MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
General
SurModics is a leading provider of surface modification solutions to
medical device manufacturers. The Company's revenues are derived from four
primary sources: fees from licensing its patented technology to customers;
royalties received from licensees; the sale of photo-reactive chemical compounds
to licensees and stabilization products to the diagnostics industry; and
research and development fees generated on projects for commercial customers and
government grants. In March 1998, the Company completed an initial public
offering ("IPO") of 4.6 million shares of Common Stock that generated proceeds
of $15.5 million, net of related offering expenses.
Fiscal 2000 was a record year for SurModics. Total revenues increased 35%
to $18.3 million from $13.5 million in fiscal 1999. The primary revenue growth
driver was PhotoLink, as demand for its coating technology continued to
increase. PhotoLink-related revenue increased 60% to a record $12.1 million in
fiscal 2000 from $7.6 million in 1999 as all categories showed double-digit
growth. PhotoLink royalties increased 73% to $6.8 million and reagent sales,
those chemicals used by licensees in the coating process, increased 28% to $2.4
million. These revenue gains resulted in a 120% increase in operating income to
$5.3 million from $2.4 million in fiscal 1999. Net income was $4.2 million, or
$.25 per diluted share, compared to $4.4 million, or $.27 per diluted share, in
fiscal 1999. However, the fiscal 1999 results included the reversal of a $2.5
million income tax valuation allowance related to net operating loss
carryforwards.
Results of Operations
Years Ended September 30, 2000 and 1999
Revenues. The Company's revenues were $18.3 million in fiscal 2000, an
increase of 35% over fiscal 1999. The revenue components were as follows:
<TABLE>
<CAPTION>
Increase % Increase
(Dollars in thousands) Fiscal 2000 Fiscal 1999 (Decrease) (Decrease)
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
PhotoLink revenue:
Royalties $6,763 $3,912 $2,851 73%
License fees 1,470 645 825 128%
Reagent sales 2,393 1,876 517 28%
Commercial development 1,445 1,122 323 29%
----- ----- ---
Total PhotoLink revenue 12,071 7,555 4,516 60%
Diagnostic royalties 2,917 2,758 159 6%
Stabilization & other products 2,687 2,261 426 19%
Government research 604 920 (316) (34%)
--- --- -----
Total revenues $18,279 $13,494 $4,785 35%
======= ======= ====== ===
</TABLE>
The revenue growth in fiscal 2000 was largely due to the 60% increase in
total PhotoLink revenue between years. PhotoLink royalties increased 73% due
primarily to sales growth of previously introduced coated products by licensees.
SurModics' clients now have 47 coated products on the market. Reagent sales
increased 28% due to increased production of coated devices by PhotoLink
clients. A single customer purchased 55% of the reagents sold during fiscal
<PAGE>
2000, down from 57% in fiscal 1999. More importantly, reagent sales to all other
customers increased 32% between years. During fiscal 2000, SurModics signed 10
new license agreements, compared to 14 new agreements executed in fiscal 1999.
Revenue from license fees increased 128% from fiscal 1999 due to the receipt of
a $1.0 million license fee from Motorola BioChip Systems during the fourth
quarter of fiscal 2000. The Company now has license agreements with 49 companies
covering over 100 product applications. Customer-funded development projects to
optimize the PhotoLink coatings for each customer's specific application
resulted in a 29% increase in commercial development revenue. Approximately 63%
of the commercial development revenue resulted from work on a project for a
single customer. This same customer accounted for 34% of the commercial
development revenue in fiscal 1999.
Non-PhotoLink revenue sources also grew in fiscal 2000; however, this
growth was offset by a reduction in government revenue. The diagnostic royalties
increased 6% between years. Most of this growth occurred in the first half of
the year, as FDA manufacturing issues at the sole licensee impacted royalties in
the second half. These royalties are expected to remain at a reduced level over
the next two or three quarters. Sales of stabilization & other products grew
19%. A 9% decrease in stabilization chemical sales was more than offset by large
growth in 3D-Link Activated Slides. Stabilization sales suffered from the loss
of a large customer. Finally, revenue from government grants decreased 34%
between years, as the Company has de-emphasized its reliance on grants and has
internally funded more of its research and development projects.
Product costs. The Company's product costs were $1.9 million for fiscal
2000, an increase of $400,000, or 26%, over fiscal 1999. Overall product margins
averaged 63% during both years. Efficiencies gained through increased sales
volumes were offset by additional scrap and labor costs.
Research and development expense. Research and development expense was
$6.8 million for fiscal 2000, an increase of $1.5 million, or 30%, over fiscal
1999. Most of this increase was due to compensation and benefit expenses
associated with the additional technical personnel hired by the Company during
the year. In addition, the Company incurred increased costs due to the build-out
of additional lab space within the current facility early in the year and the
associated costs to furnish the new space with equipment and supplies.
Sales and marketing expense. Sales and marketing expense was $1.6
million for fiscal 2000, a decrease of $200,000, or 11%, over fiscal 1999. This
decrease was due primarily to compensation and benefit expenses associated with
unfilled sales and marketing positions throughout the year. Some of these
positions were filled during the fourth quarter, so it is expected that sales
and marketing expense will be higher in fiscal 2001.
General and administrative expense. General and administrative expense
was $2.7 million for fiscal 2000, an increase of $100,000, or 5%, over fiscal
1999. The increase was primarily due to inflation, resulting in higher
compensation and benefit costs, and increased legal and professional fees.
Other income, net. The Company's net other income was $1.4 million for
fiscal 2000, an increase of $300,000, or 22%, over fiscal 1999. This income
primarily represents interest earned on the Company's investments. The level of
investments increased due to the $7.4 million of cash provided by operating
activities, $13.2 million from the issuance of Common Stock and higher yields
due to an increase in interest rates.
