Teleflex Incorporated (TFX) Q1 2008 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Teleflex2008 business outlook conference call. (Operator Instructions) I would now liketo turn the presentation over to your host for today’s call, Ms. JulieMcDowell, Vice President of Corporate Communications. Please proceed, Madam.

Thank you and good morning, everyone. I’d like to welcomeyou to this conference call to discuss Teleflex's preliminary outlook for 2008business and financial performance. A press release was distributed thismorning and is available on the Teleflex website. We have also posted slides toaccompany our remarks on this call. Please note that this call will be available on our websiteand the replay will be available by dialing 888-286-8010 or for internationalcalls, 617-801-6888. The passcode number is 42798181. Joining us on today’s call is Jeff Black, Teleflex'sChairman and Chief Executive Officer; and Kevin Gordon, Teleflex's ExecutiveVice President and Chief Financial Officer. Each of these gentlemen will makebrief prepared remarks and then we will open up the call for questions. Before we begin, I would like to remind you that some of thematters discussed on this conference call will contain forward-lookingstatements, including but not limited to statements relating to revenue growth,expected full year diluted earnings per share from operations before and aftergiven the effect of special charges, forecasts regarding special charges, cashflow from operations, segment performance, and operating profit marginpercentage growth, and business and operational performance. We wish to caution you that such statements are in factforward-looking in nature and are subject to risks and uncertainties. Actualresults may differ materially from those in these forward-looking statementsdue to among other things, business conditions and the general economy, marketopportunities, competitive factors, sales and marketing execution, shifts intechnology, unanticipated expenditures in connection with the effectuation ofprograms, cost and length of time required to complete integration andrestructuring programs, unanticipated difficulties in connection with theconsolidation of manufacturing administrative functions, and other factorsdescribed in Teleflex's filings with the Securities and Exchange Commission.Additional factors that can cause actual results to differ materially to theseforward-looking statements are available in the SEC filings. I will now turn the call over to Jeff Black.

