Teleflex Incorporated (TFX) Earnings Call Transcript & Summary

Well, good afternoon, everyone, and welcome to Morgan Stanley Healthcare Conference 2020. This is David Lewis, medical device analyst at Morgan Stanley. And this is a nice audio break for our first audio call here of the conference. And you're probably sick and tired of seeing my face, so maybe that's a good thing. But it's my pleasure to have with us here this afternoon, Teleflex and 2 members of management, Liam Kelly, Chairman, President and CEO; and Tom Powell, CFO. And Liam has kindly offered to dispense the preamble. So we're going to jump straight into Q&A.

And Liam, I want to start kind of with recovery here a little bit. I mean the theme of this conference has been improving recovery in the back half of the year, and we've heard kind of month-over-month positive trends from many companies so far in kind of procedural-oriented medical devices. How have your kind of month-over-month trends been here since the quarter?

Yes. So obviously, we hit the low point in the second quarter. We had a decline of about 12% in the quarter. I will say, though, that I was quite encouraged that if you excluded COVID from that performance, our underlying performance was a positive growth of about 8%. So we feel pretty good about our underlying business and the way we're performing. As we went into July -- we began to see notable modest improvement as we went into July. And now our expectation is that if you look at Q2 as the jump-off, we would expect significant sequential improvement as you go from Q2 into Q3. I don't want to mislead the investment community. We will still be negative in Q3, but notwithstanding that, we'll see significant improvement. And then our thinking is that moving from Q3 to Q4, we will again see sequential improvement into -- from Q3 to Q4. Now all of this has a few caveats in it. The expectation is that we won't get another major shutdown due to a second wave of COVID. The expectation is that COVID would be well managed through the back half of the year. And the expectation is that from where we are today in Q3, we will begin to see procedural volumes continue to come back and see a higher throughput of patients through the hospital system in the fourth quarter as compared to the third quarter. And if I was -- if you were asking me these questions in May, when do we get back to pre-COVID levels, David? I would have said, we can get back to pre-COVID levels in Q4. I'm probably thinking now that it's probably early in 2021. But if procedure volumes do ramp faster in Q4 than I'm expecting, then we have the potential to get back to pre-COVID levels in Q4. So a lot of variables, but that's how we're seeing it as we sit here today.

Okay. Totally understand. So I think prior to today, we definitely expected something that was sort of flat to negative for the third and a little bit of growth from the fourth, and you're kind of sticking with that. But then, one, maybe slight dynamic as just this dynamic of full recovery in the first quarter versus the fourth quarter. Now Liam, is that because of something that you're seeing either in the broader U.S. recovery landscape or something specific to NeoTract? Or is it just like, yes, as you take a look at where people settle out here for the fourth quarter, I noticed that the Street is sort of 4% organic. That's probably not full normal. Our number is probably a little higher than that. But is this just sort of saying, as you look at Street consensus numbers for the fourth quarter, they look a little hot to you? Or is this some dynamic that sort of played out the last couple of months either in a specific product line or across the U.S. recovery landscape?

So definitely not NeoTract. NeoTract is doing exceptionally well. I mean NeoTract had a greatest negative impact, as you know, David. We declined by 80% in April, down 30% in May and down 8% in June. And then we turned positive in July. So it has really led the charge in our recovery. And I think if you look at Teleflex and compare ourselves to the broader medtech world, our decline was less than most medtech companies because of the broad range of our portfolio, because of the emergent nature of our portfolio and because of the fact that we had some parts of our business that actually benefited from COVID. What's really informing my thinking is what I see in hospitals today. I mean obviously, there's an incentive for hospitals to get back to volumes coming through the hospitals. They're all very keen to do that. But with social distancing and the requirements they need to put in place, it's taking them a little bit longer to get that patient throughput. Some procedures, they're able to move to the ASC and to an office setting, if that's possible. So we're benefiting from that with the UroLift business. And as states move forward with easing of restrictions -- so for example, in our own state here, the rules around the number of people that can be in a location has gone from 25% to 50%. So in the state of Pennsylvania, that will actually help now with hospitals getting throughput. And if we see that continue and if we see that work in Q4, then we could potentially be a little bit better than I'm expecting. But what I see today, I see there is patient demand. I just see that hospitals are having a tougher time getting that patient demand through the channel. It is improving in Q3 over Q2, absolutely. This is a V-shape recovery. Is it going to improve again in Q4? Yes, it is. But how much is that improvement in my mind is very dependent on that patient throughput going through the hospital. And maybe I'm a little bit more cautious than other CEOs but I just think that being cautious and prudent at this stage of the year until we at least get into Q4, I would just not want to mislead any of the investment community into a more aggressive stance in thinking on that. So it's nothing other than those few factors, David, and how I'm looking at the market.

