Certain information in this Annual Report on Form 10-K pertaining to the effects of stock-based compensation may be considered non-GAAP financial information as contemplated by SEC Regulation G. Management believes the presentation of financial measures that identify the magnitude of the impact of stock-based compensation charges on its results of operations provide useful information to investors as the information allows investors to better evaluate ongoing business performance and factors that influenced performance during the period under report, including when comparing against prior periods. Management also uses such financial measures internally to monitor performance of the business. These potential non-GAAP financial measures should be considered in addition to, and not a substitute for, financial measures prepared in accordance with GAAP.
Liquidity and Capital Resources
As of September 30, 2006, the Company had working capital of $67.1 million and cash, cash equivalents and investments totaling $106.6 million. The Company’s investments principally consist of U.S. government and government agency obligations and investment grade, interest-bearing corporate debt securities with varying maturity dates, the majority of which are five years or less. The Company’s 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 plans to continue to direct its investment advisors to manage the Company’s investments primarily for the safety of principal for the foreseeable future as it assesses other investment opportunities and uses of its investments. The Company had positive cash flows from operating activities of approximately $35.3 million in fiscal 2006, compared with $26.0 million in fiscal 2005.
We conduct a significant majority of our operations at our Eden Prairie, Minnesota, headquarters. Throughout fiscal 2005 and 2006, we constructed capital improvements to enhance the research and development capabilities at the Eden Prairie facility. The $6.1 million in capital improvements were sufficiently complete by the end of second quarter of fiscal 2006, allowing us to vacate our contract manufacturing facility in Bloomington, Minnesota, and consolidate our Minnesota operations at our Eden Prairie headquarters. In addition to our Eden Prairie location, we lease approximately 3,000 square feet of commercial office space in Irvine, California, where our Ophthalmology division conducts a portion of its operations.
In January 2005, we entered into a merger agreement whereby SurModics acquired all of the assets of InnoRx, Inc. by paying approximately $4.1 million in cash and issuing 600,064 shares of SurModics common stock to InnoRx stockholders. In July 2005, we issued 60,002 shares of SurModics’ common stock to the shareholders of InnoRx upon the successful completion of the first milestone involving the InnoRx technology acquired in the purchase of InnoRx. In March 2006, we issued an additional 60,007 shares as a result of completion of the second milestone. Upon the successful completion of the remaining development and commercial milestones involving InnoRx technology acquired in the transaction, we will be required to issue up to approximately 480,060 additional shares of our common stock to the stockholders of InnoRx.
In January 2005, we made an equity investment of approximately $3.9 million in OctoPlus, a company based in the Netherlands active in the development of pharmaceutical formulations incorporating novel biodegradable polymers. In May 2006, we made an additional investment of approximately $160,000. As of September 30, 2006 the $4.1 million investment, which is accounted for under the cost method, represented an ownership interest of less than 20%. In October 2006, our fiscal 2007, we made an additional investment of $1.9 million, bringing our total investment to slightly more than $6.0 million, representing an ownership interest of approximately 9%.
We have invested a total of $5.2 million in Novocell, Inc., a privately-held Irvine, California-based biotech firm that is developing a unique treatment for diabetes. Working with Novocell, our researchers have created a coating that encapsulates pancreatic islet cells, the cells that produce insulin in the human body. If successful, this treatment using coated islet cells could dramatically change the treatment of diabetes. During the second quarter of fiscal 2006, we recorded an impairment loss of approximately $4.7 million. The balance of our investment, $559,000, which is accounted for under the cost method, is included in other assets and represents an ownership interest of less than 5%. Novocell’s primary technology is in its development stage, and we anticipate that it will be years before commercialization may be realized, if ever.
In May 2005, we invested $1.0 million in ThermopeutiX, an early stage company developing novel medical devices for the treatment of vascular and neurovascular diseases, including stroke. In addition to the investment, we have licensed our hydrophilic and hemocompatible coating technologies to ThermopeutiX for use with its devices. The $1.0 million investment, which is accounted for under the cost method, represents an ownership interest of less than 20%.
There is no assurance that the development stage companies listed above will successfully meet their immediate or future financing needs or that their financing needs will be met when required. Risks and uncertainties surrounding a development-stage company’s ability to obtain on a timely and frequent basis financing needed to continue its development activities currently affect, and will continually affect, the prospects of our investments
32
in Novocell, OctoPlus and ThermopeutiX and the revenue they may ultimately generate. If adverse results occur in the development of their respective technology, or if their respective financing needs are not continually met, the viability of such companies, the value of our investment and their ability to be future sources of revenue for the Company will be in jeopardy, and our investment in such companies would likely be considered impaired and charged against earnings at such time.
In September 2004, we made a commitment to purchase for $7 million certain additional sublicense rights and the accompanying future royalty revenue streams under certain sublicenses through an amendment to our diagnostic format patent license with Abbott Laboratories. Prior to such amendment, we were receiving only a portion of the royalties under such sublicenses. The first $5 million installment was paid in November 2004. The two remaining $1 million installments are reflected in other current and long-term liabilities.
In September 2006, we announced that our Board of Directors had authorized the repurchase of $35 million and up to 1 million shares of the Company’s stock. In November 2006, the Company entered into a Rule 10b5-1 agreement and purchased $17.5 million of the $35 million authorized at an average price of $32.87 per share.
As of September 30, 2006, we had no debt, nor did we have any credit agreements. We believe that our existing capital resources will be adequate to fund our operations into the foreseeable future.
Off-Balance Sheet Arrangements
As of September 30, 2006, the Company did not have any off-balance sheet arrangements with any unconsolidated entitites.
Contractual Obligations
Presented below is a summary of contractual obligations and other minimum commercial commitments. We do not have any long-term debt or any capital or operating leases. See Notes to Financial Statements for additional information regarding the below obligations and commitments.
| | Maturity by Fiscal Year |
| Contractual obligations | | | Total | | 2007 | | 2008 | | 2009 | | 2010 | | 2011 | | Thereafter |
| | (in millions) |
| Other long-term liabilities reflected on | | | | | | | | | | | | | | |
| balance sheet under GAAP | | $2.0 | | $1.0 | | $1.0 | | — | | — | | — | | — |
| Total | | $2.0 | | $1.0 | | $1.0 | | — | | — | | — | | — |
New Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board (FASB) issued statement No. 154, Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3 (“SFAS 154”). This statement applies to all voluntary changes in accounting principle and changes required by an accounting pronouncement where no specific transition provisions are included. SFAS 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The provisions of SFAS 154 are effective for the Company for accounting changes and correction of errors made in fiscal 2007. The Company does not anticipate that the implementation of this standard will have a material impact on its financial position, results of operations or cash flows.
On July 13, 2006, FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109, was issued. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new FASB standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are effective for the Company beginning fiscal 2008. The Company is currently evaluating the effect that the adoption of FIN 48 will have on its results of operations and financial condition.
33
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement establishes a consistent framework for measuring fair value and expands disclosures on fair value measurements. SFAS No. 157 is effective for the Company starting in fiscal 2008. The Company has not determined the impact, if any, the adoption of this statement will have on its financial statements.
| ITEM 7A. | | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. |
The Company’s investment policy requires investments with high credit quality issuers and limits the amount of credit exposure to any one issuer. The Company’s investments principally consist of U.S. government and government agency obligations and investment-grade, interest-bearing corporate debt securities with varying maturity dates, the majority of which are five years or less. Because of the credit criteria of the Company’s investment policies, the primary market risk associated with these investments is interest rate risk. SurModics 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 $1.5 million decrease in the fair value of the Company’s available-for-sale securities as of September 30, 2006, 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 Company’s inventory exposure is not material.
Although we conduct business in foreign countries, our international operations consist primarily of sales of reagent and stabilization chemicals. Additionally, 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 8. | | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. |
The balance sheets as of September 30, 2006 and 2005 and the statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended September 30, 2006, together with the independent auditors’ report thereon and related footnotes (including selected unaudited quarterly financial data), begin on page F-1 of this Form 10-K.
| ITEM 9. | | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. |
None.
| ITEM 9A. | | CONTROLS AND PROCEDURES. |
1. 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 Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer regarding the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information that is 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 rules of the Securities Exchange Commission.
2. Internal Control over Financial Reporting.
| | (a) | | Management’s Report on Internal Control Over Financial Reporting.Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in InternalControl–Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of September 30, 2006. |
34
| | | | Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of September 30, 2006 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report below. |
| |
| (b) | | Attestation Report of the Independent Registered Public Accounting Firm. |
35
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
SurModics, Inc.
