Teleflex Incorporated (TFX) Q1 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2013 Teleflex Incorporated Earnings Conference Call. My name is Angela, and I'll be your operator today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would now 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 First Quarter 2013 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 82225144. 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 pre-prepared remarks and then we'll open up the call to questions. Before we begin, I'd like to remind you that some of the matters discussed in the conference call will contain forward-looking statements regarding future events as outlined on Slide 4. We wish to caution you that such statements are in fact forward-looking in nature and are subject to risks and uncertainties, and actual events or results may differ materially. The factors that could cause actual results or events to differ materially include, but are not limited to, factors made in our press release today, as well as our filing with the SEC, including our Form 10-K, which can be accessed on our website. With that, I'd like to now turn the call over to Benson.

Thanks, Jake, and good morning, everyone. On today's call, I'll begin with an overview of the results for the first quarter and discuss some strategic highlights. Tom will then provide you with a more detailed review of our 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 upon the momentum generated over the last 2 years, the first quarter of 2013 was another very solid quarter for Teleflex with revenues reaching approximately $412 million. This represents an increase of 8.2% versus the prior year quarter on both an as reported and constant currency basis. When adjusting for the impact of 2 fewer shipping days we had this quarter, our constant currency revenue growth would've been even higher, totaling approximately 10.5% increase. Turning to adjusted gross and operating margins, they were 48.8% and 14.7%, respectively. This represents a year-over-year improvement of 44 basis points at the gross margin line, but a decline of 119 basis points at the operating margin line. Year-over-year gross margin improvement was primarily due to the mix benefit of higher margin LMA product sales, as well as the continued benefit we're seeing from price increases. And while in line with our internal expectations, the decline in year-over-year adjusted operating margin was due to the inclusion of the medical device excise tax and expenses associated with businesses that were acquired after the first quarter of 2012 that were not in our prior year results. I'm pleased to say that despite operating in what is a more difficult macro environment, as well as dealing with headwinds, such as 2 fewer shipping days, the medical device excise tax and the impact of our convertible notes on our weighted average shares calculation due to…

Thanks, Benson, and good morning, everyone. Revenues for the first quarter were $411.9 million. This represents an increase of 8.2% on both an as reported and constant currency basis versus the first quarter of 2012. The growth in constant currency revenue is largely due to the acquisition of LMA, which contributed approximately 8.8% growth. In addition, the sales of recently introduced products added approximately 113 basis points of growth, while price increases contributed another 55 basis points of growth. Partially offsetting these gains were lower volumes associated with 2 fewer shipping days in the first quarter of 2013 as compared to 2012. Turning to gross profit. Adjusted gross profit and margin were $201.1 million and 48.8%, respectively. This compares to $184.1 million and 48.4% in the prior year quarter. And as Benson mentioned in his opening remarks, the increase in gross profit and margin in the first quarter is primarily due to the acquisition of LMA, as well as selective price increases. Let's now move to a discussion of operating margins. For the first quarter of 2013, adjusted operating margins were 14.7%. This represents a decrease of 119 basis points versus the prior year quarter. The decline in adjusted operating margin can largely be attributed to medical device excise tax and additional amortization and operating expenses associated with the late-stage technology acquisitions, which were completed after the first quarter of 2012. If we were to exclude these costs, the adjusted operating margin would've been approximately 16.7%. Turning now to taxes. The GAAP tax rate for the first quarter of 2013 was 21.7%. Included in the quarterly rate were a discrete tax benefit related to the reinstatement of the R&D tax credit due to the improvement in rate as a result of mix. However, on a non-GAAP basis, the tax rate…

[Operator Instructions] Please standby for your first question, which comes from the line of Larry Keusch from Raymond James. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: I guess, Benson, first question is on price. Obviously, the 55 basis points was below what you're trending last year, I recognize that. You are now obviously anniversary-ing a bunch of the price increases, but how was that relative to your expectations in the quarter? And if it was different, what may have changed and how should we think about that going forward? I know you indicated that you expect it to step up some, but just some color on why that would happen and where we should be thinking about it for the year?

