0001564590-16-021781.txt : 20160729 0001564590-16-021781.hdr.sgml : 20160729 20160729154743 ACCESSION NUMBER: 0001564590-16-021781 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 84 CONFORMED PERIOD OF REPORT: 20160630 FILED AS OF DATE: 20160729 DATE AS OF CHANGE: 20160729 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SURMODICS INC CENTRAL INDEX KEY: 0000924717 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 411356149 STATE OF INCORPORATION: MN FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-23837 FILM NUMBER: 161794019 BUSINESS ADDRESS: STREET 1: 9924 W 74TH ST CITY: EDEN PRAIRIE STATE: MN ZIP: 55344 BUSINESS PHONE: 9525007000 MAIL ADDRESS: STREET 1: 9924 WEST 74TH ST CITY: EDEN PRAIRIE STATE: MN ZIP: 55344 FORMER COMPANY: FORMER CONFORMED NAME: BSI CORP DATE OF NAME CHANGE: 19970506 10-Q 1 srdx-10q_20160630.htm SRDX-Q3-20160630 srdx-10q_20160630.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-Q

 

(Mark One)

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

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)

Registrant’s 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  x    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  x    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 filer

o

 

Accelerated filer

x

Non-accelerated filer

o

(Do not check if a smaller reporting company)

Smaller reporting company

o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x

The number of shares of the registrant’s Common Stock, $.05 par value per share, outstanding as of July 22, 2016 was 13,045,714.

 

 

 

 

 

 


 

TABLE OF CONTENTS

 

PART I.   FINANCIAL INFORMATION

 

 

Item 1.

Financial Statements

 

3

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

23

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

33

Item 4.

Controls and Procedures

 

33

 

 

 

 

PART II.   OTHER INFORMATION

 

 

Item 1.

Legal Proceedings

 

35

Item 1A.

Risk Factors

 

35

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

35

Item 3.

Defaults Upon Senior Securities

 

36

Item 4.

Mine Safety Disclosures

 

36

Item 5.

Other Information

 

36

Item 6.

Exhibits

 

36

 

 

 

SIGNATURES

 

 

 

EX-3.1

 

 

EX-10.1

EX-10.2

EX-10.3

 

 

EX-12

 

 

EX-31.1

 

 

EX-31.2

 

 

EX-32.1

 

 

EX-32.2

 

 

EX-101 INSTANCE DOCUMENT

 

 

EX-101 SCHEMA DOCUMENT

 

 

EX-101 CALCULATION LINKBASE DOCUMENT

 

 

EX-101 DEFINITION LINKBASE DOCUMENT

 

 

EX-101 LABEL LINKBASE DOCUMENT

 

 

EX-101 PRESENTATION LINKBASE DOCUMENT

 

 

 

2


 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Surmodics, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

 

 

June 30,

 

 

September 30,

 

 

 

2016

 

 

2015

 

(in thousands, except share and per share data)

 

(Unaudited)

 

ASSETS

 

 

 

 

 

 

 

 

Current Assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

34,656

 

 

$

55,588

 

Available-for-sale securities

 

 

9,523

 

 

 

 

Accounts receivable, net of allowance for doubtful accounts of $19 and $10 as of

   June 30, 2016 and September 30, 2015, respectively

 

 

5,859

 

 

 

7,478

 

Inventories

 

 

3,345

 

 

 

2,979

 

Deferred tax assets

 

 

 

 

 

546

 

Prepaids and other

 

 

686

 

 

 

1,198

 

Total Current Assets

 

 

54,069

 

 

 

67,789

 

Property and equipment, net

 

 

17,183

 

 

 

12,968

 

Deferred tax assets

 

 

5,555

 

 

 

6,704

 

Intangible assets, net

 

 

22,889

 

 

 

2,760

 

Goodwill

 

 

26,544

 

 

 

8,010

 

Other assets, net

 

 

674

 

 

 

479

 

Total Assets

 

$

126,914

 

 

$

98,710

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

1,547

 

 

$

781

 

Accrued liabilities:

 

 

 

 

 

 

 

 

Compensation

 

 

3,020

 

 

 

2,772

 

Due to customers

 

 

1,741

 

 

 

63

 

Accrued other

 

 

1,493

 

 

 

731

 

Business combination consideration payable

 

 

 

 

 

305

 

Deferred revenue

 

 

268

 

 

 

48

 

Total Current Liabilities

 

 

8,069

 

 

 

4,700

 

Contingent consideration

 

 

13,950

 

 

 

 

Deferred revenue, less current portion

 

 

192

 

