Benson Smith - Chairman, President & CEO
Teleflex Incorporated (TFX) Bank of America Merrill Lynch 2012 Health Care Conference May 16, 2012 4:40 PM ET
Teleflex to present. Benson Smith, the company's CEO is here speaking on behalf of the company. We will have a 15-20 minute presentation followed by Q&A right here. So, thanks very much for joining us.
Thanks [Bob] and good afternoon everyone. As Bob mentioned, I am going to run through about 15 or 20 minutes of prepared remarks. The slide deck is available online or a manual copy.
Just to get started, I do want to mention that I will be making some forward-looking statements. The future can be very different than what we think is going to look like. So with that, we will get in to what we’re going to cover this afternoon.
Let me go through a brief company overview. Teleflex has changed a lot in just the last few years, making a transition from an industrial conglomerate to a pure-play medical device company. I want to give you a good idea in terms of where we are today, talk a little bit about our strategic objectives. This is sort of a five-year look we have in terms of the goals we set out for ourselves, give you some financial information about full-year of 2011 and our first quarter 2012, which we just announced a couple of weeks ago and then a brief summary and then open it up to questions and answers.
From a company overview, Teleflex began life as an aerospace provider, middle of World War II. We were making steering systems for planes. We’re a very aggressive company, migrated from aerospace into Marine and then eventually in to the automotive business and along the way, acquired a couple of medical device assets.
By 2005, with a pretty significant downturn in the automotive business, Teleflex was looking at its future and was at least at that point interested in expanding its resources in the medical device industry; had a management team that didn’t have much experience there and a Board that had no experience in medical devices. That’s how I happened to come by way Teleflex went on Board in 2005.
Over the next two years, as the future of the automotive industry looked bleaker and bleaker at least from a supplier perspective, a decision was made to be a lot more aggressive and getting rid of those assets and acquire medical device companies. We did that, acquired Arrow in the process in 2007 and then around that time made a much more conscious decision to move more towards a pure-play medical device company.
By the end of 2010, we’ve pretty much divested all our non-medical assets. We had a few aerospace assets left, put those into discontinued operations and for basically in 2011, what you saw was Teleflex as a pure-play medical device company. It took us till the end of the year to actually divest those assets and where we sit right now all of our businesses are in the medical device arena.
Certainly, these words on the page mean a lot more than just the words here to us. We really see that particularly where we are in the healthcare industry that medical device companies can play an increasingly important role.
First of all, at improving technology, most of our resources are looking at how we can improve clinical outcomes in the areas that we serve. And I think for us, the additive value of being able to reduce procedural cost for the hospital is an important element for us. So we try and define our businesses around franchises and look for very concrete ways we can accomplish this within our franchises.
The other thing that I think is important to us as a company is the way we act with our employees, with our partners, with our customers and that we hold ourselves to high ethical standards and our expectation is that we become a trust resource for our customers.
To give you just a brief overview in terms of our product portfolio, it’s a diverse product portfolio. There is no signal product that amounts to a majority of our sales. We’re not completely evenly distributed throughout this entire portfolio, but mostly so. The biggest business for us right now is our vascular access business and the key product for us right now is in the CVC line, central venous catheters that came with the Arrow acquisition. We’re the global market leader in that particular product line with about an 80% share.
PICC product line is of course related to CVC’s and we also have a PICC product line entry as well. And we recently expanded our offering in this area with the acquisition of VasoNova; I’ll talk a little bit more explicitly about that a couple of slides from now. But this is a targeting system that helps the clinician figure out exactly where the catheter is without having to send the patient down for confirmatory X-Ray.
We also have some well know brands within the surgical arena, certainly DEKNATEL, and HEMOCLIP are two well known brands; we’re the market leader in cardiovascular sutures and in polymer clips which we begin to put product. We have an old line of general instruments that were acquired from Weck and from Pilling.
You don’t hear a lot about Teleflex in urology business in the United States, my ex-company C.R. Bard, pretty much holds the mantle there and we have a brand called RUSCH and we are the market leader in Europe, both in the Foley catheter segment and a lot of the urinary and [cardiac] segments as well.
