ICU Medical, Inc. (ICUI) Earnings Call Transcript & Summary

Hello, everyone. Good morning. My name is Raphael Taubenfeld, and I'm a member of the health care investment banking team at JPMorgan. Welcome to the JPMorgan Healthcare Conference. [Operator Instructions] With that, it's my pleasure to introduce Vivek Jain, who is the Chairman and CEO of ICU Medical, to walk through the presentation.

Thanks, Raphael, for having us, and thanks to JPMorgan for including us. It's nice to see the H&Q name on these slides. It's a firm I have a fond history of. I hope folks aren't Zoomed out from too many online meetings, so we'll try to go quickly here and leave enough time for Q&A. We do have some revisions to our slide show. So I'll call out the slide numbers as everybody is following along. Obviously, feel free to see our safe harbor language on your own. On Slide 3, just to start, ICU Medical is a pure-play infusion therapy company. We sell a full line of products that cover all the basic needs for hospital ICU and general ward infusion therapy care. For us, that starts with our core largest business, which is our consumables business. Think about that business as the pipes in infusion therapy that deliver important life-saving medicines or IV solutions to a patient. Those medicines or solutions are delivered via an infusion pump, which is our IV systems business, our second largest business. The fluids themselves are in our IV Solutions segment, which is our third business. And we have a smaller hemodynamic monitoring and critical care business. On Slide 4, what you'll see is we have a very large product offering with real breadth across the infusion therapy category. We're #1 or #2 in each of these spots in the U.S. market, and there are parts of our portfolio kind of moving left to right that have different features, both in terms of growth and size and differentiation. On the left-hand side, the categories are more commoditized in nature, but there's real differentiation around production scale, distribution and ability to serve the customer. As we move right on the page, there's more differentiation either around clinical features or workflow features or safety features that directly impact the clinician and the patient. For us, some of these categories are very high growth, in particular, the oncology category, which is really a consumables offering that sits between very expensive or very dangerous biological drugs as a pharmacy of patient; or on the far right-hand side in the software area, where we're sitting between valuable information around drug delivery, billing or patient safety that connects our infusion pump to the broader hospital environment. On Slide 5, one of the things we take a lot of pride in is we think we're big enough to be big and small enough to be small. So even as $1.2 billion or $1.3 billion revenue company, in this category, we compete everywhere we need to compete globally. Our IV Solutions business is only a U.S. business. But if we exclude that, the remainder of our portfolio around consumables and pumps is almost 40% an OUS business. That's helped us to gain scale and made our brand valuable in many corners of the planet. We compete directly in all relevant geographies. And we continue to invest in our expanding our footprint around the planet. Just a quick snapshot of us on Slide 6. We have about 21.5 million shares outstanding. We do have a bunch of cash on our balance sheet. We have slightly over $4 billion enterprise value. And basically, the core message of this slide is everything we do, with the exception of infusion pump, is a $10 or less product; 90% of what we sell are single-use disposables, a portion of those disposables in the infusion systems side are related to the pump; and the vast majority of those disposables in our consumables segment are open disposables be able to use with anybody's system in the hospital environment. Page 7, for those of you who are new to us, we do have some history here. A new team came on board at ICU Medical about 6 years ago. The first 3 or 4 years, 5 years, we had an amazing amount of consistency. We did deploy capital multiple times for a variety of both opportunistic and strategic reasons. In 2019, we had a number of issues come to the forefront that caused us to have our kind of first earnings reset. We've worked our way through those issues. And really now over the last -- even in the midst of the COVID environment, over the last 4 or 5 quarters, found a large amount of stability across all of our businesses. And the core message here is that we find ourselves finished with our historical integrations on much more stable footing. Our free cash flow is increasing, and we, frankly, have the ability and time to handle more. Page 7 is -- or Page 8, excuse me, industry structure matters a lot in our space. And so it is a deeply consolidated industry structure. There continues to be significant regulatory barriers, which are an advantage and a challenge at times. To participate, it requires a deep focus on manufacturing. Most of the products, when used properly, have a high degree of recurring revenue with very sticky market share. We have some tailwinds around guidelines in our oncology business. I already mentioned some of the international opportunities, and we do have this category creation going on in software that surrounds the pump. That's the industry structure about us. We think we're the only pure-play company in the infusion area. We have a deep commitment to innovation. We do have a balance sheet that allows us to make investments. A lot of CapEx has been put into the business as a result of the acquisition we did, and some catch-up CapEx that we had the availability to do given our financial performance. We have a set of incentives that are aligned with shareholder interest, and our integration is finished, allowing us to do more. Okay. To get into our businesses a little bit. Each of our headline businesses has a number of subcategories within them. And so our consumables business, which is our largest business, is about a $500 million business, and it really has 3 key pieces. The first portion is our legacy business around infusion therapy, and I'll talk more about each of these as we get to them. And then we have 2 higher growth portions of the business, our specialty devices and our oncology business. On Page 10, the most valuable piece or the largest