 

 

217

 

Other long-term liabilities

 

 

1,897

 

 

 

1,920

 

Total Liabilities

 

 

24,108

 

 

 

6,837

 

Commitments and Contingencies (Note 16)

 

 

 

 

 

 

 

 

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; 13,040,978 and

   12,945,157 shares issued and outstanding, respectively

 

 

652

 

 

 

647

 

Additional paid-in capital

 

 

5,764

 

 

 

3,060

 

Accumulated other comprehensive income

 

 

888

 

 

 

5

 

Retained earnings

 

 

95,502

 

 

 

88,161

 

Total Stockholders’ Equity

 

 

102,806

 

 

 

91,873

 

Total Liabilities and Stockholders’ Equity

 

$

126,914

 

 

$

98,710

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

3


 

Surmodics, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

June 30,

 

 

June 30,

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

(In thousands, except per share data)

 

(Unaudited)

 

(Unaudited)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Royalties and license fees

 

$

10,556

 

 

$

7,908

 

 

$

25,207

 

 

$

22,566

 

Product sales

 

 

7,512

 

 

 

6,583

 

 

 

22,866

 

 

 

18,082

 

Research, development and other

 

 

1,904

 

 

 

1,423

 

 

 

5,139

 

 

 

3,887

 

Total revenue

 

 

19,972

 

 

 

15,914

 

 

 

53,212

 

 

 

44,535

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product costs

 

 

2,777

 

 

 

2,174

 

 

 

8,069

 

 

 

6,031

 

Research and development

 

 

4,693

 

 

 

3,860

 

 

 

13,195

 

 

 

11,839

 

Selling, general and administrative

 

 

4,483

 

 

 

3,872

 

 

 

12,984

 

 

 

11,387

 

Acquisition transaction, integration and other costs

 

 

61

 

 

 

 

 

 

3,192

 

 

 

 

Acquisition related intangible asset amortization

 

 

806

 

 

 

151

 

 

 

1,940

 

 

 

454

 

Contingent consideration accretion expense

 

 

555

 

 

 

 

 

 

1,056

 

 

 

 

Total operating costs and expenses

 

 

13,375

 

 

 

10,057

 

 

 

40,436

 

 

 

29,711

 

Operating income

 

 

6,597

 

 

 

5,857

 

 

 

12,776

 

 

 

14,824

 

Other income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment income, net

 

 

19

 

 

 

36

 

 

 

37

 

 

 

149

 

Gain on strategic investments

 

 

16

 

 

 

 

 

 

377

 

 

 

 

 

Foreign exchange gain (loss)

 

 

234

 

 

 

 

 

 

(336

)

 

 

 

Other (loss) income, net

 

 

(6

)

 

 

(40

)

 

 

(6

)

 

 

496

 

Other income (loss) , net

 

 

263

 

 

 

(4

)

 

 

72

 

 

 

645

 

Income before income taxes

 

 

6,860

 

 

 

5,853

 

 

 

12,848

 

 

 

15,469

 

Income tax provision

 

 

(2,857

)

 

 

(1,929

)

 

 

(5,507

)

 

 

(4,879

)

Net income

 

$

4,003

 

 

$

3,924

 

 

$

7,341

 

 

$

10,590

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic net income per share

 

$

0.31

 

 

$

0.30

 

 

$

0.57

 

 

$

0.81

 

Diluted net income per share

 

$

0.30

 

 

$

0.30

 

 

$

0.56

 

 

$

0.79

 

Weighted average number of shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

12,995

 

 

 

13,002

 

 

 

12,969

 

 

 

13,057

 

Diluted

 

 

13,284

 

 

 

13,279

 

 

 

13,203

 

 

 

13,324

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

4


 

Surmodics, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

June 30,

 

 

June 30,

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

(In thousands)

 

(Unaudited)

 

 

(Unaudited)

 

Net income

 

$

4,003

 

 

$

3,924

 

 

$

7,341

 

 

$

10,590

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding losses on available-for-sale securities

  arising during the period

 

 

(34

)

 

 

(59

)

 

 

(36

)

 

 

(1,216

)

Reclassification adjustment for realized gains included in net

   income

 

 

 

 

 

26

 

 

 

 

 

 

(315

)

Foreign currency translation adjustments

 

 

(809

)

 

 

 

 

 

919

 

 

 

 

Other comprehensive (loss) income

 

 

(843

)

 

 

(33

)

 

 

883

 

 

 

(1,531

)

Comprehensive income

 

$

3,160

 

 

$

3,891

 

 

$

8,224

 

