. Contingent consideration associated with the NorMedix transaction is payable as earned. This acquisition strengthens the Company’s vascular device expertise and R&D capabilities. Total transaction, integration and other costs associated with the NorMedix acquisition aggregated $0.3 million for the year ended September 30, 2016. NorMedix’s operating results have been included in the Medical Device segment since the acquisition date. The Company realized $0.9 million of revenue and a loss of $0.4 million from the NorMedix’s operations
for the period from the acquisition date through
September 30, 2016.
The purchase price of NorMedix consisted of the following
(in thousands)
:
Cash paid
|
|
$
|
6,905
|
|
Contingent consideration
|
|
|
3,520
|
|
Total purchase price
|
|
|
10,425
|
|
Less cash and cash equivalents acquired
|
|
|
(17
|
)
|
Total purchase price, net of cash acquired
|
|
$
|
10,408
|
|
|
|
|
|
|
The purchase accounting allocation of assets acquired and liabilities assumed was finalized during the fourth quarter of fiscal 2016. During the measurement period, which ended September 30, 2016, certain insignificant adjustments were made from amounts previously reported to finalize NorMedix’s preliminary fair value estimates related primarily to working capital, intangible assets, goodwill, certain property value, contingent liabilities and the related deferred tax impacts.
The following table summarizes the allocation of the purchase price to the fair values assigned to the assets acquired and the liabilities assumed at the date of the NorMedix acquisition:
|
|
Fair Value
(Dollars in thousands)
|
|
Estimated Useful Life (In years)
|
Net current assets
|
|
$
|
113
|
|
N/A
|
Property and equipment
|
|
|
60
|
|
7.0
|
Developed technology
|
|
|
6,850
|
|
10.0-14.0
|
Customer relationships
|
|
|
900
|
|
4.0
|
Deferred tax asset
|
|
|
690
|
|
N/A
|
Other noncurrent asset
|
|
|
13
|
|
N/A
|
Accounts payable
|
|
|
(187
|
)
|
N/A
|
Deferred tax liabilities
|
|
|
(2,483
|
)
|
N/A
|
Net assets acquired
|
|
|
5,956
|
|
|
Goodwill
|
|
|
4,452
|
|
N/A
|
Total purchase price, net of cash acquired
|
|
$
|
10,408
|
|
|
|
|
|
|
|
|
F-20
The NorMedix goodwill, which is a result of acquiring and retaining the NorMedix existing workforce and expected synergies from integrating their business into the Medical Device segment, is not deductible for tax purposes.
Unaudited Pro Forma Results
The following unaudited pro forma financial information presents the combined results of operation of the Company as if the acquisitions of Creagh Medical and NorMedix had occurred as of October 1, 2014, the beginning of fiscal 2015.
The fiscal 2016 unaudited pro forma financial information includes adjustments for additional amortization expense on identifiable intangible assets of $2.8 million and contingent consideration accretion expense of $1.8 million, and to eliminate non-recurring, transactional professional fees of $3.2 million, and the related tax effect impact of $0.2 million.
The fiscal 2015 unaudited pro forma financial information includes adjustments for additional amortization expense on identifiable intangible assets of $3.2 million and contingent consideration accretion expense of $2.1 million and tax effect impact of $0.5 million.
The tax impact of the adjustments in all periods reflects no tax benefit from either the contingent consideration accretion or a significant portion of the transaction related costs in fiscal 2016 as they are not deductible for tax purposes. Further, Creagh Medical amortization expense does not reflect an Irish tax benefit as the Company acquired a net operating loss carryforward as of the acquisition date that was offset in the aggregate by deferred tax liabilities and valuation allowance. Therefore, the amortization of Creagh Medical intangible assets results in an increase in deferred tax liabilities with a corresponding increase to a deferred tax valuation allowance. NorMedix amortization expense reflects a tax benefit based on the Company’s incremental U.S. tax rate.
The unaudited pro forma financial information is not necessarily indicative of what the Company’s consolidated results of operations actually would have been had the acquisition occurred at the beginning of each year. Additionally, the unaudited pro forma financial information does not attempt to project the future operating results of the combined company.
|
|
Years Ended
|
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
(In thousands, except per share data)
|
(Unaudited)
|
|
Revenue
|
|
$
|
72,416
|
|
|
$
|
65,432
|
|
Net income
|
|
$
|
12,315
|
|
|
$
|
6,583
|
|
|
|
|
|
|
|
|
|
|
Per share amounts:
|
|
|
|
|
|
|
|
|
Basic net income per share
|
|
$
|
0.95
|
|
|
$
|
0.51
|
|
Diluted net income per share
|
|
$
|
0.93
|
|
|
$
|
0.50
|
|
4. Fair Value Measurements
The accounting guidance on fair value measurements defines fair value, establishes a framework for measuring fair value under U.S. GAAP, and expands disclosures about fair value measurements. The guidance is applicable for all financial assets and financial liabilities and for all nonfinancial assets and nonfinancial liabilities recognized or disclosed at fair value in the consolidated financial statements on a recurring basis. Fair value is defined as the exchange price that would be received from selling an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and also considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions and risk of nonperformance.
Fair Value Hierarchy
Accounting guidance on fair value measurements requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:
Level 1 — Quoted (unadjusted) prices in active markets for identical assets or liabilities.
F-21
The Company did not have any Level 1 assets as of September 30, 2017 or 2016.
Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
The Company’s Level 2 assets as of September 30, 2017 and 2016 consisted of money market funds, commercial paper instruments and corporate bond securities. Fair market values for these assets are based on quoted vendor prices and broker pricing where all significant inputs are observable. To ensure the accuracy of quoted vendor prices and broker pricing, the Company performs regular reviews of investment returns to industry benchmarks and sample tests of individual securities to validate quoted vendor prices with other available market data.
Level 3 — Unobservable inputs to the valuation methodology that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.
Included in Level 3 liabilities as of September 30, 2017 is a $14.9 million contingent consideration liability, of which $13.1 million is noncurrent. Included in Level 3 liabilities as of September 30, 2016 is a $14.5 million contingent consideration liability, of which $13.6 million is noncurrent. The contingent consideration liabilities are subject to achievement of revenue and value-creating milestones in future periods. There were no Level 3 assets as of September 30, 2017 or 2016.