Income tax expense. The Company's income tax provision was $2.5 million
for fiscal year 2000 versus a $783,000 income tax benefit recorded in fiscal
1999. The Company's effective tax rate was 37% in fiscal 2000. The income tax
benefit in fiscal 1999 resulted from the reversal of an income tax valuation
allowance of approximately $2.5 million, reducing the Company's tax provision at
statutory rates to a net credit of $783,000.
<PAGE>
Years Ended September 30, 1999 and 1998
Revenues. The Company's revenues were $13.5 million in fiscal 1999, an
increase of 38% over fiscal 1998. The revenue components were as follows:
<TABLE>
<CAPTION>
Increase % Increase
(Dollars in thousands) Fiscal 1999 Fiscal 1998 (Decrease) (Decrease)
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
PhotoLink revenue:
Royalties $3,912 $2,205 $1,707 77%
License fees 645 222 423 191%
Reagent sales 1,876 794 1,082 136%
Commercial development 1,122 891 231 26%
----- --- ---
Total PhotoLink revenue 7,555 4,112 3,443 84%
Diagnostic royalties 2,758 2,578 180 7%
Stabilization & other products 2,261 2,004 257 13%
Government research 920 1,085 (165) (15%)
--- ----- -----
Total revenues $13,494 $9,779 $3,715 38%
======= ====== ====== ===
</TABLE>
The revenue growth in fiscal 1999 was mainly due to the 84% increase in
PhotoLink revenue between years. PhotoLink royalties increased 77% due to the
introduction of six additional coated products as well as increases in the sales
of previously introduced coated products by licensees. Reagent sales increased
136% due to increased production of PhotoLink-coated devices by these clients. A
single customer purchased 57% of the reagents sold during fiscal 1999, up from
12% in fiscal 1998. During fiscal 1999, SurModics signed 14 new license
agreements, compared to three new agreements in fiscal 1998, resulting in a 191%
increase in license fees. Increased customer-funded development projects
resulted in a 26% increase in commercial development revenue. Approximately 75%
of the commercial development revenue resulted from work on projects for two
customers. One of these customers accounted for 50% of the commercial
development revenue in fiscal 1998.
The growth of the non-PhotoLink revenues was more moderate in fiscal 1999.
The diagnostic royalties grew 7% between years due to increased product sales by
the licensee. Sales of stabilization chemicals grew 13% between years as a
result of increased market penetration. Finally, revenue from government grants
decreased 15% between years, as the Company began to internally fund more of its
research and development projects rather than relying on grants.
Product costs. The Company's product costs were $1.5 million for fiscal
1999, an increase of $300,000, or 27%, over fiscal 1998. Overall product margins
increased to 63% in fiscal 1999 from 57% in fiscal 1998. The margin improvement
was primarily due to cost efficiencies realized in the production of reagent
chemicals as a result of increased production volumes. The margins on
stabilization product sales remained relatively flat between years.
Research and development expense. Research and development expense was
$5.2 million for fiscal 1999, an increase of $700,000, or 16%, over fiscal 1998.
Most of this increase was due to compensation and benefit expenses associated
with the additional technical personnel hired by the Company during the year. In
addition, the Company incurred expense on project management training for its
technical personnel and increased legal expense related to the filing of new
patents. These cost increases were offset by a reduction in the amount of
research performed at external laboratories on government grants.
<PAGE>
Sales and marketing expense. Sales and marketing expense was $1.8 million
for fiscal 1999, an increase of $400,000, or 25%, over fiscal 1998. This
increase was primarily due to compensation and benefit expenses associated with
additional sales and marketing personnel hired during the year, increased
incentive compensation associated with the sales growth and increased
promotional spending. These cost increases were offset by a reduction in market
research costs.
General and administrative expense. General and administrative expense was
$2.5 million for fiscal 1999, an increase of $800,000, or 50%, over fiscal 1998.
The increase was primarily due to compensation and benefit costs associated with
additional personnel hired during the year, increased expenses associated with
being a public company for the full year (such as investor relations costs,
Nasdaq fees and other external reporting expenses) and expenses associated with
the shareholder rights plan adopted in fiscal 1999. In addition, a portion of
the overall increase was from expenses associated with the Company president,
who was appointed in the fourth quarter of 1998.
Other income, net. The Company's net other income was $1.2 million for
fiscal 1999, an increase of $400,000, or 59%, over fiscal 1998. The increase in
interest income was due to earnings generated on the investments resulting from
the $15.5 million of IPO proceeds received in March 1998. The level of
investments also increased due to the $4.4 million of cash provided by operating
activities in fiscal 1999.
Benefit from income taxes. The Company's net income was benefited by a
positive income tax adjustment. During fiscal 1999, management concluded that
the Company would generate sufficient taxable income in the future to utilize
all of the previously unrecognized tax net operating loss ("NOL") carryforwards
prior to their expiration. Therefore, during fiscal 1999, the Company reversed a
$2.5 million valuation allowance related to these NOL carryforwards.
Net Operating Loss Carryforwards
As of September 30, 2000, the Company had NOL carryforwards of
approximately $450,000 that expire in varying amounts through 2014. It is
expected that these NOL carryforwards will be fully utilized in fiscal 2001. The
Company also has $400,000 of capital loss carryforwards at September 30, 2000,
which expire in 2001. A valuation allowance has been established due to the
uncertainty of realization of the capital loss carryforwards.
Liquidity and Capital Resources
As of September 30, 2000, the Company had working capital of $18.7 million
and cash, cash equivalents and investments totaling $39.7 million. The Company
generated positive cash flows from operating activities of $7.4 million in
fiscal 2000, $4.4 million in fiscal 1999 and $2.1 million in fiscal 1998. The
increase in cash flows in fiscal 2000 was primarily due to the increased net
income generated during the year and the usage of NOL carryforwards, which
resulted in a limited amount of cash required for the payment of income taxes.