 

$

9,059

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

5


 

Surmodics, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

 

 

 

Nine Months Ended

 

 

 

June 30,

 

 

 

2016

 

 

2015

 

(in thousands)

 

(Unaudited)

 

Operating Activities:

 

 

 

 

 

 

 

 

Net income

 

$

7,341

 

 

$

10,590

 

Adjustments to reconcile net income to net cash provided by operating activities from continuing

   operations:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

3,703

 

 

 

2,083

 

Stock-based compensation

 

 

2,729

 

 

 

1,841

 

Contingent consideration expense and unrealized foreign exchange loss

 

 

1,369

 

 

 

 

Deferred taxes

 

 

(114

)

 

 

450

 

Gain on sales of available-for-sale securities and strategic investments

 

 

(377

)

 

 

(496

)

Excess tax benefit from stock-based compensation plans

 

 

(67

)

 

 

(436

)

Other

 

 

(15

)

 

 

(42

)

Change in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

1,999

 

 

 

(1,244

)

Inventories

 

 

(112

)

 

 

(647

)

Prepaids and other

 

 

45

 

 

 

66

 

Accounts payable and accrued liabilities

 

 

746

 

 

 

132

 

Income taxes

 

 

1,253

 

 

 

(221

)

Net cash provided by operating activities from continuing operations

 

 

18,500

 

 

 

12,076

 

Investing Activities:

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(4,869

)

 

 

(396

)

Cash proceeds from sales of property and equipment

 

 

15

 

 

 

42

 

Payments for acquisitions, net of cash acquired

 

 

(25,054

)

 

 

 

Purchases of available-for-sale securities

 

 

(9,562

)

 

 

(3,377

)

Sales and maturities of available-for-sale securities

 

 

 

 

 

22,199

 

Cash received from sale of strategic investments

 

 

377

 

 

 

21

 

Cash transferred to discontinued operations

 

 

 

 

 

(45

)

Net cash (used in) provided by investing activities from continuing operations

 

 

(39,093

)

 

 

18,444

 

Financing Activities:

 

 

 

 

 

 

 

 

Excess tax benefit from stock-based compensation plans

 

 

67

 

 

 

436

 

Issuance of common stock

 

 

284

 

 

 

451

 

Repurchase of common stock

 

 

 

 

 

(20,000

)

Purchase of common stock to pay employee taxes

 

 

(371

)

 

 

(810

)

Payment of contingent consideration

 

 

(305

)

 

 

 

Net cash used in financing activities from continuing operations

 

 

(325

)

 

 

(19,923

)

Net cash (used in) provided by continuing operations

 

 

(20,918

)

 

 

10,597

 

Discontinued Operations:

 

 

 

 

 

 

 

 

Net cash used in operating activities

 

 

 

 

 

(45

)

Net cash provided by financing activities

 

 

 

 

 

45

 

Net cash provided by discontinued operations

 

 

 

 

 

 

                  Effect of exchange rate changes on cash

 

 

(14

)

 

 

 

Net change in cash and cash equivalents

 

 

(20,932

)

 

 

10,597

 

Cash and Cash Equivalents:

 

 

 

 

 

 

 

 

Beginning of period

 

 

55,588

 

 

 

43,511

 

End of period

 

$

34,656

 

 

$

54,108

 

Supplemental Information:

 

 

 

 

 

 

 

 

Cash paid for income taxes

 

$

4,313

 

 

$

4,651

 

Noncash transactions from investing and financing activities:

 

 

 

 

 

 

 

 

Acquisition of property and equipment on account

 

$

133

 

 

$

113

 

Contingent consideration and debt assumed in acquisitions

 

$

13,597

 

 

$

 

Issuance of performance shares, restricted and deferred stock units

 

$

1,390

 

 

$

2,250

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

6


 

Surmodics, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

Period Ended June 30, 2016

(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 (“U.S.”) (“GAAP”) and, in the opinion of management, reflect all adjustments, consisting of normal recurring adjustments, needed to fairly present the financial results of Surmodics, Inc. and subsidiaries (“Surmodics” or the “Company”) for the periods presented. The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The results of operations for the three and nine months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the entire 2016 fiscal year.

In accordance with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”), the Company has omitted footnote disclosures that would substantially duplicate the disclosures contained in the audited consolidated financial statements of the Company. These unaudited condensed consolidated financial statements should be read together with the audited consolidated financial statements for the fiscal year ended September 30, 2015, and footnotes thereto included in the Company’s Form 10-K as filed with the SEC on December 4, 2015, and as amended on May 10, 2016.

