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SurModics 10-K 2009

Documents found in this filing:

  1. 10-K/A
  2. Ex-23
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
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Table of Contents

SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
 
Form 10-K/A
 
Amendment No. 1
 
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
 
For the fiscal year ended September 30, 2009
 
 
Commission file number 0-23837
 
 
 
 
 
     
Minnesota   41-1356149
(State or other jurisdiction of
incorporation or organization)
  (IRS Employer
Identification No.)
     
9924 West 74th Street
Eden Prairie, Minnesota
(Address of Principal Executive Offices)
  55344
(Zip Code)
 
 
(Registrant’s Telephone Number, Including Area Code)
(952) 829-2700
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Exchange on Which Registered
 
Common Stock, $0.05 par value
  NASDAQ Global Select Market
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
     
Large accelerated filer o
  Accelerated filer þ
Non-accelerated filer o
  Smaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
The aggregate market value of the Common Stock held by shareholders other than officers, directors or holders of more than 5% of the outstanding stock of the registrant as of March 31, 2009 was approximately $197 million (based upon the closing sale price of the registrant’s Common Stock on such date).
 
The number of shares of the registrant’s Common Stock outstanding as of December 7, 2009 was 17,471,760.
 
 
None
 


 

EXPLANATORY NOTE
     SurModics, Inc. (the “Company”) filed a Form 10-K for the fiscal year ended September 30, 2009 (the “Original Filing”) with the Securities and Exchange Commission on December 11, 2009. This Amendment No. 1 is being filed solely for the purpose of adding the signature of DELOITTE & TOUCHE LLP, the Company’s Independent Registered Public Accounting Firm, to Deloitte & Touche LLP’s Report of Independent Registered Public Accounting Firm (“Report”) on page F-1 included in this Amendment No. 1, which signature was inadvertently omitted from the Original Filing.
     For purposes of this Amendment No. 1, and in accordance with Rule 12b-15 under the Securities Exchange Act of 1934, as amended, Item 8 of Part II and Item 15 of Part IV of the Original Filing are amended and restated in their entirety. Other than adding Deloitte & Touche LLP’s signature to its Report on page F-1 of the financial statements, there are no other changes to Item 8 of Part II and Item 15 of Part IV of the Original Filing. Except as expressly set forth in this Amendment No. 1, the Original Filing has not been amended, updated or otherwise modified.
     In addition, as required by Rule 12b-15 under the Securities Exchange Act of 1934, as amended, new certifications by our principal executive officer and principal financial officer are being filed as exhibits to this Amendment No. 1.
Table of Contents
         
    Page No.  
Part II
       
    3  
 
       
       
    3  
 EX-23
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
     The consolidated balance sheets as of September 30, 2009 and 2008 and the consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended September 30, 2009, together with Report of Independent Registered Public Accounting Firm and related footnotes (including selected unaudited quarterly financial data) begin on page F-1 of this Form 10-K/A.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
     (a) 1. Financial Statements
          The following statements are included in this report on the pages indicated:
     
    Page (s)
Report of Independent Registered Public Accounting Firm
  F-1
Consolidated Balance Sheets
  F-2
Consolidated Statements of Income
  F-3
Consolidated Statements of Stockholders’ Equity
  F-4
Consolidated Statements of Cash Flows
  F-5
Notes to Consolidated Financial Statements
  F-6 to F-27
2. Financial Statement Schedules. See Schedule II — “Valuation and Qualifying Accounts” in this section of this Form 10-K/A. All other schedules are omitted because they are inapplicable, not required, or the information is in the consolidated financial statements or related notes.
3. Listing of Exhibits. The exhibits which are filed with this report or which are incorporated herein by reference are set forth in the Exhibit Index following the signature page.
SurModics, Inc.
Valuation and Qualifying Accounts
                                 
Column A   Column B     Column C     Column D     Column E  
    Balance at     Additions     Deductions     Balance at  
    Beginning     Charged to     From     End of  
Description   of Period     Expenses     Reserves     Period  
Year Ended September 30, 2007 Allowance for doubtful accounts
  $ 40     $ 7     $ 7 (a)   $ 40  
 
                       
 
                               
Year Ended September 30, 2008 Allowance for doubtful accounts
  $ 40     $ 228     $ 133 (a)   $ 135  
 
                       
 
                               
Year Ended September 30, 2009 Allowance for doubtful accounts
  $ 135     $ (34 )   $ 19 (a)   $ 82  
 
                       
 
                               
Restructuring accrual
  $     $ 1,763     $ 808 (b)   $ 955  
 
                       
 
(a)   Uncollectible accounts written off and adjustments to the allowance.
 
(b)   Adjustments to the accrual account reflect payments or non-cash charges associated with the accrual.

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SIGNATURES
     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  SURMODICS, INC.
 
 
Dated: December 14, 2009  By:   /s/ Bruce J Barclay    
    Bruce J Barclay    
    Chief Executive Officer   
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant, in the capacities, and on the dates indicated.
         
Signature   Title   Date
/s/ Bruce J Barclay
 
Bruce J Barclay
  President and Chief Executive Officer (principal executive officer)   December 14, 2009
 
       
/s/ Philip D. Ankeny
 
Philip D. Ankeny
  Senior Vice President and Chief Financial Officer (principal financial officer)   December 14, 2009
 
       
/s/ Mark A. Lehman
 
Mark A. Lehman
  Corporate Controller (principal accounting
officer)
  December 14, 2009
 
       
*
 
  Director   December 14, 2009
José H. Bedoya
       
 
       
*
 
  Director   December 14, 2009
John W. Benson
       
 
       
*
 
  Director   December 14, 2009
Mary K. Brainerd
       
 
       
*
 
  Director   December 14, 2009
Robert C. Buhrmaster
       
 
       
*
 
  Director   December 14, 2009
Gerald B. Fischer
       
 
       
*
 
  Director   December 14, 2009
Kenneth H. Keller
       
 
       
*
 
  Director   December 14, 2009
Susan E. Knight
       
 
       
*
 
  Director   December 14, 2009
John A. Meslow
       
 
         
* BY:
  /s/ Bruce J Barclay    
 
       
 
  Name: Bruce J Barclay    
 
  Attorney-in-Fact    

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
EXHIBIT INDEX TO FORM 10-K/A
For the Fiscal Year Ended September 30, 2009
SURMODICS, INC.
     
Exhibit    
23
  Consent of Deloitte & Touche LLP.*
 
   
31.1
  Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.*
 
   
31.2
  Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.*
 
   
32.1
  Certification of Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.*
 
   
32.2
  Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.*
 
*   Filed herewith

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Board of Directors and Stockholders
SurModics, Inc.
Eden Prairie, Minnesota
 
We have audited the accompanying consolidated balance sheets of SurModics, Inc. and subsidiaries (the “Company”) as of September 30, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended September 30, 2009. Our audits also include the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of SurModics, Inc. and subsidiaries as of September 30, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2009, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of September 30, 2009, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated December 11, 2009 expressed an unqualified opinion on the Company’s internal control over financial reporting.
 
As discussed in Note 8 to the consolidated financial statements, on October 1, 2007, the Company adopted new accounting guidance on the accounting for uncertainty in income taxes.
 
DELOITTE & TOUCHE LLP
 
Minneapolis, Minnesota
December 11, 2009


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Table of Contents

SurModics, Inc. and Subsidiaries
 
As of September 30
 
                 
    2009     2008  
    (In thousands, except share data)  
 
ASSETS
Current Assets
               
Cash and cash equivalents
  $ 11,636     $ 15,376  
Short-term investments
    8,932       9,251  
Accounts receivable, net of allowance for doubtful accounts of $82 and $135 as of
               
September 30, 2009 and 2008, respectively
    11,320       14,589  
Inventories
    3,330       2,651  
Deferred tax asset
    353       1,058  
Prepaids and other
    1,443       3,584  
                 
Total Current Assets
    37,014       46,509  
                 
Property and equipment, net
    66,915       41,897  
Long-term investments
    27,300       47,351  
Deferred tax asset
    2,548       11,099  
Intangible assets, net
    17,458       16,870  
Goodwill
    21,070       18,001  
Other assets, net
    13,257       9,301  
                 
Total Assets
  $ 185,562     $ 191,028  
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
               
Accounts payable
  $ 3,468     $ 3,466  
Accrued liabilities:
               
Compensation
    926       3,015  
Accrued income taxes payable
    186        
Accrued other
    1,637       1,407  
Deferred revenue
    905       4,335  
Other current liabilities
    862       303  
                 
Total Current Liabilities
    7,984       12,526  
Deferred revenue, less current portion
    623       33,243  
Other long-term liabilities
    4,583       3,453  
                 
Total Liabilities
    13,190       49,222  
                 
Commitments and Contingencies (Note 9)
               
Stockholders’ Equity
               
Series A preferred stock — $.05 par value, 450,000 shares authorized;
               
no shares issued and outstanding
           
Common stock — $.05 par value, 45,000,000 shares authorized; 17,471,472
               
and 18,030,270 shares issued and outstanding
    874       901  
Additional paid-in capital
    66,005       74,573  
Accumulated other comprehensive income (loss)
    1,504       (107 )
Retained earnings
    103,989       66,439  
                 
Total Stockholders’ Equity
    172,372       141,806  
                 
Total Liabilities and Stockholders’ Equity
  $ 185,562     $ 191,028  
                 
 
The accompanying notes are an integral part of these consolidated financial statements.