The significant increase in investing activities over the last year was
primarily due to the activity in the Company's available-for-sale investment
portfolio as managed by an independent investment manager. Additional funds were
available for investment due to the Company's positive cash flows and from the
issuance of Common Stock. SurModics' 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. A 10% increase in interest rates would result in an approximate
$380,000 decrease in the fair value of the Company's available-for-sale
securities as of September 30, 2000, but no material impact on the results of
operations or cash flows.
<PAGE>
The Company purchased $3.0 million of property and equipment in fiscal
2000, and $4.7 million in fiscal 1999, including $3.2 million for the land and
building it currently occupies. The most significant financing activity over the
last three years was the completion of the initial public offering of 4.6
million shares of Common Stock in March 1998, which generated net proceeds to
the Company of $15.5 million, net of related offering expenses. In August 2000,
the Company sold almost 800,000 shares of its Common Stock to Motorola, Inc. in
a private placement that generated $13.0 million. Proceeds from stock option
exercises generated an additional $200,000 and $1.3 million during fiscal 2000
and 1999, respectively.
As of September 30, 2000, the Company had no debt, nor did it have any
credit agreements. The Company believes that its existing capital resources will
be adequate to fund the Company's operations into the foreseeable future.
New Accounting Pronouncements
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 requires that license and other up-front fees be recognized
over the term of the agreement unless the fee is in exchange for products
delivered or services performed that represent the culmination of a separate
earnings process. The Company will adopt SAB 101 when required, which is
currently expected to be in the fourth quarter of fiscal 2001. The Company is
currently evaluating SAB 101 to determine whether its implementation will have
any material impact on the Company's financial position or results of operations
with respect to the license fees earned by SurModics. Any adjustment would
result in a charge to earnings for the cumulative effect of the change. This
amount would then be deferred and be recognized as revenue in future periods.
Forward-Looking Statements
Certain statements contained in this Annual Report and other written and
oral statements made from time to time by the Company do not relate strictly to
historical or current facts. As such, they are considered "forward-looking
statements" that provide current expectations or forecasts of future events.
These forward-looking statements are made pursuant to the safe harbor provisions
of the Private Securities Reform Act of 1995. Such statements can be identified
by the use of terminology such as "anticipate," "believe," "estimate," "expect,"
"intend," "may," "could," "possible," "plan," "project," "will," "forecast" and
similar words or expressions. The Company's forward-looking statements generally
relate to its growth strategy, financial results, product development programs,
sales efforts and the impact of the Motorola and Cordis agreements. One must
carefully consider forward-looking statements and understand that such
statements involve a variety of risks and uncertainties, known and unknown, and
may be affected by inaccurate assumptions. Consequently, no forward-looking
statement can be guaranteed and actual results may vary materially. The Company
undertakes no obligation to update any forward-looking statement.
Although it is not possible to create a comprehensive list of all factors
that may cause actual results to differ from the Company's forward-looking
statements, such factors include, among others, (i) the trend of consolidation
in the medical device industry, resulting in more significant, complex and
long-term contracts than in the past and potentially greater pricing pressures;
(ii) the Company's ability to attract new licensees and to enter into agreements
for additional product applications with existing licensees, and the willingness
of potential customers to sign license agreements under the terms offered by the
Company; (iii) the success of existing licensees in selling products
incorporating SurModics' technology and the timing of new product introductions
by licensees; (iv) the difficulties and uncertainties associated with the
lengthy and costly new product development and foreign and domestic regulatory
approval processes, such as delays, difficulties or failures in achieving
acceptable clinical results or obtaining foreign or FDA marketing clearances,
which may result in lost market opportunities or postpone or preclude product
commercialization by licensees; (v) efficacy or safety concerns with respect to
products marketed by SurModics and its licensees, whether scientifically
justified or not, that may lead to product recalls, withdrawals or declining
sales; (vi) the development of new products or technologies by competitors,
technological obsolescence and other changes in competitive factors; (vii)
economic factors over which the Company has no control, including changes in
inflation and consumer confidence. Investors are advised to consult any further
disclosures by the Company on this subject in its filings with the Securities
and Exchange Commission.
<PAGE>
Report of Independent Public Accountants
To SurModics, Inc.:
We have audited the accompanying balance sheets of SurModics, Inc. (a Minnesota
corporation) as of September 30, 2000 and 1999, and the related statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended September 30, 2000. 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 auditing standards generally
accepted in the 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, the financial statements referred to above present fairly,
in all material respects, the financial position of SurModics, Inc. as of
September 30, 2000 and 1999, and the results of its operations and its cash
flows for each of the three years in the period ended September 30, 2000 in
conformity with accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
Minneapolis, Minnesota,
December 6, 2000
<PAGE>
SurModics, Inc.