On July 11, 2016, we amended our articles of incorporation to change our name from SurModics, Inc., to Surmodics, Inc., which change became effective immediately. The name change was effected by our board of directors.

During the nine months ended June 30, 2016 the Company recorded an out-of-period adjustment of $1.1 million in the second quarter of fiscal 2016 to correct an estimated cumulative overstatement of royalty revenue with a customer, of which $1.0 million related to years prior to fiscal 2016. The overstatement was evaluated and concluded to not be material to fiscal 2016, the nine- months ended June 30, 2016, or any prior periods. During the quarter ended June 30, 2016, the Company entered into a settlement agreement with this customer and agreed to pay the customer a total of $1.4 million to settle this matter.  The additional obligation amount settled was considered to be a change in estimate and was recorded as a reduction of royalty revenue during the quarter ended June 30, 2016.  The total settlement amount of $1.4 million was included in the Due to Customer liability on the consolidated balance sheet at June 30, 2016 and was paid in July 2016.

 On April 29, 2016, a customer reported $2.9 million,  of royalties was owed to the Company for the period from fiscal 2009 through fiscal 2016. Payment of this amount was received and royalty revenue was recognized in the third quarter of fiscal 2016, when collectability was reasonably assured and completion of the earnings process occurred, consistent with the Company’s revenue recognition policy.

 

 

2. New Accounting Pronouncements

Accounting Standards to be Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) Update No. 2014-09, Revenue from Contracts with Customers (ASC Topic 606).  Principles of this guidance require entities to recognize revenue in a manner that depicts the transfer of goods or services to customers in amounts that reflect the consideration an entity expects to be entitled to in exchange for those goods or services. The guidance also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This accounting standard will be effective for the Company beginning in the first quarter of fiscal year 2019 (October 1, 2018) using one of two prescribed retrospective methods. The Company is currently evaluating the impact that the adoption of this standard will have on the Company’s results of operations, cash flows and financial position.

In February 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-02, Leases (ASC Topic 842).  The new guidance primarily affects lessee accounting, while accounting by lessors will not be significantly impacted by the update.  The update maintains two classifications of leases: finance leases, which replace capital leases, and operating leases. Lessees will need to recognize a right-of-use asset and a lease liability on the statement of financial position for those leases previously classified as operating leases under the old guidance. The liability will be equal to the present value of lease payments.  The asset will be based on the liability, subject to adjustment, such as for direct costs. The accounting standard will be effective for the Company beginning the

7


 

first quarter of fiscal year 2020 (October 1, 2019) using a modified retrospective approach. The Company is currently evaluating the impact that the adoption of this standard will have on the Company’s results of operations, cash flows and financial position.

In March 2016, the FASB issued ASU No 2016-09, Compensation – Stock Compensation (ASC Topic 718): Improvements to Employee Share-Based Payment Accounting. The accounting standard intends to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The accounting standard will be effective for the Company beginning in the first quarter of fiscal 2018 (October 1, 2017), and early adoption is permitted. We currently are evaluating the impact that the adoption of this standard will have on the Company’s results of operations, cash flows and financial position.

In June 2016, the FASB issued ASU No 2016-13, Financial Instruments – Credit Losses (ASU Topic 326), Measurement of Credit Losses on Financial Statements. This ASU requires a financial asset (or a group of financial assets) measured at an amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The accounting standard will be effective for the Company beginning in the first quarter of fiscal 2020 (October 1, 2019), and early adoption is permitted. We currently are evaluating the impact that the adoption of this standard will have on the Company’s results of operations, cash flows and financial position.

Accounting Standards Adopted

In September 2015, the FASB issued ASU 2015-16, Business Combinations (ASC Topic 805): Simplifying the Accounting for Measurement-Period Adjustments.  The update requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, including the cumulative effect of the change in provisional amounts as if the accounting had been completed at the acquisition date. The adjustments related to previous reporting periods since the acquisition date must be disclosed by income statement line item either on the face of the income statement or in the notes. The accounting standard is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years, with early adoption permitted.  The Company adopted this accounting standard in the first quarter of fiscal 2016 without any material impact on the Company’s financial position or financial results.

In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes, which eliminates the current requirement to present deferred tax liabilities and assets as current and noncurrent in a classified balance sheet. Instead, entities will be required to classify all deferred tax assets and liabilities as noncurrent. This accounting standard is effective for the Company beginning in its first quarter of fiscal year 2018 and early implementation is permitted using either the prospectively or retroactive adoption method. The Company prospectively adopted this accounting standard in the first quarter of fiscal 2016.

