Teleflex Incorporated (TFX) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q4 2012 Teleflex Incorporated Earnings Conference Call. My name is Sheena, and I will be your operator today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. And now I'd like to turn the call over to Jake Elguicze, Treasurer and Vice President of Investor Relations. Please proceed, sir.

Thank you, operator, and good morning, everyone and welcome to the Teleflex Incorporated Fourth Quarter and Full Year 2012 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 10277897. 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 would like to now turn the call over to Benson.

Thanks, Jake, and good morning, everyone. On today's call, I'll begin with an overview of the results for the fourth quarter and full year and discuss some strategic highlights. Tom will then provide you with a more detailed review of our fourth quarter financial performance, including details of our product line and geographic revenue mix and then finally our outlook for 2013. So beginning with our financial highlights, building on the performance for the first 9 months of the year, 2012 ended with another strong quarter for Teleflex with revenues reaching $419 million. This represents an increase of 4% versus the prior-year quarter on an as reported basis, and when you exclude the impact of foreign currency fluctuations, sales increased by 5.1%. I want to remind you though that the fourth quarter 2012 had a negative impact resulting from fewer shipping days compared to the fourth quarter 2011. We estimate that our constant currency revenue growth would have been between 4% and 5% higher had it not been for those fewer shipping days. Turning to gross and adjusted operating margins, they were 47.5% and 15.16% -- 15.6%, respectively. This represents a year-over-year improvement of 50 basis points at the gross margin line, but a decline of 130 basis points at the operating margin line. And while Tom will go through the financial results in more detail, I want to add that the gross and operating margins in the quarter were impacted by investments we made associated with our new centralized North American distribution center as well as the write off of some inventory. Tom will provide more commentary on the causes of the inventory write-offs, but I want to emphasize that we do not anticipate similar levels of inventory scrap in the future. In addition to the items I just…

Thanks, Benson, and good morning, everyone. Revenues for the fourth quarter were $419 million, an increase of 4% on an as-reported basis. Adjusting for currency fluctuations, revenue grew 5.1%. The growth in constant currency revenue is largely due to the acquisition of LMA, which contributed approximately 6% of growth. In addition, price increases contributed another 1.3% of growth, and sales of recently introduced products contributed approximately 70 basis points of growth. Partially offsetting these gains were lower volumes associated with fewer shipping days in the fourth quarter of 2012 as compared to 2011. Turning to gross profit. Gross profit margin were $199.2 million and 47.5%, respectively. This compares to $189.8 million or 47.1% in the prior-year quarter. The increase in gross profit in the fourth quarter is primarily due to the acquisition of LMA, as well as selected price increases. And as Benson mentioned earlier, our gross profit and margin for the fourth quarter were impacted by the following items that we do not believe to be representative of our longer-term operating performance. First, we incurred some transition-related costs in connection with the consolidation of multiple U.S.-based distribution centers into one central location. We expect to incur similar cost through the first half of 2013 as we complete the transition. Afterwards, we look to realize spending efficiencies and expect the project to be breakeven for 2013 and about $4 million to $5 million accretive for 2014. Additionally, during the fourth quarter, we incurred higher than typical costs for product that was considered to be unsalable. The large portion of the costs is due to short shelf life issue in Asia, which is an outcome of inventory builds as we brought up the Asia distribution center. During the transition to the Asia distribution center, we chose to increase safety stock levels…

[Operator Instructions] Our first question is from David Lewis, Morgan Stanley.

Just a couple of quick financial questions. I guess the first on medical device tax, I think. Should we still assume the impact around $0.27? What we've heard so far to your earnings is based on inventory timing, some of the device tax has sort of been pushed or delayed. Just give us a sense of whether the device tax is going to be relatively ratable across the quarters. And is the magnitude still the same, or should that push out a little bit based on inventory timing?

Well, we think the magnitude is about the same as you referenced, about $0.25 for the year, and we expect that to be ratable throughout the year.

Okay. And then on your commentary on the first quarter was pretty much in line with our expectations. I guess, just thinking about some of the charges you talked about in the fourth quarter, has any of the impacts from the distribution change in the first quarter sort of pushed into the fourth, so we can see relatively less impacts in the first quarter? Or would you sort of call the fourth quarter and the first quarter roughly in line with the timing you had expected?

