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Good day, ladies and gentlemen, and welcome to Q2 Teleflex Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference is being recorded.
I would now like to introduce our host for today's conference, Mr. Jake Elguicze, Treasurer and Vice President of Investor Relations. Sir, you may begin.
Good morning, everyone and welcome to the Teleflex Incorporated second quarter 2018 earnings conference call. The press release and slide to accompany this call are available on our website at www.teleflex.com. As a reminder, this call will be available on our website and a replay will be available by dialing 855-859-2056 or for international calls, 404-537-3406, passcode 4890067.
Participating on today's call are Liam Kelly, President and Chief Executive Officer and Thomas Powell, Executive Vice President and Chief Financial Officer. Liam and Tom will provide prepared remarks and then we'll open up the call for Q&A.
Before we begin, I'd like to remind you that some of the matters discussed in the conference call will contain forward-looking statements regarding future events as outlined in our slides. We wish to caution you that such statements are, in fact, forward-looking in nature and are subject to risks and uncertainties and actual events or results may differ materially. The factors that could cause actual results or events to differ materially include, but are not limited to, factors referenced in our press release today as well as our filings with the SEC, including our Form 10-K which can be accessed on our website.
With that, I'd like to turn the call over to Liam.
Thank you, Jake, and good morning everyone. During the second quarter, Teleflex revenue grew 15.4% on an as-reported basis and 12.4% on a constant currency basis. The constant currency revenue growth rate we achieved in the quarter continued to be fueled by our two most recent completed scale acquisitions, NeoTract and Vascular Solutions.
We continue to invest behind businesses such as these that bring higher growth potential, are going to benefit most from demographics and augment our margin profile long term. To that end, I am pleased to report that NeoTract continued its strong momentum, delivering $47.7 million in revenue, which is an increase of approximately 58% as compared to the prior year period.
During the quarter, we were very pleased to see that the prostatic urethral lift, PUL, procedure was included in the most recently provided AUA Guidelines as a standard of care for the treatment of benign prostate hyperplasia (sic) [benign prostatic hyperplasia] (00:02:55). In addition, findings from independent analysis performed in the UK confirmed the cost effectiveness of UroLIft as compared to surgery.
Turning to Vascular Solutions, quarter two revenue reached $52.6 million, which represents an increase of approximately 17% as compared to the prior year period. We were very pleased to see that Vascular Solutions worldwide revenue grew at such a robust rate, driven by strength in both North America and EMEA, thanks in part to several distributor conversions which were completed as we exited 2017.
As you may recall, part of Teleflex's acquisition criteria is to leverage our established O.U.S. infrastructure. This was an opportunity that we highlighted when we announced the deal and we remain confident in the continued performance of VSI globally.
However, not everything in the quarter met our expectations, as our organic shipping day adjusted revenue growth rate took a step back from the level achieved during the first quarter of the year. Investors familiar with the Teleflex story understand that we are subject to ebbs and flows in our distributor ordering pattern. At times, these patterns have proven difficult to predict with accuracy and we believe them to be temporary and do not cause us concern as to our 2018 goals or our longer-term outlook.
We are obviously disappointed to have seen this occur, as up until very late in the quarter ordering trends pointed to a sequential improvement. Unfortunately, due to some temporary unpredictable issues associated with the timing of distributor orders in advance of the July 4 holiday and certain product constraints from suppliers, that did not occur. Importantly though, during the quarter we saw positive end customer tracing data and we do not believe that second quarter core organic growth rate represents a trend.
In fact, I can tell you that during the month of July, orders and revenue rebounded nicely, as distributors bought in significantly during the first week of the month. That coupled with a few other factors is why we continue to believe that we will grow our revenue on a constant currency basis between 12% and 13%, including full year organic revenue growth of between 5% and 5.5%. In a few moments, I will bridge for you how we get there.
Turning to some other key metrics, during the quarter our adjusted gross and operating margins continued to expand, reaching 57.1% and 26%, respectively. The 120 basis point improvement in gross margin and the 90 basis point improvement in operating margin is a testament to the leverage that can be driven within our income statement.
Finally, this culminated into adjusted earnings per share of $2.47, which is an increase of 21.1% over second quarter 2017. And despite foreign currency exchange rates being less favorable as compared to when we last provided guidance, we continue to have confidence in our ability to achieve our previously provided full year adjusted EPS guidance range of between $9.70 and $9.90 per share.
With that as an overview, let's now look at quarter two revenues in more detail. Second quarter 2018 revenue totaled $609.9 million, which is an increase of 12.4% on a constant currency basis. Beginning with the components of organic revenue growth; during quarter two, we saw organic constant currency revenue growth of 3.6%. This included a benefit of approximately 1% from one additional shipping day.
So, on a shipping day adjusted basis, we estimate our organic constant currency revenue growth was approximately 2.6%. This day adjusted organic growth consisted of 1.7% from new product introduction, 80 basis points from legacy product volumes, and positive pricing adding about 70 basis points. These positive contributors were partially offset by the surgical product exit which negatively impacted quarter two growth by about 60 basis points.
Moving to the contribution we received from acquisitions, this quarter was all NeoTract, which added 8.8%. In fact, NeoTract revenue would have been even higher in quarter two had it not been for a product supply issue, as towards the end of June, we made a proactive change to one of the molds associated with the UroLift device. Because of this change, in a small number of cases we began to see the needle inserted into the prostate and retracted normally, but no implant deployed.
