Teleflex's CEO Presents at Deutsche Bank 37th Annual Health Care Conference (Transcript)

May.11.12 | About: Teleflex Inc. (TFX)

Teleflex Incorporated (NYSE:TFX)

Deutsche Bank 37th Annual Health Care Conference Call

May 08, 2012 2:50 pm ET


Benson F. Smith – Chairman, President & Chief Executive Officer


Kristen M. Stewart – Deutsche Bank Securities, Inc.

Kristen M. Stewart – Deutsche Bank Securities, Inc.

Okay all right. We are going to get started on the next session. Again, I'm Kristen Stewart, the Medical Device analyst, and I am pleased to introduce Benson Smith from Teleflex. He's going to provide us with an overview of the Company. For those of you that do not know Teleflex, they have completely shed pretty much all their other businesses and now are a pure play medical supplies company.

So certainly, it's nice to have you here and have the conversation just on medical and remove some of the other businesses that were a little misunderstood by the healthcare investment community. So with that, I'm going to turn it over. We will have Q&A after, so, as always, you can certainly ask questions, send them to me via the (URN) application or e-mail me them as well. So with that, I'll turn it over. Thank you.

Benson F. Smith

Thanks, Kristen. So, again, I'm Benson Smith with Teleflex. I'm going to take us through brief company overview. Before I get started, I just want to remind you that I am likely to make some forward-looking statements today.

What I'm going to cover today is a brief overview of Teleflex, get into some discussion of our strategic objectives and talk a little bit about financial review for all of 2011 and first quarter 2012. Got some summary information to share with you, and then we'll turn it over to question and answers.

First of all, I should say that going back to about 2005 or 2006 only about a third of Teleflex's portfolio was in the medical device space. We were primarily a supplier to the automotive industry, the marine industry, and the aerospace industry. There was a conscious decision, really made over several years to divest those businesses.

For the most part, that was completed by the beginning of 2011. We had a few remnant aerospace businesses that we put into discontinued operations, but certainly had the public view of a medical device company through most of 2011 and we completed those divestitures at the end of 2011. And so at this point are a full-fledged medical device company.

Throughout our history, really, the medical devices that Teleflex has been involved in largely revolve around the care of critically ill patients, and so our mission as a company certainly takes that into consideration, and a lot of our focus every day is to spend time and effort on products and technologies that have the opportunity to improve clinical results.

Given the current environment that healthcare is under and the tremendous pressure we expect from a cost perspective over the next decade, we also have a considerable focus on technologies that also have the opportunity to reduce procedural costs. As we have become more and more known as an entity certainly in the GPO arena and in the hospital arena, we have a lot of strong brands to rely on, but we continue to try and present ourselves to our customers and to our employees as a highly ethical company and a trusted partner and resource for our customers. And our customers have certainly recognized that about us this year.

For example, we were voted by Novation, one of the largest GPOs in the United States, as the medical device supplier of the year for them. And so, I thought that was a great testimony to the progress that we've made in terms of our reputation with the medical device provider community.

Teleflex has a broad array of product offerings. We have a diverse portfolio. And so, we are not dependent on the success of really any single product as we look to our growth in the future. The best way to look at our products right now is in the breakdown that you see before you on the screen, we're a significant player in the in the Vascular Access business. We're the market leader in the central venous catheter segment in that, with growing contributions in the PICC line.

In the Surgical area, we have a lot of specialty niche products, particularly with the closure devices or ligation. Hemoclip is one of our best products in that area. In Urology, we don't have a particularly strong presence in the United States, but we are the market leader in urological hospital products and home healthcare products in the European theater. Cardiac Care is our intra aortic balloon pump business, and we share that market with Datascope.

Our business in Anesthesia and Respiratory comes to us from our Arrow acquisition and from our Hudson acquisition and then we also have an active business in the OEM segment, where we supply components or finished products almost entirely to other medical device companies. The significant thread, I think, that is common in most of the products that we sell is that they are used in and for critically ill patients in non-postponable events. So, we have not seen some of the decline in our revenue as a result of decreased utilization. Most of what we do is very difficult to postpone.

The other element of this, of our product line, is that it generally has a fairly significant clinical component in it, because of the nature in which it’s used in the hospital. But the other interesting thing about our product line, it usually doesn’t represent a significant part of the expenditure of the procedural costs.

So unlike a company, for example, that might provide pacemakers or other implants where the device itself is a big component of the procedural cost, most of what we provide is a relatively insignificant amount of the overall procedural costs. And so again, we have some immunity from some of the cost pressures that other medical device manufacturers may be exposed to.