With respect to the North American distribution center, that's really progressing along as we have scheduled. So the costs that we'll incur in the first quarter are as expected, and the costs in the fourth quarter of the year were also as expected and included in the forecast and guidance we had provided.

Okay. And then Benson, maybe just an operational question. It sounds like LMA is tracking at or better than expectations. But if you think about 2013 and distributor changes that you may make as associated with LMA, what allotments, if any, have you made for sales disruption to the extent that you see it as you move forward with distribution changes?

So the general plan for synergy realization for 2013 lies primarily on the elimination of the LMA corporate offices and the integration of the U.S. sales teams. The plan for -- or the synergies coming from distribution absorption are largely related to expected synergies in 2014. So we're taking somewhat of a cautious approach in terms of the synergies coming from distributions for those very reasons. I would say we just had a presentation this week in terms of the progress that we're making there. And essentially, we're on schedule, but we are taking a slower approach to that than we are to the things that will have the biggest impact in 2013.

Our next question is from Matt Taylor, Barclays.

I guess the first question is, I'm just curious as you go forward here, certainly you're still getting nice pricing uplift over some of the smaller pricing uplifts you took last year, but wanted to know how you're thinking about next year as you start to lap the 100 basis points-plus pricing increases that you took this year. Are we going to see the same magnitude? Could it go up or down? And how should we think about that?

So for fourth quarter 2011, price amounted to 50 basis points. A year later, it was at 126 basis points above and beyond that point. And it really had more to do with the time that it takes from an announced price increase for it to filter its way through various contracts and -- so it takes about 6 months for that to happen at its full extent. At this point, I'll only reiterate that I think our -- the plans we presented publicly have about 1% price increase and we're -- from everything we're looking at, we're -- again, we're confident that we are most likely to see that as we move forward.

Great. And then another question just on volumes. We've heard some noise about the press volumes around the holidays and more recently. Have you seen any trends like that in your average daily sales volumes, specifically in Europe or any geographies more recently?

So fourth quarter for us, particularly the last month in the fourth quarter, probably came in slightly up. We largely attribute that to a strong flu season as opposed to any underlying trends in procedural rates.

Okay. What about more recently? Can you comment on what you've seen to date?

So I think things -- we -- really, we don't have any additional information that would lead us to believe that there's been any substantive change there. I'll reiterate that in our own particular product line, we tend not to be influenced as much by ups and downs in some of the procedural rates as other of our competitors. So I don't know that we're a good barometer for what's happening across the board in the marketplace. But generally speaking, other than some of the idiosyncrasies that Tom referred to with our OEM business and shipping days, we haven't seen anything to lead us in that direction.

Our next question is from Jonathan Palmer, CLSA. Jonathan J. Palmer - Credit Agricole Securities (USA) Inc., Research Division: I just wanted to come back to pricing for a moment here. If I take your comments around the timing and delay from when you initiated pricing increase to when it actually flows through, you guys initially guided 2012 around 50 to 75 basis points and obviously came in substantially higher. Given where things are in 2012, would you say the 100 basis points guidance for 2013 is conservative based on some of these delays?

So I would say that it represents our best guess in terms of what it's likely to be. As in most things, we try and err on the slightly conservative side than the more optimistic side. But I would say the range that we're looking at is relatively small within 9 -- I would say the range is between 90 basis points and 120 basis points. Jonathan J. Palmer - Credit Agricole Securities (USA) Inc., Research Division: That's very helpful. Then switching gears here, at the Analyst Day, you discussed that you're going to limit your commercial investments to high-growth geographies like China and Brazil. Can you just give us an update on how you finished 2012 and what the plans are for 2013 in those geographies?

So we finished 2012 as we expected in China. Brazil was lower than what our expectations were going into the year largely because of a customs strike in Brazil that did not allow the importation of our products for several months. That has been resolved, and our expectations for Brazil return to a more normalized healthy growth rate for 2013. And China continues to be on track and will be buoyed somewhat by LMA where we have, I think, aggressive growth expectations for that product line as well. Jonathan J. Palmer - Credit Agricole Securities (USA) Inc., Research Division: Great. And then one housekeeping question for Tom on the guidance. Can you give us a range on the intangible amortization expectations for 2013?

I may have to check in to give you a specific number on that, unless you...

