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Edited Transcript of SRDX earnings conference call or presentation 31-Jul-19 9:00pm GMT

Q3 2019 Surmodics Inc Earnings Call

EDEN PRAIRIE Aug 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Surmodics Inc earnings conference call or presentation Wednesday, July 31, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gary R. Maharaj

Surmodics, Inc. - CEO, President & Director

* Timothy J. Arens

Surmodics, Inc. - CFO

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Conference Call Participants

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* Brooks Gregory O'Neil

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* James Philip Sidoti

Sidoti & Company, LLC - Research Analyst

* Michael John Petusky

Barrington Research Associates, Inc., Research Division - MD & Senior Investment Analyst

* Michael Stephen Matson

Needham & Company, LLC, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Surmodics Third Quarter Fiscal 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Tim Arens, Vice President of Finance and Chief Financial Officer. Please go ahead, sir.

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Timothy J. Arens, Surmodics, Inc. - CFO [2]

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Thank you, Todd. Good afternoon and welcome to Surmodics Fiscal 2019 Third Quarter Earnings Call. Before we begin, I would like to remind you that during this call we will be making forward-looking statements. These forward-looking statements are covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and include statements regarding Surmodics future financial and operating results or other statements that are not historical facts. Please be advised that actual results could differ materially from those stated or implied by our forward-looking statements, resulting from certain risks and uncertainties, including those described in our SEC filings. Surmodics disclaims any duty to update or revise our forward-looking statements as a result of new information, future events, developments or otherwise.

We'll also refer to non-GAAP measures because we believe they provide useful information for our investors. Today's news release contains a reconciliation table to our GAAP results. This conference call is being webcast and is accessible through the Investor Relations section of the Surmodics website, where the audio recording of the webcast will also be archived for future reference. A press release disclosing our quarterly results was issued earlier this afternoon and is available on our website at surmodics.com.

I will now turn the call over to Gary Maharaj. Gary?

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [3]

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Thank you, Tim. Good afternoon and thank you for joining us. First, I'd like to give a big shout out to our team at Surmodics. Even as we've been dealing with some unpredictably choppy waters, our team has not been phased. In fact they have doubled down, adapted and overcome the challenges that are within our control. The good results you will now hear about are because of their grit, thank you.

Our third quarter results demonstrated continued strong commercial and operational execution marked by our ability to simultaneously produce strong organic revenue growth and to make progress towards our key strategic initiatives. During the third quarter, we made excellent progress in the enrollment of our trends and trial. We advanced our AVess and Sundance drug-coated balloon programs and made important progress on our radial and thrombectomy device technology platforms. Our team continues to deliver consistent revenue growth driven by our medical device business unit. I'm confident that we are positioned for sustainable growth as we continue to make progress on the transformation of Surmodics into provider of unique products that improve patient outcomes, safety and health care economics.

Turning now to our results. In the third quarter, we generated revenue of $24.3 million, growing 9% over the third quarter of 2018. This included $2 million of revenue from our SurVeil agreement with Abbott. We also reported diluted GAAP earnings of $0.11 per share, non-GAAP earnings of $0.15 per share. As a result of our continued strong performance, we are raising our full-year revenue and earnings guidance for fiscal 2019 as Tim will discuss later. As we finish the final quarter of fiscal 2019. We are confident that both our Medical Device and IVD businesses will generate quarterly top line growth. And we will continue to execute on our three major strategic objectives for fiscal 2019.

As a reminder, these are, first, to ensure the success of SurVeil, specifically to complete patient enrollment in the TRANSCEND study and to make substantial progress towards achieving the CE Mark. Second, to continue to make meaningful advances within our DCB pipeline and our non-drug delivery device portfolio, including the acceleration of our thrombectomy platform development. And finally to continue to drive revenue growth and cash flow from our existing Medical Device coatings and IVD offering. These offerings provide significant and ongoing return on invested capital and cash flow, which fuels our strategic growth initiatives.

Starting with SurVeil, we remain acutely aware of the current uncertainty surrounding paclitaxel-coated devices and the potential impact on patients and the future of the therapeutic modality, including our own paclitaxel-coated balloon applications. As mentioned in our last earnings call, immediately following the FDA communication in March, we temporarily pause an enrollment in our TRANSCEND clinical study as we implemented the changes in response to the FDA's direct recommendations. These recommendations included updating the patient informed consent forms, ensuring rigorous and independent safety data review and improving long-term patient follow-up. The FDA subsequently hosted a meeting of its circulatory system devices panel in mid-June to discuss and make recommendations on paclitaxel devices.