In valuing assets and liabilities, the Company is required to maximize the use of quoted market prices and minimize the use of unobservable inputs. The Company did not significantly change its valuation techniques from prior periods. The carrying value of cash, accounts receivable, accounts payable and accrued liabilities approximates fair value as of September 30, 2017 and 2016 due to the short maturity nature of these instruments.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
In instances where the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.
The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2017
(in thousands)
:
|
|
Quoted Prices
in Active
Markets for
Identical
Instruments
(Level 1)
|
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
|
Total Fair
Value as of
September 30,
2017
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents
|
|
$
|
—
|
|
|
$
|
6,639
|
|
|
$
|
—
|
|
|
$
|
6,639
|
|
Available-for-sale securities
|
|
|
—
|
|
|
|
31,802
|
|
|
|
|
|
|
$
|
31,802
|
|
Total assets
|
|
$
|
—
|
|
|
$
|
38,441
|
|
|
$
|
—
|
|
|
$
|
38,441
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent consideration
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(14,864
|
)
|
|
$
|
(14,864
|
)
|
Total liabilities
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(14,864
|
)
|
|
$
|
(14,864
|
)
|
F-22
The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2016
(in thou
sands)
:
|
|
Quoted Prices
in Active
Markets for
Identical
Instruments
(Level 1)
|
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
|
Total Fair
Value as of
September 30,
2016
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents
|
|
$
|
—
|
|
|
$
|
22,160
|
|
|
$
|
—
|
|
|
$
|
22,160
|
|
Available-for-sale securities
|
|
|
—
|
|
|
|
21,954
|
|
|
|
|
|
|
$
|
21,954
|
|
Total assets
|
|
$
|
—
|
|
|
$
|
44,114
|
|
|
$
|
—
|
|
|
$
|
44,114
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent consideration
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(14,517
|
)
|
|
$
|
(14,517
|
)
|
Total liabilities
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(14,517
|
)
|
|
$
|
(14,517
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes the changes in the contingent consideration liability for fiscal 2017 and 2016:
(Dollars in thousands)
|
|
|
|
|
Contingent consideration liability at September 30, 2015
|
|
$
|
—
|
|
Additions
|
|
|
12,584
|
|
Fair value adjustments
|
|
|
70
|
|
Settlements
|
|
|
—
|
|
Interest accretion
|
|
|
1,422
|
|
Foreign currency translation
|
|
|
441
|
|
Contingent consideration liability at September 30, 2016
|
|
|
14,517
|
|
Additions
|
|
|
—
|
|
Fair value adjustments
|
|
|
(2,350
|
)
|
Settlements
|
|
|
—
|
|
Interest accretion
|
|
|
2,223
|
|
Foreign currency translation
|
|
|
474
|
|
Contingent consideration liability at September 30, 2017
|
|
$
|
14,864
|
|
|
|
|
|
|
There were no transfers of assets or liabilities to or from amounts measured using Level 3 fair value measurements during fiscal 2017 or 2016.
Valuation Techniques
The valuation techniques used to measure the fair value of assets are as follows:
Cash equivalents — These assets are classified as Level 2 and are carried at historical cost which is a reasonable estimate of fair value because of the relatively short time between origination of the instrument and its expected realization.
Available-for-sale securities — These assets are classified as Level 2 and include commercial paper instruments and corporate bonds. These securities are valued based on quoted vendor prices in active markets underlying the securities.
Contingent consideration — The contingent consideration liabilities were determined based on discounted cash flow analyses that included revenue estimates, probability of strategic milestone achievement and a discount rate, which are considered significant unobservable inputs as of the acquisition dates and September 30, 2017. In fiscal 2017, for the revenue-based milestones, the Company discounted forecasted revenue by 14.0% to 23.5%, which represents the Company’s weighted average cost of capital for each transaction, adjusted for the short-term nature of the cash flows. The resulting present value of revenue was used as an input into an option pricing approach, which also considered the Company’s risk of non-payment of the revenue-based milestones. Non-revenue milestones were projected to have a 25% to 100% probability of achievement and related payments were
F-23
discounted using the Company’s estimated cost of debt for the remaining contingency periods, or 2.7% to 3.0%. In fiscal 2016, for the revenue-based milestones, the Company discounted forecasted reven
ue by 14.1% to 22.8%, which represents the Company’s weighted average cost of capital for each transaction, adjusted for the short-term nature of the cash flows.
The resulting present value of revenue was used as an input into an option pricing approach, w
hich also considered the Company’s risk of non-payment of the revenue-based milestones. Non-revenue milestones were projected to have a 25% to 100% probability of achievement and related payments were discounted using the Company’s estimated cost of debt
for the remaining contingency periods, or 5.6% to 6.7%. To the extent that actual results differ from these estimates, the fair value of the contingent consideration liabilities could change significantly.
The €12 million
(approximately $14.2 million
as o
f
September 30, 2017)
contingent consideration related to the Creagh Medical acquisition is denominated in Euros and is not hedged. The Company recorded
foreign currency losses of $0.5 million and $0.4 million, respectively, in fiscal 2017 and 2016 relate
d to this contingent consideration as this obligation was marked to year-end exchange rates.
Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
The Company’s investments in non-marketable securities of private companies are accounted for using the cost method as the Company does not exert significant influence over the investees’ operating or financial activities. These investments are measured at fair value on a non-recurring basis when they are deemed to be other-than-temporarily impaired. In determining whether a decline in value of non-marketable equity investments in private companies has occurred and is other-than-temporary, an assessment is made by considering available evidence, including the general market conditions in the investee’s industry, the investee’s product development status and subsequent rounds of financing and the related valuation and/or the Company’s participation in such financings. The Company also assesses the investee’s ability to meet business milestones and the financial condition and near-term prospects of the individual investee, including the rate at which the investee is using its cash and the investee’s need for possible additional funding at a potentially lower valuation. The valuation methodology for determining the decline in value of non-marketable equity securities is based on inputs that require management judgment and are Level 3 inputs.
In the fourth quarter of fiscal 2015, the Company recognized an other-than-temporary impairment loss of $1.5 million on its investment in CeloNova. These impairment charges were based on Level 3 inputs further discussed in Note 2 to the consolidated financial statements. No other-than-temporary impairment losses were recognized during fiscal 2017 or 2016.
