Teleflex Incorporated (TFX) Earnings Call Transcript & Summary

Matt Taylor, Jefferies analyst here with Teleflex, Liam Kelly, CEO; Larry Keusch, who heads the IR function; and John Hsu also in IR in the audience. We've scheduled 30 minutes because of the weather, we're only going to do 10. I really wanted to turn up the heat on these guys. So just the hard-hitting questions from here out. Anyway, so we always start high level. So maybe just for folks that don't know, talk about Teleflex's strategy, how you've kind of constructed the portfolio, talk about some of the bits and pieces that you've put together to create some of these focus areas. And then what that does for your long-term growth and margin plans.

Yes. So we started with a core group of products within Teleflex. We began our journey in 2011. We were a diversified med tech company, and we became a pure-play medical device company. Back then, our growth rate was anything from minus 1% to plus 1%. Gross margins were 47% and our operating margins are around 18% or 19%. So what we began to do is put together a portfolio through a variety of stakes. So we started investing in R&D in order to increase the top line growth from the -- organically from the businesses that we had. We started to use our balance sheet to add assets to the company. And between 2011 today, we've added a number of scale transactions to Teleflex, the most notable in '17, where we added VSI, we added NeoTract. Then we added HBC, and we added Z-Medica. And we just recently did a tuck-in with a company called Standard Bariatrics. We have continued a restructuring program to augment our margins. We've been moving facilities from high-cost parts of the world to existing facilities in lower-cost parts of the world. And where we stand today is a company that has a 3-year plan to grow 5% to 6%. We're at close to 60% -- 67% pardon me. We have a company that's in the high 50s from a gross margin perspective, and we're in the high 20s from an operating margin perspective. So we've really transformed this business over time, and we have a balance sheet that's in really good shape. We really like to focus our investment in procedures within the acute setting that are single-use, that are high-value products within the hospital, that are in the area of clinical differentiation with the health care economics. So that's really been our strategy. We continue to execute on that. We continue to invest behind are -- in R&D and through M&A.

Great. So just following up on that. So help people understand a bunch of different businesses is a diversified growth model. But what are some of the power alleys for the company? What are the areas of focus and maybe ones where you might add to going forward?

Yes. So for us, we've got a number of business units. Some of the business units are faster growing than others. Obviously, a key business unit for us is our interventional urology, where the UroLift product sits. We bought that company in 2017. It had done $50 million the year before. It will do something in the region of $320 million this year. It's been a little bit impacted by staffing shortages in hospitals, and it's also being somewhat impacted by patient throughput in Urology Care. Then you look at our Interventional Access business, our Interventional Access business is a high-single, low double-digit grower accretive Teleflex margins. We have a portfolio of products within Vascular Access where we are market leader in central venous catheters that grows mid-single digits. And we have an OEM division that grows in the high single with good execution into the low double that continues to expand. So the portfolio works, if you were to try and sum up Teleflex in a word, you would -- or in a sentence, you would say we are in that kind of emergent care, nonpostponable care, which quite candidly should serve us well as we potentially head into tougher times and perhaps a recession. The bulk of our procedures are nonpostponable and therefore, in tough economic times, those sometimes procedures get postponed. It's very difficult to postpone a Teleflex procedure.

I want to dig into some of the divisions. But first, maybe you could just recap some of the highlights from recent results from Q3. Talk about what you think the key takeaways were there? And what are some of the hot topics coming out of Q3 that you heard from investors?

Yes. So we've met investors since Q3, I think we were happy with our Q3 performance. We were right in line with our revenue expectations and we beat on earnings per share. I think a few of the hot topics were supply chain disruption. Obviously, in the quarter, we had some impact from disruption. We had a few million dollars that didn't ship within the quarter in the Vascular and Interventional business. So that was an area of conversation. Another area of conversation is supply chain disruption and inflation. We continue to see that supply chain disruption. We continue to see some inflation within the marketplace. But I think that most investors focused on the fact that 88% of Teleflex performed really, really well within the quarter and performed really well throughout the year. And I think investors were pleased that ex UroLift, which is a little bit light within the quarter, ex-UroLift, the high-growth portfolio within Teleflex, which is 25% of our revenue in 2021 has been growing at 14%, and that bodes well for the future once we get UroLift back on track, that, that part of the portfolio is performing exceptionally well. And a lot of investors are really starting to dig in a little bit deeper into that high-growth portfolio.