Thanks, Julie. Good morning, everyone. 2007 was a remarkableyear for Teleflex. We made dramatic changes in our portfolio with theacquisition of Arrow International, our largest acquisition ever, acquisitionsin all three segments, and the significant divestiture in commercial andaerospace. As an organization, we entered 2008 with a strong sense ofdirection and confidence. While 2008 will be somewhat of a transition year aswe integrate acquisitions and invest for future growth, we see ourselvesdelivering on the potential of our redefined portfolio. With the changes we’ve made to the portfolio in 2008, weexpect to deliver significantly higher overall segment operating marginsincreasing to the mid-teens for the year. As a comparison, our overall segmentoperating margins were in the 11% range on an annual basis with our 2006portfolio. We expect to deliver strong cash flow and businessperformance improvements, even with the integration of Arrow and theinvestments we are making in our other businesses for future growthopportunities. We are making great progress on the Arrow acquisition andare ahead of our schedule. As a result, we’ve increased our forecast ofpotential pre-tax synergies in 2008 from the Arrow integration by 10% to 20% tobe in the $33 million to $37 million range, and we completed the planneddivestiture of our automotive and industrial businesses by year-end, enablingus to use the expected net after-tax proceeds in the range of $400 million topay long-term debt, obviously improving our balance sheet position. Teleflex is quite a different company today than we werejust one year ago today. During the fourth quarter alone, we completed theArrow acquisition, the acquisition of Nordisk Aviation Products in ouraerospace segment, and the sale of our automotive and industrial businesses toKongsberg Automotive. Just to give you some perspective on our portfolio changes,this slide compares our revenue and our operating profit contributions bysegment for 2006 with our 2008 expectations. As illustrated here, thetransactions we completed in 2007 created a portfolio defined by our medicaltechnology business that provides more than 60% of the company’s revenues andmore than 75% of the company’s operating profit. Our two aerospace businesses are established market leaderswith well-known brands and a strong after-marker position. Both businessesenjoy long-term growth opportunities as the aerospace market strengthcontinues, newer engine types age, and as platforms from Airbus and Boeing comeonline. The commercial segment, which has historically been ourlargest, is now our smallest, representing less than 20% of our revenues andless than 10% of our operating profits. We are the market leaders in marinesteering and in the rating services, and we see future opportunity inalternative fuels and auxiliary power when the truck market rebounds, as fuelcost and environmental concerns get greater attention. Turning to slide number seven and a little detail on ourexpectations for each of the segments in 2008, I’ll provide you a little briefdescription of the business performance expectations for each of the segmentsand then Kevin will provide detail on the financial outlook. In medical, looking ahead to 2008, the medical segment isnow the defining business for the company. We expect revenue growth in ourmedical segment, driven by the continued penetration of our critical careproduct lines. We will be releasing or have recently introduced some nice newproducts to our core venous access and respiratory product lines. We’re addinga pressure injectable central venous catheter to join our pressure injectablePICC and an ultrasound system used for placing lines. We also recentlyintroduced a new humidification system in our respiratory product line as well. We see nice growth in the medical business internationally.We’re particularly excited about the growth potential in Asia and in some ofthe European markets, where combining the Arrow and Teleflex product linecreates strong cross-selling opportunities, and we also expect our OEM businessto rebound slightly with the orthopedic market and with new products in ourspecialty areas. Overall, we see the combined medical segment at mid singledigit core growth this year. This is a nice recurring revenue business growingwith or a little ahead of the market trends. We will discuss integration costs and synergy expectationsin more detail but we expect to see the segment operating margins reaching the20% range during the year. Additionally, I wanted to note that we have accelerated ourcompliance related activities for Arrow facilities to address the FDA corporatewarning letter issued to Arrow in October of 2007. We’ve dedicated significantresources and made good progress. We’ve met with the FDA, responded to theletter in writing, reviewed employee training records and process controlsrelated to all of the citations noted. As in the case of these things, it willtake some time to work through but effectively, I’m pleased with the progressthat we’ve made to date. While the main focus for this year will be executing onintegration plans and meeting compliance requirements, we will be continuing tobuild on our core products and investing in new products. In our aerospace business, revenue growth will comeprimarily from the impact of the Nordisk acquisition. This acquisition providedus with market leadership, strong customer relations, and a global operationsfor air cargo containers. While we continue to see a strong commercial aviationmarket, segment core growth is likely to be relatively flat. Following a stronggrowth year in 2007, 2008 will be a transition year as we prepare for a surgein demand in 2008 and beyond, created by our position on new aircraft platformsand an increased demand for repair on new engine types. In the cargo systems business, which is roughly now about50% of the segment revenues, Telair continues to lead the market and expand theinstalled base of cargo systems. We’ve recently been selected as a supplier offurnished equipment for the new Boeing 747-8 with deliveries currentlyscheduled to begin at the end of 2008. Additionally, we are very pleased that we are now thesupplier of furnished equipment on the upcoming Airbus A350, adding to ourpresence with Airbus and creating significant long-term opportunity inpartnership with these OEMs and the airlines. As we prepare for these platforms, we’ve seen delays in theA380 deliveries, deferring conversions of 747-4 aircraft from passenger tofreighter as customers keep these planes in service as passenger aircraft. The repairs business will experience moderate growth in 2008as utilization of newer CFM engines continues and demand for repairs andmaintenance maintains current levels. As the CFM and other new engine types ageand the flight hours continue at the current pace, we expect to see increaseddemand for engine repairs and new technology. Our repairs business iswell-positioned here and we are investing in R&D and operationalinitiatives to prepare for future demand. Overall, the aerospace segment will benefit from recentrestructuring and from operational effectiveness initiatives and continue tosee margin improvement with low double-digit margins. Obviously the most significant change has been in ourcommercial segments, which now represents less than 10% of the company’soverall operating profit. Marine products where Teleflex has a market leadingposition should represent more than half of the revenues in this segment. We stayed ahead of the slower marine markets over the lastfew years with a nice mix of new products and increases in the internationaland after-market sales. We expect to see a continued nice growth in marginimprovement from our marine and rigging services business, offset by a declinein demand for our power system products for the North American truck market. With that, let me turn it over to Kevin for financialremarks.