Balance Sheets
As of September 30
(thousands, except share data)
<TABLE>
<CAPTION>
2000 1999
-------- --------
ASSETS
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 1,510 $ 1,975
Short-term investments 15,847 3,947
Accounts receivable, net of allowance for doubtful accounts of $40 1,406 1,433
Inventories, net 500 459
Deferred tax asset 912 --
Prepaids and other 911 260
-------- --------
Total current assets 21,086 8,074
Property and Equipment, net 7,166 5,275
Long-Term Investments 22,293 15,917
Other Assets, net 204 2,692
-------- --------
$ 50,749 $ 31,958
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 379 $ 710
Accrued liabilities-
Compensation 1,110 783
Other 474 478
Deferred revenues 433 268
-------- --------
Total current liabilities 2,396 2,239
Deferred Revenues, less current portion 50 --
-------- --------
Total liabilities 2,446 2,239
-------- --------
Commitments and Contingencies (Note 6)
Stockholders' Equity
Series A preferred stock- $.05 par value, 450,000 shares
Authorized, no shares issued and outstanding -- --
Common stock- $.05 par value, 45,000,000 shares authorized
16,556,002 and 15,403,842 shares issued and outstanding 828 770
Additional paid-in capital 45,740 31,624
Unearned compensation (289) (267)
Stock purchase notes receivable (7) (58)
Accumulated other comprehensive loss (46) (187)
Retained earnings (accumulated deficit) 2,077 (2,163)
-------- --------
Total stockholders' equity 48,303 29,719
-------- --------
$ 50,749 $ 31,958
======== ========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
<PAGE>
SurModics, Inc.
Statements of Operations
For the Years Ended September 30
<TABLE>
<CAPTION>
(thousands, except net income per share) 2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Revenues
Royalties $ 9,680 $ 6,670 $ 4,783
License fees 1,470 645 222
Product sales 5,080 4,137 2,798
Research and development 2,049 2,042 1,976
-------- -------- --------
Total revenues 18,279 13,494 9,779
-------- -------- --------
Operating Costs and Expenses
Product 1,903 1,511 1,193
Research and development 6,797 5,248 4,522
Sales and marketing 1,573 1,769 1,419
General and administrative 2,673 2,547 1,697
-------- -------- --------
Total operating costs and expenses 12,946 11,075 8,831
-------- -------- --------
Income from Operations 5,333 2,419 948
-------- -------- --------
Other Income
Investment income and other, net 1,418 1,069 698
Gain (loss) on sale of investments (2) 89 28
-------- -------- --------
Other income, net 1,416 1,158 726
-------- -------- --------
Income Before Income Taxes 6,749 3,577 1,674
Income Tax 2,509 (783) 37
-------- -------- --------
Net Income $ 4,240 $ 4,360 $ 1,637
======== ======== ========
Net Income per Share
Basic $ .27 $ .30 $ .13
Diluted $ .25 $ .27 $ .12
Weighted Average Shares Outstanding
Basic 15,699 14,708 12,449
Dilutive effect of outstanding stock options 1,119 1,376 1,148
-------- -------- --------
Diluted 16,818 16,084 13,597
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
SurModics, Inc.
Statements of Stockholders' Equity
For the Years Ended September 30, 2000, 1999 and 1998
<TABLE>
<CAPTION>
Convertible Voting
Preferred Stock Common Stock Additional
Shares Amount Shares Amount Paid-In Capital
------ -------- ------ -------- --------
<S> <C> <C> <C> <C> <C>
Balance, September 30, 1997 377 $ 19 6,802 $ 340 $ 13,322
Components of comprehensive income:
Net income -- -- -- -- --
Change in unrealized gain on available-
for-sale securities -- -- -- -- --
Total comprehensive income
Common stock options exercised -- -- 52 2 111
Conversion of preferred stock to common stock (377) (19) 3,014 151 (132)
Issuance of common stock -- -- 4,600 230 15,291
Restricted stock activity -- -- (40) (2) (18)
Net loan activity -- -- -- -- --
Amortization of unearned compensation -- -- -- -- --
------ -------- ------ -------- --------
Balance, September 30, 1998 -- -- 14,428 721 28,574
Components of comprehensive income:
Net income -- -- -- -- --
Change in unrealized gain on available-
for-sale securities -- -- -- -- --
Total comprehensive income
Common stock options exercised, net -- -- 966 48 1,286
Tax benefit from exercise of stock options -- -- -- -- 1,650
Restricted stock activity -- -- 17 1 170
Net loan activity -- -- (7) -- (56)
Amortization of unearned compensation -- -- -- -- --
------ -------- ------ -------- --------
Balance, September 30, 1999 -- -- 15,404 770 31,624
Components of comprehensive income:
Net income -- -- -- -- --
Change in unrealized gain on available-
for-sale securities -- -- -- -- --
Total comprehensive income
Issuance of common stock -- -- 794 40 12,960
Common stock options exercised, net -- -- 360 18 220
Tax benefit from exercise of stock options -- -- -- -- 818
Restricted stock activity -- -- (2) -- 118
Net loan activity -- -- -- -- --
Amortization of unearned compensation -- -- -- -- --
------ -------- ------ -------- --------
Balance, September 30, 2000 -- -- 16,556 $ 828 $ 45,740
====== ======== ====== ======== ========
(Table continued)
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
(Table continued)
<TABLE>
<CAPTION>
Stock Accumulated
Purchase Other Total
Unearned Notes Comprehensive Accumulated Stockholders'
Compensation Receivable Income (Loss) Deficit Equity
-------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Balance, September 30, 1997 $ (259) $ (160) $ -- $ (8,160) $ 5,102
Components of comprehensive income:
Net income -- -- -- 1,637 1,637
Change in unrealized gain on available-
for-sale securities -- -- 278 -- 278
--------
Total comprehensive income 1,915
--------
Common stock options exercised -- -- -- -- 113
Conversion of preferred stock to common stock -- -- -- -- --
Issuance of common stock -- -- -- -- 15,521
Restricted stock activity 20 -- -- -- --
Net loan activity -- (22) -- -- (22)
Amortization of unearned compensation 69 -- -- -- 69
-------- ------- -------- -------- --------
Balance, September 30, 1998 (170) (182) 278 (6,523) 22,698
Components of comprehensive income:
Net income -- -- -- 4,360 4,360
Change in unrealized gain on available-
for-sale securities -- -- (465) -- (465)
--------
Total comprehensive income 3,895
--------
Common stock options exercised, net -- -- -- -- 1,334
Tax benefit from exercise of stock options -- -- -- -- 1,650
Restricted stock activity (171) -- -- -- --
Net loan activity -- 124 -- -- 68
Amortization of unearned compensation 74 -- -- -- 74
-------- ------- -------- -------- --------
Balance, September 30, 1999 (267) (58) (187) (2,163) 29,719
Components of comprehensive income:
Net income -- -- -- 4,240 4,240
Change in unrealized gain on available-
for-sale securities -- -- 141 141
--------
Total comprehensive income 4,381
Issuance of common stock -- -- -- -- 13,000
Common stock options exercised, net -- -- -- -- 238
Tax benefit from exercise of stock options -- -- -- -- 818
Restricted stock activity (118) -- -- -- --
Net loan activity -- 51 -- -- 51
Amortization of unearned compensation 96 -- -- -- 96
-------- ------- -------- -------- --------
Balance, September 30, 2000 $ (289) $ (7) $ (46) $ 2,077 $ 48,303
======== ======= ======== ======== ========
</TABLE>
<PAGE>
SurModics, Inc.
