Teleflex 2008 Business Outlook Conference Call Transcript

Teleflex Incorporated (TFX)

2008 Business Outlook Conference Call

January 7, 2008 9:00 am ET

Executives

Julie McDowell - Vice President. Corporate Communications

Jeffrey P. Black - Chairman of the Board, President and Chief Executive Officer

Kevin K. Gordon - Chief Financial Officer, Executive Vice President

Analysts

Deane Dray - Goldman Sachs

James C. Lucas - Janney Montgomery Scott

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Teleflex 2008 business outlook conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Julie McDowell, Vice President of Corporate Communications. Please proceed, Madam.

Julie McDowell

Thank you and good morning, everyone. I’d like to welcome you to this conference call to discuss Teleflex's preliminary outlook for 2008 business and financial performance. A press release was distributed this morning and is available on the Teleflex website. We have also posted slides to accompany our remarks on this call.

Please note that this call will be available on our website and the replay will be available by dialing 888-286-8010 or for international calls, 617-801-6888. The passcode number is 42798181.

Joining us on today’s call is Jeff Black, Teleflex's Chairman and Chief Executive Officer; and Kevin Gordon, Teleflex's Executive Vice President and Chief Financial Officer. Each of these gentlemen will make brief prepared remarks and then we will open up the call for questions.

Before we begin, I would like to remind you that some of the matters discussed on this conference call will contain forward-looking statements, including but not limited to statements relating to revenue growth, expected full year diluted earnings per share from operations before and after given the effect of special charges, forecasts regarding special charges, cash flow from operations, segment performance, and operating profit margin percentage growth, and business and operational performance.

We wish to caution you that such statements are in fact forward-looking in nature and are subject to risks and uncertainties. Actual results may differ materially from those in these forward-looking statements due to among other things, business conditions and the general economy, market opportunities, competitive factors, sales and marketing execution, shifts in technology, unanticipated expenditures in connection with the effectuation of programs, cost and length of time required to complete integration and restructuring programs, unanticipated difficulties in connection with the consolidation of manufacturing administrative functions, and other factors described in Teleflex's filings with the Securities and Exchange Commission. Additional factors that can cause actual results to differ materially to these forward-looking statements are available in the SEC filings.

I will now turn the call over to Jeff Black.

Jeffrey P. Black

Thanks, Julie. Good morning, everyone. 2007 was a remarkable year for Teleflex. We made dramatic changes in our portfolio with the acquisition of Arrow International, our largest acquisition ever, acquisitions in all three segments, and the significant divestiture in commercial and aerospace.

As an organization, we entered 2008 with a strong sense of direction and confidence. While 2008 will be somewhat of a transition year as we integrate acquisitions and invest for future growth, we see ourselves delivering on the potential of our redefined portfolio.

With the changes we’ve made to the portfolio in 2008, we expect to deliver significantly higher overall segment operating margins increasing to the mid-teens for the year. As a comparison, our overall segment operating margins were in the 11% range on an annual basis with our 2006 portfolio.

We expect to deliver strong cash flow and business performance improvements, even with the integration of Arrow and the investments we are making in our other businesses for future growth opportunities.

We are making great progress on the Arrow acquisition and are ahead of our schedule. As a result, we’ve increased our forecast of potential pre-tax synergies in 2008 from the Arrow integration by 10% to 20% to be in the $33 million to $37 million range, and we completed the planned divestiture of our automotive and industrial businesses by year-end, enabling us to use the expected net after-tax proceeds in the range of $400 million to pay long-term debt, obviously improving our balance sheet position.

Teleflex is quite a different company today than we were just one year ago today. During the fourth quarter alone, we completed the Arrow acquisition, the acquisition of Nordisk Aviation Products in our aerospace segment, and the sale of our automotive and industrial businesses to Kongsberg Automotive.

Just to give you some perspective on our portfolio changes, this slide compares our revenue and our operating profit contributions by segment for 2006 with our 2008 expectations. As illustrated here, the transactions we completed in 2007 created a portfolio defined by our medical technology business that provides more than 60% of the company’s revenues and more than 75% of the company’s operating profit.

Our two aerospace businesses are established market leaders with well-known brands and a strong after-marker position. Both businesses enjoy long-term growth opportunities as the aerospace market strength continues, newer engine types age, and as platforms from Airbus and Boeing come online.

