Teleflex's (TFX) CEO Benson Smith On Q2 2014 Results - Earnings Call Transcript

Jul.30.14 | About: Teleflex Inc. (TFX)

Teleflex, Inc. (NYSE:TFX)

Q2 2014 Earnings Conference Call

July 30, 2014 8:00 am ET

Executives

Jake Elguicze - Treasurer & VP, IR

Benson Smith - Chairman, President & CEO

Thomas Powell - EVP & CFO

Analysts

David Lewis - Morgan Stanley

Kayla Crum - William Blair

John Hsu - Raymond James

Dave Turkaly - JMP Securities

Matthew Taylor - Barclays

Richard Newitter - Leerink Partners

Matthew Mishan - KeyBanc

Jason Wittes - Brean Capital

Raj Denhoy - Jefferies

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2014 Teleflex Incorporated Earnings Conference Call. My name is Nina, and I'll be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder this call is being recorded for replay purposes.

I would like to turn the call over to Mr. Jake Elguicze, Treasurer and Vice President of Investor Relations. Please proceed, sir.

Jake Elguicze

Good morning everyone, and welcome to the Teleflex Incorporated Second Quarter 2014 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 18970797.

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.

Benson Smith

Thanks, Jake, and good morning everyone. It's a pleasure to be with you once again and similar to prior calls I will start with an overview of the company results and then discuss some highlights.

But even before I get into the details, I want to point out that as the management team we are quite pleased with the results we have been able to generate in the second quarter. In spite of somewhat anemic procedural trends in the U.S. and for us one less shipping day in the quarter, we were able to achieve significant revenue and EPS growth, we made good improvements in both gross and operating margins, and we improved our tax rate. All of which brings us much closer to achieving our longer-term financial goals by the end of 2015.

In fact, our ability this quarter to reach gross margins above the 52% level is a key component in our ability to retain our 55% gross margin target exiting 2015. So we feel quite positive about our results.

Now beginning with our second quarter highlights. Both the second quarter revenue and adjusted earnings per share exceeded our expectations. Revenue in the second quarter totaled $468.1 million. This represents an increase of 11.4% versus prior year on an as reported basis, and 10.1% versus the prior year on a constant currency basis.

Our better than expected revenue performance in the second quarter resulted from several factors, including the over performance of both our Vidacare and Mayo acquisitions, our ability to continue to generate higher revenue from price increases, and improvement in the sales of existing products resulting from a slight improvement in end market utilization trends, primarily in Europe, and our as reported revenue benefited from foreign exchange favorability.

Finally, I would point out that our year-over-year revenue growth is somewhat understated because of one less day in the quarter as compared to last year. We will make up that one additional day in the fourth quarter of this year.

Turning to adjusted earnings per share. Second quarter 2014 adjusted EPS was $1.51. That compares to second quarter 2013 adjusted EPS of $1.27, or an increase of 18.9%. And well, Tom will cover this in more detail during his prepared remarks, the improvement in year-over-year adjusted earnings resulted from higher volumes, the continued ability to increase prices, and a favorable mix of higher gross margin sales. In addition, we continue to generate increased leverage to the income statement from non-revenue dependent items, such as lower adjusted tax rate when compared to the second quarter of 2013.

These improvements were in spite of higher year-over-year operating expenses, resulting from the Vidacare and Mayo acquisitions. However, I will note that this increase in spending was planned and is one of the contributing factors to the over performance of both of these acquisitions.

Moving on to our 2014 guidance. Based on the company's performance during the first six months of 2014, and our outlook for the remainder of the year, we are reaffirming our full year constant currency revenue growth guidance range of 7% to 9%. But are increasing our full year adjusted EPS guidance range from $5.35 to $5.55 per share to a range of $5.45 to $5.60 per share.

Concerning our guidance, let me address two questions that may be on your minds. The first is, given our very strong revenue performance in the second quarter, why aren't we raising our full revenue guidance? And the second question is why aren't we raising our EPS guidance even more?

Regarding our revenue guidance, our original projection was between 7% and 9% on a constant currency basis. We assume that we could safely get above the 7% figure, even if there was no uptick in procedures in the United States. Our expectation though was that, while we did not expect much improvement in the first half of the year in procedural rates, we thought we would likely see some improvement beginning to materialize in the second half of the year. That second half improvement was one of the factors we thought could drive us towards the higher end of our range.

Our most recent conversations with U.S. providers leads to believe that we may not see much of an uptick in procedural rates in the second half of 2014. Our current estimate for our product lines is that procedures are somewhere between flat to down 1% compared to last year. For us though the good news is that our over performance in other areas will make up for this deficit more. However, without at least some improvement in U.S. procedures our view is that exceeding the top-end of our revenue guidance is likely a stretch.

Now forecasting U.S. procedural rates still remains cloudy, and hence that's one of the reasons that's responsible for our conservatism.

EPS is a little easier to forecast and therefore we feel more comfortable in raising our EPS guidance. However, as the year progress to the extent that we see ourselves trending towards the high-end of our new EPS range, we would likely increase spending against certain higher growth and higher margin products and regions. Vidacare and China standout as the most likely targets for increased investments, though not the only ones.

Next, I would like to discuss second quarter pricing, volumes, GPO and IDN contract awards, and new product introductions in more detail.

During the second quarter, the average selling prices of our products once again expanded when compared against the prior year. This past quarter, the improvement in the average selling prices of products contributed approximately 193 basis points of revenue growth and resulted from a combination of distributor-to-direct conversions, as well as core product price increases.

From a segment perspective, we saw price increases, highest in Asia. And as expected, this was primarily due to the distributor conversions. This was followed by improvements in pricing we are able to generate in Europe, as well as those we are able to generate in our North American Surgical, Anesthesia/Respiratory, and Vascular Segments. These price increases were somewhat offset by a decline in the average selling prices of some of our OEM product offerings.

Turning to sales of existing products, during the second quarter sales volumes of core products improved and contributed approximately 102 basis points of revenue growth. This growth is net of the impact of the one less shipping day in the second quarter of 2014 versus the second quarter of 2013. If you were normalize for that impact, sales volumes to core products would have increased approximately 200 basis points. This growth was stronger than initially expected and came primarily from our European and our OEM segments.