Great. it's a good, so, I wanted to help people kind of disaggregate the growth algorithm into whether you want to do UroLift, ex-UroLift or maybe durable core, high-growth, Urolift. Can you help us kind of parse through those things and how you think they'll grow.

Yes. Well, in May, we laid out a long-range plan, which actually starts on January 1 of next year. And within that, we had 6% to 7% top line growth. I feel really confident that we'll be able to deliver that 6% to 7% CAGR over the 3-year horizon. We were going to expand our margins by 250 to 350 basis points on the gross line and 200 to 300 on the line, double-digit earnings per share growth and obviously deliver $1.7 billion in free cash flow. The building blocks to that top line growth was really around 3 key elements: the high-growth portfolio, which includes UroLift, which includes MANTA, includes PICCs, includes hemostats and intraosseous and will now include Standard Bariatrics going forward. That portfolio was to grow 14% to 15%. The durable core was to grow 4% to 5%. And then the other category, which is being impacted by the divestiture of the respiratory assets was to decline 6% to 7%. The divestiture of the respiratory assets will be complete at the end of 2023 and therefore, investors will be able to see the true underlying performance of the company. We've always said that within that high-growth portfolio, what makes it unique is that in all of the products in there are accretive to Teleflex's gross margin. So you get great leverage within the income statement when that high-growth portfolio continues to grow. And as I said earlier, ex UroLift through 3 quarters, it's growing in excess of 14%, right in line with our 14% to 15% that we laid out in our Analyst Day. So we feel that the high growth is doing well. Durable core is doing a little bit better than we had anticipated. We've laid it out 4% to 5% beginning next year. It's having a better year this year, it's closer to that 5% through 3 quarters, and we feel confident and there's some real -- we call it the durable core, but some excellent product categories within there. You've got our central venous catheters, you've got our OEM business within there. You've got our interventional -- a large part of our interventional portfolio within that and that gives us confidence that, that business will continue to grow over the LRP period.

Great. Why don't we spend a couple of minutes on your UroLift and talk about, first, some of the challenges that UroLift has seen to date this year, what you think is causing the declines in growth over the last 2 quarters. And then talk about your confidence in how that can return to growth later this year and into next year and over the LRP.

Yes. So I know what's causing it. I don't need to think about it. I know what's causing the pressure on UroLift right now. It's really 2 things. It is patient flow to urology practices. Patient flow to urology practices is down 20% since 2019. It was impacted by the pandemic, and it continues to be an overhang on the UroLift business. And the second impact is ultimately staffing shortages. What we've seen, in particular, in the United States where the vast, vast bulk of the UroLift revenue is in the United States. We have seen a lot of pressure on staffing conditions. Now the good news is that in quarter 3 in the rest of our business and also within UroLift, we saw it improve in the hospital side of service. That's a good omen for the future, because once it improves in the hospital side of service, in a quarter or 2 or so, it should begin to see an impact in the other 2 sites of service where we do UroLift namely the physician's office and the ASC. So we would anticipate that, that would start to improve. On top of that, we are beginning an international expansion for UroLift. So we've begun with Japan in April, and that launch is going very, very well. In Q4, we will do cases in China. The first cases will be done in China in this quarter right now, and we should get a reimbursement decision for France in this quarter. And beyond that, then we'll continue to roll it out in places like Brazil, Italy, Spain, India and Taiwan. So we will continue the globalization of this product. There is a massive, massive market out there with men suffering from BPH. It's a $6 billion market in the United States, and it's another $6 billion globally. So the end customer is significant. The opportunity is significant. It's just a question of getting that market dynamic and staffing issue addressed as we go through 2023 and beyond.

Maybe I could just ask a follow-up. So could you talk about the amount of improvement that you saw in the hospital and why that's a harbinger of improvement in other settings for UroLift?