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SurModics, Inc. and Subsidiaries
 
For the Years Ended September 30
 
                         
    2009     2008     2007  
    (In thousands, except net
 
    income per share)  
 
Revenue
                       
Royalties and license fees
  $ 75,464     $ 51,788     $ 52,679  
Product sales
    19,333       20,052       13,543  
Research and development
    26,737       25,211       6,942  
                         
Total revenue
    121,534       97,051       73,164  
                         
Operating Costs and Expenses
                       
Product
    7,508       8,476       5,584  
Customer research and development
    13,183       19,187       5,840  
Other research and development
    21,179       21,311       22,625  
Selling, general and administrative
    17,200       20,816       13,643  
Purchased in-process research and development
    3,200             15,573  
Restructuring charges
    1,763              
                         
Total operating costs and expenses
    64,033       69,790       63,265  
                         
Income from Operations
    57,501       27,261       9,899  
                         
Other Income (Loss)
                       
Investment income, net
    1,839       3,329       4,844  
Impairment loss on investment
          (4,314 )      
Other income (loss), net
    184       616       (75 )
                         
Other income (loss), net
    2,023       (369 )     4,769  
                         
Income Before Income Taxes
    59,524       26,892       14,668  
Income Tax Provision
    (21,974 )     (12,153 )     (11,321 )
                         
Net Income
  $ 37,550     $ 14,739     $ 3,347  
                         
Basic net income per share
  $ 2.15     $ 0.82     $ 0.19  
Diluted net income per share
  $ 2.15     $ 0.80     $ 0.18  
Weighted Average Shares Outstanding
                       
Basic
    17,435       18,026       18,033  
Dilutive effect of outstanding stock options
    34       304       184  
                         
Diluted
    17,469       18,330       18,217  
 
The accompanying notes are an integral part of these consolidated financial statements.


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SurModics, Inc. and Subsidiaries
 
For the Years Ended September 30, 2009, 2008 and 2007
 
                                                 
                      Accumulated
             
                Additional
    Other
          Total
 
    Common Stock     Paid-in
    Comprehensive
    Retained
    Stockholders’
 
    Shares     Amount     Capital     Income (Loss)     Earnings     Equity  
    (In thousands)  
 
Balance September 30, 2006
    18,830     $ 942     $ 96,281     $ (293 )   $ 48,273     $ 145,203  
Components of comprehensive income, net of tax:
                                               
Net income
                            3,347       3,347  
Unrealized holding gains on available-for-sale securities arising during the period
                      1,999             1,999  
Add reclassification for losses included in net income, net of tax benefit of $10
                      17             17  
                                                 
Comprehensive income
                                  5,363  
                                                 
Issuance of common stock
    14       1       457                   458  
Common stock repurchased
    (1,008 )     (50 )     (34,980 )                 (35,030 )
Common stock options exercised, net
    217       11       4,778                   4,789  
Purchase of common stock to pay employee taxes
    112       5       (379 )                 (374 )
Excess tax benefit from exercise of stock options
                466                   466  
Stock-based compensation
                10,312                   10,312  
Other
                (265 )                 (265 )
                                                 
Balance September 30, 2007
    18,165       909       76,670       1,723       51,620       130,922  
Components of comprehensive income, net of tax:
                                               
Net income
                            14,739       14,739  
Unrealized holding losses on available-for-sale securities arising during the period
                      (5,882 )           (5,882 )
Add reclassification for losses included in net income, net of tax provision of $167
                      4,052             4,052  
                                                 
Comprehensive income
                                  12,909  
                                                 
Issuance of common stock
    16       1       516                   517  
Common stock repurchased
    (342 )     (17 )     (13,954 )                 (13,971 )
Common stock options exercised, net
    114       4       2,514                   2,518  
Purchase of common stock to pay employee taxes
    77       4       (1,678 )                 (1,674 )
Excess tax benefit from exercise of stock options
                1,081                   1,081  
Stock-based compensation
                9,652                   9,652  
Other
                (228 )                 (228 )
Accounting change for income taxes
                            80       80  
                                                 
Balance September 30, 2008
    18,030       901       74,573       (107 )     66,439       141,806  
Components of comprehensive income, net of tax:
                                               
Net income
                            37,550       37,550  
Unrealized holding gains on available-for-sale securities arising during the period
                      2,123             2,123  
Add reclassification for gains included in net income, net of tax provision of $299
                      (512 )           (512 )
                                                 
Comprehensive income
                                  39,161  
                                                 
Issuance of common stock
    40       2       611                   613  
Common stock repurchased
    (624 )     (31 )     (14,967 )                 (14,998 )
Common stock options exercised, net
    15       1       65                   66  
Purchase of common stock to pay employee taxes
    10       1       (569 )                 (568 )
Excess tax benefit from exercise of stock options
                (366 )                 (366 )
Stock-based compensation
                6,853                   6,853  
Other
                (195 )                 (195 )
                                                 
Balance September 30, 2009
    17,471     $ 874     $ 66,005     $ 1,504     $ 103,989     $ 172,372  
                                                 
 
The accompanying notes are an integral part of these consolidated financial statements.


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SurModics, Inc. and Subsidiaries
 
For the Years Ended September 30
 
                         
    2009     2008     2007  
    (In thousands)  
 
Operating Activities
                       
Net income
  $ 37,550     $ 14,739     $ 3,347  
Adjustments to reconcile net income to net cash provided by
                       
operating activities
                       
Depreciation and amortization
    5,912       6,071       4,214  
(Gain) loss on equity method investments and sales of investments
    (103 )     415       75  
Amortization of premium (discount) on investments
    139       70       (1,388 )
Impairment loss on investment
          4,314        
Stock-based compensation
    6,853       9,652       10,312  
Purchased in-process research & development
    3,200             15,573  
Restructuring charges
    1,763              
Deferred tax
    8,229       (3,428 )     (9,434 )
Excess tax benefit from exercise of stock options
    366       (1,081 )     (466 )
Loss on disposals of property and equipment
    291       78       379  
Other
    (250 )            
Change in operating assets and liabilities:
                       
Accounts receivable
    3,269       1,548       1,940  
Inventories
    (679 )     (154 )     (850 )
Accounts payable and accrued liabilities
    (2,387 )     (264 )     2,594  
Income taxes
    2,656       (5,003 )     5,501  
Deferred revenue
    (36,050 )     11,452       19,166  
Prepaids and other
    562       1,413       (248 )
                         
Net cash provided by operating activities
    31,321       39,822       50,715  
                         
Investing Activities
                       
Purchases of property and equipment
    (29,364 )     (23,866 )     (3,626 )
Sales of property and equipment
          32       37  
Purchases of available-for-sale investments
    (33,568 )     (22,857 )     (136,498 )
Sales/maturities of available-for-sale investments
    55,263       29,258       185,075  
Purchases of held-to-maturity investments
          (6,485 )      
Investment in other strategic assets
    (2,500 )     (2,562 )     (5,749 )
Purchase of licenses and patents
    (631 )     (2,452 )     (1,355 )
Acquisitions, net of cash acquired
    (8,585 )     (3,219 )     (49,112 )
Repayment of notes receivable
          5,870       530  
Other investing activities
    (187 )     (228 )     (265 )
                         
Net cash used in investing activities
    (19,572 )     (26,509 )     (10,963 )
                         
Financing Activities
                       
Excess tax benefit from exercise of stock options
    (366 )     1,081       466  
Issuance of common stock
    679       3,037       5,247  
Repurchase of common stock
    (14,998 )     (13,971 )     (35,030 )
Purchase of common stock to pay employee taxes
    (568 )     (1,674 )     (374 )
Repayment of notes payable
    (236 )     (222 )      
                         
Net cash used in financing activities
    (15,489 )     (11,749 )     (29,691 )
                         
Net change in cash and cash equivalents
    (3,740 )     1,564       10,061  
Cash and Cash Equivalents
                       
Beginning of year
    15,376       13,812       3,751  
                         
End of year
  $ 11,636     $ 15,376     $ 13,812  
                         
Supplemental Information
                       
Cash paid for income taxes
  $ 11,285     $ 21,058     $ 14,930  
Noncash transaction — acquisition of property,
                       
plant, and equipment on account
  $ 1,247     $ 1,745     $ 252  
Noncash transaction — acquisition of intangibles on account
  $ 210     $     $  
 
The accompanying notes are an integral part of these consolidated financial statements.


F-5


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
September 30, 2009 and 2008
 
1.   Description
 
SurModics, Inc. and subsidiaries (the “Company”) develops, manufactures and markets innovative drug delivery and surface modification technologies for the healthcare industry. The Company’s revenue is derived from three primary sources: (1) royalties and license fees from licensing its patented drug delivery and surface modification technologies and in vitro diagnostic formats to customers; (2) the sale of polymers and reagent chemicals to licensees; substrates, antigens and stabilization products to the diagnostics industry; microarray slides to the diagnostic and biomedical research markets; and (3) research and development fees generated on projects for customers.
 
