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TFX > SEC Filings for TFX > Form 10-K on 24-Feb-2014All Recent SEC Filings

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Form 10-K for TELEFLEX INC


24-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are a global provider of medical technology products that enhance clinical benefits, improve patient and provider safety and reduce total procedural costs. We primarily design, develop, manufacture and supply single-use medical devices used by hospitals and healthcare providers for common diagnostic and therapeutic procedures in critical care and surgical applications. We sell our products to hospitals and healthcare providers in more than 150 countries through a combination of our direct sales force and distributors. Because our products are used in numerous markets and for a variety of procedures, we are not dependent upon any one end-market or procedure.

We categorize our products into four groups: Critical Care, Surgical Care, Cardiac Care and Original Equipment Manufacturer and Development Services ("OEM"). Critical Care, representing our largest product group, includes medical devices used in vascular access, anesthesia, respiratory care and specialty markets; Surgical Care includes surgical instruments and devices; and Cardiac Care includes cardiac assist devices and equipment. OEM designs and manufactures instruments and devices for other medical device manufacturers.

Effective January 1, 2014, we realigned our operating segments. The Vascular, Anesthesia/Respiratory and Surgical businesses, which previously comprised much of the Americas operating segment, are now separate operating segments. Additionally, the Company made changes to the allocation methodology of certain costs, including manufacturing variances and research and development costs, among the businesses to improve accountability. Because the change in segment reporting structure became effective in the first quarter of 2014, the segment information presented in this document does not reflect this change.

Through an extensive acquisition and divestiture program, we have significantly expanded our presence in the medical technology industry, while divesting all of our businesses serving the aerospace, automotive, industrial and marine markets. The following is a listing of our more significant acquisitions and divestitures that have occurred since the beginning of 2011. With respect to divested businesses listed below, we have reported results of operations, cash flows and
(gains) losses on the disposition of these businesses as discontinued operations for all periods presented. See Note 18 to the consolidated financial statements included in this Annual Report on Form 10-K for additional information regarding our significant divestitures.

Medical Device Business Transactions

December 2013 - Acquired Vidacare Corporation, a provider of intraosseous, or inside the bone, access devices ("Vidacare"), which complements the vascular access and specialty product portfolios;
June 2013 - Acquired the assets of Ultimate Medical Pty. Ltd. and its affiliates, a supplier of airway management devices with a full range of laryngeal mask airways, which complements our anesthesia product portfolio;
June 2013 - Acquired Eon Surgical, Ltd., a developer of a minimally invasive microlaparoscopy surgical platform technology designed to enhance a surgeon's ability to perform scarless surgery while producing better patient outcomes, which complements our surgical care product portfolio;
October 2012 - Acquired substantially all of the assets of LMA International N.V. (LMA), a global provider of laryngeal masks whose products are used in anesthesia and emergency care, which enhanced our anesthesia product portfolio.
2012 - Completed four late-stage technology acquisitions in furtherance of our strategy to invest in new technologies and research and development to support our future growth.


We may be required to pay contingent consideration in connection with some of the acquisitions listed above. The amount of contingent consideration we ultimately will pay will be based upon the achievement of specified objectives, including regulatory approvals and sales targets. For additional information on the contingent consideration, see Note 3 to the consolidated financial statements included in this Annual Report on Form 10-K.

Former Aerospace Segment Divestiture

In December 2011, we sold the cargo systems and container businesses for approximately $280 million and realized a gain of $126.8 million, net of tax.

Former Commercial Segment Divestiture

In March 2011, we sold the marine businesses that were engaged in the design, manufacture and distribution of steering and throttle controls and engine and drive assemblies for the recreational marine market, heaters for commercial vehicles and burner units for military field feeding appliances for $123.1 million, consisting of $101.6 million in cash, net of $1.5 million of cash included in the marine business as part of the net assets sold, plus a subordinated promissory note in the amount of $4.5 million (which has subsequently been repaid in full) and the assumption by the buyer of approximately $15.5 million in liabilities related to the marine business. We realized a gain of $57.3 million, net of tax benefits, in connection with the sale.

