Teleflex Incorporated (TFX) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Quarter 2 2013 Teleflex Incorporated Earnings Conference Call. My name is Carolyn, and I'll be your operator for today. [Operator Instructions] A reminder, the call is being recorded for replay purposes. And now, I'd like to turn the call over to Jake Elguicze. He's Treasurer and Vice President of Investor Relations. Please go ahead, sir.

Good morning, everyone, and welcome to the Teleflex Incorporated Second Quarter 2013 Earnings Conference Call. The press release and slides to accompany this call are available on our website at www.teleflex.com. As a reminder, this call will be available on our website, and a replay will be available by dialing (888) 286-8010, or for international calls, (617) 801-6888, passcode 88095129. Participating on today's call are Benson Smith, Chairman, President and Chief Executive Officer; and Thomas Powell, Executive Vice President and Chief Financial Officer. Benson and Tom will make brief prepared remarks and then we'll open up the call to questions. Before we begin, I'd like to remind you that some of the matters discussed in the conference call will contain forward-looking statements regarding future events, as outlined on Slide 4. We wish to caution you that such statements are in fact forward-looking in nature and are subject to risks and uncertainties, and actual events or results may differ materially. The factors that could cause actual results or events to differ materially include, but are not limited to, factors made in our press release today, as well as our filing with the SEC, including our Form 10-K, which can be accessed on our website. With that, I'd like to now turn the call over to Benson.

Thanks, Jake, and good morning, everyone. Similar to our other calls, I'll begin with an overview of the results for the second quarter and discuss some strategic highlights. Tom will then provide you with a more detailed review of our financial performance, including details of our product line and geographic revenue mix, and then finally, our outlook for 2013. So beginning with our financial highlights. Second quarter 2013 revenue was approximately $420 million. This represents an increase of 9.6% versus the prior year quarter on both an as-reported and constant currency basis. We saw both a year-over-year and sequential improvement in pricing, as well as from the contribution of recently introduced products to the market. In addition, LMA continued to contribute meaningfully to our top line growth, adding approximately 8.5% of constant currency revenue growth in the quarter. From an overall Teleflex portfolio perspective, we continue to see the impact of negative hospital and physician office trends on a year-over-year basis. Our current internal estimate has hospital utilization rates down approximately 3% for the first half of 2013, versus 2% growth for the full year of 2012. In 2012, the combination of share gains, price and new product introductions provided an additional 3% growth on top of the 2% utilization growth for total Teleflex growth of approximately 5%. This year, the combination of share gains, price and new product introductions is generating approximately a 4% improvement. However, through the first half of 2013, the negative 3% utilization number is reducing this to approximately 1%. Past data shows that utilization rates eventually rebound and almost always within 6- to 12-month time frame. Given the basic underlying demographics, it's hard to construct a scenario where that won't happen in this case. When exactly that will happen is harder to predict. So we…

Thanks, Benson, and good morning, everyone. Revenues for the first quarter were $420.1 million. This represents an increase of 9.6% on both an as-reported and constant currency basis versus the second quarter of 2012. The growth in constant currency revenue is largely due to the acquisition of LMA, which contributed approximately 8.5% of growth and pricing, which contributed another 91 basis points of growth. Turning to gross profit. Adjusted gross profit and margin were $209.2 million and 49.8%, respectively. This compares to $184.4 million and 48.1% in the prior year quarter. A 170-basis-point increase in gross margin in the second quarter is primarily due to the acquisition of LMA, as well as selective price increases. In addition, gross profit in the second quarter of 2012 was adversely impacted by certain costs associated with the startup of the Singapore distribution center, and these costs did not reoccur in 2013. Now let's move to the discussion of operating margin. For the second quarter of 2013, the adjusted operating margin was 17%. This represents a sequential increase of approximately 230 basis points as compared to the first quarter of 2013. When compared to the second quarter of 2012, adjusted operating margin was flat. Versus 2012, the gains achieved in gross margin were offset by additional costs for the medical device excise tax and additional amortization and operating expenses associated with the late-stage technology acquisitions completed in 2012. If we were to exclude these costs, the adjusted operating margin would have been approximately 18.4%. Turning now to taxes. The GAAP tax rate for the second quarter of 2013 was 12.3% and included net tax benefits from the resolution of both a foreign tax matter and a U.S. state matter. Both of these benefits related to prior periods and were, therefore, added back in determining…

[Operator Instructions] To begin, please stand by for your first question, which comes from the line of David Lewis of Morgan Stanley.