Eden Prairie, Minnesota
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Report, that SurModics, Inc. (the “Company”) maintained effective internal control over financial reporting as of September 30, 2006, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of September 30, 2006, is fairly stated, in all material respects, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2006, based on the criteria established inInternal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the financial statements as of and for the year ended September 30, 2006, of the Company and our report dated December 12, 2006, expressed an unqualified opinion on those financial statements.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
December 12, 2006
36
3. Changes in Internal Controls.
There were no changes in the Company’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
| ITEM 9B. | | OTHER INFORMATION. |
All information required to be disclosed in a report on Form 8-K during the fourth quarter of the year covered by this Form 10-K has been reported.
37
PART III
| ITEM 10. | | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT |
The information required by Item 10 relating to directors, our audit committee, the nature of changes, if any, to procedures by which our shareholders may recommend nominees for directors, codes of ethics and compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated herein by reference to the sections entitled “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Code of Ethics and Business Conduct” that appear in the Company’s definitive Proxy Statement for its 2007 Annual Meeting of Shareholders.
| ITEM 11. | | EXECUTIVE COMPENSATION. |
The information required by Item 11 is incorporated herein by reference to the section entitled “Executive Compensation and Other Information” that appears in the Company’s definitive Proxy Statement for its 2007 Annual Meeting of Shareholders.
| ITEM 12. | | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. |
The information required by Item 12 is incorporated herein by reference to the sections entitled “Principal Shareholders,” “Management Shareholdings” and “Equity Compensation Plan Information” which appear in the Company’s definitive Proxy Statement for its 2007 Annual Meeting of Shareholders.
| ITEM 13. | | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS |
None.
| ITEM 14. | | PRINCIPAL ACCOUNTING FEES AND SERVICES. |
The information required by Item 14 is incorporated herein by reference to the section entitled “Independent Registered Public Accounting Firm” which appears in the Company’s definitive Proxy Statement for its 2007 Annual Meeting of Shareholders.
38
PART IV
| ITEM 15. | | EXHIBITS, FINANCIAL STATEMENT SCHEDULES. |
| | (a) | | 1.Financial statements |
| | | |
| | | The following statements are included in this report on the pages indicated: |
| | | | Page (s) |
| Report of Independent Registered Public Accounting Firm | | F-1 |
| | | |
| Balance Sheets | | F-2 |
| | | |
| Statements of Operations | | F-3 |
| | | |
| Statements of Stockholders’ Equity | | F-4 |
| | | |
| Statements of Cash Flows | | F-5 |
| | | |
| Notes to Financial Statements | | F-6 – F-15 |
| | 2.Financial Statement Schedules. All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission other than the ones listed above are not required under the related instructions or are not applicable, and, therefore, have been omitted. |
| | | |
| | | 3.Listing of Exhibits. The exhibits which are filed with this report or which are incorporated herein by reference are set forth in the Exhibit Index following the signature page. |
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
SURMODICS, INC.
(“Registrant”)
Dated: December 14, 2006 | By: | /s/ Bruce J Barclay | |
| | Bruce J Barclay |
| | | Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant, in the capacities, and on the dates indicated.
(Power of Attorney)
Each person whose signature appears below authorizes BRUCE J BARCLAY and PHILIP D. ANKENY, and constitutes and appoints said persons as his true and lawful attorneys-in-fact and agents, each acting alone, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any or all amendments to this Annual Report on Form 10-K and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, authorizing said persons and granting unto said attorneys-in-fact and agents, each acting alone, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all said attorneys-in-fact and agents, each acting alone, or his substitute or substitutes, may lawfully do or cause to be done by virtue thereof.
| Signature | | | Title | | Date |
| /s/ Bruce J Barclay | | President and Chief Executive Officer (principalexecutive officer) | | December 14, 2006 |
| Bruce J Barclay | | | | |
| |
| /s/ Philip D. Ankeny | | Senior Vice President and Chief Financial Officer, (principal | | December 14, 2006 |
| Philip D. Ankeny | | financialofficer) | | |
| |
| /s/ Loren R. Miller | | Vice President and Controller (principal accounting officer) | | December 14, 2006 |
| Loren R. Miller | | | | |
| |
| /s/ Jose H. Bedoya | | Director | | December 14, 2006 |
| Jose H. Bedoya | | | | |
| |
| /s/ John W. Benson | | Director | | December 14, 2006 |
| John W. Benson | | | | |
| |
| /s/ Gerald B. Fischer | | Director | | December 14, 2006 |
| Gerald B. Fischer | | | | |
| |
| /s/ Kenneth H. Keller | | Director | | December 14, 2006 |
| Kenneth H. Keller | | | | |
| |
| /s/ David A. Koch | | Director | | December 14, 2006 |
| David A. Koch | | | | |
| |
| /s/ Kendrick B. Melrose | | Director | | December 14, 2006 |
| Kendrick B. Melrose | | | | |
| |
| /s/ Dale R. Olseth | | Director | | December 14, 2006 |
| Dale R. Olseth | | | | |
| |
| /s/ John A. Meslow | | Director | | December 14, 2006 |
| John A. Meslow | | | | |
40
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
EXHIBIT INDEX TO FORM 10-K
For the Fiscal Year Ended September 30, 2006
SURMODICS, INC.
| Exhibit | | |
| 2.1 | | Agreement of Merger, dated January 18, 2005, with InnoRx, Inc.--incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K dated January 18, 2005, SEC File No. 0-23837. |
| |
| 3.1 | | Restated Articles of Incorporation, as amended--incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-QSB for the quarter ended December 31, 1999, SEC File No. 0-23837. |
| |
| 3.2 | | Bylaws, as amended to date--incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-QSB for the quarter ended December 31, 1998, SEC File No. 0-23837. |
| |
| 4.1 | | Rights Agreement, dated as of April 5, 1999, between the Company and Firstar Bank Milwaukee, NA., as Rights Agent, including as: Exhibit A Statement of Designation of Series A Preferred Stock of the Company; Exhibit B Summary of Rights to Purchase Shares of Series A Preferred Stock; and Exhibit C Form of Right Certificate--incorporated by reference to Exhibit 1 to the Company’s Registration of Securities on Form 8-A, SEC File No. 0-23837. |
| |
| 10.1* | | Company’s Incentive 1987 Stock Option Plan, including specimen of Incentive Stock Option Agreement--incorporated by reference to Exhibit 10.2 to the Company’s Registration Statement on form SB-2, Reg. No. 333-43217. |
| |
| 10.2* | | Company’s Incentive 1997 Stock Option Plan, including specimen of Incentive Stock Option Agreement--incorporated by reference to Exhibit 10.3 to the Company’s Registration Statement on form SB-2, Reg. No. 333-43217. |
| |
| 10.3* | | Form of Restricted Stock Agreement under 1997 Plan--incorporated by reference to Exhibit 10.4 to the Company’s Registration Statement on form SB-2, Reg. No. 333-43217. |
| |
| 10.4* | | Form of Non-qualified Stock Option Agreement under 1997 Plan--incorporated by reference to Exhibit 10.5 to the Company’s Registration Statement on form SB-2, Reg. No. 333-43217. |
| |
| 10.5 | | Form of License Agreement--incorporated by reference to Exhibit 10.6 to the Company’s Registration Statement on form SB-2, Reg. No. 333-43217. |
| |
| 10.6* | | SurModics, Inc. Executive Income Continuation Plan--incorporated by reference to Exhibit 10 to the Company’s Quarterly Report on Form 10-QSB for the quarter ended June 30, 1999, SEC File No. 0-23837. |
| |
| 10.7 | | Adjusted License Agreement by and between the Company and Cordis Corporation effective as of January 1, 2003--incorporated by reference to Exhibit 10.11 to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002, SEC File No. 0-23837. |
| |
| 10.8 | | Reagent Supply Agreement by and between the Company and Cordis Corporation effective as of January 1, 2003--incorporated by reference to Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002, SEC File No. 0-23837. |
| |
| 10.9* | | Form of officer acceptance regarding employment/compensation – incorporated by reference to Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2005, SEC File No. 0-23837. |
| |
| 10.10* | | 2003 Equity Incentive Plan (as amended and restated December 13, 2005) (adopted December 13, 2005 by the board of directors and approved by the shareholders on January 30, 2006) —incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed February 3, 2006, SEC File No. 0-23837. |
| |