5. Stockholders’ Equity
Repurchase of Common Stock
Shares are repurchased from time to time to support the Company’s stock-based compensation programs and to return capital to stockholders. The Company accounts for repurchases of common stock using the par value method.
On November 5, 2014, the Company’s Board of Directors authorized it to repurchase up to $30.0 million of the Company’s outstanding common stock in open-market purchases, privately negotiated transactions, block trades, accelerated share repurchase transactions, tender offers or by any combination of such methods. The authorization has no fixed expiration date. As part of the accelerated share repurchase (“ASR”) program discussed below, the Company repurchased 758,143 shares of common stock on November 11, 2014 and 89,721 of common stock on July 8, 2015, the date that the ASR program was completed.
On November 11, 2014, the Company entered into an ASR program with Wells Fargo Bank, National Association. In connection with this agreement, the Company made a $20.0 million payment to the bank and immediately received an initial delivery of 758,143 shares of its common stock with a fair value of $16.0 million as of the purchase date. Effective as of the date of the initial share purchase, the transaction was accounted for as a share retirement, resulting in a reduction of common stock of less than $0.1 million, additional paid-in capital of $2.5 million and retained earnings of $13.5 million. The remaining $4.0 million of the Company’s payment was also reported as a reduction in retained earnings. The specific number of shares that the Company ultimately purchased under the ASR agreement was based on the volume weighted average price of the Company’s common stock during the purchase period, less an agreed upon discount. In the aggregate the Company purchased 847,864 shares under the ASR program for an average price of $23.59 per share. Based on the facts associated with the agreement, the forward contract was indexed to the Company’s common stock and met the U.S. GAAP requirements to be classified as permanent equity as of July 8, 2015, the date the ASR was completed.
On November 6, 2015, the Company’s Board of Directors authorized the repurchase of up to $20.0 million of the Company’s outstanding common stock in open-market purchases, privately negotiated transactions, block trades, accelerated share repurchase
F-24
transactions, tender offers or by any combination of such methods. The authorization has no fixed expiration date.
During
fiscal 20
17, we paid $4.7 million to repurchase 196,190 common shares in open market purchases
at an average price of $23.97 per share
. As of September 30, 2017,
$25.3
million remained available to the Company for the purchase of its common stock under outstanding
authorizations.
6. Stock-Based Compensation Plans
The Company has stock-based compensation plans under which it grants stock options, restricted stock awards, performance share awards, restricted stock units and deferred stock units. Accounting guidance requires all share-based payments to be recognized as an expense, based on their fair values, over the requisite service period. The Company also estimates forfeitures of awards granted, which are based on historical experience and reduce the recognized expense. The Company’s stock-based compensation expenses for the years ended September 30 were allocated to the following expense categories
(in thousands):
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Product costs
|
|
$
|
90
|
|
|
$
|
22
|
|
|
$
|
24
|
|
Research and development
|
|
|
510
|
|
|
|
324
|
|
|
|
226
|
|
Selling, general and administrative
|
|
|
2,872
|
|
|
|
3,498
|
|
|
|
2,131
|
|
Total stock-based compensation expense
|
|
$
|
3,472
|
|
|
$
|
3,844
|
|
|
$
|
2,381
|
|
As of September 30, 2017, approximately $4.7 million of total unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted average period of approximately 2.1 years. Such costs include $1.5 million based on payout levels associated with performance share awards that are currently anticipated to be fully expensed because the performance conditions are expected to be met above the minimum levels for each award period.
Under the amended 2009 Equity Incentive Plan (“2009 Plan”), the Company is authorized to issue up to 2,000,000, plus the number of shares that have not yet been awarded under the 2003 Equity Incentive Plan, or were awarded and subsequently returned to the pool of available shares under the 2003 Equity Incentive Plan pursuant to its terms. As of September 30, 2017, there were 888,546 shares available for future equity awards, including stock options, restricted stock awards, performance share awards, and restricted stock and deferred stock units, under the 2009 Plan.
Stock Option Awards
The Company uses the Black-Scholes option pricing model to determine the weighted average grant date fair value of stock options. Weighted average per share fair values of stock options granted during fiscal 2017, 2016 and 2015 were $7.63, $6.95 and $7.26, respectively. The assumptions used as inputs in the model for the years ended September 30 were as follows:
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Risk-free interest rates
|
|
|
1.74
|
%
|
|
|
1.89
|
%
|
|
|
1.43
|
%
|
Expected life
|
|
4.6 years
|
|
|
4.6 years
|
|
|
4.5 years
|
|
Expected volatility
|
|
|
34
|
%
|
|
|
37
|
%
|
|
|
43
|
%
|
Dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
The risk-free interest rate assumption was based on the U.S. Treasury’s rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award. The expected life of options granted is determined based on the Company’s experience. Expected volatility is based on the Company’s stock price movement over a period approximating the expected term. Based on management’s judgment, dividend rates are expected to be 0.0% for the expected life of the options.
Non-qualified stock options are granted at fair market value on the grant date. Non-qualified stock options expire in seven to ten years or upon termination of employment or service as a Board member. With respect to members of the Board, non-qualified stock options generally become exercisable on a pro-rata basis over the one-year period following the date of grant. With respect to employees, non-qualified stock options generally become exercisable with respect to 25% of the shares on each of the first four anniversaries following the grant date. The stock-based compensation table above includes stock option expenses recognized related to these awards, which totaled $1.3 million, $1.2 million and $1.2 million during fiscal 2017, 2016 and 2015, respectively.
As of September 30, 2017, the aggregate intrinsic value of the option shares outstanding and option shares exercisable was $10.0 million and $6.1 million, respectively. As of September 30, 2017, the average remaining contractual life of options outstanding
F-25
and options exe
rcisable was 4.0 years and 2.8 years, respectively. The total pre-tax intrinsic value of options exercised during fiscal 2017 and 2016 was $0.1 million and $5.1 million, respectively. The intrinsic value represents the difference between the exercise price
and the fair market value of the Company’s common stock on the last day of the respective fiscal year end.