A limited number of devices in the field were impacted and in the interest of the excellent reputation of UroLift, we made the decision to withdraw these products from customers. We have not seen any impact from any UroLift implants that were deployed. We since returned to using the original mold; however, some cases were delayed during the end of June because of this issue, most of which have been rescheduled for the third quarter of 2018.
We are extremely proud of how quickly we were able to act to rectify this issue, and have been very pleased with the near universal physician support for our handling of the process. And while this is something you never want to happen, it has in no way altered the short- or long-term demand for UroLift, and we feel confident in our ability to meet that demand.
Given the performance for the first six months of 2018 as well as our expectations for the remainder of the year, we are increasing our revenue expectation for NeoTract. Previously, we said that NeoTract would grow at least 40% over 2017 levels and that it would add approximately 50 basis point to our full year organic constant currency growth rate. We now expect that NeoTract will grow approximately 50% over 2017 levels, and it will add approximately 75 basis points towards our full year organic constant currency revenue growth rate.
Turning next to our revenue performance by segment; Vascular North America second quarter revenue increased 1.4% on a constant currency basis to $80.1 million. When normalizing for the shipping day impact, we estimate that Vascular revenue growth was flat in the quarter. This was primarily due to the timing of orders and we expect this to come back in the second half of the year.
Moving to Interventional North America, second quarter revenue was $65 million, which is an increase of approximately 11.3% on a constant currency basis. When normalizing for the shipping day impact, we estimate that Interventional revenues grew approximately 9.5%. The increase here is primarily the result of Vascular Solutions product as well as growth in our OnControl and AC3 product line.
Turning to Anesthesia North America, second quarter revenue was $50.5 million, which is an increase of 2.7%. When normalizing for the impact of shipping days, we estimate that revenue growth within our Anesthesia segment was approximately 1%.
Shifting to our Surgical North America business, its revenue decreased 9.2% on a constant currency basis to $40.7 million. When normalizing for the shipping day impact, we estimate that Surgical revenues would have declined 10.6%. Like Q1, the decrease in Surgical revenues was primarily due to the exit of a lower margin product line in the third quarter of 2017 as well as some supplier constraints.
As we look forward into the second half of 2018, we expect that our Surgical business will be approximately flat on a constant currency basis. The improvement in the second half of 2018 as compared to the first half is primarily due to the easing of the comps associated with the product line exit.
Moving to our overseas operations, second quarter EMEA revenues were up 2.8% to $153.4 million. Within this growth rate, M&A contributed approximately 80 basis points. When normalizing for the impact of M&A and shipping days, we estimate that organic revenue growth within this segment would have been 1.2%.
Now to Asia; our second quarter revenue increased 5.9% on a constant currency basis to $72.4 million. Within this growth rate, M&A contributed approximately 1.5%. When normalizing for the impact of M&A, organic revenue growth within this segment was 4.4%. Shipping days did not have an impact on this segment. Organic growth in this segment was led by China, whose revenues expanded 22% and this was largely driven by an increase in volumes following our decision to take our business direct last year.
Next, I'd like to brief you on our OEM segment. During the second quarter, revenue was up approximately 14.9% and reached $52.6 million. When normalizing for the shipping day impact, we estimate that the increase in OEM revenue would have been 14.5%. The increase in OEM revenue was all organic and was due to higher sales volume of existing products.
And lastly, second quarter revenue for the businesses within our All Other category was up 98.6% on a constant currency basis, totaling $95.2 million. Growth here is primarily attributable to the acquisition of NeoTract and to a lesser extent, our Latin American business which grew approximately 11.5%. Also during the quarter, we signed a total of 16 GPO and IDN agreements, of which 7 were new agreements. That completes my comments on quarter two revenue performance.
Turning to a brief update on UroLift. During the quarter, the product saw numerous milestones from a society and clinical evidence perspective. First, we were thrilled that the PUL procedure was included in the updated AUA Guidelines announced during the association's annual meeting in late May. Not only did the AUA recommends the PUL procedure as part of the standard of care for BPH, it also included favorable language that physicians should consider PUL as a potential treatment for men with benign prostate hyperplasia (sic) [benign prostatic hyperplasia] (00:14:05).
This is especially important for men who want to avoid sexual dysfunction, as UroLift remains the only minimally invasive treatment option that has been shown to provide rapid and durable symptom and urinary flow rate improvement without inducing sustained sexual dysfunction.
We also had several meaningful posters and presentations at AUA, highlighting the expanded body of clinical evidence for UroLift, and further extending its leadership as one of the most studied treatments for BPH and, indeed, one of the most studied treatments in urology. An independent analysis of UroLift in the UK using actual NHS data highlighted the cost effectiveness and improved quality of life associated with UroLift as compared to TURP.
Post-surgery complications, including urinary tract infections and blood transfusions, are expensive complications of TURP and other tissue destructive procedures. The UroLift system offers men a new minimally invasive option that reduces the occurrence of these significant side effects, demonstrating a predicted savings of approximately ÂŁ27 million per year over five years for each annual cohort of patient.
While the one-year MedLift study, on which the approval of median lobe indications was based, demonstrated safety and efficacy consistent with the LIFT study, including no instance of de novo, sustained sexual dysfunction, there was a significant IPSS improvement, low retreatment rate, and adverse events were mild to moderate.
And lastly, a thought leading urologist presented a predictors of response analysis of the LIFT randomized study, which measured the outcomes of patients in two categories. Those who had a UroLift earlier in the BPH disease progression, while bladder function was still preserved, and those who had a UroLift later in the disease progression after bladder function had been compromised.