No other new accounting pronouncement issued or effective has had, or is expected to have, a material impact on the Company’s consolidated financial statements.

 

 

3. Business Combinations

For all business combinations, the Company records all assets and liabilities of the acquired business, including goodwill and other identified intangible assets, generally at their fair values starting in the period when the acquisition is completed. Contingent consideration, if any, is recognized at its fair value on the acquisition date and changes in fair value are recognized in earnings until settlement. Acquisition-related transaction costs are expensed as incurred.

Creagh Medical Ltd.

On November 20, 2015, the Company acquired 100% of the outstanding common shares and voting shares of Creagh Medical Ltd. (“Creagh Medical”) located in Ballinasloe, Ireland. The results of Creagh Medical’s operations have been included in the Company’s condensed consolidated financial statements as of the Creagh Medical acquisition date. The acquisition was financed with cash on hand. The Company acquired Creagh Medical for up to €30 million (approximately $32 million as of the acquisition date), including an upfront payment of €18 million (approximately $19.3 million as of the acquisition date), and up to €12 million (approximately $12.8 million as of the acquisition date) based on achievement of revenue and value-creating operational milestones through September 30, 2018. The payment of the milestones if met will occur in the quarter ending December 31, 2018. As of June 30, 2016, the Company had paid $18.4 million in cash for this acquisition, in addition to $0.8 million to an escrow account to fund the repurchase of certain Creagh Medical debt classified securities during fiscal 2016. As these securities were not initially legally defeased by the establishment of the escrow fund, the Company recorded a corresponding restricted cash and business combination consideration payable in prior periods.  These securities were repaid in the third quarter of fiscal 2016. The Company also assumed

8


 

$0.8 million of debt that was repaid in the second quarter of fiscal 2016. Total transaction, integration and other costs associated with the Creagh Medical acquisition aggregated less than $0.1 million and $2.7 million for the three and nine months ended June 30, 2016, respectively. Creagh Medical is included in the Company’s Medical Device reporting segment.

Creagh Medical designs and manufactures high-quality percutaneous transluminal angioplasty (“PTA”) balloon catheters. Since 2006, Creagh Medical has grown its technical and product capability with PTA products approved throughout the world, including Europe, the United States, and Japan. With these resources, the Company is uniquely positioned to offer a total solutions approach from product design and development, through in-house extrusion, balloon forming, top-assembly, packaging and regulatory capabilities to approved products for exclusive distribution. The acquisition is a major step forward in the Company’s strategy to transform its Medical Device segment from being a provider of coatings technologies to offering whole-product solutions to medical device customers in the large and growing global interventional vascular market.

The purchase price of Creagh Medical consisted of the following:

 

(Dollars in thousands)

 

 

 

 

Cash paid

 

$

18,417

 

Debt assumed

 

 

793

 

Contingent consideration

 

 

9,064

 

Total purchase price

 

 

28,274

 

Less cash and cash equivalents acquired

 

 

(251

)

Total purchase price, net of cash acquired

 

$

28,023

 

 

The following table summarizes the preliminary allocation of the purchase price to the fair values assigned to the assets acquired and the liabilities assumed at the date of the Creagh Medical acquisition:

 

 

 

Fair Value

(Dollars in thousands)

 

Estimated Useful Life

(In years)

Current assets

 

$

708

 

N/A

Property and equipment

 

 

634

 

1.0-10.0

Trade name

 

 

75

 

N/A

Developed technology

 

 

1,787

 

7.0

In-process research and development

 

 

942

 

N/A

Customer relationships

 

 

11,119

 

7.0-10.0

Other noncurrent assets

 

 

81

 

N/A

Current liabilities

 

 

(923

)

N/A

Deferred tax liabilities

 

 

(9

)

N/A

Net assets acquired

 

 

14,414

 

 

Goodwill

 

 

13,609

 

N/A

Total purchase price, net of cash acquired

 

$

28,023

 

 

 

The Creagh Medical goodwill is a result of acquiring and retaining the Creagh Medical existing workforce and expected synergies from integrating their business into Surmodics. The goodwill will not be deductible for tax purposes. Purchase accounting is considered preliminary, subject to revision, mainly with respect to working capital, income taxes and goodwill, as final information was not available as of June 30, 2016.

As a result of the Creagh Medical acquisition, the Company has adopted a foreign currency translation policy. Assets and liabilities of non-U.S. dollar functional currency subsidiaries are translated into U.S. dollars at the period-end exchange rates, and revenues and expenses are translated at the average exchange rate for the period. The net effect of these translation adjustments in the condensed consolidated financial statements are recorded as a foreign currency translation adjustment, as a component of accumulated other comprehensive income. Foreign currency transaction gains and losses are included in other, income (loss) net in our Condensed Consolidated Statements of Income.