The commercial segment, which has historically been our largest, is now our smallest, representing less than 20% of our revenues and less than 10% of our operating profits. We are the market leaders in marine steering and in the rating services, and we see future opportunity in alternative fuels and auxiliary power when the truck market rebounds, as fuel cost and environmental concerns get greater attention.

Turning to slide number seven and a little detail on our expectations for each of the segments in 2008, I’ll provide you a little brief description of the business performance expectations for each of the segments and then Kevin will provide detail on the financial outlook.

In medical, looking ahead to 2008, the medical segment is now the defining business for the company. We expect revenue growth in our medical segment, driven by the continued penetration of our critical care product lines. We will be releasing or have recently introduced some nice new products to our core venous access and respiratory product lines. We’re adding a pressure injectable central venous catheter to join our pressure injectable PICC and an ultrasound system used for placing lines. We also recently introduced a new humidification system in our respiratory product line as well.

We see nice growth in the medical business internationally. We’re particularly excited about the growth potential in Asia and in some of the European markets, where combining the Arrow and Teleflex product line creates strong cross-selling opportunities, and we also expect our OEM business to rebound slightly with the orthopedic market and with new products in our specialty areas.

Overall, we see the combined medical segment at mid single digit core growth this year. This is a nice recurring revenue business growing with or a little ahead of the market trends.

We will discuss integration costs and synergy expectations in more detail but we expect to see the segment operating margins reaching the 20% range during the year.

Additionally, I wanted to note that we have accelerated our compliance related activities for Arrow facilities to address the FDA corporate warning letter issued to Arrow in October of 2007. We’ve dedicated significant resources and made good progress. We’ve met with the FDA, responded to the letter in writing, reviewed employee training records and process controls related to all of the citations noted. As in the case of these things, it will take some time to work through but effectively, I’m pleased with the progress that we’ve made to date.

While the main focus for this year will be executing on integration plans and meeting compliance requirements, we will be continuing to build on our core products and investing in new products.

In our aerospace business, revenue growth will come primarily from the impact of the Nordisk acquisition. This acquisition provided us with market leadership, strong customer relations, and a global operations for air cargo containers.

While we continue to see a strong commercial aviation market, segment core growth is likely to be relatively flat. Following a strong growth year in 2007, 2008 will be a transition year as we prepare for a surge in demand in 2008 and beyond, created by our position on new aircraft platforms and an increased demand for repair on new engine types.

In the cargo systems business, which is roughly now about 50% of the segment revenues, Telair continues to lead the market and expand the installed base of cargo systems. We’ve recently been selected as a supplier of furnished equipment for the new Boeing 747-8 with deliveries currently scheduled to begin at the end of 2008.

Additionally, we are very pleased that we are now the supplier of furnished equipment on the upcoming Airbus A350, adding to our presence with Airbus and creating significant long-term opportunity in partnership with these OEMs and the airlines.

As we prepare for these platforms, we’ve seen delays in the A380 deliveries, deferring conversions of 747-4 aircraft from passenger to freighter as customers keep these planes in service as passenger aircraft.

The repairs business will experience moderate growth in 2008 as utilization of newer CFM engines continues and demand for repairs and maintenance maintains current levels. As the CFM and other new engine types age and the flight hours continue at the current pace, we expect to see increased demand for engine repairs and new technology. Our repairs business is well-positioned here and we are investing in R&D and operational initiatives to prepare for future demand.

Overall, the aerospace segment will benefit from recent restructuring and from operational effectiveness initiatives and continue to see margin improvement with low double-digit margins.

Obviously the most significant change has been in our commercial segments, which now represents less than 10% of the company’s overall operating profit. Marine products where Teleflex has a market leading position should represent more than half of the revenues in this segment.

We stayed ahead of the slower marine markets over the last few years with a nice mix of new products and increases in the international and after-market sales. We expect to see a continued nice growth in margin improvement from our marine and rigging services business, offset by a decline in demand for our power system products for the North American truck market.

With that, let me turn it over to Kevin for financial remarks.

Kevin K. Gordon

Thanks, Jeff. Good morning, everybody. Thanks for joining us this morning. As Jeff mentioned, at the end of the year, we completed the divestiture of the automotive industrial businesses. These businesses will be classified as discontinued operations in the fourth quarter of 2007. Last week, we filed a Form 8-K with unaudited pro forma historical financial information reflecting the divestiture of the automotive industrial businesses and the acquisition of the Arrow business.

