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spk03: Good afternoon, and welcome to the ICU Medical third quarter 2022 earnings conference call. All participants will be in a listen-only mode. Should you need any assistance, 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 a question, please press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note that this event is being recorded today. I would now like to turn the conference over to John Mills with ICR. Please go ahead, sir.
spk00: Good afternoon, everyone. Thank you for joining us to discuss ICU Medical's financial results for the third 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 have a presentation accompanying today's prepared remarks. To view the presentation, please go to the investor page and click on the events calendar, and it will be under the third 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're 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 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 into 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.
spk01: Thanks, John. Good afternoon, everybody, and we hope you are well. Once again, it's been a quick 90 days or so since the last call. and our legacy ICU business unit revenues were, again, very predictable in Q3, and we did have operational performance improvements 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 since mid-2021 surpassed even the Q2 2022 levels, which was hard to believe. As we said previously, Q2 was the highest peak for any time our team's been in the industry. However, the issues around raw material availability are narrowing. From a customer perspective, we felt U.S. hospital census was stable and international underlying demand was good in all geographies in Q3. Like everyone in our industry, we wanted to start first by thanking all of our customers and their frontline workers for trusting us to serve you during these times. While Q3 revenues were generally in line with our previous comments for legacy ICU medical, Our revenues for Smith Medical were ahead of our expectations that we laid out on the last call. And since everyone is now talking about items they would have never imagined describing on an earnings call, we'll join that group and wanted to use the time today on the call to comment on the year-over-year drivers of the three main legacy ICU businesses, explain the Smith Medical revenues we achieved in Q3 and how that bridges with our comments on the last call, provide a status update on the Smith Medical two buckets of challenges we've been highlighting all year, Go a bit deeper on the specific items that have really hurt gross margins this year because the scale is so astounding and it answers the question of where has the profit gone this year. Foreshadow, and it's subject to change, how we might report next year as we realign our reporting business units. Highlight the continued challenges with the strong U.S. dollar and why we're taking our medicine today and its most up-to-date impact in the near term. And lastly, note a few important strategic items we've now finished as they will impact the base of 2022 going forward as these were the first must-do strategic items as they were negative situations. And we'll skip the standard long-term value creation comments as that is after we get the self-help items secured in the near term. Q3 2022 is our third quarter of joint reporting, and finally the story is getting a bit shorter. I'll quickly summarize the whole company results and then discuss each segment of the business. We finished the quarter with $582 million in adjusted revenue. Adjusted EBITDA came in at $93 million, and adjusted EPS was $1.75. We had a softer quarter of investment into the business, and it was largely about inventory builds that Brian will describe. Again, it was a less clean quarter in the cost of goods as we spent at a very high rate to improve the service levels of Smith's Medical, and we had restructuring and integration costs that we remain focused on reducing next year as they impact cash flow. The strong dollar and current and FX impact are worse in Q2, worse than Q2 at the moment. So let me start with Legacy ICU Medical, which is a relatively straightforward story. In Q2, Legacy ICU had $320 million in revenue, which is flat on a constant currency basis and minus two reported. We had small growth on a year-over-year basis in our most differentiated businesses with negligible COVID impact, and as previously discussed, Q3 2021 had a strong COVID surge. Nothing was dramatically different on underlying demand in Q3, but there was some inter-quarter slowdown during the quarter and bounce back in September. The public hospital companies validated our view on their recent calls that surgeries were up and long-stay high-acuity admissions were down. Our U.S. sales were flat to down year over year due to the strong COVID comp in Q3 of 21, and all the growth came from the 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 $141 million, which was a 1% increase on a year-over-year constant currency basis, and minus 3% on a reported basis. We had growth in the OUS markets, and the U.S. market was slightly down in core IV and helped by the specialty categories, which foots with a strong COVID comp in the summer of 21. In oncology, we've been a bit constrained due to some raw material challenges that should abate by the end of this year. We're happy the international markets are holding up, and the U.S. is a little harder to judge right now. Moving to infusion systems, which is primarily our LVP pumps and associated dedicated sets, this segmented $88 million in adjusted revenues, which was an increase of 1% on a constant currency basis or minus 