 
The consolidated financial statements include all accounts and wholly owned subsidiaries, and have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). All significant inter-company transactions have been eliminated.
 
 
Subsequent events have been evaluated through December 11, 2009, the date the financial statements were issued.
 
On October 5, 2009, the Company entered into a license and development agreement with F. Hoffmann-La Roche, Ltd. (“Roche”) and Genentech, Inc., a wholly owned member of the Roche Group (“Genentech”), associated with the Company’s proprietary biodegradable microparticles drug delivery system. SurModics received an up front licensing fee of $3.5 million, could be eligible to receive up to approximately $200 million in fees and milestone payments in the event of the successful development and commercialization of multiple products, and will be paid for development work done on these products. Roche and Genentech will have the right to obtain manufacturing services from SurModics. In the event a commercial product is developed, the Company will also receive royalties on sales of such products.
 
2.   Summary of Significant Accounting Policies
 
 
Cash and cash equivalents consist of financial instruments with original maturities of three months or less and are stated at cost which approximates fair value.
 
 
Investments consist principally of U.S. government and government agency obligations and mortgage-backed securities and are classified as available-for-sale or held-to-maturity at September 30, 2009 and 2008. Available-for-sale investments are reported at fair value with unrealized gains and losses net of tax excluded from operations and reported as a separate component of stockholders’ equity, except for other-than-temporary impairments, which are reported as a charge to current operations. A loss would be recognized when there is an other-than-temporary impairment in the fair value of any individual security classified as available-for-sale, with the associated net unrealized loss reclassified out of accumulated other comprehensive income with a corresponding adjustment to other income (loss). This adjustment results in a new cost basis for the investment. Investments that management has the intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. If there is an other-than-temporary impairment in the fair value of any individual security classified as held-to-maturity, the Company will write down the security to fair value with a corresponding adjustment to other income (loss). Interest on debt securities, including amortization of premiums and accretion of discounts, is


F-6


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
included in other income (loss). Realized gains and losses from the sales of debt securities, which are included in other income (loss), are determined using the specific identification method.
 
The original cost, unrealized holding gains and losses, and fair value of available-for-sale investments as of September 30 were as follows (in thousands):
 
                                 
    2009  
    Original Cost     Unrealized Gains     Unrealized Losses     Fair Value  
 
U.S. government obligations
  $ 10,837     $ 253     $     $ 11,090  
Mortgage-backed securities
    7,938       177       (106 )     8,009  
Municipal bonds
    7,210       232             7,442  
Asset-backed securities
    2,334       65       (143 )     2,256  
Corporate bonds
    1,181       3             1,184  
                                 
Total
  $ 29,500     $ 730     $ (249 )   $ 29,981  
                                 
 
                                 
    2008  
    Original Cost     Unrealized Gains     Unrealized Losses     Fair Value  
 
U.S. government obligations
  $ 18,440     $ 91     $ (87 )   $ 18,444  
Mortgage-backed securities
    10,147       46       (179 )     10,014  
Municipal bonds
    11,022       153       (3 )     11,172  
Asset-backed securities
    6,193       2       (171 )     6,024  
Corporate bonds
    4,582       8       (33 )     4,557  
                                 
Total
  $ 50,384     $ 300     $ (473 )   $ 50,211  
                                 
 
The original cost and fair value of investments by contractual maturity at September 30, 2009 were as follows (in thousands):
 
                 
    Original Cost     Fair Value  
 
Debt securities due within:
               
One year
  $ 6,830     $ 6,911  
One to five years
    14,297       14,749  
Five years or more
    8,373       8,321  
                 
Total
  $ 29,500     $ 29,981  
                 
 
The following table summarizes sales of available-for-sale securities for the years ended September 30, 2009, 2008 and 2007 (in thousands):
 
                         
    2009     2008     2007  
 
Proceeds from sales
  $ 55,263     $ 29,258     $ 185,075  
Gross realized gains
  $ 823     $ 454     $ 7  
Gross realized losses
  $ (12 )   $ (26 )   $ (34 )
 
At September 30, 2009, the amortized cost and fair market value of held-to-maturity debt securities were $6.3 million and $6.4 million, respectively. Investments in securities designated as held-to-maturity consist of tax-exempt municipal bonds and have maturity dates ranging between three months and three years from September 30, 2009. At September 30, 2008, the amortized cost and fair market value of held-to-maturity debt securities were $6.4 million and $6.3 million, respectively.


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Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
 
Inventories are principally stated at the lower of cost or market using the specific identification method and include direct labor, materials and overhead. Inventories consisted of the following as of September 30 (in thousands):
 
                 
    2009     2008  
 
Raw materials
  $ 1,287     $ 1,308  
Finished products
    2,043       1,343  
                 
Total
  $ 3,330     $ 2,651  
                 
 
 
Property and equipment are stated at cost and are depreciated using the straight-line method over 1 to 32 years, the estimated useful lives of the assets. The Company recorded depreciation expense of $3.8 million, $3.1 million and $2.2 million for the years ended September 30, 2009, 2008 and 2007, respectively.
 
The September 30, 2009 and 2008 balances in construction-in-progress include the cost of enhancing the capabilities of the Company’s Eden Prairie, Minnesota and Birmingham, Alabama facilities. As assets are placed in service, construction-in-progress is transferred to the specific property and equipment categories and depreciated over the estimated useful lives of the assets.
 
In April 2008, the Company acquired a 286,000 square foot facility situated on 42 acres in Birmingham, Alabama for $12.2 million. The Company has been renovating the existing facility to accommodate research and development, clinical manufacturing and commercial manufacturing of drug delivery products for pharmaceutical and biotechnology customers. The building is currently classified as construction-in-progress until renovation and remodeling is completed. The value of the land associated with the purchase is classified as part of the total land carrying value.
 
In August 2008, the Company acquired approximately five acres of undeveloped land adjacent to its headquarters in Eden Prairie, Minnesota for $3.6 million. The value of the land purchase is classified as part of the total land carrying value.
 
Property and equipment consisted of the following components as of September 30 (in thousands):
 
                         
    Useful Life     2009     2008  
    (In years)              
 
Land
          $ 7,409     $ 7,409  
Laboratory fixtures and equipment
    3 to 12       19,549       15,767  
Building and improvements
    1 to 32       15,911       15,025  
Office furniture and equipment
    3 to 10       4,550       4,156  
Construction-in-progress
            40,210       16,931  
Less accumulated depreciation
            (20,714 )     (17,391 )
                         
Property and equipment, net
          $ 66,915     $ 41,897  
                         
 
 
Other assets consist principally of strategic investments. In fiscal 2009, the balance in other assets increased primarily as a result of an investment in a medical technology company and an increase in the value of the Company’s investment in OctoPlus N.V. (“OctoPlus”).


F-8


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
In January 2005, the Company made an initial equity investment of approximately $3.9 million in OctoPlus, a company based in the Netherlands active in the development of pharmaceutical formulations incorporating novel biodegradable polymers. Subsequent investments brought the Company’s total investment to $6.0 million. In October 2006, OctoPlus common stock began trading on an international exchange following an initial public offering of its common stock. With a readily determinable fair market value, the Company now treats the investment in OctoPlus as an available-for-sale investment rather than a cost method investment. Available-for-sale investments are reported at fair value with unrealized gains and losses reported as a separate component of stockholders’ equity, except for other-than-temporary impairments, which are reported as a charge to current operations, recorded in the other income (loss) section of the consolidated statements of income, and result in a new cost basis for the investment. As of September 30, 2009, the investment in OctoPlus represented an ownership interest of less than 10%. The Company recorded no realized gain or loss related to this investment in fiscal 2009. The Company recognized an impairment loss on the investment totaling $4.3 million in fiscal 2008 based on a significant decline in the stock price of OctoPlus as a result of market conditions. The cost basis in the Company’s investment in OctoPlus is $1.7 million.
 
Beginning in May 2005, the Company has invested $1.2 million in ThermopeutiX, Inc. (“ThermopeutiX”), a California-based early stage company developing novel medical devices for the treatment of vascular and neurovascular diseases. In addition to the investment, SurModics has licensed its hydrophilic and hemocompatible coating technologies to ThermopeutiX for use with its devices. The Company’s investment in ThermopeutiX, which is accounted for under the cost method, represents an ownership interest of less than 20%.
 
The Company has invested a total of $5.2 million in Novocell, Inc. (“Novocell”), a privately-held California-based biotechnology firm that is developing a unique treatment for diabetes using coated islet cells, the cells that produce insulin in the human body. In fiscal 2006, the Company determined its investment in Novocell was impaired and that the impairment was other-than-temporary. Accordingly, the Company recorded an impairment loss of $4.7 million. The balance of the investment, $559,000, which is accounted for under the cost method, represents less than a 5% ownership interest.
 
In July 2007, the Company made equity investments in Paragon Intellectual Properties, LLC (“Paragon”) and Apollo Therapeutics, LLC (“Apollo”), a Paragon subsidiary, totaling $3.5 million. SurModics made an additional equity investment in fiscal 2008 totaling $2.5 million, based upon successful completion of specified development milestones. In addition to the investments, the Company has licensed its Finaletm prohealing coating technology and provides development services on a time and materials basis to Apollo. In October 2008, Paragon announced that it had restructured, moving from a limited liability company with seven subsidiaries to a single C-corporation named Nexeon MedSystems, Inc. (“Nexeon”). SurModics continued to account for the investments in Paragon and Apollo under the equity method in the first quarter of fiscal 2009, as both entities report results to us on a one-quarter lag. Commencing with the second quarter of fiscal 2009, SurModics accounted for the investment in Nexeon under the cost method as the Company’s ownership level is less than 20%. The Company made an additional investment of $500,000 in Nexeon in fiscal 2009.
 