Yes, I think for the adjusted add back, I believe, is somewhere around $0.82, I think, for the full year net of tax from an intangible standpoint.

Our next question is from Larry Keusch, Raymond James. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: Benson, I guess one of the big opportunities for margin expansion as you guys look forward is continued optimization of the manufacturing facilities and footprint. Obviously, you've made some small moves relative to moving some things over to the Czech Republic. But again, I'm just trying to think about the timing and how you're thinking about impact as you dig deeper into what seems to be a pretty large opportunity on the manufacturing front?

So in previous calls and at the Analyst Day, we suggested that the impact from some of those other manufacturing moves is likely to start to take -- have some impact to us in late 2014 and then certainly in 2015. At this point, about the only commentary I can make is we have a pretty well orchestrated plan that we are marching to and looks at optimization from a number of perspectives and risk of execution and likelihood of achievement are figure high in selecting the actual projects that we're undertaking. I think from a general perspective, we're comfortable with the range of improvement in gross margin that we have articulated earlier, which is somewhere between 250 and 350 basis points. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: Okay. So if we think about just sort of the cadence here of the margin expansion as you move over the course of the next several years, it sounds like obviously this year is masked by the medical device tax and some of the acquisition-related items. And then it sounds like what you're saying is the manufacturing will have a bigger impact as we move towards the end of '14 and into '15. So is it fair to sort of think about well obviously move up in the range that you talked about this year. You then will have, if you will, easier comps in the first half of '14, then we'd see the next leg up in operating expansion in the back half of '14 and into '15?

Overall, I think that's a pretty good estimate, Larry. We expect, and I think have already announced that we expect gross margin improvement this year to be in the 200 basis points range, and that holds true for the next couple of years after that. There is a bit of a lag between the time that shows up in operating margins, largely driven this year by the medical device tax and also by just some of the investments you have to make to get to those gross margin improvements. But your timing is about as we see it. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: Okay. Perfect. And then 2 other quick ones. I was hoping that you guys -- I know you provided the breakdown of the various items that impacted the gross margin, but I was wondering if you had any more quantification around exactly how much, sort of on a basis point level, how much that may have impacted margin? And also, you made a comment that IABP units were a bit softer in the quarter, just any thoughts around that.

So the general capital acquisition market globally for capital equipment is soft, and that is what we would attribute the biggest driver to in terms of balloon pumps. We did see above expected rates in our actual balloon sales, so we do not attribute that to any change in practice in the use of intra-aortic balloons as part of clinical procedures. I think it's just a matter of timing and capital equipment and may be influenced also by some changes in pump design that have to be available on the market by the mid part of 2014, I think it is. And that may be delaying some institution's purchase of equipment until some of those adjustments are made. I'll turn it over to Tom to answer in a bit more detail about inventory write-offs.

So for the quarter, for the fourth quarter, reported gross margins were in the 47.5% range. And to give you some perspective on how these different items impacted the margins, the investment we made in the distribution center is about 40 basis points for the quarter. We had about 10 basis points associated with the start up of one of our acquired businesses, largely associated with ramping up manufacturing and the typical scrap and other matters associated with just getting the manufacturing up and running. And then the biggest cost was associated with the unsalable product. As mentioned, the majority of that was largely associated with the Asian distribution center. But that was kind of in the 60 to 80 basis points of impact for the quarter.

Our next question is from Anthony Petrone, Jefferies Group. Our next question is from Richard Newitter, Leerink Swann.

Just -- I wasn't sure if I -- I might have missed it. Did you give the breakdown for price by region for the fourth quarter? I know you gave it for the full year.

No, we just gave it for the full year.

Is there any chance we can have it for the fourth quarter?

We don't have that...

Just give me a second here, Rich, and I'll find it for you.

And maybe, Jake, while you're looking for that, on pricing regionally, can you maybe just talk -- are there any particular regions where you feel incrementally better or worse, or where you see the pricing environment getting more challenging? Where do you kind of see the price as most -- your ability to take price easiest and where is it maybe at the margin a little bit tougher as we look into '13?

So right now, Asia is the easiest place for us to take price, and I think one of the areas where we were simply well underpriced across the board. Europe because it's largely a tender market and also because of just the economic circumstances in Europe is more difficult. That's been reflective of the differences in price improvements throughout the year, and it's our expectation that that's going to be quite similar in 2013.