Looking ahead, our strategy is to continue to be opportunistic and focus our attention on adding a combination of technology and strategic acquisitions to further strengthen our existing product portfolio within the medical technology industry. Additionally, we will continue to identify opportunities to expand our margins by evaluating our existing product portfolio and shedding product lines that do not meet our financial criteria as well as optimizing our overall facility footprint to further reduce our cost base.

Health Care Reform

On March 23, 2010 the Patient Protection and Affordable Care Act was signed into law. This legislation will have a significant impact on our business. For medical device companies such as Teleflex, the expansion of medical insurance coverage should lead to greater utilization of the products we manufacture, but this legislation also contains provisions designed to contain the cost of healthcare, which could negatively affect pricing of our products. In addition, commencing in 2013, the legislation imposes a 2.3% excise tax on sales of medical devices. For the year ended December 31, 2013, we paid medical device excise taxes of $11.5 million, which is included in selling, general and administrative expenses.

Global Economic Conditions

Global economic conditions have had adverse impacts on market activities including, among other things, failure of financial institutions, falling asset values, diminished liquidity, and reduced demand for products and services. In response, we adjusted production levels and engaged in new restructuring activities and we continue to review and evaluate our manufacturing, warehousing and distribution processes to maximize efficiencies through the elimination of redundancies in our operations and the consolidation of facilities. Although, on a consolidated basis, the economic conditions did not have a significant adverse impact on our financial position, results of operations or liquidity, healthcare policies and practice trends vary by country, and the impact of the global economic downturn was felt to varying degrees in each of our regional markets over the last three years. The continuation of the present broad economic trends of weak economic growth, constricted credit and public sector austerity measures in response to growing public budget deficits could adversely affect our operations and our liquidity.

Hospitals in some regions of the United States experienced a decline in admissions, a weaker payor mix, and a reduction in elective procedures. Hospitals consequently took actions to reduce their costs, including limiting their capital spending. Distributors in the supply chain generally have reduced inventory levels and have not replenished inventories to pre-recession levels. The impact of these actions is most pronounced in capital goods markets, which affected our surgical instrument and cardiac assist businesses. More recently, the economic environment has improved somewhat, but has not returned to pre-recession levels, and challenges persist, particularly in some European countries, as discussed below. Approximately 92 percent of our net revenues come from single-use products primarily used in critical care and surgical applications, and our sales volume could be negatively impacted if hospital admission rates or payor mix change as a result of continuing high unemployment rates (and subsequent loss of insurance coverage by consumers). Conversely, our sales volume could be positively impacted if there are additional insured individuals resulting from the Patient Protection and Affordable Care Act.


In Europe, some countries have taken austerity measures due to the current economic climate. Elective surgeries have been delayed and hospital budgets have been reduced. In certain countries (mainly Germany) we have seen changes in the local reimbursement to home care patients and pricing impacts on business awarded through the tendering process. These markets have introduced more buying groups and group purchasing organizations, or GPOs, resulting in reductions in commodity product pricing. It is possible that funding for publically funded healthcare institutions could be affected in the future as governments make further spending adjustments and enact healthcare reform measures to lower overall healthcare costs. The public healthcare systems in certain countries in Western Europe, most notably Greece, Spain, Portugal and Italy, have experienced significantly reduced liquidity due to recessionary conditions, which has resulted in a slowdown in payments to us. We believe this situation will continue and may worsen unless and until these countries are able to find alternative means of funding their respective public healthcare sectors.

In Asia, recovery from the global recession has varied by country. China has announced plans for major healthcare investment targeted at second tier cities and hospitals, which may provide future growth opportunities for us, while slow economic growth and continued pursuit of reimbursement cuts by the public hospital sector in Japan is expected to limit growth in that market.

Results of Operations

The following comparisons exclude the impact of discontinued operations (see Note 18 to the consolidated financial statements included in this Annual Report on Form 10-K and "Discontinued Operations" in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" for discussion of discontinued operations). Discussion of constant currency excludes the impact of translating the results of international subsidiaries at different currency exchange rates from year to year. Certain financial information is presented on a rounded basis, which may cause minor differences.