In August 2009, the Company invested $2.0 million in a medical technology company. The Company’s investment is accounted for under the cost method, as the Company’s ownership interest is less than 20%. This investment is included in the category titled “Other” in the table below.


F-9


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
Other assets consisted of the following components as of September 30 (in thousands):
 
                 
    2009     2008  
 
Investment in OctoPlus
  $ 3,700     $ 1,714  
Investment in Nexeon MedSystems
    5,651       5,388  
Investment in ThermopeutiX
    1,185       1,185  
Investment in Novocell
    559       559  
Other
    2,162       455  
                 
Other assets, net
  $ 13,257     $ 9,301  
                 
 
In the years ended September 30, 2009, 2008 and 2007, the Company recognized revenue of $1.4 million, $4.1 million and $909,000, respectively, from activity with companies in which it had a strategic investment.
 
 
Intangible assets consist principally of acquired patents and technology, customer relationships, licenses, and trademarks. The Company recorded amortization expense of $2.1 million, $3.0 million, and $2.0 million for the years ended September 30, 2009, 2008 and 2007, respectively.
 
In fiscal 2009, the Company acquired certain assets of PR Pharmaceuticals, Inc., which resulted in an increase to intangible assets. See Note 4 for further information regarding the acquisition.
 
Intangible assets consisted of the following as of September 30 (in thousands):
 
                         
    Useful Life     2009     2008  
    (In years)              
 
Customer lists
    9-11     $ 8,657     $ 7,340  
Abbott license
    4             7,037  
Core technology
    8-18       8,330       6,930  
Patents and other
    2-20       3,076       3,398  
Trademarks
            600       580  
Less accumulated amortization
            (3,205 )     (8,415 )
                         
Intangible assets, net
          $ 17,458     $ 16,870  
                         
 
The Abbott license was fully amortized as of September 30, 2009 and the original cost and accumulated amortization have been removed from the 2009 amounts presented. Based on the intangible assets in service as of September 30, 2009, estimated amortization expense for the next five fiscal years is as follows (in thousands):
 
         
2010
  $ 1,627  
2011
    1,604  
2012
    1,602  
2013
    1,602  
2014
    1,602  
 
 
Goodwill represents the excess of the cost of the acquired entities over the fair value assigned to the assets purchased and liabilities assumed in connection with the Company’s acquisitions (see Note 4 for further information). The carrying amount of goodwill is evaluated annually, and between annual evaluations if events occur or circumstances change indicating that the carrying amount of goodwill may be impaired.


F-10


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
In fiscal 2009 a milestone was achieved associated with the July 2007 acquisition of SurModics Pharmaceuticals, and $3 million of additional purchase price was recorded as an increase to goodwill.
 
 
The Company periodically evaluates whether events and circumstances have occurred that may affect the estimated useful life or the recoverability of the remaining balance of long-lived assets, such as property and equipment and investments. If such events or circumstances were to indicate that the carrying amount of these assets would not be recoverable, the Company would estimate the future cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) or other measure of fair value were less than the carrying amount of the assets, the Company would recognize an impairment loss reducing the carrying value to fair market value.
 
 
In accordance with Securities and Exchange Commission (SEC) guidance, revenue is recognized when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) shipment has occurred or delivery has occurred if the terms specify destination; (3) the sales price is fixed or determinable; and (4) collectability is reasonably assured. However, when there are additional performance requirements, revenue is recognized when all such requirements have been satisfied. Under revenue arrangements with multiple deliverables, the Company recognizes each separable deliverable as it is earned.
 
The Company’s revenue is derived from three primary sources: (1) royalties and license fees from licensing patented drug delivery and surface modification technologies and in vitro diagnostic formats to customers; (2) the sale of polymers and reagent chemicals, stabilization products, antigens, substrates and microarray slides to the diagnostics and biomedical research industries; and (3) research and development fees generated on customer projects.
 
Taxes collected from customers and remitted to governmental authorities are excluded from revenue and amounted to $187,000, $309,000 and $170,000 for the years ended September 30, 2009, 2008 and 2007, respectively.
 
Royalties & License Fees.  The Company licenses technology to third parties and collects royalties. Royalty revenue is generated when a customer sells products incorporating the Company’s licensed technologies. Royalty revenue is recognized as licensees report it to the Company, and payment is typically submitted concurrently with the report. Generally, license fees are recognized as revenue when the Company receives payment and the contract price is fixed or determinable. For stand-alone license agreements, up-front license fees are recognized over the term of the related licensing agreement. Minimum royalty fees are recognized in the period earned.
 
Revenue related to a performance milestone is recognized upon the achievement of the milestone, as defined in the respective agreements and provided the following conditions have been met:
 
  •  The milestone payment is non-refundable.
 
  •  The milestone is achieved, involves a significant degree of risk, and was not reasonably assured at the inception of the arrangement.
 
  •  Accomplishment of the milestone involves substantial effort.
 
  •  The amount of the milestone payment is commensurate with the related effort and risk.
 
  •  A reasonable amount of time passes between the initial license payment and the first and subsequent milestone payments.


F-11


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
 
If these conditions have not been met, the milestone payment is deferred and recognized over the term of the agreement.
 
Product Sales.  Product sales to third parties are recognized at the time of shipment, provided that an order has been received, the price is fixed or determinable, collectability of the resulting receivable is reasonably assured and returns can be reasonably estimated. The Company’s sales terms provide no right of return outside of the standard warranty policy. Payment terms are generally set at 30-45 days.
 
Research and Development.  The Company performs third party research and development activities, which are typically provided on a time and materials basis. Generally, revenue for research and development is recorded as performance progresses under the applicable contract.
 
Arrangements with multiple deliverables.  Arrangements such as license and development agreements are analyzed to determine whether the deliverables, which often include a license and performance obligations such as research and development, can be separated or whether they must be accounted for as a single unit of accounting in accordance with accounting guidance. The Company recognizes up-front license payments under these agreements over the economic life of the technology licensed. If the fair value of the undelivered performance obligations can be determined, such obligations would then be accounted for separately. If the license is considered to either (i) not have stand-alone value or (ii) have stand-alone value but the fair value of any of the undelivered performance obligations cannot be determined, the arrangement would then be accounted for as a single unit of accounting, and the license payments and payments for performance obligations would be recognized as revenue over the estimated period of when the performance obligations are performed, or the economic life of the technology licensed to the customer. When the Company determines that an arrangement should be accounted for as a single unit of accounting, it recognizes the related revenue based on a time-based accounting model. Revenue associated with arrangements with multiple deliverables totaled $45.3 million, $4.2 million and $0.3 million in fiscal 2009, 2008 and 2007, respectively. The fiscal 2009 revenue associated with multiple deliverable arrangements is reflected in royalties and license fees revenue ($37.6 million) and in research and development revenue ($7.7 million) in the consolidated statements of income.
 
Merck Agreement.  On June 27, 2007 the Company announced a license and research collaboration agreement with Merck & Co., Inc. (“Merck”). The agreement called for SurModics and Merck to pursue the joint development and commercialization of SurModics’ I-vation sustained drug delivery system with TA (triamcinolone acetonide), and other products combining certain of Merck’s proprietary drug compounds and the I-vation system for the treatment of serious retinal diseases. Under the terms of the agreement, Merck led and funded development and commercialization activities. SurModics received an up-front license fee of $20 million in fiscal 2007 and additional license fees totaling $11 million in fiscal 2008. In addition, the Company was paid for its activities in researching and developing the combination products. Research and development fees totaling $5.8 million were billed in fiscal 2008. The Company recognized out-of-pocket reimbursements, totaling $1.6 million in fiscal 2008, as revenue in the period since the related costs were incurred when commensurate value was transferred to Merck in exchange for the reimbursement received.
 
The Company recognized revenue from the up-front license fee, additional license fees and research and development fees over the economic life of the technology licensed to Merck, which was 16 years.
 
In September 2008, following a strategic review of Merck’s business and product development portfolio, Merck gave notice to SurModics of its intent to terminate the collaborative research and license agreement as well as the supply agreement entered into in June 2007. The termination was effective December 2008. The Company recognized all remaining deferred revenue related to the Merck agreement, totaling $34.8 million, as revenue in fiscal 2009. The Company also recognized a $9 million milestone payment from Merck associated with the termination of the triamcinolone acetonide development program in fiscal 2009. As of September 30, 2009, there were no deferred revenue amounts from Merck, compared with $34.8 million of license fees and research and development fees in deferred revenue as of September 30, 2008.


F-12


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
 
Amounts received prior to satisfying the above revenue recognition criteria are recorded as deferred revenue in the accompanying consolidated balance sheets, with deferred revenue to be recognized beyond one year being classified as non-current deferred revenue. As of September 30, 2009 and 2008, the Company had deferred revenue of $1.5 million and $37.6 million, respectively.
 