piece of the consumables business is the core IV therapy business. And this is built around our Clave connector technology. This was the product line that we sold both to the direct to the end market and to our distribution partner, Hospira, which is why we bought that business a number of years ago. This business really relies on clinical superiority around the product features. We're deeply vertically integrated into all aspects of producing, sterilizing, distributing this product. And we deliver this product to customers in very unique ways in a way that works within their own workflow that allows them to optimize care in their own care settings, dependent on their own protocols. This business was -- the innovation around this business, just to dwell on that for a second, has really been around keeping those pipes open that these connectors deliver more safety, better outcomes and better efficacy for patients. So switching gears a little bit to some of the higher growth aspects of the consumables business. But we do have a number of specialty products here. So think about these as kind of niche applications under the consumables umbrella. A very important one for us is around the category of dialysis. We have a product called ClearGuard HD. This is something we brought into our portfolio 14 or 15 months ago. It's been very successful, and it brings more safety and infection reduction in the category of dialysis catheters, both in the situation those catheters are used in the large dialysis operator clinics as well as the hospital environment. And we also have a number of other innovations around our consumables portfolio. In particular, we now have broadened our line of disinfecting caps with both a male and female cap, and you'll see us continue to add to the specialty device category. It's an area that's been important for us from a capital deployment perspective, and it's really about finding those niches where there's unmet clinical needs, and we can continue to innovate and acquire in this area. The largest pocket of growth for us over the last couple of years in our consumables business has been our oncology offerings. And so for us, these offerings are really about consumables that fit between hazardous, expensive and dangerous drugs. And we have a history of innovation here that started really in the nursing arena and migrated more to the pharmacy. This segment for us has been growing double digits for a number of years. It was impacted a bit with COVID in 2020. We believe nothing has fundamentally changed, and we'll get back to our historical growth levels. And this business has been driven by guidelines in the broader market that mandate the use of these safe handling systems so that both clinicians and patients are safe in the drug delivery process. It's a global opportunity. There are new opportunities for us in Asia and other markets that we continue to incrementally invest to build value here across the globe. I think this oncology, just to dwell on it a bit more, this oncology area is a good example of our ability to innovate and sort of follow the bouncing ball of where clinical practice is going. This started on the back of our original connector franchise, where we realized that the Clave technology had application with a closed male luer into safe drug delivery. That migrated from a nursing product into the pharmacy with ChemoLock in 2015. We've now integrated those disposable products with a serious hardware that allows better drug preparation, safer preparation. And ultimately, we'll integrate these components with the pump set itself, and I'll talk about pumps in a second, but to ensure that you have closed medication delivery throughout the entire infusion workflow cycle. Obviously, there's guidelines here that I just talked about in USP <800>. And the value in the near term is not only expanding the available market, which still is deeply underpenetrated, but to expand the addressable market by bringing in more concepts around hardware and integration with the pump. Okay. Shifting gears a little bit to our Infusion Systems business, which is our infusion pump platform. Our flagship product here is called the Plum LVP pump. It is a product that was the #1 infusion pump for many years. It lost its way. Additionally, that was one of the reasons ICU had to step into Hospira. We've spent the last 3 years kind of resolidifying our position with the Plum, getting our validations right from all the important notified bodies, regulatory authorities and agencies along the way. And we think whether it's on a safety basis, clinical basis, technical basis or the ability to integrate IT, we're in a very good place. And the LVP market is the most valuable market in the infusion space because it drives high disposables usage. And so while you'll see our Infusion Systems business line, a portion of that is capital, but the much larger portion is the use of dedicated disposables that flow through that capital. There's been a lot of questions with us over the last number of years as to whether we were turning the corner in our LVP business and what was happening with the legacy Hospira pump portfolio. When we bought the business, it was about a $350 million, $360 million business. And it has had major market declines from $500 million or $550 million a number of years before that. Those declines continued for the first 2 years of our ownership. At the same time, we had a number of non-LVP products that were also declining. But what this slide finally lays out for 2020 over 2019 is in the face of pretty significant declines at the non-LVP products, we've been finally able to grow the LVP business. We believe that we had more market share at the end of 2019. We had more market share at the end of 2020, and we believe that trend will continue going forward. In the short term, it's about continuing to take advantage of the market opportunity today. In the mid- to longer term, it's about adding new platforms to the pump business. It's about innovating on the software side and expanding the informatics offering to move beyond the kind of historical situation that's transacting around the pump and disposable. The other big growth driver here, again, I talked about oncology, which is market creation from whole cloth, the same is happening on software that surrounds the pump. And so over time, our view value will transition to the software