Perfect. And in your defense, you're not the only CEO who has flagged a dynamic like this. We heard similar commentary from iRhythm and Intuitive Surgical that both have kind of fundamentally different business models than your own, but you haven't really talked about exactly the same thing that you're speaking to, heading into the fourth quarter. Given your acute care focus, Liam, are there specific lines of business that are sort of more exposed? Obviously, NeoTract, given the ASC focus, is not exposed. So I would assume sort of your Vascular Access business. Are there just certain businesses that you're finding are more exposed to this hospital scheduling or hospital capacity dynamic you're expressing here in the fourth quarter?

Yes. So I think that any of the procedure that has to be done in a hospital. So UroLift, you're right. We can move some of those procedures outside of the hospital. And actually, in the last quarter, we saw a 2% shift. So traditionally, 40% of our procedures would be done in the hospital, 60% outside. There was a 2% shift out of the hospital in the last quarter. And I would expect that, that will continue through this quarter. But in particular, I guess, our Surgical and Interventional Access business that have to occur within the hospital walls, they will recover in Q3. They'll continue in Q4. The speed in Q4 will be determined by how quickly hospitals can get complex PCIs through the channel and so on and so forth. So if you look at our vascular business, as you pointed out, that's really a critical care, intensive care. That will probably benefit from hospitals' anticipation of COVID in the fourth quarter. And our respiratory business will benefit from the anticipation of COVID in the fourth quarter. But it's more of those acute, procedure-driven businesses. And of course, it's our OEM businesses just waiting for our customers to catch up in the fourth quarter. So they're just a few of the dynamics. But we are, I guess, enthusiastic about the recovery but also just tempered about what's going to happen in Q4 and not to get people over -- and not for us to get over our own ski tips quite frankly.

Okay. Understood. So growth from the fourth quarter, just a question of the magnitude of that growth. That message seems pretty clear. You started off, Liam, talking about -- encouraged by the momentum in your business. And look, if I back out your predicted COVID impact in the first and second quarter, you really have accelerated the underlying momentum of the business the last 6 quarters. By our math, it's almost entirely driven by NeoTract. Is there any other part of the business that you would sort of call out, that you think is driving sort of that fundamental underlying acceleration other than NeoTract?

Yes. So look, our business -- it's a great observation. And our business has been building momentum over the last few quarters. And David, your analysis a few years ago would have pointed out that we weren't capable of sequential growth quarter-over-quarter, and we've definitely addressed that in the last 7 or 8 quarters and we have seen that continued momentum. If you go back to 2018, we grew about 5% on an organic basis. Then we accelerated to 8% in '19 and also grew 8% in the first half of 2020, as I said earlier, on an underlying basis. And if you want to look at what's contributing to that acceleration in growth, about half of it is coming from UroLift, but there are some other significant contributions as well. In the past, our core business, if we want to call it that, everything at UroLift was growing in -- above that 3-ish percent, but the underlying contributors are coming from Interventional Access, Vascular Access, Asia and OEM. But for sure, NeoTract has been an absolute stellar acquisition, a solid performer. And those familiar with the story will know that we trained nearly 500 urologists in 2019, accelerated our investment in sales force expansion and performed 18 regional direct-to-consumer campaigns, which all contributed to the momentum of the business and moved that forward and made it a driver of our accelerated growth and driving approximately, about half of our top line growth on a fairly consistent basis.

Okay. Very helpful. And I -- Tom, I want to talk about '21 here. I know we're going to get very specific guidance from you. But some companies have certainly commented on '21. It's interesting. As I was looking at my Teleflex model this weekend, our '21 number relative to 2019 is about 13% higher, which is conveniently at the midpoint of sort of your 6% to 7% growth over a 2-year period of time. So it seems, give or take, kind of a reasonable expectation. How are you thinking about sort of 2021 from a revenue growth perspective? And are there any sort of headwinds and tailwinds despite the obvious dynamics of COVID that you'd kind of point us to?

Well, I would say that we haven't guided yet for '21 and withdrawn guidance for 2020. So it's -- the decided number specifically for next year would be beyond what we're prepared to do right now. As we think about what's happening now in the third quarter, fourth quarter, as Liam mentioned, we're seeing a nice recovery in those businesses that really were most impacted during the second quarter due to COVID. And our hope is that, that continues to progress forward, and we get back to a much more normalized run rate. I will say that we see this COVID issue as being something that has perhaps delayed our ability to get to those longer-term 6% to 7% revenue numbers as a result of what it's done in 2020. But we don't see it as permanently derailing the business. In fact, if you look at the growth we put up in 2019 and some of the activity we've got and we'll restore into 2021, we're pretty confident about the future. We're just not in a position to give specific guidance right now.