Costs related to products and services delivered are recognized in the period revenue is recognized except for services related to the Merck agreement, which were recognized as incurred. Customer advances are accounted for as a liability until all criteria for revenue recognition have been met.
 
 
Research and development costs are expensed as incurred. Some research and development costs are related to third party contracts, and the related revenue is recognized as described in “Revenue Recognition” above. The research and development costs are presented in the consolidated statements of income in two categories; those associated with customer related projects and those associated with other research and development costs.
 
Costs associated with customer related research and development include specific project direct labor costs and material expenses as well as an allocation of overhead costs based on direct labor dollars.
 
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Ultimate results could differ from those estimates.
 
 
In October 2009, the Financial Accounting Standards Board (FASB) issued an update to authoritative accounting guidance to address the accounting for multiple-deliverable arrangements. This accounting update enables vendors to account for products and services (deliverables) separately rather than as a combined unit. This authoritative guidance establishes the accounting and reporting for arrangements under which the vendor will perform multiple revenue-generating activities. The amendments to the authoritative guidance establish a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. The authoritative guidance also expands the disclosures related to multiple-deliverable revenue arrangements and in the year of adoption requires additional disclosures following previous authoritative guidance. The authoritative guidance is effective for the Company beginning in fiscal 2011 with early adoption permitted. The Company expects to early adopt this authoritative guidance in the first quarter of fiscal 2010 and is currently evaluating the impact on the consolidated financial statements.
 
In June 2009, the FASB issued authoritative guidance to eliminate the historical GAAP hierarchy and establish only two levels of GAAP, authoritative and nonauthoritative. When launched on July 1, 2009, the FASB Accounting Standards Codification (ASC) became the single source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the Securities and Exchange Commission (SEC), which are sources of authoritative GAAP for SEC registrants. All other nongrandfathered, non-SEC accounting literature not included in the ASC became nonauthoritative. The subsequent issuances of new standards will be in the form of Accounting Standards Updates that will be included in the ASC. This authoritative guidance was effective for financial statements for interim or annual reporting periods ended after September 15, 2009. The Company adopted the new codification in


F-13


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
the fourth quarter of fiscal 2009. As the codification was not intended to change or alter existing GAAP, it did not have any impact on the Company’s consolidated financial statements.
 
In April 2008, the FASB issued authoritative accounting guidance which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of intangible assets under goodwill and other intangible asset accounting. The authoritative guidance is intended to improve the consistency between the useful life of a recognized intangible asset under goodwill and intangible asset accounting and the period of the expected cash flows used to measure the fair value of the asset under business combination accounting and other GAAP. The authoritative guidance is effective for the Company in fiscal 2010, with early adoption prohibited. The Company does not expect the adoption of the authoritative guidance to have a material impact on its consolidated financial statements.
 
In December 2007, the FASB issued authoritative accounting guidance which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. The authoritative guidance is effective for the Company in fiscal 2010 and once adopted will impact recognition and measurement of future business combinations.
 
In September 2006, the FASB issued authoritative accounting guidance associated with fair value measurements. This guidance defines fair value, establishes a consistent framework for measuring fair value, gives guidance regarding methods used for measuring fair value and expands disclosures about fair value measurements. These provisions were implemented in fiscal 2009. See Note 3 for additional information regarding fair value measurements. However, in February 2008, the FASB issued guidance which delayed the effective date from fiscal 2009 to fiscal 2010 for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company is currently evaluating the potential impact of the authoritative guidance for which the effective date was delayed until fiscal 2010 on its consolidated financial statements.
 
No other new accounting pronouncement issued or effective has had, or is expected to have, a material impact on the Company’s consolidated financial statements.
 
3.   Fair Value Measurements
 
Effective October 1, 2008, the Company adopted new accounting guidance on fair value measurements. The new guidance defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. The guidance is applicable for all financial assets and liabilities and for all nonfinancial assets and liabilities recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Fair value is defined as the exchange price that would be received from selling an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and also considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions and risk of nonperformance.
 
 
New accounting guidance on fair value measurements requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:
 
Level 1 — Quoted (unadjusted) prices in active markets for identical assets or liabilities.


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Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
The Company’s Level 1 asset consists of its investment in OctoPlus (see Note 2 for further information). The fair market value of this investment is based on the quoted price of OctoPlus shares as traded on the Amsterdam Stock Exchange.
 
Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
 
The Company’s Level 2 assets consist of money market funds, U.S. Treasury securities, corporate bonds, municipal bonds, U.S. agency securities, agency and municipal securities and certain asset-backed securities and mortgage-backed securities. Fair market values for these assets are based on quoted vendor prices and broker pricing where all significant inputs are observable.
 
Level 3 — Unobservable inputs to the valuation methodology that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.
 
The Company’s Level 3 assets include a U.S. government agency security and certain asset-backed and mortgage-backed securities. The fair market values of these investments were determined by broker pricing where not all significant inputs were observable.
 
In valuing assets and liabilities, the Company is required to maximize the use of quoted market prices and minimize the use of unobservable inputs.
 
We did not significantly change our valuation techniques from prior periods.
 
 
In instances where the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability. The following table presents information about the Company’s financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2009 (in thousands):
 
                                 
    Quoted Prices
                   
    in Active
    Significant
             
    Markets for
    Other
    Significant
    Total Fair
 
    Identical
    Observable
    Unobservable
    Value as of
 
    Instruments
    Inputs
    Inputs
    September 30,
 
    (Level 1)     (Level 2)     (Level 3)     2009  
 
Assets:
                               
Cash equivalents
  $     $ 9,108     $     $ 9,108  
Short-term investments
          6,911             6,911  
Long-term investments
          21,867       1,203       23,070  
Other assets
    3,700                   3,700  
                                 
Total assets measured at fair value
  $ 3,700     $ 37,886     $ 1,203     $ 42,789  
                                 
 
Short-term and long-term investments disclosed in the consolidated balance sheets include held-to-maturity investments totaling $6.3 million as of September 30, 2009 and 2008. Held-to-maturity investments are carried at an amortized cost.


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Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
 
The following table is a reconciliation of financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) (in thousands):
 
         
    2009  
 
Balance, beginning of year
  $ 264  
Total realized and unrealized gains included in other comprehensive income
    25  
Purchases, sales and maturities, net
    339  
Transfer in (out) of Level 3
    575  
         
Balance, end of year
  $ 1,203  
         
 
As of September 30, 2009, marketable securities measured at fair value using Level 3 inputs was comprised of $36,000 of a U.S. government agency security, $73,000 of a mortgage-backed security and $1,094,000 of asset-backed securities within the Company’s available-for-sale investment portfolio. These securities were measured using observable market data and Level 3 inputs as a result of the lack of market activity and liquidity. The fair value of these securities was based on the Company’s assessment of the underlying collateral and the creditworthiness of the issuer of the securities.
 
Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
 
The Company’s investments in non-marketable securities of private companies are accounted for using the cost or equity method. These investments as well as held-to-maturity securities are measured at fair value on a non-recurring basis when they are deemed to be other-than-temporarily impaired. In determining whether a decline in value of non-marketable equity investments in private companies has occurred and is other-than-temporary, an assessment is made by considering available evidence, including the general market conditions in the investee’s industry, the investee’s product development status and subsequent rounds of financing and the related valuation and/or the Company’s participation in such financings. The Company also assesses the investee’s ability to meet business milestones and the financial condition and near-term prospects of the individual investee, including the rate at which the investee is using its cash and the investee’s potential need for additional funding at a possibly lower valuation. The valuation methodology for determining the decline in value of non-marketable equity securities is based on inputs that require management judgment and are Level 3 inputs.
 
4.   Acquisitions
 
PR Pharmaceuticals, Inc.  On November 4, 2008, the Company’s SurModics Pharmaceuticals, Inc. (formerly known as Brookwood Pharmaceuticals, Inc.) subsidiary entered into an asset purchase agreement with PR Pharmaceuticals, Inc. (“PR Pharma”), whereby it acquired certain contracts and assets of PR Pharma for $5.6 million consisting of $2.9 million in cash on the closing date, additional consideration of $2.4 million upon successful achievement of specified milestones and $0.3 million in transaction costs. PR Pharma is eligible to receive up to an additional $3.6 million in cash upon the successful achievement of milestones for contract signing and invoicing, successful patent issuances and product development. Management believes this acquisition strengthens the Company’s portfolio of drug delivery technologies for the pharmaceutical and biotechnology industries. The purchase price was allocated as follows as of November 4, 2008 (in thousands):
 
         
Core technology
  $ 1,400  
Customer relationships
    900  
In-process research and development
    3,200  
Trade names
    20  
Non-compete agreements
    50  
         
Total purchase price
  $ 5,570  
         


F-16


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
The acquired developed technology is being amortized on a straight-line basis over 18 years, customer relationships are being amortized over 9 years, and non-compete agreements are being amortized over 2 years. The trade names have a life of less than one year and were fully amortized in fiscal 2009. As part of the acquisition, the Company recognized fair value associated with in-process research and development (IPR&D) of $3.2 million. The IPR&D was expensed on the date of acquisition and relates to polymer-based drug delivery systems. The value assigned to IPR&D is related to projects for which the related products have not achieved commercial feasibility and have no future alternative use. The amount of purchase price allocated to IPR&D was based on estimating the future cash flows of each project and discounting the net cash flows back to their present values. The discount rate used was determined at the time of acquisition in accordance with accepted valuation methods. These methodologies include consideration of the risk of the project not achieving commercial feasibility. The research efforts ranged from 5% to 50% complete at the date of acquisition. The Company used the Relief from Royalty valuation method to assess the fair value of the projects with a risk-adjusted discount rate of 25%. The Company determined the method was appropriate based on the nature of the projects and future cash flow streams. The research and development work performed is billed to customers, in most cases, using standard commercial billing rates which include a reasonable markup. Accordingly, the Company has no fixed cost obligations to carry projects forward. There have been no significant changes to the development plans for the acquired incomplete projects. Significant net cash inflows would commence with the commercial launch of customer products that are covered by the intellectual property rights and related agreements acquired from PR Pharma.
 