So we began to see some more competitive pricing show up on European tenders and we gave our European managers the flexibility to be able to respond to that. So I think our overarching goal with pricing, not just this year but really for the next several years, is to push our pricing to the extent that we can without putting volume at risk. And -- so we wanted to be responsive to some of those tenders that were coming in, in Europe. The second area, which also had an impact on it was we were in the midst of a changeover of our general manager in Japan. We had a significant price increase scheduled on the calendar for Japan, didn't want to go through that without a manager -- without the new manager in place there. So we expect to move forward on that. And our current expectations that we'll see -- we'll see some improvement in our overall pricing through the balance of the year. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: And do you -- any sense of, I know internally you do, but externally, can you give us any sense of where you think it can be for the year?

Yes, so I -- we started off this year in the expectation of about 100 basis points. We think that's going to be a little bit more difficult to get to because of the situation in Europe right now. So I think we expect somewhere in the 70-basis-point range right now from what we can tell. But again, our key goal here is to be -- is to continue to be competitive in the marketplace as well. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: Yes, understood. Okay. And then 2 other just quick ones. Number one, can you give us a feel for the organic growth when you try to adjust for the days? And then, I think if I got this right, the free cash flow looked like there wasn't a whole lot this quarter, just it looked like working capital was up in the quarter. And so, any thoughts around how should we think about free cash flow generation for the year?

I'll let Tom take care of that question first, then I'll get back to you on the revenue number.

Yes, you are correct. In the first quarter, free cash flow was a little bit lower than we've seen in the past and that's in part due to working capital, most notably inventories. We had mentioned that we are in the process of rolling out an SAP project to some sites and we're building up some inventories, just a safety stock in connection with that. So on a full year basis, we don't anticipate that inventories will be up markedly, other than the addition of bringing, obviously, the LMA business into ours. So we'd expect free cash flow on a full year basis to be relatively comparable to what we had the last year and up slightly given a little larger revenue base.

So getting into the revenue projections, as I mentioned in my remarks, just accounting for the extra 2 days would have brought both our constant currency and as reported revenue up above that 10.5% number. There was just a series of onetime events that contributed probably to another 50 basis points. So I think that the run rate for our revenue, taking those things out of -- putting it into context, would be in about that 11% number, which from our perspective, put us where we felt we needed to be first quarter. I would remind you that we were of the opinion that the first half of this year was going to be a little bit less favorable comparisons than the second half. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: Does that imply that organic growth, when I remove LMA, specifically, was sort of in the low-single-digit range, is that fair?

Yes.

Next question comes from David Lewis from Morgan Stanley.

A couple of [indiscernible] questions here. I guess, just first going back to last quarter in some of the detail you've provided, you sound, Benson, that LMA was ahead of schedule. I think last quarter, you tried to quantify what you think the relative earnings accretion was for LMA. Can you just kind of reset us again through where you first stated you thought LMA accretion could be, which I think was $0.31 to $0.37? And in terms of what you saw in the fourth quarter versus the first quarter impact and what you think -- or how LMA is trending versus that range?

Yes. So we -- I think the numbers that we used and have been -- consistent around have been $0.35 to $0.40 accretion this year. I would say that we feel quite comfortable that those numbers are going to be attained. There are some puts and takes in some other parts of the P&L that would lead us to probably kind of keep that expectation corralled in around that range still. Most of the things that have been happening up to this point that are ahead of schedule actually affect moving forward some of the accretion in 2015 into 2014. So we would expect to see most of the accretion that we had been planning in 2015 to roll into 2014. So instead of $0.15 in 2014, we think it's going to be closer $0.30 in 2014 and that's where the biggest sort of ahead of schedule kind of comments really apply as opposed to this year.

And just to connect kind of the $0.31 to $0.37, David, you had referenced versus the $0.35 to $0.40 that Benson did, we had assumed there were $0.03 to $0.04 that we're going to get in 2012 associated with the acquisition. And so the $0.31 to $0.37 that you referenced would be the incremental this year, and the $0.35 to $0.40 would be that in total.

Yes, understood. And Benson, the commentary in the call here, maybe you can just talk to us a little bit the back half of the year outlook in 2 specific buckets. One, margins that you had been very explicit, this is probably going to be the toughest margin quarter of the year. Maybe Tom can talk to us about margin rends throughout the balance of the year and the drivers of that improvement. And specifically as it relates to organic growth trends, factors we should be considering. It sounds like price will get better across the quarters with Japan. But specifically on organic growth, is it just a series of comp adjustments throughout the back of the year that get you more comfortable with growth improvement or other dynamics we may be using? So just your thoughts in organic growth and maybe Tom's thoughts on margin progression?

