Teleflex Incorporated (TFX) Earnings Call Transcript & Summary

Great. Good morning. Thank you for joining us for the third and final day of the Morgan Stanley Healthcare Conference. I am Cecilia Furlong. I'm medical device analyst here at Morgan Stanley. It's my pleasure to have Teleflex with us this morning; Liam Kelly, Chairman, President and CEO; and Larry Keusch, VP of IR, Strategy and Development. Thank you both for being here today.

Our pleasure. Thank you very much for having us.

Thanks. And really quickly, disclosures, please see morganstanley.com/research disclosures.

Instead of talking about the macro first, I wanted to talk about your recent acquisition. You announced it late August, Standard Bariatrics. Can you just walk through the strategic rationale? How it fits into your portfolio? How it leverages your existing sales force? And really what you had seen out of the business? I think kind of a $15 million run rate business. So just talk about why now? What were you seeing in the underlying fundamentals that made this the right time to make a move?

Yes. Like all our M&A, we've been talking to Standard Bariatrics for a long period of time. So we've been monitoring them pretty closely. We met with the company first before the technology was even on the market and did a pretty in-depth assessment at the time. We liked the technology. They were not ready at that time to enter into a discussion. But we continued to do some work in the background. What we really like about the product category is that it's right in our wheelhouse. We have sales reps every day in that call point. We have a plethora of products from our mini lab to our trocars to our ligation devices that we are in there and our closure products that we are in there every day with those surgeons. So we know the call point very, very well. The product has gotten very good response, early adoption. There are about 120,000 sleeves done in the United States every year. So it's an attractive market. And not alone is it attractive and it's growing mid-single digits on its own, but then on top of that it's drawing from other bariatric procedures. So it's a nice high-growth area and it's an area that we are particularly enthusiastic about. The product itself has 31 filed patents, so it's very well protected. And it's growing and taking share within the marketplace. As you said, it will do something in the region of around $15 million, and we will be able to pivot off that. We'll combine their sales force with our sales force. We'll put some additional investment in behind the product, and it will be a nice growth driver. And as we've said earlier, our goal in Teleflex is to continue to add to our high-growth portfolio. So this will be included in our high-growth portfolio.

Can you talk to you about where Standard Bariatrics are seeing initial traction and their approach to targeting physicians? Where you're seeing adoption? And then you talked about, I think, $30 million to $35 million that you're forecasting for next year. Can this double, do you think, within 2 years?

Yes. So we called out $30 million to $35 million next year. Where they are getting traction is in a few areas. Number 1, getting through the value analysis committees has been very smooth in the initial adoption, which is very, very encouraging. Secondly, in some of the high-volume users, they have converted some of the high-volume users. And high-volume users is somebody that's doing 10 sleeves a month. So these individuals, I think, we've had some initial success. The procedure itself is a simplification on the existing procedure. So it saves the surgeon time. And when you're doing a sleeve, it's actually a full roll of staples in one application. So once they get the stomach through the device, it's a simple push of a button. It applies all of the sleeve. Technically, then you don't have any staples crossing over each other. So you have less leakage. The surgeons really like that, because if you get leakage, once you've done this, then you have to go back in and do a secondary procedure, and this means they don't have to do that. They've also had some nice traction with one of the larger GPOs. And normally, with a technology like this, if you're going to get on a GPO, you go in under an innovative technology, so you're not disrupting the contracts they already have in place. This GPO put them on directly as a sleeve technology, which is very, very encouraging. Regarding the latter part of your question, we didn't give longer-term guidance. But most analysts, and you included, in your note had pointed out, it's going to add about 50 basis points to Teleflex, which would actually add approximately $15 million or so every year, which would get it to what you say a doubling in a number of years. So I think that, that seems reasonable to me right now. And I think this will be a nice high-growth portfolio within the Surgical business unit.

And the gross margin profile, too. I know you talked about the key attributes you look at in M&A and accretive to growth, accretive on the margin side. Where is this at from a margin standpoint today and longer term? And was this really kind of a growth asset that was kind of the forefront in what you were looking at here?