NorMedix, Inc.

On January 8, 2016, the Company acquired 100% of the shares of NorMedix, Inc. (“NorMedix”), a privately owned design and development company focused on ultra thin-walled, minimally invasive catheter technologies based in Plymouth, Minnesota. The acquisition was financed with cash on hand. The Company acquired NorMedix for $14.0 million, including an upfront payment of

9


 

$6.9 million, and up to $7.0 million based on achievement of revenue and value-creating operational milestones through September 30, 2019. Contingent consideration associated with the NorMedix transaction is payable as earned. This acquisition strengthens the Company’s vascular device expertise and Research and Development (“R&D) capabilities. This acquisition positions the Company to make significant progress on its strategy to offer whole-product solutions to medical device customers, while continuing its commitment to consistently deliver innovation in coating technologies and in vitro diagnostics. Total transaction, integration and other costs associated with the NorMedix acquisition aggregated $0.0 million and $0.3 million for the three and nine months, respectively, ended June 30, 2016. NorMedix is included in the Company’s Medical Device reporting segment.  

The purchase price of NorMedix consisted of the following:

 

(Dollars in thousands)

 

 

 

 

Cash paid

 

$

6,905

 

Contingent consideration

 

 

3,740

 

Total purchase price

 

 

10,645

 

Less cash and cash equivalents acquired

 

 

(17

)

Total purchase price, net of cash acquired

 

$

10,628

 

 

 

 

 

 

 

The following table summarizes the allocation of the preliminary purchase price to the fair values assigned to the assets acquired and the liabilities assumed at the date of the NorMedix acquisition:

 

 

 

Fair Value

(Dollars in thousands)

 

Estimated Useful Life (In years)

Net current assets

 

$

196

 

N/A

Property and equipment

 

 

76

 

N/A

Developed technology

 

 

6,850

 

10.0-14.0

Customer relationships

 

 

900

 

4.0

Deferred tax asset

 

 

812

 

N/A

Other noncurrent asset

 

 

12

 

N/A

Deferred tax liabilities

 

 

(2,597

)

N/A

Net assets acquired

 

 

6,249

 

 

Goodwill

 

 

4,379

 

N/A

Total purchase price, net of cash acquired

 

$

10,628

 

 

 

The NorMedix goodwill is a result of acquiring and retaining the NorMedix existing workforce and expected synergies from integrating their business into Surmodics. The goodwill will not be deductible for tax purposes. Purchase accounting is considered preliminary, subject to revision, mainly with respect to working capital, income taxes and goodwill, as final information was not available as of June 30, 2016.

These strategic acquisitions combine the best-in-class capabilities of NorMedix’s catheter-based technologies, Creagh Medical’s PTA balloon platform capabilities, and Surmodics’ innovative coating and drug delivery technologies to develop highly differentiated delivery and therapeutic intravascular solutions. The result is an organization with unique device design and development expertise, rich technology content, manufacturing capabilities, and a state-of-the-art facility equipped for medical device R&D and manufacturing.

Pro Forma Results

The following unaudited pro forma financial information presents the combined results of operation of the Company as if the acquisitions of Creagh Medical and NorMedix had occurred as of October 1, 2014.  The Company has realized $2.8 million of revenue and a net loss of $2.3 million from the Creagh Medical and NorMedix operations since their acquisitions.

The fiscal 2016 nine month pro forma financial information includes adjustments for additional amortization expense on identifiable intangible assets of $0.4 million and contingent consideration accretion expense of $0.3 million, eliminating non-recurring transactional professional fees of $3.0 million, and tax effect impact of $0.1 million.

The fiscal 2015 three and nine month pro forma financial information includes adjustments for additional amortization expense on identifiable intangible assets of $0.6 million and $1.9 million, contingent consideration accretion expense of $0.1 million and $0.9 million and tax effect impact of $0.1 million and $0.4 million, respectively.

10


 

The tax impact of the adjustments in all periods reflects no tax benefit from contingent consideration accretion as well as a significant portion of our transaction related costs in fiscal 2016 as they are not deductible for tax purposes.  Further, Creagh Medical amortization expense does not reflect an Irish tax benefit as we acquired a net operating loss carryforward as of the acquisition date that was offset in the aggregate by deferred tax liabilities and valuation allowance.  Therefore, the amortization of Creagh Medical intangible assets results in a decrease in deferred tax liabilities with a corresponding increase to a deferred tax valuation allowance. NorMedix amortization expense reflects a tax benefit based on our incremental U.S. tax rate.