Moving to new product introductions. During the second quarter, new products contributed approximately 73 basis points of revenue growth and this was below our original expectations. This was driven by a variety of factors. First, we are seeing longer regulatory approval times globally. Second, it is taking longer timeframes in order to get new products through hospital evaluation committees in the United States. Also, sales force time allocation, particularly in those divisions that are also selling the Vidacare product has resulted in less selling time against other new products. But because of the high margins and high growth rate associated with Vidacare, we have not been discouraging this shift in sales time allocation. But there is a tradeoff. Lastly, we took a conservative posture regarding commercial spending in the first half of the year.

Shifting gears, the second quarter of 2014 saw continued expansion of contractual agreements between Teleflex and our GPO and IDN partners. In fact, during this past quarter, Teleflex won a total of 14 agreements. All of these awards were renewals of existing agreements and included product categories like central venous and dialysis catheters, laryngoscopes, and our LMA product offerings.

Next, I would like to talk to you more detail about Vidacare. We continue to be quite pleased with the customer reception we have received to-date with respect to both the EZ-IO and OnControl product offerings. And during the second quarter, Vidacare contributed approximately $21.3 million of revenue and 5.1% or about half of Teleflex's constant currency revenue growth. If you were to compare these results to the second quarter of 2013, Vidacare's revenue increased approximately 30% on an as reported basis. And while, Vidacare revenue growth shows up as acquisition-related growth in 2014, if we were to maintain these types of growth rates next year, it would mean slightly more than 1% of additional organic revenue growth for Teleflex in 2015.

We remain excited about the future potential of this product and consequently, we remained committed to growing the Vidacare business in the second half of 2014. And as I stated earlier, we plan to increase our commercial spending and clinical training expenditures to drive further revenue growth.

Moving on, I would like to update you on a handful of recently received regulatory approvals and new product launches, beginning with the recent 510(k) approval, we received to market the ARROW-Clark VectorFlow Chronic Hemodialysis Catheter.

Expanding our presence in the dialysis market continues to be a goal for Teleflex, and this product will be another step towards the attainment of that objective. This product features a symmetrical tip design that allows for ease of placement and sustained high flows with minimal recirculation. It's only catheter in the market with an innovative tip designed to produce a three-dimensional transition of blood entering and leaving the catheter.

The next product I would like to bring to your attention is the LMA SureSeal PreCurved Laryngeal Mask. This product was developed from the asset that Teleflex gained in its acquisition of Ultimate Medical. We expect this product, which was recently launched in Europe to benefit the LMA portfolio by providing customers the option of a first-generation fixed curve device with a silicone cuff designed for ease of insertion and improved patient comfort.

And finally, before I update you on the acquisition of Mayo Healthcare, the last new product that I would like to highlight for you is the ARROW GPS Balloon Dilatation Catheter. This product is for the Hotspur acquisition Teleflex completed in mid 2012 and combined angioplasty and targeted injection in one device for used in below the knee peripheral angioplasty procedures. The company recently received 510(k) clearance to market these catheters, and we believe that this product will enable clinicians to inject fluids, such as contrast media, while maintaining the guide wire position.

Now, while we have released earlier version of Hotspur balloons, this particular release is much more important to us. It particularly teaches of a Hotspur targeted injection mechanism, are only relevant clinically when the lesion is quite far from the insertion site. In below the knee applications much longer length catheters are typically used. And so this should be an ideal application for the principal Hotspur VisioValve feature. We are in the midst of a limited market release in Europe in below the knee applications and so for the response has been quite favorable. We will similarly conduct a fairly extensive limited market release in the United State beginning later in the year.

Turning to Mayo. This acquisition would provide high quality products education and technical services and customer support to healthcare institutions throughout Australia, was completed in February of this year. I'm pleased to report that the integration activities associated with the major distributor-to-direct conversion that Teleflex had planned to complete in 2014 remains on track. During the second quarter Mayo contributed approximately $9.4 million or 224 basis points of growth of Teleflex's constant currency revenue growth. Approximately half revenue growth came in the form of volume but the other half came in the form of price increases.

And while we continue to expect Mayo to contribute meaningfully towards Teleflex's total constant currency revenue growth in both the third and the fourth quarters, I do want to point out that the June time period represent the financial year-end for most Australian based government hospitals.

So toward the end of June those hospitals tend to spend whatever is left in the kitty. As a result Australia's revenue in the third quarter tends to dip when compared to the second quarter.

This seasonal revenue performance somewhat mimics Europe, which will also typically has a softer third quarter primarily resulting from August vacations. However to-date the Mayo acquisition has exceeded our expectations and we expect that we will finish the year that way. That completes my prepared remarks. I would like to now turn the call over to Tom for him to provide you with a more detailed review of our second quarter financial performance and our 2014 outlook. Tom?

Thomas Powell

Thanks, Benson, and good morning everyone. Let me start out by saying that I am pleased to report that Teleflex had a strong second quarter across a number of important metrics. Revenues exceeded our expectations, adjusted growth and operating margins expanded both sequentially and year-over-year, we reduced our adjusted tax rate, and adjusted earnings per share increased almost 19% from the prior year.

Operating cash flows were strong. We took steps to strengthen our balance sheet and to delever. In aggregate we feel good about the progress made during this quarter and now let's move on to second quarter specifics.

During the second quarter revenues were $468.1 million, which represents an increase of 10.1% on a constant currency basis. Approximately 7.9% of revenue was related to acquisitions and distributor-to-direct conversion, predominantly Vidacare and Mayo. The remaining 2.2% of revenue growth was organic in nature and was comprised of an increase in core product volumes, core product price increases, and revenues from new products. Somewhat limiting the growth was the fact that we had one less shipping day in the second quarter of 2014 as compared to the second quarter of 2013.

We estimate that this negatively impacted our constant currency revenue growth by approximately 1%. If you were to normalize the impact of the one less shipping day and count the roughly $5 million of year-over-year revenue growth achieved by Vidacare, then organic revenue growth would be in the range of 4.5%.