We're also quite diversified when it comes to our geographic distribution of our product. About half of our product is sold in United States 52%., 36% is sold in Europe, and then we have 12% of our product portfolio that is sold in Asia. We did see, starting with the first quarter this year, really good growth across every single one of our product franchises and in every single geography.

Like most medical device manufacturers, we do have a focus on Asia, and a particular emphasis on China and Asia rim countries. From a standpoint of who uses our products, well over 80% of our products are used in a hospital or healthcare provider segment. Some of those products do have some spillover application in the home healthcare market. That's particularly true of some of our urological products and some of our respiratory therapy products.

We don’t particularly design products for that market, so it tends to be a secondary market for us, but a growing segment of the market, particularly in Europe that have quite favorable reimbursement for home healthcare. And then we do have a segment of our business, as I said before, in the OEM segment, where we are providing in many cases finished products or components to other major medical device manufacturers. In fact, most of the people you'd be talking to or listening to today probably buy something from Teleflex OEM.

In terms of the size of the markets that we serve, the total market where our products have some use are approximately $10.3 billion. The biggest segment of that is obviously in that surgical arena. Although we are principally a niche player in that market, we're in some very attractive segments. And the remainder of the chart shows you the balance of the various markets that we participate in.

We are, I would say, quite optimistic about the future of healthcare device market, certainly in the segments that we serve, as we look out over the next year five, 10 or 15 years, in spite of some of the difficulties that are in the macro environment right now, there are some irreversible trends that we think are quite favorable to healthcare device manufacturers.

The first and most noteworthy, I think is the aging population and while it's true we're all getting older every day, there is this lump of baby boomers that are rapidly approaching their optimal years for healthcare utilization. And just to give you some numbers by comparison, the amount most Western countries spend on people that are between 55 and 65, for example, looks pretty much like other 10 year periods.

It doesn’t change significantly until you get to that 65 to 75 year old category, and for those people that are in that 10 year bracket, healthcare expenditures even in relatively tightly controlled environments like Canada, accelerate by about 2.5 times. So the per capita expenditure on per population is 2.5 times more in that age group.

When it gets to 75 to 79, it's almost 5 times the amount of per capita spending and that over 80 group is in the 8 times amount. So as that baby boomer population is getting older and older, there is going to be tremendous expectation for increased healthcare services. It is one of the things that is obviously driving a lot of the attention on cost and cost pressures, but the bottom line driver that is increased utilization.

The other really optimistic thing about the healthcare device market is stemming from emerging markets, and for us, we're particularly attentive to China, Asia rim and Brazil. And this largely comes from an emerging middle class that is willing to spend more and more on healthcare. And in these countries, some of dynamics are quite different.

In Western countries, for example, most of our senior healthcare expenditures are supported by the government. In China, by way of comparison it's almost all up to the individual to pay for their own healthcare. So as that middle class becomes more and more affluent, they have more dollars to be able to spend on healthcare, and I’m sure all of you are familiar with the basic high degree of growth that's occurring in China and the Asia rim countries.

Lastly, medical technology itself is a driver for increased use of medical technology. The better we get at saving a person from a heart attack, the more likely they are to go on and spend something on something additional. And so, there is a -- almost an automatic increase in growth as the result of healthcare technology becoming more effective.

There are certainly some challenges to that, chief among them I think are the changing regulatory environment, rising costs, and how different payers systems are thinking about dealing with some of those costs. From Teleflex's perspective, we believe that we are, have some immunity from some of those pressures, because most of what we make goes towards that critically ill patient, and they have been the hardest and most difficult patients for healthcare systems, for national healthcare systems, to be able to cut levels of care. Aside from that, I think Teleflex itself is dedicated to a great degree of technology advancements. Again, coupled with improvements in cost outcomes for hospitals, and I've got a couple of examples I'll share with you as we move forward.

A few years ago, the middle of 2010, as Teleflex was contemplating becoming a pure play medical device company, the current management at the time put forward some profitability objectives and growth objectives, and they projected that Teleflex should be in a position to grow their constant currency revenue at greater than 5%. They established a goal, by 2015, to get gross margins to approximately 55%, that we wanted to increase our research and development expense to approximately 5%, and operating margins of approximately 25%, and then return on equity of approximately 15%.

We've made some really good progress in some of those goals already. By fourth quarter of 2011, our constant currency revenue growth was about 6.7%. I'll share some first quarter numbers with you at the end of the presentation, but that same positive trend continues. This year, we're projecting that we're going to improve our overall gross margins by about 200 basis points and that's about the track we need to be on to reach that 55% number by 2015.