So addressing the organic growth numbers, again without trying to get too much into the weeds, there were a number of kind of unique situations first quarter. For instance, in OEM sales we actually had a decline of 1% in revenue versus the typical 3% to 5% revenue growth. A lot of that had to do with a paybacks back quarter last year, which elevated their sales growth for the first half of the year as they were responding to that back order, which shows up as an unfavorable comparison this year to last year. And without trying to go through all of those, there's sort of 5 or 6 things that fall into that kind of bucket that have a more negative effect and aren't likely to persist. There has been a fair amount of conversation about decreased utilization. And again, I think, this affects us less than other competitors, but where that happened in the first quarter was a relatively precipitous decline in physician calls. And our experience here is that, that does tend to have an immediate impact and then usually, what happens is there is an increase in acuity 3 to 6 months down the road. It's an area we're watching pretty closely, but we would expect to see that mitigate quite a bit by the end of the year. There's only a certain amount you can postpone the kind of conditions where most of our products are used in. We also will continue new product launches throughout the balance of the year. And again, expect some modest improvements in pricing. But I would say on that point, we are moving very aggressively into longer-term gross margin improvements that are not revenue dependent and are not pricing dependent. I think we're taking a pretty conservative view of the market. And overall, aren't anticipating an uptick in the macro conditions to get the improvement we're trying to get.

So just a little bit on margins. So for the first quarter, gross margin came in -- or adjusted gross margin came in at 48.8%. A couple things that you want to understand in those numbers. First of all, we talked about some of the investment we're making to consolidate facilities. So in the first quarter, we had some expenses associated with the consolidation of our North American Distribution Centers. We're essentially consolidating 3 distribution centers into 1, as well as consolidating the LMA distribution center into that 1. And we're largely completed or pretty much completed through 3 of the 4 initiatives. We expect to wrap that up in kind of the early Q3 timeframe. So there's an expense this quarter, we expect that to turn accretive in the back half of the year. In addition, we also had some expenses associated with the consolidation of a distribution center in Europe and the exit of a warehouse in Asia. So some cost that we incurred in the first quarter that we don't expect to reoccur back half of the year. And also, we expect that North American Distribution Center will turn accretive in the back half. We also had some unfavorable performance in the first quarter from a manufacturing perspective that was -- that actually occurred in the fourth quarter and rolled out in the inventory in the first quarter. We don't expect that to continue in the second. Based on what we saw, manufacturing performance was pretty good in Q1 and don't expect to have some unfavorable variances rolling out in the second quarter related to that which we again saw in Q1. In addition, some additional drivers to the back half that will help us increase margins. We will continue to put cost-improvement programs into place that will help drive cost out. We also have generally a higher level of revenues in the second and third quarter, and even higher level in the fourth quarter, which will help us further leverage our fixed overhead cost. And then we're also projecting some more positive mix in the back half of the year as a result of some stronger growth in some higher margin regions and businesses. So as we look at the margin throughout the year, we expect it to continue to build quarter after quarter throughout the year and still get to our kind of gross margin to target of 50% to 51% on a full year basis.

Next question comes from the line of Matt Taylor from Barclays.

So I wanted to just ask about the guidance. You talked about keeping guidance the same in -- just modestly lower pricing, is there any other change in assumptions with regard to either LMA, new products or volume growth?

With regard to guidance, we really are staying in the same reach in terms of volume growth. Pricing, as mentioned, is a little bit softer than what was initially expected, although not markedly. Offsetting that, we've got a little bit better performance in execution on LMA through the first quarter. We also are doing a nice job in managing our operating expenses. And so, those are the real drivers of kind of the pluses and minuses, if you will, to help offset some of the downside from issues such as the dilution for the convert and obviously the lesser pricing.

Okay. And just to be clear in terms of your 3-year outlook, do you -- does the change in pricing this quarter change how you think pricing trends will occur next year at all or this is just more of a one-time thing?

Yes. So that's -- I would say the answer to that, Matt, we don't necessarily see this as a linear progression. There are different kinds of opportunities that present themselves to us and a lot of these have to do with our pushing margins in some of the areas where we still use distributors. So because it's a 55% this quarter doesn't necessarily mean we're projecting it to stay at that level as we look over the next couple of years. But I would say, it would take a fairly significant change in our pricing assumptions to start to have much of an impact of what we expect to be our overall gross margin improvements over the next 3 years. And those gross margin improvements will start to provide, I think, more clarity as the year rolls out. But we now start to get into the phase where they are less revenue-dependent, they're less pricing-dependent, and really just a matter of execution in terms of our consolidation of our manufacturing footprint.