I wonder -- so 2 questions I want to focus in on both the top and bottom line. First of all, you think about the trends in the first quarter. Most of the business metrics are coming in, in line or slightly better. But organic growth, specifically volumes, is obviously soft again for the second quarter. So if you think about the back half of the year visibility of organic growth, our math has your organic growth sort of having to accelerate kind of 1% to 2% in the first half to something like 5% or so in the back half. I wonder if you could just give us some very specific commentary on if that's sort of how you see the back half? And what gives you the confidence that, that organic growth number can get better in the back half? Or is it simply assuming that LMA gets dramatically better in the organic growth and acceleration is not as severe. But that's the first question. I have one follow-up.

So the overall answer really is we have an additional day in the back half and we have some new products that have already been launched in the first half that start to contribute. And I'll turn it over to Tom to give you some more specifics around those points.

Okay. Well, we do see it similar to the math you just laid out. And as Benson mentioned, we have an extra shipping day just how our days are calendarized during the year. And that, we expect to add about 120 basis points of growth by itself. But then in addition, we have a number of items, none of them by themselves are all that significant but, collectively, they do support the growth. And I'll just highlight a number of those. First of all, as mentioned, we acquired Ultimate during the year, which will add revenues in the back half of the year. We also had a number of new products coming out. I think Benson highlighted a number of the key ones. And that will add some fairly significant growth in the back half. We also had acquired EFx, EZ-Blocker, Hotspur and we expect, as those businesses continue to ramp up, we'll get more revenue growth out of them in the back half of the year versus the first half. We also have a distributor go-direct strategy that's aiding our revenues a little bit. And then a number of one-off issues that really benefit the back half of the year versus the first half, and I'll enumerate a couple of bigger ones. In 2012, there was a customs strike in Brazil that we don't expect to reoccur this year, and so it somewhat helps with an easy comparable. We also had some import restrictions being imposed by the government of Argentina and we're trying to see those loose, then we have some belief that we may get some additional benefit in the back half. And then we had a distributor who was adjusting stocking levels down in the first half, that now has kind of reached that new point and we expect those revenues to continue as normally as would be expected. And also, we're likely to get a little bit of benefit from the euro in the third quarter as a result of just last year's exchange rate, I think, being around EUR 1.25. Have some negativity from the yen likely. But overall, I expect all of these different matters to add up to support the stronger second half that we've got projected.

Okay, Tom, very clear. And then maybe just one quick one. Benson made a comment about maintaining the earnings guidance range regardless of the adjustment. But just so we're crystal clear, on the $4.70 to $4.90, is the approximate $0.12 to $0.16 of antidilution included in that number or not? And if it is included, is the way to think about this the operational performance is the low end of the range and you're at the top end of the range when you include the adjustment?

So our operational income expectations right now are exactly the same place they were when we issued our guidance. So we expect operational performance to come in at exactly the same number. There is a modest benefit that comes from the adjustment that we're making, but not enough to take us outside the range.

Yes, so one way to think about it is, if you go back to when we first communicated earnings for the year, back in December at our Analyst Day, we had assumed a dilution from the converts sent from the warrants of $0.11. And as a result of this change, we're going to be taking out the dilution associated with the converts because we're now going to be counting the hedge agreement, which essentially offsets that dilution. However, we still have the dilution associated with the warrants. And if stock price stays at today's level, that's probably about $0.04. If it increases a little bit, it might be a $0.06 of dilution. So net-net, we see this change as, perhaps, generating a net $0.05 benefit versus our initial kind of guidance expectations. And so we didn't see that as being meaningful enough to cause us to change our guidance range at all on EPS. However, as Benson mentioned, we do want to reiterate that our underlying business performance is still very much on track with our initial expectations. While revenue is softer than planned, as discussed, we've enacted a number of cost-savings measures and we've also seen some greater performance out of LMA than initially expected. And some of the productivity initiatives that we're putting in place are really starting to drive some performance improvements. So overall, I think the headline is that operating performance is largely on track with our expectations at the beginning of the year.

And Tom, is it safe to assume based on your comments around distribution being on track here in the second quarter, that margin performance in the back half of the year should be stronger than the first half? You still feel comfortable with that?

On the gross margin line, we feel comfortable that gross margin will be kind of that 50% level that we achieved in the second quarter, perhaps a little bit higher as we get into the fourth quarter. On the operating margin line, we had a pretty solid performance in the second quarter and that's going to be tough to replicate throughout the whole year. But we do see improved performance over what we'd see in the first quarter, perhaps not quite at the level that we saw in the second quarter on the operating margin line.

The next question we have comes from the line of Matthew Taylor from Barclays.