The study showed that earlier intervention with UroLift helps to preserve the bladder from deteriorating and leads to better outcomes than interventions later, when the bladder may have lost some of its function. We think this is a first step in building a body of clinical evidence that supports UroLift can be a first-line therapy.
And before I turn the call over to Tom, given that we are reaffirming both our full year constant currency revenue growth rate of between 12% and 13% as well as our full year organic constant currency revenue growth rate of between 5% and 5.5%, I would like to spend a few moments to explain how we expect to get there on an organic basis.
This slide starts with the organic constant currency revenue growth rate that we achieved during the first six months of the year and highlights the drivers of revenue growth acceleration necessary in the second half of the year to achieve the midpoint of our full year organic constant currency revenue guidance range of between 5% and 5.5%.
Admittedly, at first glance this appears to be a large increase. However, as you see in this slide, the drivers of this revenue growth acceleration are well defined and we believe achievable.
First, let's start with NeoTract. During the first half of 2018, none of the NeoTract revenue growth has been considered organic. That changes beginning in the fourth quarter. And while it will only be considered organic for one quarter, we estimate that NeoTract will add approximately 1.5% towards our organic growth rate in the second half of the year.
Now let's turn to Vascular Solutions. Growth within Vascular Solutions has been strong during the first six months of the year, and we expect that to further improve in the back half of 2018. The main driver behind this improvement stems from the distributor-to-direct conversions that occurred in late 2017.
As I am sure you will all recall, as we began the negotiations of these various distributor acquisitions in the second half of 2017, revenue growth of Vascular Solutions products suffered in international markets, as distributors simply stopped buying product in advance of Teleflex acquiring them. With those distributor conversions behind us, the second half of the year should show strong international revenue growth.
Third, we have one additional shipping day in the second half of the year as compared to the first, and this should translate into approximately one additional point of revenue growth.
Fourth, the headwinds in the surgical exit product line eased. We still expect there will be a negative impact from this exit. However, during the first half of 2018, this impacted us negatively by approximately 60 basis points, while in the back half of the year, this will only impact us negatively by about 20 basis points. Therefore, we will see an increase in the second half of the year by approximately 40 basis points.
And lastly, we expect an improvement in our base business of approximately 120 basis points. This is primarily due to improvements within Asia and our expectation of higher EZ-IO volumes in the second half of the year, coupled with volume moving from Q2 to the second half of the year.
The point of this exercise is that while at first glance it appears that we are talking about a large increase, there are a handful of well-defined items that are within our control, and we feel confident in our ability to achieve them.
That takes me to the end of my prepared remarks. At this time, I would like to turn the call over to Tom. Tom?
Thanks, Liam, and good morning, everyone. Given the previous discussion of the company's revenue performance, I'll begin at the gross profit line. For the quarter, adjusted gross profit was $348.3 million versus $295.3 million in the prior year quarter, or an increase of 18%.
Adjusted gross margin was 57.1%, a 120 basis point increase when compared to the prior year period. The expansion in adjusted gross margin reflects the impacts of the acquisitions of Vascular Solutions and NeoTract, favorable fluctuations in foreign currency exchange rates, and the favorable impact of cost improvement initiatives.
Adjusted operating margin improved 90 basis points to 26%. The improvement was related to the gross margin flow-through. However, this was partially offset by the inclusion of NeoTract, which currently operates at a higher OpEx cost structure. During the quarter, adjusted gross margin and adjusted operating margin would have been approximately 50 basis points higher had we not incurred approximately $2.7 million of expense associated with the NeoTract production issue that Liam mentioned earlier.
Adjusted net interest expense increased to $26.5 million from $19.4 million in the prior year quarter. The increase reflects the impact of additional borrowings required to finance the acquisitions of Vascular Solutions and NeoTract.
For the quarter, the adjusted tax rate was 12.7% versus 16.6% in the prior year period. The year-over-year decline reflects the impacts of the recently enacted Tax Cuts and Jobs Act Tax and a larger tax windfall benefit this year versus last. On the bottom line, for the second quarter 2018, adjusted earnings per share increased 21.1% to $2.47. The second quarter performance is testament to the financial leverage potential of Teleflex's business model.
Before turning to the balance sheet, I'll take a moment to comment on second quarter GAAP earnings. For the second quarter, GAAP EPS was a loss of $0.06. The GAAP loss reflects the impact of $57.8 million of restructuring, restructuring related and impairment expenses, which primarily relate to the company's recently announced 2018 footprint realignment plan. Additionally, during the quarter, we incurred $25.7 million of contingent consideration expense as a result of an increase in the longer-term revenue expectations for NeoTract.
Turning now to balance sheet and cash flow highlights. For the first six months of the year, cash flow from operations totaled $182 million, down approximately 8% over the prior year. The decrease was primarily due to changes in working capital, partially offset by favorable operating results. It is also worth noting that NeoTract fully achieved the first contingent consideration milestone. As such, the company made full payment of the $75 million milestone. Finally, during the quarter, our leverage level as defined under our credit facility stood at 3.4 times. And that completes my comments on the second quarter.
Now, I'll move to an update of 2018 guidance. Beginning with revenue, we are reaffirming our full year constant currency revenue growth guidance range of between 12% and 13%. And we continue to expect our organic revenue growth will be between 5% and 5.5%. So, we now expect the combination of NeoTract and Vascular Solutions to contribute approximately 1.75% towards our full year organic growth rate, whereas previously we expected that combination to contribute approximately 1.5%.