The panel unanimously agreed that paclitaxel-coated devices have a certain near-term benefits of improved efficacy and an uncertain long-term risk of mortality, but ultimately should remain in the market. The panel also recommended labeling for paclitaxel devices should be updated to reflect the meta analysis findings of the presence of mortality signal. Panelists emphasized the need for physicians and patients to make joint decisions on the appropriate use of these devices. The panel also noted that the paclitaxel dose mortality relationship was inconclusive, pre-clinical animal testing has not provided any mechanic insights into the late mortality signals. And efforts to maximize existing data and complete ongoing trials to resolve this question is seen as preferable to requiring new and very large randomized controlled trials.

Finally, the panel recognized a large positive impact of these devices on the patient's quality of life. The worldwide TRANSCEND trial team has done a remarkable job of quickly and effectively providing the relevant updated information to trial sites and communicating with all stakeholders to un-pause the trial. As a result of these efforts and ongoing commitment of the trial investigators, I'm quite pleased to say that we are more than 90% complete with enrollment. We have fewer than 40 enrollments left to achieve the 446 patient enrollment milestone. This is a huge accomplishment to get trial enrollment back on track to this level. Recall that in the last earnings call, we were only 75% completed. If you do the math, you will recognize the significance of this accomplishment.

Our ability to complete this trial by the end of Q4 fiscal 2019 will depend on the enrollment rate achieved, especially in the month of August, as well as any further actions by the FDA with respect to the existing recommendation and use of paclitaxel coated devices. August can be a slow month for clinical trial enrollment in the US and Europe. Now we do have a couple of sites in the southern hemisphere, namely, Australia and New Zealand and we are within striking distance to complete the TRANSCEND enrollment in a high quality and efficient manner, and would absolutely love to get this done and meet our original commitment to complete enrollment by the end of the fiscal year. However, given the risk factors, I just described, even as we go all out to get this done, we continue to exercise prudent realism with regard to the fiscal 2019 revenue guidance, related to the SurVeil agreement with Abbott.

It's important to note that TRANSCEND trial has an independent steering committee comprised of the world's leading clinicians, with expertise in this specific area. They passionately support the trial, given its unique head-to-head design, multiple levels of Independent safety assessment and long-term follow-up. As a reminder, TRANSCEND is a head-to-head trial to assist Medtronic IN. PACT Admiral Drug-Coated Balloon and thus does not impose the use of the DCB treatment, rather a patient is only considered a candidate for participating in TRANSCEND after the treating physician has determined based on the applicable standard of medical care that the patients should be treated with the drug-coated balloon. TRANSCEND is in my opinion, one of the most highly monitored trials for this DCB devices.

We have an independent medical monitor and independent data and safety monitoring board, as well as an independent Clinical Events Committee, all comprised of physicians. And these will critically review the clinical efficacy and safety data in this area, including the five-year follow-up data. We are also continuing to make progress in our regulatory filing to obtain a CE Mark for SurVeil and expect to complete all data required for European submission in the fourth fiscal quarter. We are targeting CE Mark approval by the end of calendar 2019, although it is hard to predict how the European regulatory bodies will react to the recent debate on the FDA's guidance regarding paclitaxel-coated devices.

Turning to our drug-coated balloon product pipeline. We continue to make progress with our first in human study for AVess, our arteriovenous access drug-coated balloon, which can treat up to a total of 15 patients. We continue to target completion of enrollment in this trial by the end of fiscal 2019. Moving on to our innovative below-the-knee sirolimus drug-coated balloon, also known as Sundance. As you know below-the-knee disease this complex and multi-factorial, and our excellent progress this quarter positions us closer to delivering a device that has a significant favorable impact for these patients. I am again pleased to announce that we have successfully completed the required pre-clinical studies that allows us to finalize the formulations and dosing for Sundance.

We believe that this formulation and dosing provides an excellent, therapeutic window for maximizing the required drug effect while avoiding adverse events. This is a big step, since, we now have the critical information that allows us to begin the process for filing for regulatory approval to conduct a first in human clinical trial. While it is a tight timeline, we have targeted submission for regulatory approval to initiate the trial by the end of fiscal 2019. In the beginning of July, we acquired an innovative early stage technology for treating peripheral vascular disease, which is highly complementary to our product development pipeline. This technology has potential for use in multiple peripheral vascular applications in difficult lesions. This acquisition reflects our ongoing commitment to identify and acquire viable early stage technology platforms and intellectual property that completes our pipeline.

Turning to our non-drug delivery pipeline, we continue to make progress in the next wave of product innovations, including our radial artery access and thrombectomy platforms. We expect to commercialize as many as 15 of these in innovative and differentiated technologies over the next five years, which will help us build and doubled our addressable markets. By the end of fiscal '19, we are on track to file submissions for regulatory approvals for three to four more new devices. As part of these efforts, we continue to make major advances in our thrombectomy platform.