| 10.11* | | Form of SurModics, Inc. 2003 Equity Incentive Plan Nonqualified Stock Option Agreement—incorporated by reference to Exhibit 99.1 to the Company’s 8-K filed March 20, 2006, SEC File No. 0-23837. |
| Exhibit | | |
| 10.12* | | Form of SurModics, Inc. 2003 Equity Incentive Plan Incentive Stock Option Agreement—incorporated by reference to Exhibit 99.2 to the Company’s 8-K filed March 20, 2006, SEC File No. 0-23837. |
| | | |
| 10.13* | | Form of SurModics, Inc. 2003 Equity Incentive Plan Restricted Stock Agreement—incorporated by reference to Exhibit 99.3 to the Company’s 8-K filed March 20, 2006, SEC File No. 0-23837. |
| | | |
| 10.14* | | Form of SurModics, Inc. 2003 Equity Incentive Plan Performance Share Award Agreement—incorporated by reference to Exhibit 99.4 to the Company’s 8-K filed March 20, 2006, SEC File No. 0-23837. |
| | | |
| 10.15* | | Form of SurModics, Inc. 2003 Equity Incentive Plan Performance Unit Award (cash settled) Agreement—incorporated by reference to Exhibit 99.5 to the Company’s 8-K filed March 20, 2006, SEC File No. 0-23837. |
| | | |
| 10.16* | | Form of SurModics, Inc. 2003 Equity Incentive Plan Restricted Stock Unit Agreement—incorporated by reference to Exhibit 99.6 to the Company’s 8-K filed March 20, 2006, SEC File No. 0-23837. |
| | | |
| 10.17* | | Form of SurModics, Inc. 2003 Equity Incentive Plan Stock Appreciation Rights (cash settled) Agreement—incorporated by reference to Exhibit 99.7 to the Company’s 8-K filed March 20, 2006, SEC File No. 0-23837. |
| | | |
| 10.18* | | Form of SurModics, Inc. 2003 Equity Incentive Plan Stock Appreciation Rights (stock settled) Agreement—incorporated by reference to Exhibit 99.8 to the Company’s 8-K filed March 20, 2006, SEC File No. 0-23837. |
| | | |
| 10.19* | | The Company’s 2005 Bonus Plan--incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2004, SEC File No. 0-23837. |
| | | |
| 10.20* | | The Company’s FY 2006 Bonus Plan, as adopted by the Compensation Committee of the Board of Directors on September 30, 2005 -- incorporated by reference to Exhibit 10.15 to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2005, SEC File No. 0-23837. |
| | | |
| 10.21* | | The Company’s FY 2007 Bonus Plan, as adopted by the Compensation Committee of the Board of Directors of the Company on September 15, 2006.** |
| | | |
| 10.22* | | The Company’s Board Compensation Policy, Amended and Restated in its entirety as of July 31, 2006.** |
| | |
| 10.23* | | FY 06 Summary of Compensation Arrangements for Named Executive Officers of the Company -- -- incorporated by reference to Exhibit 10.14 to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2005, SEC File No. 0-23837. |
| | | |
| 10.24* | | FY 07 Summary of Compensation Arrangements for Named Executive Officers of the Company.** |
| | |
| 10.25* | | Change of Control Agreement with Bruce J Barclay, dated April 19, 2006—incorporated by reference to Exhibit 99.1 to the Company’s Form 8-K filed April 25, 2006, SEC File No. 0-23837. |
| | | |
| 10.26* | | Change of Control Agreement with Philip D. Ankeny, dated April 19, 2006—incorporated by reference to Exhibit 99.2 to the Company’s Form 8-K filed April 25, 2006, SEC File No. 0-23837. |
| | | |
| 10.27* | | Change of Control Agreement with Paul A. Lopez, dated November 15, 2006.** |
| | |
| 10.28* | | Description of certain retirement benefits for Dale R. Olseth.** |
| | |
| 23.1 | | Consent of Deloitte & Touche LLP.** |
| | |
| 24 | | Power of Attorney (included on signature page of this Form 10-K).** |
| | |
| 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.** |
____________________
| * | | Management contract or compensatory plan or arrangement |
| |
| ** | | Filed herewith |
| |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
SurModics, Inc.
Eden Prairie, Minnesota
We have audited the accompanying balance sheets of SurModics, Inc. (the “Company”) as of September 30, 2006 and 2005, and the related statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended September 30, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material respects, the financial position of SurModics as of September 30, 2006 and 2005, and the results of its operations and cash flows for each of the three years in the period ended September 30, 2006, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 3 to the financial statements, in 2006 the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, which relates to the method of accounting for stock-based compensation.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of September 30, 2006, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated December 12, 2006, expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
December 12, 2006
F-1
| SurModics, Inc. | | | | | | | |
| Balance Sheets | | | | | | | |
| As of September 30 | | | | | | | |
| |
| (thousands, except share data) | | 2006 | | 2005 |
| ASSETS | | | | | | | |
| Current Assets | | | | | | | |
| Cash and cash equivalents | $ | 3,751 | | | $ | 3,921 | |
| Short-term investments | | 55,062 | | | | 20,524 | |
| Accounts receivable, net of allowance for doubtful accounts of $40 as of | | | | | | | |
| September 30, 2006 and 2005 | | 14,493 | | | | 10,996 | |
| Income taxes receivable | | — | | | | 3,640 | |
| Inventories | | 952 | | | | 1,091 | |
| Deferred tax asset | | 435 | | | | 353 | |
| Prepaids and other | | 1,403 | | | | 1,079 | |
| Total current assets | | 76,096 | | | | 41,604 | |
| Property and Equipment, net | | 11,686 | | | | 14,832 | |
| Long-Term Investments | | 47,758 | | | | 48,874 | |
| Deferred Tax Asset | | 4,883 | | | | 2,868 | |
| Other Assets, net | | 16,979 | | | | 16,047 | |
| Total Assets | $ | 157,402 | | | $ | 124,225 | |
| |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | |
| Current Liabilities | | | | | | | |
| Accounts payable | $ | 963 | | | $ | 1,163 | |
| Accrued liabilities- | | | | | | | |
| Compensation | | 1,275 | | | | 1,629 | |
| Accrued income taxes payable | | 1,910 | | | | — | |
| Accrued other | | 1,605 | | | | 1,917 | |
| Deferred revenue | | 2,236 | | | | 414 | |
| Other current liabilities | | 1,000 | | | | — | |
| Total current liabilities | | 8,989 | | | | 5,123 | |
| Deferred revenue, less current portion | | 2,210 | | | | 1,521 | |
| Other long-term liabilities | | 1,000 | | | | 2,000 | |
| Total liabilities | | 12,199 | | | | 8,644 | |
| | | | | | | | |
| Commitments and Contingencies (Note 5) | | | | | | | |
| 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 18,830,455 | | | | | | | |
| and 18,535,761 shares issued and outstanding | | 942 | | | | 927 | |
| Additional paid-in capital | | 96,281 | | | | 89,721 | |
| Unearned compensation | | — | | | | (2,621 | ) |
| Accumulated other comprehensive income (loss) | | (293 | ) | | | (360 | ) |
| Retained earnings | | 48,273 | | | | 27,914 | |
| Total stockholders’ equity | | 145,203 | | | | 115,581 | |
| Total Liabilities and Stockholders Equity | $ | 157,402 | | | $ | 124,225 | |
| |
| The accompanying notes are an integral part of these financial statements. | | | | | | | |
F-2
| SurModics, Inc. | | | | | | | | | | | | |
| Statements of Operations | | | | | | | | | | | | |
| For the Years Ended September 30 | | | | | | | | | | | | |
| |
| (thousands, except net income per share) | | | 2006 | | 2005 | | | 2004 |
| Revenue | | | | | | | | | | | | |
| Royalties and license fees | | $ | 53,008 | | | $ | 47,582 | | | $ | 34,836 | |
| Product sales | | | 11,172 | | | | 9,403 | | | | 10,478 | |
| Research and development | | | 5,704 | | | | 5,396 | | | | 4,424 | |
| Total revenue | | | 69,884 | | | | 62,381 | | | | 49,738 | |
| Operating Costs and Expenses | | | | | | | | | | | | |
| Product | | | 3,399 | | | | 2,855 | | | | 3,035 | |
| Research and development | | | 20,391 | | | | 16,072 | | | | 12,633 | |
| Sales and marketing | | | 1,424 | | | | 1,209 | | | | 1,683 | |
| General and administrative | | | 8,507 | | | | 6,496 | | | | 5,416 | |
| Asset impairment charge | | | — | | | | 2,487 | | | | 16,497 | |
| Purchased in-process research & development | | | — | | | | 30,277 | | | | — | |
| Total operating costs and expenses | | | 33,721 | | | | 59,396 | | | | 39,264 | |
| Income from Operations | | | 36,163 | | | | 2,985 | | | | 10,474 | |
| Other Income (Loss), net | | | | | | | | | | | | |
| Investment income | | | 4,210 | | | | 1,967 | | | | 1,185 | |
| Impairment loss on investment | | | (4,651 | ) | | | — | | | | — | |
| Other loss | | | (157 | ) | | | (602 | ) | | | (7 | ) |
| Other income (loss), net | | | (598 | ) | | | 1,365 | | | | 1,178 | |
| Income Before Income Taxes | | | 35,565 | | | | 4,350 | | | | 11,652 | |
| Income Tax Provision | | | (15,231 | ) | | | (12,596 | ) | | | (4,410 | ) |
| Net income (loss) | | $ | 20,334 | | | ($ | 8,246 | ) | | $ | 7,242 | |
| |
| Basic net income (loss) per share | | | $1.10 | | | | ($0.45 | ) | | $ | 0.41 | |
| Diluted net income (loss) per share | | | $1.09 | | | | ($0.45 | ) | | $ | 0.41 | |
| Weighted Average Shares Outstanding | | | | | | | | | | | | |
| Basic | | | 18,527 | | | | 18,131 | | | | 17,501 | |
| Dilutive effect of outstanding stock options | | | 192 | | | | — | | | | 299 | |
| Diluted | | | 18,719 | | | | 18,131 | | | | 17,800 | |
The accompanying notes are an integral part of these financial statements.
