Teleflex Incorporated (TFX) Earnings Call Transcript & Summary

Good morning, and thank you for joining us for the fifth day of the 2021 Morgan Stanley Healthcare Conference. I'm Cecilia Furlong, Medical Device Analyst and a member of the health care research team here at Morgan Stanley. It's my pleasure to have Teleflex with us today. Liam Kelly, Chairman, President and CEO; and Thomas Powell, EVP and CFO. Before we begin, I'll run through our disclaimer. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, Liam and Tom, thank you for joining us today.

Thank you, Cecilia. It's our pleasure to be here.

And Liam, I was hoping, just to kick us off, can you provide a brief overview of recent trends and then we can hop into some of the Q&A.

Yes. I think most investors are familiar with Teleflex. We're a diversified med tech company. What I think is most interesting about our company is we have multiple growth drivers within our portfolio. Those include UroLift with UroLift international expansion, Interventional Access for our product MANTA is housed, Z-Medica and EZPlaz within our anesthesia division and within vascular picks and intraosseous and, of course, OEM. And I think that we have multiple levers from margin expansion, both gross and operating margin expansion really coming from mix because of those 5 growth drivers for are accretive to our gross margin with OEM being accretive to our op margin and also with some restructuring programs. And I think that the trends that we see and I think the most important factor is that despite the upswing in the delta variant that we saw in this current quarter, we definitely see that our full year 2021 guidance is very much intact. And just to reiterate that, our guidance on revenue is 8% to 9.75% constant currency and our adjusted EPS is $12.90 to $13.10 or well over a 20% increase in EPS.

Liam, I was hoping just to start off kind of high level, but outlook today versus entering 2021. I just wanted to ask, where do you have increased confidence across the business? And really, also, where have you seen the greatest outperformance versus your initial expectations, notwithstanding evolving COVID dynamics?

So I think as an organization, we have executed extremely well in 2021 despite the COVID surge that we saw in January and February. And again, delta that raised its head during the summer. We were able to raise our revenue guidance in Q1 and implicitly raised it in Q2, again on excellent execution. And why I say implicitly in Q2 because we divested a respiratory asset that was scheduled to deliver $28 million to $32 million in the back half of the year, but we maintained our overall revenue guidance. So by any other metric, that would have been considered $28 million to $32 million raise. And also in Q2, we raised our gross and operating margin, targeting our 21% to 23% earnings per share growth. So by any metric, we continue to execute at a very high level, and I'm really pleased with our performance through the first half. And as I opened with, I'm pleased to reiterate our full year guidance.

Okay. And I did want to ask really what you're seeing in the field today to the extent you're able to talk about it. But just relative to the time of your 2Q print, how have you seen Delta's impact on your business evolve? And really, can you contrast what you're seeing with this way versus the COVID wave in January and February, either from a hospital standpoint or ability to manage and balance COVID and continued normal care? And also curious, just as you think about your implied second half guidance, is COVID having a meaningful impact on shifting your outlook around the recovery cadence?

Yes. So generally speaking, Cecilia, I think hospitals are continuing to see improvements in the ability to treat and performing non-emergent surgical procedures relative to the initial COVID outbreak. Whereas we still expect the delta variant to have an impact, it's not going to be nearly the impact we saw in Q2 last year. Nonetheless, the increase in Delta variant infections accelerated in late July and through August. And now we have 28 states, as we sit here today, having some restrictions on elective surgical procedures in specific countries or cities within the states. And although the -- as I said, the reduction isn't as draconian, we think it's -- will have a certain impact. And even your note this morning, Cecilia, highlighted that fact across all med tech. This isn't the Teleflex issue for elective procedures. It's an impact on med tech. Regarding your second part of your question, elective surgical procedures has -- we have seen an impact in late July, early -- during August. We do anticipate seeing a recovery beginning this month and continuing into Q4. This is the beauty about having a diversified medical portfolio, and I think those types of companies, like Teleflex, would be able to protect themselves against the delta variant out there. And as I said in my opening remarks and I'll repeat it again, as I sit here today, I believe that our guidance for the full year constant currency revenue growth and EPS provided at the time of our Q2 calls are still intact.