As mentioned previously, our newest devices uniquely designed to be easy to use, solve the problem on the table without the use of capital equipment. The devices performed extremely well to-date, and we continue to conduct pre-clinical assessments of its performance and have seen valuable clinician feedback in the coming months. We remain on track to complete this design activities by the end of fiscal 2019 and expect to submit our first application for regulatory approval by the end of the first quarter of fiscal 2020. Our goal is to expand this thrombectomy platform from material and deep vein thrombosis to ultimately treat stroke and pulmonary embolism.

Turning now to radial access, we continue to make substantial progress in designs of products for radial access to the peripheral arteries. Radial access offers many benefits relative to the femoral access, including puncture side bleeding, complications, early ambulation and reduced length of hospital stay, which results in lower health care costs. Our sublime guide sheet, which received 510(k) approval last quarter is another step forward in our strategy to provide these vascular solutions, including an entire family of radial products. This sheet as I've said before is available in 4, 5 and 6 French diameters and 120 centimeter to 150 centimeter lengths. We recently filed for US regulatory approval for our 2.5 meter long 014 PTA balloons that are capable of treating below-the-knee vessels using the radial approach.

As an example, Tim here is 6 foot 3 inches and these devices will be able to track all the way from his wrist through his long arms and long legs, all the way to his ankle, simply amazing. We intend to begin the development of our other radial access therapeutic devices in Q1 of fiscal '20.

Now for some even more good news. I'm quite happy to announce that literally just moments ago, we signed an agreement with a leading multinational medical device partner to commercialize our Telemark coronary support catheter in the United States and Europe. At the request of our partner, we've agreed to withhold announcing their identity until they formally launch the Telemark product, which we expect will occur during the first quarter of fiscal 2020.

This is a major top tier medical device worldwide manufacturer. Our medical device business continues to produce solid performance, benefiting from strengthening our coatings offerings. During the quarter, this business grew 13% on the top line, despite a tough top line comparison quarter, our IVD business continued to deliver improved and always excellent operating income performance of the quarter. Going forward, we expect modest mid-single-digit growth in our IVD business revenue, coupled with the expected double-digit revenue growth in our medical device business in fiscal 2019.

Looking ahead, we are on track to become a leading and enduring medical device innovator by combining our key strategic technology assets with our medical device customer relationships to deliver best-in-class products for the treatment and detection of disease. We are encouraged by our clinical regulatory and development achievements coupled with the ongoing top line performance and operational excellence, and intend to use this momentum of our recent accomplishments to further accelerate our pipeline. As I said, I'm proud of the team at Surmodics for creating this continued momentum in our business and look forward to sharing updates in the future.

I'll now turn the call over to Tim to provide more details on our third quarter fiscal 2019 results, as well as our outlook for fiscal 2019. Tim?

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Timothy J. Arens, Surmodics, Inc. - CFO [4]

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Thank you, Gary. Revenue for the third quarter of fiscal 2019 increased year-on-year for the sixth straight quarters. Driving our third quarter revenue performance was our medical device business, which generated sequential revenue growth for the sixth consecutive quarter. Total revenue for the quarter grew 9% to $24.3 million, as compared with $22.2 million in the third quarter of fiscal 2018.

Looking at our two business units, medical device delivered 13% revenue growth, increasing $2.2 million to $18.9 million in the third quarter. For our in vitro diagnostics business, third quarter fiscal 2019 revenue totaled $5.4 million, down 2% compared to the prior year quarter. Looking at specific areas within Medical Device, third quarter royalty and license fee revenue totaled $11.6 million, up $2 million from the comparable prior year quarter. As a result of the acceleration of enrollment in our TRANSCEND clinical study, we recognized $2 million of SurVeil revenue associated with the $25 million upfront license fee during the quarter. This compares with $1.7 million in the prior year quarter.

In addition, organic growth within our hydrophilic coating license portfolio resulted in more than $900,000 of additional royalty revenue, as compared with the prior year quarter. Finally, royalty revenue for the quarter includes $1 million benefit as a result of the extension of an existing hydrophilic coating license technology that was executed during the quarter. R&D Services revenue once again saw strong performance increasing $700,000 or 31% from the prior year quarter. Driving this continued performance was increased hydrophilic coating customer project activity, including support for our customers pre-commercial and commercial products.

Product sales decreased $500,000 or 9% as a result of declines in reagent sales, as well as sales of our non-proprietary medical device products. IVD revenue, which is comprised primarily of product revenue generated third quarter revenue of $5.4 million, down $100,000 or 2% compared with the prior year quarter. Our IVD revenue performance was impacted by lower sales of our distributed antigen products. Offsetting the decline in antigen sales was growth in our core product offerings. These include chemical components used in diagnostic tests and microarray slides, which together were up $300,000 or 7% from the prior year quarter.