Yes. I mean, I think we've spoken many times about doing a tuck-in within the Surgical business, and this is definitely a growth asset within there. It's a pretty complex device to manufacture. And with any of these technologies, as you ramp, therefore, you get your margins to a better place. All of the assets within our high-growth portfolio are accretive to Teleflex. And this will be accretive to Teleflex's gross margin sometime in 2024. And then we'll continue to ramp beyond that. It will be slightly below UroLift margins at the endpoint, but still quite accretive to Teleflex. So we're very encouraged by that. And then with leverage on the top line, it will become accretive to our op margins in pretty short order as well. I mean the deal will get to above our internal cost of capital by year 4. And as you know from covering is our internal cost of capital is in the very, very high single digits. So all of the financial metrics, all of the growth metrics, the margin metrics, it really fits right down the middle of the Teleflex playbook. The product is what I would describe as sticky. Once the surgeons use it, they really like it. And they use it over and over and over again. It can also be used in conjunction with the robot. And therefore, that has that market open to it. It's got very strong IP. It fits right within our call point. It's got an excellent health care economics argument because it shortens the time to do the procedure, so it does give a good return. And it's already reimbursed. We don't have to go looking for additional reimbursement. The procedure is very well reimbursed and is profitable for the hospital and the ASC performer.

Can you talk to just the deal structure -- structured deal? How you think about that versus just straight up M&A? And as you think here today, what is your outlook now one deal kind of under your belt this year, around future M&A near term? And what do you feel comfortable from a leverage standpoint going to?

Yes. So the deal is a structured deal. There's $170 million upfront, with $130 million earn-out. I personally like structured deals. Most of the deals that we've done, except for VSI, have had some form of structure, some form of earn-out. And if we paid the full $300 million, I will be incredibly happy, because that will mean that the deal has actually outperformed our internal model. So therefore, the multiple will be less, the revenue will be higher, and we get to our gross and operating margins quicker. And I think that a structured deal is appropriate in this instance because it is a product that is ramping, gaining traction quickly. Most of the revenue initially will be in the United States. And then eventually, we'll bring it to the overseas markets. As I said, the U.S. market is just over 120,000 sleeves. So you'd normally get something similar, a little bit more overseas in that regard. With regard to our capability and capacity to do additional deals and whether we're working on them, we are, in a word. We're about 2x levered right now. So it still means that we will have firepower for the equivalent of about $2 billion there available to do deals. Our M&A team are working very diligently. There are assets that we like out there that we're looking at. There are tokens that are dealer to direct. There are scales. And there are late-stage technologies right across the portfolio of Teleflex and the type of deals that we do. We would like to bring in a scale transaction over the next period of time. I think we're a modest company, but by gosh, we're good at M&A. It's been a hallmark of Teleflex that we've been able to bring in good assets, like Standard Bariatrics, which is a nice tuck-in, like VSI, like NeoTract. And we've been able to execute really strong. I mean Z-Medica has been performing exceptionally well. HPC and OEM has been performing exceptionally well. I can't think of a deal that is in the tuck-in or scale that we haven't really brought into Teleflex, integrated well, given a significant return to shareholders. And we still think it's the best use of our capital.

And do you think too -- and last question kind of on strategy portfolio management, but you divested the respiratory assets. How do you think about additions versus subtractions? Other key areas for potential subtractions? How you're looking at additions? And then you talked about converting distributor to direct, I think, on the 2Q call. But what's your outlook there? Just the pipeline, potential benefit you could see from a margin standpoint?