We will also post to our website unaudited quarterly adjusted results of operations for 2006 and the first three quarters of 2007, reflecting segment data with the automotive industrial businesses classified as discontinued operations for those periods. This data does not include any impact from the Arrow acquisition, which occurred after that time.

We won’t be discussing specific expectations for the fourth quarter or 2007 year-end results on this call. It’s still a bit early. We have a lot of work to do in the year-end close with many of the moving parts but our preliminary projections show operating financial performance from our continuing core operations that is relatively in line with our expectations for these businesses for the year prior to certain transaction related charges and a possible impairment charge.

As we have said before, with the fourth quarter activities related to the divestiture and acquisitions, we expect to have transaction related charges related to inventory step-up, in-process R&D, transaction costs and such, as well as the gain on the sale of the automotive industrial businesses.

The gain on sale is currently estimated at approximately $90 million net of tax but is subject to working capital and other operating adjustments. We may also record a non-cash charge related to impairment of principally intangible assets of the power systems business. While these businesses enjoyed a healthy market early in 2007, market shifts, particularly for the North American truck market, have adversely impacted our valuations considering the required annual good will impairment testing currently being completed.

Slide 12 outlines some of the overall assumptions that we made in providing you the outlook for this new coming year. First, our financial goals and metrics; we made significant changes to the business in 2007, most notably in the fourth quarter. As we look ahead to 2008, we project revenues for Teleflex to top $2.4 billion.

As Jeff indicated earlier, our strongest core top line growth is expected to be in the medical segment. Aerospace revenue growth will be driven by the addition of Nordisk in the cargo systems business and moderate growth in the repairs business, and the commercial segment is expected to be relatively flat year over year.

Our projected overall segment operating margins are expected to reach the mid-teens for the year, which Jeff mentioned is a significant improvement over the margins prior to the change in the portfolio.

We see overall revenues and operating profit growth accelerating as the year progresses, resulting in a stronger second half. This growth comes largely from volume increases, synergies net of costs related to integration activities, and continued productivity improvements. Clearly spending will be higher earlier in the year with synergy benefits increasing as the year progresses.

Also important, our cash flow story will continue to be compelling. Another strong year of operating cash flow will be driven by increasing operating margins and continued improvement in working capital management. In particular, we see opportunity to improve working capital management for the Arrow product lines; however, we will make significant tax payments in the first half of 2008 related to the gain on sale recorded in discontinued operations in December 2007.

Considering the changes in the portfolio, we expect the effective tax rate to be between 27% and 29% for the year. With the investments required for the medical segment and the Arrow integration and additional investment in capacity for future growth principally in aerospace, we expect capital expenditure requirements to be $60 million to $70 million, or something in the range of 3% of sales.

Recent transactions and capital requirements will have an impact on our depreciation/amortization levels expected to total approximately $120 million as we depreciate current capital expenditures and have increased amortization costs related to both purchase accounting and financing costs. And as we stated, repayment of debt will be a high priority to reduce interest expense and provide capital for future growth opportunities.

With the completion of the divestiture of our automotive industrial businesses, we utilized proceeds from the divestiture to pay down debt by approximately $530 million in December, reducing the debt balance to approximately $1.7 billion as of December 31, 2007.

We expect to enter 2008 with cash of approximately $150 million and will utilize the revolving line of credit as needed in the first half of 2008 to fund tax payments related to the divestiture in 2007.

In relation to the acquisition of Arrow, annual pretax synergies are expected to be in the range of $70 million to $75 million by 2010. The integration team has made great progress in the first few months and we are ahead of our original expectation in terms of timing. We now see annual pretax synergies in 2008 in the range of $33 million to $37 million, exceeding our original expectations of approximately $30 million for 2008.

Integration costs are currently estimated to total $70 million to $80 million through 2010 with $35 million to $40 million treated as expense and the remaining amount of approximately $35 million treated as a liability in purchase accounting.

Turning to the earnings outlook, prior to special charges, we are forecasting the EPS range of $3.70 to $3.90 per share for 2008. Special charges, which principally relate to Arrow integration and inventory step up charges, are currently forecasted at $0.60 to $0.67 per share. Earnings per share from continuing operations including special charges is expected to be in the range of $3.03 to $3.30 per share.

With significantly improved overall operating margins and disciplined working capital management, offset by integration spending and higher interest costs, cash flow from operations is expected to be approximately $250 million, excluding tax payments related to the gain recorded in 2007.