Because of a less favorable currency environment since we last provided guidance, most notably the euro, we are exhausting our as-reported revenue growth guidance from a range of between 15% and 16% to a range of between 14% and 15%. Based on our updated currency assumptions, this translates to an as-reported revenue dollar range of between $2.447 billion and $2.468 billion.
We are also reaffirming both our previously provided adjusted gross margin guidance range of between 57.5% and 58%, and our adjusted operating margin guidance range of between 26.1% and 26.5%. We now expect our full year 2018 adjusted tax rate to be approximately 14.5%. This compares to our prior guidance which called for an adjusted tax rate of between 15% and 16%. The improvement in our full year tax rate guidance is primarily due to a larger tax windfall benefit than previously expected.
On the bottom line, our outlook for 2018 adjusted earnings per share remains in the range of between $9.70 and $9.90, as we expect to be able to offset the earnings headwind from a less favorable foreign currency environment.
And to summarize, as previously outlined, second quarter organic growth was soft relative to expectations, but we have line of sight to an acceleration of growth in the second half. As for NeoTract, the results continue to exceed expectations. We are very pleased with the progress to date, including revenue growth of 58% in the second quarter and an improved longer-term revenue outlook.
Vascular Solutions is also performing well and posted growth of 16.8% during the second quarter. Our new products pipeline continues to build momentum and we're excited about the future potential of select pipeline opportunities such as RePlas.
On the margin front, our restructuring and efficiency programs continue to deliver improved financial results and helped propel the second quarter adjusted gross margin to over 57% for the first time. The tax rate provided an added positive for the quarter. And all these factors came together to produce a real nice bottom line outcome. For the second quarter, adjusted earnings per share grew by 21.1% versus the prior year.
And that concludes my prepared remarks. Now, I'd like to turn the call back to the operator for Q&A.
And our first question comes from the line of David Lewis from Morgan Stanley. Your line is open.
Good morning. Liam, the acquired businesses are getting better, the core obviously 25% gets worse, but the ramp looks very steep. So, I believe you need kind of 2.5%, organic has to go to 5% in the back half and a big ramp into the third. So, why should investors have confidence you can deliver given these recent core disappointments? What's your level of conviction you can improve, and more importantly, that this pattern of kind of one step forward, two steps back can stop?
Thanks, David. So, that is why during the call that we tried to bridge from the 2.7% to give investors comfort as to the building blocks to our ability to drive our organic growth into the future. And we did reaffirm our 5% to 5.5%. And if you want to compare the first half to the second half, I'm happy to run through the drivers. NeoTract would roll into organic in the last quarter, and it adds 1.5%. NeoTract is performing exceptionally well, so therefore we believe that that is – we're very comfortable with that. VSI is performing well and it will add 1% in the second half of the year, just primarily driven by the go-directs in the EMEA.
We also anniversary the surgical exit which will add 40 basis points. Vidacare volume, PICC volume, surgical supplier resolution, and the quarter two order rate rebalancing, we're very confident that's going to deliver 1.2%. And, of course, we have the additional shipping day which falls in the fourth quarter which will add 8%. And all of these factors, David, make me confident in our ability to achieve the full year organic guidance range and our ability to achieve our longer-term growth rates of 6% to 7%.
I think that we should point out to investors that two of those elements are in the fourth quarter. So, NeoTract will roll off into the fourth quarter and also the billing days in the fourth quarter. So, what we would expect you to see is an uptick in Q3, but then a larger uptick in Q4. And we have line of sight to all of these.
I agree with you that it's unfortunate with distributor timings, but quite frankly that's outside of our control, and on a full year basis, we're very confident on the 5% to 5.5% and our ability to deliver that and our 6% to 7% longer term. And if you look at our pro forma within the quarter, David, and if we normalize for NeoTract and the surgical exit, we're in excess of 6% pro forma. So, that gives me also confidence in our longer-term ability.
Okay. And, Liam, I'd just sort of follow up on that. I'll stick with growth. One, just you're as confident or more confident in the core, I'm very interested in the core improvement into the third quarter. Maybe you can just sort of reiterate your confidence there. And then just NeoTract obviously, that number is going up on the year. Your confidence in that number as you head through the fourth quarter and the investments you're making to instill that growth rate can be easily in excess of 50%. Thanks so much.
Okay, David. So, I'll go to the core, first of all, and if I take the core, excluding VSI, and if we look at that number, the core has grown at 2.2% for the first half of the year. Obviously, the shipping day in the latter half will impact the core. That should give us the percent. The surgical exit should add 40 basis points. And then in the All Other buckets where we have the order repositioning from Q2 into the back half, we overcome the supply issue, Vidacare will accelerate and APAC accelerate. Those are the drivers of that 1.2% and those are the building blocks as we look at it as a core business in the latter half of the year and then you layer on VSI and NeoTract.
Regarding your question on our confidence in NeoTract, I mean NeoTract continues to perform exceptionally well. It was a superb acquisition for Teleflex. The supply issue had a modest impact of about $1 million with the quarter. That will simply be re-phased most likely into quarter three. We continue to invest behind it. The growth within NeoTract is not free. The growth within NeoTract is as a result of the investment decisions that Teleflex makes every day, put more resources behind that. And we're very confident and so much so that we've actually upped the guidance from at least 40% to be able to deliver 50%.
And based on the performance of the assets, we believe it'll continue to do that. And the investments that will get us to that 50% are the increased sales heads that we spoke about previously. As we said in quarter one, we were going to add an additional seven sales heads to the organization. We're also investing in marketing. We've done a lot of direct-to-consumer initiatives, and all of these are leading to our confidence that we will get to that 50% growth rate within NeoTract.