Turning to gross profit. For the second quarter adjusted gross profit was $245 million versus $209.2 million in the prior year quarter. Adjusted gross margin increased 254 basis points to 52.3%. The increase in adjusted gross margin was primarily due to product pricing, distributor-to-direct conversion, and the inclusion of Vidacare's high margin products into our portfolio. Further gross margin gains were limited by higher than anticipated manufacturing costs coming from a decision to delay the planned closing of a manufacturing facility and the deferral of select cost improvement programs.

Turning next to adjusted operating margin. For the second quarter, the adjusted operating margin increased 109 basis points to 21%. The year-over-year improvement was the outcome of the gross margin gain, coupled with slightly lower R&D spending.

So what's tampering the gains in operating margin are additional SG&A expenses associated with the Vidacare and Mayo businesses, increased product registration expenses to support our Asia growth strategy, and increased sales commission and bonus cost associated with the higher level of revenues.

Moving next to our adjusted tax rate. For the second quarter of 2014, the adjusted tax rate declined 370 basis points from year ago level to 22.3%. The improvement in the adjusted tax rate stems from efficiencies realized to the integration of Vidacare and further optimization of our supply chain structure.

On the bottom-line second quarter adjusted earnings per share increased 18.9% to $1.51.

We have leveraged the growth in earnings to drive operating cash flow. For the first six months of 2014 cash flow from operations reached $120.2 million representing an increase of 114% versus the comparable period of 2013. The improvement in cash flow generation was largely due to the growth in earnings, improved working capital, and reduced pension contribution. Also during this quarter we took steps to further refine our capital structure and to delever.

In April, the company integrated Vidacare into its legal entity structure. In connection with its integration we restructured our bond holdings which enabled us to efficiently repatriate $230 million of cash from our operations outside of the United States. Repatriated cash was then used to fund $235 million repayment of the outstanding principal amount of borrowings under our revolving credit facility.

Then in May, we issued $250 million of senior unsecured notes. These notes bear interest at 5.25% and come due in 2024. We then used the proceeds to fund an additional $245 million repayment of borrowings under our revolving credit facility.

Through these actions we were able to both reduce overall leverage and free up the revolver by turning out borrowings in an attractive 10-year rate. As a result, we will be better positioned to take advantage of future strategic opportunities.

Finally, during the second quarter, we announced the manufacturing footprint rationalization plan intended to further improve the company's cost structure. Since we cover this in our last earnings call, I do not plan to revisit the details again, but will answer any questions later in the Q&A.

And with that said, I will advise that we continue to make progress on this initiative and I have now provided notice to employees of two plans that were impacted by this restructuring decision.

Next, let's turn to review of the segment operating results. Vascular North America revenue in the second quarter increased 13.5% to $64.2 million. The increase in Vascular revenue was largely due to the addition of Vidacare, new products, and price increases. Anesthesia Respiratory North America revenue decreased 5.7% to $55 million. The decline in Anesthesia Respiratory revenue was largely the result of the GPO contract that was lost in 2013 and an increase in back orders of select airway management products. We expect the negative impacts of the loss GPO award to moderately improve in the second half of the year. Partially offsetting this decline in the Anesthesia Respiratory volume was increase in the sales of new products and select price increases.

Surgical North America revenue in the second quarter increased 1.3% to $38 million. The increase in surgical revenue was due to an increase in the average selling prices of products and new product introductions. These gains were partially offset by lower sales volume of existing products and it is our belief that the reduced volumes was primarily the result of one less shipping day during the second quarter versus the prior year.

Moving to EMEA. Revenue in the second quarter was up 7.3% totaling $154.7 million. The increase in EMEA revenue was due to Vidacare product sales, higher sales volume of existing products, price increases, and the introduction of new products. Revenue in Asia increased 25.2% to $62.5 million during the second quarter.

The increase in Asia revenue was due to the Vidacare and Mayo Healthcare acquisitions price increases, the introduction of new products, and higher sales volume of existing products. Similar to the first quarter, growth from China and Southeast Asia was particularly strong.

Turning to OEM. Revenue in the second quarter increased 13.1% to $36.6 million. The increase in OEM revenue was due to higher sales volume of existing products in particular sutures and the introduction of new products. This was somewhat offset by a decline in average selling prices.

And lastly, our other product revenue for the quarter was up 23%, totaling $57.1 million. The increase in other revenue was due to Vidacare sales that fall under our specialty business fall point.

During second quarter the Latin America business, which also falls under our other segment, was flat year-over-year as strong results in Argentina were offset by softness in Venezuela and Brazil.

Finally, I would like to provide you with an update regarding our full year 2014 financial outlook. With six months of 2014 now behind us, today we are reaffirming our previously provided 2014 outlook for constant currency revenue growth of between 7% and 9%. Consistent with our initial expectations approximately 75% of our projected 2014 constant currency growth will be sourced from a combination of the Vidacare acquisition and distributor-to-direct conversion. Remaining 25% of revenue growth will come from volume gains, new product introductions, and core product price increases.

We are currently trending ahead of expectations for volume and pricing and trending a little bit behind on new product introductions. As a reminder, we expect that the majority of the 2014 pricing will come from distributor-to-direct conversions and that pure product price increases are expected to be much more selective than in past years.

In terms of GAAP revenue growth expectations, we now expect revenue growth to be in a range of 7% to 9%. This is an increase from our original expectations which calls for GAAP revenue growth of 6% to 8%.

As we began the year we anticipated that currency translation would cause a headwind of approximately 1%. However, largely due to the strength of the Euro relative to the U.S. Dollar, currency transformation turned out to be a tailwind rather than the expected headwind for that first half of the year.

For the second half, we continue to anticipate that currency will be a headwind but now project a more neutral full year impact from currency.

And now turning to adjusted gross margin. We continue to project adjusted gross margin to be in a range between 52% and 52.5% for the year. The projected 2014 gross margins represents an increase of approximately 240 to 290 basis points over 2013 and it's largely the result of the addition of Vidacare, distributor-to-direct conversion, and manufacturing operations efficiency programs.