Statements of Cash Flows
For the Years Ended September 30
<TABLE>
<CAPTION>
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Operating Activities
Net income $ 4,240 $ 4,360 $ 1,637
Adjustments to reconcile net income to net cash provided by
operating activities-
Depreciation and amortization 1,126 709 617
Loss (gain) on sale of investments 2 (89) (28)
Amortization of unearned compensation, net 96 74 69
Change in deferred rent -- (30) (18)
Tax benefit from exercise of stock options 818 1650 --
Deferred tax provision 1,553 (2,465) --
Change in operating assets and liabilities:
Accounts receivable 27 (377) (134)
Inventories (41) (79) (116)
Accounts payable and accrued liabilities (8) 716 482
Deferred revenue 215 (53) (205)
Prepaids and other (651) (4) (181)
-------- -------- --------
Net cash provided by operating activities 7,377 4,412 2,123
-------- -------- --------
Investing Activities
Purchases of property and equipment, net (2,994) (4,721) (775)
Purchases of available-for-sale investments (52,862) (24,436) (33,595)
Sales/maturities of available-for-sale investments 34,725 23,972 17,455
Repayment (issuance) of stock purchase notes receivable 51 68 (22)
Other -- 3 32
-------- -------- --------
Net cash used in investing activities (21,080) (5,114) (16,905)
-------- -------- --------
Financing Activities
Issuance of common stock, net 13,238 1,334 15,634
-------- -------- --------
Net cash provided by financing activities 13,238 1,334 15,634
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (465) 632 852
Cash and Cash Equivalents
Beginning of year 1,975 1,343 491
-------- -------- --------
End of year $ 1,510 $ 1,975 $ 1,343
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
SurModics, Inc.
Notes to Financial Statements
1. Description
SurModics, Inc. (the Company) develops, manufactures and markets innovative
surface modification solutions to the medical device industry. The Company's
revenues are derived from the following: fees from licensing its patented
technology to customers; royalties received from licensees; the sale of
photoreactive chemical compounds to licensees, stabilization products to the
diagnostic industry, and coated glass slides to the genomics market; and
research and development fees generated on projects for commercial customers and
government grants. The Company markets its products through a direct sales force
primarily in the United States and some international markets.
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 corporate debt securities and are classified as
available-for-sale as of September 30, 2000 and 1999. 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 amortized cost, unrealized holding gains and losses, and fair value of
investments as of September 30, 2000 and 1999 were as follows (in thousands):
<TABLE>
<CAPTION>
September 30, 2000
-------------------------------------------------------------------
Amortized Cost Unrealized Unrealized Fair Value
Gains Losses
-------------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
U.S. government obligations $14,039 $52 $(74) $14,017
Corporate bonds 9,095 2 (14) 9,083
Mortgage-backed securities 9,003 35 (33) 9,005
Asset-backed securities 3,598 10 (7) 3,601
Municipal bonds 2,451 3 (20) 2,434
============== ========== ========== ==========
Total $38,186 $102 $(148) $38,140
============== ========== ========== ==========
<CAPTION>
September 30, 1999
-------------------------------------------------------------------
Amortized Cost Unrealized Unrealized Fair Value
Gains Losses
-------------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
U.S. government obligations $10,423 $ - $(134) $10,289
Corporate bonds 3,458 - (5) 3,453
Mortgage-backed securities 2,683 3 (28) 2,658
Asset-backed securities 2,310 - (8) 2,302
Municipal bonds 1,177 1 (16) 1,162
============== ========== ========== ==========
Total $20,051 $ 4 $(191) $19,864
============== ========== ========== ==========
</TABLE>
<PAGE>
The amortized cost and fair value of investments by contractual maturity at
September 30, 2000, were as follows:
Amortized Cost Fair Value
-------------- ----------
Debt securities due within:
One year $15,896 $15,847
One to five years 17,815 17,799
Five years or more 4,475 4,494
============== ==========
Total $38,186 $38,140
============== ==========
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 components as of September 30 (in
thousands):
2000 1999
---- ----
Raw materials $197 $179
Finished products 303 280
---- ----
Total $500 $459
==== ====
Property and Equipment
Property and equipment are stated at cost and are depreciated using the
straight-line method over three to twenty years, the estimated useful lives of
the assets. Upon completion, construction-in-progress will begin depreciation
over the estimated useful lives of the assets (in thousands).