Operator, we can take the next question.
And our next question comes from the line of Larry Keusch from Raymond James. Your line is now open.
Oh, hi. Good morning, everyone.
Good morning.
Liam, I want to come back to the distributor stocking/destocking issue. This has become a bit more of a frequent event than I think we've seen in the past, at least it's become more visible. So, I really wanted to understand, A, why you think that's happening and then, B, this now sounds like the second time that it's really caught you at the end of the quarter, and your visibility as you look forward on that since it seems to catch you by surprise quite often.
Yes. It has become a little bit unpredictable, Larry. And I can tell you that we received well in excess of $3 million in orders in the first week in July. Those orders we had anticipated would land in the last week of June. The fact that the 4th of July fell on a Wednesday rather than earlier in the week, we think, was the issue here that our distributors placed those orders on Monday rather than placing them as we anticipated on the Friday ahead of the 4th of July. They're always placed traditionally at the end of June for the 4th of July and that was a simple anomaly in this instance.
I think to understand – the unpredictable nature of it is to understand how these distributors work. There is not one central ordering group. It is the sites and if you take, they can have up to 20 sites, a distribution hub to place their individual orders. Our expectation was that they would order in the end of June.
The good news, Larry, if I can make any good news out of this is that it's happened in the second quarter. Anytime it has ever happened in a quarter, we've always recovered in the subsequent quarter if those orders are right. I have a high level of confidence that we'll because of the fact that we sell well in excess of $3 million in orders, above our expectation in the first week of July. It's simply a timing issue, Larry, unfortunately.
Okay. That's helpful. And then, two other ones. I'll just rattle them off and let you address them. Coming back to the second half growth and some of what David was picking at, the All Other is the category that strikes me again as the most unpredictable. I think NeoTract will do well, obviously VSI should do well. The surgical exit is pretty explainable. You have mentioned a couple times EZ-IO and Asia. So, what again gives you the confidence that those revenues can come forward?
And then, the second one is just on the manufacturing side around NeoTract, and I understand the issue with this specific mold that you had. But how do you drive increased volume, or said another way, how do you not have that manufacturing issue going forward to make sure that you can achieve your volume targets? Thank you.
Okay, Larry. So, I'll start with the All Other, the 1.2%. Obviously, a component of that is the ordering volume that moves from Q2 into the latter half of the year.
We also had one of our suppliers for our surgical business and another supplier that had a late breaking issue. The surgical supplier had a fire, which caused about $2 million of volume that's going to move from Q2 into the latter half of the year.
Vidacare, even though it's growing by around 14%, the intraosseous and Vidacare business through the half year, due to – and this happens at municipalities. The orders in the second quarter, our total growth within Vidacare and the intraosseous was around – on a constant currency non-days adjusted is about 8%, Larry.
So that's just timing of orders because of municipality budgets. We expect that to come back. And we would anticipate a much stronger second half. And indeed we'll start to begin to see that in the third quarter.
In APAC, we now have control over our channel within China. So we won't see as robust growth as we saw this quarter within China, but we will continue to see strong growth within China over prior year.
We would also anticipate that we have an opportunity within Japan within the Vascular space that's going to help us to augment that and that quite frankly is pretty much a given. We have excellent line of sight into that.
So again, Larry, a lot of confidence around that All Other 1.2% based on those building blocks. That's what gives me that high level of confidence.
Your other question was about NeoTract and the mold issue and why we're confident that won't have an ongoing impact. So I think, Larry, the mold issue was a decision that we made to change the mold as part of the manufacturing improvement. We changed back very, very quickly to the old mold. And now we're manufacturing with that old mold and getting product out to customers.
We were able to make that change in a very short period of time. I've got to tell you, I'm very proud of how quick the company acted. It had zero impact on patients. Physicians were very comfortable with how we handled it. And we are now currently manufacturing with that mold, and we'll definitely have enough product by the end of Q3 to eliminate all backorders at that time. And we're making excellent progress right now.
Okay. Perfect. Thank you very much.
Thanks, Larry.
And our next question comes from the line of Richard Newitter from Leerink Partners. Your line is now open.
Hi. Thanks for taking the questions. I just wanted to follow up on your organic growth cadence for the year. I appreciate the color on the bridge from kind of how you get to 2Q to the back half of 2018. And I know that you said it's very 4Q weighted. But I think it's important, just if you can give us any directional comments on kind of how steep into the 4Q?
My takeaway from your comments, the guide, the fact that two of the four main components that bridge you to acceleration occur in the fourth quarter. Improvement off 2Q levels could be something close to the 3% range and then a really, really big steep kind of 8%-plus performance in 4Q.
Am I thinking about that directionally correct? Or is it going to be a little bit more balanced between 3Q and 4Q? Thanks.
So what I'll do for you, Rich, is I'll try and identify what's going to be the main drivers in Q4. And that'll obviously help then. And the impact specifically to Q4 of those drivers.
So just two of the biggest drivers that hit in Q4 that are not in Q3 are obviously NeoTract and the billing days. In the quarter, those two elements will drive over 3.5% of growth within that quarter. So that should help you bridge that we should be getting our core business in the ballpark of a 5% in Q3. And then those other building blocks will come in in Q4. Of course, you'll have the surgical exit in both Q3 and Q4.
Okay. That's helpful.
Does that help? Okay good.