Yes, because we know in the rest of our business in the hospital, we know what's happening within the hospital side of service, and we know that they are getting to groups that long last with that staffing impediment that they have. And why that is a bellwether for what should happen in the ASC in the office is because it's similar pools of talent. So as hospitals start to build out their staffing issues. It will have the ASC and the office get their staffing issues resolved. And the cost of contract labor in the hospital has come down fairly significantly from Q1 to Q3. The cost of a -- if a hospital recruits a nurse, and I'll just use a staff nurse as an example, it's normally around $50 or $60 an hour that you're paying for that type of labor. In Q1, the cost of a contract nurse was about $250. Right now, it's about $110 an hour. So it's really come back over that period of time, which is a good bellwether for supply in the math.

Okay. Okay. Before I transition to margins, I wanted to ask you, you have the high-growth portfolio. You've got some other areas that you highlighted that you think are good growth drivers. What's 1 or 2 underappreciated areas that you want to highlight for people that you think could be significant growth drivers over the next couple of years?

Well, there's a couple of business units in a region that I'd like to point out. So I think one of the most underappreciated assets within Teleflex is our OEM business. It's been growing high single, low double digits for the past number of years. It's accretive to our op margins. We have good line of sight into that channel and the opportunity. We bought a company called HPC, which brings us into the -- it's a complex steerable micro catheter that allows you to go into the EP and the neuro space which we haven't been able to play in before, and that continues to perform exceptionally well. The other business unit that I would point out would be the Interventional Access business unit, [ increased ] our margins, high single-digit growth, could do low doubles with good execution, and that's where we sell the MANTA product. And Asia is doing really well for us. Asia is growing high single, low double-digit growth, again, accretive to our margins. A lot of talk about volume-based procurement in China, I know that. We have a very differentiated part of our portfolio that we sell in China that I think should protect us against some of those volume-based procurement because there isn't competing products directly for our portfolio that we sell in China to disrupt us. So those are a few of the -- in the durable cohort that I would like to highlight, I guess.

Okay. Great. So I want to move on to margins. Let's talk first about so as you mentioned -- you've mentioned supply chain inflation, really hot topics. I want you to just first review what the pain points have been for Teleflex and how much that's been impacting your margins? And then we'll talk about how it could potentially improve.

Yes. I mean at the beginning of the year, Matt, I would have told you and I would have put it into 3 buckets. I would have said shipping costs, material costs, labor. Q3, as I sit here today, the 2 -- the top 2 have changed order, material costs, shipping costs and labor. Those are the 3 buckets of inflation. We started the year thinking it was going to cost us around 70 basis points in gross margin. Now it's going to cost us around 100 basis points. We outlined that in our Q3 calls already baked into our guidance. So we're offsetting some of that with pricing. So that's an option for us, and we continue to manage the environment as it is today. Q1, Q2, we were dealing with hands and toes of issues. That's how many we are dealing with. Right now, we're dealing with 5 big issues. There's about -- there's a shortage of Tyvek globally for medical device companies that everybody is being impacted by including Teleflex that should get resolved around Q2 of next year when the company brings on a new plant. So at least as line of sight to that disruption, and we continue to work through some of the other ones.

All right. And then I guess thinking about those buckets of shipping materials and labor, can you talk about when some of those things could stabilize/improve, how much they could improve? And what would that do kind of in a good and bad scenario to your margin progression?

So I think what we're seeing is shipping lanes begin to improve. We were -- in January, we were paying about $20,000 a container to move it from Asia to Europe or the United States. Right now, we're paying about $12,000 a container. So we've seen that improvement. If that continues, that will obviously help next year. It will help every company that's moving product around the world. From a material standpoint, some of that is linked to shipping costs because some of the resin costs went up because of the shipping costs. So there is a link there that should lag a couple of quarters. What you're going to see for every medical device companies, you're going to see continued inflation through Q1, because the inflation you see in Q4 gets capped enrolled into your inventory and it rolls off in Q1. And we'll continue to try and offset inflation with pricing. We had envisioned that we would do 50 basis points of price this year. Teleflex has always been a company, even in a nonpricing market, we'd always carve out 10 basis points of pricing. This year, we're coming in with planned 50, we're going to come in, in excess of 50. We'll do 50 easily. And as I sit here today, I think we'll probably be able to another 50 perhaps next year because the way it works, most of your tenders come up on 1/3, 1/3, 1/3. So we've impacted 1/3, it's another 1/3 next year and it's going to be another 1/3 in 2024.