Cardiac Care is our Intra Aortic balloon pump business that came to Teleflex by way of the Arrow acquisition and that particular segment it’s us and Datascope are the only two manufacturers of these balloon pumps in the world and that’s a growing segment for us.
The anesthesia and respiratory business also largely came to us by acquisitions some from Arrow products some from Hudson. We recently combined those two businesses and we essentially have two sorts of product segments that we compete in, one is the airway management business which is something that’s too big (inaudible) while under general anesthesia and the other segment is the regional anesthesia which is needles essentially used at the local anesthesia.
And we also have somewhat of a unique business in OEM segment. Teleflex is actually a manufacturer of either components or end products that other medical device companies or customers include some of the best and biggest and well known medical device companies. It’s a bit of an unusual segment for us to be in, but its an important business to us both because it keeps us current in terms of some technologies, but also it allows us to participate in some market segments that we wouldn't want to enter into on our own, orthopedics being an example of that.
I would say the common thread among almost all of our products is that they tend to be used on critically ill patients or on non-postpone able procedures. So last year for example in 2011, some of the peer companies we compare ourselves to, commented on a slowdown in procedures affecting their revenue. We didn't experience that nearly to the extent that some of those other companies did; again, largely because most of what we make is very difficult to postpone.
The other thing that's kind of unique about our product offering is that although it’s critical to the procedure, it usually is in a big expense item of the procedure. So we might make a $200 product that’s used in a $12,000 procedure. So we don't and haven't experienced the same degree of heightened price pressure that other device manufacturers have. So unlike a hip, or a knee, or a pacemaker what we make doesn't have a big component of [VRG]. So we don't have quite the same size target on our back that some other device manufacturers might have with the GPO contracts.
Here is a breakdown of the geographic distribution and customer distribution of our product line. We are little unique in the sense that we don't have as much of a weight in the US, most of the companies we compare ourselves to are in the 60% or 70% range in terms of the US sales we’re at 52%, 36% in EMEA and then a 12% in the emerging market area which we comprise of Asia, Latin America and Canada is also included in that number, I am not sure it’s fair to characterize it as an emerging market, but that's where it lands in our description.
About 81% of our products are sold directly into hospitals. We do have an OEM segment which constitutes about 11% of our portfolio and then some of the products we make for hospitals also have an application in home healthcare markets. It’s not something we address deliberately, but with the spillover, we take advantage of that especially in certain markets Germany, UK and United States and about 8% of our revenue goes to home healthcare segments.
I would say that one of the things that we are really excited about is we see the next 15 years in the medical device arena as really a tremendous place to be. Just to give you some numbers, the effect of the ageing population I think is the biggest market driver. In the United States, on a per capita basis, we spend five times as much on people who are between 65 and 75 as we do on people who are between 55 and 65; five times as much as you make that transition to that slightly older category.
As you move to that 75 to 79, it goes to about 8% more and by the time you get into that over 80 segment it’s 11 times what we spend on that 55 to 65 population. Even in healthcare climates which are much more moderated and much tighter controls on spending, Canada, the numbers are 2.5%, 5% and 7% as you move along those age groups. So what this age, this baby-boomer population is really just poised to enter that plus 55 segment and it’s almost impossible, I think, to anticipate the impact that that’s going to have.
Certainly, how to pay for all that increased utilization is a challenge and we read about that everyday in the paper, but we like to remind ourselves constantly that what's causing that challenge is that potential explosion in utilization. So we really see this as poised for tremendous growth in a market that’s going to look different for sure over the next several years than it’s looked in the past and our job at Teleflex is really to be prepared for that.
The other market driver is the rising standard of living in emerging markets. For us, our focus tends to be on China, the Asia RIM Pacific, thirdly Brazil, and then in fourth place in India. And as the middle-class is growing in those segments, so is the desire and the ability to pay for healthcare. The challenges in some of those markets are quite different.