F-3
| SurModics, Inc. | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Statements of Stockholders’ Equity | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Years Ended September 30, 2006, 2005 and 2004 | | | | | | | | | | | | | | | | | | | | | |
| |
| | | | | | | | | | | | | | | | | Accumulated | | | | | | | | |
| | | | | | | | | Additional | | | | | | Other | | | | | Total |
| | Common Stock | | Paid-In | | Unearned | | Comprehensive | | Retained | | Stockholders’ |
| (in thousands) | | Shares | | Amount | | Capital | | Compensation | | Income (Loss) | | Earnings | | Equity |
| Balance, September 30, 2003 | 17,439 | | | $ | 872 | | | $ | 56,453 | | | $ | (466 | ) | | | $ | 337 | | | $ | 28,918 | | | $ | 86,114 | |
| Components of comprehensive income, | | | | | | | | | | | | | | | | | | | | | | | | | | |
| net of tax: | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | — | | | | — | | | | — | | | | — | | | | — | | | | 7,242 | | | | 7,242 | |
| Unrealized holding losses on available- | | | | | | | | | | | | | | | | | | | | | | | | | | |
| for-sale securities arising during the | | | | | | | | | | | | | | | | | | | | | | | | | | |
| period | — | | | | — | | | | — | | | | — | | | | (164 | ) | | | — | | | | (164 | ) |
| Less reclassification for gains included | | | | | | | | | | | | | | | | | | | | | | | | | | |
| in net income, net of tax | — | | | | — | | | | — | | | | — | | | | (117 | ) | | | — | | | | (117 | ) |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | 6,961 | |
| Issuance of common stock | 19 | | | | 1 | | | | 344 | | | | — | | | | — | | | | — | | | | 345 | |
| Common stock options exercised, net | 63 | | | | 3 | | | | 350 | | | | — | | | | — | | | | — | | | | 353 | |
| Tax benefit from exercise of stock | | | | | | | | | | | | | | | | | | | | | | | | | | |
| options | — | | | | — | | | | 325 | | | | — | | | | — | | | | — | | | | 325 | |
| Restricted stock activity | 16 | | | | 1 | | | | 377 | | | | (378 | ) | | | — | | | | — | | | | — | |
| Amortization of unearned compensation | — | | | | — | | | | — | | | | 212 | | | | | — | | | | — | | | | 212 | |
| Balance, September 30, 2004 | 17,537 | | | | 877 | | | | 57,849 | | | | (632 | ) | | | 56 | | | | 36,160 | | | | 94,310 | |
| Components of comprehensive income, | | | | | | | | | | | | | | | | | | | | | | | | | | |
| net of tax: | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | — | | | | — | | | | — | | | | — | | | | — | | | | (8,246 | ) | | | (8,246 | ) |
| Unrealized holding losses on available- | | | | | | | | | | | | | | | | | | | | | | | | | | |
| for-sale securities arising during the | | | | | | | | | | | | | | | | | | | | | | | | | | |
| period | — | | | | — | | | | — | | | | — | | | | (481 | ) | | | — | | | | (481 | ) |
| Add reclassification for losses included | | | | | | | | | | | | | | | | | | | | | | | | | | |
| in net income, net of tax | — | | | | — | | | | — | | | | — | | | | 65 | | | | — | | | | 65 | |
| Comprehensive loss | | | | | | | | | | | | | | | | | — | | | | | | | | (8,662 | ) |
| Issuance of common stock | 682 | | | | 34 | | | | 25,731 | | | | — | | | | — | | | | — | | | | 25,765 | |
| Common stock options exercised, net | 244 | | | | 12 | | | | 2,310 | | | | — | | | | — | | | | — | | | | 2,322 | |
| Tax benefit from exercise of stock | | | | | | | | | | | | | | | | | | | | | | | | | | |
| options | — | | | | — | | | | 1,258 | | | | — | | | | — | | | | — | | | | 1,258 | |
| Restricted stock activity | 73 | | | | 4 | | | | 2,573 | | | | (2,577 | ) | | | — | | | | — | | | | — | |
| Amortization of unearned compensation | — | | | | — | | | | — | | | | 588 | | | | | — | | | | — | | | | 588 | |
| Balance, September 30, 2005 | 18,536 | | | | 927 | | | | 89,721 | | | | (2,621 | ) | | | (360 | ) | | | 27,914 | | | | 115,581 | |
| Components of comprehensive loss, net | | | | | | | | | | | | | | | | | | | | | | | | | | |
| of tax: | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | — | | | | — | | | | — | | | | — | | | | — | | | | 20,334 | | | | 20,334 | |
| Unrealized holding losses on available- | | | | | | | | | | | | | | | | | | | | | | | | | | |
| for-sale securities arising during the | | | | | | | | | | | | | | | | | | | | | | | | | | |
| period | — | | | | — | | | | — | | | | — | | | | (31 | ) | | | — | | | | (31 | ) |
| Add reclassification for losses included | | | | | | | | | | | | | | | | | | | | | | | | | | |
| in net income, net of tax | — | | | | — | | | | — | | | | — | | | | 98 | | | | — | | | | 98 | |
| Comprehensive income | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 20,401 | |
| Issuance of common stock | 125 | | | | 7 | | | | 392 | | | | — | | | | — | | | | — | | | | 399 | |
| Common stock options exercised, net | 169 | | | | 8 | | | | 2,854 | | | | — | | | | — | | | | — | | | | 2,862 | |
| Tax benefit from exercise of stock | | | | | | | | | | | | | | | | | | | | | | | | | | |
| options | — | | | | — | | | | 249 | | | | — | | | | — | | | | — | | | | 249 | |
| Stock based compensation | — | | | | — | | | | 5,526 | | | | — | | | | — | | | | — | | | | 5,526 | |
| Accounting change due to adoption of | | | | | | | | | | | | | | | | | | | | | | | | | | |
| SFAS 123R | — | | | | — | | | | (2,461 | ) | | | 2,621 | | | | | — | | | | 25 | | | | 185 | |
| Balance, September 30, 2006 | 18,830 | | | $ | 942 | | | $ | 96,281 | | | $ | — | | | | ($ | 293 | ) | | $ | 48,273 | | | $ | 145,203 | |
| |
| The accompanying notes are an integral part of these financial statements. | | | | | | | | | | | | | |
F-4
| SurModics, Inc. | | | | | | | | | | | |
| Statements of Cash Flows | | | | | | | | | | | |
| |
| For the Years Ended September 30 (in thousands) | | 2006 | | 2005 | | 2004 |
| Operating Activities | | | | | | | | | | | |
| Net income (loss) | $ | 20,334 | | | ($ | 8,246 | ) | | $ | 7,242 | |
| Adjustments to reconcile net income (loss) to net cash provided by | | | | | | | | | | | |
| operating activities- | | | | | | | | | | | |
| Depreciation and amortization | | 3,710 | | | | 3,733 | | | | 3,125 | |
| Loss on sales of investments and equity method loss on | | | | | | | | | | | |
| InnoRx | | 157 | | | | 602 | | | | 7 | |
| Amortization of discount on investments | | (1,534 | ) | | | — | | | | — | |
| Asset impairment charge | | 4,651 | | | | 2,487 | | | | 16,497 | |
| Noncash compensation | | 5,711 | | | | 588 | | | | 212 | |
| Purchased in-process research & development | | — | | | | 30,277 | | | | — | |
| Deferred tax | | (2,134 | ) | | | 5,143 | | | | (5,640 | ) |
| Tax benefit from exercise of stock options | | (249 | ) | | | 1,258 | | | | 325 | |
| Loss (gain) on disposals of property and equipment | | (169 | ) | | | (65 | ) | | | 22 | |
| Change in operating assets and liabilities: | | | | | | | | | | | |
| Accounts receivable | | (3,497 | ) | | | (2,866 | ) | | | 1,015 | |