The following table summarizes all stock options activity and stock options outstanding and exercisable under the stock option plans during fiscal 2017, 2016 and 2015:
|
|
Number of
Shares
|
|
|
Weighted
Average
Exercise Price
|
|
Outstanding at September 30, 2014
|
|
|
1,210,619
|
|
|
$
|
20.35
|
|
Granted
|
|
|
164,401
|
|
|
|
21.24
|
|
Exercised
|
|
|
(166,422
|
)
|
|
|
14.54
|
|
Forfeited and expired
|
|
|
(90,590
|
)
|
|
|
35.35
|
|
Outstanding at September 30, 2015
|
|
|
1,118,008
|
|
|
|
20.10
|
|
Granted
|
|
|
241,582
|
|
|
|
20.63
|
|
Exercised
|
|
|
(437,850
|
)
|
|
|
15.68
|
|
Forfeited and expired
|
|
|
(94,415
|
)
|
|
|
31.52
|
|
Outstanding at September 30, 2016
|
|
|
827,325
|
|
|
|
21.30
|
|
Granted
|
|
|
229,039
|
|
|
|
24.08
|
|
Exercised
|
|
|
(6,819
|
)
|
|
|
13.89
|
|
Forfeited and expired
|
|
|
(47,640
|
)
|
|
|
30.65
|
|
Outstanding at September 30, 2017
|
|
|
1,001,905
|
|
|
|
21.54
|
|
Exercisable at September 30, 2017
|
|
|
547,051
|
|
|
$
|
20.80
|
|
Restricted Stock Awards
The Company has entered into restricted stock agreements with certain key employees, covering the issuance of common stock (“Restricted Stock”). Under accounting guidance, these shares are considered to be non-vested shares. The Restricted Stock is released to the key employees if they are employed by the Company at the end of the vesting period. Restricted stock awards generally vest at a 33% rate on each of the first three anniversaries following the grant date. Compensation expense is recognized on a straight-line basis over the vesting term based on the fair value of the common shares on the date of grant. The stock-based compensation table above includes Restricted Stock expenses recognized related to these awards, which totaled $0.5 million, $0.3 million and $0.3 million during fiscal 2017, 2016 and 2015, respectively.
The following table summarizes all restricted stock awards activity during fiscal 2017, 2016 and 2015:
|
|
Number of
Shares
|
|
|
Weighted
Average
Grant Price
|
|
Balance at September 30, 2014
|
|
|
18,624
|
|
|
$
|
22.45
|
|
Granted
|
|
|
18,073
|
|
|
|
21.84
|
|
Vested
|
|
|
(7,606
|
)
|
|
|
22.28
|
|
Forfeited
|
|
|
(1,316
|
)
|
|
|
22.16
|
|
Balance at September 30, 2015
|
|
|
27,775
|
|
|
|
22.12
|
|
Granted
|
|
|
20,108
|
|
|
|
20.14
|
|
Vested
|
|
|
(12,311
|
)
|
|
|
22.19
|
|
Forfeited
|
|
|
(2,439
|
)
|
|
|
21.17
|
|
Balance at September 30, 2016
|
|
|
33,133
|
|
|
|
20.96
|
|
Granted
|
|
|
51,559
|
|
|
|
25.12
|
|
Vested
|
|
|
(14,497
|
)
|
|
|
21.10
|
|
Forfeited
|
|
|
(2,278
|
)
|
|
|
25.12
|
|
Balance at September 30, 2017
|
|
|
67,917
|
|
|
$
|
23.98
|
|
Performance Share Awards
F-26
The Company has entered into performance share agreements with certain key employees, covering the issuance of common stock (“Performance Shares”). The Performance Shares vest upon the
achievement of all or a portion of certain performance objectives, which must be achieved during the performance period. The Performance Shares are not issued and outstanding until the performance objectives are met. The Organization and Compensation Commi
ttee of the Board of Directors (the “Committee”) approves the performance objectives used for executive compensation programs, which objectives were cumulative earnings per share and cumulative revenue for the three-year performance periods for fiscal 2013
awards (2013 – 2015)
,
and 2014 awards (2014 – 2016), and are cumulative earnings before interest, income taxes, depreciation and amortization (“EBITDA”) for fiscal 2015 awards (2015 – 2017), fiscal 2016 awards (2016-2018) and fiscal 2017 awards (2016-2018
). Assuming that the minimum performance level is attained, the number of shares that may actually vest will vary based on performance from 20% (minimum) to 200% (maximum) of the target number of shares. Shares will be issued to participants as soon as pra
cticable following the end of the performance periods, subject to Committee approval and verification of results. The per-unit compensation cost related to the shares to be granted under each performance period is fixed on the grant date, which is the date
the performance period begins. Compensation expense is recognized in each period based on management’s best estimate of the achievement level of the specified performance objectives for Performance Shares for each open performance period. In fiscal 2017,
the Company recognized expense of $1.2 million related to probable achievement of performance objectives for three-year Performance Shares granted in fiscal 2017, 2016 and 2015. In fiscal 2016, the Company recognized expense of $1.9 million related to prob
able achievement of performance objectives for three-year Performance Shares granted in fiscal 2016, 2015 and 2014. In fiscal 2015, the Company recognized expense of $0.5 million related to probable achievement of performance objectives for three-year Perf
ormance Shares granted in fiscal 2015, 2014 and 2013. The stock-based compensation table above includes the Performance Shares expenses.
The fair values of the Performance Shares, at target, were $1.2 million, $1.3 million and $0.9 million for grants awarded in fiscal 2017, 2016 and 2015, respectively.
The aggregate number of shares that could be awarded to key employees if the minimum, target and maximum performance goals are met, based upon the fair value at the date of grant is as follows:
Performance Period
|
|
Minimum Shares
|
|
|
Target Shares
|
|
|
Maximum Shares
|
|
Fiscal 2015 – 2017
|
|
|
8,440
|
|
|
|
42,199
|
|
|
|
84,398
|
|
Fiscal 2016 – 2018
|
|
|
13,268
|
|
|
|
66,338
|
|
|
|
132,676
|
|
Fiscal 2017 – 2019
|
|
|
10,437
|
|
|
|
52,185
|
|
|
|
104,370
|
|
The Fiscal 2015 – 2017 awards are expected to be finalized in December 2017 at an estimated 51,483 shares based on performance objective results. Based on the Company’s performance through September 30, 2017, it is estimated that approximately 57,979 shares may be earned for the Fiscal 2016 – 2018 performance period and that approximately 63,561 shares may be earned for the Fiscal 2017 – 2019 performance period.