Yes. I think that as we look at our portfolio, we continuously analyze our portfolio. And we look at the pieces of the jigsaw and see that they all fit together in order to give that return to our shareholders. Right now, I would tell you, Cecilia, I'm more a buyer than a seller. I would like to bring in another asset into Teleflex and then do an overall assessment of the portfolio to make a determination of what belongs with us and what doesn't. I think, strategically, the sale of the respiratory assets was an important one. I think as an organization, as you grow, sometimes you have to prove to grow. And as you know, the respiratory assets were actually either, if you want to call it growing, but going from minus 1% to plus 1% in any given year. And the multiple we got for that asset at the time was pretty attractive. I don't think we'd get it today if we were in the market. We've seen valuations come back somewhat. And so I think we're more of a buyer in that regard rather than a seller for Teleflex.

Okay. I wanted to turn to your LRP laid out at your Analyst Day this past spring. But just talking about gross margin. I think 250 to 350 bps of expansion that you're expecting by '25. You were cautious around inflationary pressures. So I'm just curious, kind of walk through what was incorporated there. Could we see 50 bps a point of further expansion if we do see the moderation of what we're seeing in the current environment?

Yes. So the way we built our LRP, it was all based out the 2022 jump-off. And we built in about 100 basis points of inflation this year on top of the base inflation that we would see in a normal environment. What we're seeing right now is there's some encouraging pieces where you see at least some of the freight inflation start to modulate in this environment that we're in right now. Then in the outgoing years, we assumed that inflation would continue. We didn't build in, I guess where you're leading to, any deflation. And I think that was prudent, and I think that's still prudent right now. It's pretty dynamic out there with regard -- you saw the latest numbers that came out yesterday, inflation was slightly higher than people were expecting. So I think that we have built in incremental inflation. But notwithstanding that, we still have pretty solid gross margin expansion. Where that's coming from is it's coming from our restructuring programs, which, at the midpoint, we have about $26 million coming from the restructuring program. And then it's coming from mix. The high-growth portfolio being 25% of Teleflex, getting to a larger part of Teleflex as we go through the LRP and getting leverage from that because every product that's within that portfolio is accretive to Teleflex and you get leverage from it. And then you have inflation and we have positive pricing. The pricing is not fully able to offset the inflation. But all in all, we still get pretty significant margin expansion even in an inflationary environment, which I think is testament to the type of company that Teleflex is.

You talked about -- I mean, M&A is a core component of the story and in the growth story. And at your Analyst Day, I think the one area that was a little different than we were expecting was OpEx, and specifically, R&D, a bit of deleveraging there as you step up R&D versus what you've done historically. But can you just talk about if your mentality has really shifted in terms of internal focus and really the key areas of the portfolio that you're looking to kind of push forward from an internal standpoint at this point?

So I think most of the best companies today, and I would see Teleflex as one of the best companies, you do it all. You do M&A and you also continue to invest behind R&D. If you exclude OEM -- for OEM, R&D is a billable event. If you exclude OEM, we're just shy of 5% of our revenue that's invested behind R&D. I think that we would see that there is a potential to spend some more in research and development in order to continue to augment the top line growth. And all of our new products that we would bring in, we would want them to be accretive to our gross margins once they get to any level of scale. So what we told investors at the day was that our top line would grow 6% to 7%, but our R&D spend would grow faster than that. So you're going to see incremental additional spend on R&D. And the output of that in the horizon, it normally takes about 2 years -- 2 to 3 years for a product to begin to augment your top line. But you should see the revenue generated from new products. And our expectation is that, that will improve following that spend in about 2 or 3 years' time. And we're a much larger company than we were back in the day. And I think it is appropriate that we should spend above 5% on R&D in order to get that better return for shareholders. And it is a much greater return, but we would still augment that with late-stage technologies. That would still be our plan. And we would still consider continuing to do dealer to directs in order to get the channel for those new products like the one we announced in Q2, a small go direct in Brazil, for example.

In terms of -- and I want to spend some time on UroLift, but UroLift expansion into Asia Pacific, that's a big part of the story if you think longer term. Outside of UroLift, though, as we think through your LRP, where are the other opportunities to really increase your presence in Asia Pacific? And then as you think about, too, just the sales force build or the commercial build, what do you have incorporated in your outlook at this point?