3% on a reported basis. We did have a decent level of installs in Q3, and here we had some dedicated set declines on a year-over-year basis in the U.S. due to COVID in 2021, but the segment grew due to better international performance. On the last call, we said we felt that customer attention was back, with bandwidth to have real discussions as some of the fatigue from COVID is passing, and the acceptance of inflation and the cost of nursing, et cetera, are being internalized. Yes, the stresses of the current environment do make it a bit bumpier for decision-making, but we don't believe over the medium term, relative to our size, there's any change to our competitive opportunity, and we are focused on commercial execution here and have no change to our previous commentary on the segment. Finishing the segment discussion with Infusion Solutions, we had $81 million in adjusted revenue, or about the same as last year on a year-over-year basis. No additional comments on the revenue side here. The bigger issue for us is this is a segment that has disproportionately absorbed the majority of inflation at LegacyICU, which has impacted LegacyICU profits. The vast majority of unexpected inflation and earnings pressure relative to our view on 2022 LegacyICU profits is primarily about fuel and shipping costs and currency, and to a lesser degree, electronic component surge pricing. Through Q3, 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. 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 improvement where we can, and to try to illustrate to customers the need to have some of these costs indexed 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're also focused in the next round of contracting how to separate the costing on some of these items. For example, where 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 historical negligible inflation, suppliers never had to think this way. Okay, so let me move to the Smith businesses, first talking about aggregate revenues relative to our last comments, and then to update the two buckets of issues we've been talking about all year. The Smith medical revenues came in at $262 million, with infusion systems at $97 million, vascular access at $95 million, and vital care at $70 million. This was more than we expected, and the short story on why this happened is a combination of a few more billing days, and that part we knew, but with more stable operational processes in terms of IT systems and labor. all of which led to improved performance on clearing some of our backorders, albeit, again, spending freely to do so. The underlying performance for the domestic business has substantially improved, with international performance still under repair. On the last call, we talked about more confidence and predictability in the Smith Infusion Systems line. We did better than we thought in Q3 as we supported existing MedFusion customers And more importantly, all U.S. backorders on CAD disposables were cleared, which makes the competitive focus on new wins more actionable. We had not anticipated recovery until Q4, but regardless, the entire unit is running better now with reliable production and fulfillment on the Smith's dedicated pump sets and some of the other items. On the last call, we also said vascular access would have some improvement, but still a work in progress, even with a strong Q3. We did benefit $5 million from the last COVID syringe order, and here, too, we're very healthy from a production and U.S. distribution standpoint on all the major sub-product lines, but our commercial execution remains a work in progress, as Smith, like Hospira, did go backwards here. Lastly, vital care remains an area where some of the supply challenges remaining backorders continue to be worked as it was neglected the most. We've spent a lot of time, airtime on the last two calls, explaining the two buckets of issues. Let me take them in reverse order today from the previous scripts. On the quality-related interruptions, we continue to make execution progress that supports the previous communication to both customers and regulators in 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 that we received in late 2021. This part feels very similar to Hospira and our previous experience, and we have the right people who have been through the exact same experience, and our team is fully embedded into the operation. We'd say the main difference since the last call is in Q3, we began to execute the various field actions in line with our commitments that we had made in the earlier communication period. As we said on the last calls, 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're spending heavily, so making progress here is extremely important. On the operational issues, with regards to production, it can generally be said that the entire Smith's production network is producing at acceptable levels with a few minor interruptions. The silicone availability we described in the last call has resolved, and now we're fully producing those items. We continue to work on securing the base of supply and insourcing the key high-margin disposable components with proper factory staffing levels. 