Yeah, it does, it does. Thank you. And then, Liam, so I'm going to ask you to do the impossible and predict the unpredictable. But July 4 seemed to be a potential point of unpredictability for this inventory and ordering pattern. You've seen the times over the past two years when it happened in the past.
I guess as you look to 3Q and 4Q of this year, are there any potential – based on past experience, any potential times within the two respective upcoming quarters that you think an inventory – late in the quarter inventory ordering pattern could slip you up? And then what's the – is there anything you can do to kind of de-risk that? And how contingent is that 5% that you just kind of said vicinity for 3Q on a potential disruption from an inventory ordering disruption?
So, Rich, I appreciate the question. So it is somewhat difficult to have visibility. But I will tell you this, that we did see, as I said, in excess of $3 million coming in the very first few days of July, which is obviously the orders that we were anticipating the back end of June. That's in our run rate right now as a company. So I'm very confident that's going to carry through to the remainder of the year.
In Q4 last year, distributors did not order late in December. So we have a reasonably light comparable. So if anything, I would expect a positive from distributor orders into Q4 based on returning to previous year normal patterns to buy ahead of the flu season in late December.
Okay. Thank you very much.
Thanks, Rich.
And our next question comes from the line of Brian Weinstein from William Blair. Your line is now open.
Hi, guys. This is actually Andrew Brackmann on for Brian this morning. Liam, might also ask you to predict the impossible. You notice that China was up 22% in the quarter. Any commentary that you can provide here on tariff impact? Thanks.
On tariff, yeah, so we believe that it's highly unlikely that tariffs will be placed on medical devices going into China. They have not been in the scope of any of the discussions that I have seen. Now, tariffs from product leaving China and coming into the U.S. that would be – we don't have a large exposure in China to manufacture product and the exposure that we have is in the region of about $17 million that we import from China, which is a very, very small part of our overall business.
So, if there were tariffs placed on that, it would not have a significant impact on us. And of that $17 million, in actual fact, part of that volume will be moving out of that geography over the next couple of years, the biggest portion of it. So, I don't see that having a major impact. Tom, would you like to add?
I can probably give you a little more detail. So, our assessments of the product coming out of China currently is a total exposure of about $500,000 for the year. And this estimate doesn't include any tariffs that could be placed on purchased finished goods, which may impact future pricing, but it's absolutely those products coming out of China.
Given the makeup of our products, we don't have much of an impact at all from steel or aluminum tariffs and the exposure really is again on China origin products, the largest exposure being on that first list. There's also some exposure on the third list of products. But again, we currently quantify that to be about $500,000 for the year and we'll absorb that as part of our forecasting and be able to still achieve our guidance as a result of that.
Great. Thanks. And then my second question was you made the comment that there were some supplier constraints acting as a headwind in Q2. Any additional color there? Thanks.
Yeah. The main impact of this was a supplier in our surgical business that had a fire. And we had a urology supply issue overseas for EMEA. That impacted us by about $2 million within the quarter. The urology EMEA issue will be resolved in the quarter. The surgical issue will either be resolved late in Q3 or early in Q4.
Thank you.
And our next question comes from the line of Raj Denhoy from Jefferies. Your line is now open.
Thanks. Anthony in for Raj. Maybe just jump to margins real quick, you haven't touched on that here. It's ahead of our expectations in the quarter. Obviously, at Analyst Day there was a number of drivers there, too specifically was mix and restructuring. Can you just walk through the uptick in the quarter, how much was mix versus restructuring? And I'll have a couple of follow-ups. Thanks.
Sure. So, as we look at the quarter and focusing on gross margin, probably the largest contributor during the quarter was NeoTract. VSI also provided a benefit. Pricing provided some benefit as we heard, I think it was 70 bps of positive pricing and then a very modest benefit from foreign exchange. I will point out that manufacturing was impacted by the UroLift expenditures. So, those are the big drivers in the second quarter gross margin.
Now, on an operating margin, it obviously is benefiting from the gross margin drivers, although NeoTract is operating at a higher cost structure, so we don't get the same leverage in operating margin. It's actually about breakeven from an operating margin standpoint. And then VSI and SG&A probably provide a little more benefit on the operating margin. So, those are the key drivers in the quarter, so should come as no surprise that NeoTract is a pretty big component of gross margin.
Yeah. And then just to stay on the topic then. Restructuring, can you just remind us what are the expectations for this year in terms of incremental margin to the bottom line? That will be the first follow-up.
And then secondly just on NeoTract, can you give us a sense of the growth drivers sort of as you look at the back end of the year as it relates to deeper account penetration versus new account openings and again, maybe how all of this plays on the sort of temporary withdrawal of the device and then reentry? Thanks again.
Sure. In terms of the full year impact of the restructuring programs, we're going to contribute a little bit less than a point of margin expansion. Now, I have to say that that goes into a large component of pluses and minuses and helps frankly to offset some of the inflation that we're seeing.
As we look at restructuring programs over the longer term, of all the programs that are currently out there and announced, we've got the 2014, 2016 and 2018 footprint programs as well as the integration of VSI and the OEM manufacturing project. In total, those projects will generate savings of $107 million and $127 million. And we outlined the cadence of that. About $45 million of that savings was realized through the end of 2017. We expect another $25 million to $35 million over the period 2019 to 2021, and then the balance 2021 to 2024.
And some of the reasons for that that we're drawing out savings schedule is the more recent footprint alignment programs really involve working through the German labor law requirements which have a lengthy notice period. And then we'll take time to also develop replacement machinery and design, and then we'll stagger some of those transitions to leverage our internal workforce and candidly de-risk the project. So, we have savings forthcoming over the next number of years. And again this year, it's part of the whole package of savings that gets to that gross margin target.