Thanks, Jeff. Good morning, everybody. Thanks for joining usthis morning. As Jeff mentioned, at the end of the year, we completed thedivestiture of the automotive industrial businesses. These businesses will beclassified as discontinued operations in the fourth quarter of 2007. Last week,we filed a Form 8-K with unaudited pro forma historical financial informationreflecting the divestiture of the automotive industrial businesses and theacquisition of the Arrow business. We will also post to our website unaudited quarterlyadjusted results of operations for 2006 and the first three quarters of 2007,reflecting segment data with the automotive industrial businesses classified asdiscontinued operations for those periods. This data does not include anyimpact from the Arrow acquisition, which occurred after that time. We won’t be discussing specific expectations for the fourthquarter or 2007 year-end results on this call. It’s still a bit early. We havea lot of work to do in the year-end close with many of the moving parts but ourpreliminary projections show operating financial performance from ourcontinuing core operations that is relatively in line with our expectations forthese businesses for the year prior to certain transaction related charges anda possible impairment charge. As we have said before, with the fourth quarter activitiesrelated to the divestiture and acquisitions, we expect to have transactionrelated charges related to inventory step-up, in-process R&D, transactioncosts and such, as well as the gain on the sale of the automotive industrialbusinesses. The gain on sale is currently estimated at approximately $90million net of tax but is subject to working capital and other operatingadjustments. We may also record a non-cash charge related to impairment ofprincipally intangible assets of the power systems business. While thesebusinesses enjoyed a healthy market early in 2007, market shifts, particularlyfor the North American truck market, have adversely impacted our valuationsconsidering the required annual good will impairment testing currently beingcompleted. Slide 12 outlines some of the overall assumptions that wemade in providing you the outlook for this new coming year. First, ourfinancial goals and metrics; we made significant changes to the business in2007, most notably in the fourth quarter. As we look ahead to 2008, we projectrevenues for Teleflex to top $2.4 billion. As Jeff indicated earlier, our strongest core top linegrowth is expected to be in the medical segment. Aerospace revenue growth willbe driven by the addition of Nordisk in the cargo systems business and moderategrowth in the repairs business, and the commercial segment is expected to berelatively flat year over year. Our projected overall segment operating margins are expectedto reach the mid-teens for the year, which Jeff mentioned is a significantimprovement over the margins prior to the change in the portfolio. We see overall revenues and operating profit growthaccelerating as the year progresses, resulting in a stronger second half. Thisgrowth comes largely from volume increases, synergies net of costs related tointegration activities, and continued productivity improvements. Clearlyspending will be higher earlier in the year with synergy benefits increasing asthe year progresses. Also important, our cash flow story will continue to becompelling. Another strong year of operating cash flow will be driven byincreasing operating margins and continued improvement in working capitalmanagement. In particular, we see opportunity to improve working capitalmanagement for the Arrow product lines; however, we will make significant taxpayments in the first half of 2008 related to the gain on sale recorded indiscontinued operations in December 2007. Considering the changes in the portfolio, we expect the effectivetax rate to be between 27% and 29% for the year. With the investments requiredfor the medical segment and the Arrow integration and additional investment incapacity for future growth principally in aerospace, we expect capitalexpenditure requirements to be $60 million to $70 million, or something in therange of 3% of sales. Recent transactions and capital requirements will have animpact on our depreciation/amortization levels expected to total approximately$120 million as we depreciate current capital expenditures and have increasedamortization costs related to both purchase accounting and financing costs. Andas we stated, repayment of debt will be a high priority to reduce interestexpense and provide capital for future growth opportunities. With the completion of the divestiture of our automotiveindustrial businesses, we utilized proceeds from the divestiture to pay downdebt by approximately $530 million in December, reducing the debt balance toapproximately $1.7 billion as of December 31, 2007. We expect to enter 2008 with cash of approximately $150million and will utilize the revolving line of credit as needed in the firsthalf of 2008 to fund tax payments related to the divestiture in 2007. In relation to the acquisition of Arrow, annual pretaxsynergies are expected to be in the range of $70 million to $75 million by2010. The integration team has made great progress in the first few months andwe are ahead of our original expectation in terms of timing. We now see annualpretax synergies in 2008 in the range of $33 million to $37 million, exceedingour original expectations of approximately $30 million for 2008. Integration costs are currently estimated to total $70million to $80 million through 2010 with $35 million to $40 million treated asexpense and the remaining amount of approximately $35 million treated as aliability in purchase accounting. Turning to the earnings outlook, prior to special charges,we are forecasting the EPS range of $3.70 to $3.90 per share for 2008. Specialcharges, which principally relate to Arrow integration and inventory step upcharges, are currently forecasted at $0.60 to $0.67 per share. Earnings pershare from continuing operations including special charges is expected to be inthe range of $3.03 to $3.30 per share. With significantly improved overall operating margins anddisciplined working capital management, offset by integration spending andhigher interest costs, cash flow from operations is expected to beapproximately $250 million, excluding tax payments related to the gain recordedin 2007. 2008 will be a year of continued focus on cash generation tosupport our growth initiatives and to improve the capital structure. I will now turn it back to Jeff for some closing remarks. Jeff.