Okay. All right. So I have just 2 follow-ups. So one on the inflation deflating, so some of the costs going down. Maybe talk about just how long that will take in terms of recontracting and then inventory rolling through with materials and freight. Do you start to see the benefit in Q2? Or is it more of a second half?

So the rolling off, you should see it in Q2. So you should burn through that inventory in the first quarter and to come through in Q2. The shipping costs, you should also -- you should begin to see that. If it continues on the current trajectory, you should continue to see that Q1, if it continues on the current trajectory. So I think that there are opportunities. But inflation is real. All this talk of it's transient, will wake up and in transient. It's there, and it's been there for a period of time. I think that -- but we are in a price positive market to try and offset that. And I think you'll see companies work to become more vertically integrated because if you're -- if you have a third-party vendor, that's normally where the inflation comes from. So I think we've got to walk that walk and then continue -- we're very vertically integrated, but I think we can even become more vertically integrated.

Great. Great. And then -- so on pricing, you've always had better pricing than most, I would say. And that's repeating here. But are you doing something differently than you've done in the past? You talked about next year getting positive price, but is it something that's durable and sustainable over many years?

So it's definitely durable and sustainable for next year and the year after because of the phenomenon of 1/3, 1/3, 1/3. It will depend on the environment thereafter. But as you said, we've always been able to carve out 10 or 20 basis points, even when everyone else was giving up pricing because it is a discipline. I've been doing this a long time. I can tell you, Matt, you know how many times the customer is calling me up and said, "Hey, Liam, you can send me through my price increase." Never. You got to go and ask for it. And that's the reality of life, you've got to go out there and you've got to walk that line where you don't damage the relationship or the volume, but there's a mutual agreement that we are in an inflationary environment, and therefore, there has to be some modest price taken.

All right. And then maybe switching gears, I wanted to talk a little bit about your capital allocation strategy. You talked a lot about the M&A and the value creation that's meant for you over time. Maybe just, a, review your capital allocation strategy overall. And then since M&A has been probably the biggest source of value creation, what are some of the ways that you look at M&A? What are some areas of interest? What are the filters that you use to look at that?

Yes. So when we look at capital allocation, obviously, internally, we look at our restructuring programs, we look at R&D investments in order to continue to build the company out and make it a better company. Again and again and again, with good clinical outcomes. The areas that we look in -- I mean, there's a few call points that I really like in Teleflex. I like the cath lab, unashamedly said that because you get better growth in the cath lab and you get better margins because you're basically moving a patient from an operating room to a day case procedure in a cath lab where the hospital is going to save money. I like our intensive care unit call point with the vascular business. I like our emergency medicine call point. I like our men's health call point. I like that urology call point. Probably want to get UroLift back to growth in the near term before we put something in there, but we should put something in there -- in the medium term because we've got an excellent channel into that urologist call point. So the good thing is we look broadly and in the -- in our zip code or we're shopping, we don't get the big companies coming down. We need $30 million for a percent of growth. Some of the big guys need $300 million per percent of growth. The assets we're buying of no interest to them, but it's really in our sweet spot. And don't ever underestimate the due diligence. That's a key part of the success of M&A. And just recently, we did present our scale transactions to our Board in our last Board meeting, and they were impressed by the actionability and the number of scale transactions that were available. I can't tell you when we're going to get one in the boat. But by God, we're fishing and we're fish and hard out there. And we're not going to rush. We're going to be disciplined. It's key for Teleflex, and we say this internally all the time. We don't get credit for M&A. We don't. We get credit for good M&A. That word is critically important that we're bringing something in, we've got to be the right acquirers, we've got to be the right assets. And if that happens in next month or if that happens next year, that's fine as long as it's the right asset for Teleflex.