And then Tom, a kind of related question to that as I think about margins, and obviously, your LRP margin targets are kind of 30%, 31% in the EBIT line. And a lot of companies have sort of said that we are still -- some have said, "We're comfortable with LRP." Some have said, "We're no longer comfortable with the LRP." I wonder on an absolute and a temporal basis -- so I think you're still confident you can get to 30%, 31%. The question is, can you get there under the pre-described time line? Is it sort of definitive right now? And as Street consensus numbers next year only have 29% margins or less, so certainly the investors aren't expecting it. But is it definitive you cannot get back to the low end of your LRP targets in '21 for EBIT?

Well, I would say that as we look at the future, we agree with the point being made and we absolutely believe they're the right targets for Teleflex. We think they're very achievable. And we believe there is more room to grow beyond what we had guided to for 2021. The -- as we look at the underlying dynamics of what are going to drive us to those margin targets, one was footprint consolidation and consolidating our manufacturing to lower-cost locations. And those projects all remain on track. We also had quite a bit of continuous improvement program work in operations where we are taking $30 million plus per year of cost-out through improvement initiatives, and that remains on track for this year and we expect it to remain on track for future years. I would say that the next component is really mix. And Interventional Urology, Interventional Access, our higher-margin, higher-growth offerings, have really slowed as a result of COVID. We need to get those back on track to drive the mix. In fact, if you look at one of the key drivers of our margin improvement, the mix coming out of UroLift growth accounts for close to half of that margin expansion over the next couple of years. And also volume leverage, as a result of losing some revenue as a result of COVID, we're not able to leverage our cost structure as well. So as we think about the components, they're still very much there. It's just a question of how quickly can we get the Interventional Urology, Interventional Access revenue back to the levels that we would -- needed to have them at to achieve those targets.

So should we assume the LRP is kind of 1-year delayed? COVID kind of impact is for 1 year. So is it a reasonable assumption just to push that out of here?

Well, I think what we've got to figure out, David, is just how quickly we will get the revenue back to the levels we had previously anticipated. And that's what we're looking at right now, and so we're studying. So again, I think it's premature to say it's a 1-year delayed.

Okay. The -- some companies that have ongoing restructuring programs, and I would definitely call you one of them, are better positioned to sort of react in kind of a post-COVID world. A lot of companies -- I'd say almost every company we've talked to believes in a post-COVID world, there's going to be middle of the income statement leverage. But the restructuring companies, I think, are better positioned to kind of go after those costs or accelerate existing programs. I mean do you think you're going to be able to accelerate existing programs in light of -- in a post-COVID world?

Well, a lot of our programs are based on pretty specific time lines that we've got out there right now, the footprint moves and they're predicated on a number of things, including social announcements and time lines. We did accelerate 1 of those programs by about 2 years. But I'm not sure what availability we have for others. I will say though that there is some leverage in the middle of the P&L to the point you're making in that as we look at the future, we believe there is an opportunity to reduce travel spending. As we've been working remotely, we found that we can be pretty productive with remote meetings versus everyone traveling to get together, and we're going to continue to leverage that. We also have identified the potential for some groups of employees to work more permanently from home even as we work through the pandemic. And as a result of that, we think we can avoid future footprint expansion at some of our office buildings and perhaps even take some space out. So we are looking at some opportunities to leverage the middle of the P&L. But again, a lot of our big restructuring programs are pretty established time lines that don't give as much flexibility to pull forward as perhaps an OpEx or other initiatives.

And David, it's Liam here. I would just add to that. I think your point is well made that companies have constantly looked at their structure and continuously look to improve. I mean they're probably better placed. I mean we just announced another restructuring program on the last quarter. It didn't really have a lot to do with COVID, had nothing to do with COVID, but it is an example of companies like Teleflex who continuously look at their cost structure to see how we can make it more efficient and how we can take cost out and use that cost to reinvest, as we did in the last restructuring program into higher growth assets like UroLift, Interventional Access and Vascular.

Okay. Very helpful. Let's transition away from guidance a little bit here and then focus on sort of the core debate, which is NeoTract. So Liam, obviously, one disclosure of last quarter despite the recovery in the business was the CID investigation or DOJ CID investigation. So we've obviously written about this. And most often, these things end in fines regardless of guilt sometimes, unfortunately. But 2-step process. First, the big focus is, is there any way in which this investigation can impact the commercial progress of the business? Meaning were the practices that were identified here, did they cease long ago so we can be certain that there should be no impact on commercial momentum? How confident are you in that?