We'll spend about 3.5% this year on research and development. Last year, that expense went up about 14%, we're seeing another increase this year, and we will continue to spend at that level – we'll get to that level, I should say, clearly, by that 2015 goal.

Operating margins we’re projecting about a 100 basis point improvement in our operating margins this year and certainly that’s an area that we continue to spend focus on to make sure we can get to that 25% goal into the future. We do have a fair amount of cash about 84% of it is outside the United States.

Right now, we frequently get asked about our capital allocation strategy, so I'm going to in broad terms sort of scope out where we think that's going to go. Our number one priority at this juncture is to make strategic and technology acquisitions. By technology acquisitions we’re really talking about late stage technology companies that have just gotten a product to through the FDA may not be in the commercialization stage yet.

We do have a couple of areas within our franchises where we think there is an opportunity to enhance our share position from some strategic acquisitions. To give you a, sort of a financial reference those are, the strategic investments are in that $200 million to $300 million range and the technology acquisitions really run anywhere from $5 million to $80 million and usually with steep milestones attached to them.

We continue to make an internal investment in innovation and people. We have actually accomplished quite a bit in terms of organizing our company in a way that develops a succession plan. We are committed over time to continue reduction of outstanding debt although, right now in the present time much of our cash is overseas and it doesn’t seem to be the most lucrative or wisest way to spend our capital right now. And we continue to have a return of capital to shareholders buy a dividends and Teleflex right now has a very healthy dividend policy.

To give you an on ideal some of the strategic investments we've made, VasoNova is a technology that we acquired at the very beginning of 2011. Very briefly what this technology does, it allows nurse practitioners who are placing a PICC catheter to be sure exactly where that catheter is placed. Now they don’t have to send the patient down to X-ray for a confirmatory X-ray.

That not only saves clinical time, gets the patient into therapy faster at has some direct clinical benefits, but also reduces the expense related to the procedure. We acquired this technology, I’ve said at the beginning of 2011, we saw actually early stage acceptance of this during 2011.

We now have approximately 30 trials per month scheduled through the first half of the year and are seeing an extremely positive acceptance rate. We had 10 accounts closed in the first quarter of 2012, excuse me, 11 accounts come to conclusion and 10 of them went in favor of the VasoNova product.

So we are getting quite good acceptance to this and we are very optimistic the contribution that this particular device can make over the next several years. In fact, we believe a relatively substantial independent targeting market will be created in the PICC marketplace.

We just announced with our first quarter earnings, acquisition of EZ-Blocker. This is a relatively small market in the $30 million segment, but this is a very unique way to be able to close off one-lung and there is a variety of diagnostic and therapeutic procedures where the clinicians wants to do that and there is no easy way for them to do right now.

Another product acquisition that we just announced with our first quarter results is the EFx family of laparoscopic closure system devices. Every time they do laparoscopic surgery, they make a hole and that hole has to be sealed up at the end of the procedure and the larger the hole, the more difficult it is to seal.

And in general in laparoscopic surgery, they are going towards larger holes to be able to accommodate more instruments in single-port procedures. So sealing up that hole has become a problem, it's a cumbersome thing to do what this allows the clinician to do is somewhat automate that process and it makes it much easier and quicker to do without the accompanying negative effects that can come from a poorly closed opening.

So this is a little bit bigger. This is closer to $200 million market and it fits very well within our surgical product line franchise right now and with our existing sales force. So those are the kinds of technology acquisitions we've been focusing on. We have developed actually an excellent target list of additional technologies that we’re excited about and we’ll be continuing to bring those into our product fold during the course of the year.

To give you an idea of our new product line extensions, we are making investments essentially in every single one of our franchises businesses. This gives you an idea of our new product, and line extension activity in 2011 and 2012 and looking at the impact that these new products have that are general sales revenue has and technology acquisitions. We have recently raised our longer term revenue projections from 5% constant currency growth to 7% constant currency growth beginning in the out years of 2014 and 2015.

A brief financial review, just to look at 2011 year-over-year, our revenue was at that $1.528 billion number that represented a real increase of 6.7% and a constant currency increase of 4.3%. We also saw an increase in our gross profit and you can see that made a 14.3% increase in our research and development expense, an increase in our operating profit and an increasing our diluted EPS from continuing operations.

We started the year with some growth in 2011 and actually ended up fourth quarter with a much more robust performance in every one of those categories and that continued on into our first quarter of 2012 and you can see that in the first quarter 2012 our real revenue growth was 9.5%, our constant currency revenue growth was 10.9%. And as I mentioned earlier, we saw growth in every one of our major product categories and in every geographic region.