2000 1999
------- -------
Laboratory fixtures and equipment $ 4,651 $ 3,009
Office furniture and equipment 1,790 1,383
Building and improvements 5,811 4,533
Construction-in-progress 52 408
Less-Accumulated depreciation and amortization (5,138) (4,058)
------- -------
Property and equipment, net $ 7,166 $ 5,275
======= =======
Other Assets
Other assets consist principally of patents, which are amortized over seven
to twelve years. Accumulated amortization was $87,000 and $64,000 as of
September 30, 2000 and 1999, respectively.
Revenue Recognition
Royalties are recognized as third-party licensees report sales of the
licensed product or as minimum royalties become due. Initial nonrefundable
license fees are recognized as revenue upon execution of the license agreement.
Certain nonrefundable license and research and development fees are recoverable
by the licensees as offsets against a percentage of future earned royalties.
<PAGE>
Revenues on product sales are recognized as products are shipped, and
revenues for research and development are recorded as performance progresses
under the applicable contract.
Cash received prior to performance is recorded as deferred revenues in the
accompanying balance sheets.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of 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 period.
Estimates are used for such items as depreciable lives and uncollectible
accounts. Ultimate results could differ from those estimates.
New Accounting Pronouncements
SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities," establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. The Company will adopt SFAS No. 133 on
October 1, 2000 with no expected impact on its financial statements.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 requires that license and other up-front fees be recognized
over the term of the agreement unless the fee is in exchange for products
delivered or services performed that represent the culmination of a separate
earnings process. The Company will adopt SAB 101 when required, which is
currently expected to be in the fourth quarter of fiscal 2001. The Company is
currently evaluating SAB 101 to determine whether its implementation will have
any material impact on the Company's financial position or results of operations
with respect to the license fees earned by SurModics. Any adjustment would
result in a charge to earnings for the cumulative effect of the change. This
amount would then be deferred and be recognized as revenue in future periods.
3. Stockholders' Equity
The Company effected a 2-for-1 split of its Common Stock on December 6,
2000, in the form of a 100% stock dividend. All share, per share and weighted
average share information has been restated to reflect the split.
On January 24, 2000, shareholders approved an amendment to the Articles of
Incorporation to eliminate all references in the Articles to a class of
Convertible Preferred Stock, shares of which were automatically converted as
part of the Company's initial public offering in 1998. The amendment also
increased the number of capital shares to 50,000,000 shares of capital stock,
$.05 per share par value, of which 45,000,000 shares are Common Stock, 450,000
are Series A Preferred Stock and 4,550,000 shares are undesignated. The Series A
Preferred Stock was designated by board action in conjunction with a Shareholder
Rights Plan and has certain preferential voting, liquidation and dividend rights
as follows:
a. Each share of Series A Preferred Stock is entitled to 200 votes on all
matters submitted to a vote of the stockholders of the Company.
b. In the event of liquidation of the Company, the holders of these shares are
entitled to receive the greater of $100 per share or 200 times the per share
amount to be distributed to holders of shares of Common Stock.
<PAGE>
c. Preferred stockholders are entitled to receive a quarterly dividend of the
greater of $1.00 per share or 200 times the per share amount of any dividend
declared on the Common Stock.
1999 Employee Stock Purchase Plan
During fiscal 2000, the Company adopted the 1999 Employee Stock Purchase
Plan (the "Stock Purchase Plan") under which the Company is authorized to issue
up to 200,000 shares of Common Stock. All full-time and part-time employees
(including officers) can choose to have up to 10% of their annual compensation
withheld to purchase the Company's Common Stock. The purchase price of the stock
is 85% of the average closing price over the five trading days immediately
preceding March 1, 2000 or the average closing price over the five days
immediately preceding February 28, 2001, whichever is less. The Company has not
issued any shares under the Stock Purchase Plan during fiscal 2000. As of
September 30, 2000, there was approximately $164,000 of employee contributions
included in accrued liabilities in the accompanying financial statements. The
Stock Purchase Plan does not allow an employee to purchase stock through the
Stock Purchase Plan if immediately after the grant of an option, he or she would
own stock representing 5% or more of the total combined voting power or value of
all classes of the stock of the Company. The Stock Purchase Plan will terminate
on February 28, 2010, unless the Board of Directors extends the term.
Restricted Stock Awards
The Company has entered into restricted stock agreements with certain key
employees, covering the issuance of Common Stock (the "Restricted Stock"). The
Restricted Stock will be released to the key employees if they are employed by
the Company at the end of a five-year waiting period. Unearned compensation has
been recognized for the estimated fair value of the applicable common shares,
reflected as a reduction of stockholders' equity, and is being charged to
operations over the five-year term.
Transactions in restricted stock were as follows:
Outstanding at September 30, 1997 252,800
Granted 8,000
Canceled (48,000)
Exercised (84,800)
-------
Outstanding at September 30, 1998 128,000
Granted 25,000
Canceled (8,000)
-------
Outstanding at September 30, 1999 145,000
Granted 11,000
Canceled (12,500)
Exercised (48,000)
-------
Outstanding at September 30, 2000 95,500
=======
Stock Purchase Notes Receivable
The Company established a loan program during fiscal 1997 to assist
employees in purchasing shares of the Company's stock. The loans are
collateralized by the employees' purchased shares and require annual interest
payments at a rate equal to prime at the date of issuance (8.5%) with principal
and any unpaid interest due at the earlier of five years after the date of
issuance or three months after termination of employment. The loans may be
repaid in either cash or mature shares held by the employee. No further loans
have been granted under this program since fiscal 1997.
<PAGE>
4. Stock-Based Compensation Plan
Under the Company's 1997 Incentive Stock Option Plan (the Plan), 1.2
million shares of Common Stock were reserved for issuance to employees and
officers. The Plan requires that the option price per share must be at least
100% of the fair market value of the Common Stock on the date of the grant of
the option 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 five to seven
years or upon termination of employment and are exercisable at a rate of 20% per
year from the date of grant or 20% per year commencing one year after the date
of grant. In addition, options representing a total of 170,220 shares remain
outstanding from the Company's 1987 Incentive Stock Option Plan which was
replaced by the 1997 Plan.