Revenues

Information regarding net revenues by product group is provided in the following
table:



                                      Year Ended December 31                 % Increase/(Decrease)
                                 2013          2012          2011        2013 vs 2012     2012 vs 2011
                                        (Dollars in millions)
Critical Care                $   1,182.7   $   1,040.3   $   1,005.4             13.7              3.5
Surgical Care                      306.5         291.1         276.9              5.3              5.1
Cardiac Care                        75.9          79.4          80.6             (4.5 )           (1.5 )
OEM and Development Services       131.2         140.2         129.6             (6.5 )            8.2

Net Revenues                 $   1,696.3   $   1,551.0   $   1,492.5              9.4              3.9


The following table presents the percentage increases or decreases in product group net revenues during the years ended December 31, 2013 and 2012 compared to the respective prior years on a constant currency basis, the impact of foreign currency fluctuations on those revenues and the total increase or decrease in net revenues for the periods presented:

                                                             % Increase/ (Decrease)
                                            2013 vs 2012                              2012 vs 2011
                                 Constant     Currency                     Constant     Currency
                                Currency(1)    Impact    Total Change     Currency(1)    Impact    Total Change
Critical Care                          13.4        0.3           13.7             6.5       (3.0 )          3.5
Surgical Care                           4.5        0.8            5.3             7.9       (2.8 )          5.1
Cardiac Care                           (4.1 )     (0.4 )         (4.5 )           2.4       (3.9 )         (1.5 )
OEM and Development Services           (7.0 )      0.5           (6.5 )           9.5       (1.3 )          8.2

Total Change                            9.0        0.4            9.4             6.8       (2.9 )          3.9

(1) Constant currency is a non-GAAP financial measure that measures the change in net revenues between current and prior year periods by excluding the impact of translating the results of international subsidiaries at different currency exchange rates from period to period. The constant currency increase/decrease percentage is calculated by translating the prior year period's local currency net revenues into an amount reflecting the current year period's foreign currency exchange rates and calculating the percentage difference between net revenues for the current year period and net revenues for the prior year period. Management believes this measure is useful to investors because it eliminates items that do not reflect our day-to-day operations. In addition, management uses this financial measure for internal managerial purposes, when publicly providing guidance on possible future results, and to assist in our evaluation of period-to-period comparisons. This financial measure may not be comparable to similarly titled measures used by other companies, is presented in addition to results presented in accordance with GAAP and should not be relied upon as a substitute for GAAP financial measures.

Comparison of 2013 and 2012

Net revenues for the twelve months ended December 31, 2013 increased 9.4% to $1,696.3 million from $1,551.0 million in the twelve months ended December 31, 2012. The $145.3 million increase in net revenues is largely due to the businesses acquired during 2012 and 2013, which generated net revenues of approximately $121.1 million in 2013, including approximately $110.3 million generated by the LMA business. Net revenues further benefited from new products ($19.2 million) primarily in the Americas, EMEA and OEM, price increases ($15.2 million) in the Americas, EMEA and Asia, volume gains in Asia ($9.3 million) and EMEA ($1.3 million) and the favorable impact of foreign currency exchange rates ($5.7 million). These increases were partly offset by volume declines in the Americas ($14.7 million), in anesthesia, respiratory, vascular, surgical and cardiac products, and OEM ($11.8 million), primarily on lower sales of catheters and performance fibers.

Critical Care net revenues increased 13.7% in 2013 to $1,182.7 million from $1,040.3 million in 2012. On a constant currency basis, net revenues increased 13.4% over the corresponding prior year period. The increase in net revenues for the twelve months ended December 31, 2013 was due primarily to higher sales of anesthesia products as well as higher sales of vascular, urology and interventional access products. The growth in sales of anesthesia products was primarily related to the acquisition of the LMA business. The increase in net revenues for the twelve months ended December 31, 2013 was partially offset by a decline in sales of respiratory products.

Surgical Care net revenues increased 5.3% in 2013 to $306.5 million from $291.1 million in 2012. On a constant currency basis, net revenues increased 4.5% over the corresponding prior year period. The increase in net revenues for the twelve months ended December 31, 2013 was due to higher sales of ligation, suture and access products, partially offset by a decline in sales of general surgical instrument products.

Cardiac Care net revenues decreased 4.5% to $75.9 million in 2013 from $79.4 million in 2012. On a constant currency basis, net revenues decreased 4.1% over the corresponding prior year period. The decrease in net revenues for the twelve months ended December 31, 2013 was primarily due to a decline in sales of intra-aortic balloon pumps.