SurModics Pharmaceuticals, Inc.  On July 31, 2007, the Company entered into a stock purchase agreement with Southern Research Institute (“SRI”) whereby it acquired 100% of the capital stock of SurModics Pharmaceuticals, Inc. (formerly Brookwood Pharmaceuticals, Inc.) (“SurModics Pharmaceuticals”) held by SRI for $42.3 million consisting of $40 million in cash on the closing date and $2.3 million in transaction costs. SRI could receive up to an additional $22 million in cash upon the successful achievement of specified milestones. In fiscal 2009, a milestone was achieved and $3 million of additional purchase price was recorded as an increase to goodwill. In fiscal 2008, a milestone was achieved and $2 million of additional purchase price was recorded as an increase to goodwill. SurModics Pharmaceuticals is a drug delivery company based in Birmingham, Alabama that provides proprietary polymer-based technologies to companies developing pharmaceutical products. SurModics Pharmaceuticals, a wholly owned subsidiary of SurModics, operates as a separate business unit. Management believes this acquisition strengthens SurModics’ portfolio of drug delivery technologies for the pharmaceutical and biotechnology industries in particular. Operating results of SurModics Pharmaceuticals have been included in the Company’s consolidated financial statements since August 1, 2007.
 
As part of the acquisition, the Company recognized IPR&D of $15.6 million. The IPR&D was expensed on the date of acquisition and relates to polymer-based drug delivery systems. The value assigned to IPR&D is related to projects for which the related products have not received commercial feasibility and have no future alternative use. The amount of purchase price allocated to IPR&D was based on estimating the future cash flows of each project and discounting the net cash flows back to their present values.
 
BioFX Laboratories, Inc.  On August 13, 2007, the Company acquired 100% of the capital stock of BioFX Laboratories, Inc. (“BioFX”), a provider of substrates to the in vitro diagnostics industry, for $11.6 million, $11.3 million of which was in cash paid to the sellers and $300,000 in transaction costs. The Company is also required to pay up to an additional $11.4 million in cash upon the successful achievement of specified revenue targets. In fiscal 2008, a milestone was achieved and $1.1 million of additional purchase price was recorded as an increase to goodwill. The sellers are still eligible to receive up to $7.6 million in additional consideration. BioFX is a wholly owned subsidiary of SurModics, and operates within the In Vitro Technologies business unit. Management believes the acquisition enhances the Company’s technological position in the in vitro diagnostics market. Operating results of BioFX have been included in the Company’s consolidated financial statements since August 14, 2007.


F-17


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
The following pro forma consolidated condensed financial results of operations for the 2007 fiscal year, are presented as if the SurModics Pharmaceuticals and BioFX acquisitions had been completed at the beginning of fiscal 2007 (in thousands).
 
         
Pro forma revenue
  $ 89,708  
Pro forma income from operations
  $ 28,034  
Pro forma net income
  $ 17,735  
Pro forma basic earnings per share
  $ 0.98  
Pro forma diluted earnings per shares
  $ 0.98  
 
5.   Revolving Credit Facility
 
In February 2009, the Company entered into a two-year $25.0 million unsecured revolving credit facility. Borrowings under the credit facility, if any, will bear interest at a benchmark rate plus an applicable margin based upon the Company’s funded debt to EBITDA ratio. In connection with the credit facility, the Company is required to maintain certain financial and nonfinancial covenants. As of September 30, 2009, the Company had no debt outstanding under this credit facility and was in compliance with all covenants.
 
6.   Stockholders’ Equity
 
The Company has stock-based compensation plans under which it grants stock options and restricted stock awards. Accounting guidance requires all share-based payments to be recognized as an operating expense, based on their fair values, over the requisite service period. The Company’s stock-based compensation expenses for the years ended September 30 were allocated as follows (in thousands):
 
                         
    2009     2008     2007  
 
Product
  $ 87     $ 161     $ 96  
Research and development
    3,621       3,793       5,188  
Selling, general and administrative
    3,145       5,698       5,028  
                         
Total
  $ 6,853     $ 9,652     $ 10,312  
                         
 
As of September 30, 2009, approximately $8.7 million of total unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted average period of approximately 2.6 years. The unrecognized compensation costs include $2.8 million associated with performance share awards that are currently not anticipated to be fully expensed because the performance conditions are not expected to be met.
 
 
The Company uses the Black-Scholes option pricing model to determine the weighted average grant date fair value of stock options granted. The weighted average per share fair value of stock options granted during fiscal 2009, 2008 and 2007 was $8.95, $14.85, and $17.42, respectively. The assumptions used as inputs in the model for the years ended September 30 were as follows:
 
                         
    2009   2008   2007
 
Risk-free interest rates
    2.30 %     2.80 %     4.50 %
Expected life
    4.8 years       4.6 years       5.4 years  
Expected volatility
    40 %     37 %     45 %
Dividend yield
    0 %     0 %     0 %
 
The risk-free interest rate assumption was based on the U.S. Treasury’s rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award. The expected life of options granted is


F-18


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
determined based on the Company’s experience. Expected volatility is based on the Company’s stock price movement. Based on management’s judgment, dividend rates are expected to be zero for the expected life of the options. The Company also estimates forfeitures of options granted, which are based on historical experience.
 
The Company’s Incentive Stock Options (ISO) are granted at a price of at least 100% of the fair market value of the Common Stock on the date of the grant or 110% with respect to optionees who own more than 10% of the total combined voting power of all classes of stock. ISOs expire in seven years or upon termination of employment and are exercisable at a rate of 20% per year commencing one year after the date of grant. Nonqualified stock options are granted at fair market value on the date of grant. Nonqualified options expire in 7 to 10 years or upon termination of employment or service as a Board member. Nonqualified options granted prior to May 2008 generally become exercisable with respect to 20% of the shares on each of the first five anniversaries following the grant date such that the entire option is fully vested five years after date of grant, and nonqualified options granted subsequent to May 2008 generally become exercisable with respect to 25% on each of the first four anniversaries following the grant date such that the entire option is fully vested four years after the grant date. The Company has authorized 2,400,000 shares for grant under the 2003 Equity Incentive Plan of which 51,000 remain available for future awards. In September 2009, the Company granted 29,066 performance share awards to officers under the 2003 Equity Incentive Plan and 229,552 stock options to officers under the 2009 Equity Incentive Plan. The 2009 Equity Incentive Plan is subject to shareholder approval at the February 2010 Annual Meeting of Shareholders. As of September 30, 2009, the aggregate intrinsic value of the option shares outstanding and option shares exercisable was $0.7 million and $0.6 million, respectively. At September 30, 2009, the average remaining contractual life of options outstanding and options exercisable was 4.3 and 3.2 years, respectively. The intrinsic value of options exercised during fiscal 2009, 2008 and 2007 was $235,000, $2.9 million and $4.4 million, respectively.
 
                 
          Weighted
 
    Number of
    Average
 
    Shares     Exercise Price  
 
Outstanding at September 30, 2006
    1,510,780     $ 29.69  
Granted
    166,400       37.85  
Exercised
    (253,060 )     25.82  
Forfeited
    (22,700 )     33.71  
                 
Outstanding at September 30, 2007
    1,401,420       31.29  
Granted
    392,917       41.86  
Exercised
    (163,297 )     27.45  
Forfeited
    (108,250 )     33.59  
                 
Outstanding at September 30, 2008
    1,522,790       34.26  
Granted
    268,700       24.06  
Exercised
    (17,600 )     8.82  
Forfeited
    (104,320 )     35.33  
                 
Outstanding at September 30, 2009
    1,669,570     $ 32.82  
Exercisable at September 30, 2009
    902,589     $ 32.07  
 
 
The Company has entered into restricted stock agreements with certain key employees, covering the issuance of Common Stock (Restricted Stock). Under accounting guidance these shares are considered to be non-vested shares. The Restricted Stock will be released to the key employees if they are employed by the Company at the end of the vesting period. Compensation has been recognized for the estimated fair value of the 100,895 common shares awarded and is being charged to income over the vesting term. The stock-based compensation table includes the


F-19


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
Restricted Stock expenses recognized related to these awards, which totaled $1.8 million, $2.2 million and $1.2 million during fiscal 2009, 2008 and 2007, respectively.
 