| Inventories | | 139 | | | | (51 | ) | | | (177 | ) |
| Accounts payable and accrued liabilities | | (532 | ) | | | 912 | | | | (966 | ) |
| Income taxes | | 5,799 | | | | (7,467 | ) | | | 2,269 | |
| Deferred revenue | | 2,489 | | | | (81 | ) | | | (663 | ) |
| Prepaids and other | | 404 | | | | (274 | ) | | | (78 | ) |
| Net cash provided by operating activities | | 35,279 | | | | 25,950 | | | | 23,190 | |
| Investing Activities | | | | | | | | | | | |
| Purchases of property and equipment | | (5,857 | ) | | | (2,109 | ) | | | (5,474 | ) |
| Sales of property and equipment | | 238 | | | | — | | | | — | |
| Purchases of available-for-sale investments | | (193,966 | ) | | | (98,716 | ) | | | (45,976 | ) |
| Sales/maturities of available-for-sale investments | | 161,778 | | | | 88,955 | | | | 27,092 | |
| Purchase of equity in OctoPlus, Novocell and other | | (160 | ) | | | (5,133 | ) | | | (302 | ) |
| Purchase of licenses | | (1,592 | ) | | | (5,238 | ) | | | (64 | ) |
| Investment in and acquisition costs for InnoRx | | — | | | | (5,181 | ) | | | (2,331 | ) |
| Repayment of notes receivable | | 600 | | | | — | | | | 1,869 | |
| Net cash used in investing activities | | (38,959 | ) | | | (27,422 | ) | | | (25,186 | ) |
| Financing Activities | | | | | | | | | | | |
| Tax benefit from exercise of stock options | | 249 | | | | — | | | | — | |
| Issuance of common stock | | 3,261 | | | | 2,684 | | | | 698 | |
| Net cash provided by financing activities | | 3,510 | | | | 2,684 | | | | 698 | |
| Net increase (decrease) in cash and cash equivalents | | (170 | ) | | | 1,212 | | | | (1,298 | ) |
| Cash and Cash Equivalents | | | | | | | | | | | |
| Beginning of year | | 3,921 | | | | 2,709 | | | | 4,007 | |
| End of year | $ | 3,751 | | | $ | 3,921 | | | $ | 2,709 | |
| Supplemental Information | | | | | | | | | | | |
| Cash paid for taxes | $ | 11,338 | | | $ | 13,780 | | | $ | 7,265 | |
| Noncash transaction-purchase Abbott Laboratories sublicense | | — | | | | — | | | $ | 7,020 | |
| Noncash proceeds from sale of property | $ | 6,655 | | | | — | | | | — | |
| Noncash transaction-acquisition of property, plant, and equipment | | | | | | | | | | | |
| on account | $ | 989 | | | $ | 1,268 | | | $ | 248 | |
| |
| The accompanying notes are an integral part of these financial statements. | | | | | | | | | | |
F-5
SurModics, Inc.
Notes to Financial Statements September 30, 2006 and 2005
1. Description
SurModics, Inc. (the Company) develops, manufactures and markets innovative surface modification and drug delivery technologies for the healthcare industry. The Company’s revenue is derived from three primary sources: (1) royalties and license fees from licensing its patented surface modification and drug delivery technologies and in vitro diagnostic formats to customers; (2) the sale of reagent chemicals to licensees of its technologies, stabilization products to the diagnostics industry, and coated slides to the genomics market; and (3) research and development fees generated on projects for customers.
2. Summary of Significant Accounting Policies
Cash and Cash Equivalents
Cash and cash equivalents consist principally of money market instruments with original maturities of three months or less and are stated at cost which approximates fair value.
Investments
Investments consist principally of U.S. government and government agency obligations and mortgage-backed securities and are classified as available-for-sale as of September 30, 2006 and 2005. Available-for-sale investments are reported at fair value with unrealized gains and losses 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 and result in a new cost basis for the investment.
The original cost, unrealized holding gains and losses, and fair value of investments as of September 30 were as follows(in thousands):
| | 2006 |
| | Original Cost | | Unrealized Gains | | Unrealized Losses | | Fair Value |
| U.S. government obligations | $ | 70,085 | | | $ | 18 | | | ($227 | ) | | $ | 69,876 |
| Mortgage-backed securities | | 12,312 | | | | 42 | | | (123 | ) | | | 12,231 |
| Municipal bonds | | 10,595 | | | | 20 | | | (124 | ) | | | 10,491 |
| Asset backed securities | | 8,658 | | | | 3 | | | (76 | ) | | | 8,585 |
| Corporate bonds | | | 1,639 | | | | | — | | | | (2 | ) | | | 1,637 |
| Total | | $ | 103,289 | | | | $ | 83 | | | | ($552 | ) | | $ | 102,820 |
| |
| | 2005 |
| | Original Cost | | Unrealized Gains | | Unrealized Losses | | Fair Value |
| U.S. government obligations | $ | 32,392 | | | $ | 36 | | | ($256 | ) | | $ | 32,172 |
| Mortgage-backed securities | | 15,782 | | | | 37 | | | (157 | ) | | | 15,662 |
| Municipal bonds | | 10,127 | | | | 1 | | | (154 | ) | | | 9,974 |
| Asset backed securities | | 10,744 | | | | 3 | | | (81 | ) | | | 10,666 |
| Corporate bonds | | | 927 | | | | | 1 | | | | (4 | ) | | | 924 |
| Total | | $ | 69,972 | | | | $ | 78 | | | | ($652 | ) | | $ | 69,398 |
F-6
The original cost and fair value of investments by contractual maturity at September 30, 2006, were as follows(in thousands):
| | Original Cost | | Fair Value |
| Debt securities due within: | | | | | |
| One year | $ | 55,091 | | $ | 55,062 |
| One to five years | | 32,208 | | | 31,875 |
| Five years or more | | 15,990 | | | 15,883 |
| Total | $ | 103,289 | | $ | 102,820 |
The following table summarizes sales of available-for-sale securities for the years ended September 30, 2006, 2005, and 2004(in thousands):
| | 2006 | | 2005 | | 2004 |
| Proceeds from sales | $ | 161,778 | | | $ | 88,955 | | | $ | 27,092 |
| Gross realized gains | | $24 | | | | $17 | | | | $187 |
| Gross realized losses | | ($181 | ) | | | ($119 | ) | | | $0 |
Inventories
Inventories are 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 as of September 30(in thousands):
| | 2006 | | 2005 |
| Raw materials | $ | 512 | | $ | 512 |
| Finished products | | 440 | | | 579 |
| Total | $ | 952 | | $ | 1,091 |
Property and Equipment
Property and equipment are stated at cost and are depreciated using the straight-line method over 3 to 30 years, the estimated useful lives of the assets. The Company recorded depreciation expense of approximately $2.0 million in 2006, $2.0 million in 2005, and $3.1 million in 2004. The balance in property and equipment as of September 30, 2005 included $6.7 million in real property located in Bloomington, Minnesota. The Company entered into an agreement to sell the Bloomington property in September 2005; we completed the sale and consolidated operations at our Eden Prairie location at the end of March 2006. The 2006 and 2005 balances in construction-in-progress include the cost of enhancing the capabilities of our Eden Prairie facility. Once placed in service, construction-in-progress is transferred to the specific property and equipment categories and depreciated over the estimated useful lives of the assets.