Product gross margins for the quarter were 65.9% of product sales, as compared with 60.8% in the prior year quarter. Product gross margins as compared with the prior year quarter were impacted by product mix changes in our IVD business as well as favorable impacts from operating efficiencies and product mix in our medical device business. As a result of revenue, third quarter fiscal 2019 R&D expenses, including cost of clinical and regulatory activities totaled 55% compared with 44% in the year ago period. R&D expense was $13.3 million for the quarter, up $3.5 million from the third quarter of fiscal 2018. Increased R&D spending for the quarter was largely driven by activities to support our three drug-coated balloon programs, including our TRANSCEND clinical trial as well as proprietary product development activities. Specifically with regard to our [3D CD] programs, research and development cost increased $2.5 million from the prior year quarter.

As a reminder, we also saw a lower clinical trial expense in the fiscal 2018, third quarter related to the change in the scope of work with one of our clinical research providers. In addition, other R&D expenses, including the investments in our radial and thrombectomy platforms drew $1 million as compared with the prior year quarter. We continue to expect our full year, R&D expenses to be in the mid '50s as a percentage of revenue for fiscal 2019. SG&A expenses in the third quarter of fiscal 2019 were 24% of revenue versus 27% in the prior year period. On the dollar basis, SG&A in the third quarter of fiscal 2019 totaled $5.9 million as compared with $6 million a year ago. We expect our full year SG&A expenses to be in the mid '20s as a percentage around for fiscal 2019. As a reminder, Q3 2018 Operating expenses included a $7.9 million IP R&D charge, related to the thrombectomy technology acquisition. For fiscal 2019, we expect an IP R&D charge of approximately $1 million associated with the recent asset acquisition as Gary had mentioned in which we acquired an early stage technology that has the potential to enhance our product development pipeline.

Looking at the operating results of our two business segments, the Medical Device unit reported operating income of $750,000 in the third quarter versus an operating loss of $6.2 million in the prior year quarter, which included a previously mentioned $7.9 million IP R&D charge. Impacting the operating results for the quarter, aside from the prior year IP and R&D charge was strong revenue performance, offset by an increase in R&D expense. IVD operating income of $2.5 million in the third quarter increased $300,000 or 14% compared to the year ago period despite lower revenue for the current year quarter.

Operating income significantly outpace revenue performance for the quarter, as the business benefited from margin expansion due to operating efficiencies and favorable product mix. Operating margin in the third quarter of fiscal 2019 was 46%, compared to 39% in the prior year quarter. We recorded an income tax benefit of $260,000 in the third quarter of fiscal 2019, as compared with income tax benefit of $2.6 million in the prior-year period, which included the aforementioned IP R&D charge.

On a GAAP basis, our diluted earnings totaled $0.11 per share in the current year quarter as compared with a loss of $0.20 per share in the third quarter of fiscal 2018. On a non-GAAP basis, quarterly earnings per share was $0.15 in the third quarter of fiscal 2019 as compared with $0.27 per share in the prior year quarter. We continue to maintain a strong balance sheet, cash and investments totaled $45 million at quarter end. We used cash in operations of $500,000 in the third quarter. In addition, we invested $1 million in production plant and equipment during the third quarter of our fiscal 2019.

Our current cash and investment balances and expected operating cash flows provide adequate capacity to support our corporate strategic growth initiatives. Given the strong third quarter operating results, we are raising our fiscal 2019 revenue expectations to a range of $92 million to $94 million from our previous revenue range of $88.5 million to $91.5 million. Our outlook now includes between $7.5 million to $8 million of revenue from our SurVeil distribution and development agreement with Abbott, which compares to our previous guidance of $7 million to $7.5 million.

As Gary mentioned at the top of the call, enrollment in our TRANSCEND clinical study is greater than 90% complete, and while we are optimistic that enrollment may be completed by fiscal year-end, our guidance assumes full enrollment does not occur until the first fiscal quarter of 2020. Should we achieve the $10 million full enrollment milestone during fiscal 2019, we would expect to recognize an additional license fee revenue of approximately $5 million in the fourth quarter. As a result of our continued strong revenue performance, we are increasing our fiscal 2019 diluted GAAP EPS to range from $0.24 to $0.32 per share. Compared with our previous expectations of $0.14 to $0.24 per share. Non-GAAP diluted EPS is now expected to be in the range of $0.41 to $0.49 per share compared with previous expectations of $0.26 to $0.36 per share. Our full-year non-GAAP EPS guidance reflects a $0.05 charge related to the previously mentioned Q4 technology asset acquisition.

Operator, this concludes our prepared remarks. We would now like to open the call to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from Mike Mattson of Needham and Company.

