An old article from the Minneapolis Star which I am afraid will become unavailable soon.
Star Tribune (Minneapolis)
Sunday, January 26, 2003
Surmodics: The right chemistry
Dick Youngblood
when last we encountered Dale Olseth, the management veteran who once headed Tonka Toys and Medtronic Inc., he was indulging his passion for metaphors to describe his latest enterprise as "the high-tech equivalent of an oil field."
That was three years ago, and the oil field has turned into a gusher since then. And with a client list that includes the bulky likes of Johnson & Johnson and the former Motorola Life Sciences, the outlook is for an even more abundant flow in the near future.
Olseth, 72, is CEO of SurModics Inc., an Eden Prairie company that operates in the arcane arena of surface modification sciences. Translated, that means its PhotoLink specialty chemicals, when exposed to ultraviolet light, can alter dramatically the properties of almost any surface.
A pacemaker lead can be made more slippery to facilitate insertion and movement in the body; a dialysis catheter can be treated to resist infection; a stent used to reopen arteries can be made to resist blood-clotting.
Or, if Food and Drug Administration (FDA) approval comes through in the current quarter, as expected, Johnson & Johnson coronary stents will be coated with PhotoLink chemistry to provide a controlled release of therapeutic drugs that can keep arteries open longer. That development promises to propel SurModics rapidly out of the realm of small businesses, to which I've been assigned.
What we've got here, in short, is a technology so attractive that clients not only are willing to pay a 2 to 4 percent royalty on the sale of products treated with PhotoLink, many of them also pay SurModics to develop specific applications for their products. Then they shell out tens of thousands more to buy the chemicals for inclusion in their manufacturing processes.
The result is a gross margin that approaches 90 percent, and a pretax margin that tops 40 percent. Olseth can call that an oil field if he likes; I call it a gold mine.
Perpendicular growth path
Whatever term you choose, the fact is that SurModics -- which was small, unprofitable and going nowhere when Olseth took over in 1986 -- is on a perpendicular growth path. Sales reached $29.5 million in fiscal 2002 ended Sept. 30, up 30 percent from $22.7 million in 2001 and triple the level in 1998, the year before my last interview with Olseth.
Net earnings have followed an even steeper growth pattern, climbing from $1.6 million, or 12 cents a share, in 1998 to $7.8 million, or 44 cents a share last year. The pattern continued in the first quarter ended Dec. 31, when the company boosted sales 33 percent, to $8 million, and earnings rose 50 percent, to $2.2 million, or 12 cents a share.
While two-thirds of the business still involves treating stents and catheters to make them more slippery, Johnson & Johnson's drug-coated stent promises to shift that proportion dramatically.
Consider: In a recent analysis, the New York Times cited projections by a Banc of America Securities analyst that the new J&J stent could double the total stent market this year to about $3.2 billion, with J&J capturing about $2.8 billion of that amount.
This prospect has securities analysts projecting continued rapid growth for SurModics.
James Terwilliger, an analyst with Morgan Keagan in Memphis, expects 2003 earnings of $11.3 million, or 63 cents a share, on sales of $36.8 million. Steve Hamill, an analyst with RBC Dain Rausher in Minneapolis, is only slightly less optimistic: He looks for a net of $10.9 million, or 61 cents a share, on sales of $36 million. Both Hamill and Terwilliger have assigned an "outperform" rating to the company.
And if J&J receives prompt approval for its drug-coated stent, the performance in 2004 could be even more spectacular. Hamill, for example, is projecting that earnings will more than double in '04 to $23.5 million, or $1.28 a share, on sales of nearly $58 million.
Genomics a potential market
Meanwhile, SurModics is laboring in ever more unfathomable fields, including genomics. In a partnership started with Motorola Life Sciences, which since has been sold to Amersham PLC in London, SurModics developed a unique coating that allows a more accurate and consistent method of attaching DNA to glass slides. Olseth said the market for genetic structure analysis is about $500 million a year.
All of which represents a significant shift for a company that was struggling to survive in the intensely competitive field of diagnostic chemistry when Olseth signed on.
"The market [for chemistry used in diagnostic testing] was dominated by big companies," he recalled. "I knew we had to find a less-crowded niche or we'd get eaten alive." The answer was to focus on the surface-modification technology on which the company, then known as Biometric Systems, also had been working with only modest emphasis.
Despite the eye-fetching performance of recent years, however, SurModics stock closed Friday at a share, its peak of $59.37 in mid-2001 and well below the 12-month high of $46.50 in March.
Olseth is unconcerned: "At the peak, our stock was trading at more than 150 times [2001] earnings," he said, the fallout from favorable results of J&J's clinical studies with the drug-coated stent. "That gave us a market value of nearly $1 billion. We were way overvalued in a market that was heading south."
There's good reason for his sanguine attitude. Even at Friday's close, SurModics stock still was trading at
"I'm not complaining," Olseth said, "and neither are our shareholders."
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