I just wanted to touch on the pricing initiatives. You had some bounce back from last quarter. One thing you talked about last quarter was some disruption in Asia and prices were down there. So I was wondering if you could just give us a little more insight on some of the dynamics in the different regions. And what you're expecting out of each of those going forward? You mentioned your long-term view is kind of intact. So any commentary on that would be helpful.

So I'll repeat a comment I made last quarter, and that is the underlying instructions that each of our regions have is not to be aggressive with price to the point that it puts volume at risk. In this particular quarter, the -- most of the pricing decline that came in China came from a decision to lower the price on a clip applicator so that we would get those placed in more hospitals and sell more clips. We took the hit on price for the applicators but we'll see the revenue in future quarters come in from the clips. So -- and I use that as an example. Most of these changes in our estimates from quarter-to-quarter are really around very unique circumstances. Last quarter, it happened to be Europe. We were able to recover relatively nicely in Europe in the quarter and I would say the same thing is true as we look through the last half of the year in Asia. We expect improved pricing in Asia to come out. So -- and as I said last quarter, as we move further into next year, more and more of our pricing comes from increasing prices to distributors, as opposed to end users. And we have a high level of confidence of being able to achieve that.

And I just wanted to ask one on your organic growth and revenue expectations for the year. So you talked about some lower utilization, I guess, in the U.S. hospitals. In terms of making your guidance for the year, how much of that is predicated on continuation of the current trends in the environment? And how much is more Teleflex specific with some of the new products that you talked about? If you could help us just kind of parse out those different factors, that would be great.

So I would say comments on utilization, well, there's probably more publicity about what's going on in the United States. There's lower utilization trends in Europe and lower utilization trends in Japan as well. Our assumption is that they stay -- that these utilization trends stay at about the same level they are now, which is in negative territory for the balance of the year. Our ability to take share, launch new products and get price doesn't seem to be impacted by those declines in utilization. So those are sort of the baseline assumptions in hitting our new revenue guidance line.

The next question we have comes from the line of Matt O'Brien from William Blair.

This is Kaila in for Matt. I just have a couple of questions for you. With respect to those utilization trends that you just discussed, what gives you the confidence in those markets just remaining stable and not deteriorating?

Yes, so that's a good question. And I would say, we have no magic crystal ball. Personally, over the last 4 weeks, I visited with most of the largest GPOs in the United States. And I would say, they don't have a good explanation for the lower utilization trends. They were as surprised as much as anyone else. So I can't say that we know for sure what's going to happen, whether they're going to improve or that anybody else knows that they're not going to decline. The best we can do is really peg our growth rates on top of what we think the utilization rates are likely to be at this point in time. They've been relatively consistent that, that minus 3% level throughout the year. So that's sort of the core that's driving that assumption. But we don't have a magic crystal ball here to be able to say for sure what's going to happen to utilization rates.

Understood. Great. And then just with respect to VasoNova, what sort of pull-through revenue are we currently seeing in PICCs? And then where do you think that, that could go over time?

So I think right now, Kaila, I think we're approximately still seeing the same type of pull-through on additional PICC revenue that we've stated in the past. I believe that our prior statements refer to somewhere around, call it, a 30%-or-so pull-through rate on additional PICC product revenue associated with VPS sales, and I think that, that's still in line.

Okay, and then just over time, where do you think that, that could go?

So I'll take a stab at this. The biggest, I think, improvement that we can make in our product offering over the next 6 months is the ability to package our Stylet with our antimicrobial and antithrombogenic PICC. Right now, there's some product modifications that we need to undergo so that the Stylet will fit comfortably within that product. So right now, the very best PICC we have that's receiving some attention doesn't marry well with the Stylet to the VPS unit. Once that obstacle is removed, we're pretty confident that we're going to see some upward trends in PICC conversions as a result of VasoNova placements.

The next question we have comes from the line of Larry Keusch from Raymond James. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: Benson, I was just wondering if I could take your temperature on M&A. You've obviously done some larger deals with M&A and with LMA and obviously some of these smaller technology deals. But how are you thinking about sort of size and scope of M&A activities at this point?

So I would say that the best answer to that, Larry, is what you've seen from us over the past 2 years is what you can probably expect at least over the next 1.5 years. We still see some very attractive technology additions that we can make, Eon Surgical being a good example of something that occurred this quarter. And we've got some other things that we're looking at during the balance of the year. And we remain quite alert to other sort of LMA-type opportunities. It's very hard to predict whether they materialize or not, but our appetite for that remains pretty consistent with what it has been over the last 2 years. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: Okay, and then just lastly on LMA, specifically, I wonder if you can give us any update? You indicated, again in your prepared remarks, that the integration is slightly ahead of plan. That's sort of what you indicated in the first quarter. I think you've been looking for a $0.35 to $0.40 accretion for this year? And I think in the last quarter you indicated that you expected to pull some forward, some of the accretion that was going to be spread in 2014 and 2015, more into 2014. So if you could just update us on how that's all progressing, that would be helpful.