Property and equipment consisted of the following components as of September 30(in thousands):
| | | | | | | | | | Useful life |
| | 2006 | | 2005 | | (in years) |
| Laboratory fixtures and equipment | $ | 10,531 | | | $ | 9,550 | | | 3 to 10 |
| Building and improvements | | 12,083 | | | | 7,306 | | | 5 to 20 |
| Building subject to sale agreement | | — | | | | 6,650 | | | 5 to 30 |
| Office furniture and equipment | | 3,022 | | | | 2,718 | | | 3 to 10 |
| Construction-in-progress | | 94 | | | | 2,456 | | | |
| Less accumulated depreciation | | (14,044 | ) | | | (13,848 | ) | | |
| Property and equipment, net | $ | 11,686 | | | $ | 14,832 | | | |
F-7
Other Assets
Other assets consist principally of investments, acquired patents, and licenses. The cost of patents is amortized over 4 to 19 years. The Company recorded amortization expense of $1.7 million in 2006, $1.7 million in 2005, and $22,000 in 2004.
In September 2004, we made a commitment to purchase for $7 million certain additional sublicense rights and the accompanying future royalty revenue streams under certain sublicenses through an amendment to our diagnostic format patent license with Abbott Laboratories. Prior to such amendment, we were receiving only a portion of the royalties under such sublicenses. The first $5 million installment was paid in November 2004. The remaining installments are reflected in other current liabilities and other long-term liabilities.
In September 2005, the Company entered an agreement to sell its contract manufacturing facility and 27 acres of land located in Bloomington, Minnesota. The terms of the sale agreement included a $100,000 cash down payment and a note receivable of $6.9 million, which is collateralized by the assets. The terms of the note call for monthly installment payments of principal and interest at 6% with the remaining amount due and payable in September 2010. The $5.6 million balance in other assets represents the long-term portion due on the note.
In January 2005, the Company made an equity investment of approximately $3.9 million in OctoPlus, a privately owned company based in the Netherlands active in the development of pharmaceutical formulations incorporating novel biodegradable polymers. In May 2006, we made an additional investment of approximately $160,000. As of September 30, 2006 our $4.1 million investment, which is accounted for under the cost method, represents an ownership interest of less than 20%. In May 2005, the Company invested $1.0 million in ThermopeutiX, an early stage company developing novel medical devices for the treatment of vascular and neurovascular diseases, including stroke. In addition to the investment, SurModics has licensed its hydrophilic and hemocompatible coating technologies to ThermopeutiX for use with its devices. The $1.0 million investment, which is accounted for under the cost method, represents an ownership interest of less than 20%.
SurModics has invested a total of $5.2 million in Novocell, Inc., a privately-held Irvine, California-based biotech firm that is developing a unique treatment for diabetes using coated islet cells, the cells that produce insulin in the human body. After reviewing updated guidance provided by FASB Staff Position 115-1 (“FSP 115-1”), The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, combined with Novocell valuation information gathered in conjunction with a prospective round of financing, the Company determined its investment in Novocell was impaired and that the impairment was other-than-temporary. During the second quarter of fiscal 2006, we recorded an impairment loss of approximately $4.7 million. The balance of our investment, $559,000, which is accounted for under the cost method, is included in other assets and represents an ownership interest of less than 5%.
In February 2004, the Company invested $2.1 million in InnoRx, Inc., an Alabama-based, early-stage company developing drug delivery devices and therapies for the ophthalmology market. SurModics made an additional investment of approximately $1.6 million in the first quarter of fiscal year 2005. In January 2005, SurModics acquired via a merger all of InnoRx’s assets by paying approximately $4.1 million in cash, issuing 600,064 shares of SurModics common stock to InnoRx stockholders and agreeing to issue up to an additional 600,064 shares if certain development and commercial milestones are met. In July 2005, the Company issued 60,002 shares of SurModics common stock to the shareholders of InnoRx upon the successful completion of the first milestone involving the InnoRx technology acquired in the purchase of InnoRx. In March 2006, the Company issued an additional 60,007 shares a result of completion of the second milestone. Upon the successful completion of the remaining development and commercial milestones involving InnoRx technology acquired in the transaction, the Company will be required to issue up to approximately 480,060 additional shares of our common stock to the stockholders of InnoRx. As the transaction was accounted for as a purchase of assets, SurModics was required to determine the fair value of the assets acquired and the total consideration given. The assets of InnoRx we acquired consisted almost exclusively of in-process research and development assets. In the second fiscal quarter of 2005, we recorded a charge of $30.3 million to write-off the value of these in-process research and development assets. In connection with the purchase, the Company recorded an $8.1 million credit to additional paid-in capital to record the aggregate estimated value of the contingent payment obligations. Since the contingent payment obligations are recorded as additional paid-in capital, the obligations will not have any impact on future results of operations.
F-8
The Company expects to incur approximately $1.8 million of amortization expense in fiscal 2007 and 2008, $532,000 in fiscal 2009, and $113,000 in fiscal 2010 and 2011 related to all of its licenses and patents. Other assets consisted of the following as of September 30(in thousands):
| | 2006 | | 2005 |
| Abbott license | $ | 7,037 | | | $ | 7,037 | |
| Long-term portion of note receivable | | 5,635 | | | | — | |
| Investment in OctoPlus | | 4,095 | | | | 3,935 | |
| Investment in ThermopeutiX | | 1,000 | | | | 1,000 | |
| Patents and other | | 2,262 | | | | 732 | |
| Investment in Novocell | | 559 | | | | 5,210 | |
| Less accumulated amortization of intangible assets | | (3,609 | ) | | | (1,867 | ) |
| Other assets, net | $ | 16,979 | | | $ | 16,047 | |
Impairment of Long-Lived Assets
The Company periodically evaluates 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 investments. If such events or circumstances were to indicate that the carrying amount of these assets would 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) or other measure of fair value was less than the carrying amount of the assets, the Company would recognize an impairment loss. In fiscal 2004, the Company announced that after careful examination of its redefined business goals, the Company believed its Bloomington contract manufacturing facility was no longer necessary for the execution of its strategic plan. Accordingly, results in the third quarter of fiscal 2004 included a non-cash asset impairment charge of $16.5 million. In September 2005, the Company signed an agreement to sell the Bloomington property and facility and based on the selling price recorded an additional $2.5 million impairment charge in the fourth quarter of fiscal 2005.
Revenue Recognition
Royalty revenue is generated when a licensed customer sells products incorporating the Company’s technologies. Royalty revenue is recognized as the Company’s licensees report it to the Company, and payment is typically submitted concurrently with the report. The Company recognizes initial license fees over the term of the related licensing agreement. Revenue related to a performance milestone is recognized upon the achievement of the milestone, as defined in the respective agreements. Revenue on sales of the Company’s products is recognized when persuasive evidence of an agreement exists, delivery has occurred, the fee is fixed and determinable and collectibility is probable. Generally, these criteria are met at the time the Company’s product is shipped. Revenue for research and development is recorded as performance progresses under the applicable contract.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Ultimate results could differ from those estimates.
Reclassifications and Retroactive Adjustments
Fiscal year 2004 results have been retroactively adjusted to show the impact of accounting for InnoRx under the equity method. The net impact reduced net income an approximate $194,000 from previously reported results.
F-9
New Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3 (“SFAS 154”). This statement applies to all voluntary changes in accounting principle and changes required by an accounting pronouncement where no specific transition provisions are included. SFAS 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The provisions of SFAS 154 are effective for the Company for accounting changes and correction of errors made in fiscal 2007. The Company does not anticipate that the implementation of this standard will have a material impact on its financial position, results of operations or cash flows.
On July 13, 2006, FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109, was issued. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new FASB standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are effective for the Company beginning fiscal year 2008. The Company is currently evaluating the effect that the adoption of FIN 48 will have on its results of operations and financial condition.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement establishes a consistent framework for measuring fair value and expands disclosures on fair value measurements. SFAS No. 157 is effective for the Company starting in fiscal 2008. The Company has not determined the impact, if any, the adoption of this statement will have on its consolidated financial statements.
3. Stock-Based Compensation
Commencing October 1, 2005, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share Based Payment” (“SFAS 123(R)”), which requires all share-based payments, including grants of stock options, to be recognized in the income statement as an operating expense, based on their fair values, over the requisite service period. The Company recorded $5.5 million of related compensation expense, before taxes, for the year ended September 30, 2006. The $3.4 million compensation expense, net of related tax effects, reduced basic earnings per share by $.19 and diluted earnings per share by $.18 the year ended September 30, 2006. We additionally reclassified our unearned compensation on non-vested share awards (restricted stock) of $2.6 million to additional paid in capital. The cumulative effect adjustment for forfeitures related to non-vested share awards was immaterial.