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 drag to gross margins. In the vein of we can't believe we're talking about this, we did want to give a little more detail on the largest gross margin variances from expectations, because at this moment, those are the largest buckets of addressable opportunities, and the scale is so astounding, and it goes a long way to answering where has the profit gone. Brian will go through those in more detail. We've already seen our ability to manage our costs across operating expenses, and our focus obviously needs to be on growing revenues, but it's equally important to improve our gross margin performance. One area I'd highlight is our freight and logistics costs, which will approach $250 million this fiscal year. That is orders of magnitude more than any historical level. Part of that is diesel costs, part is ocean freight rates, part is expedited shipping costs, not only to our customers, but also to ensure we have the right raw material supply to our network. This is not something we intend to talk about regularly, but it's hard to understand the profit shortfall without some huge drivers, as it's not like ASP is going down anywhere in the business. This area, along with other large items like improving the quality system and reducing remediation costs, are all large areas for self-help in cash flow generation. In terms of next year, we did want to foreshadow, and it's subject to change, how we might report as we realign our reporting business units. It's likely that we'll aggregate revenues into three segments. The largest would be a consumable segment that would contain the legacy ICU IV consumables, most of the legacy Smith's medical vascular access, and a few other consumable slides. We think production and operations for most of that pillar should be improved in 2023. with work needed on the vascular access commercial execution as previously mentioned. The second segment would be a system segment, which was all the legacy ICU IV pumps combined with most of the legacy Smith Medical IV system segment and the associated dedicated disposables. Again, we think service levels and quality for most of that pillar should be improved in 2023. This segment would have almost all the capital sales of the company. And as a reminder, we published in previous investor presentations Capital sales are less than 15% of the total company, and that includes a large amount of software, service, spare parts, accessories, et cetera. The remaining segment would be a vital care segment, combining legacy ICU IV solutions, critical care, and most of what is in the legacy Smith's medical vital care segment. We'll provide some schedules when ready. And just to note, there are a few strategic efforts that would adjust the base year of 2022. Some examples are items we just finished recently, such as an agreement to exit India as a direct selling organization via distributor and exiting other negative margin situations if pricing or cost cannot be rational. So these may be a small hit to base year revenues, but are being done to improve a negative profit situation to a neutral or positive. In terms of the balance of this year, from an earnings perspective, the only real difference from our previous call is currency. Even though the euro has been in a more stable range the last few months, our largest direct countries are Canada, Japan, Australia, which have all had additional currency weakness. For what it's worth, we only carried the legacy currency hedges inherited from Smith this year. ICU always ran unhedged, so to speak. As a result, we've really taken our medicine today, and it's had a large impact on the year. From a revenue standpoint, we felt Q3 showed what we can do when fulfillment operations are more stable, even if more expensive. We did catch up on some of the back orders faster than we thought, so that may impact Q4, depending on where this underlying market settles. Regarding longer-term performance, I'm not going to repeat the comments from the previous calls, as we feel we've been transparent here on the size and scale of the self-help opportunities. What we want to get back to after the challenges of this year is 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 with the hot spirit transaction, 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 necessary. 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 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 offering 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 participate in a logical industry structure. Even though we've been consumed with basic operations, we still believe this is all the strategic case and the big opportunity over the long term is using this combined portfolio to improve our position in existing markets and also move to the right areas as the value shifts into new spaces. The construction of the Smith portfolio was logical and frankly, why it's 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, stabilize, and improve the operations, we could be presented with more opportunities here. While the pandemic introduced substantial volatility, strategically, we do think the weakness 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's 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 over 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.
spk07: Thanks, Vivek, and good afternoon, everyone. To begin, I'll first walk down the P&L and discuss our results for the third quarter and then move on to cash flow and the balance sheet. Along the way, I'll provide our updated outlook for the full year for each of these areas. So, starting with the revenue line, our third quarter 2022 gap revenue was $598 million, compared to $336 million last year, which is up 78% on a reported basis, reflecting the impact of the Smith Medical Acquisition. For your reference, the 2021 and 2022 adjusted revenue figures by business unit can be found on slide number three of the presentation. For the legacy ICU business, adjusted revenue for the quarter was 320 million compared to 328 million last year, which is flat on a constant currency basis and down 2% on a reported basis. Infusion consumables was up 1% constant currency and down 3% reported. Infusion systems was also up 1% constant currency and down 