I'll cover your question on UroLift. So, we continue to make good progress with our rep hires. We continue to follow our strategy of going deep rather than wide. We continue to see excellent progress on building champions within the urology practices and, obviously, we're buoyed by the AUA Guidelines that I spoke about during my prepared remarks.
We now have 250 million lives covered. We have trained 1,600 urologists. 60% of the cases approximately are still coming from the ASC and the office (00:48:51). So, that continues to bolster this. And obviously, we continue to invest behind it. As I said on the Q1 call, we're going to add another 78 reps within the year. So, we're going to be well above the original expectations that NeoTract as a stand-alone company had from an investment profile. And all of that is helping us to augment the top line revenue growth and put it in a position to go to update our NeoTract expectations from at least 40% to exceed or to reach 50% within this year. And we're still very bullish on the, at least, 20% CAGR over the next three years as we outlined during our Analyst Day.
Thanks.
And our next question comes from the line of Matt Matson (sic) [Mike Matson] (00:49:43) from Needham & Company. Your line is now open.
Hi. Good morning. Thanks for taking my questions. I guess I just want to go back to the UroLift mold issue. I know it had a margin impact, but did it have an impact on sales and can you quantify that?
Yeah. Mike, as I said, there was about $1 million of sales that moved from Q2. Given the fact that this product does benefit from the demographics, but is not an emergent procedure, almost all of those, if not all of them will be just repositioned into Q3. So, we don't see a significant impact. And we also see we have a modest backorder now, but we'll have that resolved by the end of Q3. And we don't see it having any impact on our short, medium or long-term aspirations for the growth of this company.
Okay. Thanks. And then pricing at 70 basis points seemed a little bit higher than where it had been trending and I know there's probably some quarter-to-quarter volatility there, but is that sustainable and can you just remind us where you're getting the positive pricing, which products or businesses generally?
So, most of the pricing that you see there is as a result of our go-direct that we did last year in Europe as part of the VSI go-direct. The core pricing is normally pretty flat.
Okay. Thanks. And then finally, I know there was a question about the tariffs, but we've also seen costs going up for raw materials, oil, resin, things like that, as well as labor costs. So, maybe you could just comment on that. Thanks.
Okay. So, we've looked at the inflation in raw materials and don't see a meaningful impact as of yet. Where we are seeing some inflation to your point is in the labor markets. In Mexico and Czech Republic, in particular, we've seen tight labor supply which has put some pressure on wages. So, we've actually made some responses to maintain our competitiveness in those markets and that has led to additional cost during the year.
All right. Thanks a lot.
Thanks, Michael.
And our next question comes from the line of Chris Cooley from Stephens. Your line is now open.
Good morning. Thanks for taking the questions. Just two for me at this point. Tom or maybe Liam, when we look back basically from 2015 forward and appreciating that the portfolio mix has changed pretty significantly, underlying volume growth kind of averages out around 1% approximately. Could you help us maybe just come back to that volume number again and maybe think about why that wouldn't be higher as we look at this historically closer to 3-ish-plus percent, kind of more in line with general surgery? Give us confidence in kind of why we can see that step-up.
And then just my follow-on, Tom, would you mind reminding us what's available in terms of capacity on the existing credit facilities? Thank you.
Hey, Chris. I'll take the volume one. So, I think when you look at volume, you got to include new products. So, you got to add the two of those together and our new products, I think, was 1.7% for the quarter. So, that really is how you should try and look at volume with regards to Teleflex.
I do think that it's an important point that I'd like to make is that even though in the quarter the volume in the key North American market was in line with our expectations, our tracings as in end customer demand was almost 4%. So, again, that gives us confidence that – I think we've already seen it actually that that – that step function from volume coming from these distributor orders would right itself, and it's already righted itself in the first week of July just based on the tracings. That disconnect between the recognized revenue and the strong tracings within the market helps us have a lot of comfort around the fact that our volume will return in the second quarter, and we should see a core organic growth improvement in the third quarter.
And Tom will take the other question that you had.
So, you were looking for availability on our credit facility. We have about $650 million of availability at the end of the quarter.
Thank you.
Thanks, Chris.
And our next question comes from the line of Matthew Mishan from KeyBanc. Your line is now open.
Great. Thank you for taking the questions, guys. So, I just want to make sure I have this right because I think there's a lot of moving pieces, but it doesn't seem all that bad. The two pieces that you're talking about are a distributor order that got pushed from the end of June into the first week of July, and then the second piece is a product supply issue with Urotrack (00:55:01) that's already resolved. Are those the two pieces?
Pretty close. So, the distributor orders are within the North America that moved from the end of June into the first week in July, and that was in excess of $3 million. The actual product supply issues were related to our surgical business because of a fire one of our suppliers had late in the quarter. And to a lesser extent, a urology supplier in EMEA and they total about $2 million.
And have those been resolved?
The urology supply will be resolved within the quarter. The surgical supply will be resolved either late in Q3 or early into Q4, but it will be resolved before the end of the year.
Okay. And then just can you give us an – and I'm sorry if I missed it. It was a busy morning. Any update you can give us on the clinical trial for RePlas? How many patients have you enrolled so far? And some of the early results from the initial patients? And then just lastly, any update you can give on Percuvance?