Okay. I wanted to ask too about UroLift. And you talked about on your 2Q call, continuing to expect 30% plus growth from UroLift in 2021. I'm just curious kind of -- as you sit here today, is that still a reasonable outlook just given what we've seen with Delta? And then also talking about procedure pressures just from a COVID standpoint, but I'm curious can you balance what you saw also from a seasonality impact over the past few quarters or few months really relative to what you've seen the historic seasonality? And especially in the U.S., was there -- if we heard a lot about increased vacations. So just curious kind of the balancing impacts on UroLift as the quarter played out?

So I don't want to get into too much detail on inter-quarter trends, Cecilia, as you can appreciate. But the 2 main impacts that I would see is obviously the Delta variant. And not so much vacations. I'd see that as a smaller impact. I think that the ability to have staff return to work, the stimulus checks were required at the time of the first wave of COVID impact but that caused somewhat of a reluctance for individuals to return to work. And in the month of September, a lot of those checks ceased. So I would -- again, as I said earlier, expect this month, September, to show a good solid recovery based on people returning to work and the impact of vacations, even though I see that as a smaller impact. As we look back to 2020 and the experience with our business exposed to elective procedures clearly had an impact. It started with UroLift and then it went to Interventional Access and Surgical. As I said earlier, this current wave is not having nearly the impact as the first wave had. And I think the important factor is for a diversified company that you have offsets in other areas of your business if you do see any impact of surgical procedure postponement.

Okay. I wanted to ask you just your margin outlook for the back half of this year. On your 2Q call, you also highlighted an increase in planned commercial investment tied to UroLift and MANTA as well as the flowback of expenses previously curtailed due to COVID. Can you just walk through, as you are here today, to the cadence of these investments in the second half of the year? Where you see sources of upside? And what's factored in really to your guidance from an inflationary pressure or labor headwind perspective?

I might ask Tom, if you don't mind, Cecilia, to cover that one. Tom?

Absolutely. So we increased our investment for both UroLift and MANTA by about $10 million in the second half of the year. And as for the cadence of it, it will be slightly weighted a little bit more towards the fourth quarter. And just as a reminder, the incremental investment for UroLift as related to the direct-to-consumer campaign given the solid return on investments that we've seen from the program. As for MANTA, we're adding more training resources to drive penetration largely in the U.S. And from an inflation standpoint, we've assumed higher costs of direct and indirect labor in our manufacturing locations, also slightly higher raw material costs, principally in resins and higher logistics costs.

And I wanted to ask too about the increased spend. Is this primarily a second half of 2021 dynamic? And as we initially contemplate 2022 and realizing you have your Investor Day coming up shortly in November, but should we expect more OpEx leverage? Or do you see drivers of sustained higher spend flowing into the first half of next year?

A little bit of a combination of both though. We would expect incremental investment in 2022 as we view our geographic and product specific growth drivers as compared to 2021. And although we haven't provided specific 2022 guidance yet, it would be fair to assume that there would be some normalized OpEx spend as we come out of the other side of COVID.

Okay. I do want to turn to UroLift, specifically reimbursement, Liam. Just can you update us on UroLift reimbursement dynamics and your current outlook? You posted your view in your comment letter asking CMS to postpone implementation until further assessment is possible in AMA [ Rock's ] commentary appears to suggest they're supportive of a 4-year phase-in period. And from your standpoint, just curious if you could, one, provide more details. But just what a 4-year phase-in period have any upside for you, as you sit here today? Just from the standpoint, potentially of enabling an opportunity to come back possibly reassess down the road.

So -- thanks, Cecilia. So first of all, I just want to level set everyone that approximately 20% of all UroLift procedures are associated with Medicare patients in the office setting or 2% of total Teleflex revenues. You are correct. We submitted our CMS response about 2 weeks ago. And in that, we were vehemently opposed to a phase-in. I mean that's simply just kicking the can down the road. So it phases in over 4 years, but you still get to the same endpoint. Our comments were really focused on how the proposed rule settings such as the ASC in the hospital, which is counterintuitive to what Medicare should be doing and what CMS should be doing for Medicare patients. They should be trying to make procedures available to them in lower-cost sites of service rather than forcing them into higher-cost sites of service. We actually argued that the best thing to to do given the numerous unintended consequence from the proposed fee schedule is to postpone implementation until a full analysis can be completed, specifically with the 600 office-based procedures, and in particular, to the 100 procedures that are equipment heavy, and those were most impacted. And I think CMS themselves realized that, that was an unintended consequence. The level of comment has been extraordinary. There have been nearly 30,000 comments submitted as of the end of last week, and there are comments from individual surgeons as well as medical societies, including the AMA and from patient advocacy groups as well and in vast, vast, vast majority are asking what we asked, which is to postpone making the decision until there is further analysis done for the benefit of Medicare, Medicaid patients.