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Michael Stephen Matson, Needham & Company, LLC, Research Division - Senior Analyst [2]

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I guess I'll just start with the FDA panel in the paclitaxel situation. So I guess, Gary, at this point based on everything that we know and the way the panel went, in what sort of your best guess as to what the FDA does? And then what sort of timing do you expect on that? I know there has been some other companies out there saying that they expected something potentially by the end of August, so I wanted to see if that was consistent with your views?

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [3]

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So my best guess will have some limiters on it based on what I saw at the panel meeting. The FDA, I'm sure has other factors in consideration when they do come out. And if they do come out with a recommendation, I did view the panel as being very balanced. They clearly sought based on the meta analysis there was signal, but as you saw -- the large observational data bases, which on the second day were propensity matched with adjusted risk factors showed absolutely no signal and some of those data bases from VQI and CMS, I think over 100,000 patients. So that's a big factor that's unresolved. What really came through for me on the second day and first of all I will say the medical device companies or competitors just did an amazing job of collaboration.

I didn't think that I'd ever witnessed that level of collaboration amongst competitors, in what I believe is the best interest of the patient in the industry. But on the second day what really came out to me was that the quality of life impact on these patients and patient welfare suggests that the patients have a say in what they get treated with and so -- if a patient is well informed and well consented, they should be able to choose a treatment because in many cases quality of life may trump the potential murkiness of quantity of life in the signal.

And so I thought I came through loud and clear. I think the second things is as the FDA wrote their minutes, it always telling in what we see and observe and what somebody writes -- as the organization writes as a minute. I thought the minutes were spot on and in fact I would say a kindler, gentler minutes that -- I thought they would write. So who knows, I mean the best minds are thinking that there's going to be certainly some clinical follow up and market follow up. There may be some sort of our trial that is conjoined by all the manufacturers on this, not a major clinical randomized trial, but a trial that actually does post market follow-up of these patients. And there might be some labeling requirements that will be changed. I don't know how that's going to be implemented and over what period of time, so that's been suggested as well.

And then finally, this important factor of therapeutic consent between the doctor -- the treating physician and the patient. How do you explain a fairly unstraightforward signal to a patient who has this disease? And so I think that's going to be part of it. Beyond that and I simply don't know the timing. I've heard on other earnings call that it would be imminent. Now keep in mind, this is marketing a product -- approved product issue in United States. So clearly the FDA will be -- I can imagine communicating directly with those manufacturers, where in our case we're not an approved products so there is some action, we may not be within that inner circle. So I would go with what we heard from the strategics who have approved products in terms of timing.

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Michael Stephen Matson, Needham & Company, LLC, Research Division - Senior Analyst [4]

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And I mean, I guess just to summarize, do you expect the outcome of this to and up being sort of more positive than the FDA's prior statement and allow the market to recover at all. The market for paclitaxel DCB to recover at all from the hit that it has taken as a result of all this. Again I'm not asking, this is kind of going to go back to where it was. There is some sort of inflection point here and a recovery in utilization of the products?

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [5]

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I expect that. I mean, between statistical idealism, where you only look at randomized controlled studies and then look for confirmation from observational studies, and the other part of (inaudible) statistical pragmatism where very large propensity matched observational studies are showing you nothing. I think that's a really, really important factor here. Neither of them can be fudged. The answer is somewhere in between there, which fits in-between would suggest a lower mortality risk in the real world of patient care versus trials that were not developed specifically for mortality. And the FDA did say they weren't looking for a 40,000 patient study. I think (inaudible) himself said that.

What I believe is a trigger point is, it is a medical-legal standard of care here, that has become the limiting issue because the current recommendation I believe makes it exceedingly difficult from the physicians I talked to. And I would say this provocatively they would say to properly treat their patients. And so if the FDA's recommendation is shifted to be either milder, but more (inaudible) to take treating physicians out of their concerns of medical-legal risk, I believe the market will absolutely recover. There is a pent-up demand and there aren't really good solutions for these patients, and the quality of life is right in everybody's face of how dramatic positive impact these devices have had. So I think the seminal issue in the market, I believe is giving some relief to the risk of medical-legal issues for treating physicians in the United States.

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Michael Stephen Matson, Needham & Company, LLC, Research Division - Senior Analyst [6]

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And then just one additional question on Telemark. So great to hear that you've got a deal. I know you can't tell us yet who the partner is. But can you tell us anything about -- well one I just wanted to hear the timing, I think you said it. And two, the structure of the deal, I mean I assume you're going to -- is it going to be similar to the Abbott deal, where you're manufacturing the product, getting a transfer price and then -- profit sharing or is it more just straight-up just the transfer price?