Thanks, Kevin. Well, I think you’ll all agree that Teleflexis quite a different company than it was at last year’s outlook call. Today,Teleflex is a tough competitor in its markets, has strong brands and customerrelationships, strong engineering capabilities, and a management team with aproven track record of execution on operational and strategic initiatives,clearly something we’ve demonstrated with the magnitude of our changes inrecent years. From a financial fundamental standpoint, we have expandingoperating margins, sound working capital management, and outstanding cash flow.Teleflex has always appealed to cash flow investors and we will strive tocontinue enhancing that profile. Now, our remaining challenge is to energize top line growthand continue to build through R&D acquisition. We are clearly in a positionto make this happen in 2008 and beyond. With that, I’ll turn it back over to Julie.

Operator, we’re ready to take questions. We’d like to askour participants to give one question and then a follow-up. Thank you.

(Operator Instructions) Your first question comes from theline of Deane Dray of Goldman Sachs. Please proceed.

Thank you. Good morning and happy new year. The spirit of myquestion is, Jeff, what is the targeted business mix for Teleflex goingforward? And specifically, we would argue that you are no longer pursuing whatwe would characterize as the diversified business model because you’ve gotarguably 75%, 80% of profit now coming from medical. So increasingly, nottoday, but increasingly the non-medical businesses at Teleflex are going to beviewed potentially as a distraction. So that goes back to the question, what’sthe ideal business mix? And then, looking down the road, if these aredistractions might you be opening yourself up to some activist shareholdersthat would be pushing for further divestitures?

Let me first start with the mix of the portfolio, Deane. Imean, we’ve worked hard over the last five years to get -- obviously reduce thecyclicality, drive improved margins but I think when you take a look at whatremains in our portfolio today, we feel very good. They are very strong franchises,whether it be in the repairs business with ATI, whether it be in the cargoloading with Telair, or even in the marine business. I think it’s -- that’sreally what we are looking for, is franchises that one, have strong positions;number two, that can continue to grow despite some of the cyclicality; and moreimportantly, that can generate significant cash flow that we can invest backinto our businesses. So I think you can see that just in the last -- in ’07, wemade investments into the rigging services business. We made investments intothe cargo because we believe we are well-positioned there to continue to expandon our leadership. So while it would be easy to say should we be pure play, Iwill tell you at this point we are happy to be diversified and I think we aregoing to continue to work on our portfolio as opportunities arise, both on the buyand potentially on the sell side. I think that’s what we are paid to do. In terms of distractions, I have to tell you, when you lookat the work that’s gone on, I think our biggest distraction is getting back togrowing our core businesses, not necessarily the segments that we have in termsof do we stay in some of these or not, but I think for the time being, when youtake a look at some of the growth rates where we’ve outperformed the markets, Ithink we do a little better in some of the medical markets. I think we’veoutperformed the marine market for at least the past two years and would hopeto do so in ’08. So I think management is very focused and more importantly,for ’08 and beyond, we’ve got to focus on driving cash and getting back to astronger core growth.