The unaudited pro forma financial information is not necessarily indicative of what the Company’s consolidated results of operations actually would have been had the acquisition occurred at the beginning of each year.  Additionally, the unaudited pro forma financial information does not attempt to project the future results of operations of the combined company.

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

June 30,

 

 

June 30,

 

 

 

2015

 

 

2016

 

 

2015

 

(In thousands, except per share data)

(Unaudited)

 

(Unaudited)

 

Revenue

 

$

16,858

 

 

$

54,262

 

 

$

46,922

 

Net income

 

$

1,232

 

 

$

6,857

 

 

$

2,347

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Per share amounts:

 

 

 

 

 

 

 

 

 

 

 

 

Basic net income per share

 

$

0.09

 

 

$

0.53

 

 

$

0.18

 

Diluted net income per share

 

$

0.09

 

 

$

0.52

 

 

$

0.18

 

 

 

4. 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) at the measurement date under current market conditions. 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 Company did not have any Level 1 assets as of June 30, 2016 or September 30, 2015.  

Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

The Company’s Level 2 assets as of June 30, 2016 consisted of money market funds, commercial paper instruments and corporate debt securities. Fair market values for these assets are based on quoted vendor prices and broker pricing where all significant inputs are observable. To ensure the accuracy of quoted vendor prices and broker pricing, the Company performs regular reviews of investment returns to industry benchmarks and sample tests of individual securities to validate quoted vendor prices with other available market data.

Level 3 — Unobservable inputs to the valuation methodology that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.

11


 

Included in Level 3 liabilities as of June 30, 2016 is $13.9 million of noncurrent contingent consideration liabilities related to achievement of revenue and value-creating milestones associated with the Creagh Medical and NorMedix acquisitions. There were no Level 3 instruments as of September 30, 2015.

In valuing assets and liabilities, the Company is required to maximize the use of quoted market prices and minimize the use of unobservable inputs.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

In instances where the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2016:

 

(Dollars in thousands)

 

Quoted Prices in

Active Markets

for Identical

Instruments

(Level 1)

 

 

Significant Other Observable Inputs

(Level 2)

 

 

Significant Unobservable Inputs

(Level 3)

 

 

Total Fair

Value as of

June 30,

2016

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents

 

$

 

 

$

26,087

 

 

$

 

 

$

26,087

 

Available-for-sale debt securities

 

 

 

 

 

9,523

 

 

 

 

 

 

9,523

 

Total assets

 

$

 

 

$

35,610

 

 

$

 

 

$

35,610

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contingent consideration - noncurrent

 

$

 

 

$

 

 

$

(13,950

)

 

$

(13,950

)

Total liabilities

 

$

 

 

$

 

 

$

(13,950

)

 

$

(13,950

)

 

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2015:

 

(Dollars in thousands)

 

Quoted Prices in

Active Markets

for Identical

Instruments

(Level 1)

 

 

Significant Other Observable Inputs

(Level 2)

 

 

Significant Unobservable Inputs

(Level 3)

 

 

Total Fair

Value as of

September 30,

2015

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents

 

$

 

 

$

53,591

 

 

$

 

 

$

53,591

 

Total assets

 

$

 

 

$

53,591

 

 

$

 

 

$

53,591

 

 

12


 

Included in Level 3 fair value measurements as of June 30, 2016 was a $13.9 million noncurrent contingent consideration liability related to achievement of revenue and value-creating milestones associated with the Creagh Medical and NorMedix acquisitions. The following table summarizes the changes in the noncurrent contingent consideration liability for the three and nine month periods ended June 30, 2016:

 

(Dollars in thousands)

 

 

 

 

Current and noncurrent contingent consideration liability as of September 30, 2015

 

$

 

Additions

 

 

9,064

 

Fair value adjustments

 

 

 

Settlements

 

 

 

Interest accretion

 

 

109

 

Foreign currency translation loss

 

 

135

 

Current and noncurrent contingent consideration liability as of December 31, 2015

 

 

9,308

 

Additions

 

 

3,517

 

Fair value adjustments

 

 

 

Settlements

 

 

 

Interest accretion

 

 

392

 

Foreign currency translation loss

 

 

429

 

Current and noncurrent contingent consideration liability as of March 31, 2016

 

 

13,646

 

Additions

 

 

 

Fair value adjustments

 

 

70

 

Settlements

 

 

 

Interest accretion

 

 

485

 

Foreign currency translation gain

 

 

(251

)

Current and noncurrent contingent consideration liability as of June 30, 2016

 

$

13,950

 

 

Valuation Techniques

The valuation techniques used to measure the fair value of assets are as follows:

Cash equivalents — These assets are classified as Level 2 and are carried at historical cost, which is a reasonable estimate of fair value because of the relatively short time between origination of the instrument and its expected realization.