We were helped a little bit first quarter by some extra shipping days, but even taking that into account it was a stronger revenue performance for us. Our goal is to always improve our gross profit faster that our revenue improvement and we saw that occur in the first quarter with a 13% improvement in our gross profit. Our research and development expenses also went up in the 4.7% range. Our operating profit, we were a little disappointed, we’d hoped that to be closer our gross margin number, we did had some one-time expense that we don't think will occur during the course of the year, but nevertheless, still had a 9.2% increase in our operating profit and our earnings per share went up 14.8%.

So just as a brief summary, Teleflex has completed its transition from an industrial conglomerate to a pure-play medical device company. We have been continuing to invest in pipeline expansion, focusing particularly on products that are well within our franchises right now that have an evident clinical benefit to them and also have a demonstrable way to show clinicians that we can reduce the cost in the procedures.

We continue to leverage our global brands Teleflex had excellent positioning in Asia and in Europe, which allows us to not just sell these devices in the United States, but really all over the world. We continue to take advantage of licensing partnerships and other programs to open up our markets and have a very effective distribution network through particularly in Europe and Asia.

I’ll talk a little bit about our financial strength, we feel quite confident about our ability to continue our revenue growth and our margin expansion plans throughout 2015. As conditions present themselves, we are also are looking for opportunities to de-lever ourselves from the current debt level that we have. And fortunately, we have essentially strong free cash flow that will enable us to do both of those things, acquire new technologies and improve our balance sheet.

So that pretty much concludes my prepared remarks, so I’ll turn it over to Kristen for questions.

Question-and-Answer Session

Kristen M. Stewart – Deutsche Bank Securities, Inc.

Okay, any question, don’t be shy, raise your hand. All right, I’ll kick it off. I guess one of the consistent, I guess kind of push backs that I often hear just on the overall strategy that you have now, it’s just more on the ability for you guys to raise price and that’s clearly a part of the story in terms of the top line growth, as well as the margin expansion over the next couple of years.

So can you maybe just talk and remind people just kind of where you are in price relative to some of your competitors and just how that has been going over the last year or so?

Benson F. Smith

So, I certainly don't want to give you the impression we think it's easy to raise prices out there. This is a very difficult market and has been for a number of companies. Teleflex has somewhat of a unique position in the sense that we weren’t very good at pricing as we’ve been before.

And so, it became evident as one of the reasons our gross margins were lower than some of our competitors where we were simply, really not pricing appropriately. Even in a difficult environment, we found that there was about a third of our product line that we sell were so outpaces the marketplace that we could execute a price increase and we expected that to net about 1% improvement per year.

We started that essentially in July of 2011. We saw some very modest indications that it was working since we just put it in place in the third quarter. By fourth quarter, we saw essentially a 50 basis point improvement, a net improvement of 50 basis points coming largely out of Asia, from the United States; with some negative pricing in Europe reducing it to 50%.

By first quarter this year, the total net price was 100% basis points largely due to the same trend, positive trends in the U.S. and in Asia, but also we were able to reverse the negative pricing in Europe.

So, I realize we were somewhat of a contrarian. I don’t think strategy would work for many companies, but it does work for us because there was such a gap between where we should be and where we were and we expect that to continue over the next year or two. So we realize there's lots of skepticism about, can you do it, but we are and it’s working and it’s already contributing.

Kristen M. Stewart – Deutsche Bank Securities, Inc.

Okay and would it be fair to say that some of the I guess contracts that you maybe renegotiating, maybe with GPOs, and so multi-year in nature, so since you're starting to see the benefit now. Is it correct to assume that in some of your confidence that you can still do it as basically locked in already for the next couple of years or?

Benson F. Smith

So, the good fortune is, last year was a very good year for us with GPO contracts we had. We had 37 total awards that we won, 10 of them were brand new. And we were able to build in our pricing increases – again this was for some very specific product, but build those into our longer-term contract, so that's one of the reasons why we feel some comfort that they are sustainable.

Kristen M. Stewart – Deutsche Bank Securities, Inc.

Okay. And I guess the device tax is going to be coming in 2013. When do you guys stand in terms of the total impact for the company and what are your thoughts on offsetting it, I guess to the extent you can take price, but that's a little bit of a mitigating factor, but…

Benson F. Smith

So to be clear if we're against it?

Kristen M. Stewart – Deutsche Bank Securities, Inc


Benson F. Smith

We had estimated what we think the impact is going to be to us on a worse case scenario is $15 million pre-tax. There' is a lot of complications in how you actually calculate the tax and your ability to use the lowest price. And so, we think the actual amount is somewhat south of that worse case scenario. I do think that since we have been talking about price increases, or customers in the U.S., we're in a better position to use that as one of the issues about price increases.