Moving on to adjusted operating margin. For the full year of 2014, we continue to expect adjusted operating margin, excluding intangible amortization expense to increase by approximately 100 basis points to a range of 20% to 21%. Further gains in adjusted operating margin are being tampered by investments to support the distributor-to-direct strategy and the addition of Vidacare.

Moving on to taxes. As discussed earlier we remain on track to achieve a full year 2014 adjusted tax rate of 22.5% to 23.5%.

Turning next to interest expense. Based on the capital structure now in place, our expectation is that we will achieve an adjusted weighted average interest rate of approximately 5.1% in the second half of 2014. This rate has modestly improved versus our prior expectations due to favorable market conditions allowing us to have priced the senior unsecured note offering more attractively than we had expected.

Turning to shares outstanding. We continue to expect the adjusted weighted average share count to be approximately 44 million shares for full year 2014.

And finally, on the bottom-line. Based on the company's performance during the first six months of 2014, and our outlook for the remainder of the year, we are increasing our full year adjusted earnings per share guidance range from the previous range of $5.35 to $5.55 per share to an updated range of $5.45 to $5.60 per share. And while we do not provide specifically quarterly financial guidance ranges, I will advise that our expectation is for third quarter revenues and adjusted earnings to be sequentially lower than results we achieved in the second quarter.

There are few reasons that I can point to for the sequential revenue and earnings decline from Q2 to Q3.

First, our historical experience indicates that there is a sequential decline in European product sales in the second to the third quarter. Given our large presence in Europe, this impact us a bit more than other medical device companies who do not have a significant presence there. Additionally, Mayo Healthcare had a particularly good second quarter resulting from the June year-end for government-owned hospitals in Australia.

Also during the first half of the year we remain cautious in the level of investment spending, until we saw how utilizations and revenue played out. And given our strong overall revenues results, we are now more confident in our ability to further invest behind key growth initiatives.

And finally, we are not anticipating foreign currency to contribute us positively in the third quarter as it did in the second quarter.

In closing, we have gotten off to a solid start relative to our first half 2014 financial expectations. We are excited to be in a position of both increasing our 2014 financial guidance and having the financial flexibility to be able to invest behind some of our higher margin, high growth opportunities, such as Vidacare and China. We believe that these actions could help position us positively for 2015 and beyond.

That concludes my prepared remarks and I will now turn the call back to the operator for questions. Operator?

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions).

Your first question comes from the line of David Lewis from Morgan Stanley. Please go ahead. Your line is open.

David Lewis - Morgan Stanley

Benson, just two questions here. And congrats on a solid quarter. The first question is on organic growth. I think margins have been very good for several quarters. Organic growth has been the issue for most investors the last several quarters. This quarter clearly organic growth took somewhat of a step forward, and I think what's interesting is, when you consider Vidacare next year, you have some visibility back into that 3% to 5% organic growth range, may be with this quarter's 2% plus may be 1 point from Vidacare. So may be just kind of help us understand, after a couple quarters of difficult organic growth, how you're feeling about the organic growth set up for this business over the next three to four quarters as it relates to Vidacare impact, the core business in utilization, and may be some of the new products?

Benson Smith

Yes. So I think the overall response I will give you David is we are certainly more positive about it now than we were even six months ago. We're still a little concerned about the absence of procedural uptick in the U.S. and that has the potential to add about an extra 100 to 200 basis points in organic growth rate. But even absent that, I think the numbers that Tom laid out for you, the way we're looking at this, we're probably in that 4% to 5% range when we count in the organic momentum for Vidacare, when we look at the absence of a shipping day. So we're a lot closer to that 5% even without the uptick in U.S. procedural rates that we think our portfolio is capable of.

So I think the short answer is we feel certainly better about getting close to that number even in the absence of U.S. procedural growth but that would be a nice kicker on top of it.

David Lewis - Morgan Stanley

Okay, very helpful. The second question is, obviously the debate in the stock is largely margin expansion. This particular quarter margins were good but you're obviously choosing to reinvest some of the upside away. May be just talk to us about where you are investing those dollars. Why should investors feel confident that based on that sort of reinvestment they are still going to see the type of margin and earnings upside in out years that they are expecting? Thank you.

Benson Smith

Yes. So our six month experience with Vidacare leads to believe very strongly that the driving force behind that growth is the clinical education programs, which get users, accustomed to this device initially. And those take place in the form largely of cadaver labs and there is a very, very strong correlation to people going to one of those labs and returning back to their setting and starting to use the device much more frequently.

So I think we've seen that very strong correlation and have a high level of confidence that that's really what's going to continue to drive Vidacare revenue. I think again relative to Vidacare, we've got some brand new markets that the product has been approved for recently. It's approved for sale in Japan; it's approved for sale in China. Those are really brand new opportunities for us. But again, we're going to require some investment in clinical education to actually get that product moving forward.

We have been, I would say, overall extremely selective in looking at the kind of initiatives we want to support and are even aside from Vidacare looking at those kinds of activities that we've seen have demonstrated, relationship between spending in that area and increasing revenue.

David Lewis - Morgan Stanley

Just for a follow-up on Vidacare and I'll jump back in queue, if there was any concern on Vidacare on your part it was the end market size for Vidacare, based on some of your comments today and, just frankly, based on the traction the last two quarters. Your views on the size of the market on Vidacare relative to now versus when you bought it, can you share with us either any qualitative or quantitative view on that?

Benson Smith

So I think we're more confident now that there is a substantial international market as we've gotten a certainly preliminary feedback from key users in China and Japan, in Europe. So I think that's been a positive to us. I think we also have been quite pleased with the adoption rate or the OnControl device in the oncology segment, which had only started to receive some attention from the Vidacare's sales force in the last year that they owned the product.

And we're seeing some pretty good traction in the military segment as well. So all those things I think have bolstered our view about the potential performance of this product, above certainly what we had in our acquisition model.

David Lewis - Morgan Stanley

Okay. Thank you.