Available-for-sale debt securities — These assets are classified as Level 2 and includes corporate debt securities.  These securities ae valued based on quoted vendor prices in active markets underlying the securities.

Contingent consideration — The contingent consideration liabilities were determined based on discounted cash flow analyses that included revenue estimates, probability of strategic milestone achievement and a discount rate, which are considered significant unobservable inputs as of the acquisition date and June 30, 2016. For the revenue based milestones, the Company discounted forecasted revenue by 14.1% to 22.8%, which represents the Company’s weighted average cost of capital for each transaction, adjusted for the short-term nature of the cash flows. The resulting present value of revenue was used as an input into an option pricing approach, which also considered the Company’s risk of non-payment of the revenue-based milestones.  Non-revenue milestones are assumed to have a 75% to 100% probability of achievement and related payments were discounted using the Company’s estimated cost of debt, or 5.6% to 6.7%.  To the extent that these assumptions were to change, the fair value of the contingent consideration liabilities could change significantly. Included in the condensed consolidated statement of income for the third quarter and first nine months ended June 30, 2016 is $0.5 million and $1.1 million, respectively, of expense related to the accretion of the contingent consideration. The €12 million contingent consideration related to the Creagh Medical acquisition is denominated in Euros and is not hedged.  The Company recorded a $0.3 million and $(0.3) million foreign currency exchange gain (loss) in the third quarter and first nine months of fiscal 2016, respectively, related to this contingent consideration.

 

 

5. Investments

Investments consist principally of corporate debt securities and are classified as available-for-sale as of June 30, 2016. Available-for-sale securities are reported at fair value with unrealized gains and losses, net of tax, excluded from the condensed consolidated statements of income and reported in the condensed consolidated statements of comprehensive income as well as a separate component of stockholders’ equity in the condensed consolidated balance sheets, except for other-than-temporary impairments, which are reported as a charge to current earnings. A loss would be recognized when there is an other-than-temporary impairment in the fair value of any individual security classified as available-for-sale, with the associated net unrealized loss

13


 

reclassified out of accumulated other comprehensive income with a corresponding adjustment to other income. This adjustment results in a new cost basis for the investment.  Interest earned on debt securities, including amortization of premiums and accretion of discounts, is included in other income. Realized gains and losses from the sales of debt securities, which are included in other income, are determined using the specific identification method.

The amortized cost, unrealized holding gains and losses, and fair value of available for sale securities as of June 30, 2016 were as follows:

 

 

 

June 30, 2016

 

(Dollars in thousands)

 

Amortized Cost

 

 

Unrealized Gains

 

 

Unrealized Losses

 

 

Fair Value

 

Corporate bonds

 

$

9,562

 

 

$

1

 

 

$

(40

)

 

$

9,523

 

Total

 

$

9,562

 

 

$

1

 

 

$

(40

)

 

$

9,523

 

During the year ended September 30, 2015, the Company liquidated its investment portfolio to support corporate initiatives, as a result the ending balance of available-for-sale investments as of September 30, 2015 was zero.

The following table summarizes sales of available-for-sale debt securities:

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

June 30,

 

 

June 30,

 

(Dollars in thousands)

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Proceeds from sales

 

$

 

 

$

19,071

 

 

$

 

 

$

21,722

 

Gross realized gains

 

$

 

 

$

26

 

 

$

 

 

$

26

 

Gross realized losses

 

$

 

 

$

(65

)

 

$

 

 

$

(73

)

 

 

6. Inventories

Inventories are principally stated at the lower of cost or market using the specific identification method and include direct labor, materials and overhead, with cost of product sales determined on a first-in, first-out basis. Inventories consisted of the following components:

 

 

 

June 30,

 

 

September 30,

 

(Dollars in thousands)

 

2016

 

 

2015

 

Raw materials

 

$

1,630

 

 

$

1,264

 

Finished products

 

 

1,715

 

 

 

1,715

 

Total

 

$

3,345

 

 

$

2,979

 

 

 

7. Other Assets

Other assets consist principally of the following:

 

 

 

June 30,

 

 

September 30,

 

(Dollars in thousands)

 

2016

 

 

2015