Under the Company's Nonqualified Stock Option Plan, 1,944,480 shares of
Common Stock were reserved for issuance to outside directors, employees and
officers. The options are granted at fair market value. Options expire in five
to ten years and are exercisable at a rate of 20% per year from the date of
grant or 20% per year commencing two years after the date of grant.
As of September 30, 2000, there were 603,560 additional shares available
for grant under the stock plans. Information regarding stock options under all
plans is summarized as follows:
<TABLE>
<CAPTION>
2000 1999 1998
----------------------- ------------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Options Shares Exercise Price Shares Exercise Price Shares Exercise Price
------------------------ --------- -------------- --------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding,
beginning of year 1,748,580 $ 3.76 2,539,280 $ 2.43 2,409,600 $ 2.30
Granted 270,300 23.74 367,400 7.87 274,600 3.49
Exercised (417,720) 2.56 (1,082,060) 2.08 (52,440) 2.24
Canceled (33,100) 4.83 (76,040) 2.91 (92,480) 2.39
--------- ------ --------- ------ --------- ------
Outstanding, end of year 1,568,060 $ 7.48 1,748,580 $ 3.76 2,539,280 $ 2.43
========= ====== ========= ====== ========= ======
Exercisable, end of year 727,280 $ 3.19 878,820 $ 2.59 1,515,720 $ 2.24
========= ====== ========= ====== ========= ======
Weighted average fair
value of options granted $16.92 $5.73 $2.45
========= ========= =========
</TABLE>
<PAGE>
The options outstanding at September 30, 2000 have exercise prices ranging
between $2.50 and $25.09, with a weighted average exercise price of $7.48 and a
weighted average remaining contractual life of 4.12 years.
The fair value of each option is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 2000, 1999 and 1998, respectively: risk-free
interest rates of 5.95%, 6.01% and 5.00%; expected lives of 7.2, 7.3 and 6.4;
and expected volatility of 72%, 71% and 73%.
The Company accounts for the options under APB Opinion No. 25, under which
no compensation cost has been recognized. Had compensation cost for the options
been determined consistent with SFAS No. 123, "Accounting for Stock-Based
<PAGE>
Compensation," the Company's net income would have been the following pro forma
amounts for the years ended September 30 (in thousands, except per share data):
2000 1999 1998
------ ------ ------
Net income:
As reported $4,240 $4,360 $1,637
Pro forma $3,565 $4,120 $1,506
Net income per share-diluted:
As reported $.25 $.27 $.12
Pro forma $.21 $.26 $.11
Because the SFAS No. 123 method of accounting has not been applied to options
granted prior to October 1, 1995, the resulting pro forma information may not be
representative of that to be expected in future periods.
5. 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. Reserves are established on the basis of
expected ability to utilize the deferred assets.
The deferred income tax provision (benefit) 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):
2000 1999 1998
------ ------ ------
Current provision:
Federal $ 904 $ -- $ 33
State and foreign 77 17 4
------ ------ ------
Total current provision 981 17 37
Deferred benefit:
Federal 1,528 (735) --
State -- (65) --
------ ------ ------
Total deferred benefit 1,528 (800) --
------ ------ ------
Total provision (benefit) $2,509 $ (783) $ 37
====== ====== ======
The reconciliation of the difference between amounts calculated at the statutory
federal tax rate and the Company's effective tax rate was as follows:
2000 1999 1998
------- ------- -------
Amount at statutory federal income tax rate: $ 2,500 $ 1,323 $ 621
Change due to:
Reversal of tax valuation allowance -- (2,466) --
Utilization of net operating losses -- -- (619)
Rate difference for deferred tax assets -- 180 --
Other 9 180 35
------- ------- -------
Income tax provision (benefit) $ 2,509 $ (783) $ 37
======= ======= =======
<PAGE>
The components of deferred income taxes consisted of the following as of
September 30:
2000 1999
------- -------
Net operating loss carryforwards $ 167 $ 2,048
Capital loss carryforwards 149 149
Depreciation 319 265
Deferred revenue 129 --
Accruals and reserves 297 152
------- -------
Total deferred tax assets 1,061 2,614
Less- valuation allowance (149) (149)
------- -------
Net deferred tax assets $ 912 $ 2,465
======= =======
These deferred tax assets result from differences in the recognition of
transactions for income tax and financial reporting purposes. The Company has
NOL carryforwards of approximately $450,000 at September 30, 2000. The Company
also has $400,000 of capital loss carryforwards at September 30, 2000, which
expire in 2001, on which a 100% valuation allowance has been established.
6. Commitments and Contingencies
Government Contracts
Under provisions contained in the government research contracts,
representatives of the government agencies have the right to access and review
the Company's underlying records of contract costs. The government retains the
right to reject expenses considered unallowable under the terms of the contract.
The Defense Contract Audit Agency has reviewed the contracts through 1989. In
the opinion of management, future amounts due, if any, with respect to open
contract years will not have a material impact on the financial position or
results of operations of the Company.
7. Defined Contribution Plan
The Company has a 401(k) retirement and savings plan for the benefit of
qualified employees. Under the plan, qualified employees may elect to defer up
to 20% of their compensation, subject to a maximum limit determined by the
Internal Revenue Service. Beginning October 1, 1998, the Company matched 50% of
each dollar of the first 6% of the tax deferral elected by each employee. In
prior years, the Company made discretionary contributions to the plan subject to
the approval of the Board of Directors. Company contributions totaling $138,000,
$122,000, and $117,000 have been charged to operations for the years ended
September 30, 2000, 1999 and 1998, respectively.
