ICU Medical, Inc.

and welcome to the ICU Medical Inc. second quarter 2022 earnings conference call. All participants will be in a listen-only mode. To the need assistant, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask questions, you may press star then one on your touch-tone phone. To withdraw your question, please press Start and 2. Please note this event is being recorded. I would now like to turn the conference over to John Mills with ICR. Please go ahead.

Good afternoon, everyone. Thank you for joining us to discuss ICU Medical's financial results for the second quarter of 2022. 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 that 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'll be under the second quarter 2022 events. 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 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 risk and uncertainties that have a direct bearing on operating results and 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 any 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 are well. It's been a quick 90 or so days since the last call, and our legacy ICU business unit revenues are on track in 2022, and we have now seen weekly improvements over the last eight to ten weeks through today in our operational performance for the businesses that came with Smith's Medical. The external economic volatility in the supply chain around freight and fuel that we've been describing for a while hit its highest peak in Q2 for any time our team has been in the industry. However, the issues around raw material availability are narrowing but still remain volatile. From a customer perspective, we felt hospital census was stable and underlying demand was good in all geographies. Like everyone in our industry, we want to first start by thanking all of our customers and their frontline workers for trusting us to serve you during these times. While Q2 revenues were generally in line with our previous comments for Legacy ICU Medical, our results for Smiths Medical were again different from our original expectations, so we wanted to use the time and the call today to first comment on the year-over-year drivers of the three main Legacy ICU businesses, give an update of the current inflation in the market, and how it has negatively impacted legacy ICU profits, which is really just about fuel. Explain the Smith's medical revenues we achieved in Q2 and bridge to how that fits with our comments on the last call. Provide status update on the Smith's medical businesses' current challenges and opportunities in the two buckets we've highlighted on the last two calls. Begin to talk about Smith's medical revenues sequentially and describe what we think the next few quarters could look like in the individual segments. to try to narrow the range of outcomes for the balance of this year, and lastly, to illustrate how we see revenue and profitability in the short and medium term and how we think about value. Q2 2022 is our second quarter of joint reporting, and given some of the challenges on the Smith's medical businesses and the current environment, it continues to be a bit of a longer story. I'll quickly summarize the whole company results and then discuss each segment of the business. We finished the quarter with $547 million in adjusted revenues, Adjusted EBITDA came in at $85 million, and adjusted EPS was $1.37. We again had a heavy quarter of investment into the business with inventory builds, et cetera, that Brian will describe. It was a less clean quarter as we're spending at a very high rate to improve the service levels of Smith's Medical, and we had restructuring and integration costs, and we are focused on reducing those costs next year as they impact cash flow. The strong dollar and currency have also been a bit challenging. So let me start with Legacy ICU Medical, which is a relatively straightforward story, a good story. In Q2, Legacy ICU had $324 million in revenue, which was growth of 6% on a constant currency basis and 4% reported. We again had good year-over-year growth in our most differentiated businesses with negligible COVID impact, and as previously discussed, have been normalizing our operations on a more predictable basis. There's nothing dramatically different on underlying demand from previous comments on a macro level. The public hospital companies validated our view on their recent calls that acuity was decreasing in at least US hospitals and electives were okay. Specifically, the legacy ICU businesses grew at 7% in the US and at 6% constant currency in international markets. 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 $144 million, which was a 9% increase year over year on a constant currency basis and 6% reported. Growth was most driven specifically by core IV therapy and some specialty items in the U.S. again. In oncology, we've been a bit constrained due to some of the remaining raw material challenges that should abate by the end of this year. We have talked on the previous calls about feeling positive in the U.S. market and our growth products setting up well as the rest of the world opened, which is what happened. There's nothing new on our outlook here, just to mention The base in infusion consumables did materially step up in Q3 2021 due to pandemic ordering, and it is our largest ICU OUS business, so currency impact is meaningful. Moving to infusion systems, which is primarily our LVP pumps and associated dedicated sets, this segmented $87 million in adjusted revenue, which is an increase of 5% on a constant currency basis, or three reported. We did have a decent level of installs in Q2 and do expect a better back half of installs globally than we had in the back half of last year. It's still a bit bumpy on dedicated set utilization that's been inconsistent, but we're focusing on installing a larger amount of hardware. It feels that the customer attention is back, with bandwidth to have real discussions, and some of the fatigue from COVID is passing, and the acceptance of inflation and future costs of nursing, et cetera, are being internalized. We still believe relative to our size, there's solid competitive opportunity, and we're focused on commercial execution here as of no change to any previous commentary on this segment. Finishing the segment discussion with Infusion Solutions, we had $80 million in adjusted revenues or an increase of 3% on a year-over-year basis, both