If rates ultimately do land near proposed levels, can you just walk through also the flexibility physicians have to shift site of care? And how you think about your site of care mix shifting or any other underlying changes in your approach you would contemplate?

So I've spoken to a number of urologists, as you would imagine. And following those conversations, it is clear that the majority of nonacademic surgeons have access our ownership to an ASC to the extent that there is a need to shift to different sites of service from the office. We believe that there are likely be -- 3 likely outcomes to the extent that the physician fee schedule gets implemented as proposed. First, surgeons will accept the lower profit due to the clinical value of the UroLift procedure; second, a shift of site of service to ASC or the hospital; or three, simply move to do more chart procedures in the hospital. I think that the biggest bucket of those 3 surgeons will be bucket #2, which will shift, in particular, to the ASC, given my earlier statement that most urologists have either an economic interest or access to an ASC. And investors should also bear in mind that our direct-to-consumer campaign execution is actually sending patients to the urologists for the BPH procedure, so we probably have a little bit more control. And I think also -- we should also bear in mind that the UroLift procedure is profitable in the ASC and the office. And therefore, if we have that level of flexibility, when competing products would not have that same level of flexibility.

Okay. Turning back to really your core business today, but just the 30% plus growth for UroLift in 2021. I'm curious, you just touched on DTC, Liam, but what's factored in from just -- when can UroLift get back to a more normalized growth rate in the U.S., reflective of true underlying demand? And two, just the impact of DTC either a prior campaign and also your current DTC efforts, bringing new patients to the funnel, I guess. As you thought about guidance, how did you balance those 2 factors?

Yes. So I think that we -- when we gave our guidance, we were expecting a more normalized back half of the year. We have seen Delta raise its head, obviously, in late July and through the month of August. We anticipate a recovery as we go through this month, this current month that we're in. And we would also anticipate that continuing into the fourth quarter. With regard to the DTC campaign, I couldn't be happier about the results that we're seeing from the initial launch, which began in the second half of 2020. The campaign has continued to meet its preset performance objectives. This includes raising brand awareness for UroLift with increases from the beginning of the campaign of awareness for men with BPH. Now these are men that have BPH. At the beginning of the campaign, their awareness is 4%, and now it's 10% after 6 months. We will measure that again at the end of this year, and we would expect an increase again. We are seeing even greater response rates in 2021 as we progress with the full year campaign, that increases the spend versus 2020. And currently, we are focused on weekly optimization of networks and programs, which has enabled greater efficiencies by staying ahead of the ad wear off, which sometimes happens in these campaigns. Regarding the impact to your question relative to the pandemic, it will be fair to assume that COVID has masked some of the benefit of the campaign but we think it is important to continue to fund the outreach to consumers, especially with this variability in reimbursement. And as COVID infection rates decline, we should continue to see the benefit from the heightened awareness of UroLift and having more people there. And it is also, Cecilia, our intention to train 450 to 500 urologists this year.

How do you think to, Liam, about just the demand, the pent-up demand potentially from UroLift caused by Delta? How do you see that unwinding, especially as you look back seeing what transpired post the second wave in terms of procedures going back? But just as you think about the cadence impact on your business from potentially pent-up demand, how do you see that playing out through the back half of this year and into 2022 possibly?

So philosophically, there just has to be pent-up demand there. 2020, for UroLift, in particular, was flat over 2019. So there are a number of procedures that did not get done. And investors familiar with UroLift will realize that there are 12 million men in the United States and several with BPH, 12 million. And cumulatively, we've done 300,000 procedures. Now we just breached at 300,000 recently, and we're very proud of that fact. We -- so we would imagine that the backlog driven by men who have seen urologists but have not yet had the UroLift procedure due to concerns regarding COVID should flush through. We saw the beginning of that at the end of the first wave as people came back. And as we get COVID in the rearview mirror, we would expect that backlog of conversion to continue. And we -- as I said, the other gating factor is training new urologists. And investors familiar with Teleflex, again, will know, we've only trained over 3,000 of the 12,000 U.S. urologists. So between DTC backlog, training new urologists and the number of patients that are out there, we've only scratched the surface of this product, and that's even before we start talking about the international opportunities for UroLift to expand overseas. So we just need to get out the other side of the COVID pandemic to get to a more normalized level of growth because we have significant levers to pull over a multiyear period.