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [7]

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Yes, I'll take the first part and then, Tim will talk about the second part. First of all, we would have liked to put this in our press release, but I mean literally not figuratively, the deal was just fine. And so unfortunately, we just had to verbalize it in the earnings call and I imagine we will be filing an 8-K on it. But this is a very large strategic partner. Remember our customer relationship is both wide and deep and so this will be commercialization of this device in the United States and Europe. As far as the -- probably the high level part of the deal, Tim.

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Timothy J. Arens, Surmodics, Inc. - CFO [8]

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Mike, great question and to provide a little clarity. It is a different agreement with different mechanics versus the added agreement. And the way to think about the agreement with this partner for Telemark is to really think about it as a distribution agreement. So Surmodics will manufacture the product. We'll put it in the box with the partner's name on it, and we will ship it to the partner and for that we will receive a transfer price. So this will show up in product revenue when we get to that point.

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Michael Stephen Matson, Needham & Company, LLC, Research Division - Senior Analyst [9]

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And that will start in the first quarter of calendar '20, is that fiscal '20?

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Timothy J. Arens, Surmodics, Inc. - CFO [10]

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That would be fiscal '20. That's the expectation.

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [11]

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And the reason for not being identified is the [U. S.], as we know, [where Switzerland] with many partners. For competitive reasons, they want a chance to develop their launch plans. Clearly, you’ll see -- I believe you will see the Telemark name on the product. So you will identify that is where (inaudible).

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Timothy J. Arens, Surmodics, Inc. - CFO [12]

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It's pretty exciting day for us Mike.

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Michael Stephen Matson, Needham & Company, LLC, Research Division - Senior Analyst [13]

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I completely understand why they don't want to disclose it. So I'm not concerned about that, but I'll get to other question -- I'd have is just will this be -- I would assume then that this you would factor this into your fiscal '20 guidance when you get it?

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Timothy J. Arens, Surmodics, Inc. - CFO [14]

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That's correct.

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Operator [15]

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We'll take our next question from Brooks O'Neil with Lake Street Capital Markets.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [16]

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I just want to continue on with Mike's line of questioning there for a second. Should we expect any kind of upfront payment or any kind of milestone payment or is the distribution agreement type structure? What we're going to see on Telemark?

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Timothy J. Arens, Surmodics, Inc. - CFO [17]

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Brooks, there will be no upfront. And as I was describing with Mike's question, it will be really just as described. We will manufacture the product and ship it over to the partner, and for which we will receive the transfer price. So it really will be -- will invoice and that will be shown up on the P&L as product revenue.

And it's exciting, this partners has a very strong channel presence, which is why we, as I said we wanted to -- it's worth the wait for the right deal, but their channel presence in this particular segment is excellent around the world, actually.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [18]

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So just continuing on, you mentioned Gary, the Sundance licensing opportunity. I'm assuming that said in earlier stage maybe still reached out into the marketplace, but can you give us any feel for what you're seeing or what likely progress or for pathway is for that product?

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [19]

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For Sundance BTK, first of all it's our proprietary 014 balloon platform developed by our Irish team and its sirolimus. And we took some time to optimize. Just as we did with SurVeil, it's sort of painful to optimize dose and the therapeutic window we call. We want the biggest therapeutic window. So I don't know this because I don't know what the other sirolimus companies technology performance very well. I should say, I know what's published, but I don't know the insight. We were able to reduce the dose of the drug and get an incredibly strong signal, which is just -- that's the direction you want to go as those trade off curves head in two ways. So the next step is really deciding what this first in human trial.

Earlier today, I was part of that team working through the biostatistics on that trial. And so how many patients would be treated and what part of the world. And so we haven't made those decisions yet because we're trying to optimize for both the quality and capability of patient treating BTK disease. As you know that BTK trials are exceedingly difficult to perform, given the morbidity and mortality that these patients experience.

So we're taking our time to design that, but we -- our team still intends to file for the regulatory approval to start the trial by the end of the quarter, which is not the same as starting to trial by the end of our fiscal year. Realistically, it will take a couple of quarters before we can even contemplate starting the trial because we're not in control of the regulators and which geography, they allow us to start this in. And then the trials startup time. So I don't want to ballpark it too much, but it'll be great if this happened towards the end of our second fiscal quarter next year. The team is going to beat me up as soon as I leave the room for saying that, but that would be a good goal.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [20]

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And then my last question is just, I'm trying to ballpark the percent of your current revenue that is related in any way to paclitaxel. Let's take SurVeil out of that and I'm not looking for a super precise number, but I'm just sort of a ballpark number, what should we kind of figure of the current Surmodics' revenue paclitaxel or related?