1999 Employee Stock Purchase Plan
Under the amended 1999 Employee Stock Purchase Plan (“Stock Purchase Plan”), the Company is authorized to issue up to 600,000 shares of common stock. All full-time and part-time U.S. employees can choose to have up to 10% of their annual compensation withheld, with a limit of $25,000, to purchase the Company’s common stock at purchase prices defined within the provisions of the Stock Purchase Plan. As of September 30, 2017 and 2016, there were less than $0.1 million of employee contributions in accrued liabilities in the consolidated balance sheets. Stock compensation expense recognized related to the Stock Purchase Plan for the fiscal years ended September 30, 2017, 2016 and 2015 totaled $0.1 million or less for each year. The stock-based compensation table above includes the Employee Stock Purchase Plan expenses.
Restricted Stock and Deferred Stock Units
The Company awarded 16,004 and 18,877 restricted stock units (“RSU”) in fiscal 2017 and 2016, respectively, under the 2009 Plan to non-employee directors and certain key employees in foreign jurisdictions with forfeitures of 495 and 1,609 in fiscal 2017 and 2016, respectively.
RSU awards are not considered issued or outstanding common stock of the Company until they vest. The estimated fair value of the RSU awards was calculated based on the closing market price of Surmodics’ common stock on the date of grant. As of September 30, 2017 and 2016, outstanding RSU’s totaled 44,391 and 32,101, respectively. Compensation expense is recognized over the vesting term based on the fair value of the common shares on the date of grant. The stock-based compensation table above includes RSU expenses recognized related to these awards, which totaled $0.3 million, $0.2 million and $0.4 million for fiscal 2017, 2016 and 2015, respectively.
F-27
Directors may elect to receive their annual fees for services to the Board in deferred stock units (“DSUs”). As
of September 30, 2017 and 2016, outstanding DSUs totaled 24,441 and 21,077, respectively, with an estimated fair value of $0.8 million. These DSUs are fully vested when granted. Stock-based compensation expense related to DSU awards, totaled $0.1 million,
$0.2 million and $0.1 million in fiscal 2017, 2016 and 2015, respectively.
7. Revolving Credit Facility
The Company has a revolving credit facility with available principal totaling $30.0 million, which terminates on November 1, 2019. In addition, the Company has a $5.0 million multi-currency overdraft facility in Ireland with the same bank. Borrowings under the credit facility, if any, bear interest at a benchmark rate plus a margin ranging from 1.00% to 1.75% based on the Company’s leverage ratio, as defined in the loan agreement. A facility fee is payable quarterly on unused commitments at a rate of 0.15% per annum. The Company has the option to increase the credit facility increments of $5.0 million up to an additional $20.0 million, subject to approval of the lender. The Company’s obligations under the credit facility are secured by substantially all of its assets, other than intellectual property and real estate, as well as the majority of its equity interest in its subsidiaries.
In connection with the credit facility, the Company is required to maintain certain financial covenants related to a maximum leverage ratio and a minimum EBITDA amount and to comply with nonfinancial covenants. As of September 30, 2017, the Company had no borrowings outstanding on the line of credit and was in compliance with all financial covenants under the credit facility.
8. Income Taxes
Income taxes from continuing operations in the accompanying consolidated statements of income for the fiscal years ended September 30 are as follows
(in thousands):
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Current provision:
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Federal
|
|
$
|
2,125
|
|
|
$
|
6,550
|
|
|
$
|
6,065
|
|
U.S. State
|
|
|
(72
|
)
|
|
|
250
|
|
|
|
106
|
|
International
|
|
|
54
|
|
|
|
(98
|
)
|
|
|
30
|
|
Total current provision
|
|
|
2,107
|
|
|
|
6,702
|
|
|
|
6,201
|
|
Deferred provision (benefit):
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Federal
|
|
|
1,085
|
|
|
|
169
|
|
|
|
58
|
|
U.S. State
|
|
|
(85
|
)
|
|
|
(43
|
)
|
|
|
35
|
|
International
|
|
|
—
|
|
|
|
135
|
|
|
|
—
|
|
Total deferred provision (benefit)
|
|
|
1,000
|
|
|
|
261
|
|
|
|
93
|
|
Total provision
|
|
$
|
3,107
|
|
|
$
|
6,963
|
|
|
$
|
6,294
|
|
F-28
The reconciliation of the difference between amounts calculated at the statutory U.S. federal tax rate of 35
% for the fiscal years ended September 30 and the Company’s effective tax rate from continuing operations is as follows
(in thousands):
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Amount at statutory U.S. federal income tax rate
|
|
$
|
2,461
|
|
|
$
|
5,932
|
|
|
$
|
6,385
|
|
Change because of the following items:
|
|
|
|
|
|
|
|
|
|
|
|
|
State income taxes, net of federal benefit
|
|
|
(13
|
)
|
|
|
142
|
|
|
|
67
|
|
Stock-based compensation
|
|
|
330
|
|
|
|
(607
|
)
|
|
|
16
|
|
Valuation allowance change
|
|
|
665
|
|
|
|
(2,500
|
)
|
|
|
348
|
|
Tax reserve change
|
|
|
(52
|
)
|
|
|
258
|
|
|
|
34
|
|
Federal manufacturing deduction
|
|
|
(313
|
)
|
|
|
(280
|
)
|
|
|
(268
|
)
|
U.S. Federal and foreign research and development credits
|
|
|
(706
|
)
|
|
|
(571
|
)
|
|
|
(74
|
)
|
Gain on strategic investment and corporate subsidiary
|
|
|
—
|
|
|
|
2,630
|
|
|
|
—
|
|
Foreign rate differential
|
|
|
948
|
|
|
|
622
|
|
|
|
—
|
|
Acquisition-related transaction costs
|
|
|
—
|
|
|
|
768
|
|
|
|
—
|
|
Contingent consideration (gain) expense
|
|
|
(45
|
)
|
|
|
522
|
|
|
|
—
|
|
Unrealized foreign currency exchange loss on contingent consideration obligation
|
|
|
170
|
|
|
|
—
|
|
|
|
—
|
|
Other
|
|
|
(338
|
)
|
|
|
47
|
|
|
|
(214
|
)
|
Income tax provision
|
|
$
|
3,107
|
|
|
$
|
6,963
|
|
|
$
|
6,294
|
|
The federal research and development tax credit for fiscal 2016 and 2015 includes the benefit generated for the periods from October 1, 2015 to December 31, 2015, October 1, 2014 to December 31, 2014 and October 1, 2013 to December 31, 2013, respectively, prior to the expiration of the benefit in each period. During fiscal 2016, the Company utilized $7.5 million of capital losses generated in prior years by accelerating built-in gains in the Company’s IVD subsidiary. For tax purposes, this resulted in an increase in the Company’s tax basis in the IVD subsidiary and a $2.6 million reduction in both deferred tax assets and the valuation allowance as of September 30, 2016.