Next question comes from Jonathan Palmer from CLSA. Jonathan J. Palmer - Credit Agricole Securities (USA) Inc., Research Division: Tom, you mentioned in the prepared remarks the increased share count, is there an explicit number that we should be modeling here or a range?

Well, let me give you our thoughts on how to approach that. Obviously, the share count will change depending on the stock price. And what we've attempted to do is to provide, in our 10-K filing, a pretty comprehensive disclosure of how the share count will change based on the stock price given, the warrants and the convertible notes. And so as a suggestion, one approach might be to think about, you're thinking about price targets for the year. You could then tie that into the share dilution that we've provided in the 10-K filing. So you could use that as a basis for establishing your share count dilution. Jonathan J. Palmer - Credit Agricole Securities (USA) Inc., Research Division: All right. And then, Benson, with one quarter behind you here and some puts and takes in the first half with a ramp in the margin in the second, what are some of the headwind that would conceivably take you through the bottom of your guidance range for the year?

So, I think the -- probably the geography that we continue to monitor most closely is Europe. I think it's fair to say that the economic situation in Europe does not appear to be getting any better during the course of the year, so we have, I think, somewhat scaled down our pricing expectations in Europe. Other aspects of our business in Europe are actually doing quite well. So that's probably the area where we're just are monitoring it quite closely. We believe that we -- if there was some good news in this, it's that the apparent downfall in the utilization rates have, even though we think we have got some immunity from that, have cost us to take a very, very close look at our spending and planned spending for the balance of the year. So we think we have some pretty good visibility in terms of how we would adjust our operations based on if the market turns out to be more conservative than we think we're going to be. So I guess the short answer is probably Europe is the biggest area where we have some concern about continuing volatility there. We think we've got a pretty good understanding, we've got good European managers on the ground. But it remains an area for us that we have, I think, are watching more closely than other places.

Next question comes from Anthony Petrone from Jefferies Group. Anthony Petrone - Jefferies & Company, Inc., Research Division: I have a question on R&D in the quarter. Actually, it seemed a little bit light versus our model. And we know you have a number of late stage acquisitions, R&D programs that are going on among Semprus, Hotspur, et cetera. Can you elaborate -- have some of those projects reached a level of maturity? Or do the company elect to actually slow some of those investments in the queue? And I have a couple of follow-ups.

So I think that's just an ongoing prioritization basis which projects make the most sense for us to continue. We don't expect significant revenue contributions out of Semprus or out of Hotspur until mid-2014. We are continuing to spend on both those projects as per plan. The -- some of the shortfall in spending really came out of some internal R&D projects that, for a variety of reasons, became lower priorities for us. Anthony Petrone - Jefferies & Company, Inc., Research Division: That's helpful. If we move over to Cardiac, you mentioned weakness in intra-aortic balloon pump volumes. There was some chatter about weak PCI volumes in the quarter from some of your competitors. I'm just wondering how much was related to slower overall PCI volumes versus perhaps competitive share losses?

So we don't attribute any of our slowdown to competitive share losses. There's a couple of different things going on here. There's relatively slow capital markets in the U.S. and in Europe, accompanied by relatively risk capital markets in China for the pumps themselves. It appears that the Shock II trial has had an impact on balloon utilization in Germany. So far, it's largely contained to Germany. The results of that trial were more negative than most people's expectation about the effect of the use of balloons. There's a lot of questions about whether the control group was a good representation. But so far, Germany has been the only noticeable place that seems to have been -- seems to have changed their practice or utilization of balloons as a result of that study. So there's a couple things going on there, but I'm, at least, not aware that we've lost any pump accounts or lost any balloon accounts to competitive activity that would've been the reason for the comparative slow down. Anthony Petrone - Jefferies & Company, Inc., Research Division: That's very helpful. And the last one for me, and I'll jump back in, is can you just give an update, Benson, on the capital allocation policy? Is M&A still on top of the list or do you envision maybe allocating more capital to offset dilution from the convert? And then maybe just a touch on where you stand on debt service.

So there's -- I would say that generally speaking, this year our capital allocation thinking is quite similar to what it was last year. You could expect to see some continued efforts in acquisitions this year in the late-stage technology area, primarily. We are continuing to look at the best way to manage and deal with dilution issue. The big complication there I think from our perspective is that if the end result is much different than the -- how we're reporting it on the quarter and we're trying to understand how we could do a better job explaining that.