In China, for example, you might be surprised to learn that the government doesn’t pay for healthcare. And it’s the individual patient who goes in and pays for healthcare. So as that population becomes wealthier, their ability to pay for more and more expensive care is also accelerating. And right now, it’s one of the fastest growth areas in the world, not just for us, but for just any medical device manufacturer.
As we look at some of the challenges in the healthcare market, certainly there is an increasingly stringent regulatory environment. We don’t necessarily see that as a threat; it’s barrier-of-entry; it makes many low cost providers in third all country shy away from the medical device segment and so its something that we need to deal with, but actually we’re start to benefit I think for larger companies.
There is an increasing demand for an increased quality of life, as people get older and again while that’s contributing to considerable pressure around rising cost, we think the net effect is going to be that this is going to be a growth industry.
When we look at the actual markets we serve it’s about a $10.3 billion market. In some of these areas we participate in only niches, surgeries are good example. There are some huge competitors there, Covidien and J&J just to name two. We intend to participate in that market in really much smaller areas where we tend to be the market leader and where there is not a really good competitive alternative.
The other, I think that has been true and will continue to be true about the healthcare device companies is, it is an area where product pipeline is absolutely important technology has made a huge difference in the standard of care over the last 20 years and I think we have every reason to believe that’s going to continue at an even accelerated rate in the future. And I also think that many of the cost pressures of that provider space can be handled through better technology and we’ve got a couple of examples in our portfolio right now that our improved medicine and in fact lower the cost of procedures to the healthcare provider.
In about the middle of 2010, as Teleflex was viewing the point of being a pure-play medical device company, we published some aspirational goals in terms of where we thought the company could go. And looking at other competitors in kind of same segments, we felt that it would be certainly reasonable to expect revenue growth of 5% or greater. Now that may or may not seem like an ambitious goal to you at the time, we had grown zero for the three prior years, so increasing our revenue to 5% seemed like a walk (inaudible) aspiration.
We also are looking around at our peers, felt that our gross margins were below where they should be and again set a five year goal to get our gross margins up to 55%. We were spending about 3% on R&D and most of that was actually going to remedial activities in response to some FDA concerns and so recognized the need to ramp our R&D spending to that 5% level and we are looking at generating operating margins of approximately 25% and the return of equity of approximately 15%. And as we get through the financials, I’ll give you a little bit of a scorecard in terms of where we are.
Recently, we have revised our upward revenue projections to that 6% or 7% number, because quite frankly, we’ve been able to increase our revenue more quickly than we thought we are going to and think that that 6% to 7% numbers are more attainable as a five year goal. I’ll give us some sort of benchmarks in terms of where we are, in terms of our gross margins. Some of that is coming from pricing, I will talk about that in a few minutes, some of it is coming from consolidation of facilities and some of it is coming from either divestiture or harvesting of low gross margin products.
We are on a five year plan to improve our research and development expense. This year it’s up to about a 3.5% and are on-track over the next several years to increase it about 0.5% a year to get to that 5% number. And our operating margins I’ll comment on a little bit later on the presentation, but we will improve our operating margins by about 100 basis points this year.
We have about $600 million in cash right now; about 84% of this is sitting overseas. Our plans for most of that capital really is in the area of strategic and technology acquisitions. We've been talking about the last year about the importance that late stage development acquisitions will play in our future.
When I came to Teleflex as a CEO last January, we did have somewhat of an anemic product pipeline. The current environment is actually very favorable to these kinds of acquisitions. There is a lot that's actually on the market right now, late stage technology companies are a little intimidated about trying to raise another round of capital and start their own sales forces. They are worried about the medical device tax. They are worried about all kinds of things which are quite favorable to acquirers like Teleflex.
Also in the realm of acquisitions, there is a couple of our franchises that do have some opportunities to acquire some companies where we really just boost our share into a number one position as a result of those acquisitions.