3% reported. and IV Solutions was down 1% on both a constant currency and reported basis. Overall, we were pleased with the results for the legacy ICU businesses as compared to a very strong Q3 last year. For the third quarter, Smith Medical contributed $262 million in revenue. Compared to the second quarter, this represents a sequential quarter increase of $39 million. It is worth noting that Smith Medical's historical financial reporting calendar resulted in five additional business days during the quarter as compared to legacy ICU. We estimate that these five additional business days accounted for approximately half of the 39 million sequential increase in revenue, with the remaining increase due primarily to improvement in customer order fulfillment and reductions in backorder levels, most notably within the legacy of Smith Medical infusion systems and vascular access businesses. During the quarter, we completed the IT systems work to align the Smith Medical financial reporting calendar to that of ICU, and going forward, the number of business days will be the same across the combined company. As you can see from the gap to non-gap reconciliation in the press release, For the third quarter, our adjusted gross margin for the combined company was 35%. During the quarter, we continued to experience the impact from the same items as the second quarter and largely to the same degree, with the exception of foreign exchange, which worsened during the third quarter as a result of the continued strengthening of the U.S. dollar. For the full year, we expect adjusted gross margin to be around 36%. Coming into 2022, we originally expected adjusted gross margins to be 40%, or four percentage points higher than our current forecast. So let's recap the drivers of this difference, which fall into a few distinct categories. The first category is operational inefficiencies being driven by the current supply chain environment. Here, we're seeing a two percentage point impact to gross margin from a combination of the continued effect of lower manufacturing absorption from reduced volumes, plus additional expenses related to air freight and other forms of expedited shipping to customers, which has been incurred to address the legacy Smith's medical operational challenges. The second category is higher market prices for fuel and diesel, as well as certain categories of raw materials. The higher freight rates are disproportionately driven by the legacy ICU solutions business, while the higher raw material prices are spread more broadly. These higher freight and raw material costs reduce adjusted gross margins by approximately two percentage points. In the final category, is foreign exchange, which will have a one percentage point negative impact to adjusted gross margin for the year as a result of the strengthening U.S. dollar. Recently, we have seen some improvement related to manufacturing absorption as we continue to increase manufacturing output and improve customer fulfillment. But this benefit has been largely offset by the impact of foreign exchange from the continued strengthening of U.S. dollar. Additionally, our willingness to expedite shipments to ensure product availability for customers, along with the lag between manufacturing improvements and the cost recognition in the P&L, we don't expect to see a meaningful improvement to adjusted gross margin during the fourth quarter. Adjusted SG&A expense was $107 million in Q3, and adjusted R&D was $23 million. Total operating expenses in Q3 declined compared to Q2 by approximately $6 million from a combination of continued realization of synergies, lower personnel costs, and timing. Restructuring, integration, and strategic transaction expenses were $14 million in the third quarter and related primarily to the integration of the Smith's Medical Acquisition. This was the same level of spend as the second quarter, and we anticipate we will maintain a similar level of spending in Q4. Adjusted diluted earnings per share for the third quarter was $1.75 compared to $2.07 last year. The current quarter results reflect an adjusted effective tax rate of 18.5% and basic and diluted shares outstanding for the quarter were 23.9 million. And finally, adjusted EBITDA for Q3 increased 29% to 93 million compared to 72 million last year. Now, moving on to cash flow in the balance sheet. For the quarter, free cash flow was a net outflow of 18 million. Sequentially, this was a meaningful improvement compared to a net outflow of 86 million in the second quarter due to a combination of improved earnings and lower working capital. And we saw this improvement in cash flow while at the same time continuing to invest heavily into the three key areas of the business that we've highlighted for the past several calls. The first is higher levels of inventory to bolster safety stock and allow for onboarding of new customers. Here, we invested $52 million in additional raw materials and finished goods inventory during the quarter, most of which was related to the Smith Medical product lines in order to protect our manufacturing operations from supply disruptions and to replenish our distribution channels to better serve customers. The second area was the integration of the Smith Medical business. And as previously mentioned, we spent $14 million on restructuring and integration. And the third was quality improvement initiatives for Smith Medical. And during the quarter, we spent $19 million on quality system and product-related remediation work. Additionally, we spent $21 million on CapEx. for general maintenance and capacity expansion at our facilities, as well as placement of revenue-generating infusion pumps with customers outside of the U.S. And we