2008 will be a year of continued focus on cash generation to support our growth initiatives and to improve the capital structure.

I will now turn it back to Jeff for some closing remarks. Jeff.

Jeffrey P. Black

Thanks, Kevin. Well, I think you’ll all agree that Teleflex is quite a different company than it was at last year’s outlook call. Today, Teleflex is a tough competitor in its markets, has strong brands and customer relationships, strong engineering capabilities, and a management team with a proven track record of execution on operational and strategic initiatives, clearly something we’ve demonstrated with the magnitude of our changes in recent years.

From a financial fundamental standpoint, we have expanding operating margins, sound working capital management, and outstanding cash flow. Teleflex has always appealed to cash flow investors and we will strive to continue enhancing that profile.

Now, our remaining challenge is to energize top line growth and continue to build through R&D acquisition. We are clearly in a position to make this happen in 2008 and beyond.

With that, I’ll turn it back over to Julie.

Julie McDowell

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

Question-and-Answer Session

Operator

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

Deane Dray - Goldman Sachs

Thank you. Good morning and happy new year. The spirit of my question is, Jeff, what is the targeted business mix for Teleflex going forward? And specifically, we would argue that you are no longer pursuing what we would characterize as the diversified business model because you’ve got arguably 75%, 80% of profit now coming from medical. So increasingly, not today, but increasingly the non-medical businesses at Teleflex are going to be viewed potentially as a distraction. So that goes back to the question, what’s the ideal business mix? And then, looking down the road, if these are distractions might you be opening yourself up to some activist shareholders that would be pushing for further divestitures?

Jeffrey P. Black

Let me first start with the mix of the portfolio, Deane. I mean, we’ve worked hard over the last five years to get -- obviously reduce the cyclicality, drive improved margins but I think when you take a look at what remains in our portfolio today, we feel very good. They are very strong franchises, whether it be in the repairs business with ATI, whether it be in the cargo loading with Telair, or even in the marine business. I think it’s -- that’s really what we are looking for, is franchises that one, have strong positions; number two, that can continue to grow despite some of the cyclicality; and more importantly, that can generate significant cash flow that we can invest back into our businesses.

So I think you can see that just in the last -- in ’07, we made investments into the rigging services business. We made investments into the cargo because we believe we are well-positioned there to continue to expand on our leadership.

So while it would be easy to say should we be pure play, I will tell you at this point we are happy to be diversified and I think we are going to continue to work on our portfolio as opportunities arise, both on the buy and potentially on the sell side. I think that’s what we are paid to do.

In terms of distractions, I have to tell you, when you look at the work that’s gone on, I think our biggest distraction is getting back to growing our core businesses, not necessarily the segments that we have in terms of do we stay in some of these or not, but I think for the time being, when you take a look at some of the growth rates where we’ve outperformed the markets, I think we do a little better in some of the medical markets. I think we’ve outperformed the marine market for at least the past two years and would hope to do so in ’08.

So I think management is very focused and more importantly, for ’08 and beyond, we’ve got to focus on driving cash and getting back to a stronger core growth.

Deane Dray - Goldman Sachs

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

Jeffrey P. Black

It’s a good point, Deane and you know, what I would say is when we looked at where we are in the medical segment, I mean, one of the attractions when we hired Ernest Waaser was his strong background in R&D. He got a lot of that experience at Dupont and along the way in some of his other medical operations, so I think we feel we have the right leadership. I think we are better structured but when you take a look at the overall spending, we typically were spending about 3% in R&D for medical. Arrow was spending probably a little north of six, so I think we look at it and say I think we’re committed to spending about 4.5% in ’08 on R&D and I will tell you, I think it’s going to be more on pure R&D as opposed to some of the reengineering that we had probably done in the past.

So I actually feel pretty good but obviously that was the real attraction to Arrow for us, was getting an organization that had a strong R&D capability and then taking some of the anti-microbial coatings and take them across our respiratory and urology products, so I think we feel pretty good about it.

I would also say that we are seeing opportunities on the OEM side where the OEMs in the medical business are doing more supplier consolidation and looking for suppliers like Teleflex who has broader capabilities than many of the other single skill capabilities.

So at this point, I feel pretty good about it. We’ve invested a fair amount in the last few years in our marine business to move more from a mechanical company to a electro-mechanical and electronics company and I think that’s why we’ve seen increased growth over the market, at least in that segment itself.