constant currency and reported. Capacity constraints here are easing. No additional comments on the revenue side here. The biggest issue for us is this segment has disproportionately absorbed the majority of inflation at Legacy ICU, which dovetails with our comments on Legacy ICU profits. The vast majority of unexpected inflation and earnings pressure relative to our view on 2022 Legacy ICU profits is primarily about fuel and shipping costs into a lesser degree currency. Labor has been much more consistent this year, and we budgeted those items properly. Yes, there's been some raw material surge pricing, but as we highlighted in the last few calls, these items are not so much more inherently valuable over the long term, particularly with aggregate demand below historical levels. We've talked about believing in the markets, and when capacity increases, pricing should rationalize. So for us, it's about trying to run a stable and predictable operation in a normal environment to get price improvements where we can, to try to illustrate to our customers the need to have some of these costs indexed and to ultimately just ride it out, serve customers with a belief that supply and demand will balance over time. But there is a longer-term tactical element to this in some of the businesses. We listen to the comments on price actions from the larger players in the industry, and we obviously support that. But we are also focused in the next round of contracting on how to separate the costing of some of these items, for example, our transportation and logistics costs, should be separate items, no different than airline seat and baggage fees or next-day delivery. Given the historical margin structure of the healthcare industry and its historical negligible inflation, suppliers have never had to think this way. Okay, let me move to the Smith businesses, first talking about aggregate revenues and then how that fits broadly with the two buckets of issues we had on the last call, which did lead to a wider range of outcomes on even a monthly basis in the first two quarters, and that has to be incorporated into the full year now. And then I'll give some updates on progress on the issues, et cetera. Starting with revenues, the Smith's medical businesses contributed $223 million, with vascular access at $77 million, infusion systems at $78 million, and vital care at $68 million. So to try to make sense of this, we need to go back and compare this to our comments on the previous call and then talk about each of the segments individually. To make it extremely clear, while we did pick up a number of shipping days, we also had a number of setbacks in the first half of Q2, which caused us to have to make more distinct fulfillment choices based on customer need and availability. Specifically, we had a number of down days due to reasons that are too detailed for this call, but at a generic level about the intersection of IT, product availability, and operations. The net result of this was a fulfillment environment that was actually worse in the first half of Q2 versus even Q1, and so we did not get the full benefit of the additional days or clawback into the backorders. As a result, we had to prioritize fulfillment on the most critical and clinical items, which are dedicated pump sets, which explains the sequential improvement in Smith's medical infusion systems, but in the earlier part of the quarter, it came at the expense of the other segments. What obviously matters is where we are right now, and I'll get to that in a moment as it relates to the status of the challenges we've described, with the short story being, it's better. We spent a lot of time, we spent a lot of airtime on the last two calls, explaining these two buckets of issues, how we wound up here and how we're trying to solve them, so we'd rather just cut to the status of each. The first bucket of issues are around production and fulfillment operations. With regard to production, with the exception of a few items related to silicone availability, it can generally be said that the entire Smith's production network is producing at acceptable demand levels. We continue to work on securing the base of supply and insourcing the key high margin disposable components with proper factory staffing levels. The fulfillment process, while still challenging, and as we said on the last call, was quickly becoming our main focal point, has made progress since mid-May, with June better than May, July better than June, et cetera. We still have bumps, but on certain key IT systems issues, et cetera, it has been recently more stable. From an expense perspective, we've been spending carte blanche to improve customer service levels with an ICU mindset And with factories only getting to scale recently, there continues to be a huge hit to gross margin in the short term. There's plenty of demand. None of this really has to do with product features. This is about cleaning up the self-inflicted harm and the basics of blocking and tackling with a good focus on operations. The second bucket of items we talked about were quality-related interruptions. And again, we previously described how we got here. Since the last call, we've made significant progress with communication to both customers and regulators, on our view of a path forward and have made some significant decisions. Those decisions, such as stopping sales for certain older generation products and committing to a deliberate and timely remediation plan, have allowed us to begin supporting existing MedFusion syringe pump customers in early Q3. We've also made progress in addressing the root causes of the warning letter received in late 2021. This part feels very similar to Hospira and our previous experience and we have the right people have been through the exact same experiences and our team is now fully embedded into the operation. As we said in the last call, the existence of a warning letter, while undesirable, is the regulatory agency trying to move the ball forward. And we talked about how these regulations give us the right to participate. We're making progress in solidifying the foundation and hope to be in a position where we can demonstrate further progress as soon as possible. Again, regardless of where it appears on the P&L, we are spending heavily, so making progress here is extremely important. So now having updated the main two issues, let me come back to the segments