OEM net revenues decreased 6.5% to $131.2 million in 2013 from $140.2 million in 2012. On a constant currency basis, net revenues decreased 7.0% over the corresponding prior year period. The decrease in net revenues for the twelve months ended December 31, 2013 was due to a decline in sales of catheter, extrusion and performance fiber products.

Comparison of 2012 and 2011

Net revenues increased 3.9% in 2012 to $1,551.0 million from $1,492.5 million in 2011. The $58.5 million increase in net revenues was largely due to higher volume (approximately $39.7 million), reflecting core growth in all segments,


acquisitions (approximately $25.3 million), primarily from our acquisition of LMA (approximately $24.4 million), price increases (approximately $18.6 million) across all segments and new products (approximately $17.5 million) in North America and EMEA. These increases were partly offset by the $42.3 million unfavorable impact of foreign currency exchange rates in 2012.

Critical Care net revenues increased 3.5% in 2012 to $1,040.3 million from $1,005.4 million in 2011. Excluding the impact of foreign currency exchange rates, net revenues increased 6.5% over the corresponding prior year period. The increase in net revenues was due to higher sales of vascular access, anesthesia, urology and respiratory products.

Surgical Care net revenues increased 5.1% in 2012 to $291.1 million from $276.9 million in 2011. Excluding the impact of foreign currency exchange rates, net revenues increased 7.9% over the corresponding prior year period. The increase in net revenues was due to higher sales of ligation, general surgical instrument and closure products.

Cardiac Care net revenues decreased 1.5% in 2012 to $79.4 million from $80.6 million in 2011. Excluding the impact of foreign currency exchange rates, net revenues increased 2.4% over the corresponding prior year period. The increase in net revenues was due to higher sales of intra-aortic pumps and catheters.

OEM net revenues increased 8.2% in 2012 to $140.2 million from $129.6 million in 2011. Excluding the impact of foreign currency exchange rates, net revenues increased 9.5% over the corresponding prior year period. The increase in net revenues was due to higher sales of specialty suture and catheter fabrication products.

Gross profit

                                           2013       2012      2011
                                             (Dollars in millions)
                 Gross profit           $  838.9    $ 748.2   $ 708.8
                 Percentage of revenues     49.5 %     48.2 %    47.5 %

Comparison of 2013 and 2012

For the twelve months ended December 31, 2013, gross profit as a percentage of revenues increased 130 basis points compared to the corresponding prior year period. The increase is principally due to the inclusion of higher margin sales from the LMA and Vidacare businesses, price increases in the Americas, EMEA and Asia, new products in the Americas, EMEA and OEM, manufacturing efficiencies in EMEA and OEM and the favorable impact of foreign currency exchange rates. In addition, gross profit in the 2012 period was adversely affected by inventory write-offs for excess, slow moving and damaged product in Asia. These benefits were partly offset by higher warehousing and freight costs in the Americas, EMEA and Asia, lower volumes in the Americas and OEM and higher product costs in the Americas and Asia.

Comparison of 2012 and 2011

For the twelve months ended December 31, 2013, gross profit as a percentage of revenues increased 70 basis points compared to the corresponding prior year period. The increase is primarily due to price increases in all segments and lower manufacturing costs in North America. In addition, 2011 gross profit reflected charges related to a stock keeping unit ("SKU") rationalization program we implemented to eliminate SKUs that provided low sales volume or insufficient margins to help improve future profitability. The increases were partly offset by the unfavorable impact of foreign currency exchange rates, higher manufacturing costs in EMEA and inventory write-offs for excess and slow moving product and damaged product in Asia.