8. Operating Segments (Dollars in thousands)
Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance.
The Company manages its business on the basis of three business segments:
licensing, manufacturing, and research and development. The licensing segment
includes all license fees and royalty revenues generated from the transfer of
the Company's technology. No expenses are allocated to the licensing segment.
<PAGE>
The manufacturing segment includes revenue from the sale of PhotoLink reagents,
stabilization products and DNA slides. The expenses include all production
costs, including analytical costs to verify quality of the finished products and
certain technical support. The research and development segment includes the
revenue generated from development projects for commercial customers and
research revenues received from government grants. The expenses include all
costs of the Company's technical personnel. Corporate includes all
administrative, sales and marketing costs of the Company. These costs, along
with interest income and income taxes, are not allocated to the other business
segments. The Company's assets are not reviewed by business segment. The
accounting policies for segment reporting are the same as for the Company as a
whole (see Note 2).
<TABLE>
<CAPTION>
Research &
Licensing Manufacturing development Corporate Consolidated
--------- ------------- ----------- --------- ------------
<S> <C> <C> <C> <C> <C>
Year Ended September 30, 2000
Revenues:
PhotoLink $ 8,233 $ 2,393 $ 1,445 $ -- $ 12,071
Diagnostic 2,917 -- -- -- 2,917
Stabilization & other -- 2,687 -- -- 2,687
Government -- -- 604 -- 604
-------- -------- -------- -------- --------
Total revenues 11,150 5,080 2,049 -- 18,279
Expenses -- 1,903 6,797 4,246 12,946
-------- -------- -------- -------- --------
Operating income (loss) 11,150 3,177 (4,748) (4,246) 5,333
Other income 1,416
Income tax provision (2,509)
--------
Net income $ 4,240
========
Year Ended September 30, 1999
Revenues:
PhotoLink $ 4,557 $ 1,876 $ 1,122 $ -- $ 7,555
Diagnostic 2,758 -- -- -- 2,758
Stabilization & other -- 2,261 -- -- 2,261
Government -- -- 920 -- 920
-------- -------- -------- -------- --------
Total revenues
7,315 4,137 2,042 -- 13,494
Expenses -- 1,511 5,248 4,316 11,075
-------- -------- -------- -------- --------
Operating income (loss) 7,315 2,626 (3,206) (4,316) 2,419
Other income
1,158 1,158
Income tax expense
783 783
--------
Net income $ 4,360
========
Year Ended September 30, 1998
Revenues:
PhotoLink $ 2,427 $ 794 $ 891 $ -- $ 4,112
Diagnostic 2,578 -- -- -- 2,578
Stabilization & other -- 2,004 -- -- 2,004
Government -- -- 1,085 -- 1,085
-------- -------- -------- -------- --------
Total Revenues
5,005 2,798 1,976 -- 9,779
Expenses -- 1,193 4,522 3,116 8,831
-------- -------- -------- -------- --------
Operating income (loss) 5,005 1,605 (2,546) (3,116) 948
Other income 726 726
Income tax expense (37) (37)
--------
Net income $ 1,637
========
</TABLE>
<PAGE>
Major Customers
Revenues from customers that exceed 10% of total revenues were as follows for
the years ended September 30:
2000 1999 1998
--
U.S. government agencies 3% 7% 11%
Company A 20% 20% 26%
Company B 24% 12% 2%
Revenues from U.S. Government agencies are derived from the research and
development segment. Revenues from Company A are derived from the licensing
segment. Revenues from Company B are derived from all three revenue segments.
Geographic Revenue
Geographic revenues were as follows for the years ended September 30:
2000 1999 1998
---- ---- ----
Domestic 89% 87% 90%
Foreign 11% 13% 10%
9. Quarterly Financial Data (Unaudited, in thousands except per share data)
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Fiscal 2000
Revenues $4,149 $4,441 $4,165 $5,524
Income from operations 1,206 1,151 1,039 1,937
Net income 944 904 861 1,531
Net income per share:
Basic .06 .06 .06 .10
Diluted .06 .05 .05 .09
Fiscal 1999
Revenues $2,639 $3,308 $3,685 $3,862
Income from operations 265 591 755 808
Net income 925 1,105 1,214 1,117
Net income per share:
Basic .06 .08 .08 .07
Diluted .06 .07 .08 .07
<PAGE>
STOCK LISTING AND PRICE HISTORY
SurModics' stock is traded on the Nasdaq National Market under the symbol
"SRDX." The table below sets forth the range of high and low closing sale prices
for the Company's Common Stock, as reported by Nasdaq, since the date of the
Company's Initial Public Offering in March 1998.
FISCAL QUARTER ENDED HIGH LOW
---------------------------------------------------------
September 30, 2000 $ 28.46 $ 14.44
June 30, 2000 $ 18.66 $ 9.56
March 31, 2000 $ 17.31 $ 11.25
December 31, 1999 $ 16.06 $ 6.75
September 30, 1999 $ 9.38 $ 7.06
June 30, 1999 $ 8.38 $ 6.38
March 31, 1999 $ 7.25 $ 4.94
December 31, 1998 $ 7.75 $ 3.25
September 30, 1998 $ 7.06 $ 3.59
June 30, 1998 $ 5.88 $ 4.13
March 31, 1998 $ 4.50 $ 3.88
According to the records of the Company's transfer agent, as of November 27,
2000, the Company had 201 holders of record of the Company's Common Stock and
approximately 2,900 beneficial owners of shares registered in nominee or street
name.
The Company has never paid any cash dividends on its Common Stock and does not
anticipate doing so in the foreseeable future.
