SURMODICS INC - Quarter Report: 2011 June (Form 10-Q)
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2011
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 0-23837
SurModics, Inc.
(Exact name of registrant as specified in its charter)
MINNESOTA | 41-1356149 | |
(State of incorporation) | (I.R.S. Employer Identification No.) |
9924 West 74th Street
Eden Prairie, Minnesota 55344
(Address of principal executive offices) (Zip Code)
Eden Prairie, Minnesota 55344
(Address of principal executive offices) (Zip Code)
Registrants telephone number, including area code: (952) 500-7000
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 þ No o
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 þ No o
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.
Large accelerated filero | Accelerated filerþ | Non-accelerated filero | Smaller reporting companyo | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
The number of shares of the registrants Common Stock, $.05 par value per share, outstanding as of
August 1, 2011 was 17,524,607.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SurModics, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
June 30, | September 30, | |||||||
2011 | 2010 | |||||||
(in thousands, except share data) | (Unaudited) | |||||||
ASSETS |
||||||||
Current Assets |
||||||||
Cash and cash equivalents |
$ | 18,437 | $ | 11,391 | ||||
Short-term investments |
15,909 | 9,105 | ||||||
Accounts receivable, net of allowance for doubtful accounts
of $290 and $461 as of June 30, 2011 and September 30,
2010, respectively |
9,166 | 8,987 | ||||||
Inventories |
3,735 | 3,047 | ||||||
Deferred tax asset |
830 | 247 | ||||||
Prepaids and other |
2,526 | 4,701 | ||||||
Total current assets |
50,603 | 37,478 | ||||||
Property and equipment, net |
63,842 | 65,395 | ||||||
Long-term investments |
28,899 | 36,290 | ||||||
Deferred tax asset |
3,102 | 2,606 | ||||||
Intangible assets , net |
14,097 | 15,257 | ||||||
Goodwill |
8,010 | 8,010 | ||||||
Other assets, net |
4,896 | 5,243 | ||||||
Total assets |
$ | 173,449 | $ | 170,279 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current Liabilities |
||||||||
Accounts payable |
$ | 1,615 | $ | 3,341 | ||||
Accrued liabilities: |
||||||||
Compensation |
2,322 | 930 | ||||||
Accrued other |
1,834 | 1,753 | ||||||
Deferred revenue |
1,376 | 562 | ||||||
Other current liabilities |
376 | 1,061 | ||||||
Total current liabilities |
7,523 | 7,647 | ||||||
Deferred revenue, less current portion |
3,656 | 3,598 | ||||||
Other long-term liabilities |
4,394 | 4,675 | ||||||
Total liabilities |
15,573 | 15,920 | ||||||
Commitments and contingencies (Note 15) |
||||||||
Stockholders Equity |
||||||||
Series A Preferred stock- $.05 par value, 450,000 shares
authorized; no shares issued and outstanding |
| | ||||||
Common stock- $.05 par value, 45,000,000 shares
authorized; 17,525,477 and 17,423,601 shares issued and
outstanding |
876 | 871 | ||||||
Additional paid-in capital |
73,373 | 69,702 | ||||||
Accumulated other comprehensive income |
568 | 886 | ||||||
Retained earnings |
83,059 | 82,900 | ||||||
Total stockholders equity |
157,876 | 154,359 | ||||||
Total liabilities and stockholders equity |
$ | 173,449 | $ | 170,279 | ||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial
statements.
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SurModics, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(In thousands, except per share data) | (unaudited) | (unaudited) | ||||||||||||||
Revenue |
||||||||||||||||
Royalties and license fees |
$ | 7,529 | $ | 9,356 | $ | 22,787 | $ | 26,333 | ||||||||
Product sales |
5,839 | 5,769 | 16,449 | 15,586 | ||||||||||||
Research and development |
4,599 | 3,483 | 11,393 | 12,430 | ||||||||||||
Total revenue |
17,967 | 18,608 | 50,629 | 54,349 | ||||||||||||
Operating costs and expenses |
||||||||||||||||
Product costs |
1,704 | 2,388 | 5,813 | 6,820 | ||||||||||||
Customer research and development |
4,379 | 4,642 | 14,141 | 12,748 | ||||||||||||
Other research and development |
3,522 | 4,223 | 8,923 | 13,507 | ||||||||||||
Selling, general and administrative |
4,916 | 4,944 | 14,998 | 13,667 | ||||||||||||
Goodwill impairment charge |
| | 5,650 | | ||||||||||||
Restructuring charges |
| | 1,236 | 1,306 | ||||||||||||
Asset impairment charges |
| 191 | | 2,265 | ||||||||||||
Total operating costs and expenses |
14,521 | 16,388 | 50,761 | 50,313 | ||||||||||||
Income (loss) from operations |
3,446 | 2,220 | (132 | ) | 4,036 | |||||||||||
Other income (loss) |
||||||||||||||||
Investment income |
147 | 241 | 498 | 819 | ||||||||||||
Impairment loss on investments |
| (2,577 | ) | | (2,577 | ) | ||||||||||
Other income, net |
172 | 298 | 401 | 301 | ||||||||||||
Other income (loss) |
319 | (2,038 | ) | 899 | (1,457 | ) | ||||||||||
Income before income taxes |
3,765 | 182 | 767 | 2,579 | ||||||||||||
Income tax benefit (provision) |
77 | (1,098 | ) | (608 | ) | (2,005 | ) | |||||||||
Net income (loss) |
$ | 3,842 | $ | (916 | ) | $ | 159 | $ | 574 | |||||||
Basic net income (loss) per common share |
$ | 0.22 | $ | (0.05 | ) | $ | 0.01 | $ | 0.03 | |||||||
Diluted net income (loss) per common share |
$ | 0.22 | $ | (0.05 | ) | $ | 0.01 | $ | 0.03 | |||||||
Weighted average shares outstanding |
||||||||||||||||
Basic |
17,437 | 17,360 | 17,409 | 17,373 | ||||||||||||
Dilutive effect of outstanding stock
options and non-vested stock |
92 | | 47 | 12 | ||||||||||||
Diluted |
17,529 | 17,360 | 17,456 | 17,385 |
The accompanying notes are an integral part of these unaudited condensed consolidated financial
statements.
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SurModics, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
Nine Months Ended | ||||||||
June 30, | ||||||||
2011 | 2010 | |||||||
(in thousands) | (Unaudited) | |||||||
Operating Activities |
||||||||
Net income |
$ | 159 | $ | 574 | ||||
Adjustments to reconcile net income to net cash provided by operating
activities of continuing operations |
||||||||
Depreciation and amortization |
5,397 | 5,950 | ||||||
Gain on sales of investments |
(380 | ) | (300 | ) | ||||
Amortization of premium on investments |
72 | 101 | ||||||
Stock-based compensation |
3,239 | 4,192 | ||||||
Goodwill impairment charge |
5,650 | | ||||||
Asset impairment charges |
| 2,265 | ||||||
Impairment loss on investments |
| 2,577 | ||||||
Deferred taxes |
(871 | ) | 990 | |||||
Tax benefits from exercise of stock options |
41 | (72 | ) | |||||
Other |
134 | 3 | ||||||
Change in operating assets and liabilities: |
||||||||
Accounts receivable |
(179 | ) | 568 | |||||
Inventories |
(688 | ) | (176 | ) | ||||
Accounts payable and accrued liabilities |
(565 | ) | 531 | |||||
Income taxes |
1,876 | (2,796 | ) | |||||
Deferred revenue |
872 | 2,881 | ||||||
Prepaids and other |
263 | (575 | ) | |||||
Net cash provided by operating activities |
15,020 | 16,713 | ||||||
Investing Activities |
||||||||
Purchases of property and equipment |
(3,279 | ) | (7,196 | ) | ||||
Purchases of available-for-sale investments |
(48,309 | ) | (32,834 | ) | ||||
Sales/maturities of investments |
48,827 | 23,009 | ||||||
Payments related to prior business acquisitions |
(5,650 | ) | (750 | ) | ||||
Other investing activities |
| (500 | ) | |||||
Net cash used in investing activities |
(8,411 | ) | (18,271 | ) | ||||
Financing Activities |
||||||||
Tax benefit from exercise of stock options |
(41 | ) | 72 | |||||
Issuance of common stock |
487 | 892 | ||||||
Repurchase of common stock |
| (2,032 | ) | |||||
Purchase of common stock to pay employee taxes |
(9 | ) | (393 | ) | ||||
Net cash provided by (used in) financing activities |
437 | (1,461 | ) | |||||
Net change in cash and cash equivalents |
7,046 | (3,019 | ) | |||||
Cash and Cash Equivalents |
||||||||
Beginning of period |
11,391 | 11,636 | ||||||
End of period |
$ | 18,437 | $ | 8,617 | ||||
Supplemental Information |
||||||||
Cash paid (received) for income taxes |
$ | (398 | ) | $ | 3,811 | |||
Noncash transaction acquisition of property, plant, and equipment on account |
$ | 104 | $ | 1,096 | ||||
Noncash transaction acquisition of intangible assets on account |
$ | | $ | 210 |
The accompanying notes are an integral part of these unaudited condensed consolidated financial
statements.
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SurModics, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
Period Ended June 30, 2011
(Unaudited)
Period Ended June 30, 2011
(Unaudited)
(1) Basis of Presentation
The accompanying unaudited interim condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the United States of
America (GAAP) and reflect all adjustments, consisting solely of normal recurring adjustments,
needed to fairly present the financial results for the periods presented. These financial
statements include some amounts that are based on managements best estimates and judgments. These
estimates may be adjusted as more information becomes available, and any adjustment could be
significant. The impact of any change in estimates is included in the determination of earnings in
the period in which the change in estimate is identified. The results of operations for the
three-month and nine-month periods ended June 30, 2011 are not necessarily indicative of the
results that may be expected for the entire 2011 fiscal year.
In accordance with the rules and regulations of the United States Securities and Exchange
Commission, the Company has omitted footnote disclosures that would substantially duplicate the
disclosures contained in the audited financial statements of the Company. These unaudited condensed
consolidated financial statements should be read together with the audited consolidated financial
statements for the year ended September 30, 2010, and footnotes thereto included in the Companys
Form 10-K as filed with the United States Securities and Exchange Commission on December 14, 2010.
Subsequent events have been evaluated through the date the financial statements were issued.
(2) Key Accounting Policies
Revenue recognition
Revenue is recognized 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 Companys revenue is derived from three primary sources: (1) royalties and license fees
from licensing its proprietary drug delivery and surface modification technologies to customers;
(2) the sale of polymers and reagent chemicals, stabilization products, antigens, substrates and
microarray slides to the diagnostics and biomedical research industries; and (3) research and
development fees generated on customer projects.