continue to expect total CapEx spending in 2022 of approximately $100 million. For the fourth quarter, we will continue to invest in the Smith Medical integration and quality system improvements, along with higher levels of inventory across the combined company. However, inventory has been the area of greatest investment, with $152 million spent through the first three quarters this year, and we believe we are nearing the point of stabilization and expect inventory levels to peak by Q1 2023. And just to wrap up on the balance sheet, we finished the quarter with $1.7 billion of debt and $249 million of cash and investments. Since our last call, the macroeconomic factors that impact our near-term earnings outlook remained mostly stable, with the exception of foreign exchange where the U.S. dollar has continued to strengthen relative to foreign currencies in markets where we have a meaningful presence. As a result of the foreign exchange impact on our P&L for the second half of this year, we expect to end the year at the lower end of our previously provided guidance ranges for adjusted EBITDA, of $350 to $370 million and adjusted EPS of $6.20 to $6.80 per share. For modeling purposes, the Q4 adjusted EPS guidance assumes interest expense of $21 million, a non-GAAP tax rate of approximately 23% and diluted shares outstanding of $24.1 million. In summary, we're pleased with the meaningful progress we made during the third quarter to address the operational challenges of the Smith's Medical Business. While profitability will remain constrained as we invest to repair the legacy Smith's Medical Business and deal with the current macroeconomic pressures, we remain convinced of the longer-term opportunity to improve the financial performance of the combined organization with the list of items under our control. Strategically, we have broadened our available markets and we're working to get all portions of the business on the same trajectory as Legacy ICU. We look forward to providing updates on our progress along with our 2023 outlook during our call early next year. And with that, I'd like to turn the call over for any questions.
spk03: We will now begin the question and answer session. To ask a question, You may press star, then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then 2. At this time, we will take our first question, which is coming from Jason Bedford with Raymond James. Please go ahead.
spk04: Hi. Good afternoon. Can you hear me okay? Perfectly. Hey, Jason. Hey, I always feel like I need more time to digest all of the information given in these calls, but let me take a stab at it here. On the legacy infusion systems business, good set of installations. You did mention you're seeing a benefit from the Smith combination. Are you seeing some selling synergies as a result of Smith?
spk01: I would say, Jason, if you kind of look the way the markets lined up historically, every place that used a Smith's product was using either our LVP pumps or someone else's. So we had a very good sense of where ours were. I think on where it was being used in other spots, those are doors at least we have a reason to be in now where we didn't necessarily have a reason to be there before. So I would say it's... It's forcing us to have some conversations that, or allowing us to have some conversations we may not have had access to before.
spk04: And the environment for capital is conducive to those discussions?
spk01: I mean, I think that's what I tried to address in the script. It felt pretty good 120 days ago. It's still pretty good. It's a little bit, taking a little bit longer, just given the week-to-week drama. in the world right now. That's why I was saying it could slow down some decision making. So we haven't seen anything material. The other point I was trying to make there is if you look at kind of the stuff we published, capital, what we called capital for the combined company is 15%, but if you dig a little bit deeper, a chunk of that is software, annual software licenses and service contracts and spare parts, actual capitals. not such a huge part of the company. Important, obviously, because it drives future dedicated disposable share, but it's the vast majority of the company is single-use disposables.
spk04: And on the legacy consumables business, growth slowed. I realize you had a tough comp here. I think you alluded to some supply chain constraints, and I think in the past you've called out oncology. Is there any way to either kind of quantify the impact of the supply chain constraints, or at least just kind of frame the current situation and when it will be resolved?
spk01: Yeah, I think there's probably two issues that happened. One, that's why we were trying to say there was a little bit of intra-quarter volatility. It was a little bit soft out there in U.S. hospitals, kind of mid-July, early August, maybe, I don't know if it was holiday travel or what, but it was a little bit less than we had expected. And that's part of what happened in Q3. And the other part is being short some of these items on oncology and one or two other areas. I would say, I don't want to give a precise number around that, but it's certainly more than a million bucks over the balance of the year.
spk04: Over the balance of the year or the quarter, sorry?
spk01: Well, I'm saying a lot of it happened in Q3, so a million bucks in the quarter is probably better.
spk04: Okay. Just on gross margin, you kind of called out the $250 million impact. I think you cited diesel, ocean freight, expedited freight. But you also mentioned that there's areas of self-help within that. Is there any way to kind of walk us through where you see the opportunity and when we'll see an impact on gross margin?