Okay. So on Percuvance, I can start there if you don't mind, Chris (sic) [Matt] (00:56:16), we've submitted our 510(k). That happened early in this quarter, quarter three. So we're right on schedule there.
With regard to RePlas, the BLA submission is still on plan for Q1 of 2019. And in all of it, we will have completed enrollment and the infusion of 24 subjects in the Phase 1 clinical trial. And we should have the final report by Q4 of 2018.
Unfortunately, Chris (sic) [Matt] (00:56:46), you don't get preliminary reports on a clinical study. You got to wait until Q4 to get them, but we're – or, Matt, sorry. My apologies.
But the BLA submission is still on track for Q1 of 2019. I would take this moment to point out that there was some – this Pittsburgh Study Of Medicine (sic) [Pittsburgh School of Medicine] (00:57:09) completed a study of 500 trauma patients where they infused them, some with plasma and some without. And they actually showed a cohort of those patients who got two units and the others that did not.
There was a 77% survival rate on the patients who got two units of plasma versus 67% survival rate on those that did not. And this is one of our target markets for freeze-dried plasma when it becomes available. And we're encouraged by that study coming out that is coincidental as it leads up to our approval to have RePlas in the marketplace.
All right. Thank you very much, Liam.
Thanks, Matt.
And our next question comes from the line of Matthew O'Brien from Piper Jaffray. Your line is now open.
Thanks so much and good morning. Just a couple questions for me. On the distributor issues, I think Liam in the past you've mentioned, hey, this happens occasionally and then for a quarter and then the demand comes back. But this is now two out of the last three quarters where this has happened. So just wondering if there's anything that Teleflex has been doing internally that's causing some kind of gaming from your distributors that's different than in the past? Or just said another way, just the comfort that this will be more of a once every kind of year or six quarter kind of phenomenon versus two out of every three quarters now?
Yeah. Matt, I think that there's nothing that we have changed and that we are doing differently with our distributors. As we get – VSI has already rolled into organic and as NeoTract rolls into organic, those two product categories do not traditionally go through distributors. In previous years, 50% of our volume went through the distributor, the box-moving distributors.
As we go into 2019, that will move down to one-third of our business going through these box-moving distributors. So we'll be less exposed to volatility within them, and quite frankly, Matt, I look forward to that day because it is, I've got to tell you, a frustration within Teleflex as much as it is for our investors.
Okay. That makes a ton of sense. And then as far as UroLift goes, I'm a little curious as to why you decided to make the change to the molding process just given how fast that business is growing. And then is there any risk here in Q3 as the sales force is dealing with a little bit of a backlog, the new AUA Guidelines that there could be just a little bit of a slowdown in terms of the growth of that business? And then with the molding change, is there any update to the Gen 2 product timing?
So I'll take the last one first. There's no impact on the Gen 2 product timing. The mold change, Matt, was a change that we made to improve the manufacturing process of the product. So we were trying to improve its manufacturability quite frankly.
And we did all the validation testing. We engineered tested things. As it ramped up and accelerated the volume, we saw a small incidence where the implant would not release after we fired. And just to protect the reputation of this product, we took the decision to pull the product back from the market, put the old molds in and ramp up manufacturing very quickly.
The backorder will be resolved by the end of the quarter. And I don't see it having an impact on the growth of NeoTract. And the order rate continues to be very robust for the product.
So I see it having – it had an impact of about $1 million in Q2. That will just roll into the last half of the year. But I don't see it having a significant impact or any impact in Q3 or Q4 except for a modest backorder during the Q3, and probably a heavier ramp to the back end of Q3 than we normally have.
Very helpful. Thank you.
And our next question comes from the line of Isaac Ro from Goldman Sachs. Your line is now open.
Good morning, guys. Thank you. Just one more question on the distributor dynamic that we went over here earlier in the call. Can you give us a sense as to whether or not your distributors are effectively running with just lower levels of inventory on an ongoing basis? And to the extent that's something that's actually been happening, what's your best sense of where we're going from here? Just trying to figure out whether there is a change in behavior there on the part of your distributors.
So it's hard for us to see what our distributors' working capital assessments are. I can tell you, Isaac, that in this instance, this was simply timing. It was just the fact that the July 4 holiday fell on a Wednesday. And given the fact that it fell on the Wednesday, people didn't bridge – that people normally take a couple of days off. They didn't bridge the Monday, Tuesday. They bridged the Thursday, Friday.
So they normally place orders on the Friday in order to have the product in as people are on vacation. And it was just simply a timing issue in this regard.
As I've said, we saw well in excess of $3 million above our expectation in the first week of July. It was just a one-week timing, and we expected to see it reflect itself in our expectations in the third quarter.
Okay. And this is a follow-up on UroLift. The molding dynamic you talked about, will there be any noticeable impact to gross margin there, either transient or maybe more prolonged? And I appreciate it's a smaller part of the business, but curious if it's something we should be thinking about as we update our models. Thank you.
So I'll ask Tom, because Tom did mention that in his remarks.
Yeah. So, during the quarter we incurred cost of about $2.7 million which impacted margins by about 50 basis points in the quarter. Depending on resolution and how easy it is to rework some of the product that was in inventory, if it is reworkable that would be the end of the costs. If not, there would be additional charges in the third quarter.
Okay. Thank you.
Again, we have rolled those expectations into our forecast.
Got it.
Thank you. And at this time, I'm showing no further questions. I'd like to turn the call back over to Jake Elguicze for any closing remarks.
Thanks, operator, and thanks, everyone, for joining us on the call today. This concludes the second quarter 2018 earnings conference call.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.