Royalties and licenses fees. The Company licenses technology to third parties and collects
royalties. Royalty revenue is generated when a customer sells products incorporating the Companys
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 over the term of the related licensing agreement. 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 are recognized at the time of shipment, provided
that an order has been received, the price is fixed or determinable, collectability of the
resulting receivable is reasonably assured and returns can be reasonably estimated. The Companys
sales terms provide no right of return outside of the standard warranty policy. Payment terms are
generally set at 30- 45 days.
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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.
Arrangements with multiple deliverables. In October 2009, the Financial Accounting Standards
Board (FASB) amended the accounting standards for multiple deliverable revenue arrangements to:
(i). | provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated; | ||
(ii). | require an entity to 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). | eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method. |
The Company enters into license and development arrangements that may consist of multiple
deliverables that could include license 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 would 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 a contract 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.
Under the accounting guidance, the Company is still 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 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 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 Companys
management, taking into consideration the marketing strategies for each business unit.
Valuation of long-lived assets
Accounting guidance requires the Company to periodically evaluate whether events and circumstances
have occurred that may affect the estimated useful life or the recoverability of the remaining balance of
long-lived assets, such as property and equipment 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.
New accounting pronouncements
In May 2011, the FASB issued changes to conform existing guidance regarding fair value
measurement and disclosure between GAAP and International Financial Reporting Standards. These
changes both clarify the FASBs intent about the application of existing fair value measurement and
disclosure requirements and amend certain principles or requirements for measuring fair value or
for disclosing information about fair value measurements. The clarifying changes relate to the
application of the highest and best use and valuation premise concepts, measuring the fair value of
an instrument classified in a reporting entitys shareholders equity, and disclosure of
quantitative information about unobservable inputs used for Level 3 fair value measurements. The
amendments relate to measuring the fair value of financial instruments that are managed within a
portfolio; application of premiums and discounts in a fair value measurement; and additional
disclosures concerning the valuation processes used and sensitivity of the fair value measurement
to changes in unobservable inputs for those items categorized as Level 3, a reporting entitys use
of a nonfinancial asset in a way that differs from the assets highest and best use, and the
categorization by level in the fair value hierarchy for items required to be measured at fair value
for disclosure purposes only. These changes become effective for SurModics on January 1, 2012.
Management is currently evaluating the potential impact of these changes on the condensed
consolidated financial statements.
In June 2011, the FASB issued changes to the presentation of comprehensive income. These
changes give an entity the option to present the total of comprehensive income, the components of
net income, and the components of other comprehensive income either in a single continuous
statement of comprehensive income or in two separate but consecutive statements; the option to
present
components of other comprehensive income as part of the statement of changes in stockholders
equity was eliminated. The items that must be reported in other comprehensive income or when an
item of other comprehensive income must be reclassified to net income
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were not changed.
Additionally, no changes were made to the calculation and presentation of earnings per share. These
changes become effective for SurModics on October 1, 2012. Management is currently evaluating these
changes to determine which option will be chosen for the presentation of comprehensive income.
Other than the change in presentation, management has determined these changes will not have an
impact on the condensed consolidated financial statements.
No other new accounting pronouncement issued or effective has had, or is expected to have, a
material impact on the Companys consolidated financial statements.
(3) Fair Value Measurements
The accounting guidance on fair value measurements defines fair value, establishes a framework
for measuring fair value under 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 financial
statements on a recurring basis (at least annually). 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.
The Companys Level 1 asset consists of its investment in OctoPlus, N.V. (see Note 6 for
further information). The fair market value of this investment is based on the quoted price of
OctoPlus shares traded on the Euronext Amsterdam Stock Exchange.
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 Companys Level 2 assets consist of money market funds, U.S. Treasury securities,
corporate bonds, municipal bonds, U.S. agency securities, agency and municipal securities, certain
asset-backed securities and mortgage-backed securities. Fair market values for these assets are
based on quoted vendor prices and broker pricing where all significant inputs are observable.
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.
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.
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 Companys 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 Companys financial assets and liabilities measured at fair
value on a recurring basis as of June 30, 2011 (in thousands):
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Quoted Prices | ||||||||||||||||
in Active Markets | Total Fair | |||||||||||||||
for Identical | Significant Other | Significant | Value as of | |||||||||||||
Instruments | Observable Inputs | Unobservable Inputs | June 30, | |||||||||||||
(Level 1) | (Level 2) | (Level 3) | 2011 | |||||||||||||
Assets: |
||||||||||||||||
Cash equivalents |
$ | | $ | 4,337 | $ | | $ | 4,337 | ||||||||
Available for sale debt securities |
||||||||||||||||
US government obligations |
| 29,391 | | 29,391 | ||||||||||||
Mortgage backed securities |
| 4,145 | | 4,145 | ||||||||||||
Municipal bonds |
| 2,932 | | 2,932 | ||||||||||||
Asset backed securities |
| 1,617 | | 1,617 | ||||||||||||
Corporate bonds |
| 3,672 | | 3,672 | ||||||||||||
Other assets |
2,476 | | | 2,476 | ||||||||||||
Total assets measured at fair value |
$ | 2,476 | $ | 46,094 | $ | | $ | 48,570 | ||||||||
Short-term investments disclosed in the condensed consolidated balance sheets include
held-to-maturity investments totaling $3.1 million as of June 30, 2011. Held-to-maturity
investments are carried at an amortized cost.
The following table presents information about the Companys financial assets and liabilities
measured at fair value on a recurring basis as of September 30, 2010 (in thousands):
Quoted Prices | ||||||||||||||||
in Active Markets | Total Fair | |||||||||||||||
for Identical | Significant Other | Significant | Value as of | |||||||||||||
Instruments | Observable Inputs | Unobservable Inputs | September 30, | |||||||||||||
(Level 1) | (Level 2) | (Level 3) | 2010 | |||||||||||||
Assets: |
||||||||||||||||
Cash equivalents |
$ | | $ | 10,128 | $ | | $ | 10,128 | ||||||||
Available for sale debt securities |
||||||||||||||||
US government obligations |
| 25,626 | 704 | 26,330 | ||||||||||||
Mortgage backed securities |
| 4,757 | 69 | 4,826 | ||||||||||||
Municipal bonds |
| 3,150 | | 3,150 | ||||||||||||
Asset backed securities |
| 1,113 | | 1,113 | ||||||||||||
Corporate bonds |
| 5,852 | | 5,852 | ||||||||||||
Other assets |
2,624 | | | 2,624 | ||||||||||||
Total assets measured at fair value |
$ | 2,624 | $ | 50,626 | $ | 773 | $ | 54,023 | ||||||||
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Changes in Level 3 Instruments Measured at Fair Value on a Recurring Basis
The Company had no financial assets in the three months ended June 30, 2011, that were
measured using significant unobservable inputs (Level 3 inputs), thus no table is presented. The
following tables reconcile financial assets and liabilities measured at fair value on a recurring
basis using significant unobservable inputs (Level 3) (in thousands):
Fair Value Measurements Using Significant | ||||||||||||
Unobservable Inputs (Level 3) | ||||||||||||
Nine Months Ended June 30, 2011 | ||||||||||||
Available-for-Sale Debt Securities | ||||||||||||
U.S. Government | Mortgage | |||||||||||
Obligations | Backed | Total | ||||||||||
Balance, September 30, 2010 |
$ | 704 | $ | 69 | $ | 773 | ||||||
Transfers into Level 3 |
| | | |||||||||
Transfers out of Level 3 |
(695 | ) | (68 | ) | (763 | ) | ||||||
Total realized and unrealized gains (losses): |
||||||||||||
Included in other comprehensive income (loss) |
19 | (1 | ) | 18 | ||||||||
Purchases, issuances, sales and settlements, net |
(28 | ) | | (28 | ) | |||||||
Balance, June 30, 2011 |
$ | | $ | | $ | | ||||||
Fair Value Measurements Using Significant | ||||||||||||
Unobservable Inputs (Level 3) | ||||||||||||
Three Months Ended June 30, 2010 | ||||||||||||
Available-for-Sale Debt Securities | ||||||||||||
U.S. Government | Mortgage | |||||||||||
Obligations | Backed | Total | ||||||||||
Balance, March 31, 2010 |
$ | 924 | $ | 145 | $ | 1,069 | ||||||
Transfers into Level 3 |
| | | |||||||||
Total realized and unrealized gains (losses): |
||||||||||||
Included in other comprehensive income (loss) |
(33 | ) | 1 | (32 | ) | |||||||
Purchases, issuances, sales and settlements, net |
(103 | ) | (3 | ) | (106 | ) | ||||||
Balance, June 30, 2010 |
$ | 788 | $ | 143 | $ | 931 | ||||||
Fair Value Measurements Using Significant | ||||||||||||
Unobservable Inputs (Level 3) | ||||||||||||
Nine Months Ended June 30, 2010 | ||||||||||||
Available-for-Sale Debt Securities | ||||||||||||
U.S. Government | Mortgage | |||||||||||
Obligations | Backed | Total | ||||||||||
Balance, September 30, 2009 |
$ | 1,130 | $ | 73 | $ | 1,203 | ||||||
Transfers into Level 3 |
| 147 | 147 | |||||||||
Transfers out of Level 3 |
(36 | ) | (73 | ) | (109 | ) | ||||||
Total realized and unrealized gains (losses): |
||||||||||||
Included in other comprehensive income (loss) |
(39 | ) | 4 | (35 | ) | |||||||
Purchases, issuances, sales and settlements, net |
(267 | ) | (8 | ) | (275 | ) | ||||||
Balance, June 30, 2010 |
$ | 788 | $ | 143 | $ | 931 | ||||||
Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
The Companys 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, as well as held-to-maturity securities, 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 investees industry, the investees
product development status and subsequent rounds of financing and the related valuation and/or the
Companys participation in such financings. The Company also assesses the investees ability to
meet business milestones and the
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financial condition and near-term prospects of the individual investee, including the rate at
which the investee is using its cash and the investees 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.
(4) Investments
Investments consist principally of U.S. government and government agency obligations and
mortgage-backed securities and are classified as available-for-sale or held-to-maturity at June 30,
2011 and September 30, 2010. Available-for-sale investments are reported at fair value with
unrealized gains and losses net of tax excluded from operations and reported as a separate
component of stockholders equity, except for other-than-temporary impairments, which are reported
as a charge to current operations. 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 results in a new cost basis for
the investment. Investments that management has the intent and ability to hold to maturity are
classified as held-to-maturity and reported at amortized cost. If there is an other-than-temporary
impairment in the fair value of any individual security classified as held-to-maturity, the Company
will write down the security to fair value with a corresponding adjustment to other income (loss).
Interest 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 debt securities, which
are included in other income (loss), are determined using the specific identification method.