On UroLift 2, just would love to hear how that rollout is going. And as you think about cadence of margin impact as you drive conversion through the end of 2022, could you just provide some color in terms of how you view conversion rolling out over the next several quarters.

Yes. So we've already begun the conversion of doctors with UL 2. And there are significant advantages with the product. It's got better visualization and it is easier to use. We had a big showcase for the UroLift 2 and the ATC at last week's AUA in the meeting, and we were very encouraged by the response that we got. We still believe that we will convert absolutely the majority of surgeons to UL 2 in the United States by the end of 2022. And just to refresh everyone's memory, we expect about 400 basis points of operating margin expansion, growth going directly to operating following the full conversion of UL 2, implying a high 70% gross margin, which implies 40 basis points of margin expansion for Teleflex as a whole. So I think that it's a very positive story with the UL 2.

UroLift in Japan also, I wanted to ask reimbursement. You talked about seeing this quarter play out and then potential initial contributions in Q4. Just curious if you would mind providing an update where that stands? And how you think about Japan contributing beginning in 2022?

So there's no change in our expectations for reimbursement approval and launch during 4Q. Just to level set everybody, we have minimal revenues in for 4Q. We expect this to begin to get some procedures done and then ramp as we go into 2022. Our submission is complete. We're just simply waiting for the MHLW to review it in September. The UL 2, just to be clear for everybody, is only cleared for sale in the U.S. So we would expect a positive reimbursement decision in Japan very similar to the rates that we would get in the United States. And again, to level set everybody, the reimbursement rates have nothing to do with how it's reimbursed in the United States. It's simply the sale price of the product within the United States.

Just on a long-term standpoint, too, Liam, how are you thinking about UroLift growth in annual sales from a geographic mix standpoint? And really when can OUS sales begin to contribute more materially to your overall franchise?

Well, I'll begin with Japan. That's obviously a big market. It's $2 billion TAM versus the $6 billion for the U.S. And I think a good way to think about the Japan ramp is one of the bigger international markets is it's 1/3 of the size of the U.S. and look at how the U.S. ramped. The U.S. went from $5 million first year to $16 million, $50 million, $125 million, $200 million and then $300 million. We've already put initial market development specialists and sales force on the ground. We've identified the key opinion leaders in the marketplace in Japan and will begin to ramp. So that's Japan. We also anticipate getting the reimbursement started out in France in time to allow for launch activities in 2022. We see France is approximately $200 million total addressable market once the reimbursement is addressed. Later in '22, we would anticipate Brazil, Italy and Spain. China would remain a 2023 opportunity. And I think it's important for the investment community to realize that the government in China have indicated it will not require an in-country study to allow us to submit -- and has allowed us to submit the Lift pivotal trial results. So that's a great step forward for us and move that launch forward by a year because we don't have to do this study. And although we expect increased OUS traction in '22, we would expect that cadence to continue and ramp as we bring on those other countries in '23 and '24 and beyond.

Okay. Liam, I wanted to ask to M&A. It's a core part of the Teleflex story over the past several years. Just if you could provide your current outlook for 2021 and beyond this year? And can we expect to see you more active in M&A over the next 6 to 12 months after a relatively quiet period following your acquisition of Z-Medica last fall?

So I mean, don't forget, we did 2 acquisitions last year. We did HPC, and we did Z-Medica. And also, this year, we had the divestiture of our respiratory assets. So we're always active on the M&A front. And it continues to be an important part of our growth strategy for Teleflex. So we continue to remain focused on it. We continue to have an active pipeline of targets at various stages. And these are targets that are in scale transactions, in tuck-in acquisitions, late-stage technologies and dealer to direct. It's always difficult for us to know when we can get an M&A executed, but investors should expect that Teleflex will maintain our disciplined approach and augment our growth engines and margins with add-on acquisitions. I mean our balance sheet at the end of Q2 is in great shape. If you take into account the fundings from the sale of the respiratory assets, we're at about 2.3x levered. So we definitely have firepower, and we are always active out there and continue to look at opportunities.