Yes, I would say we're well on track, certainly in -- for 2013, where we expected to be, and as we've indicated, we're performing a little ahead of that and actually expect that trend to continue. At this point, we're still in the process of quantifying some of the 2014 accretion and still have the opinion that it's going to be higher than what we initially thought of it. Because some things are moving a little faster than what we had in our planning process. So I guess the bottom line is my remarks sort of remain unchanged from what they were on last quarter's call.

The next question comes from the line of Chris Cooley of Stephens.

Question for you, Benson. Just looking at the results here to date, and the leverage you've been able to realize through the P&L, and as you see the mix starting to kind of ramp. We see these newer products and LMA ahead of expectations, a little bit on integration. Could you revisit for us this morning your long-term objectives? In particular, how you think about the business from a margin structure? Has that changed at all, in light of the current environment post the analyst meeting at the end of last year? And then I have just 1 quick follow-up thereafter.

Yes. So the short answer to that question, Chris, is really, no. The majority of the improvement that we need to make to get to those longer-term gross margin numbers and operating margin numbers are not particularly revenue sensitive. They have more to do with changes that we're making in our operational footprint and again, are not appreciably revenue dependent. Now more revenue helps but we don't expect utilization softness to be an interference with our ability to make those improvements. And excuse me, I forgot the second half of your question.

That's fine. What I just wanted to get is basically if you feel like you can still obtain the margin targets there? And then...

Well, as an overall statement, I would say, I feel a greater sense of confidence in our ability to get there just based on the details and issues that have been addressed. We've been putting more and more meat on the bones in terms of exactly how we're going to get there and what the timetable is. So if anything has happened in the confidence factor in our getting there, it's gone up as opposed to gone down over the last quarter.

Makes sense. And if I could, just 1 quick follow-up and I'll get back in queue. When you look at the second quarter results, respiratory and OEM both down, 6.5% and 11%, respectively, was there any -- could you kind of parse out that decline for us between volume? Or was there anything structural there in terms of like a contract shift, depletion of the product? Just kind of curious about getting a little bit of color behind both of those declines.

So there are different drivers there. OEM benefited last year considerably by a Pebax shortage. We happened to have it on hand and that resulted in a lot of orders for those products well in advance of our end customers real need. So it was a benefit to us to last year, probably inflated the OEM numbers somewhat last year. And this year, simply as a comparison, this year to last year, it looks negative. Now on top of that, there is some softness in our end customers' utilization rates for some products that is contributing to that a little bit, and that's really due to some utilization decline. Our expectation is that most of that Pebax issue is behind us and as we look at the balance for the year, it's going to be more favorable. Respiratory therapy is perhaps one of the products that is generally used by lots of hospital patients. And that probably has had a greater impact from downward trends in utilization than other product areas. In fact, if you look at our surgical numbers, they're up quite nicely. So where we've gotten products in really strong niches that are non-postponable, we continue to see good growth out of those segments. So those are the answer for respiratory and OEM.

[Operator Instructions] The next question we have comes from the line of Jim Sidoti of Sidoti & Company. James Sidoti - Sidoti & Company, LLC: Great. Just a bookkeeping question. On the first quarter call, you guys -- and I think the guidance, initial guidance, you expected the total of the noncash amortization and the noncash interest expense to be about $0.99 and you've taken that down to $0.90. Can you just let us know why the change there?

So, Jim, I think it was just a slight reduction there from the initial expectations once we looked at it as part of the reforecast process, but nothing material there. James Sidoti - Sidoti & Company, LLC: Okay, and then the -- on previous calls, you talked about making some further consolidations, I think with the LMA manufacturing to get additional accretion in 2014. Is that still on track?

So we expect a good gross margin improvement in the LMA product line, yes, and I can't be more specific about the details on that.

[Operator Instructions] We have no questions at this time. So I'd now like to turn the call back over to Jake for closing remarks.

Thank you, operator. And thanks to everyone that joined us for the call today. This concludes the Teleflex Incorporated Second Quarter 2013 Earnings Conference Call.

Thank you, Jake. Ladies and gentlemen, thank you for your participation in today's conference. That concludes your presentation. You may now disconnect. Have a good day.