The original cost, unrealized holding gains and losses, and fair value of available-for-sale
investments as of June 30, 2011 and September 30, 2010 were as follows (in thousands):
June 30, 2011 | ||||||||||||||||
Original Cost | Unrealized Gains | Unrealized Losses | Fair Value | |||||||||||||
U.S. government obligations |
$ | 29,337 | $ | 58 | $ | (4 | ) | $ | 29,391 | |||||||
Mortgage-backed securities |
4,061 | 126 | (42 | ) | 4,145 | |||||||||||
Municipal bonds |
2,891 | 42 | (1 | ) | 2,932 | |||||||||||
Asset-backed securities |
1,659 | 3 | (45 | ) | 1,617 | |||||||||||
Corporate bonds |
3,646 | 27 | (1 | ) | 3,672 | |||||||||||
Total |
$ | 41,594 | $ | 256 | $ | (93 | ) | $ | 41,757 | |||||||
September 30, 2010 | ||||||||||||||||
Original Cost | Unrealized Gains | Unrealized Losses | Fair Value | |||||||||||||
U.S. government obligations |
$ | 25,968 | $ | 395 | $ | (34 | ) | $ | 26,329 | |||||||
Mortgage-backed securities |
4,711 | 164 | (48 | ) | 4,827 | |||||||||||
Municipal bonds |
3,079 | 72 | | 3,151 | ||||||||||||
Asset-backed securities |
1,146 | 8 | (42 | ) | 1,112 | |||||||||||
Corporate bonds |
5,828 | 24 | | 5,852 | ||||||||||||
Total |
$ | 40,732 | $ | 663 | $ | (124 | ) | $ | 41,271 | |||||||
The original cost and fair value of investments by contractual maturity at June 30, 2011 were
as follows (in thousands):
Amortized Cost | Fair Value | |||||||
Debt securities due within: |
||||||||
One year |
$ | 12,851 | $ | 12,858 | ||||
One to five years |
23,407 | 23,537 | ||||||
Five years or more |
5,336 | 5,362 | ||||||
Total |
$ | 41,594 | $ | 41,757 | ||||
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The following table summarizes sales of available-for-sale securities for the three-month and
nine-month periods ended June 30, 2011(in thousands):
Three Months Ended | Nine Months Ended | |||||||
June 30, 2011 | June 30, 2011 | |||||||
Proceeds from sales |
$ | 23,247 | $ | 47,827 | ||||
Gross realized gains |
$ | 171 | $ | 384 | ||||
Gross realized losses |
$ | | $ | (4 | ) |
At June 30, 2011, the amortized cost and fair market value of held-to-maturity debt securities
was $3.1 million. Investments in securities designated as held-to-maturity consist of tax-exempt
municipal bonds with maturity dates of less than one year as of June 30, 2011. At September 30,
2010, the amortized cost and fair market value of held-to-maturity debt securities were $4.1
million and $4.3 million, respectively.
(5) 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 (in thousands):
June 30, | September 30, | |||||||
2011 | 2010 | |||||||
Raw materials |
$ | 1,238 | $ | 1,140 | ||||
Finished products |
2,497 | 1,907 | ||||||
Total |
$ | 3,735 | $ | 3,047 | ||||
(6) Other Assets
Other assets consist principally of strategic investments as follows (in thousands):
June 30, | September 30, | |||||||
2011 | 2010 | |||||||
Investment in OctoPlus N.V. |
$ | 2,475 | $ | 2,624 | ||||
Investment in Nexeon MedSystems |
285 | 285 | ||||||
Investment in ThermopeutiX |
1,185 | 1,185 | ||||||
Investment in Novocell |
559 | 559 | ||||||
Other |
392 | 590 | ||||||
Other assets |
$ | 4,896 | $ | 5,243 | ||||
The Company accounts for most of its strategic investments under the cost method. The Company
accounts for its investment in OctoPlus N.V. (OctoPlus) common stock, whose shares are traded on
the Euronext Amsterdam Stock Exchange, as an available-for-sale investment. Available-for-sale
investments are reported at fair value with unrealized gains and losses reported as a separate
component of stockholders equity, except for other-than-temporary impairments, which are reported
as a charge to current operations, recorded in the other income (loss) section of the condensed
consolidated statements of operations. The cost basis in the Companys investment in OctoPlus is
$1.7 million.
The Company recognized revenue of less than $0.1 million and $1.3 million for the three-month
periods ended June 30, 2011 and 2010, respectively, and recognized revenue of $0.1 million and $1.5
million for the nine-month periods ended June 30, 2011 and 2010, respectively, from activity with
companies in which it had a strategic investment.
(7) Intangible Assets
Intangible assets consist principally of acquired patents and technology, customer
relationships, licenses, and trademarks. The Company recorded amortization expense of $0.4 million
for each of the three-month periods ended June 30, 2011 and 2010. The Company recorded amortization
expenses of $1.2 million for each of the nine-month periods ended June 30, 2011 and 2010.
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Intangible assets consisted of the following (in thousands):
Useful life | June 30, | September 30, | ||||||||||
(in years) | 2011 | 2010 | ||||||||||
Customer list |
9 11 | $ | 8,657 | $ | 8,657 | |||||||
Core technology |
8 18 | 8,330 | 8,330 | |||||||||
Patents and other |
2 20 | 2,376 | 2,376 | |||||||||
Trademarks |
600 | 600 | ||||||||||
Less accumulated amortization of intangible assets |
(5,866 | ) | (4,706 | ) | ||||||||
Intangible assets, net |
$ | 14,097 | $ | 15,257 | ||||||||
Based on the intangible assets in service as of June 30, 2011, estimated amortization expense
for each of the next five fiscal years is as follows (in thousands):
Remainder of 2011 |
$ | 386 | ||
2012 |
1,544 | |||
2013 |
1,544 | |||
2014 |
1,544 | |||
2015 |
1,533 | |||
2016 |
1,395 |
Future amortization amounts presented above are estimates. Actual future amortization expense
may be different, as a result of future acquisitions, impairments, changes in amortization periods,
or other factors.
(8) Goodwill
Goodwill represents the excess of the cost of the acquired entities over the fair value
assigned to the assets purchased and liabilities assumed in connection with the Companys
acquisitions. The carrying amount of goodwill is evaluated annually, and between annual evaluations
if events occur or circumstances change indicating that the carrying amount of goodwill may be
impaired.
The following table summarizes the changes in carrying amount of goodwill (in thousands):
Balance at September 30, 2010 |
$ | 8,010 | ||
Payments related to prior business acquisitions |
5,650 | |||
Goodwill impairment |
(5,650 | ) | ||
Balance at
June 30, 2011 |
$ | 8,010 | ||
During the Companys fiscal 2010 annual test of goodwill impairment, the Company determined
that goodwill related to the SurModics Pharmaceuticals, Inc. (SurModics Pharma) reporting unit was
fully impaired, and a non-cash goodwill impairment charge totaling $13.8 million was recognized in
the fourth quarter of fiscal 2010
In the first quarter of fiscal 2011, two milestones were achieved associated with the July
2007 acquisition of SurModics Pharma and $5.7 million of additional purchase price was recorded as
an increase to goodwill. There had been no substantial changes in operating results for SurModics
Pharma in the first quarter of fiscal 2011, and as such the Company concluded the goodwill
associated with the milestone events was fully impaired, and a $5.7 million non-cash goodwill
impairment charge was recognized in the three months ended December 31, 2010.
The remaining $8.0 million of goodwill at June 30, 2011 is related to the In Vitro
Diagnostics reporting unit. The goodwill was not impaired based on the outcome of the fiscal 2010
annual impairment test, and there have been no events or circumstances that have occurred in fiscal
2011 to indicate that the goodwill may be impaired.
(9) Revolving Credit Facility
In February 2011, the Company extended its unsecured revolving credit
facility through March 2012 and reduced the credit facility to $15.0 million. Borrowings
under the credit facility, if any, will bear interest at a benchmark rate plus an applicable margin
based upon the Companys funded debt to EBITDA ratio. As of June 30, 2011, the Company had no debt
outstanding under the credit facility and was in compliance with all covenants.
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(10) Stock-based Compensation
The Company has stock-based compensation plans under which it grants stock options and
restricted stock awards. Accounting guidance requires all share-based payments to be recognized as
an operating expense, based on their fair values, over the requisite service period. The Companys
stock-based compensation expenses were allocated as follows (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Product costs |
$ | 62 | $ | 29 | $ | 164 | $ | 95 | ||||||||
Customer research and development |
93 | 202 | 285 | 505 | ||||||||||||
Other research and development |
239 | 659 | 728 | 1,718 | ||||||||||||
Selling, general and administrative |
670 | 542 | 2,062 | 1,874 | ||||||||||||
Total |
$ | 1,064 | $ | 1,432 | $ | 3,239 | $ | 4,192 | ||||||||
As of June 30, 2011, approximately $5.3 million of total unrecognized compensation costs
related to non-vested awards is expected to be recognized over a weighted average period of
approximately 3 years. The unrecognized compensation costs above exclude $1.9 million associated
with performance share awards that are currently not anticipated to be fully expensed because the
performance conditions for certain award periods are not expected to be met.
Stock Option Plans
The Company uses the Black-Scholes option pricing model to determine the weighted average
grant date fair value of stock options granted. There were no stock options granted in the
three-month period ended June 30, 2011. The weighted average per share fair value of stock options
granted during the three-month period ended June 30, 2010 was $7.05. The weighted average per share
fair value of stock options granted during the nine-month periods ended June 30, 2011 and 2010 was
$3.96 and $6.91, respectively. The assumptions used as inputs in the model were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Risk-free interest rates |
N/A | 2.2 | % | 1.5 | % | 2.0 | % | |||||||||
Expected life (years) |
N/A | 4.8 | 4.8 | 4.8 | ||||||||||||
Expected volatility |
N/A | 41.2 | % | 45.0 | % | 41.4 | % | |||||||||
Dividend yield |
N/A | 0 | % | 0 | % | 0 | % |
The risk-free interest rate assumption was based on the U.S. Treasurys 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 Companys experience. Expected
volatility is based on the Companys stock price movement over a period approximating the expected
term. Based on managements judgment, dividend rates are expected to be zero for the expected life
of the options. The Company also estimates forfeitures of options granted, which are based on
historical experience.
The Companys Incentive Stock Options (ISO) are granted at a price of at least 100% of the
fair market value of the common stock of the Company on the date of the grant or 110% with respect
to optionees who own more than 10% of the total combined voting power of all classes of stock. ISOs
expire in seven years or upon termination of employment and are exercisable at a rate of 20% per
year commencing one year after the date of grant. Nonqualified stock options are granted at fair
market value on the date of grant. Nonqualified stock options expire in 7 to 10 years or upon
termination of employment or service as a Board member. Nonqualified stock options granted prior to
May 2008 generally become exercisable with respect to 20% of the shares on each of the first five
anniversaries following the grant date, and nonqualified stock options granted subsequent to May
2008 generally become exercisable with respect to 25% of the shares on each of the first four anniversaries
following the grant date.