Excess tax benefits (shortfalls) related to stock based compensation expense are recorded within income tax expenses in the consolidated statements of income and totaled $(0.2) million and $0.6 million for the years ended September 30, 2017 and 2016, respectively. During fiscal 2015, under accounting guidance then in effect, excess tax benefits totaling $0.4
were recorded in additional paid-in capital.
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):
|
|
2017
|
|
|
2016
|
|
Depreciable assets
|
|
$
|
(3,335
|
)
|
|
$
|
(2,257
|
)
|
Accruals and reserves
|
|
|
1,123
|
|
|
|
1,153
|
|
Stock-based compensation
|
|
|
3,370
|
|
|
|
3,113
|
|
Impaired strategic investments
|
|
|
2,701
|
|
|
|
2,701
|
|
NOL carryforwards
|
|
|
3,627
|
|
|
|
3,324
|
|
U.S. Federal and state R&D credits
|
|
|
242
|
|
|
|
110
|
|
Other
|
|
|
810
|
|
|
|
730
|
|
Valuation allowance
|
|
|
(4,511
|
)
|
|
|
(3,847
|
)
|
Total deferred tax assets
|
|
$
|
4,027
|
|
|
$
|
5,027
|
|
As of September 30, 2017 and 2016, the Company recorded deferred tax asset valuation allowances of $4.5 million and $3.9 million, respectively. The valuation allowances are primarily related to other-than-temporary impairment losses on strategic investments, state R&D credit carryforwards, and net operating loss carryforwards of Creagh Medical. As of September 30, 2017, the Company had federal and Minnesota R&D credit carryforwards of $0.3 million that will begin expiring in 2029 and state net operating loss carryforwards $0.2 million that will begin expiring in 2022. The Ireland and Luxembourg net operating loss carryforward assets totaling $3.0 million, much of which was acquired as part of the Creagh Medical acquisition in fiscal 2016, have
F-29
an unlimited carryforward peri
od. The U.S. federal and Minnesota net operating losses acquired as part of the NorMedix, Inc. acquisition are subject to the IRC Section 382 limitation rules. The Company has projected that these losses will be utilized with over the ten years remaining
in the carryforward period.
Unrecognized tax benefits are the differences between a tax position taken, or expected to be taken in a tax return, and the benefit recognized for accounting purposes pursuant to accounting guidance. A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest and penalties, is as follows
(in thousands):
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Beginning of fiscal year
|
|
$
|
1,508
|
|
|
$
|
1,248
|
|
|
$
|
1,216
|
|
Increases in tax positions for prior years
|
|
|
8
|
|
|
|
77
|
|
|
|
50
|
|
Decreases in tax positions for prior years
|
|
|
(35
|
)
|
|
|
(21
|
)
|
|
|
(10
|
)
|
Increases in tax positions for current year
|
|
|
216
|
|
|
|
365
|
|
|
|
146
|
|
Lapse of the statute of limitations
|
|
|
(216
|
)
|
|
|
(161
|
)
|
|
|
(154
|
)
|
End of fiscal year
|
|
$
|
1,481
|
|
|
$
|
1,508
|
|
|
$
|
1,248
|
|
The total amount of unrecognized tax benefits excluding interest and penalties that, if recognized, would affect the effective tax rate as of September 30, 2017, 2016 and 2015, respectively, are $1.2 million, $1.2 million and $0.9 million. Currently, the Company does not expect the liability for unrecognized tax benefits to change significantly in the next 12 months and has classified the above balances on the consolidated balance sheets in other long-term liabilities. Interest and penalties related to unrecognized tax benefits are recorded in income tax expense. As of September 30, 2017, 2016 and 2015, a gross balance of $0.5 million, $0.6 million and $0.6 million, respectively, has been accrued related to the unrecognized tax benefits balance for interest and penalties.
The Company files income tax returns, including returns for its subsidiaries, in the U.S. federal jurisdiction and in various state jurisdictions as well as several non-U.S. jurisdictions. Uncertain tax positions are related to tax years that remain subject to examination. The Internal Revenue Service (“IRS”) commenced an examination of the Company’s fiscal 2016 U.S. federal income tax return in the fourth quarter of fiscal 2017. The examination has not been completed. U.S. federal income tax returns for years prior to fiscal 2013 are no longer subject to examination by federal tax authorities. For tax returns for state and local jurisdictions, the Company is no longer subject to examination for tax years generally before fiscal 2007. For tax returns for non-U.S. jurisdictions, the Company is no longer subject to income tax examination for years prior to 2012. Additionally, the Company has been indemnified of liability for any taxes relating to Creagh Medical and NorMedix for periods prior to the respective acquisition dates, pursuant to the terms of the related share purchase agreements. As of September 30, 2017 and 2016, there were no undistributed earnings in foreign subsidiaries.
9. Defined Contribution Plan
The Company has a 401(k) retirement and savings plan for the benefit of qualifying U.S. employees, and a defined contribution PRSA plan for the benefit of qualifying Ireland employees. For U.S. employees, the Company matches 50% of employee contributions on the first 6% of eligible compensation. For Ireland employees, the Company makes contributions of up to 8% of eligible compensation on employee contributions of up to 6% of eligible compensation. Company contributions totaling $0.7 million, $0.3 million and $0.3 million have been expensed in the years ended September 30, 2017, 2016 and 2015, respectively.