spk01: Just to be clear, we were just saying $250 is the absolute spend, right? And by any historical measure, spending 10% of your revenues on moving stuff around is not sort of a normal level. So it's not saying that's all incremental pain. There's lots of pieces of that you can pick at. I mean, one piece that we've been very focused on, we knew we were going to have some expedited freight when we did the transaction, and we were behind in even some of our own production, which had more expedites. So I don't know. I'd say the number of expedite freight costs this year was somewhere north of $20 million, $25 million. That's a very tangible thing that we need to go after. It's not all going to get solved in one quarter. It takes time to get it, but it's fully under our control, and we need to – We need to do that. And that's a big chunk of variance relative to our original plan for the year.
spk04: And since you kind of clarified the spend, I realize we're not in a normal environment, but what is normal? Meaning if 250 is what it was this year in a normalized environment for a business this size, what would be the normal level?
spk01: I think we'd want to separate IV solutions. I don't want to get too granular, but we'd want to separate IV solutions from everything else. Historically, those costs were in the 4% to 5% range for outside of solutions, and they're obviously a much higher percentage right now.
spk04: Okay.
spk06: I'll jump in the queue and let someone else jump in. Thanks. Thanks, Jason. Good talking.
spk03: Our next question will come from Matt and Shannon with KeyBank. Please go ahead.
spk05: Hey, good afternoon. Thank you for taking the questions. In fact, I don't want to get too granular around like a single quarter, but I know a lot of people are focused on like the exit rate for this year and running that out to next year. So as I think about like low end of guidance, I'm thinking 350 to 360 and the range that takes you down to 350 is a step back from, you know, some of the progress you've made this quarter. And getting closer to 360 is, like, another step forward and moving towards 2023. You know, how should we think about, like, that range of outcomes for the fourth quarter?
spk01: I'm looking at Brian. Sorry, Matt. It's good to hear a few words. I think we just, it's been a difficult year, Matt, and we just don't want to make a mistake. I think your question is 100% fair. I mean, we were pretty transparent in the last call script. We got a little ahead of that for a revenue perspective. There is room to improve margins. I would feel better just saying we stay within there. We'll address next year when we get there. If revenues didn't come through and currency got worse, there's a chance what you just said could be right. But there's an equal chance that if we do what we're supposed to do, we land where we intend to land. So I get the question. I don't want to pick at any one quarter either, given what we've put people through and what this year has felt like.
spk05: Okay. I think that's fair. And then you talked about a few strategic efforts you were making. How are you thinking about the timing of portfolio rationalization at this point?
spk01: There were, there are a few countries where we have lines of business that are truly money losing. And we should address those first if they're actionable. And so we've been doing that some spots where we had to change pricing in the market and some spots where it just makes sense to have a different go-to-market model. And so we've been focused on those because those are true negatives. And then in terms of is there something else on the portfolio rationalization front, it's not exactly the best seller's market of things in the world, which I don't think is of groundbreaking use to anybody. So I think right now our focus is to get the assets running well in order and kind of see what the road brings, right? If they're positive cash flow contributing to the overall enterprise, we don't feel under any pressure or rush to do anything other than to maximize value.
spk05: Okay. And then I don't know, I'm not sure if Jason asked this or not, how much was oncology constrained this year? Is there any chance you can quantify that?
spk01: I mean, I think the answer we gave there was about the quarter, which you could say, you know, it was a million bucks or something. I don't think it would be an unrealistic assumption to say if you annualize that number, that was the impact of oncology constraints this year.
spk06: Okay. Got it. All right. All right. Thank you, Zach. Thanks, Mike. Thanks, Matt.
spk03: And our next question will come from Larry Solo with CJS Securities. Please go ahead.
spk02: Hey, guys. Good afternoon. Just a couple of follow-ups. The slowness in the U.S. July and August, could that also be – is there, from what I'm hearing from a couple of companies, a little bit of return to some seasonality? Could that kind of feel that impact for you guys as well at the hospital level? Sure.
spk01: Possibly. It looked more like the world did pre-COVID, but even a bit less than that, so it's hard to say. Okay, that's fair. It's still a little bumpy even in the fourth quarter, right? That's what I was trying to say. We need to hold our market share, gain market share, create new categories. That's what we're focused on, right? We're not going to change so much the underlying. We have to just make sure our portfolio is in the right places with the right customers.