Well, maybe talk about the most recent deal, the Standard Bariatrics deal. Why are you the right owner of that? Why is that strategic? And how does that fit with your portfolio?

So it's a great asset for Teleflex. Basically, it fits all of our criteria. It's got IP that runs to 2035. It fits within Teleflex because we already have a really strong bariatric call point with the rest of our surgical portfolio. We're going to double the sales force immediately selling that from what the company had what we have today, it's going to add $4 million or $5 million this quarter. It will add -- it will do $30 million to $35 million next year, and it's going to add 50 basis points of top line growth to Teleflex over a multiyear period. It will be accretive to our gross margins at the end of this year and to become accretive to our op margins thereafter. It's just a better mousetrap to deal with bariatric patients.

Great. Are we -- we still have 5 minutes or we're out of time, confused. There's a lot of people, but there's 4 minutes over there. Just checking. Okay. Cool. So let's talk about divestitures and portfolio pruning. So you got a way of respiratory, you've done a lot of that shaping over time. What things are left in the portfolio that you might want to prune? And how do you look at things from a divestiture perspective as well?

Yes. Well, we constantly look at our portfolio. As part of our strategic cycle, we will look at our overall portfolio. Right now, I would tell you, I'm more of a buyer than a seller. I would like to bring in an asset into Teleflex and then look at the jigsaw again and see with that asset in Teleflex, what belongs, what doesn't belong. And for all the portfolio managers in here, it's not like being a portfolio manager. You can't sell one company and buy Teleflex. It takes time to get an asset ready and to move it out of the company. We're vertically integrated, so that does take time. But right now, I think the sale of the respiratory assets was strategically important because it showed that we weren't afraid to prune to grow. At the time we sold it, we wouldn't get the same valuation today that we've got for the time that we sold it. So our timing was good. And right now, I think we look at our overall portfolio, we would -- I would like to bring in an asset before I would look at the overall portfolio of Teleflex at that stage.

And you brought up a couple of interesting points about your OEM business and that's brought you into neuro and EP and you talked about vertical integration. So I guess, I had two questions: one is, does having the OEM business and having your tentacles in some of these other markets give you a strategic motivation to perhaps move in to some of those markets? Or what are the other ways that you are thinking about vertical And you brought up a couple of interesting points about your OEM business, and that's brought you into neuro NEP, and then you talked about vertical integration. So I guess I have 2 questions. One is, does having the OEM business and having your tentacles in some of these other markets give you a strategic motivation to perhaps move into some of those markets? Or what are the other ways that you're thinking about vertical integration that we could actually see happen in the next couple of years?

It gives us an opportunity to have an understanding as to how those markets work and where the technologies are moving. So for example, our OEM business does a lot of interventional cardiology catheters and that type of thing. That was really helpful when we were looking at acquiring VSI. We had an intricate knowledge of that market segment without having a huge footprint within that market segment. And potentially in the future, it might help us in other areas that we may want to go into. And that's why I love that business because we get an insight into markets that we don't have a branded product in today that may potentially be of interest to us in the future.

Great. And then aside from that, what are some of the other ways that you might leverage vertical integration in the future? Do you have any thoughts or plans that you could share there? What are some of the ways you're already vertically integrated? And how could you further press on that pedal?

So our manufacturing is incredibly vertically integrated. But we do have some further opportunities out there that could work in our advantage. All of the products that we focus on within the high-growth portfolio that we mentioned already, UroLift is completely vertically integrated hemostats are completely vertically integrated the picks are vertically integrated. So we do want to control our own destiny. And if anything, this supply chain disruption has told us, that's a really good place to be -- to be in control of your own destiny as a company. And are there potential opportunities out there? There are potential opportunities to go even further with some of the other portfolio.

Okay. Great. I think we're about out of time. We should probably end there. But Liam, thanks so much for your time. Larry, thanks a lot for joining us, and thanks for your attention.

Thank you very much.