Selling, general and administrative

                                                  2013       2012      2011
                                                    (Dollars in millions)
           Selling, general and administrative $  502.2    $ 454.5   $ 423.9
           Percentage of revenues                  29.6 %     29.3 %    28.4 %


Comparison of 2013 and 2012

Selling, general and administrative expenses increased $47.7 million during the twelve months ended December 31, 2013 compared to the twelve months ended December 31, 2012. The increase is largely due to expenses associated with the businesses acquired ($36.4 million), including $29.6 million in expenses associated with the LMA business, the excise tax associated with the Patient Protection and Affordable Care Act ($11.5 million), higher employee related expenses, increased costs associated with the conversion of several of our locations to a new enterprise resource planning system ($4.2 million), acquisition costs ($3.2 million) primarily related to the acquisition of Vidacare in the fourth quarter 2013, higher legal costs ($5.8 million) due to increases in the legal reserve resulting from new developments during the year related to certain ongoing litigation, including a verdict against us with respect to a non-operating joint venture, and professional fees and the impact of foreign currency exchange rates ($1.1 million). The increases were partly offset by $12.3 million reversals of contingent consideration related to the acquisitions of Hotspur Technologies Inc. ("Hotspur") ($8.5 million), Semprus BioSciences Corp. ("Semprus") ($2.4 million) and the assets of Axiom Technology Partners LLP ("Axiom") ($1.4 million) after determining that certain conditions for the payment of certain contingent consideration would not be satisfied. Selling, general and administrative expenses in 2012 also reflected the loss of $7.6 million from foreign currency forward exchange contracts entered into in anticipation of the acquisition of the LMA business.

Comparison of 2012 and 2011

Selling, general and administrative expenses increased $30.6 million in 2012. The increase is primarily due to higher general and administrative costs across all segments, principally with respect to higher employee related costs ($15.1 million), incremental operating expenses associated with the businesses acquired ($14.7 million), a $7.6 million loss on foreign currency forward exchange contracts entered into in anticipation of the acquisition of the LMA business, acquisition related costs ($7.2 million) and higher selling costs ($4.8 million), generated by increased revenue and support of new products. These increases were partly offset by favorable foreign currency exchange rates ($11.1 million). In addition, 2011 expenses included increases in the valuation allowance with respect to the Greek government bonds that we received in 2011 in settlement of trade receivables due to us from sales to the public hospital system in Greece ($4.5 million); approximately $2.2 million of net separation costs for our former CEO (comprised of $5.5 million of payments under his employment agreement, less approximately $3.3 million of stock option and restricted share forfeitures) and increases in litigation reserves ($1.7 million).

During the third quarter of 2012, we entered into forward exchange contracts for Singapore dollars and US dollars in anticipation of the acquisition of the LMA business. In accordance with FASB guidance, a forecasted transaction is not eligible for hedge accounting if the forecasted transaction involves a business combination. Therefore, gains and losses relating to this arrangement were recognized as incurred. We realized a pre-tax loss of $7.6 million upon settlement of the forward exchange contracts.

Research and development

                                            2013         2012      2011
                                              (Dollars in millions)
                Research and development $   65.0     $   56.3   $ 48.7
                Percentage of revenues        3.8 %        3.6 %    3.3 %

Comparison of 2013 and 2012

The increase in research and development expenses is primarily due to the businesses acquired in 2012.

Comparison of 2012 and 2011

The increase in research and development expenses in 2012, compared to 2011, principally reflects continued investment in the new technologies obtained in the second quarter of 2012 through acquisitions and increased investments related to vascular products in North America.

Goodwill impairment

In the first quarter 2012, we changed our North America reporting unit structure from a single reporting unit to five reporting units comprised of Vascular, Anesthesia/Respiratory, Cardiac, Surgical and Specialty. We allocated the assets and liabilities of our North America Segment among the new reporting units based on their respective operating activities,


and then allocated goodwill among the reporting units using a relative fair value approach, as required by FASB Accounting Standards Codification ("ASC") Topic 350.

Following this allocation, we performed goodwill impairment tests on these new reporting units. As a result of these tests, we determined that three of the reporting units in our North America Segment were impaired, and, in the first quarter of 2012, we recorded goodwill impairment charges of $220 million in our Vascular reporting unit, $107 million in our Anesthesia/Respiratory reporting unit and $5 million in our Cardiac reporting unit in the first quarter of 2012.

Restructuring and other impairment charges

                                                       2013         2012       2011
                                                          (Dollars in millions)
     LMA restructuring program                      $   12.2    $      2.5   $    -
     2013 restructuring charges                         10.2             -        -
     2012 restructuring charges                          4.2           2.4        -
     2011 restructuring program                          0.8             -      3.0
     2007 Arrow integration program                      0.2          (1.9 )    0.5
     In-process research and development impairment      7.4             -        -
. . .
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