No stock options were exercised during the three-month periods ended June 30, 2011 and 2010
and during the nine-month period ended June 30, 2011. The total pre-tax intrinsic value of options
exercised during the nine-month period ended June 30, 2010 was not meaningful, as our stock price
of $16.41 on June 30, 2010 was below the value of options exercised. The intrinsic value
represents the difference between the exercise price and the fair market value of the Companys
common stock on the last day of the respective fiscal period.
Restricted Stock Awards
The Company has entered into restricted stock agreements with certain key employees, covering
the issuance of common stock
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(Restricted Stock). Under accounting guidance these shares are considered to be non-vested
shares. The Restricted Stock will be released to the key employees if they are employed by the
Company at the end of the vesting period. The stock-based compensation table above includes
Restricted Stock expenses of $0.2 million and $0.6 million during the three-month and nine-month
periods ended June 30, 2011, respectively, and $0.2 million and $0.8 million for the three-month
and nine-month periods ended June 30, 2010, respectively.
Performance Share Awards
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. Compensation is recognized in each period based on managements best estimate
of the achievement level of the grants specified performance objectives and the resulting vesting
amounts. The Company recognized expenses of $0.1 million and $0.2 million related to Performance
Shares for the three-month and nine-month periods ended June 30, 2011, respectively. The Company
did not recognize an expense for the three-month period ended June 30, 2010 and recognized expense
of less than $0.1 million for the nine-month period ended June 30, 2010.
1999 Employee Stock Purchase Plan
Under the 1999 Employee Stock Purchase Plan (Stock Purchase Plan), the Company is authorized
to issue up to 400,000 shares of common stock. All full-time and part-time employees can choose to
have up to 10% of their annual compensation withheld, with a limit of $25,000, to purchase the
Companys common stock at purchase prices defined within the provisions of the Stock Purchase Plan.
As of June 30, 2011 and 2010, there were less than $0.1 million and $0.2 million of employee
contributions, respectively, included in accrued liabilities in the accompanying condensed
consolidated balance sheets. Stock compensation expense recognized related to the Stock Purchase
Plan for the three-month periods ended June 30, 2011 and 2010
totaled less than $0.1 million in each period. Stock compensation expense for the nine-month periods ended June 30,
2011 and 2010 totaled $0.1 million and $0.2 million, respectively. The stock-based compensation
table above includes the Stock Purchase Plan expenses.
(11) Restructuring Charges
The Company recorded total restructuring charges of approximately $1.2 million in connection
with the reorganization announced in October 2010. The charges for fiscal 2011 have been presented
separately as restructuring charges in the condensed consolidated statements of operations. These
pre-tax charges consisted of $1.2 million of severance pay and benefit expenses and $0.1 million of
facility-related costs. The restructuring was expected to result in approximately $3.0 to $3.5
million in annualized cost savings. Cash payments associated with the fiscal 2011 restructuring
charges totaled $1.1 million as of June 30, 2011, leaving a balance of $0.1 million. There were also
payments of $0.9 million associated with facility-related costs in the period related to the fiscal
2009 and 2010 restructuring events. The remaining balance for all restructuring charges is expected
to be paid within the next 30 months. The current portion totaling $0.3 million is recorded as a
current liability within other accrued liabilities and the long-term portion totaling $0.1 million
is recorded as a long-term liability within other long-term liabilities within the condensed
consolidated balance sheets.
The following table summarizes the restructuring accrual activity for the nine-month period
ended June 30, 2011 (in thousands):
Employee | Facility- | |||||||||||
severance and | related | |||||||||||
benefits | costs | Total | ||||||||||
Balance at September 30, 2010 |
$ | 4 | $ | 1,179 | $ | 1,183 | ||||||
Accruals during the period |
1,174 | 62 | 1,236 | |||||||||
Cash payments |
(1,057 | ) | (942 | ) | (1,999 | ) | ||||||
Balance at June 30, 2011 |
$ | 121 | $ | 299 | $ | 420 | ||||||
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(12) Comprehensive Income (Loss)
The components of comprehensive income (loss) are as follows (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net income (loss) |
$ | 3,842 | $ | (916 | ) | $ | 159 | $ | 574 | |||||||
Other comprehensive income (loss): |
||||||||||||||||
Unrealized holding gains
(losses) on available-for-sale
securities arising during the
period, net of tax |
(80 | ) | (260 | ) | (82 | ) | (869 | ) | ||||||||
Less reclassification adjustment
for realized gains included in
net income, net of tax |
(106 | ) | (179 | ) | (236 | ) | (184 | ) | ||||||||
Other comprehensive income (loss) |
(186 | ) | (439 | ) | (318 | ) | (1,053 | ) | ||||||||
Comprehensive income (loss) |
$ | 3,656 | $ | (1,355 | ) | $ | (159 | ) | $ | (479 | ) | |||||
(13) Income Taxes
The Company recorded an income tax benefit of $0.1 million for the three-month period ended
June 30, 2011 and an income tax expense of $1.1 million for the three-month period ended June 30,
2010, representing tax rates of negative 2.0% and positive 603.3%, respectively. The Company
recorded income tax provisions of $0.6 million and $2.0 million for the nine-month periods ended
June 30, 2011 and 2010, respectively, representing tax rates of 79.3% and 77.7%, respectively. The
difference between the U.S. federal statutory tax rate of 35% and the Companys tax rate for fiscal
2011 three- and nine-month periods ended June 30, 2011, reflected the non-deductible goodwill
impairment. For the fiscal 2010 three- and nine-month periods ended June 30, 2010, the difference
between the U.S. federal statutory tax rate of 35% and the Companys tax rate, reflected the
non-deductible impairment loss on investments, state income taxes and other permanent items.
The total amount of unrecognized tax benefits including interest and penalties that, if
recognized, would affect the effective tax rate as of June 30, 2011 and September 30, 2010,
respectively, are $1.7 million and $1.9 million. Currently, the Company does not expect the
liability for unrecognized tax benefits to change significantly in the next twelve months. Interest
and penalties related to the unrecognized tax benefits are recorded in income tax expense.
The Company files income tax returns, including returns for its subsidiaries, in the United
States (U.S.) federal jurisdiction and in various state jurisdictions. Uncertain tax positions are
related to tax years that remain subject to examination. The Internal Revenue Service completed an
examination of the Companys U.S. income tax return for fiscal 2009 and a payment was made in the
third quarter of fiscal 2011 associated with timing adjustments. U.S. income tax returns for fiscal years
ended September 30, 2007, 2008 and 2010 remain subject to examination by federal tax authorities.
Tax returns for state and local jurisdictions for fiscal years ended September 30, 2003 through
2010 remain subject to examination by state and local tax authorities.
(14) Operating Segments
Operating segments are defined as components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating decision maker, or
decision making group, in deciding how to allocate resources and in assessing performance.
The Company manages its operations according to its three business units, 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, as well as drug delivery
coating technologies to provide site-specific drug delivery from the surface of a medical device.
End markets include coronary, peripheral, and neuro-vascular, and urology, among others; (2) the
Pharmaceuticals unit, which incorporates a broad range of drug delivery technologies for injectable
therapeutics, including microparticles, nanoparticles, and implants addressing a range of clinical
applications including ophthalmology, oncology, dermatology and neurology, among others. Based in
Birmingham, Alabama, the Pharmaceuticals business includes the Companys Current Good Manufacturing
Practice (cGMP) manufacturing facility; and (3) the In Vitro Diagnostics unit, which consists of
component products and technologies for diagnostic test kits and biomedical research applications.
Products include microarray slide technologies, protein stabilization reagents, substrates, and
antigens.
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The table below presents revenue and operating income (loss) from the business units, for the
three- and nine-month periods in fiscal 2011 and 2010, as follows (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Revenue |
||||||||||||||||
Medical Device |
$ | 9,557 | $ | 11,684 | $ | 29,342 | $ | 33,385 | ||||||||
Pharmaceuticals |
4,970 | 3,711 | 11,804 | 12,645 | ||||||||||||
In Vitro Diagnostics |
3,440 | 3,213 | 9,483 | 8,319 | ||||||||||||
Total revenue |
$ | 17,967 | $ | 18,608 | $ | 50,629 | $ | 54,349 | ||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Operating Income (Loss) |
||||||||||||||||
Medical Device |
$ | 4,516 | $ | 5,814 | $ | 14,885 | $ | 15,776 | ||||||||
Pharmaceuticals |
(799 | ) | (2,841 | ) | (12,116 | ) | (8,163 | ) | ||||||||
In Vitro Diagnostics |
1,426 | 1,212 | 3,323 | 2,572 | ||||||||||||
Corporate |
(1,697 | ) | (1,965 | ) | (6,224 | ) | (6,149 | ) | ||||||||
Total |
$ | 3,446 | $ | 2,220 | $ | (132 | ) | $ | 4,036 | |||||||
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Depreciation and Amortization |
||||||||||||||||
Medical Device |
$ | 397 | $ | 536 | $ | 1,230 | $ | 1,633 | ||||||||
Pharmaceuticals |
1,026 | 1,201 | 3,041 | 3,237 | ||||||||||||
In Vitro Diagnostics |
200 | 208 | 598 | 626 | ||||||||||||
Corporate |
179 | 153 | 528 | 454 | ||||||||||||
Total |
$ | 1,802 | $ | 2,098 | $ | 5,397 | $ | 5,950 | ||||||||
Segment results above for the three-month period ended June 30, 2010 include an asset
impairment charge of $375 in Corporate and adjustment of $184 to a prior fiscal 2010 asset
impairment charge in the Pharmaceuticals segment.
Segment results above for the nine-month period ended June 30, 2011 include goodwill
impairment charges of $5,650 in the Pharmaceuticals segment and restructuring charges of $1,236 in
Corporate.
Segment results for the nine-month period ended June 30, 2010 include an asset impairment
charge of $1,890 in the Pharmaceuticals segment and an asset impairment charge of $375 and
restructuring charges of $1,306 in Corporate.
Corporate includes expenses for administrative corporate functions, such as executive,
corporate accounting, legal, human resources and Board related, that have not been fully allocated
to segments. Corporate also includes special charges, such as restructuring costs, which are not
specific to a segment.
Asset information by segment is not presented in the table above because the Company does not
provide our chief operating decision maker assets by segment, as the data is not readily available.
(15) 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 Companys complete
control and may not be known for prolonged periods of time. In some actions, the 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 lost
revenues. 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
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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, significant
judgment is required to estimate the amount and timing of a loss to be recorded.
InnoRx, Inc. In January 2005, the Company entered into a merger agreement whereby SurModics
acquired all of the assets of InnoRx, Inc. (InnoRx), an early stage company developing drug
delivery devices and therapies for the ophthalmology market. SurModics 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.