Yes. So we believe that we are going to be able to augment the growth of APAC. It should be in the high single digits, hopefully getting to the low doubles with excellent execution. And really, it's almost selling old as new, because by the time you go through the registration process, if you think about it, we acquired the UroLift product in 2017. It had been on the market since 2015. And here we are in 2022, and we just got it registered in Japan since April and we're going to start in China in quarter 4. So it does take that period of time. And we have a suite of products that fit into that category for APAC. Specifically, within our vascular portfolio, we have PICCs that we're launching our core technology in China and other geographies. We also have our intraosseous portfolio that we're bringing to those markets. We have our VSI products that we have gone through the registration, and they're going to begin to ramp in those geographies over time. So we have a full suite of products that we're taking to the Asian market. And we see Asia becoming a bigger percentage of our revenue over the LRP.

In terms of just your recent performance, turning there in 2Q, over 20% growth, if you look at the high-growth portfolio ex UroLift, as you think through the back half of this year, just puts and takes in terms of where you've seen the greatest growth among that portfolio and how you think about being able to continue at that type of growth rate through the balance of the year?

Yes. Obviously, there's some products growing faster than others within that portfolio. MANTA continues to perform exceptionally well. We continue to develop that market. And for investors that are not familiar with it, MANTA is a large bore closure product when you do a TAVR procedure. The other products that are performing well are the hemostatic portfolio. We've really been able to take that technology overseas. But also in the domestic market, we've been able to use our channel and leverage our channel to accelerate the growth there. Intraosseous continues to perform very well, and we continue to drive penetration within that product category. And of course, our PICCs, we continue to take share in our PICCs because of our coding technology. But if you were to look at the growth profile of them, you would have to say that the MANTA is the highest growth of those. And within that 20% you discussed, the PICCs would be at the lower end, with the others in between.

Okay. And you also talked about a little bit of supply chain pressure in 2Q, and you specifically talked about your interventional business. But was it just in that specific area? Did you see broader across your portfolio pressure? And can you speak to kind of any evolution since that time in terms of what you're seeing from a macro perspective?

Yes. I mean, I'm sure you're not hearing that only from Teleflex. I mean, the supply chain is fairly disrupted right now for every company out there. In Q2, we made specific reference to supply chain disruptions for interventional and for vascular. That's really down to some of the resins within the interventional portfolio. Tyvek is also an issue for the industry, and I'm sure you've heard that from other companies. The main manufacturer of Tyvek is opening a new plant next year. So once you get halfway through next year, that should alleviate the whole Tyvek situation, and should help. And then components within the vascular, trying to source components to go into the kits, so we can continue to keep product flowing. I will say that we're managing it really well. I'm really happy with our global supply chain team and how they're managing this very dynamic environment. And it is getting better. If I go back to Q2 and the number of issues that we're dealing with, it's a smaller number of issues they're dealing with today, and it's getting better. It's not normal yet. And we still have a slightly elevated back order situation for some of our products. And we would anticipate that will alleviate sometime in 2023. But we're working through it, and it is impacting some of those products. Now we don't have much exposure to electronic components and chips except in the interventional business unit where we've an intraaortic balloon pump business that's also getting slightly disrupted at this moment in time. But it is getting better. And I think I'm encouraged by what I see. I think 2023 should be a much more stable year than this year.

You've talked to just about the ability to take price in some of your businesses. And I think you quantified maybe 50 bps of benefit there. As you think to the back half of this year, where are areas that you could look to take additional prices? Is there upside to that 50 if you were to do so? And then beyond '22, what's your thought on continued areas to look to continue to take price?

