ICU Medical, Inc.

Greetings, and welcome to ICU Medical Incorporated Third Quarter 2021 Earnings Conference Call. At this time, all participants are in listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during a conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host today, Mr. John Mills, Managing Partner. Thank you. You may proceed.

Great. Thank you, LaTanya. Good afternoon, everyone. Thank you for joining us today to discuss the ICU Medical financial results for the third quarter of 2021. On the call today representing ICU Medical is Vivek Jain, Chief Executive Officer and Chairman, and Brian Bunnell, Chief Financial Officer. We wanted to let everyone know we have a presentation accompanying today's prepared remarks. To view the presentation, please go to our investor page and click on Events Calendar, and it will be under the third quarter 2021 event. Before we start our prepared remarks, I want to touch upon any forward-looking statements made during the call, including beliefs and expectations about the company's future results. Please be aware they are based on the best available information to management and assumptions that are reasonable. Such statements are not intended to be a full representation of future results and are subject to risk and uncertainties. Future results may differ materially from management's current expectations. We refer all of you to the company's SEC filings for more detailed information on the risks and uncertainties that have a direct bearing on operating results in the financial position. Please note that during today's call, we will also discuss non-GAAP financial measures, including results on an adjusted basis. We believe these financial measures can facilitate a more complete analysis and greater transparency in the ICU medical's ongoing results of operations, particularly when comparing underlying results from period to period. We've also included a reconciliation of these non-GAAP measures in today's release and provided as much detail as possible on many addendums that are added back. And with that, it is my pleasure to turn the call over to Vivek.

Thanks, John. Good afternoon, everybody. And we hope you and your families are all well. It's been a busy 90 days for us since the last call. With the resolution of our Pfizer dispute, the announced acquisition of Smith's Medical, and a record or near record sales levels in our most differentiated businesses, all of which aligns with our comments on the last few calls about it being a fluid environment. The volatility in the U.S. supply chain and in hospital centers for our customers did make it a bit more challenging quarter operationally than the normalcy we had described on our Q2 call. Q3 for us was really about meaningful increases in U.S. volumes and good stability or small improvements in the international markets. Like everyone in our industry, we want to start first by thanking all of our customers and their frontline workers for trusting us to serve you during these times. And it's been great to see, again, our teams face-to-face around the world and to meet some of our soon-to-be colleagues from Smith's Medical Life. While results were generally in line with our previous comments, we wanted to use the time today in the call to Comment on the inter-quarter trends and drivers of our business and try to explain some of the growth we had that was slightly above our expectations. Then relate that to any impacts on near-term business and at least our current feelings about next year in each segment. Try to sketch out how inflation has impacted us at a high level relative to our budget for the year. Provide an update on the Smith's medical transaction as well as our normal housekeeping of items, of which there are not many. And bookend the scenarios we see post-deal and comment on the criteria by which we'll be judging ourselves post the Smith's Medical Acquisition. And given the transaction, we can pass on the capital deployment comments we had recited for a while. The short story on Q3 is as follows. As we previewed on the last call, we did see sequential revenue growth in our most differentiated business segments and stability in IV solutions. On a year-over-year basis, This resulted in a reported and constant currency sales increase of 8%, driven by market share gains and increased utilization in IV systems and IV consumables, but was also likely helped with some pandemic ordering in the context of a difficult supply chain. We finished the quarter with $328 million in adjusted revenues. Adjusted EBITDA came in at $72 million, and adjusted EPS was $2.07. It was a clean quarter again, except for some costs related to the transaction and and it highlighted the power of mix and our operating improvements as EBITDA improved, but it also illustrated some of the additional costs we are bearing as gross margins could have been higher. We had an extremely strong quarter of free cash flow generation of 62 million and finished with 545 million of cash on our balance sheet as operational improvements have materialized and restructuring integration costs have dramatically reduced. When looking deeper at the results, It was really a big uptick in the U.S. business sequentially from Q2 to Q3 that drove the performance more than the international markets, where performance was fine relative to Q2 with either small sequential gains or neutral. As we previewed on the last call, Asia, Europe, and LATAM all had good results on a year-over-year basis because Q3 2020 was really low, but nothing was dramatic sequentially. We're most tilted to the U.S. market where we're dependent on admissions and electives. And again, we saw procedures as pretty solid and admissions as okay. I know there's been a wide range of commentary here from all the companies, but the simple message from us is our U.S. customers are busy managing COVID spikes and the day-to-day procedures. So let's go through the businesses quickly and then come back to discuss the current environment. Starting as usual with Infusion Consumables, which is our largest business. Infusion consumables had revenues of $145 million, which was a 25% increase year over year on a reported basis and 24% on a constant currency basis. The