SurModics Pharmaceuticals, Inc. In July 2007, the Company acquired 100% of the capital stock
of SurModics Pharmaceuticals, Inc. (SurModics Pharma) a drug delivery company that provides
proprietary polymer-based technologies to companies developing pharmaceutical products. The sellers
of SurModics Pharma are still eligible to receive up to $2.9 million in additional consideration
based on successful achievement of specified project milestones through calendar 2011.
PR Pharmaceuticals, Inc. In November 2008, the Companys subsidiary SurModics Pharma
acquired certain contracts and assets of PR Pharmaceuticals, to enhance its portfolio of drug
delivery technologies for the pharmaceutical and biotechnology industries. The sellers of PR
Pharmaceuticals are still eligible to receive up to $3.0 million in additional consideration based
on successful achievement of specified milestones for successful patent issuances and product
development.
Alabama Jobs Commitment. In April 2008, the Company purchased a 286,000 square foot
office and warehouse facility to support cGMP needs of customers and the anticipated growth of the
SurModics Pharma business. At the same time, SurModics Pharma entered into an agreement with
various governmental authorities to obtain financial incentives associated with creation of jobs in
Alabama. Some of the governmental agencies have recapture rights in connection with the financial
incentives if a specific number of full-time employees are not hired by June 2012, with an
extension to June 2013 if circumstances or events occur that are beyond the control of SurModics
Pharma or could not have been reasonably anticipated by SurModics
Pharma (Permitted Extension). As of June 30, 2011,
SurModics Pharma has received $1.7 million in connection with the agreement, and the Company has
recorded the payment in other long-term liabilities as the Company
believes the Permitted Extension is applicable.
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Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion and analysis provides information that we believe is useful in
understanding our operating results, cash flows and financial condition. The discussion should be
read in conjunction with both the unaudited condensed consolidated financial statements and related
notes included in this Form 10-Q, and Managements Discussion and Analysis of Financial Condition
and Results of Operations included in our Annual Report on Form 10-K for the year ended September
30, 2010. This discussion contains various Forward-Looking Statements within the meaning of the
Private Securities Litigation Reform Act of 1995. We refer readers to the statement entitled
Forward-Looking Statements located at the end of Part I of this report.
Overview
SurModics is a leading provider of drug delivery and surface modification technologies to the
healthcare industry. In October 2010, we announced a change in our organizational structure moving
from a functional structure into one consisting of three business units: Medical Device,
Pharmaceuticals, and In Vitro Diagnostics. We believe this structure improves the visibility,
marketing and adoption of the Companys broad array of technologies within specific markets and
helps our customers in the medical device, pharmaceutical and life science industries better solve
unmet clinical needs.
The organizational change resulted in the Company presenting revenue and operating
results 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, as
well as drug delivery coating technologies to provide site-specific drug delivery from the surface
of a medical device. End markets include coronary, peripheral, and neuro-vascular, and urology,
among others; (2) the Pharmaceuticals unit, which incorporates a broad range of drug delivery
technologies for injectable therapeutics, including microparticles, nanoparticles, and implants
addressing a range of clinical applications including ophthalmology, oncology, dermatology and
neurology, among others. Based in Birmingham, Alabama, the Pharmaceuticals business includes our
cGMP manufacturing facility; and (3) the In Vitro Diagnostics unit, which consists of component
products and technologies for diagnostic test kits and biomedical research applications. Products
include microarray slide technologies, protein stabilization reagents, substrates, and antigens.
The Companys revenue is derived from three primary sources: (1) royalties and license fees
from licensing our proprietary drug delivery and surface modification 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) the sale of polymers and reagent chemicals, stabilization
products, antigens, substrates and microarray slides to the diagnostics and biomedical research
industry; and (3) research and development (R&D) fees generated on customer projects. Revenue
fluctuates from quarter to quarter depending on, among other factors: our customers success in
selling products incorporating our technologies; the timing of introductions of licensed products
by customers; the timing of introductions of products that compete with our customers products;
the number and activity level associated with customer development projects; the number and terms
of new license agreements that are finalized; the value of reagent chemicals and other products
sold to customers; and the timing of future acquisitions we complete, if any.
On October 5, 2009, we entered into a License and Development Agreement with F.
Hoffmann-La Roche, Ltd. (Roche) and Genentech, Inc., a wholly owned member of the Roche Group
(Genentech). Under the terms of the agreement, Roche and Genentech will have an exclusive license
to develop and commercialize a sustained drug delivery formulation of Lucentis® (ranibizumab
injection) utilizing SurModics proprietary biodegradable microparticles drug delivery system. We
received an up-front licensing fee of $3.5 million and are eligible to receive potential payments
of up to approximately $200 million in fees and milestone payments in the event of the successful
development and commercialization of multiple products, as well as payment for development work
done on these products. Roche and Genentech will have the right to obtain manufacturing services
from SurModics. In the event a commercial product is developed, we will also receive royalties on
sales of such product. During fiscal 2010 and continuing into fiscal 2011, the focus of our
development activities has changed, primarily as a result of technical issues experienced in the
Lucentis® microparticle product development program. Such technical issues reflect the inherent
challenges often experienced in the development of new or reformulated pharmaceutical products. We
are continuing to collaborate with Genentech under our agreement on sustained drug delivery
products utilizing our proprietary biodegradable microparticle drug delivery system. However, the
program remains subject to a number of risks and uncertainties, including those detailed under the
heading Risk Factors in Item 1A of the Companys 2010 Form 10-K.
In addition, in December 2010, we announced that the Board of Directors of the
Company had authorized the Company to explore strategic alternatives for our
Pharmaceuticals business, including a potential sale of that business. This decision by the
Board reflected our focus on returning the Company to profitable growth, and our
renewed commitment to pursuing growth opportunities and investments in our Medical
Device and In Vitro Diagnostics businesses. We have retained Piper Jaffray & Co. as our
financial advisor in connection with this process. We have made no decision to enter into
any transaction regarding the Pharmaceuticals business, and there can be no assurance
that we will enter into such a transaction in the future. While the assets of the
Pharmaceuticals business did not qualify as held-for-sale as of June 30, 2011,
because we have not committed to a plan to sell, we continue to make progress assessing
our various alternatives and anticipate reaching a conclusion by the end of calendar 2011.
We determined that the assets of the Pharmaceuticals business were not impaired as of
June 30, 2011, however, we would expect to incur a loss on
disposal should we determine that a sale transaction is the most beneficial outcome for
the Company.
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Overview of research and development activities
We manage our customer-sponsored R&D programs (Customer R&D), based largely on the
requirements of our customers. In this regard, our customers typically establish the various
measures and metrics that are used to monitor a programs progress, including key deliverables,
milestones, timelines, and an overall program budget. The customer is ultimately responsible for
deciding whether to continue or terminate a program, and does so based on research results
(relative to the above measures and metrics) and other factors, including their own strategic
and/or business priorities. Customer R&D programs are mainly in our Medical Device and
Pharmaceuticals segments and the processes do not differ significantly.
For our internal R&D programs (included in Other R&D) in our three segments, we utilize R&D
review committees to prioritize these programs based on a number of factors, including a programs
strategic fit, commercial impact, potential competitive advantage, technical feasibility, and the
amount of investment required. The measures and metrics used to monitor a programs progress varies
based on the program, and typically includes many of the same factors discussed above with respect
to our Customer R&D programs. We typically make decisions to continue or terminate a program based
on research results (relative to the above measures and metrics) and other factors, including our
own strategic and/or business priorities, and the amount of additional investment required.
With respect to cost components, R&D expenses in each of our three segments consist of labor,
materials and overhead costs (utilities, depreciation, indirect labor, etc.) for both Customer R&D
and Other R&D programs. We manage our R&D organization in a flexible manner, balancing
workloads/resources between Customer R&D and Other R&D programs primarily based on the level of
customer program activity. Therefore, costs incurred for Customer R&D and Other R&D can shift as
customer activity increases or decreases. As a result of the recent economic conditions, some
customers have delayed, slowed or cancelled development projects, which has affected the R&D
expense mix between Customer R&D and Other R&D.
Critical Accounting Policies
Critical accounting policies are those policies that require the application of managements
most challenging subjective or complex judgment, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain and may change in subsequent periods.
Critical accounting policies involve judgments and uncertainties that are sufficiently likely to
result in materially different results under different assumptions and conditions. For a detailed
description of our critical accounting policies, see the notes to the consolidated financial
statements included in our Annual Report on Form 10-K for the year ended September 30, 2010.
Results of Operations Three Months Ended June 30
Revenue. Revenue during the third quarter of fiscal 2011 was $18.0 million, a decrease of $0.6
million, or 3%, compared with the third quarter of fiscal 2010. The following table provides a
summary of each operating segments revenue with the narrative below the table providing additional
explanation.
Three Months Ended June 30, | ||||||||||||||||
Increase | ||||||||||||||||
(Dollars in thousands) | 2011 | 2010 | (Decrease) | Change | ||||||||||||
Revenue: |
||||||||||||||||
Medical Device |
$ | 9,557 | $ | 11,684 | $ | (2,127 | ) | (18 | )% | |||||||
Pharmaceuticals |
4,970 | 3,711 | 1,259 | 34 | % | |||||||||||
In Vitro Diagnostics |
3,440 | 3,213 | 227 | 7 | % | |||||||||||
Total revenue |
$ | 17,967 | $ | 18,608 | $ | (641 | ) | (3 | )% | |||||||
Medical Device. Revenue in Medical Device was $9.6 million in the third quarter of fiscal
2011, a decrease of 18% compared with $11.7 million in the third quarter of fiscal 2010. The
decrease in total revenue reflected primarily lower license fees and royalty revenue. Our third
quarter of fiscal 2010 included $1.3 million in license fee revenue that was one-time in nature. In
addition, we had a $0.7 million decrease in royalty revenue from Cordis Corporation in the third
quarter of fiscal 2011 compared with the prior year period.
As we have noted in previous disclosures, Medical Device has derived a substantial amount of
revenue from royalties and license fees and product sales attributable to Cordis Corporation, a
Johnson & Johnson company, on its CYPHER® Sirolimus-eluting Coronary Stent. The
CYPHER® stent incorporates a proprietary SurModics polymer coating that
delivers a therapeutic drug designed to reduce the occurrence of restenosis in coronary artery
lesions. The CYPHER® stent faces continuing competition from Boston
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Scientific, Medtronic and Abbott Laboratories. In June 2011, Johnson & Johnson announced
the cessation of the manufacture of the CYPHER® and CYPHER
SELECT® Plus stents by the end of 2011.