Operator

Thank you. Your --

Jake Elguicze

David, this is Jake. Just real quick. Just to add on to your question here. I also think that these investments that we're talking about accelerating into 2014, a lot of these were already planned for from our standpoint in 2015. And we're simply taking the opportunity potentially to invest a little bit earlier. And we're still maintaining our 2014 adjusted operating margin range of between 20% to 21%.

So I don't think simply by making some additional investments in 2014 that that takes away from our -- any of our prior thoughts related to margin expansion and where we think we could end up 2015.

David Lewis - Morgan Stanley

Great, thanks for that clarity.

Operator

Okay, thank you. Your next question comes from the line of Matthew O'Brien from William Blair. Please go ahead. Your line is open.

Kayla Crum - William Blair

Hi, guys, this is Kayla in for Matt. Thanks for taking our questions. Just wanted to start off trying to get a sense for the sustainable growth profiles of your required assets. Anesthesia was a bit softer than what we were looking for. And, so, just wanted to see where LMA is within its trajectory. And then, I know you touched on this a bit, but how you view Vidacare as a contributor over the next several years, as well.

Benson Smith

So I think that the softness in anesthesia is somewhat particularized to the U.S. and relates I would say primarily to just soft procedural rates in the United States. So those are the particularly LMA, the LMA portion that is used in general anesthesia. If those procedural rates are down we have a very large share of the U.S. market. So we tend to feel of that that way.

Overall, LMA companywide experienced approximately 3.1% growth rate this year. So except for the United States we're seeing that product perform as expected. And again, we have some -- we think we have a very good couple of new products that will come along. One is just been released that I referenced in my remarks. And we have another product that should be on the marketplace in the early part of 2015. So our long-term view of LMA, given some adjustment in U.S. rates, is in that 4.5% to 5% growth potential range.

Vidacare, every time we think we've quantified what we think the opportunity is, we see some blue sky opportunities on top of that. So I think I'll just reiterate what I said today. We certainly feel more bullish about it than when we bought it. And we are anxious to see the extent and the speed at which we're able to get some adoption with some additional spending against the clinical education.

Kayla Crum - William Blair

Okay, great. And, then, you've done a number of late-stage technology acquisitions over the last couple of years. Can you just help us get a sense for when those assets will begin to contribute on the top-line more substantially?

Benson Smith

Hotspur was one of those late-stage acquisitions. We have kind of been waiting for that product to get its way to the marketplace, for below the knee applications. We don't expect it to meaningfully contribute in 2014, because we will just be largely confined to limited market releases in the U.S. in the last part of the year. We do expect that to start to show some revenue growth in 2015.

The other, certainly the largest inventions we've made to-date in the late-stage technology arena is in Semprus. We experienced some technical difficulties in attaching the polymer to various substrates. That issue seems to be resolved at this point in time and so we are in the later stages of doing some testing, particular testing around specific product categories and we should start to see those creep into the marketplace in the latter half of 2015.

Operator

Thank you. Your next question comes from the line of John Hsu from Raymond James. Please go ahead. Your line is open.

John Hsu - Raymond James

Good morning. Hi, this is John in for Larry.

Benson Smith

Good morning.

Thomas Powell

Good morning, John.

John Hsu - Raymond James

Good morning. Just had a quick question as given consolidation in M&A in the space, and we really believe that scale is becoming more important, just I guess going forward help us think about how you're thinking about that may be from an M&A perspective. And just more broadly your capital allocation plans as well. Thank you.

Benson Smith

So just addressing the scale issue, I think you're right in that, in your assessment that scale is becoming increasingly important. There is a size at which it becomes less important though and I would say that if you're not big enough to be able to walk into GPOs on a pre-frequent basis in the United States, if you're not big enough to have a real global distribution of your product line, it's hard to compete against those companies that had that size.

Well we are certainly smaller in comparison to -- obviously other medical device companies; we are actually big enough that we meet that criteria. We have frequent visits and/or certainly well known to GPOs and IDNs in the U.S. We have a good capability to be able to sell a product in every significant market globally. So I actually think the size we're at is an advantage rather than a disadvantage. It's an entirely different matter if you're $100 million company and really only able to sell the product in one market.

I do think from our -- therefore our acquisitions strategy is really driven around products that particularly strengthen our franchise rather than simply trying to get bigger for the sake of being bigger. And so again I think what you've seen in the past remarks, which is acquisitions in the size of Vidacare and LMA provided they meet our criteria, some investment, some continued investment in late-stage technology acquisitions, some continued investment in distributor acquisitions is what you can expect I think over the next three years for sure. So we don't see our thoughts about acquisition changing much over what we've done over the last couple of years.

Operator

Thank you. If we can move on to the next question which comes from the line of Dave Turkaly from JMP Securities. Thank you. Please go ahead.

Dave Turkaly - JMP Securities

Thanks. I guess it's nice to hear somebody talking about end markets in Europe ticking up a little bit. I was wondering if you could give us a little color. Is that kind of across the board? Or anywhere you'd highlight as sort of being a little better from a utilization standpoint.

Benson Smith

So I would generally describe it as across the board. I think we're seeing a little bit better results out of Italy and Germany. If you get down to some product lines we are certainly seeing good results in the UK. France has probably been one of the areas that's been a little more sluggish to come back but overall it's good throughout the continent.

Dave Turkaly - JMP Securities

And could you just remind us of the mix of Vidacare geographically, when you purchased it?

Benson Smith

Yes, about 75% of the revenue was in the U.S. and about 25% of it was outside the U.S. The majority of that outside the U.S. revenue was in Europe, very little contribution from Asia.

Dave Turkaly - JMP Securities

Thank you. And then last, $867 million in net debt. Can you remind us what your covenants are, like whatever turn rate you can -- how levered you can get at this point?

Thomas Powell

Well in terms of our covenant we can go up to four times. What we talked about in the past is that we're comfortable with a longer-term three times leverage we take it up to three-and-a-half times for the right acquisition opportunity, if we had a pathway back that three time level.

Dave Turkaly - JMP Securities

And where are you sitting today?

Thomas Powell

We're about 2 --

Benson Smith

2.8.

Thomas Powell

2.8.

Operator

Thank you, sir. Your next question comes from the line of Matthew Taylor from Barclays. Please proceed.