U.S. market grew just a shade under 20% on a year over year basis, and the international markets were even higher due to low volumes last year. Core IV therapy grew globally over 20%, and oncology was over 30%, and both had strong sequential growth in the U.S. market, which is extremely important to us. We had talked on the previous call about feeling positive about the U.S. market and our growth products setting up well for the rest of the year and the rest of the world opening up. Now is to the question of why it was this much. First and most importantly, we've improved our position in the market and have implemented new business. Second, we believe there was some pandemic ordering, which was really the combination of COVID spikes in part of the country, combined with some industry shortages, and a general wariness about the supply chain, which probably caused wholesalers and direct customers to hit the order button a bit more than normal. It's really difficult to know exactly how much of this contributed, but we would rather talk about this now versus coming back to explain distributor or customer destocking later. This primarily applies to the US IV therapy portion of consumables. We think the actual run rate is somewhere between Q2 and Q3 of this year, and we're not exactly sure when any extra inventory in the channel will burn off. The 2020 comps are not meaningful as the business was so impacted by the pandemic last year. But going forward into 2022, we continue to feel optimistic about this segment with it being a bigger business with growth at or above market rates. Moving to infusion systems, which is primarily our LVP pumps and associated dedicated sets, this segment did $91 million in adjusted revenue, which was an increase of 3% on both a reported and constant currency basis. On a year-over-year basis, the increase was due to the implementation, of competitive pumps earlier in the year, a little more demand due to COVID spikes and pandemic ordering of dedicated sets. And that was with the non-LVP products declining almost 5 million year-over-year in the quarter. On the last call, we said we had a great quarter of competitive installations in Q2 of 2021, and those pumps are now active in the market. It's been hard to follow exactly what's been happening in pumps between the loss of install base in the first two years when we bought the Hospira business the decrease in non-LVP products, and the growth in LVP. Let me try to give a few facts that may help make this clearer. First, if you go back to our comments in 2019, we were talking about our install base of LVP pumps bottoming out in the middle of 2019. Today, as compared to mid-2019, our US LVP install base is about 20% larger, and LVP revenues are more than 10% larger, reflecting our 50-50 geographic mix. Second, at the business level, We've had a decline of almost 35 million in the non-LVP products since we bought the business. We've had the best year to date of competitive LVP installations since we've owned the business and have a strong backlog heading into Q4. The obvious question is where does this show up on the P&L? And it shows up over time as we begin to get the dedicated disposals and software revenue associated with these pumps. We continue to not see capital as a customer constraint, rather just the issues in the markets of nursing and labor shortages at our customers and fatigue from COVID. But we still believe, relative to our size, there's solid competitive opportunity, and we're focused on commercial execution here. We believe this business is a larger business in 2022, where we do not have to speak about non-LVP products at declines anymore. Finishing the segment discussion with Infusion Solutions, we had $81 million in adjusted revenue, or a decrease of 6% year-over-year on a reported and constant currency basis. Nothing really unusual during the quarter with sales very balanced versus Q2, which had a lot more intra-quarter volatility. We continue to believe the quality of our customer book has improved with us holding the best list of sustainable relationships versus the day we bought the business, and the entire industry has moved forward into renewals of long-term contracts. The volatility in the supply chain and labor shortages, transportation costs, and raw materials was felt by us here in Q3, So we did not have as robust of a production environment as in Q2. As a reminder, with COVID spiking in the summer of 2020, we moved our annual plant maintenance shutdown to Q4, and it happened last month, which does have an impact on margins like it does every year, and Brian will go through that. We continue to believe this business annualizes at plus or minus $80 million a quarter. Okay, obviously the topic of supply chain and inflation is on everyone's mind. The facts on the freight backup are all true. And even when turning onto I-5 South here in San Clemente, you could see cargo freighters out on the water 40 miles south of Long Beach, which we've never seen before. We wanted to give a bit more color to add to the last call on the economic impact to us in 2021 and how to think about it for the future. To make the math really simple, this year we will sell somewhere on the order of 70 million more in consumable sales across IV consumables and dedicated sets. Even with a conservative assumption on contribution margin, we would expect half of that to flow through to the income statement. But we'll only capture about half or so of that contribution in 2021. Yes, normal costs around T&E and healthcare costs did increase a bit over 2020, but the rest is the impact of increases in transportation, particularly around fuel, expediting, and raw materials and labor. On the last call, we said labor was permanent, and we continue to believe that. The harder item to know is what is really permanent on the other categories. we find ourselves asking the question of why some of these raw material and transportation services are inherently materially more valuable over the long term than they were before the pandemic, particularly as a total utilization for healthcare and markets is still below historical levels at aggregate. Obviously, some of these costs are indexed to CPI, but we believe in the