In July 2011, Cordis Corporation notified the Company of its intention to terminate the exclusivity
arrangements under the license agreement, which will also result in a termination of the minimum royalty requirements beginning in the first quarter of fiscal
2012. For the last several years, royalty revenue and reagent product sales have decreased as a
result of lower CYPHER® stent sales, and we had anticipated that royalty
revenue from CYPHER® stents would continue to decrease slightly in the
remainder of fiscal 2011 until it reached minimum royalty levels per the license agreement with
Cordis Corporation. The decline in CYPHER® stent sales in our fiscal third
quarter resulted in SurModics recognizing minimum royalty income of $1 million for the third
quarter per the terms of our license agreement with Cordis.
Beginning with our first quarter of fiscal 2012, any royalties under the license agreement will be
based on a percentage of CYPHER® sales, if any. We also receive a royalty on
sales of delivery systems used to deliver the Medtronic Endeavor® and
Endeavor®
Resolute drug-eluting stents. These stent delivery systems
incorporate our proprietary hydrophilic technology.
Pharmaceuticals. Pharmaceuticals revenue was $5.0 million in the third quarter of fiscal 2011,
an increase of $1.3 million, or 34%, compared with the third quarter of fiscal 2010. The increase
principally reflected a $1.1 million increase in R&D revenue, as certain existing and new R&D
customers have increased program activity in recent months.
In Vitro Diagnostics. Revenue in In Vitro Diagnostics was $3.4 million in the third quarter of
fiscal 2011, an increase of 7% compared with $3.2 million in the prior-year period. This increase
was attributable to higher sales of our antigen products and microarray slides, partially offset by
lower stabilization sales. All of these items are component in vitro diagnostic products sold to a
number of in vitro diagnostic test kit manufacturers.
Product costs. Product costs were $1.7 million in the third quarter of fiscal 2011, compared
with $2.4 million in the prior-year period. The $0.7 million decrease in product costs principally
reflected the mix of products sold and lower operating costs in the Pharmaceuticals segment.
Overall product margins averaged 71%, compared with 59% reported in the prior-year period.
Customer research and development expenses. Customer R&D expenses were $4.4 million, a
decrease of 6% compared with the third quarter of fiscal 2010. The decrease principally reflected
lower labor and material costs, partially offset by higher overhead costs associated with the
customer programs in our Pharmaceuticals segment. Customer R&D margins were 5%, compared with
negative 33% in the third quarter of fiscal 2010.
Other research and development expenses. Other R&D expenses were $3.5 million for the third
quarter of fiscal 2011, a decrease of 17% compared with the third quarter of fiscal 2010. The
decrease principally reflected $0.5 million in lower labor costs resulting from the March and October
2010 organizational changes, $0.1 million in lower material costs, and $0.1 million in lower
overhead costs, as the Company has reduced the number of currently active internal R&D programs.
Selling, general and administrative expenses. Selling, general and administrative expenses
were $4.9 million for each of the three months ended June 30, 2011 and 2010. While the expenses
were comparable on a quarter-to-quarter basis, fiscal 2011 included higher variable compensation
expenses, which were offset by lower consulting and bad debt expenses.
Asset impairment charges. In the three months ended June 30, 2010, we recognized an impairment
charge of $0.4 million associated with prototypes and other equipment related to a development
project for which no ongoing business was expected in the near term in light of market conditions.
We also reversed $0.2 million of previously recorded asset impairment charges associated with a
facility in Alabama. The facility was presented as an asset held-for-sale and was recorded at fair
value less the cost to sell during the second quarter of fiscal 2010, resulting in an asset
impairment charge of $2.1 million. During the third quarter of fiscal 2010, we re-classified the
facility to held and used property following further analysis of various factors associated with
the consolidation of facilities, which resulted in the property being recorded at its current fair
value, which was $0.2 million higher than the fair value less estimated selling costs at the time
we determined it to be available-for-sale in the second quarter of fiscal 2010 and recorded the
initial asset impairment charge.
Other income (loss), net. Other income was $0.3 million in the third quarter of fiscal 2011,
compared with a loss of $2.0 million in the third quarter of fiscal 2010. Income from investments
was $0.1 million, compared with $0.2 million in the prior-year period, with the decrease reflecting
lower yields on our investment balances. In addition, there were realized gains generated by our
investment portfolio of $0.2 million and $0.3 million in fiscal 2011 and 2010, respectively. The
third quarter of fiscal 2010 loss also reflected an impairment loss on two of our strategic
investments totaling $2.6 million.
Income tax benefit (provision). The income tax provision was a benefit of $0.1 million in the
third quarter of fiscal 2011, compared with an expense of $1.1 million in the third quarter of
fiscal 2010. The tax rate was negative 2.0%, compared with positive 603.3% in the prior-year
period. The reduction in the tax rate for the third quarter of fiscal 2011 was principally driven
by our non-deductible goodwill impairment charge in fiscal 2011, which impacts the projected full
year results used in our tax computation. In the third quarter of fiscal 2010, the tax rate was
impacted by the non-deductible impairment loss on investments, state
income taxes and other permanent items.
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Segment Operating Results
Operating income (loss) for each of our reportable segments was as follows (in thousands):
Three months ended | ||||||||
June 30, | ||||||||
2011 | 2010 | |||||||
Operating Income (Loss) |
||||||||
Medical Device |
$ | 4,516 | $ | 5,814 | ||||
Pharmaceuticals |
(799 | ) | (2,841 | ) | ||||
In Vitro Diagnostics |
1,426 | 1,212 | ||||||
Corporate |
(1,697 | ) | (1,965 | ) | ||||
Total |
$ | 3,446 | $ | 2,220 | ||||
Medical Device. Operating income was $4.5 million in the third quarter of fiscal 2011,
compared with $5.8 million in the third quarter of fiscal 2010. The decreased operating income was
driven by $1.3 million of one-time license fee
revenue recognized in the third quarter of fiscal 2010. Adjusting for this event in
fiscal 2010, operating income was relatively flat, as lower fiscal 2011 revenue was offset by lower
product costs, lower compensation costs resulting from our March and October 2010 reorganizations
and lower development costs.
Pharmaceuticals. Operating loss was $0.8 million in the third quarter of fiscal 2011,
compared with a loss of $2.8 million in the third quarter of fiscal 2010. The decrease in the
operating loss in the fiscal 2011 period was driven primarily by the $1.2 million increase in
revenue, $0.4 million reduction in product costs and $0.8 million reduction in operating expenses,
mostly related to the cGMP facility.
In Vitro Diagnostics. Operating income was $1.4 million in the third quarter of fiscal 2011,
compared with $1.2 million in the third quarter of fiscal 2010. The revenue increase of $0.2
million compared to the prior-year period was the primary contributor to the operating income
increase.
Corporate. Operating loss was $1.7 million in the third quarter of fiscal 2011, compared with
a loss of $2.0 million in the third quarter of fiscal 2010. The third quarter of fiscal 2010
included an asset impairment charge of $0.4 million. The operating loss for the third quarter of
fiscal 2010, adjusted to exclude this charge, was $1.6 million. The minor increase in operating
loss for fiscal 2011 reflected higher variable compensation costs, partially offset by lower
consulting expenses.
Results of Operations Nine Months Ended June 30
Revenue. Revenue for the first nine months of fiscal 2011 was $50.6 million, a decrease of
$3.7 million, or 7%, compared with the first nine months of fiscal 2010. The following table
provides a summary of each operating segments revenue with the narrative below the table providing
additional explanation.
Nine Months Ended June 30, | ||||||||||||||||
Increase | ||||||||||||||||
(Dollars in thousands) | 2011 | 2010 | (Decrease) | Change | ||||||||||||
Revenue: |
||||||||||||||||
Medical Device |
$ | 29,342 | $ | 33,385 | $ | (4,043 | ) | (12 | )% | |||||||
Pharmaceuticals |
11,804 | 12,645 | (841 | ) | (7 | )% | ||||||||||
In Vitro Diagnostics |
9,483 | 8,319 | 1,164 | 14 | % | |||||||||||
Total revenue |
$ | 50,629 | $ | 54,349 | $ | (3,720 | ) | (7 | )% | |||||||
Medical Device. Revenue in Medical Device was $29.3 million in the first nine months of
fiscal 2011, a decrease of 12% compared with $33.4 million in the first nine months of fiscal 2010.
The decrease in total revenue reflected lower royalties and license fees and R&D revenue, partially
offset by higher product sales. Growth in royalty revenue from our hydrophilic coating license
agreements was not strong enough to offset the 40% decrease in royalty revenue from Cordis
Corporation, as a result of the rapid decline in CYPHER® stent sales. Medical
Device R&D revenue decreased 37%, as a certain customer project was completed in the first six
months of fiscal 2011. We have seen increased R&D revenue from a variety of customers in fiscal
2011, however this improvement did not fully offset the impact of one particular R&D program, which
experienced a significant decrease in revenue. R&D revenue, when excluding this one particular
customer, was 5% higher on a nine-month comparison basis.
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Pharmaceuticals. Pharmaceuticals revenue was $11.8 million in the first nine months of fiscal
2011, a decrease of $0.8 million, or 7%, compared with the first nine months of fiscal 2010. The
decrease principally reflected $0.5 million lower product sales, as
well as $0.1 million lower R&D revenue. While the
Pharmaceuticals business unit continues to experience softness in the R&D environment, certain R&D
customers have increased activity in recent months. However, the increased R&D activity from
existing and new customer programs was not sufficient to fully offset the decrease in activity from
a particular customer program.
In Vitro Diagnostics. Revenue in In Vitro Diagnostics was $9.5 million in the first nine
months of fiscal 2011, an increase of 14% compared with $8.3 million in the prior-year period. This
increase was primarily attributable to higher sales of our BioFX branded products and antigen
products.
Product costs. Product costs were $5.8 million in the first nine months of fiscal 2011,
compared with $6.8 million in the prior-year period. The $1.0 million decrease in product costs
principally reflected the mix of products sold and lower product costs in our Pharmaceuticals
segment. Overall product margins averaged 65%, compared with 56% reported last year.
Customer research and development expenses. Customer R&D expenses were $14.1 million, an
increase of 11% compared with the first nine months of fiscal 2010. The increase principally
reflected the fixed overhead costs attributable to our Alabama research and development operations,
including our current cGMP manufacturing facility, which was in
service for seven months of the first nine months in fiscal 2010, as opposed to nine months in fiscal 2011. The increase in
new customer programs has also driven increased costs of validation and maintenance
activities at our cGMP facility. Customer R&D margins were negative 24%, compared with negative 3%
in the first nine months of fiscal 2010.
Other research and development expenses. Other R&D expenses were $8.9 million for the first
nine months of fiscal 2011, a decrease of 34% compared with the first nine months of fiscal 2010.