Great, that’s helpful, Jeff, and just as a follow-up, youtalk about the focus on boosting growth across the core businesses, andspecifically in medical. Walk us through what the game plan is, because youreally do need to move the dial from that 3% to 4% core revenue growth inmedical up towards the group levels, which is mid to high single digits. Sotake us through the game plan -- is it -- how do you want to focus resources onR&D and what should be the contribution from new products? And are youwilling to make that R&D investment and might that come at a sacrifice tosome of the margins?

It’s a good point, Deane and you know, what I would say iswhen we looked at where we are in the medical segment, I mean, one of theattractions when we hired Ernest Waaser was his strong background in R&D.He got a lot of that experience at Dupont and along the way in some of hisother medical operations, so I think we feel we have the right leadership. Ithink we are better structured but when you take a look at the overallspending, we typically were spending about 3% in R&D for medical. Arrow wasspending probably a little north of six, so I think we look at it and say Ithink we’re committed to spending about 4.5% in ’08 on R&D and I will tellyou, I think it’s going to be more on pure R&D as opposed to some of thereengineering that we had probably done in the past. So I actually feel pretty good but obviously that was thereal attraction to Arrow for us, was getting an organization that had a strongR&D capability and then taking some of the anti-microbial coatings and takethem across our respiratory and urology products, so I think we feel prettygood about it. I would also say that we are seeing opportunities on the OEMside where the OEMs in the medical business are doing more supplierconsolidation and looking for suppliers like Teleflex who has broadercapabilities than many of the other single skill capabilities. So at this point, I feel pretty good about it. We’veinvested a fair amount in the last few years in our marine business to movemore from a mechanical company to a electro-mechanical and electronics companyand I think that’s why we’ve seen increased growth over the market, at least inthat segment itself.

And just one last one here and I’ll give up the floor, butwhen you mention pure R&D as a way of ratcheting up from 3% to 3.5%, whenyou say pure R&D, that doesn’t sound as near-term commercially impactful,so is that -- will we see impact there in top line growth coming from R&Din 2008 or is that a longer term?

I think you’re looking at ’09, to be quite honest, and againfor me, pure R&D, maybe that was maybe not the proper wording but I wouldsay a more focused effort in R&D and again, I think taking theantimicrobial, which is a very hot area in medical and utilizing it across ourportfolio is where I think we’re going to spend most of our effort right upfront.

Great. That’s very helpful. Thank you.

Your next question comes from the line of Jim Lucas ofJanney Montgomery Scott. Please proceed.

Thanks. Good morning, all. Two questions here; first, Jeff,could you give us any additional color with regard to the Arrow integration ofwhy you are saying it’s ahead of schedule? And you spent a lot of time talkingabout the synergies, you just covered it in some of your answer to Deane’squestion on the R&D side, but any additional color you can provide there? And secondly, a question for Kevin on the cash flow side,you spent some time talking about the sales and the earnings perspective, butif you could maybe spend a little more time and walk us through the cash flow,because $250 million seems to be somewhat conservative and wondering wherepotential upside could come there.

Sure. I’ll start with the synergies, Jim. I think we’ve seenit really I would say almost across the board on where we think we’ll get aheadof next year. One, it really comes back to the reception we’ve gotten from theArrow management team who remains with the organization, the receptivity thatthey’ve had to some of these changes. I would also say that I think we’vegained some momentum. I think you have to go back and obviously when we got thecorporate warning letter from the FDA, a lot of our efforts were put righttowards ensuring that we were getting the organization to a compliance state.But I really think that what we’ve seen is that the opportunities both from apersonnel standpoint and from other standpoints, we believe that 10% to 20% iswithin our ability to achieve and I think as we go through the year, we’llcontinue to provide updates as to where those synergies are. I think it mightbe a little premature to talk in detail as to how we see those coming about. With that, I’ll turn it over to Kevin on the conservativecash flow comment.

When you look at the cash flows, Jim, I think it’s importantthat you have to keep in mind the purchase accounting implications of some ofthe integration reserve, so as you look at the balance sheet pushing throughthe cash flow statement, you’ll have an impact in ’08 on some of that spending,on some of those accruals pushing through, so that drops the number a littlebit. As well as some tax related issues with some of the repatriation that we will do with cash. Certainly I think Jeff characterized it early in his remarksas somewhat of a transition year. This will be the year where you have a lot ofthat integration spending coming through that will lower it.