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [21]

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Thank you Brooks. As far as our hydrophilic coating revenue, we have no customers leveraging our hydrophilic coatings on paclitaxel or related devices. So the only, the only thing that we have with regard to revenue for paclitaxel would of course be tied to both our AVess drug-coated balloon as well as our SurVeil drug-coated balloon.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [22]

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So it's pretty small, right?

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [23]

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As far as SurVeil, it's about $7.5 million to $8 million this year and we expect that to be growing, but it's even lower than small, it's zero

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Operator [24]

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[Operator Instruction] We'll take our next question from Michael Petusky (sic) [Petuskyon] of Barrington.

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Michael John Petusky, Barrington Research Associates, Inc., Research Division - MD & Senior Investment Analyst [25]

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Tim, just a quick question. So assuming you guys and I know you're saying obviously it could slip into early '20, but assuming you guys were to complete enrollment of the SurVeil trial, you said $5 million licensing fee would hit in Q4, is that right or would it hit in Q1 or can you just speak of that?

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Timothy J. Arens, Surmodics, Inc. - CFO [26]

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Right now our guidance would be that we will complete the enrollment in Q1 of fiscal 2020 and received the $10 million payment, and a good way to think about it is approximately $5 million would be recorded as revenue in the period that we complete the enrollment. If it were to be completed in September, would have that obviously be an impact in Q4 and for the fiscal 2019 so that $5 million would show up in that period.

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Michael John Petusky, Barrington Research Associates, Inc., Research Division - MD & Senior Investment Analyst [27]

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And then there'll be another $5 million that would come in over time, is that right?

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Timothy J. Arens, Surmodics, Inc. - CFO [28]

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That's correct. Similar to how we think about -- in fact, it's the same construct in terms of revenue recognition that we employ for the SurVeil $25 million. All milestone payments will be recognized using the same approach, which I think we've talked about in the past is really matching cost for the obligations that we have to Abbott, and as we complete the work, we can take a look at what the percentage of the total costs are for that period and we recognize that revenue in that period. So as you can imagine as we get further to completing the study, at some point it will be 100% complete, until we'll recognize 100% of all the revenue. But I think what we've communicated previously is by the time we complete the enrollment, we expect to be about 50% of the expenses will have been incurred. So we should be recognizing about 50% of the revenue for any achieved milestones, hence the $5 million of the $10 million.

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Michael John Petusky, Barrington Research Associates, Inc., Research Division - MD & Senior Investment Analyst [29]

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And then, Gary, I guess, obviously the timing of these 5 10k partnerships is not the easiest, but any expectations over the next 6 to 12 months in terms of what you guys maybe can achieve there?

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [30]

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I think that we have lesson learned list here. So the first thing is really -- having a clearance doesn't mean having product available, it's always the case right. I mean, you get the clearance and you're trying to get design transfer and manufacturing and all those things. So what that means is product isn't available for clinical evaluations and the lesson learned here is we need to give the time for that, and then the real big thing is we want to do the clinical evaluations of these products. I would suggest before any other strategic gets their hands on it. Because, a, I think it purchases a little bit of a negotiation disadvantage. And we know the world's leading clinicians as well and so as we develop the dots of the value of this device, a significant part of that dot is not IP and the regulatory clearance and benched up performances. How does it work in the real world and we'd like to make sure we own that first.

Getting 100 users of the device typically tells you quite a lot of about the device. The only things you learn in the future, but 100 users is a good benchmark and that can take an additional quarter as well. So I think the first thing is the lesson we've learnt is don't see a quarter or two really to get the right deal, it's three to four. So I know that gives you some flair. And by the way, I may have misspoken, I said we'll be filing three to four more devices, I really meant three to four devices in fiscal '19, which is what we are committed to earlier.

So add three quarters to it and I believe we'll get -- it sounds like a long time, but the NPV of these things as you look at getting the right deal is still better if you take the time to get it. And as far as the 014 and 018, the low profile BK balloon catheters, we are currently in -- what I hope and believe is a final negotiation of a commercialization agreement with yet another large strategic partner. And I hope we can share updates on that by the next earnings call.

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Michael John Petusky, Barrington Research Associates, Inc., Research Division - MD & Senior Investment Analyst [31]

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So both of those are potentially with the same entity?

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [32]

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The 014 and 018 could be potentially with one entity because they both -- one popliteal, one phlebotomy device is complementary. So it's a good deal to get both of those.

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Operator [33]

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We'll take our next question from Jim Sidoti of Sidoti & Company.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [34]

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With regards to the part of the Telemark, you said somebody you do business with now or is that a new customer?

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Timothy J. Arens, Surmodics, Inc. - CFO [35]

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I will say it's one of the world's largest strategics and it's likely Jim.

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [36]

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You can call them on the market. You can count the number on one hand,

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [37]

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And is it likely that they might be interested in anything else in your portfolio?