                 
          Weighted
 
    Number of
    Average
 
    Shares     Grant Price  
 
Balance at September 30, 2006
    153,000     $ 32.14  
Granted
    83,027       42.07  
Vested
    (24,836 )     37.87  
Forfeited
    (5,000 )     34.56  
                 
Balance at September 30, 2007
    206,191       35.89  
Granted
    12,383       42.18  
Vested
    (40,336 )     38.76  
Forfeited
    (21,109 )     32.83  
                 
Balance at September 30, 2008
    157,129       36.06  
Granted
    7,700       23.93  
Vested
    (59,047 )     34.44  
Forfeited
    (4,887 )     41.91  
                 
Balance at September 30, 2009
    100,895     $ 35.80  
 
 
The Company has entered into Performance Share agreements with certain key employees, covering the issuance of Common Stock (Performance Shares). The Performance Shares vest upon the achievement of all or a portion of certain performance objectives, which must be achieved during the performance period. Compensation is recognized in each period based on management’s best estimate of the achievement level of the grants’ specified performance objectives and the resulting vesting amounts. In fiscal 2009 the Company reversed expenses previously recognized of $207,000 relating to three-year Performance Shares awarded in May 2008 and one-year Performance Shares awarded in September 2008, which was partially offset by an expense of $164,000 related to the estimated value of Performance Shares awarded to individuals based on likely achievement of specific performance objectives. The Company recorded compensation expense of $1.9 million in fiscal 2008 related to 30,552 one-year Performance Shares and 30,552 three-year Performance Shares awarded in May 2008 and 7,600 Performance Shares that vested for certain individuals that met various specific performance objectives. The Company recorded compensation expense of $4.8 million in fiscal 2007 related to 132,375 Performance Shares. The stock-based compensation table includes the Performance Shares expenses.
 
 
Under the 1999 Employee Stock Purchase Plan (Stock Purchase Plan), the Company is authorized to issue up to 200,000 shares of Common Stock. All full-time and part-time employees can choose to have up to 10% of their annual compensation withheld to purchase the Company’s Common Stock at purchase prices defined within the provisions of the Stock Purchase Plan. As of September 30, 2009 and 2008, there were $276,000 and $355,000 of employee contributions, respectively, included in accrued liabilities in the accompanying consolidated balance sheets. Stock compensation expense recognized related to the Stock Purchase Plan totaled $265,000, $199,000 and $156,000 during fiscal 2009, 2008 and 2007, respectively. The stock-based compensation table includes the Stock Purchase Plan expenses.


F-20


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
 
7.   Restructuring Charges
 
In November 2008, the Company announced a functional reorganization to allow the Company to better serve its customers and improve its operating performance. As a result of the reorganization, the Company eliminated 15 positions, or approximately five percent of the Company’s workforce. These employee terminations occurred across various functions and the reorganization plan was completed by the end of the first quarter of fiscal 2009. The Company also vacated a leased facility in Eden Prairie, Minnesota, consolidating into its owned office and research facility also in Eden Prairie, as part of the reorganization plan.
 
The Company recorded total restructuring charges of approximately $1.8 million in connection with the reorganization. These pre-tax charges consisted of $0.5 million of severance pay and benefits expenses and $1.3 million of facility-related costs which were recorded in fiscal 2009. The restructuring is expected to result in approximately $2.0 million in annualized cost savings.
 
The following table summarizes the restructuring accrual activity for fiscal 2009 (in thousands):
 
                         
    Employee
    Facility-
       
    Severance
    Related
       
    and Benefits     Costs     Total  
 
Balance at September 30, 2008
  $     $     $  
Accruals during the year
    513       1,250       1,763  
Cash Payments
    (513 )     (295 )     (808 )
                         
Balance at September 30, 2009
  $     $ 955     $ 955  
                         
 
The charges above have been shown separately as restructuring charges on the consolidated statements of income. The remaining accrual as of September 30, 2009 relates to facility-related costs that are expected to be paid within the next 15 months. As such, the current portion totaling $0.9 million is recorded as a current liability within other accrued liabilities and the long-term portion totaling $0.1 million is recorded as a long-term liability within other long-term liabilities on the consolidated balance sheets.
 
8.   Income Taxes
 
The Company accounts for income taxes under the asset and liability method prescribed in accounting guidance. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the period in which related temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in this assessment. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date of such change.


F-21


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
Income taxes in the accompanying consolidated statements of income for the years ended September 30 are as follows (in thousands):
 
                         
    2009     2008     2007  
 
Current provision:
                       
Federal
  $ 12,257     $ 13,534     $ 19,069  
State and foreign
    1,362       1,516       1,732  
                         
Total current provision
    13,619       15,050       20,801  
Deferred provision (benefit):
                       
Federal
    7,483       (2,832 )     (8,573 )
State
    872       (65 )     (907 )
                         
Total deferred provision (benefit)
    8,355       (2,897 )     (9,480 )
                         
Total provision
  $ 21,974     $ 12,153     $ 11,321  
                         
 
The reconciliation of the difference between amounts calculated at the statutory federal tax rate for the fiscal years ended September 30 and the Company’s effective tax rate is as follows (in thousands):
 
                         
    2009     2008     2007  
 
Amount at statutory federal income tax rate
  $ 20,833     $ 9,387     $ 5,067  
Change because of the following items:
                       
State taxes
    1,206       715       736  
Other
    (481 )     223       (241 )
Stock-based compensation
    416       239       262  
Valuation allowance
          1,589        
Write-off of in-process research and development
                5,497  
                         
Income tax provision
  $ 21,974     $ 12,153     $ 11,321  
                         
 
The components of deferred income taxes consisted of the following as of September 30 and result from differences in the recognition of transactions for income tax and financial reporting purposes (in thousands):
 
                 
    2009     2008  
 
Depreciable assets
  $ (2,951 )   $ (4,325 )
Deferred revenue
    261       11,005  
Accruals and reserves
    526       523  
Stock options
    5,258       4,397  
Impaired asset
    3,264       3,318  
Unrealized (losses) gains on investments
    (962 )     66  
Other
    844       571  
Valuation allowance
    (3,339 )     (3,398 )
                 
Total deferred tax asset
    2,901       12,157  
Less current deferred tax asset
    (353 )     (1,058 )
                 
Noncurrent deferred tax asset
  $ 2,548     $ 11,099  
                 
 
In fiscal 2008, the Company recorded a $1.6 million valuation allowance against the potential capital loss created by the impairment of the Company’s investment in OctoPlus (see Note 2 for further information). The valuation allowance was recorded because the Company does not currently foresee future capital gains within the


F-22


Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
allowable carry forward and carry back periods to offset this capital loss when it was recognized. As such, no tax benefit has been recorded in the consolidated statements of operations.
 
On October 1, 2007, the Company adopted new accounting guidance on the accounting for uncertainty in income taxes. The adoption of the new guidance resulted in an increase to retained earnings as of October 1, 2007, of $80,000, which was reflected as a cumulative effect of a change in accounting principle, with a corresponding decrease to the net liability for unrecognized tax expenses. Unrecognized tax benefits are the differences between a tax position taken, or expected to be taken in a tax return, and the benefit recognized for accounting purposes pursuant to accounting guidance. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
 
                 
    2009     2008  
 
Beginning of fiscal year
  $ 1,540     $ 1,120  
Increases in tax positions for prior years
    273       194  
Increases in tax positions for current year
    260       237  
Settlements with taxing authorities
           
Lapse of the statute of limitations
    (31 )     (11 )
                 
End of fiscal year
  $ 2,042     $ 1,540  
                 
 
The total amount of unrecognized tax benefits including interest and penalties that, if recognized, would affect the effective tax rate as of September 30, 2009 and 2008, respectively, are $2.0 million and $1.3 million. Currently, the Company does not expect the liability for unrecognized tax benefits to change significantly in the next twelve months with the above balances classified on the consolidated balance sheets as a part of long-term liabilities. Interest and penalties related to unrecognized tax benefits are recorded in income tax expense. As of September 30, 2009 and 2008, a gross balance of $605,000 and $397,000, respectively, has been accrued related to the unrecognized tax benefits balance for interest and penalties.
 
The Company files tax returns, including returns for its subsidiaries, in the United States (U.S.) federal jurisdiction and in various state jurisdictions. Uncertain tax positions are related to tax years that remain subject to examination. U.S. tax returns for fiscal years ended September 30, 2006, 2007, and 2008 remain subject to examination by federal tax authorities. Tax returns for state and local jurisdictions for fiscal years ended September 30, 2003 through 2008 remain subject to examination by state and local tax authorities.
 
9.   Commitments and Contingencies
 
Litigation.  From time to time, the Company has been, and may become, involved in various legal actions involving its operations, products and technologies, including intellectual property and employment disputes. The outcomes of these legal actions are not within the Company’s complete control and may not be known for prolonged periods of time. In some actions, the claimants seek damages, as well as other relief, including injunctions barring the sale of products that are the subject of the lawsuit, which, if granted, could require significant expenditures or result in lost revenues. The Company records a liability in the consolidated financial statements for these actions when a loss is known or considered probable and the amount can be reasonably estimated. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate, the minimum amount of the range is accrued. If a loss is possible but not known or probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed. In most cases, significant judgment is required to estimate the amount and timing of a loss to be recorded.
 