We are continuing to make internal investment in innovation and people; part of that ramp up is especially through in our R&D activities where we are adding people and acquiring companies and their R&D staff as well. We do have about $1 billion in debt right now and while it’s certainly possible we could use some of that cash to de-lever our debt. It’s not our number priority. I mentioned about 84% of it is overseas, so it would be somewhat costly to repatriate that cash and de-lever at their current timeframe. And we will continue our dividend policy pretty much as is. We're about 2.3%, 2.4% yield right now. We don't feel that it's necessary to increase the dividend on a quarterly basis. We think we're at the place where we need to be. So our plan is to hold that stable.
Talking specifically a little bit about a couple of the acquisitions, this is one of the things that we are increasingly optimistic about being a game changer. We acquired VasoNova January of 2011. Very basically what it is, it's a system that combines interpreting an ECG wave and a Doppler signal that helps the clinician very accurately position where a PIC catheter is in placement. One of our competitors, Bard, has a system somewhat older than this, only uses ECG wave interpretation, and therefore has some limitations.
We are very excited to acquire this company and have spent most of the first year refining the product and rolling it out on a selected basis for hospitals to try it. In the full year of 2011, we initiated approximately 60 to 80 trials by the end of the year. 21 of those had come to conclusion with the hospitals ready to make a decision. And 20 out of 21 decided to go with the VasoNova system. We began to ramp up our trial calendar moving into 2012. We're now starting approximately 30 trials per month.
We've already got those trials booked through June in terms of getting them started. And a majority of these have not closed. Obviously, it's anywhere from a four or an eight-month process for them to actually reach a conclusion. But the ones that have closed in the interim from last year, we're seeing that same kind of very high conversion rate. Why are hospitals shifting to this product? Because it's accurate in about 98% of the time and our closest competitors is accurate in about 60% of the cases.
And the big benefit of this, besides the clinical benefit, is you eliminate the need to get a confirmatory x-ray, which eliminates a $300 to $400 cost as well. So the more exposure we have to this product in the marketplace, I think the optimistic we have about two particular things. First of all, we're pretty comfortable that the targeting market per se is going to be a standalone market that it will separate itself and hospitals will chose which targeting system to use, apart from which PIC catheter that they're going to use.
And secondly, we just don't think that there's an achievable way, from a technology standpoint of view, to deliver the same results that the VasoNova system can deliver. So we're optimistic about that. At the end of first quarter, when we announced our first quarter earnings, we also announced two additional product acquisitions. The EZ-Blocker is a patented way to be able to isolate one lung for either a diagnostic or a therapeutic procedure.
There's no good way to do this, absent the EZ-Blocker. And even though it's relatively small market, in around the $30 million total global universe, what we really like about this is we believe that it's going to stand basically without a competitor, and stands a good chance of being able to capture most of that market because there's really not another available product that does the same thing that this does.
A little bit larger market is EFx family of laparoscopic fascial closure systems. Every time they do a laparoscopic surgery, they make a whole in you. That hole has to be sealed up. Right now, it's a very cumbersome process to actually seal that hole. And for some procedures, larger holes, where they can put multi-instruments through is becoming bigger. And the bigger the hole, the harder it is to seal up. This is an automatic way of really to seal that hole.
The device is inserted. There's some channels that allow you to put some sutures through. Then the device is pulled up and tied off. It saves a lot of time in the OR, and significantly reduces closure complications. This is about $200 million market. And again, what we really like about is it can be sold by our existing sales force, definite clinical advantage, saves the hospital some money on the procedure, and not really a good competitor out there.
So, a nice, niche kind of product for us to sell. This gives you, I think, a little bit of an idea in terms of where we are, in terms of new product introductions. The main point of this slide, I think, is to let you know that we are making new product introductions in basically every one of our single franchises.
Briefly on the area of financial review; in 2011, we closed at $1.528 billion. That was a 6.7% improvement in real revenue, 4.3% in constant currency. Made some improvements in our gross margin. We did make a ramp-up in our research and development expense, up 14%, some improvement in our operating profit and in our EPS. First quarter for us turned out to be a very strong quarter.