As of September 30, 2006, approximately $18.7 million of total unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted average period of approximately 3.4 years.
Prior to adopting SFAS 123(R), the Company accounted for stock-based compensation under the intrinsic value method pursuant to Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” The Company has applied the modified prospective method in adopting SFAS 123(R). Accordingly, periods prior to adoption have not been restated. The Company did not amend or alter outstanding stock-based awards in anticipation of adopting SFAS 123(R). The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to the years ended September 30(in thousands, except per share data):
| | 2005 | | 2004 |
| Reported net income (loss) | ($ | 8,246 | ) | | $ | 7,242 | |
| Restricted stock expense previously recorded, net of tax | | 374 | | | | 134 | |
| Stock-based compensation determined under fair value based method, | | | | | | | |
| net of related tax effects | | (3,120 | ) | | | (1,876 | ) |
| Pro forma net income (loss) | ($ | 10,992 | ) | | $ | 5,500 | |
| Income (loss) per common equivalent share: | | | | | | | |
| Basic - as reported | | ($0.45 | ) | | | $0.41 | |
| Diluted - as reported | | ($0.45 | ) | | | $0.41 | |
| Basic - pro forma | | ($0.61 | ) | | | $0.31 | |
| Diluted - pro forma | | ($0.61 | ) | | | $0.31 | |
F-10
The Company uses the Black-Scholes option pricing model to determine the weighted average fair value of options. The weighted average fair value of options granted during fiscal 2006, 2005 and 2004 was $16.58, $20.26, and $14.57, respectively. The fair market value of each option is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for grants in 2006, 2005, and 2004, respectively: risk-free interest rates of 4.70%, 3.77% and 3.56%; expected lives of 4.8 years, 7.0 years, and 7.4 years; and expected volatility of 46%, 63% and 66%.
The Company’s Incentive Stock Options (“ISO”) are granted at a price of at least 100% of the fair market value of the Common Stock 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. Options 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. Options expire in 7 to 10 years and are exercisable at rates of 20% per year from the date of grant or 20% to 33% per year commencing one year after the date of grant. The Company has authorized 2,400,000 shares for grant under the 2003 Equity Incentive Plan (the “2003 Plan”), of which approximately 992,000 remain available for future awards. As of September 30, 2006, the aggregate intrinsic value of the option shares outstanding and the option shares exercisable was $11.5 million and $6.1 million, respectively with an average remaining contractual life of 4.71 and 3.7 years, respectively. The intrinsic value of options exercised during fiscal years 2006, 2005, and 2004 was $3.6 million, $6.5 million and $1.1 million, respectively. The fair value of options shares vested during fiscal years 2006, 2005, and 2004 was approximately $5.1 million, $4.6 million and $2.5 million, respectively. Option transactions under the prior plans and the 2003 Plan during the fiscal year ended September 30, 2006 are summarized as follows:
| | Number of | | Weighted Average |
| | shares | | Exercise Price |
| Outstanding at September 30, 2005 | 1,529,935 | | | $ | 26.60 | |
| Granted | 317,900 | | | | 36.87 | |
| Exercised | (176,735 | ) | | | 16.52 | |
| Forfeited | (160,320 | ) | | | 28.95 | |
| Outstanding at September 30, 2006 | 1,510,780 | | | $ | 29.69 | |
| | |
| Exercisable at September 30, 2006 | 546,920 | | | $ | 25.99 | |
| | | | | | | | | | Weighted Average | | | | | | | |
| | | Shares | | | | | | Remaining | | Shares | | | | |
| | | Outstanding at | | Weighted Average | | Contractual | | Exercisable at | | Weighted Average |
| Exercise Price Range | | September 30, 2006 | | Exercise Price | | Life (in years) | | September 30,2006 | | Exercise Price |
| $ | 2.50–$14.06 | | | 64,600 | | | $ | 6.57 | | | 2.20 | | 64,600 | | | $ | 6.57 | |
| $ | 20.64–$24.27 | | | 261,270 | | | | 21.57 | | | 4.91 | | 113,510 | | | | 21.54 | |
| $ | 25.09–$29.89 | | | 617,330 | | | | 28.77 | | | 4.58 | | 249,890 | | | | 27.90 | |
| $ | 30.13–$ 35.75 | | | 230,240 | | | | 34.85 | | | 5.13 | | 74,620 | | | | 34.92 | |
| $ | 36.37–$48.85 | | | | 337,340 | | | | 38.55 | | | 6.27 | | | 44,300 | | | | 39.88 | |
| | | 1,510,780 | | | $ | 29.69 | | | 5.00 | | 546,920 | | | $ | 25.99 | |
Restricted Stock Awards
The Company has entered into restricted stock agreements with certain key employees, covering the issuance of Common Stock (“Restricted Stock”). Under SFAS 123(R), 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. Compensation has been recognized for the estimated fair value of the 153,000 common shares and is being charged to income over the vesting term. Stock compensation expense recognized related to these awards totaled $879,000, $588,000 and $212,000 during fiscal 2006, 2005 and 2004, respectively.
F-11
| | Number of | | Weighted Average |
| | Shares | | Grant Price |
| Balance at September 30, 2005 | 108,000 | | | $ | 30.15 | |
| Granted | 65,000 | | | | 36.07 | |
| Vested | (5,500 | ) | | | 35.10 | |
| Forfeited | (14,500 | ) | | | 33.24 | |
| Balance at September 30, 2006 | 153,000 | | | $ | 32.14 | |
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 will vest upon the achievement of all or a portion of certain performance objectives which must be achieved during the performance period. Compensation has been recognized for the estimated fair value of the 42,000 shares awarded in March 2006 that are estimated to vest during fiscal 2006. Fiscal 2006 stock compensation expense related to the Performance Share awards expected to vest totaled $764,000. No such expense was recorded in fiscal 2005 or 2004.
1999 Employee Stock Purchase Plan
Under the 1999 Employee Stock Purchase Plan (“Stock Purchase Plan”) the Company is authorized to issue up to 200,000 shares of Common Stock. All full-time and part-time employees can choose to have up to 10% of their annual compensation withheld to purchase the Company’s Common Stock at purchase prices defined within the provisions of the Stock Purchase Plan. As of September 30, 2006, there was approximately $283,000 of employee contributions included in accrued liabilities in the accompanying balance sheets. Stock compensation expense recognized related to Stock Purchase Plan totaled $162,000 during fiscal 2006. No such expense was recorded in fiscal 2005 or 2004.
4. Income Taxes
The Company utilizes the liability method to account for income taxes. Deferred taxes are based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws.
The deferred income tax provision reflects the net change during the year in deferred tax assets and liabilities. Income taxes in the accompanying statements of operations for the years ended September 30 were as follows(in thousands):
| | 2006 | | 2005 | | 2004 |
| Current provision: | | | | | | | | | | |
| Federal | $ | 14,701 | | | $ | 7,059 | | $ | 8,697 | |
| State and foreign | | 1,501 | | | | 371 | | | 1,179 | |
| Total current provision | | 16,202 | | | | 7,430 | | | 9,876 | |
| Deferred provision (benefit): | | | | | | | | | | |
| Federal | | (774 | ) | | | 4,592 | | | (4,827 | ) |
| State | | (197 | ) | | | 574 | | | (639 | ) |
| Total deferred provision (benefit) | | (971 | ) | | | 5,166 | | | (5,466 | ) |
| Total provision | $ | 15,231 | | | $ | 12,596 | | $ | 4,410 | |
F-12
The reconciliation of the difference between amounts calculated at the statutory federal tax rate and the Company’s effective tax rate was as follows (in thousands):
| | 2006 | | 2005 | | 2004 |
| Amount at statutory federal income tax rate | $ | 12,440 | | | $ | 1,513 | | | $ | 4,146 | |
| Change due to: | | | | | | | | | | | |
| State taxes | | 720 | | | | 496 | | | | 351 | |
| Other | | (102 | ) | | | (10 | ) | | | (87 | ) |
| Stock Option Compensation | | 365 | | | | — | | | | — | |
| Valuation Allowance | | 1,808 | | | | — | | | | — | |
| Write-off of in-process R&D | | — | | | | 10,597 | | | | — | |
| Income tax provision | $ | 15,231 | | | $ | 12,596 | | | $ | 4,410 | |
In fiscal 2006, the Company recorded a valuation allowance against the capital loss created by our impairment of the Novocell investment (see Note 2). The valuation allowance was recorded as the Company does not currently foresee future offsetting capital gains to offset this capital loss. As such, no tax benefit has been recorded in our statement of operations.