The decrease reflected $1.8 million in lower labor costs resulting from the March and October
2010 organizational changes and $1.3 million in lower material costs, principally a result of
therapeutic grant income recognized (which was recorded as a reduction of expenses) of
approximately $0.8 million associated with awards received under the federal qualified therapeutic
discovery project program. In addition, the Pharmaceuticals segment does not have ongoing internal
R&D programs in fiscal 2011, while it did incur costs associated with such programs in fiscal 2010.
Selling, general and administrative expenses. Selling, general and administrative expenses
were $15.0 million for the nine months ended June 30, 2011,
an increase of 10% compared with $13.7
million in the prior-year period. The increase was primarily attributable to higher variable
compensation costs of $0.8 million, non-recurring advisory services expenses of approximately $0.5
million related to the 2011 Annual Meeting of Shareholders, and increased costs associated with our
Board of Directors.
Goodwill impairment charge. In the first nine months of fiscal 2011, we recorded a $5.7
million goodwill impairment charge associated with our SurModics Pharmaceuticals, Inc. (SurModics
Pharma) reporting unit. Two milestone events were achieved during fiscal 2011 associated with the
July 2007 acquisition of SurModics Pharma, and $5.7 million of additional purchase price was
recorded as an increase to goodwill in the first quarter of fiscal 2011. During our annual test of
goodwill impairment in the fourth quarter of fiscal 2010, we determined the goodwill related to our
SurModics Pharma reporting unit was fully impaired and we recognized a non-cash goodwill impairment
charge totaling $13.8 million. There had been no substantial changes in operating results for
SurModics Pharma in the first quarter of fiscal 2011 when compared with fiscal 2010, and as such we
concluded the goodwill associated with the milestone events was fully impaired. There may be
additional milestone payments in the future, and if operations do not improve for the SurModics
Pharma reporting unit, there could be additional goodwill impairments associated with these
milestone events.
Restructuring charges. In October 2010, we announced initiatives to reduce our cost structure
and renew our focus on business units to more closely match operations and cost structure with the
current customer environment. As a result of the organization change, we eliminated 30 positions,
or approximately 13% of our workforce. These employee terminations occurred across various
functions, and the reorganization plan was completed by the end of the first quarter of fiscal
2011. The reorganization also resulted in SurModics vacating a leased production facility in
Birmingham, Alabama and relocating the production activities to one of our owned facilities in
Birmingham. The restructuring was expected to result in approximately $3.0 million to $3.5 million
in annualized cost savings.
We recorded total restructuring charges of $1.2 million in the nine months ended June 30,
2011, in connection with the fiscal 2011 reorganization. These pre-tax charges consisted of $1.2
million of severance pay and benefits expenses and less than $0.1 million of facility-related
costs. Payments totaling $1.1 million have been made, and we anticipate paying the remaining $0.1
million within the next six months.
In March 2010, we announced an organizational change designed to support future growth by
better meeting customer needs, leveraging our multiple competencies across the organization, and
building on our pharmaceutical industry experience.
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SurModics recorded total restructuring charges of approximately $1.3 million in the nine
months ended June 30, 2010, in connection with the fiscal 2010 reorganization. These pre-tax
charges consisted of $0.8 million of severance pay and benefits expenses and $0.5 million of
facility-related costs. The Company has paid $1.0 million of the costs, and we anticipate paying
the remaining $0.3 million within the next 30 months.
Asset impairment charge. In the nine months ended June 30, 2010, we recorded a $1.9 million
asset impairment charge associated with one of our facilities in Alabama. We also recognized a $0.4
million asset impairment charge associated with prototypes and other equipment related to a
development project for which no ongoing business was expected in the near term in light of
current market conditions.
Other income (loss), net. Other income (loss) was income of $0.9 million in the first nine
months of fiscal 2011, compared with a loss of $1.5 million in the first nine months of fiscal
2010. The loss in the nine months of fiscal 2010 includes a $2.6 million impairment loss from two
of our strategic investments. Income from investments was $0.5 million, compared with $0.8 million
in the prior-year period. The decrease primarily reflected lower yields on our investment balances.
In addition, we recognized $0.4 million and $0.3 million in realized investment gains in the nine
months of fiscal 2011 and 2010, respectively, within our investment portfolio.
Income
tax provision. The income tax provision was $0.6 million in the first nine months of
fiscal 2011, compared with $2.0 million in the first nine months of fiscal 2010. The effective tax
rate was 79.3%, compared with 77.7% in the prior-year period. The high effective tax rates were
driven by non-deductible goodwill impairment charges in fiscal 2011 and non-deductible investment
impairment losses in fiscal 2010.
Segment Operating Results
Operating income (loss) for each of our reportable segments was as follows (in thousands):
Nine Months Ended | ||||||||
June 30, | ||||||||
2011 | 2010 | |||||||
Operating Income (Loss) |
||||||||
Medical Device |
$ | 14,885 | $ | 15,776 | ||||
Pharmaceuticals |
(12,116 | ) | (8,163 | ) | ||||
In Vitro Diagnostics |
3,323 | 2,572 | ||||||
Corporate |
(6,224 | ) | (6,149 | ) | ||||
Total |
$ | (132 | ) | $ | 4,036 | |||
Medical Device. Operating income was $14.9 million in the first nine months of fiscal 2011,
compared with $15.8 million in the prior-year period. The prior-year period included $1.3 million
in one-time license fee revenue. Adjusting for this event, prior-year period operating income was
$14.5 million. Lower 2011 R&D revenue and royalty income was partially offset by improved product
margins, decreased compensation costs resulting from our March and October 2010 reorganizations,
and decreased R&D expenses as a result of therapeutic grant income (which is recorded as a
reduction of expenses) of approximately $0.8 million associated with awards received under the
federal qualified therapeutic discovery project program.
Pharmaceuticals. Operating loss was $12.1 million for the first nine months of fiscal 2011,
compared with a loss of $8.2 million in the prior-year period. The nine months of fiscal 2011
included goodwill impairment charges of $5.7 million, while the nine months of fiscal 2010 included
asset impairment charges of $1.9 million. The operating loss for the nine months of fiscal 2011 and
2010, adjusted to exclude the previously mentioned items, was $6.5 million and $6.3 million,
respectively. The increase in fiscal 2011 operating losses was driven
by a $0.8 million decrease in
revenue and two additional months of depreciation, as the cGMP facility was in service for seven
months in the fiscal 2010 period, partially offset by lower SG&A costs.
In Vitro Diagnostics. Operating income was $3.3 million in the first nine months of fiscal
2011, compared with $2.6 million in the prior-year period. The increase was driven by $0.8 million
improvement in gross margins in fiscal 2011.
Corporate. Operating loss was $6.2 million in the first nine months of fiscal 2011, compared
with a loss of $6.1 million in the prior-year period. Both periods included restructuring charges
and fiscal 2010 included an asset impairment charge; when these charges are excluded, our adjusted
operating losses were $5.0 million and $4.5 million for fiscal 2011 and 2010, respectively. The
increased operating loss was driven principally by higher variable compensation costs,
non-recurring advisory services expenses related to the 2011 Annual Meeting of Shareholders and
costs associated with transitions on our Board of Directors.
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Liquidity and Capital Resources
Operating Activities. As of June 30, 2011, we had working capital of $43.1 million, of which
$34.3 million consisted of cash, cash equivalents and short-term investments. Working capital
increased $13.3 million from the September 30, 2010 level, driven principally by higher cash and
short-term investment balances and lower accounts payable balances, offset by a decrease in prepaid
and other assets, as the Company received a $2.5 million income tax refund in the nine months ended
June 30, 2011, as well as an increase in accrued compensation and deferred revenue balances. Our
cash and cash equivalents, short-term and long-term investments totaled $63.2 million at June 30,
2011, an increase of $6.4 million from $56.8 million at September 30, 2010. Our investments
principally consist of U.S. government and government agency obligations and investment grade,
interest-bearing corporate debt securities with varying maturity dates, the majority of which are
five years or less. Our policy requires that no more than 5% of investments be held in any one
credit issue, excluding U.S. government and government agency obligations. The primary investment
objective of the portfolio is to provide for the safety of principal and appropriate liquidity
while meeting or exceeding a benchmark (Merrill Lynch 1-3 Year Government-Corporate Index) total
rate of return. Management continues to direct its investment advisors to manage the investments
primarily for the safety of principal for the foreseeable future as it assesses other investment
opportunities and uses of its investments.
We had cash flows from operating activities of approximately $15.0 million in the first nine
months of fiscal 2011, compared with $16.7 million in the first nine months of fiscal 2010. The
decrease compared with prior-year results primarily reflected investment in working capital assets
in fiscal 2011 and the fiscal 2010 receipt of a $3.5 million up-front licensing fee from Genentech
associated with a license and development agreement.
Investing Activities. We invested $3.3 million in property and equipment in the first nine
months of fiscal 2011, compared with $7.2 million in the prior-year period. The lower property and
equipment investment in fiscal 2011 reflected a return to more historical investment levels. Fiscal
2010 investment reflected higher spending associated with the final phase of completion of the
Birmingham, Alabama cGMP facility. In addition, fiscal 2011 included $5.7 million in milestone
payments, while fiscal 2010 included a $0.8 million milestone payment, both associated with the
SurModics Pharma acquisition in July 2007.
Financing Activities. In November 2007, our Board of Directors authorized the repurchase of
$35.0 million of the Companys common stock in open-market transactions, private transactions,
tender offers, or other transactions. The repurchase authorization does not have a fixed expiration
date. No shares were repurchased during the nine months ended June 30, 2011, while the Company
repurchased $2.0 million in the first nine months of fiscal 2010. Under the current authorization,
we have $5.3 million remaining available for share repurchases at June 30, 2011.
As of June 30, 2011, the Company had no debt outstanding under our $15 million unsecured
revolving credit facility and was in compliance with all covenants.
We do not have any other credit agreements and believe that our existing cash, cash
equivalents and investments, together with cash flow from operations, will provide liquidity
sufficient to meet the below stated needs and fund our operations for the next twelve months. There
can be no assurance, however, that SurModics business will continue to generate cash flows at
current levels, and disruptions in financial markets may negatively impact our ability to access
capital in a timely manner and on attractive terms, if at all. Our anticipated liquidity needs for
the remainder of fiscal 2011 include, but are not limited to, the following: general capital
expenditures in the range of $0.5 million to $1.0 million; potential contingent consideration
payments of up to $5.9 million based on achievement of certain business objectives, related to our
acquisition of SurModics Pharma, as well as the purchase of certain assets from PR Pharmaceuticals,
Inc.; and any amounts associated with the repurchase of common stock under the authorization
discussed above. While the contingent consideration timing and amounts are uncertain, we anticipate
the amounts could be paid through fiscal 2012.