Okay. That's helpful. And as we actually go -- to VasoNova, I think in the past you've kind of given a little bit more color around how you've done in competitive accounts or trialing accounts. Do you have any updates there relative to your competitor's product and how that's trending?

So we continue to see a very good acceptance of the VasoNova technology in the major accounts that we are targeting. Our experience is, is that the longer the evaluation goes on, the more likely the account is to convert over to the product. We are continuing to see good pull-through from accounts that then migrate over to our PICC product line. That has been enhanced considerably by the availability of a preloaded PICC with the Stylet in it. And we have just released what I'll say is our top-of-the-line product in that area, which is the antimicrobial, antithrombogenic PICC that was just released and comes preloaded now with the Stylet. So our optimism about that product's long-term success remains high.

Okay. And then just maybe lastly, on the share count, I understand that the convert has certain triggers for dilution. Can -- did you guys give a share count, a specific share count number in your guidance?

I'm not certain that we specifically did. But I think that, obviously, you've got to give some thought to how the converts may play out. We'd assume share count for the year would be in the range of 42 5 probably will be a fair estimate for that. And obviously, if the share price were to move up markedly from where it is today, that number could go up.

And it's fair to assume that when you originally provided your guidance back in December for 2013, that you're probably -- your share count assumption was a tiny bit lower in your preliminary projections?

I think that the balance of Tom's comments were that overall, our expected share price was a little lower. Our expectation also of the euro was a little lower, and those are balancing each other out.

Okay. So they largely offset. And Jake, do you have the update on the pricing by region by any chance?

No, I think I can probably relate [ph] that pricing pretty closely. And so for the quarter, pricing was up 126 basis points, and that breaks down about 125 points for North America; Asia was up about 330, Latin America, about 370; and then EMEA, about 30 basis points.

Not markedly different from the full year.

Our next question is from Anthony Petrone, Jefferies Group. Anthony Petrone - Jefferies & Company, Inc., Research Division: Just kind of go back to gross margin for a second, Tom, and just to get an idea of what the contribution from LMA was in the quarter and sort of how that plays out in the first quarter. It sounds like the -- some of the start-up manufacturing excess costs will go away, and perhaps you won't have the inventory write-downs but you will have some of the distribution headwind. So once we get a full quarter of LMA in there, I'm wondering how all of those moving parts play out at the gross margin level.

Sure. Well, as we think about 2013, there's really 3 different major areas that we're looking towards for driving gross margin. And the first would be similar to 2012, we're going to drive some margin associated with the pricing we discussed through mix and through new product introductions. And so we look for that to be a fairly substantial piece. And we've also got cost improvement programs, which would include such actions as the closure of our Mount Holly facility. We've got investments in automation in Malaysia. We've got products to in-source, some products for our OEM businesses. So a number of cost improvement programs in addition to the assumption that a lot of the costs that I mentioned in the fourth quarter related to the excess in obsolete inventory we put behind us. And then we also will pick up a benefit from LMA. So the fact that LMA and some of the smaller strategic acquisitions will be generating revenue at higher than average margins, that will help us. And if I were to think about the breakdown, it's about 40% from the price mix new products, 40% from cost improvement programs and 20% of the improvement comes from LMA. Anthony Petrone - Jefferies & Company, Inc., Research Division: So is it safe to say that nearly all of the benefit in 4Q is offset by these issues basically? LMA's benefit is not -- it was basically offset in the quarter?

Yes. So that's probably a fair way to look at it. Anthony Petrone - Jefferies & Company, Inc., Research Division: Okay. And then a few more for you, Tom, just one on the exposure in Japan. The Japanese yen has been under pressure here. I'm wondering what that exposure is. And then going back to the share count as well, I'm just trying to get a sense of the convertible hedge portion of the structure there. It's my understanding that there's warrants that were issued there that are in the money. But I also believe the company has the option to purchase back those warrants for their excess cash value. I'm just wondering what the approach will be there. If there's any guidance there, that will be helpful.

Sure. Well, the warrants do come into the money at around $74 a share. And so those are creating some additional dilution as the share price is above and beyond $74 range. Our intention right now is to leave both the warrants and the call which -- essentially, there's a call out there that offsets the dilution associated with the incremental shares from the convert, our intent right now is to leave both the warrants and the call outstanding. I think...