And I say our gross margins are conspicuously lower than some of the companies we compete with and I would just say that that makes our customers a little bit more tolerant about us talking about pricing, someone who want a similar item, might be making a 15% higher gross margin. So we intend to try and recoup as much of it as we can, but I think those two, as planned, certainly going to have some impact on us in 2013.

Kristen M. Stewart – Deutsche Bank Securities, Inc.

Now you took over Teleflex in the beginning of last year and I am just curious. What I guess now that you’ve had over the year under your belt, what were some of the I guess key decisions that you've made over the last year that you really think will allow Teleflex to achieve from these longer-term targets.

Benson F. Smith

So I would say, again, that’s our pricing strategy, it was carefully looked at in terms of the products that we felt we could put that against. And that’s working out, so I would say, that’s in the plus column and was a positive decision. And approximately the second quarter of last year, we began a process to reorganize the way we went about doing business in the United States from a very centralized structure to strategic business units, and put in presidents and sales forces directly reporting to those business units.

That’s actually had a really positive effect in uncovering new technology opportunities for us, in being much closer to the customer, and in our ability to direct our sales force to those products that make the most sense. So I think that has already started to pay some dividend for us. We continue – when I came here, I found that our structure in Europe was actually very, very positive. It’s one of the real strengths of Teleflex. And we continued to rely on Europe as a strong source of revenue growth for us, so that’s worked out well.

I think the biggest surprise to me were two. First of all, Teleflex had sort of had this mental set that we’re in the commodities business, and we have some products that will like that, but we have an awful lot of products that have a high level of clinical content, and that was refreshing to find out. And the second thing was, we really have a good organization, in terms of the quality of the people that are involved in Teleflex Medical. So that has helped us a lot in getting things done a lot more quickly than I think people might have expected.

Kristen M. Stewart – Deutsche Bank Securities, Inc.

All right. I think we still have a little bit more time. So, as we look out over the next year, what, I guess, should we take away, maybe increasing M&A, kind of as you look for more tuck-in acquisitions from the technology side.

Benson F. Smith

So, yes. I would expect that you will see more, some of these will be relatively small in size from the purchase price, but meeting that criteria of a unique, protectable clinical content of product. So you’ll certainly see more of that, as a way of expanding our pipeline. We do have some work ahead of us in terms of pulling the trigger on some longer-term gross margin improvement projects, consolidating distribution, consolidating some of our factories that we will begin to engage in this year. And we are continually looking at what to make sure our standing is in the most productive area as possible. So, in some cases, it’s cutting, and in some cases it’s reallocating. But that’s where the focus of most of our attention is right now.

Kristen M. Stewart – Deutsche Bank Securities, Inc.

And where is most of the incremental R&D spend going into? Which kind of business, I guess, you know?

Benson F. Smith

So what we tried to do is, is create a competitive environment where we haven’t allocated by business unit, and we’re really trying to fund the best ideas. So, if Business A comes up with a really good idea, we try and find the money to be able to find that idea. But we’ve got a pretty tight algorithm in terms of, will we establish a niche market leadership with this, will it solve a clinical problem, will hospitals pay for it, will they save money by using it? So we’ve got – we’re trying to fund products that meet those criteria, more so than just allocating it on a dollar basis, business by business.

Kristen M. Stewart – Deutsche Bank Securities, Inc.

Do you think 5% is still the right level to kind of ramp up to for R&D spend?

Benson F. Smith

So, to put this as delicately as I can, my experience at Bard was, every time we spent more than that, we spent it on stupider and stupider things. So I think 5%, well spent, is the right number for our portfolio.

Kristen M. Stewart – Deutsche Bank Securities, Inc.

Yes, perfect. All right. We have one question in the back.

Unidentified Analyst

In your acquisition of, what are (inaudible) pretty good things to say, when you have to buy small niches, what are the economics of it?

Benson F. Smith

So, we think in acquisitions, one that I wonder for a strategic share enhancer which are largely driven by the financials of the business, what is their revenue, et cetera. And those are looked at pretty closely, and our expectation is that they need to be accretive from day one for us. The new technology acquisitions are much harder to put a financial tag to. And I don’t mean to imply we don’t, we do, gut if the technology pays for themselves. If it doesn’t, they don’t. So the success of that program has more to do with our doing the right diligence and making sure we’re buying things that actually have some real potential.

Kristen M. Stewart – Deutsche Bank Securities, Inc.

All right.

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