Yes. My mother used to say, a good start is half the battle. And I think we've had a good start with pricing. I will tell you that we'll do at least 50 basis points this year. Through the half year, we're already well ahead of 50 basis points in pricing. The areas where we continue to take pricing is in the areas where we are market leaders. So our vascular portfolio is always an area for price. We just announced a large GPO agreement that we reentered, and that was with positive pricing. Our interventional business, our surgical businesses, our business in APAC is a good opportunity. And don't forget, Cecilia, when no company was getting price out there in the marketplace, Teleflex was getting price. We were always able to carve out 10 or 20 basis points of pricing even in a non-price positive market. And now that we're in a price positive market, I believe we'll do at least 50 basis points. I think once we get to our Q3 call, we might give an update on that, but we're making good solid progress. And the beauty about your pricing in the medical device world is your contracts normally come up 1/3, 1/3, 1/3, because you're into a 3-year GPO cycle, or in Europe, you're in a 3-year tender cycle normally. So there is subsequent opportunities for pricing in the following year as you normalize that price structure on the tenders and contracts that have not come up in this particular year. So I think we will continue to be a positive pricer this year for sure and then over the next couple of years as well.

Okay. I want to spend some time on UroLift. And just looking at the 2Q performance, kind of like the biggest departure for you was the June performance and greater softness than you were anticipating. But how much of that was staffing? That clearly seems to be, with us, a trend, a theme across all of it, staffing pressure going forward. How much of it was staffing? Other dynamics? And as you thought about just what you've seen seasonality-wise this summer versus kind of a traditional year, anything you would call out? I know lots of pent-up demand for vacations. But how are you thinking about just the impact there?

Yes. So the summer is playing out pretty much as we thought it would, to start with the last part of your question. We had anticipated that there would be vacations and holidays being taken in the July and August time frame. And then we anticipated that people will come back, get back to work in September. I never thought it's the America turn into Italy, where August would be such a big vacation month. But anyway, the reality of the first part of your question, it's hard to parse it out. So there are 2 elements really impacting UroLift growth. One is for sure the staffing shortages, in particular, in the office setting and the ASC setting. The hospitals are managing it much better than the other 2 sites of service, is my observation. And then the other element is the throughput of patients. We know the patient flow through the first half of the year was down 15% for urology patients going to the urologist. BPH as a condition is still very prevalent. So that will have to come back at some stage. And when we updated our guidance, we did not assume that any of those dynamics got any better in the back half of the year. We simply saw -- taking our run rate, we layered that into Q3, which is a very modest uptick on Q2. And then we just took the normal seasonality into Q4, and that's how we came to our guidance. Regarding the very first part of your question about April, May and June. Yes, April and May, April was pretty good. May was impacted by COVID with some canceled procedures, but it was still better than April. And then June was quite disappointing, as we saw that throughput of patients, additional staffing shortages and so on in June. So that was somewhat of a disappointment. Notwithstanding that, we still showed sequential improvement in UroLift from Q1 to Q2. And I think that gives us some encouragement that at least it's getting better quarter-on-quarter. The year-over-year comparisons are a little bit tougher depending on what was happening in the prior year.

You talked about, at your Analyst Day, to just an anticipation for 15% growth to the LRP. Just confidence in that today as you sit here. And as you think to what you saw in the market in April, does that sort of reinforce what's going on in the underlying market? I know there are questions in terms of canvas market, what is the true underlying growth rate? If you could strip out all of the other dynamics. So I would just love your thoughts on both of those points.

Yes. So the general urology market is only growing around 4%. But it's not about market growth for UroLift. It's about market conversion. There are 12 million men in America that have BPH. Our focus is the 1.5 million men in the drug dropout category. Those men have BPH. They tried therapy. The therapy did not work. And now they're suffering with the condition. They're getting up 6, 10 times a night to go to the bathroom, and they need something to address that. And UroLift is the best procedure, minimally invasive. You can go in on a Friday and get it done. You're sitting at your office on Monday morning with no side effects and immediate symptom relief, no sexual dysfunction, and so on and so forth. I think that if we look at the LRP, once the market recovers, yes, we should be able to get that business back to 15%. I think I'm really confident on the overall 6% to 7% growth of Teleflex because the durable core is doing a little bit better. So I think we have the ability. And now we've got Standard Bariatrics, which should add 50 basis points. So if the market takes a little bit longer to recover, we should be well able to cover any shortfall we might have there. And again, that's going to be accretive to Teleflex margins. So we'll still get the margin lift from that as we go through the LRP. We are watching very closely patient flow. It has gotten modestly better, but it's still negative as I sit here today. It's still 10% to 12% negative, not the 15% we saw in the first half of the year. We're getting a little bit better as we go through this year. And that should continue to improve in the fourth quarter and continue to improve in '23. That end market does need to improve for us to get to 15%.