Anthony, I think the other important thing is really, going back to Benson and Tom remarks that LMA and overall OpEx cost control is not associated even with R&D but just in the SG&A line, is really also helping to mitigate the impact of the additional weighted average shares from the convert.

[Operator Instructions] The next question comes from Chris Cooley from Stephens.

Benson and Tom, could you just maybe walk us through some of the expectations you have that pertains to organic growth in the back half? And specifically, what I'm trying to get at here is looks like you have some secular things that are dragging down a number of your businesses. So if we think about that organic growth, obviously x LMA, what should we be focused on to give us confidence that you can see an acceleration from low single digits in the back half of the year, especially when we see depressed volumes in the U.S.? And I just got one follow-up after that.

So that's -- so the most direct way that I can answer that is we've tried to filter through what first quarter would've looked like without some of these extraneous events and without the 2 days -- loss of shipping days, and have factored that into our reforecasting of the -- of what the balance of the year looks like. And I think across most of our product lines, we're relatively comfortable that the forecast that have been resubmitted are quite in line with what we see as sort of an average daily order rate moving forward. There are a couple of areas that are dependent on improvements in the vascular business, in particular. We expect to see continued growth in the PICC line and in the VPS number. We expect the JACC product to start to take off as a product line for us. So there, I would say, if you ask me to quantify the biggest risk, it really had to do with the acceptance of some of the new products that we're introducing during the course of the year versus concern about the underlying kind of market utilization rates. And again, I don't want to say we're completely immune from it, but we do not see that, that had been a big factor in our first quarter results.

Okay super. And then similarly, I think you mentioned early on -- I can see back at my notes, able to have cost in the quarter that were I think approximately $1.2 million as it -- that pertains to North American distribution consolidation efforts. When we think about those cost continuing into the early part of the third calendar quarter, is that the number that we should be kind of assuming in terms of the weight versus the P&L here in the second quarter? Or does that number bigger, smaller? Just trying to think about taking that as it winds down.

Yes. Right now, that represents the cost of operating duplicate centers until we're out of that. And our expectation is we're out of that early in the third quarter. So most of those costs should disappear.

Yes. So, I mean, in terms of order of magnitude, just quite think that as we move to the second quarter and you continue to have cost about at the same level as we saw in the first quarter, perhaps a little bit less. As we then go kind of into full operations in the third quarter, we expect to be at the kind of a breakeven point, and then accretive in the fourth quarter is how you should think about this cost.

[Operator Instructions] We've got a question from Jim Sidoti from Sidoti & Company. James Sidoti - Sidoti & Company, LLC: I just want to confirm, the medical device tax, that was put in the SG&A line, correct?

Correct.

Yes. James Sidoti - Sidoti & Company, LLC: And then on -- the approval for the new VasoNova system, what's the strategy for rolling that out? Do you go back to your existing customers and upgrade them? And what you do with the previous generation unit? Or will you market it more towards new users?

So there's a mix of answers to that question. Some of the accounts that have recently converted have -- we're encouraged to convert early with the expectation that they would get some assistance in moving to the new -- into the new pump. Our general expectation is we'll not do that across the board, it depends really on the discussion with individual account from a -- purely from a functional standpoint that there's -- that the existing units in the field work well. To a certain extent, we'd like to get some of those back out of hospitals because they actually work well in a trial situation as they're just testing out the general technology. So there's a little bit of a mixed answer to that based on the circumstances that have been discussed with accounts as they've been converting. James Sidoti - Sidoti & Company, LLC: Okay. And then, some of the other companies in your space that have reported have been attributing a little bit of slowdown to the timing of the Easter during the quarter. Do think that affected your business at all?

We looked at that, and the answer, we came back, it was no. I mean, the biggest single factor for us was just the 2 less shipping days. I think you can make an argument that the fact that the last day of the month fell on a holiday had some negative influence. But when we looked at order patterns the first couple of days of April, we didn't see that as a big factor.

[Operator Instructions] We have no questions at this time. I'd now like to hand the call back to Jake for closing remarks.

Thank you, operator. And thanks to everyone that joined us for the call today. This concludes the Teleflex Incorporated First Quarter 2013 Earnings Conference Call. Have a nice day.

Thank you. Ladies and gentlemen, that concludes your call for today, you may now disconnect. Thank you for joining and have a good day.