You've called out many of your segments as areas of focus in the past. Just curious where are you -- what are the most significant near-term priorities for you? And as you think about interventional cardiology, your business there, your interventional urology business specifically, where are key areas within those that you might look to augment your portfolio?

I always like procedures that are done within the cath labs, because by definition, you're moving a procedure from an operating room to a less invasive procedure and another site in the hospital and you tend to get a higher margin and there's better opportunities there. We're already in the interventional cardiology, interventional radiology space and any adjacencies within that would be of interest to Teleflex. We always seek out opportunities that would leverage our urology vascular and surgical sales channel call point. For me and for Teleflex, it's all about that call point. And obviously, we'd like to build out in our emergency medicine portfolio. We've done a really nice job there in augmenting a portfolio with our laryngeal mass, with our intraosseous opportunity with Z-Medica and with EZPlas coming down the pipe. And I think that's what's unique about Teleflex is that we look broadly. So therefore, there's always opportunities for us to find that unique asset that would fit well within the Teleflex family.

You talked about briefly the respiratory divestiture. But can you just walk us through a bit more of the rationale timing associated with the planned restructuring? And really just how does this move ultimately further streamline your business going forward?

So Cecilia, investors that know us know we're very disciplined in our portfolio optimization strategy with the intention to improve the overall trajectory of revenue growth and margins. And to that end, the case of the respiratory assets, we decided it was the right time to prune to optimize the business. The decision enables Teleflex to focus on executing on its core market segments and drive long-term sustainable growth. And the divestiture has a positive impact for our gross margins and operating margins. And I think it's important to note the respiratory transaction is accretive to all of those on a long-term basis. Regarding your question and the timing, it made sense for us to sell the portfolio of assets with a willing buyer and coming out at the tail end of COVID. And while we could not dictate the exact timing of close, if you look at the Z-Medica transaction in tandem with the divestiture, you can better appreciate the growth and margin lift of the 2 portfolio actions with an 80% gross margin portfolio growing high single digits, low double digits and addressing $600 million global TAM and fitting nicely into existing call points, partially offset by the sale of $150 million respiratory assets with margins -- gross margins in the 40s, therefore, below our corporate average and a flattish to, most years, a declining growth profile. And as I said earlier, following the divestiture, our leverage is at 2.3x net leverage giving us ample firepower to bring in future assets in the future.

Liam, last few minutes, I wanted to touch on upcoming Investor Day in November. And just to ask, what should investors expect at a high-level standpoint from a messaging standpoint and framework? And also relative to your prior LRP, do you view COVID effectively pushing out margin time lines by about a year? Or how would you frame the pandemic's impact on the long-term margin expansion story?

Yes. So I think that what investors should expect from our margin, from our Investor Day without stealing our own thunder, you should expect us to focus on our long-term durable, sustainable growth opportunities. Investments in organic and inorganic growth and continued improvements in our profitability within the income statement. Regarding your question on COVID, I think we've done an outstanding job coming out the other side of COVID already in expanding our margins in the year that we're in, and we've seen significant margin expansion as the assets that were most impacted by COVID start to come back during this year. And at the upper end of our gross margin guidance, you can see that we're knocking on the door of 60% and showing significant improvement on our operating margin guidance as well. As we come out the other side of COVID, we continue to expect those assets, that part of our business to grow. And you can expect us to invest into our growth drivers despite the impact of COVID. So I would expect investors to be very pleased with the growth trajectory, we'll look forward taking into account the divestiture of the respiratory assets, I would expect investors to be pleased with the margin expansion. And as a result, the implied earnings per share expansion that they'll see from Teleflex over a multiyear period.

And we look forward to the update in November. And I know we're out of time. Liam, Tom, I wanted to thank you both for the time this morning. And Liam, just turn the floor back over to you if you have any last closing remarks.

So I think our last -- my closing remarks will also focus on our Investor Day. We're looking forward to presenting the Teleflex 3-year plan to investors. I think investors will be pleased with the long-term trajectory of Teleflex. We would anticipate, by the time we have that Investor Day in November, we'll be seeing a more normalized COVID impact. And hopefully, we will have the results of the CMS reimbursement, and hopefully, a postponement of that reimbursement. And again, I'll finish where I started, reiterating our confidence in our full year guidance that we gave at the end of our Q2 call, I think that's an important takeaway for investors to take from this fireside chat today. So -- and Cecilia, thank you very much for having us. And to the investment community, thank you for your interest in Teleflex.

Thank you all.