Okay. And part of the underlying guidance, that 15% includes what you're doing outside the U.S. And Japan is one area that recent approval on the reimbursement side, and you've talked about kind of a ramp rate, following kind of in line with what we saw initially in the U.S. Does that continue beyond '22 to follow that same trajectory? Are there different dynamics that you could see, either pushing that down, accelerating it past what we saw in the U.S.? And as you think through the end of the LRP, what does the U.S. or U.S. mix look like at that point?

Yes. So I think that's the way we're looking at it. Nothing has changed. I think Japan was still at 1/3 of the size. We still follow the U.S. trajectory. It's the only predicate we have. And just to refresh everyone's memory, the U.S. went 5, 15, 50, 100, 200, 300. So at 1/3 of the size, you should see something similar. I will say that the launch in Japan has gone really well. I'm really happy with what we've done. I was there in Q2, met with a large number of urologists in Japan. And they are very enthusiastic for the technology. And our team there has done an exceptional job in launching the product. China will begin in Q4. So we have got our approval. Now in China, we will start at the private pay market. In Japan, we've got full reimbursement. So in China, we will start with the private pay market and then file for reimbursement and put it on all the national tenders a couple of years later and start to ramp within there. I think that I'm really encouraged by what I see going on in APAC. And I think APAC is going to be a significant driver of the overseas expansion of UroLift. Obviously, it's on a much lower base. So the percentage growth will be going to be much bigger than the United States. But it is part of our thesis that, that will help us get comfortably to that 15% growth in a normalized market condition within the United States.

At scale, Japan versus China, what's the greater opportunity for you?

So I think that if you look at the number of patients in each of the geographies, obviously, there's more patients in China. But if you look at access to the market, it's a lot easier to access the market right now in Japan because you have a single payer and you've got national coverage. So every urologist now in Japan can do a UroLift procedure and they will get reimbursed for it and the patient won't have an out-of-pocket expense. So I think from a reimbursement perspective, in the shorter term, I think Japan is the greater opportunity. I think once you get reimbursement, because there's a lot more men with BPH in China, that will, in the fullness of time, probably be an equal to, if not a larger opportunity.

Okay. I know we're almost out of time. Last question though. The BPH Summit that you've talked about, kind of starting to reengage. Can you just quickly talk through that? And as you think about just a recovering market, the ability to leverage that and drive an acceleration in growth.

Yes. So the BPH Summits are an excellent opportunity for us to engage with urologists. We normally stream them, so that we can have them now globally. That's the one good thing about COVID, we started streaming stuff in the same way as you're streaming this today. And that allows us to reach urologists all around the globe. And what it is, it's an opportunity to introduce them to the new technologies like UroLift 2, advanced tissue control, and reaffirm some of the elements around the UroLift, around the durability, represent to them the 35,000 study that demonstrates that UroLift is equal in durability to TURP and more durable than some of the other technologies that are out there. And it's a chance for us to reengage with new urologists who may be a little bit hesitant, for example, on doing a median lobe. And it is also an opportunity for us to introduce our virtual reality technology that we just announced recently, where a urologist in the United States will be able to proctor a urologist in China and demonstrate how the product works using the virtual reality platform that we're partnering with. So they are an exciting opportunity for urologists to get more educated on what truly the treatment options are for benign prostate hyperplasia and why UroLift is a better option.

Great. With that, I think we'll close. Thank you, Liam. Thank you, Larry, both for being here. I appreciate it.

Thanks.

Thank you.