10. Amounts Reclassified Out of Accumulated Other Comprehensive Income
Amounts reclassified out of Accumulated Other Comprehensive Income (“AOCI”) totaled $0.3
million on a pre-tax basis for the fiscal year ended September 30, 2015. There were no amounts reclassified out of AOCI for fiscal 2017 or 2016. The amounts reclassified out of AOCI for fiscal 2015 were associated with an unrealized gain on available-for-sale securities that were realized on the sale of the securities and are presented in other income, net in the consolidated statements of income.
11. Commitments and Contingencies
Litigation.
From time to time, the Company has been, and may become, involved in various legal actions involving its operations, products and technologies, including intellectual property and employment disputes. The outcomes of these legal actions are not within the Company’s complete control and may not be known for prolonged periods of time. In some actions, the
F-30
claimants seek damages as well as other relief, including injunctions barring the sale of products that are the subject of the lawsuit, which if granted, could require significant expenditures or result in lo
st revenue. The Company records a liability in the consolidated financial statements for these actions when a loss is known or considered probable and the amount can be reasonably estimated. If the reasonable estimate of a known or probable loss is a range
, and no amount within the range is a better estimate, the minimum amount of the range is accrued. If a loss is possible but not known or probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed. In most cases, significan
t judgment is required to estimate the amount and timing of a loss to be recorded.
On February 22, 2017, the Company was sued by Merit Medical Systems, Inc. (“Merit”) in the U.S. District Court for the District of Utah. NorMedix was added as a defendant on April 3, 2017. The lawsuit alleges breach of contract and seeks declaratory relief in connection with a services agreement entered into between Merit and NorMedix on March 3, 2015. In the lawsuit, Merit claims that certain technology and intellectual property related to thin-walled catheter technologies were developed by NorMedix under the services agreement and, pursuant to the terms of that agreement, should be owned by Merit. Pretrial proceedings are underway. The Company has not recorded an expense related to damages in connection with this matter because any potential loss is not currently probable or reasonably estimable. Additionally, the Company cannot reasonably estimate the range of loss, if any, that may result from this matter. Under the stock purchase agreement, pursuant to which the Company acquired NorMedix, the Company may have certain rights of indemnification against losses (including, without limitation, damages, expenses and costs) incurred as a result of the claims asserted in the litigation.
The Company believes that the claims in the lawsuit are without merit and plans to vigorously defend and prosecute this matter.
In the Company’s Quarterly Reports on Form 10-Q for the periods ended March 31, 2015, and June 30, 2015, it was disclosed a notice was received from a customer alleging an overpayment of approximately $5.7 million in royalties covering the period January 2009 through September 2014 (the “Claim”). On September 29, 2015, the Company entered into a settlement and release agreement resolving the Claim. Under the agreement, among other things, (a) the Company agreed to pay the customer $2.5 million to settle the Claim, (b) the customer agreed to pay the Company approximately $0.5 million for undisputed royalties that were unpaid and were not previously recognized, during fiscal 2015, and (c) the Company and the customer agreed to a mutual release relating to the Claim and certain other claims by the Company for royalties owed by the customer. In connection with the settlement, in the fourth quarter of fiscal 2015, the Company recognized revenue of approximately $0.5 million and recorded a charge of approximately $2.5 million.
InnoRx, Inc.
In January 2005, the Company entered into a merger agreement whereby the Company acquired all of the assets of InnoRx, Inc. (“InnoRx”), an early stage company developing drug delivery devices and therapies for the ophthalmology market. The Company will be required to issue up to approximately 480,059 additional shares of its common stock to the stockholders of InnoRx upon the successful completion of the remaining development and commercial milestones involving InnoRx technology acquired in the transaction. The Company has not recorded any accrual for this contingency as of September 30, 2017 as the milestones have not been achieved and the probability of achievement is remote.
InnoCore Technologies BV.
In March 2006, the Company entered into a license agreement whereby Surmodics obtained an exclusive license to a drug delivery coating for licensed products within the vascular field which included peripheral, coronary and neurovascular biodurable stent product. The license requires an annual minimum payment of 200,000 euros (equivalent to $236,000 using a euro to US $ exchange rate of 1.1801 as of September 30, 2017) until the last patent expires which is currently estimated to be September 2027. The total minimum future payments associated with this license are approximately $2.4 million. The license is currently utilized with one of Surmodics’ drug delivery customers.
Operating Leases.
The Company leases certain facilities under noncancelable operating lease agreements. Rent expense for the years ended September 30, 2017, 2016 and 2015 was $0.1 million for each period. In November 2017, the Company executed a lease for a 36,000 square feet of office and R&D facility in Eden Prairie, Minnesota. Contractual obligations under the lease agreement total $4.0 million over the ten-year lease term, which is expected to commence in May 2018. Annual commitments pursuant to operating lease agreements in place as of September 30, 2017 are as follows
(in thousands):
F-31
Year Ended September 30,
|
|
|
|
|
2018
|
|
$
|
114
|
|
2019
|
|
|
73
|
|
2020
|
|
|
74
|
|
2021
|
|
|
12
|
|
2022
|
|
|
—
|
|
Thereafter
|
|
|
—
|
|
Total minimum lease payments
|
|
$
|
273
|
|
Clinical Trials.
The Company has engaged a CRO to assist with its ongoing clinical trials. In connection with the TRANSCEND pivotal clinical trial for the SurVeil® drug-coated balloon, the Company signed a $26 million contract with a CRO for the administration of the trial, under which an estimated $23.2 million remains to be paid as of September 30, 2017. The Company estimates that the total cost of the TRANSCEND clinical trial will be in the range of $32 million to $40 million over the next several years. In the event the Company were to terminate any trial, it may incur certain financial penalties which would become payable to the CRO for costs to wind down the terminated trial.
12. Reportable Segment Information
The accounting standards for reporting information about operating segments define operating segments as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, who is the Company’s Chief Executive Officer, in deciding how to allocate resources and in assessing performance. For financial accounting and reporting purposes, the Company reports its results for the two reportable segments as follows: (1) the Medical Device unit, which is comprised of surface modification coating technologies to improve access, deliverability, and predictable deployment of medical devices; international cardiology and peripheral balloon design, development and manufacturing; as well as drug delivery coating technologies to provide site-specific drug delivery from the surface of a medical device, with end markets that include coronary, peripheral, neuro-vascular and urology, among others, and (2) the In Vitro Diagnostics unit, which consists of component products and technologies for diagnostic test kits and biomedical research applications, with products that include protein stabilization reagents, substrates, antigens and surface coatings. During fiscal 2016, the Company acquired Creagh Medical and NorMedix, which are included in the Medical Device segment.