Then Anthony, I think you had a question about Japan. Anthony Petrone - Jefferies & Company, Inc., Research Division: Yes, Japanese yen exposure, just given the pressure in that currency, sort of how that plays out this year.

Yes, so when we look at the Japanese yen, that business isn't a significant part of our total company's revenues. It's about 3%. So we don't see that as being a significant issue, plus or minus. The area that obviously we're more concerned or watch more closely is what's happening with the dollar euro. As we started out the year and for planning purposes, we assumed a rate assumption of about 126. We saw that exchange rate trend up close to 136. It's now retrenched quite a bit in the last 2 days, just under 132. So I think that from our perspective, we watch the euro U.S. dollar exchange rate much more closely than yen.

[Operator Instructions] Our next question is from Chris Cooley from Stephens.

Could you all explain a little bit more about what -- or maybe how to phrase this, maybe put a little bit more color around products that you're looking for to provide that 1% to 1.5% growth product front. Just seems like that's, I realize, conservative, but conservative look considering that you added about a little over 100 basis points to growth this past year from new products. You're building momentum there, and you clearly have a pipeline that you've discussed in the past and then again more recently at the Investor Day. So just appreciate some color around what you're expecting to contribute to kind of sum up that 1 to 150 basis points of growth from new products. And I have one quick follow-up.

So as you know, we have a very diverse product offering. And during the Analyst Day, we presented a chart that showed, really, a number of new products that we introduce. So that number is not as dependent on a single product offering. That being said, we certainly expect -- if I had to single out 3 of the bigger components in it, it would be sales related to the VPS system, the PICC sales that we expect to generate as a result of customers converting to the VasoNova system, the EFx product line that we launched in the fall of this year continues to do really well and is gaining good acceptance. So those 3 products probably are 3 that have the biggest weight. But there's another 10 products that are also into that mix that are also making a contribution.

Super. And I apologize if you covered this earlier. I juggled a couple of calls here this morning. But on the share count, as we look forward in the back half of the year, I believe there was about additional 4.2 million shares over the convert at 74 65 before you put the collar in place, about 1% dilution for every roughly $5 incremental over that, if I remember doing the math right. Have you all articulated new thoughts as it pertains to the convert and the structure there? Am I thinking about that in the right framework as I think about the increase that's implied now on the share count?

Well, could you just kind of restate the numbers that you were assuming? We weren't able to hear quite clearly. Want to make sure we're hearing what you had cited.

Sure. Just going back thinking -- looking at my notes here, I believe the original convert was at 74 65. And then I believe the depreciation over that is about 1% dilution for every $5 incremental step-up in price over that, if I remember the way the math works correctly, up to about additional 4.2 million shares. So I just wanted to look back at that math and also, if you've rethought or have any new thoughts on how you would handle not only the convert, but also the collar that you put on there -- or the call, I should say, that you put on in conjunction with that?

Well, just looking at the accounting dilution, which differ somewhat from the economic dilution in that there are 3 different dilutive or anti-dilutive instruments out there. One is the convert, the other is the call and the other are the warrants. From an accounting perspective, we do not get the benefit of the call, which essentially was structured to offset the dilution from the convert, from an economic standpoint, because that instrument is anti-dilutive, so excluded from the accounting calculation. So let's right now focus on the accounting impact. In about $75 per share, that dilution will be right about 1.2 million shares. If, in fact, the share price were to trend up to $85, the dilution would be built from 1.2 million to about 2.6 million shares. I don't think we get quite up to that point of the 4 million that you had cited unless the share price is $100 or more. So as we're thinking about this, right now we've taken a look at the economics of the convert, and it's trading at a pretty hefty premium in the marketplace. It'll be quite expensive to bring back in. So for right now, we intended to keep the convert outstanding.

[Operator Instructions] We have no further questions at this time. I would now like to turn the call over to Mr. Elguicze for closing remarks.

Thank you, operator, and thanks to everyone that joined us for the call this morning. This concludes the Teleflex Incorporated Fourth Quarter and Full Year 2012 Earnings Conference Call. Have a good day.

Thank you for joining today's conference. This concludes your presentation. You may now disconnect. Good day.