Matthew Taylor - Barclays

Hi thanks for taking the question. Can you hear me okay?

Benson Smith

You bet, Matt.

Matthew Taylor - Barclays

Great. So just wanted to ask a couple questions here. You mentioned China as a key growth opportunity, and you've talked about that in the past. Can you just give us an update on where you are in China in terms of the contribution today, and how much investment in growth we could see out of that over the next year or so?

Benson Smith

Yes, so right now I think our sense is that we continue to need to add sales heads in Japan as we rollout our additional product lines into Japan. We're making some other investments in Japan also over the next year just in terms of our presence there in other capabilities. Our overall Asia sales usually amounts to around 12% of our revenue and China accounts for about 5%.

Matthew Taylor - Barclays

Okay. And then just on the gross margin performance this quarter, you talked about several components. Can you just break down the contributions from acquisitions distributor-to-direct and cost reduction?

Thomas Powell

Sure. I can walk you through that. So on an adjusted basis we talked about our gross margin improving 250 basis points during the quarter. As we look at the components of that there is largely four pieces to highlight. The first is Vidacare with the addition of their 85% gross margin products contributed about 180 basis points to that growth. Then go-direct, which is showing up in the form of pricing and driving gross margin largely coming from our Mayo acquisition South Africa and LMA distributor-go-direct as well, now that contributed about 90 basis points. Now we also picked up another 10 or so basis points from the introduction of new products, which carry a higher margin in the average.

We did have some operation performance downsize during the quarter and that was due to a cautious decision to delay the close and move of manufacturing sites for a period of time. And so essentially what we got is some redundant costs at both the receiving site and the defending site. And then we also made the decision to defer some select manufacturing equipment programs that kind of held us back some additional gain and we will pick that up as we move forward.

But overall as we look at all the cost improvement program that we've got scheduled for the year, are largely tracking to a full year number. So we feel good about it where we stand in the aggregate for the year.

Matthew Taylor - Barclays

And just to follow-up on that, strategically you seem to be in a pretty good spot in your ability to continue to increase gross margins. You referenced having confidence in that 55% goal earlier on the call. And I was just curious, as you get some improvements here in the gross margins from things like price and new products, does that change how you think about the pace of restructuring, or whether to restructure at all, in some instances? I'm just curious how you're looking at it over a longer-term period in terms of your ability to move manufacturing to lower-cost jurisdictions or consolidate some of that stuff?

Benson Smith

So I think the best way to characterize that is to the extent that we see some over performance in our non-restructuring efforts that's just going to help us in our overall activity to continue to increase our gross margins. We don't see that as having an impact on our current thought process around the overall restructuring efforts. We've certainly indicated, I think on many occasions, that we see ourselves over the next several years with a capability to move beyond that 55% number. And so the combination of all those things is actually just is very helpful in our ability to be able to do that.

Operator

Thank you. Your next question comes from the line of Richard Newitter from Leerink Partners. Please precede sir.

Richard Newitter - Leerink Partners

Hi, thanks, guys. Thanks for taking the questions. I was just hoping you could comment. It looks like once again your North America Surgical business saw good traction. And that's an area, I think, consistently, with last kind of where you think the portfolio's a little bit under-appreciated. You always seem to point to some of the products in Surgical. Could you just give us a reminder a highlight of the products there that are gaining momentum, where you feel incrementally more confident?

Benson Smith

So we have -- we continue to see good utilization of our polymer clip ligation product line. I think as we look and that's true in the U.S. and true globally. We actually see occasional strength in our reusable instrument line as hospitals go through different sort of periods of buying instruments. I think as we look over the next several years, we are expecting one of the lead product entries to be in this micro laparoscopic areas. The feedback that we are getting from key opinion leaders now and this is quite favorable that will take us really to 2015, to the end of 2015 by the time we start to see that start to take off in a measureable way.

I think there's other product EFX continues to perform well. So generally that the good part about out that is I think we've made some great investments and have an opportunity to really propel that to above average growth rates if there is a negative that's one of the product areas that gets caught up in the procedural downturns particularly in the U.S.

Richard Newitter - Leerink Partners

Okay. And then just how do we think about surgical and how it falls within the margin contribution or mix shift, surgical to numbers?

Benson Smith

Good. It's well above our average from a gross margin standpoint of view.

Richard Newitter - Leerink Partners

Okay. So, as that continues to maybe outperform some of the other businesses, that's a positive mix shift driver, clearly?

Benson Smith

Correct.

Richard Newitter - Leerink Partners

Got it. And then, just lastly, on price, it sounds like price got a little bit better this quarter. Can you just remind me, when you refer to price you're just talking, you're not including any mix shift benefits. That's your kind of new product contribution section. Is that correct?

Benson Smith

Correct.

Richard Newitter - Leerink Partners

So -- okay, got it. So, price improved a little bit, It seems like you feel a little less confident in potentially kind of mix contribution going forward. How long do you think that lasts? How long are the -- how elongated is the approval process getting to impact this? And to the extent that you had an assumption heading into the year, what do you think the delta is? Bridge me to your new outlook with that kind of slightly eroded contribution.

Benson Smith

I'm not sure I completely understand the question so if I don't answer it feel free to ask it again. I think actually we're quite positive in terms of seeing our gross margin mix continue to improve and we are again allocating sales time continually against our higher margin growth opportunity. So our expectation is we will continue to get some benefit from that.

Relative to pricing it was better than we expected on both fronts. We're getting a bit, a more growth out of the distributor-to-direct conversions than we thought but we're also getting some better pricing out of our core pricing than we expected. So I don't think it was our intention to signal that we expect some decline about that and actually we're pretty pleased with our continued efforts to get some price out of the marketplace.

Richard Newitter - Leerink Partners

Sorry, I just I thought I heard pricing got a little bit better, but perhaps new product contribution, the outlook is slightly a touch more conservative or cautious because you're seeing it a little bit tougher to get new products approved. So, I was just trying to figure out what maybe the puts and takes were with respect to the underlying price and mix contribution going forward. It sounds like core pricing a little better than expected. As well, you're seeing some incremental price improvement due to distributor conversions, which may be offsets, whatever, slight elongated timeline for approval might impact your ability to get new products and mix shift into the market.