spk02: And, Vivek, you mentioned some of these strategic efforts. Can you – and I think you said specifically I think the exit of India for one. I imagine they're all kind of the small onesies and twosies, but can you give us an idea sort of – can you quantify anything just to give us a little frame of reference on what some of these projects are entailing and what they're doing in terms of moving the needle at all?
spk01: I mean, I think they're all onesies and twosies, but there's a number of them, right? So we'll take – that's the world we live in right now. So we have to grab them if we can, even if it's a low single-digit type of help. We've got to do it. We've got to do it. Right, right.
spk02: And the gross margin pressure, obviously nothing new. I think you said, I think Brian said, you know, I expect sort of a third of everything in Q4 as well. Were you building any kind of improvement on the prior expectations? I don't think so. I just wanted to clarify on that one.
spk07: No, we weren't, Larry. I think that was the same.
spk02: Nothing's really changed. FX has gotten a little worse, which has changed. I feel like freight at least has gotten a little better. Are you guys seeing at least a little bit of an improvement there? Maybe not enough to really move the needle just yet, but maybe some light at the end of the tunnel.
spk01: Well, if you believe the long-term forecasts, right, which show back-to-back diesel price changing next year, you would believe that. But at the moment, we have not seen any, right? There is still a strong disconnect between diesel pricing and regular fuel pricing in the U.S. And ocean – inbound to the U.S. from Asia, ocean is down, but we don't really use a lot of that, right? It's outbound to Europe and other spots for us. And air – costs have not changed at all for expedite. So air expedite is still very painful. And most of that stuff that drives that big, huge logistics number is variance on air and other expedites.
spk02: Okay. Just a couple more. You mentioned on the Medline pump, sounds like things are Medline pumps certainly progressing. So are you basically back in the market with all, can you just kind of give us a little more color there, you know, updates?
spk01: think you mean the med fusion that's usually pops excuse me yeah yeah yeah I think I'd leave it at our comments from the script which are we've informed customers regulators of the actions that need to be taken to support the product we are out in the field working on those actions and we are supporting existing customers and they have answers and That's probably all I would say, right? They didn't have a lot of information a number of months ago, and they're getting real support in the field today. Gotcha.
spk02: All right, just last one for Brian. Just on the cash flow, I know this year has been a year to date usage of cash, although it sounds like things are getting a little bit better. As you look out of the 23 without giving numbers, I know you said at least the inventory should start hopefully becoming even a good guy for you guys. next year in terms of positive. So would you expect that? I imagine a lot of the integration stuff and costs will wind down. So hopefully, do you expect to return to free cash flow positive next year? And over the long run, can free cash flow approach, it hasn't in 10 years, I think I haven't covered it, but can free cash flow sort of get close to net income?
spk07: Yeah, Larry. Yes, on inventory, that's been the largest area of investment for us this year. It's $150 million to date. We do see that peaking by Q1 of next year and then probably stable after that. I don't know if it goes down, but certainly stable. And that alone should allow us to see some positive free cash flow next year. And then I think While it will take a while since we are going to continue investing in the integration as well as the quality systems, yes, eventually at some point we do get to where free cash flow is in line with our gap net income.
spk01: Yeah. I mean, I'll pile on just two things. One, I think, Larry, it's also the type of inventory because the supply chain has been so screwed up for a year. We've been buying a lot more raw materials. So even though the numbers, we have finished goods everywhere. And I'm sure that's the same for lots of companies. The other thing is, it's not lost on us, right? In the midst of COVID, net income and free cash flow were pretty tight here at very good levels. And of course, we want to get back to that. And the truth is, the transaction we had to use and go beyond even ICUs, legacy ICUs cash flow to hold this together this year. That is what happened, right? And at a minimum, transactions is the fund itself. And, you know, that's probably a halfway goal relative to getting all the way there. Got it. Great. I appreciate all the call. Thanks, guys. Okay. Thanks, everybody. We appreciate the interest in ICU Medical. We look forward to seeing you at various conferences early next year and having a call with you in the not too distant future.
spk06: Thanks very much. Bye. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.
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