Deane Dray - Goldman Sachs

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

Jeffrey P. Black

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

Deane Dray - Goldman Sachs

Great. That’s very helpful. Thank you.

Operator

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

James C. Lucas - Janney Montgomery Scott

Thanks. Good morning, all. Two questions here; first, Jeff, could you give us any additional color with regard to the Arrow integration of why you are saying it’s ahead of schedule? And you spent a lot of time talking about the synergies, you just covered it in some of your answer to Deane’s question on the R&D side, but any additional color you can provide there?

And secondly, a question for Kevin on the cash flow side, you spent some time talking about the sales and the earnings perspective, but if you could maybe spend a little more time and walk us through the cash flow, because $250 million seems to be somewhat conservative and wondering where potential upside could come there.

Jeffrey P. Black

Sure. I’ll start with the synergies, Jim. I think we’ve seen it really I would say almost across the board on where we think we’ll get ahead of next year. One, it really comes back to the reception we’ve gotten from the Arrow management team who remains with the organization, the receptivity that they’ve had to some of these changes. I would also say that I think we’ve gained some momentum.

I think you have to go back and obviously when we got the corporate warning letter from the FDA, a lot of our efforts were put right towards ensuring that we were getting the organization to a compliance state. But I really think that what we’ve seen is that the opportunities both from a personnel standpoint and from other standpoints, we believe that 10% to 20% is within our ability to achieve and I think as we go through the year, we’ll continue to provide updates as to where those synergies are. I think it might be a little premature to talk in detail as to how we see those coming about.

With that, I’ll turn it over to Kevin on the conservative cash flow comment.

Kevin K. Gordon

When you look at the cash flows, Jim, I think it’s important that you have to keep in mind the purchase accounting implications of some of the integration reserve, so as you look at the balance sheet pushing through the cash flow statement, you’ll have an impact in ’08 on some of that spending, on some of those accruals pushing through, so that drops the number a little bit. As well as some tax related issues with some of the repatriation that we will do with cash.

Certainly I think Jeff characterized it early in his remarks as somewhat of a transition year. This will be the year where you have a lot of that integration spending coming through that will lower it.

James C. Lucas - Janney Montgomery Scott

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

Kevin K. Gordon

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

Jeffrey P. Black

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

James C. Lucas - Janney Montgomery Scott

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

Kevin K. Gordon

Well, the market -- we don’t disagree with you the market remains strong, the cycle continues to go. The two major segments we have there, as you know, are cargo and repairs. I think as we said in our remarks, we expect the repairs business to actually be up year over year with some growth in that business, Jim. New investment that we are looking at and new technology we’re investing in that business this year. As we look at some of these newer technologies that come online, whether it’s 2D to 3D dimension type blades. So there is investment going on there for these newer type engines as you go forward.

With respect to cargo, I think even over the last couple of quarters, I think we’ve talked a little bit about this conversion with the A380 and so forth. What’s exciting to us is the potential that’s ’09 and beyond with this SFE classification with the OEMs, with the A350, with the 747-8. Clearly from a platform standpoint where we have our strength in that business today, there’s a bit of a transition but what we’ve done is done a great job of positioning ourselves on the new platforms as they are coming online to really provide the growth opportunity as you’re suggesting as the cycle continues to extend beyond ’08.

Jeffrey P. Black

I think, Jim, just to add a little color, if you remember on the repair business, last year there was a fair amount of in-sourcing that took place by some of our customers on the repair business, so I think that’s why we see a slight up-tick in the revenue because we’ve actually had to replace a significant amount of business that was in-sourced by one of the engine manufacturers.

And I’ll just echo Kevin’s -- I mean, for us to finally be identified as the SFE supplier into Boeing for the cargo, I mean, we’ve talked about this. This was always a goal of Teleflex's and of our cargo business for more than 15 years. It’s a real tribute to the leadership, both at Telair and of our aerospace group, that we finally have become the SFE. I think it only substantiates that we bring the value both in terms of engineering and the fact that we are perceived as the global leader. We are now a key supplier. We’ve always been a key supplier to Airbus but now that we’ve penetrated Boeing, we still see that that’s really building an annuity stream for many years to come.

James C. Lucas - Janney Montgomery Scott

Okay. Thank you very much.

Operator

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

Julie McDowell

Thank you, everyone for joining us this morning. Please note that 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 number 42798181. Thank you.

Operator

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

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