Customer Concentrations. Our licensed technologies provide royalty revenue to SurModics, which
represents the largest revenue stream to the Company. We have licenses with a diverse base of
customers and certain customers have multiple products using our technology. There has been a
decline in royalty revenue from our largest customer, Cordis Corporation, a Johnson & Johnson
company, and with their June 2011 announcement of the cessation of the manufacture of the
CYPHER® and CYPHER SELECT® Plus stents by the end of 2011,
our royalty stream from this customer reached the contractual $1
million minimum level per the agreement in the third
quarter of fiscal 2011. We expect the royalty to be at the minimum
level in the fourth quarter, and
thereafter we expect an earned royalty amount which is below the minimum level, until the
products are no longer sold. No other individual customer product using licensed technology
constitutes more than 5% of SurModics total revenue. Further, our licensing agreements with many
of our customers, including our significant customers, cover many licensed products that each
separately generate royalty revenue. This situation reduces the potential risk to our operations
that may result from reduced sales (or the termination of a license) of a single product for any
specific customer.
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Off-Balance Sheet Arrangements
As of June 30, 2011, the Company did not have any off-balance sheet arrangements with any
unconsolidated entities.
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Forward-Looking Statements
This Quarterly Report on Form 10-Q, including Managements Discussion and Analysis of
Financial Condition and Results of Operations in Item 2, contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995. These statements
include expectations concerning our growth strategy, product development programs, future cash flow
and sources of funding, short-term liquidity requirements, the impact of potential lawsuits or
claims, and the impact of the Cordis and Genentech agreements, as well as other significant
customer agreements. Without limiting the foregoing, words or phrases such as anticipate,
believe, could, estimate, expect, forecast, intend, may, plan, possible,
project, will and similar terminology, generally identify forward-looking statements.
Forward-looking statements may also represent challenging goals for us. These statements, which
represent the Companys expectations or beliefs concerning various future events, are based on
current expectations that involve a number of risks and uncertainties that could cause actual
results to differ materially from those of such forward-looking statements. We caution that undue
reliance should not be placed on such forward-looking statements, which speak only as of the date
made. Some of the factors which could cause results to differ from those expressed in any
forward-looking statement are set forth under Part II, Item 1A of this Form 10-Q. We disclaim any
intent or obligation to update publicly these forward-looking statements, whether because of new
information, future events or otherwise.
Although it is not possible to create a comprehensive list of all factors that may cause
actual results to differ from the Companys forward-looking statements, such factors include, among
others:
| our ability to successfully identify, negotiate, sign and close a potential strategic transaction related to our Pharmaceutical business; |
| the inability to realize the anticipated benefits of any potential transaction regarding our Pharmaceuticals business, if consummated, or of our other recent cost savings initiatives; |
| the potential adverse impact to our business as a result of our announcement to pursue strategic alternatives for our Pharmaceuticals business; |
| the Companys reliance on a small number of significant customers, which causes our financial results and stock price to be subject to factors affecting those significant customers and their products, the timing of market introduction of their or competing products, product safety or efficacy concerns and intellectual property litigation could adversely affect our growth strategy and the royalty revenue we derive; |
| general economic conditions which are beyond our control, including the impact of recession, business investment and changes in consumer confidence; |
| the Companys change in its organizational structure may not increase the number of market segments and applications that use its technologies; |
| a decrease in the Companys available cash or the value of its investment holdings could impact short-term liquidity requirements; |
| the difficulties and uncertainties associated with the lengthy and costly new product development and foreign and domestic regulatory approval processes, such as delays, difficulties or failures in achieving acceptable clinical results or obtaining foreign or FDA marketing clearances or approvals, which may result in lost market opportunities or postpone or preclude product commercialization by licensees; |
| the development of new products or technologies by competitors, technological obsolescence and other changes in competitive factors; |
| the Companys ability to successfully internally perform certain product development activities and governmental and regulatory compliance activities which the Company has not previously undertaken in any significant manner; and |
| other factors described below in Risk Factors and other sections of SurModics Annual Report on Form 10-K, which you are encouraged to read carefully. |
Many of these factors are outside the control and knowledge of the Company, and could result
in increased volatility in period-to-period results. Investors are advised not to place undue
reliance upon the Companys forward-looking statements and to consult any further disclosures by
the Company on this subject in its filings with the Securities and Exchange Commission.
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Use of Non-GAAP Financial Information.
In addition to disclosing financial results in accordance with generally accepted accounting
principles, or GAAP, this report includes certain non-GAAP financial results including non-GAAP
operating income (or loss). The Company believes that the use of non-GAAP measures provide
meaningful insight into our operating performance excluding, for example, certain event-specific
charges (including the restructuring charges incurred in connection with our March 2010 and October
2010 organizational changes, the non-recurring advisory service expense incurred in connection with
our 2011 Annual Meeting of Shareholders, and certain asset and goodwill impairment charges), and
provide an alternative perspective of the Companys results of operations. The Company uses
non-GAAP measures, including certain of those set forth in this report, to assess our operating performance
and to determine payout under our executive compensation programs. We believe that presentation of
certain non-GAAP measures allows investors to review our results of operations from the same
perspective as management and our board of directors. We believe certain non-GAAP measures
facilitate investors analysis and comparisons of our current results of operations and provide
insight into the prospects of our future performance. We also believe that certain non-GAAP
measures are useful to investors because they provide supplemental information that research
analysts frequently use. The method we use to produce non-GAAP results is not in accordance with
GAAP and may differ from the methods used by other companies. Non-GAAP results should not be
regarded as a substitute for corresponding GAAP measures but instead should be utilized as a
supplemental measure of operating performance in evaluating our business. Non-GAAP measures do
have limitations in that they do not reflect certain items that may have a material impact upon our
reported financial results. As such, these non-GAAP measures presented should be viewed in
conjunction with our financial statements prepared in accordance with GAAP.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Companys investment policy requires the Company to invest in high credit issuers
and limits the amount of credit exposure to any one issuer. The Companys investments principally
consist of U.S. government and government agency obligations and investment-grade, interest-bearing
corporate debt securities with varying maturity dates, the majority of which are five years or
less. Because of the credit criteria of the Companys investment policies, the primary market risk
associated with these investments is interest rate risk. The Company does not use derivative
financial instruments to manage interest rate risk or to speculate on future changes in interest
rates. A one percentage point increase in interest rates would result in an approximate $0.7
million decrease in the fair value of the Companys available-for-sale and held-to-maturity
securities as of June 30, 2011, but no material impact on the results of operations or cash flows.
Management believes that a reasonable change in raw material prices would not have a material
impact on future earnings or cash flows because the Companys inventory exposure is not material.
Although we conduct business in foreign countries, all sales transactions are denominated in
U.S. dollars. Accordingly, we do not expect to be subject to material foreign currency risk with
respect to future costs or cash flows from our foreign sales. To date, we have not entered into any
foreign currency forward exchange contracts or other derivative financial instruments to hedge the
effects of adverse fluctuations in foreign currency exchange.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, the Company conducted an evaluation under
the supervision and with the participation of the Companys management, including the Companys
Chief Executive Officer and Chief Financial Officer regarding the effectiveness of the design and
operation of the Companys disclosure controls and procedures pursuant to Rule 13a-15(b) of the
Securities Exchange Act of 1934 (the Exchange Act). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and
procedures are effective to ensure that information required to be disclosed by the Company in
reports that it files under the Exchange Act is recorded, processed, summarized and reported within
the time period specified in the Securities Exchange Commission rules and forms, and to ensure that
information required to be disclosed by the Company in the reports the Company files or submits
under the Exchange Act is accumulated and communicated to the Companys management, including its
principal executive and principal financial officers, as appropriate, to allow timely decisions
regarding required disclosures.
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Changes in Internal Controls
There was no change in the Companys internal control over financial reporting that occurred
during the period covered by this report that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting.
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Table of Contents
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
There have been no material developments in the legal proceedings previously disclosed in the
Companys Form 10-K for the fiscal year ended September 30, 2010.
Item 1A. Risk Factors.
In our report on Form 10-K for the fiscal year ended September 30, 2010, filed with the
Securities and Exchange Commission on December 14, 2010, we identify under Item 1A important
factors which could affect our financial performance and could cause our actual results for future
periods to differ materially from our anticipated results or other expectations, including those
expressed in any forward-looking statements made in this Form 10-Q.
There have been no material change in our risk factors subsequent to the filing of our Form
10-K for the fiscal year ended September 30, 2010.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. (Removed and Reserved).
Item 5. Other Information.
None.
Item 6. Exhibits.
Exhibit | Description | |
3.1
|
Restated Articles of Incorporation, as amended incorporated by reference to Exhibit 3.1 of the Companys Quarterly Report on Form 10-QSB for the quarter ended December 31, 1999, SEC File No. 0-23837 | |
3.2
|
Restated Bylaws of SurModics, Inc., as amended November 30, 2009 Incorporated by reference to Exhibit 3.2 of the Companys Quarterly Report on Form 10-Q for the quarter ended December 31, 2009, SEC File No. 0-23837 | |
31.1*
|
Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 | |
31.2*
|
Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 | |
32.1*
|
Certification of Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002 | |
32.2*
|
Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002 | |
101*
|
Financial statements from the Quarterly Report on Form 10-Q for Surmodics, Inc. for the quarterly period ended June 30, 2011, filed on August 8, 2011, formatted in Extensible Business Reporting Language (XBRL): (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements. |
* | Filed herewith |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
August 8, 2011 | SurModics, Inc. |
|||
By: | /s/ Philip D. Ankeny | |||
Philip D. Ankeny | ||||
Senior Vice President and Chief Financial Officer (duly authorized signatory and principal financial officer) |
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Table of Contents
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
EXHIBIT INDEX TO FORM 10-Q
For the Quarter Ended June 30, 2011
SURMODICS, INC.
WASHINGTON, D.C. 20549
EXHIBIT INDEX TO FORM 10-Q
For the Quarter Ended June 30, 2011
SURMODICS, INC.
Exhibit | Description | |
3.1
|
Restated Articles of Incorporation, as amended incorporated by reference to Exhibit 3.1 of the Companys Quarterly Report on Form 10-QSB for the quarter ended December 31, 1999, SEC File No. 0-23837 | |
3.2
|
Restated Bylaws of SurModics, Inc., as amended November 30, 2009 incorporated by reference to Exhibit 3.2 of the Companys Quarterly Report on Form 10-Q for the quarter ended December 31, 2009, SEC File No. 0-23837 | |
31.1*
|
Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 | |
31.2*
|
Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 | |
32.1*
|
Certification of Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002 | |
32.2*
|
Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002 | |
101. INS*
|
XBRL Instance Document** | |
101.SCH*
|
XBRL Taxonomy Extension Schema Document** | |
101.CAL*
|
XBRL Taxonomy Calculation Linkbase Document** | |
101.LAB*
|
XBRL Taxonomy Extension Label Linkbase Document** | |
101.PRE*
|
XBRL Taxonomy Extension Presentation Linkbase Document** |
* | Filed herewith | |
** | XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these Sections. |
32