To that comment, with 2008 as a transition year and clearlywe get through the early integration, looking at a much different company in’09, looking at the underlying earnings power but looking at a more normalizedcash flow, what do you think that number could potentially be?

Well, certainly we can all do projections around what that’sgoing to look like but I think we’ve given you some pretty good insight todayinto our expectations with the improving margins and some opportunitypotentially with respect to better working capital discipline with the Arrow,so I think you get a perspective of the costs related to the integration and soforth. In ’08, those are in the $35 million to $40 million plus range in terms ofwhat we are spending there, so certainly start with that and then look at theachievement of the additional synergies that we’ll derive over the three-yearperiod that we outlined and you can understand the opportunity there.

I think, Jim, even when you go back to when we were lookingto acquire Arrow, we knew ’08 was going to be a transition year. Really, theexcitement is once we get through some of the integration in ’08, what does thebusiness look like, what does the margins look like in ’09. So I mean, we’reexcited by it but it’s the second week in January. We’ve got ’08 and we’ve gotto work through some of the execution and quite frankly, I think -- I’ve saidit in the past, is the automotive and industrial business, the effort that’sgone into that for the last two years, prepared for sale and actually finishedthe sale, taking those resources and putting them back towards growth I thinkis where we are going to spend a lot of our time in ’08 and beyond.

Okay, fair enough. And on the aerospace side of thebusiness, you know, a curious comment about the flattish core outlook, givenwhat’s still a relatively strong cycle. And you alluded to some of the thingsthat are going on there but particularly from the repair side of the business,is this a case of conservatism here or is there something underlying with yourparticular aerospace businesses? Just trying to get a feel for the disconnectbetween what we are seeing from an overall aerospace cycle versus your commentsabout flattish growth.

Well, the market -- we don’t disagree with you the marketremains strong, the cycle continues to go. The two major segments we havethere, as you know, are cargo and repairs. I think as we said in our remarks,we expect the repairs business to actually be up year over year with somegrowth in that business, Jim. New investment that we are looking at and newtechnology we’re investing in that business this year. As we look at some of thesenewer technologies that come online, whether it’s 2D to 3D dimension typeblades. So there is investment going on there for these newer type engines asyou go forward. With respect to cargo, I think even over the last couple ofquarters, I think we’ve talked a little bit about this conversion with the A380and so forth. What’s exciting to us is the potential that’s ’09 and beyond withthis SFE classification with the OEMs, with the A350, with the 747-8. Clearlyfrom a platform standpoint where we have our strength in that business today,there’s a bit of a transition but what we’ve done is done a great job ofpositioning ourselves on the new platforms as they are coming online to reallyprovide the growth opportunity as you’re suggesting as the cycle continues toextend beyond ’08.

I think, Jim, just to add a little color, if you remember onthe repair business, last year there was a fair amount of in-sourcing that tookplace by some of our customers on the repair business, so I think that’s why wesee a slight up-tick in the revenue because we’ve actually had to replace asignificant amount of business that was in-sourced by one of the enginemanufacturers. And I’ll just echo Kevin’s -- I mean, for us to finally beidentified as the SFE supplier into Boeing for the cargo, I mean, we’ve talkedabout this. This was always a goal of Teleflex's and of our cargo business formore than 15 years. It’s a real tribute to the leadership, both at Telair andof our aerospace group, that we finally have become the SFE. I think it onlysubstantiates that we bring the value both in terms of engineering and the factthat we are perceived as the global leader. We are now a key supplier. We’vealways been a key supplier to Airbus but now that we’ve penetrated Boeing, westill see that that’s really building an annuity stream for many years to come.

Okay. Thank you very much.

(Operator Instructions) And there are no further questionsat this time. I’d like to turn the call back over to Julie McDowell for closingremarks.

Thank you, everyone for joining us this morning. Please notethat this call will be available on our website and a replay will be availableby dialing 888-286-8010 or for international calls, 617-801-6888, passcodenumber 42798181. Thank you.

Thank you for your participation in today’s conference. Thisconcludes the presentation. You may now disconnect. Good day.