The tables below present segment revenue, operating income from continuing operations and depreciation and amortization, for the years ended September 30, as follows (in thousands):
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Medical Device
|
|
$
|
53,983
|
|
|
$
|
53,202
|
|
|
$
|
45,944
|
|
In Vitro Diagnostics
|
|
|
19,129
|
|
|
|
18,164
|
|
|
|
15,954
|
|
Total revenue
|
|
$
|
73,112
|
|
|
$
|
71,366
|
|
|
$
|
61,898
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
Medical Device
|
|
$
|
6,902
|
|
|
$
|
16,975
|
|
|
$
|
21,192
|
|
In Vitro Diagnostics
|
|
|
8,293
|
|
|
|
7,115
|
|
|
|
4,484
|
|
Total segment operating income
|
|
|
15,195
|
|
|
|
24,090
|
|
|
|
25,676
|
|
Corporate
|
|
|
(8,092
|
)
|
|
|
(7,231
|
)
|
|
|
(6,587
|
)
|
Total operating income
|
|
$
|
7,103
|
|
|
$
|
16,859
|
|
|
$
|
19,089
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
Medical Device
|
|
$
|
4,453
|
|
|
$
|
3,261
|
|
|
$
|
1,138
|
|
In Vitro Diagnostics
|
|
|
412
|
|
|
|
789
|
|
|
|
873
|
|
Corporate
|
|
|
690
|
|
|
|
823
|
|
|
|
794
|
|
Total depreciation and amortization
|
|
$
|
5,555
|
|
|
$
|
4,873
|
|
|
$
|
2,805
|
|
F-32
The Corporate category includes expenses that are not fully allocated to Medical Device and In Vitro Diagnostics segments. These Corporate costs are related to functions, such as executive management, corporate accounting, leg
al, human resources and Board of Directors. Corporate may also include expenses, such as litigation, which are not specific to a segment and thus not allocated to the operating segments.
Asset information by segment is not presented because the Company does not provide its chief operating decision maker assets by segment, as the data is not readily available.
Major Customers
Revenue from customers that equaled or exceeded 10% of total revenue was as follows for the years ended September 30:
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Medtronic
|
|
|
18
|
%
|
|
|
25
|
%
|
|
|
26
|
%
|
The revenue from the customer listed is derived from two primary sources: licensing and product sales (primarily in the Medical Device segment).
Geographic Revenue and Long-lived Assets
Geographic revenue was as follows for the years ended September 30:
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Domestic
|
|
|
77
|
%
|
|
|
79
|
%
|
|
|
77
|
%
|
Foreign
|
|
|
23
|
%
|
|
|
21
|
%
|
|
|
23
|
%
|
Long-lived assets, including property and equipment and intangible assets net of accumulated depreciation and amortization, respectively, by country were as follows as of September 30:
|
|
2017
|
|
|
2016
|
|
U.S.
|
|
$
|
20,949
|
|
|
$
|
21,543
|
|
Ireland
|
|
|
22,555
|
|
|
|
20,583
|
|
13. Quarterly Financial Data (Unaudited)
The following is a summary of the unaudited quarterly results for the years ended September 30, 2017 and 2016
(in thousands, except per share data).
|
|
First
Quarter
|
|
|
Second
Quarter
|
|
|
Third
Quarter
|
|
|
Fourth
Quarter
|
|
Fiscal 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
17,761
|
|
|
$
|
17,503
|
|
|
$
|
17,790
|
|
|
$
|
20,058
|
|
Operating income
|
|
|
3,268
|
|
|
|
1,677
|
|
|
|
1,743
|
|
|
|
415
|
|
Net income
|
|
|
2,300
|
|
|
|
506
|
|
|
|
720
|
|
|
|
400
|
|
Basic net income per share (1):
|
|
|
0.17
|
|
|
|
0.04
|
|
|
|
0.05
|
|
|
|
0.03
|
|
Diluted net income per share (1):
|
|
|
0.17
|
|
|
|
0.04
|
|
|
|
0.05
|
|
|
|
0.03
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
16,541
|
|
|
$
|
16,699
|
|
|
$
|
19,972
|
|
|
$
|
18,154
|
|
Operating income
|
|
|
3,939
|
|
|
|
2,240
|
|
|
|
6,597
|
|
|
|
4,083
|
|
Net income
|
|
|
2,653
|
|
|
|
821
|
|
|
|
3,934
|
|
|
|
2,577
|
|
Basic net income per share (1):
|
|
|
0.20
|
|
|
|
0.06
|
|
|
|
0.31
|
|
|
|
0.20
|
|
Diluted net income per share (1):
|
|
|
0.20
|
|
|
|
0.06
|
|
|
|
0.30
|
|
|
|
0.20
|
|
|
(1)
|
The sum of the quarterly income per share amounts may not equal the annual income per share total because of changes in the weighted average number of shares outstanding that occurred during the year.
|
F-33
In the fourth
quarter of fiscal 2017, the Company recorded a $1.1 million
license fee related to
a customer’s acquisition and the Company’s sale of related jointly-owned intellectual property to the acquirer
.
In the first quarter of fiscal 2016, the Company recorded expense related to acquisition related costs, including due diligence and integration expenses of $2.5 million, related to the acquisitions of Creagh Medical and NorMedix (Note 3).
During the second quarter of fiscal 2016, the Company recorded an out-of-period adjustment of $1.1 million to correct a cumulative overstatement of royalty revenue, of which $1.0 million related to years prior to fiscal 2016. The overstatement was evaluated and concluded to not be material to fiscal 2016, or any prior interim or annual periods.
In the third quarter of fiscal 2016, the Company recorded a $2.9 million customer royalty catch-up payment related to periods prior to the third quarter fiscal 2016.
In the fourth quarter of fiscal 2016, the Company recorded a $0.5 million reduction of the income tax provision related to the adoption of ASU 2016-09 as discussed in Note 9.
F-34