InnoRx, Inc.  In January 2005, the Company entered into a merger agreement whereby SurModics acquired all of the assets of InnoRx, Inc. (“InnoRx”), an early stage company developing drug delivery devices and therapies for the ophthalmology market. SurModics will be required to issue up to approximately 480,059 additional shares of its common stock to the stockholders of InnoRx upon the successful completion of the remaining development and commercial milestones involving InnoRx technology acquired in the transaction.


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Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
Alabama Jobs Commitment.  In April 2008, the Company purchased a 286,000 square foot facility to support Current Good Manufacturing Practices manufacturing needs of customers and the anticipated growth of the SurModics Pharmaceuticals business. At the same time, SurModics Pharmaceuticals entered into an agreement with various governmental authorities to obtain financial incentives associated with creation of jobs in Alabama. Some of the governmental agencies have recapture rights in connection with the financial incentives if the number of full-time employees are not hired by June 2012, with an extension to June 2013 if circumstances or events occur that are beyond the control of SurModics Pharmaceuticals or could not have been reasonably anticipated by SurModics Pharmaceuticals. As of September 30, 2009, SurModics Pharmaceuticals has received $1.7 million in connection with the agreement, and the Company has recorded the payment in other long-term liabilities.
 
SRI Litigation.  On July 31, 2009, the Company’s SurModics Pharmaceuticals business unit was named as a defendant in litigation pending in the circuit court of Jefferson County, Alabama, between SRI and two of SRI’s former employees (the “Plaintiffs”). In the litigation, the Plaintiffs allege that they contributed to or invented certain intellectual property while they were employed at SRI, and pursuant to SRI’s policies then in effect, they are entitled to, among other things, a portion of the purchase price consideration paid by the Company to SRI as part the Company’s acquisition of Brookwood Pharmaceuticals, Inc., pursuant to a stock purchase agreement made effective on July 31, 2007 (the “Stock Purchase Agreement”). A trial has not yet been scheduled. Pursuant to the Stock Purchase Agreement, the Company has certain rights of indemnification against losses (including without limitation, damages, expenses and costs) incurred as a result of the litigation. The Company’s consolidated financial statements do not include any expenses or liabilities related to the above litigation as the probability of the outcome is currently not determinable and any potential loss is not estimable. The Company believes that it has meritorious defenses to the Plaintiffs’ claims and will vigorously defend and prosecute this matter.
 
Operating Leases.  The Company leases certain facilities under noncancelable operating lease agreements. Rent expense for the years ended September 30, 2009, 2008 and 2007 was $994,000, $773,000 and $140,000, respectively. Annual commitments pursuant to operating lease agreements are as follows:
 
         
Year Ended September 30,
     
 
2010
  $ 422,000  
2011
    177,000  
2012
    126,000  
2013
    131,000  
2014
    33,000  
Thereafter
     
         
Total minimum lease payments
  $ 889,000  
         
 
10.   Defined Contribution Plans
 
The Company has a 401(k) retirement and savings plan for the benefit of qualifying employees. The Company has matched 50% of each dollar of the first 6% of the tax deferral elected by each employee. Effective April 1, 2009, the Company changed its matching contribution to a discretionary approach and the Company ceased matching contributions. Company contributions totaling $243,000, $539,000 and $356,000 have been expensed for the years ended September 30, 2009, 2008 and 2007, respectively. The expense increase in fiscal 2008 principally reflects the addition of employees eligible for this benefit as a result of the SurModics Pharmaceuticals acquisition.
 
11.   Operating Segments
 
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding


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Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
how to allocate resources and in assessing performance. In November 2008, the Company announced it changed its operational structure so that the Company is now organized into four clinically and market focused business units: Cardiovascular, Ophthalmology, SurModics Pharmaceuticals, and In Vitro Technologies. The Company believes that this structure will improve the visibility, marketing and adoption of the Company’s broad array of technologies within specific markets and help its customers in the medical device, pharmaceutical and life science industries solve unmet clinical needs. In addition, a new centralized research and development function has been formed to serve the needs of the Company’s clinically and market focused business units, other than the SurModics Pharmaceuticals business unit, which continues to maintain certain R&D operations.
 
The Company manages its business on the basis of the markets noted in the table below, which are comprised of the Company’s four business units. “Therapeutic” contains: (1) the Cardiovascular business unit, which provides drug delivery and surface modification technologies to customers in the cardiovascular market; (2) the Ophthalmology business unit, which is currently focused on the advancement of treatments for eye diseases, such as age-related macular degeneration (AMD) and diabetic macular edema (DME), two of the leading causes of blindness; and (3) the SurModics Pharmaceuticals business unit, which provides proprietary polymer-based drug delivery technologies to companies developing improved pharmaceutical products in cardiovascular, ophthalmology and other clinical markets. Revenue results in Therapeutic are presented below by the clinical market areas in which the Company’s customers participate (Cardiovascular, Ophthalmology and Other Markets). “Diagnostic” contains the In Vitro Technologies business unit, which includes the Company’s microarray slide technologies, stabilization products, antigens and substrates for immunoassay diagnostics tests, and its in vitro diagnostic format technology.
 
For fiscal years ended September 30, 2009, 2008 and 2007, the Company’s results are aggregated into one reportable segment, as each business unit has similar economic characteristics, technology, manufacturing processes, customers, regulatory environments, and shared infrastructures. The Company manages its expenses on a company-wide basis, as many costs and activities are shared among the business units. The focus of the business units is providing solutions to customers and maximizing financial performance over the long term.
 
The table below presents revenue from the markets, for the years ended September 30 as follows (in thousands):
 
                         
    2009     2008     2007  
 
Therapeutic
                       
Cardiovascular
  $ 39,841     $ 47,675     $ 46,487  
Ophthalmology
    52,102       10,252       2,453  
Other Markets
    13,114       17,875       4,041  
                         
Total Therapeutic
    105,057       75,802       52,981  
Diagnostic
    16,477       21,249       20,183  
                         
Total revenue
  $ 121,534     $ 97,051     $ 73,164  
                         
 
 
Revenue from customers that equaled or exceeded 10% of total revenue was as follows for the years ended September 30:
 
                         
    2009   2008   2007
 
Merck & Company
    37 %     <10 %     **  
Johnson & Johnson
    11 %     20 %     33 %
Abbott Laboratories
    <10 %     10 %     16 %
 
 
** - less than one percent


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Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
 
The revenue from the customers listed is derived from all three primary sources: royalties and license fees, product sales, and research and development fees.
 
 
Geographic revenue was as follows for the years ended September 30:
 
                         
    2009   2008   2007
 
Domestic
    84 %     79 %     81 %
Foreign
    16 %     21 %     19 %
 
12.   Quarterly Financial Data (Unaudited)
 
The following is a summary of the unaudited quarterly results for the years ended September 30, 2009, 2008 and 2007 (in thousands, except per share data).
 
                                 
    First
    Second
    Third
    Fourth
 
    Quarter     Quarter     Quarter     Quarter  
 
Fiscal 2009
                               
Revenue
  $ 63,216     $ 20,925     $ 18,186     $ 19,207  
Income from operations
    42,667       6,200       4,661       3,973  
Net income
    27,085       4,216       3,539       2,710  
Net income per share(1):
                               
Basic
    1.53       0.24       0.20       0.16  
Diluted
    1.53       0.24       0.20       0.16  
Fiscal 2008
                               
Revenue
  $ 23,829     $ 25,707     $ 24,276     $ 23,239  
Income from operations
    7,571       7,181       7,184       5,325  
Net income (loss)
    5,646       5,107       4,800       (814 )
Net income (loss) per share(1):
                               
Basic
    0.31       0.28       0.27       (0.05 )
Diluted
    0.31       0.28       0.26       (0.05 )
Fiscal 2007
                               
Revenue
  $ 16,740     $ 17,362     $ 17,762     $ 21,300  
Income (loss) from operations
    8,109       8,085       7,518       (13,813 )
Net income (loss)
    5,992       5,675       5,587       (13,907 )
Net income (loss) per share(1):
                               
Basic
    0.32       0.31       0.31       (0.78 )
Diluted
    0.32       0.31       0.31       (0.78 )
 
 
(1) The sum of the quarterly earnings per share may not equal the annual earnings per share because of changes in the average shares outstanding.


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Table of Contents

 
SurModics, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 
 
In the first quarter of fiscal 2009, the Company recorded income that had previously been deferred of $34.8 million associated with the Merck contract termination, a $9 million milestone payment from Merck associated with the termination of the triamcinolone acetonide development program, a $3.2 million charge for in-process research and development acquired in connection with the purchase of certain contracts and assets of PR Pharma, as well as a $1.8 million restructuring charge associated with a functional reorganization.
 
In the fourth quarter of fiscal 2009, the Company recorded $1.3 million in royalty income in connection with the settlement of previously disclosed litigation involving Abbott Laboratories and Church & Dwight Co, Inc.
 
In the fourth quarter of fiscal 2008, the Company recorded a $4.3 million non-cash impairment loss on its investment in OctoPlus.
 
In the fourth quarter of fiscal 2007, the Company recorded a $15.6 million charge for in-process research and development acquired in connection with the purchase of SurModics Pharmaceuticals, Inc.


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