markets, and just as we experience in our own IV solutions business, when capacity increases, pricing rationalizes, and when there's shortage, the market's penalized. So for us, It's about trying to get price improvement where we can, trying to illustrate to customers the need to have some of these costs indexed, and ultimately to just ride it out, serve customers with a belief that supply and demand will normalize over time. Moving on to our normal housekeeping updates. Commercially, more of the world is open for live customer conversations at any moment since the pandemic started. Our commercial teams are out installing new business and helping customers manage the volatility in the supply chain. Nothing new on quality. We had a light quarter for audits, et cetera. Operationally, I think the comments on the supply chain I just covered went through it, but our fulfillment rates dipped a bit in Q3 from the very high levels in Q2. We have been working to ensure that all the high-running items are secure and those that customers need daily are prioritized, and some of the more unique custom items had to take a backseat in Q3 with the substantial demand increase we saw in consumables. On the Smith Medical transaction, late last month, the Hart-Scott-Rodino or HSR waiting period in the U.S. expired with no issuance of a second request by the FTC. While the FTC reserves its right to take further action, this is a key milestone to clear the way for a successful closing. We're in the process of securing all remaining global regulatory approvals required for closing, and the Smith shareholder meeting to vote on the transaction is currently scheduled for November 17th. In addition, our integration planning management office is now getting up and running, with teams from both organizations with a goal of preparing for a swift, effective combination once the deal closes, which we expect to be as early as practical in the new year. We're pleased that after our reset in 2019, we have gotten back to strong cash flow generation. But with the volatility in the supply chain, we have gotten a bit too lean in some areas, of working capital and inventory, and we probably need to put a little cash back in to buffer the system. Q3 EBITDA margins show the power of more disposables in the mix as we laid out on the last call and the results of our focus on the high-hanging fruits from our Hospira integration. And we're about to start running up that hill again to drive value out of the next integration with Smiths. The income statement will get cloudy next year with a lot of new businesses to be added and integration costs, et cetera. Before that happens, we did want to go back and recite the criteria and how we judge ourselves as it will apply to the new code also post-integration. At the end of the day, the score we measure under our ownership is, are the businesses larger or smaller and more or less profitable? That's the ultimate score, regardless of how hard we've worked. On the last call, we said we were getting into a more normal revenue environment, and we've said for a while we can grow our valuable items of consumables and dedicated sets on a year-over-year basis. From a revenue perspective, our IV consumable segment in 2021 will be the largest it has ever been, and we feel good about that continuing into 2022. We believe the same about our infusion system segment as our U.S. and global install base of LVP infusion pumps and related disposals will be the largest under our ownership at the end of 2021. We have improved profitability in 21 versus 20. And while the new businesses will get integrated quickly, operation and on the P&L, it is certainly our goal to keep improving profitability. And this is the case without all the regions having improved utilization dynamics or new products, which could be additive. In the short to medium term with Smith Medical, just like Hospira, we see two basic bookend scenarios for the acquisition. In the best case, we will have better execution to improve Smith's top-line performance, drive operational improvements, and focus on cash conversions and returns. In the worst case, we continue to fight headwinds on Smith Medical's top line, but we can drive operational improvement and generate solid cash returns over time. Either one of those cases is value creating relative to the transaction math. And once the integration actions have been taken, returns could be generated quickly. But over the long term, the same compounding criteria applies. Are the businesses bigger or smaller and more profitable? And our team understands that point. While the pandemic introduced substantial volatility, into the markets. Strategically, we do think the weaknesses it exposed in the healthcare supply chain add to the argument for all participants to be healthy and stable, which has been our commentary since we became a full-line supplier. Smith Medical also produces essential items that require significant clinical training, capital expenditures, and in general are items that customers do not want to switch unless they have to. The combination allows us to become a broader U.S.-based manufacturer and bring our focus on vertical integration and redundancy to our collective network. We do believe the market, broadly defined, does not want a winner-take-all setup in these essential items categories, and the combination positions us better. For now, we focus on what we can control in these moments, having the best list of supportive, healthy customers, win new important customers while we wait for volumes to normalize around the globe, keeping our employees safe while delivering the best operational stability for our customers, making sure we drive differentiation in our most valuable categories, using our liquidity and taking risks to make the company more relevant to customers, and focusing on our own execution. Our company has emerged stronger from all the events of the last few years. Thank you to our shareholders who were patient on the time it took to deploy capital and use our liquidity. Thank you to all the employees, customers, suppliers, and frontline healthcare workers. Our company appreciates the role each of us has had to play. With that, I'll turn it over to Brian.