The components of deferred income taxes consisted of the following as of September 30 and result from differences in the recognition of transactions for income tax and financial reporting purposes (in thousands):
| | 2006 | | 2005 |
| Depreciable assets | $ | 2,192 | | | $ | 1,584 | |
| Deferred revenue | | 552 | | | | 611 | |
| Accruals and reserves | | 354 | | | | 362 | |
| Restricted stock amortization | | 616 | | | | 273 | |
| Stock Options | | 1,302 | | | | — | |
| Impaired Asset | | 1,733 | | | | — | |
| Equity items | | 176 | | | | (33 | ) |
| Other | | 201 | | | | 424 | |
| Valuation Allowance | | (1,808 | ) | | | — | |
| Total deferred tax asset | | 5,318 | | | | 3,221 | |
| Less current deferred tax asset | | (435 | ) | | | (353 | ) |
| Noncurrent deferred tax asset | $ | 4,883 | | | $ | 2,868 | |
5. Commitments and Contingencies
The Company is involved from time to time in routine legal matters and other claims incidental to the business. The Company believes that the resolution of such routine matters and other incidental claims, taking into account established reserves and insurance will not have a material adverse impact on its financial position, results of operations, or cash flows.
6. Defined Contribution Plan
The Company has a 401(k) retirement and savings plan for the benefit of qualified employees. The Company matches 50% of each dollar of the first 6% of the tax deferral elected by each employee. Company contributions totaling $263,000, $223,000, and $210,000 have been charged to income for the years ended September 30, 2006, 2005, and 2004, respectively.
7. 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.
F-13
SurModics manages its business on the basis of the operating segments noted in the table below, which are comprised of the Company’s six business units. The three operating segments are aggregated into one reportable segment. The “Drug Delivery” operating segment contains the Drug Delivery business unit, which is responsible for technologies dedicated to site specific delivery of drugs, and the Ophthalmology division, which is dedicated to the advancement of treatments for eye diseases, such as age-related macular degeneration (AMD) and diabetic macular edema (DME), two of the leading causes of blindness. The “Hydrophilic and Other” operating segment consists of three business units: (1) Hydrophilic Technologies business unit, which focuses on enhancing medical devices with advanced lubricious coatings that facilitate their placement and maneuverability in the body; (2) Regenerative Technologies business unit, which is developing platforms intended to augment or replace tissue/organ function (e.g., cell encapsulation applications), or to modify medical devices to facilitate tissue/organ recovery through natural repair mechanisms (e.g., hemo/biocompatible coatings); and (3) Orthopedics business unit, which is committed to innovative solutions for orthopedics patients using proven SurModics technologies, and creating new technology solutions to existing patient care gaps in the orthopedics field. The “In Vitro” operating segment contains the In Vitro Technologies (formerly Diagnostics and Drug Discovery) business unit, which includes our genomics slide technologies, our stabilization products for immunoassay diagnostics tests, our in vitro diagnostic format technology and synthetic cell culture products.
Each operating segment has similar economic characteristics, technology, manufacturing processes, customers, regulatory environments, and shared infrastructures. The Company manages its expenses on a company-wide basis, as many costs and activities are shared among the business units and a majority of the Company’s employees reside in shared resource units. The focus of the business units is providing solutions to customers and maximizing revenue over the long-term. The accounting policies for segment reporting are the same as for the Company as a whole. Revenue for each operating segment for the years ended September 30 was as follows (in thousands):
| | 2006 | | 2005 | | 2004 |
| Operating segment: | | | | | | | | |
| Drug Delivery | $ | 32,918 | | $ | 29,678 | | $ | 25,690 |
| Hydrophilic and Other | | 22,233 | | | 19,065 | | | 15,527 |
| In Vitro | | 14,733 | | | 13,638 | | | 8,521 |
| Total Revenue | $ | 69,884 | | $ | 62,381 | | $ | 49,738 |
Major Customers
Revenue from customers that exceed 10% of total revenue was as follows for the years ended September 30:
| | 2006 | | 2005 | | 2004 |
| Cordis Corporation | 47 | % | | 46 | % | | 52 | % |
| Abbott Laboratories | 12 | % | | 14 | % | | 8 | % |
The revenues from each of the customers are derived from all three primary sources: licensing, product sales, and research and development.
Geographic Revenue
Geographic revenues were as follows for the years ended September 30:
| | 2006 | | 2005 | | 2004 |
| Domestic | 84 | % | | 85 | % | | 79 | % |
| Foreign | 16 | % | | 15 | % | | 21 | % |
8. Subsequent Events
In September 2006, the Board of Directors authorized the repurchase of $35 million and up to 1 million shares of the Company’s stock. In November 2006, the Company entered into a Rule 10b5-1 agreement and purchased $17.5 million of the $35 million in shares authorized at an average price of $32.87 per share.
F-14
In October 2006, our fiscal 2007, we made an additional investment of $1.9 million in OctoPlus, a company based in the Netherlands active in the development of pharmaceutical formulations incorporating novel biodegradable polymers, bringing our total investment to slightly more than $6.0 million, representing an ownership interest of approximately 9%.
9. Quarterly Financial Data (Unaudited)
The following is a summary of the unaudited quarterly results for the years ended September 30, 2006, 2005 and 2004 (in thousands, except per share data).
| | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter |
| Fiscal 2006 | | | | | | | | | | | | | | | | |
| Revenue | $ | 16,465 | | | $ | 17,707 | | | $ | 18,139 | | | $ | 17,573 | |
| Income from operations | | 8,580 | | | | 8,953 | | | | 9,463 | | | | 9,167 | |
| Net income | | 6,218 | | | | 1,465 | | | | 6,358 | | | | 6,293 | |
| Net income per share: | | | | | | | | | | | | | | | |
| Basic | | 0.34 | | | | 0.08 | | | | 0.34 | | | | 0.34 | |
| Diluted | | 0.33 | | | | 0.08 | | | | 0.34 | | | | 0.34 | |
| Fiscal 2005 | | | | | | | | | | | | | | | | |
| Revenue | $ | 14,069 | | | $ | 15,705 | | | $ | 16,518 | | | $ | 16,090 | |
| Income (loss) from operations | | 8,638 | | | | (21,148 | ) | | | 9,148 | | | | 6,346 | |
| Net income (loss) | | 5,237 | | | | (24,371 | ) | | | 6,095 | | | | 4,793 | |
| Net income (loss) per share: | | | | | | | | | | | | | | | |
| Basic | | 0.30 | | | | (1.34 | ) | | | 0.33 | | | | 0.26 | |
| Diluted | | 0.29 | | | | (1.34 | ) | | | 0.32 | | | | 0.25 | |
| Fiscal 2004 | | | | | | | | | | | | | | | | |
| Revenue | $ | 12,087 | | | $ | 12,738 | | | $ | 11,444 | | | $ | 13,469 | |
| Income (loss) from operations | | 6,287 | | | | 6,678 | | | | (10,787 | ) | | | 8,295 | |
| Net income (loss) | | 4,111 | | | | 4,305 | | | | (6,551 | ) | | | 5,378 | |
| Net income (loss) per share: | | | | | | | | | | | | | | | |
| Basic | | 0.24 | | | | 0.25 | | | | (0.37 | ) | | | 0.31 | |
| Diluted | | 0.23 | | | | 0.24 | | | | (0.37 | ) | | | 0.30 | |
In the second quarter of fiscal 2006, we recorded a $4.7 million non-cash impairment loss on our investment in Novocell, Inc.
In the second quarter of fiscal 2005, we recorded a charge of $30.3 million to write-off the value of in-process research and development assets acquired in the purchase of InnoRx. In addition, fiscal 2005 fourth quarter results include a $2.5 million impairment charge recorded against our contract manufacturing facility.
Fiscal 2004 results have been retroactively adjusted to show the impact of accounting for InnoRx under the equity method. The net impact reduced net income an approximate $67,000 in the second quarter, $61,000 in the third quarter and $66,000 in the fourth quarter from previously reported results. Fiscal 2004 third quarter results include an impairment charge recorded against our contract manufacturing facility. The $16.5 million impairment charge was included in loss from operations.
F-15