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Timothy J. Arens, Surmodics, Inc. - CFO [38]

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We probably not comment on that, but I will say our portfolio at Switzerland, it depends on the need and any gaps in their portfolio and this is a generalization for the strategics, right. So if we have something, they don't have that really is the level of interest. So clearly being a large strategic, the things we're developing, I believe will be of interest to all of them.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [39]

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And then for fiscal '19, you took the revenue guidance up a couple of million. That does not include anything from completing the clinical trial. So what prompted that?

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Timothy J. Arens, Surmodics, Inc. - CFO [40]

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Really just, it's a really fantastic quarter and let's take a look at the performance for the first nine months of the year. We're just clicking on all cylinders. Our med device business is growing really well. I heard as describe what the reasons for the growth, just real strong organic growth within the portfolio for royalties. We're seeing really nice growth with regard to the what we call the R&D Services. IVD continues to perform very well. If you take a look at this quarter, they had a little bit of a hiccup in terms of the year-on-year revenue growth, which is driven by distributed product, but the underlying business, the core chemical components that are used in diagnostic tests grew about 7%. And so as we think through kind of what the team is expecting for Q4, we're left with really positive results, which resulted in us bringing up the guidance.

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [41]

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I'll just add one comment there. I don't typically have the company take credit for everything here, but that is because our management team -- this capital allocation on legacy businesses. We always say we're not cash calling those businesses. It’s significant investment and so when we look at capital allocation, we don't do all pocket on number 7, right. The growth business clearly and the medical devices is getting a lion's share of it, but the parts of the business in medical device and coatings, hydrophilic reagents and diagnostics clearly have very high return on invested capital and returns depending on that. So it really comes out the dynamic capital allocation. So even if we hit a paclitaxel issue we still have good performance in those businesses, which is remarkable for the Company -- in my opinion to be able to do that.

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Timothy J. Arens, Surmodics, Inc. - CFO [42]

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And Jim, I'll just also make reference to SurVeil and revenue recognition there. As Gary mentioned, the team has done a fantastic job in terms of enrollment and as we think through how to think about SurVeil revenue for the year, it's really closely tied to enrollment rate and we brought that up from the prior-year guidance in May. So you're looking at -- going from $7.5 million to $8 million. So you got to $0.5 million to $1 million swing right there. So it's really generally speaking we're really doing well across the business on all fronts.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [43]

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And the IVD business operating income it looks like it's up, despite having revenue downward a bit. Is that correct?

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Timothy J. Arens, Surmodics, Inc. - CFO [44]

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They do, they are amazing. If you saw the revenue is down about $100,000 and operating income was up a couple of hundred thousand, $300,000. Operating margins continue to expand. The team is really, really focused on operating efficiencies and driving the top line and we benefit from that in the operating income line.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [45]

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Is there anything else you can tell us about the technology acquisition you completed earlier this month?

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [46]

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I'm under a gag order by everybody here. I wish I could talk about it. And the reason -- what I will say is that they are still difficult to treat lesions and they plague physicians, especially in the lower extremity. And so what's this technology? It's embryonic, which is why IP is filed. We will be filing a lot more. So we really want to preserve and you would want to us to preserve that competitive capability of it and give it a chance to bloom. But it in my opinion, it would significantly change the ability to treat these lesions and also not have to have a lot of product in the cath lab. We always keep an eye on health care economics. And so those two things -- thrombectomy as an example is not a capital equipment-based product and that by itself takes a huge chunk out of cath lab costs, if you can solve the problem without it. So think of this along the same genre of it, but to treat difficult lesions.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [47]

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Did I hear you say that there'll be about $1,000 of (inaudible) R&D booked in the quarter -- in the fourth quarter?

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Timothy J. Arens, Surmodics, Inc. - CFO [48]

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It's $1 million.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [49]

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$1 million, but you took your GAAP EPS guidance up despite that, so that just reflects historical performance in Q3?

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Timothy J. Arens, Surmodics, Inc. - CFO [50]

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That's exactly right.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [51]

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And then the last, I mean why the tax benefit in the quarter?

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Timothy J. Arens, Surmodics, Inc. - CFO [52]

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We really benefited from R&D tax credit and we had some operating losses as you'll recall, earlier in the year and last year with regard to the US. And so we're just benefiting from that at the current time.

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Operator [53]

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There were no other questions in queue at this time, I will turn it back to Gary Maharaj for closing remarks.

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Gary R. Maharaj, Surmodics, Inc. - CEO, President & Director [54]

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Thank you for all your questions and look forward to catching up in our fourth quarter earnings call. Have a great day.

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Operator [55]

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Thank you, ladies and gentlemen, this concludes today's call. You may now disconnect.