Benson Smith

So the way we look at new products kind of from two perspectives. One is the overall contribution. And then, there are I would say just in our industry it's not unusual for the FDA to take a little longer than might have been in our original plan to get a new product on the market had we gone back a year earlier for example we would have expected this Hotspur Balloon to be on the market sooner than we anticipated or sooner what actually happened. I think the way we actually measure the success of a new product after it's released is how close is it doing to our expectation from the time it's released.

There is a bit of an issue in the U.S. I would say relative to something that cost a hospital more the process to get it through the hospital channel is a bit more complex. Those committees cannot meet in the summer time. So that can have an impact and almost everything now has to go through some kind of hospital product evaluation. So that's having certainly an effect but I don't think we see that as a long-term issue. It's just going to take a little longer to get the ball rolling in some of these activities but we're still pretty confident about our new product lineup.

Richard Newitter - Leerink Partners

Got it, so just may be delay, nothing structural.

Benson Smith

Correct.

Operator

Thank you, sir. Your next question comes from the line of Matthew Mishan from KeyBanc.

Matthew Mishan - KeyBanc

Great, thanks for taking my questions. Maybe I missed it but did you update your Vidacare expectations for this year?

Thomas Powell

We haven't specifically but as we spoke through the results of the quarter, I picked up on the fact that Vidacare is about $21 million in revenue. As we started the year we had estimated revenue in the range of $68 million to $72 million for Vidacare. Now based on a first quarter result of that $20 million -- $21 million of second quarter which was a bit strong due to a large military order which hope we would rather keep but not actually discount on. And we would expect that we're probably in that $20 million range for each of the third and fourth quarters. So we're trending towards the $80 million range for the year on revenue.

Matthew Mishan - KeyBanc

Now what about the --?

Thomas Powell

Obviously a positive story given the high gross margins associated with the product.

Matthew Mishan - KeyBanc

What about the EPS accretion? I think you also said $0.10 to $0.15 for this year. Is that a little bit higher now, too?

Thomas Powell

Yes, it would also trend higher just given the higher level of revenue.

Matthew Mishan - KeyBanc

All right. And on the R&D expense as a percentage of sales that seems to be backing off a bit. How should we be modeling that going forward?

Thomas Powell

As we think about the year we are down a bit in R&D. We touched on the fact that if we -- as we began the year we are somewhat cautious in the level of investments. I think you should think about in R&D in particular is that we did pulled off a little bit on some of the R&D spending associated with Semprus. We worked through some of the technology challenges.

As Benson mentioned, we are feeling more and more confident about that and expect to resume spending against that project. So we look to see our R&D spending ramp up throughout the back half of the year as a percentage of revenues. We're down at the 3.2% range on adjusted basis in Q1 and Q2, and we expect that to get above 3.5% for Q3 and Q4.

And certainly as we think about R&D we think about also the spending from expense standpoint. Also the investments we're making to buy this late-stage technology acquisitions. So well the R&D spending is kind of at a 3% plus range, we've also got some investments we've made and acquisitions such as Semprus or Hotspur.

Matthew Mishan - KeyBanc

Okay, great. And just last question for me -- you indicated that the repatriation gives you kind of the flexibility to do another acquisition. I was just curious about your willingness to do another deal given everything on your plate and what the pipeline looks like.

Benson Smith

So certainly our willingness to do a deal is there. We do have very type criteria that we are quite disciplined in staying within. Like those products that are largely or companies that are largely single product focused, like those companies that have a product that we think we can take globally. We like those products that obviously have higher growth rates associated within him and higher margins in our current portfolio.

So we're not anxious to do a deal just to do a deal. We're pretty tightly disciplined around that. I think the -- I would characterize the pipeline today assuming to what it was a year or two ago and again gets back to my point about size. Those companies that are in that $50 million to $200 million range in revenue have a harder time just being able to go global without incurring a lot of expenses. They have a harder time walking into GPOs and getting their products on contracts. So that still seems to be a pretty good inflexion point where particularly companies that are ventured-back are willing to look for an alternative.

Operator

Our next question will come from Jason Wittes from Brean Capital. Please go ahead. Your line is open.

Jason Wittes - Brean Capital

Hi there. Thanks for taking the questions. Solid quarter, and gross margins, in particular, appear way ahead of schedule, 52.3%. I think from your commentary earlier the assumption is that you'll continue to see improvements this year. But also, with the previously announced plan consolidation, I believe there's something in the nature of 180 to 200 basis points of an addition improvement, which we'll likely see next year which, if my math is correct, means you're very close to getting to your 55% gross margin goal by the end of next year. Is that the right way to think about it?

Benson Smith

Correct. And that's, I think that's one of the reasons why we're quite pleased we're able to break over that 52% number. We really need to be there for the manufacturing efficiencies to kick in enough to get us over that 55% number by the end of the year. So we were pleased and I think we would have been pleased had it happened any time this year but sooner is always better than later.

Jason Wittes - Brean Capital

Right. I guess the assumption is, though, you will continue to see those improvements. And also that the plant closures or plant consolidation impact really won't be felt until next year, so that's we should be adding that to next year's assumption.

Benson Smith

So the plant closures on our current plan starts to make a contribution towards the end of 2015 so that's correct.

Jason Wittes - Brean Capital

Okay.

Benson Smith

We're not going seeing much of a linear jump though between that 52.5% to 55%. The majority of that jump comes from the footprint consolidation. So I don't want to give the impression that we're going to see sequential quarter-to-quarter improvement and it's going to be a gradual ramp up to 55. It's going to be relatively what's more like a bullish jump as that starts to kick in.

Jason Wittes - Brean Capital

And that will be in the third or fourth quarter of next year roughly?

Benson Smith

That's as close as we've pinned it, publicly yes.

Jason Wittes - Brean Capital

Okay, fair enough, very helpful.