and tie this back to short-term and longer-term profits and value. It's important to start describing the Smith segments sequentially, as they will get folded into the legacy ICU segments in 2023. Given better production and fulfillment on Smith's dedicated pump sets and some of the other items, We can now see continued sequential growth for the foreseeable future in Smith's infusion system segment. Smith's vascular access is now getting more attention, and again, we would expect to see sequential growth here in the near term, but we need to commercially execute as Smith lost the focus on its market positions here. And lastly, material improvements in Smith's vital care probably will not be seen until Q4 after the other two segments. Vital Care is the most international segment of Smith's on a percentage basis and probably was the most neglected, but there are some valuable sub-segments in there going back to our previous comments on the original portfolio construction. If we add up what we think the Smith's businesses will do over the second half of 2022 and combine those with Legacy ICU, we believe we'll be very close to exiting 2022 at the original 2.4 billion annual revenue run rate after taking some large pressure on currency. Operational performance is improving, but we're choosing to spend now in order to be healthier and more stable next year to improve profits. We believe we can earn $180 to $200 million in adjusted EBITDA over the back half of 2022, and that probably is a bit more Q4 weighted. Obviously, that implies a full year that is different than our original expectations, and that weighs heavily on us. But we did try to say after Q1 that the steeper ramp for the back half was tougher. There was a wider range of outcomes. And after what the situation was through mid-May, we knew we needed to be realistic. We also said that we were very focused on material sequential improvements to the year as each month goes by to make sure we have the right exit run rate heading into next year. To talk about revenue and profitability in the medium term and to simplify the numbers a bit, If we said we could have around $600 million in revenues in Q4 and approaching $100 million in EBITDA, that is basically where we thought we would have been towards the end of Q1 or early 2Q this year. So we have gotten knocked down a few quarters, which has been tough to deal with, and everyone competes in the same environment. But to that run rate, and to be clear, we're not making a call on exact timing of these items. We know that there are positives that exist. The biggest item is obviously revenue growth. But there are also spots, just like with the HUSPEAR transaction, where we have negative margin situations. And while not huge, they do make an impact. In addition to those two items, which we control, there are other things we control, like the operational performance leading to all this expedited fulfillment. We are realistically spending over $25 million in 2022 on expedited fulfillment above base fuel rate increases through the year. And we need to bring this number down. and we control the remainder of our synergies, which don't come as quickly as the year one items, but we know we're out there. And while we don't technically control fuel costs, though we need to address the tactical item and how it should be incorporated to certain products over time, fuel increases in currency have probably been between 40 to 50 million above our starting budget this year. I'm sure there'll be offsets to synergies and other negatives in the future that we'll find, but there is a large self-help list that as we get more stable, we can start to work down. We'll skip the bookend speech for today, but a number of those items are independent of revenue growth. And to close with tying that desired income statement back to value a bit, we have not talked about the aggregate positioning of the combined portfolio and its relevance for customers and their reactions. Yes, the situation is harder than we expected, but the customer logic continues to make sense. Like Hospiro, we need to change the conversation from the historical perception to demonstrating our value through innovation and service. These portfolios make sense together, and we're working on how to integrate them either literally or economically when sensible. And we do believe more doors are being opened as a result of having a broader set of items that are mandatory for care. We get that this needs to show up on the P&L to prove that value. For Legacy ICU, Our most differentiated businesses will end 2022 larger than ever with appropriate profitability levels. The core premise of the Smith transaction is to enhance the product offerings for these exact categories that drive our returns, as well as add logical adjacencies predicated on the same characteristics of sticky categories, low capital intensity, single-use disposables, opportunities to innovate, and participation in a logical industry structure. Even though we're consumed with basic operations, we still believe this is to be the strategic case and the big opportunity over the long term is using the combined portfolio to improve in existing markets and also move as value shifts into new spaces. The construction of the Smith portfolio was logical and frankly why it survived over the years. The other part of value is maximizing the opportunity with each piece of the portfolio. We believe as we clean up and stabilize the operations, we could be presented with more opportunities here. There's no change from the previous call in our near-term priorities or in our usual bookend speech. While the pandemic introduced substantial volatility, strategically, we do think the weaknesses it has 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 hold manufacturing barriers, and in general are items that customers do not want to switch unless they have to. The market needs Smith's Medical to be a reliable supplier, and the combination positions us better. Our company has emerged stronger from all the events of the last few years. We've gotten knocked down a bit, but we see the hill to run up again together with our new colleagues to drive value out of the combination. Thank you to all the customers, suppliers, and frontline healthcare workers as we improve each day. Our company appreciates the role each of us has had to play. And with that, I'll turn it over to Brian.