Our revenue on a real basis was up 9.5%, and on a constant currency basis, almost 11%. We did have the benefit of a couple extra shipping days; in fact, six extra shipping days in the first quarter. Take that out of the equation and we still had constant currency revenue growth in about that 5% to 6% range, which was slightly ahead of our plan.
Gross profit grew faster than our revenue. Research and development expenses also ramped up 4.7%. Operating profit, not quite as fast as our gross profit. We had some one-time hits actually to that line into our gross profit line. And EPS up 14.8%. We're -- again I think I'm relatively optimistic about Teleflex's future over the next five years because of our position, because of some of the immunity that we have had in our product positioning. And I'm excited about the future.
With that --
Couple of quick things just to start out. Just on that Q1 growth number, 11% constant currency, but you said six extra selling days.
Isn't that about a point and a half per day?
So the math doesn't play out well because we have distributors that order twice a month, no matter how many shipping days happen to be there. So it's somewhat more complicated. We've never been able to do it on a day-by-day basis. And we might have a month with 18 shipping days and a month with 22 shipping days, and the orders look about even. So there is an impact but you can't do it day-by-day.
Right, okay. And then, so your operating margin right now is -- your goal you said is 25%, and you're about maybe averaging where right now?
17%? So, can you just walk me through the pathway to get there? How long is it going to take? How much of that is low-hanging fruit versus maybe structural changes? Just outline the pathway, if you wouldn't mind.
So in the 17%, there was about 50 basis points that were what I would describe as one-time events in the first quarter that aren't repeatable. We've also got considerable headwinds in currency that's affecting operating profits this year, which are different than the underlying improvements that we're making in operating margins.
Looking forward, we initiated some price increases, and I know it's hard for people to believe you can get price increases in this environment. But we did and we are getting them. We had about 107 basis points of improvement in the first quarter as a result of selected price increases.
We expect that trend to continue in over the goal period to get somewhere between 250 and 300 basis points of improvement in price. We are also making some effort to improve our facilities, consolidating --
Sorry, are you just -- that's so different from what you hear from any other manufacturer. I'm just curious, have you been mispricing your products or what would allow you -- or you just feel like the innovation you're bringing in the market would allow you to drive price increases?
Yeah, so that price increase is not reflective of a new product. So it's not innovation-driven. The fact was Teleflex wasn't a very good pricer. Didn't have anything in its regimen to discipline itself every year to look at where price increases were. We agree it's a tough environment. There was about a third of our product line that had been so mispriced in the past that there was an opportunity to close that gap.
And that's really where that's coming from, and we're doing that over a three-year period. And while there was a lot of concern about whether or not those would stick, now we've had three quarters in a row where we've seen that number grow. So we certainly have a lot of confidence that we'll see that continue.
And if you achieve those goals, where would that put you in terms of pricing, relative to the competition you have in those specific areas where you're raising price?
Yeah, so at the end of the three-year period, there's still a gap. So -- yeah, it doesn't get us to parity. We tried to use some numbers that we felt were achievable without putting the business at risk. So we're not trying to close completely. We're just trying to mitigate the gap. And this is our own business. So it's not like a competitor is coming back and lowering their price to try and meet us. So it's playing out well. And all over the world, in Europe, in Asia, and in the U.S.; it's not singular to the U.S.
So of the 700 basis points that you hope to gain, pricing is 200 --
250 to 300.
There's about that much that comes from factory consolidations and consolidations of distribution facilities. And the balance of it really comes from some exiting some product lines that are very low, slow growth for us, and replacing them with higher margin products.
Great. Question from the audience?
You've mentioned for your capital allocation strategies, both reduction of debt, as well as acquisitions for a couple of them. Does that -- is it safe to assume then that the acquisitions you'll be looking at in the near-term will be cash-only transactions?
So it's safe to assume. And I apologize; I think while we're not opposed to reduction of debt, our current cash overseas would probably not make that our number one priority.
Thanks very much, everybody.