Thomas Powell

Just to clarify in this year to make sure we got expectation I did say that we would continue to improve what, what we're thinking about in terms of first market balance of the year. We look to see that continue to strengthen in the third quarter and then in the fourth quarter we're going to have some expenses associated with the footprint consolidation that won't be adjusted out for calculating adjusted gross margins. So that will impact the gain a bit as we go through the fourth quarter.

And then just to clarify on the overall footprint project, what we talked about during the last quarter's call was that we expected to realize savings in total once fully implemented of $28 million to $35 million. And those savings would begin in 2015. So we start realizing those in the end of 2015 and then, that's going, in addition to some other actions we've got some cost saving projects will allow us to get to 55%. But then the majority of the savings from footprint really kick in, in 2016. So we're feeling confident that we can get towards the end of 2015 the 55% and then have additional benefit from footprint thereafter.

Jason Wittes - Brean Capital

Okay, very helpful. Encouraging, as well.

Benson Smith

I'm going to use this occasion though just to issue caveat that we have issuing all along and that is, if there is a risk associated with the footprint consolidation and there is a risk. The risk really has to do with timing. And we may find ourselves in a situation where because of unanticipated orders, other factors, we may need to keep a particular facility open little longer than what our plan was so that could delay the timing of getting some of these savings.

And to us we're always going to err on the side of making sure we have product supply as opposed to trying to hit an arbitrary deadline. That being said, we think we've got enough contingencies to be have crossover that 55 number by the time we exit 2015. There is a risk; it could be pushed into the early part of 2016.

Jason Wittes - Brean Capital

Okay, fair enough. And then also wanted to just revisit your guidance commentary. Just to be clear, you're not assuming any type of volume improvements in the U.S. in the upper end of that range? Or does that have some expectation there of volume improvements?

Benson Smith

Correct. We're assuming that trend we've seen for the first half of the year continues for the balance of the year. We hope we're wrong and we do see an impact but we're not counting on it in our guidance.

Jason Wittes - Brean Capital

Okay. And then Vidacare is obviously doing quite well. Quite a few questions on it. I have one more. And that is, first off, it sounds to me like you think, in terms of the growth rate, you kind of implied 30%, seems to be somewhat of a sustainable growth rate, at least into next year. And if I look at -- if we think about the breakout of that number, how much of that is U.S. driven versus OUS driven?

Benson Smith

So the big investments that we're going to make this year, in places like China and Japan, are not actually likely to derive significant revenue in 2015. But if we don't start the process now we're not going to see them in 2016. So most of our growth in 2015 is likely to come from continued expansion in the acute care setting in hospitals, continued adoption in for the oncology product throughout the U.S.

And then, in Europe it's a bit more broader base. We still have significant opportunities in the ambulance segment in Europe and then moving into the hospital segment. I would say though that as we are speaking about Vidacare's growth next year, we're not necessarily thinking it's going to grow by 30% this year over last year. We think that the -- perhaps a better way to look at it is, the dollarized growth is going to look similar in term of an increase this year or last year and that's where sort of what we were tying it to the 1% of our organic growth rate.

Operator

Thank you, sir. Your next question comes from the line of Raj Denhoy from Jefferies. Please proceed.

Raj Denhoy - Jefferies

Hi, good morning. I was curious if I could just ask about the distributor-to-direct conversion in the quarter. I think you noted, of the 193 basis points in price, that that was probably a big factor of that. I mean it also sounds like it might have bled a little bit into the acquired revenue number. So I'm, one, trying to figure out how much that actually contributed in the quarter all-in. And then my second question is, as you look forward from here, what's the prospects for additional distributor conversions over the next several quarters?

Benson Smith

So certainly, the acquisition of Mayo was our biggest by far planned distributor conversion for 2014. We are in a series of ongoing discussions and we always are with additional distributors. At this point, it's unlikely that something would happen in 2014 in a way that would significantly drive revenue because we would only have month or so at best of revenue contribution in 2014. The specific question about Mayo was in the $9.1 million.

Thomas Powell

$9.4 million

Benson Smith

$9.4 million range about half of that was driven by our increased prices to end users versus selling to distributor and about half of that came from volume.

Raj Denhoy - Jefferies

Okay. But I guess is there -- I know that you probably won't find one of that scale perhaps -- but is this a part of the plan, in a sense, going forward to find additional of these distributors or other? Because it does add nicely to your revenue growth and your pricing obviously. But is there other possibilities to do these?

Benson Smith

The answer to that Raj is yes. And actually every time we do an acquisition like Vidacare or like LMA they typically have distributors in areas where we can easily sell the product on a direct basis. And so that process in and itself ease us with a continuous supply of opportunities to overtime take that business direct. And you're right, it does have a great impact on our margin, gets as closest to the customer. We are enthusiastic about that activity.

Raj Denhoy - Jefferies

Okay. And maybe I could ask one, a bit of a segue to your previous question. You talked about the caveat in terms of pushing out some of the plant closures. In this quarter you did note that you decided to delay a plant closure, and also, I think, deferred some of your cost improvement programs. And I'm curious how to think about that. Was there something in particular in the quarter that you saw that you thought perhaps we shouldn't do this so soon? Or is there anything we should look at and think perhaps maybe you're less committed to that over the near term? Any thoughts would be helpful, really.

Benson Smith

Well, so this the particular circumstance that Tom referenced actually related to a move that was separate and apart from our restructuring program. It was an effort that was initiated last year. And as sometimes happen, demand for product exceeds what you might think it's going to be and we therefore had to renegotiate additional lease time in a facility, longer than what we had planned. And so now we have to add those or really take into account those costs.

I would say that those kinds of circumstance are always probabilities in a move like this. And I'll go back to my remarks that we're always going to err in the side of making sure we have a good customer supply as opposed to try and economize in areas that might hurt us in these moves. But it certainly doesn't discourage us at all from the overall initiation of additional cost improvement programs.

Operator

Thank you, sir. We have no questions at this time. (Operator Instructions). There are no questions coming through. I would now like to turn the call over to Mr. Jake Elguicze for closing remarks.

Jake Elguicze

Thanks, Operator. And thanks to everyone that joined the call today. This concludes the Teleflex Incorporated second quarter 2014 earnings conference call.

Operator

Thank you, sir. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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