offerings as much as they are on the disposable today. That's where the majority of our R&D spend goes, and we believe we have deep confidence in history here and, from a quality perspective, are in a very good position to continue to expand and exploit interoperability with a broad pump portfolio. Our last -- or our third business, I'll talk about, I'm not going to talk about critical care, is the place we had a lot of volatility over the last few years, which was in our IV Solutions segment. When we reset things in the summer of 2019, we talked about a business that we believed was roughly an $80 million a quarter business. The last 5 or 6 quarters, with the exception of some COVID-related impact in Q2 of 2020, we've been able to stay at or above those levels. And there's really 3 points around this business that are important today. The first is just we've been able to prove stability, and we've been able to renew the vast majority of our business under multiyear contracts. The second is that we have a number of investments we've made, but we put a lot of catch-up CapEx into our Austin manufacturing facility. We've put up CapEx to move some of the products that we acquired from Pfizer that they were producing first to move those into our Rocky Mount -- into our Austin facility from Rocky Mount. And we put a lot of money, this is a heavy logistics-driven business, into the physical footprint to be able to serve customers well and optimize our supply chain. In addition to re-signing and securing a large portion of our business, we have added some new products to the mix. So this year, in 2021, we'll start to focus on a partnership we've made with Grifols, the Spanish company, on some PVC-free IV solutions as well as some integrated transfer devices to add some workflow speed to the mixing process, drug mixing process. Hot topic of conversation this year has been the impact of COVID on the business. This slide tries to lay out exactly what our view of what happened in 2020 was. And we had some puts and takes, both positive and negative, from what we all experienced last year. Specific to us, we are driven by hospital admissions and expenses. And the decrease in admissions, which we felt like we called early in the year last year, hurt. And it hurt us a lot in Q2 and Q3. In Q2, it hurt us very specifically in our consumables business and also our IV Solutions business. In Q3, it was more on the consumables business. And for the balance of the year, it did hurt utilization of those dedicated pump sets in our Infusion Systems business. On the other hand, we did benefit from COVID, both in terms of being able to re-sign and hold a lot of our business and solutions, but also receiving extra orders from these various surges around the world in our Infusion Systems business. And so some of our expansion in systems was for government stockpiling, some of it was for expansion on existing customers. All in all, if we were to categorize the COVID experience for us in 2020, outside of being able to take great care of our employees, keeping our production factors going, serving our customers well, from a P&L standpoint, it was probably a $30 million negative hit to us across consumables, solutions and dedicated pump sets. And it was probably a $25 million or $30 million gain to us in Infusion Systems from surge ordering and extra pump orders we received around the planet. Slide 19, I'll wrap it up and we can go to Q&A. Our view, we talked about the industry structure, high amount of consolidation, significant barriers to entry, hard to reproduce manufacturing assets, tailwinds, software, et cetera. We believe we sit well in that as a vertically integrated pure-play company. Our view of value creation going forward is -- in '21, to some degree, is the same speech as the beginning of '20, which is we must grow our differentiated businesses of IV consumables and infusion pumps. We need to continue to prove, and we've done it for 6 quarters, that we have stability in IV Solutions. We need to deliver new product innovation. We need to continue our margin improvement and optimize our supply chain costs. We've gotten back to strong free cash flow generation. As our integration costs have come down, free cash flow has gone up. That's led to an improving balance sheet. We recognize it's a bit odd to hold the balance sheet we do for a company that has our level of growth. But ultimately, we also want to deploy capital successfully as we've done in the past to show that we can create value for our stakeholders. So really, in 20 minutes, that's the story of ICU Medical. Raphael, I'd love to open it up to any Q&A. I'm going to turn the camera here because Brian Bonnell, our CFO, is in the room. And I guess we'll consider this our walk to the Olympic room. Thanks.

Great. Thank you, Vivek.

That was a pretty high [ check ] there. So floor is open, Raphael. Go ahead.

Great. So the first question. I know we touched on the COVID impact at a higher level across the business. But would be helpful, I think, if you walked a little more specificity by business unit how COVID has impacted and from what you think your -- the impact will be on a go-forward.

Sure. For us, the returns start with our Infusion Consumables business. And our consumables business really got whacked in Q2 with lower census and lower admissions. I think we were probably down $10 million plus from what our expectations were in Q2. And that continued into Q3, where we were down maybe another $5 million or $7 million and started to look more normal towards the end of the year. The other thing that was a bit of a surprise to us in 2020 regarding consumables was less oncology growth than we were accustomed to seeing. And obviously, we've been paying a lot of attention to the lab companies and the screening companies. There was a bit of a slowdown in the middle of the year. It picked back up towards September, October, slowed a little bit in November. So just more volatility in consumables than we were accustomed to in oncology. I think for us, in consumables, the biggest driver of COVID related was all about admissions and census. And to the extent that normalizes, plus oncology coming back, I think we feel reasonable about that in '21. On the other businesses, on solutions. I would say it was sort of -- it took in Q2, but it gave back some in Q1 and Q4. And in the pump business, it did allow for us to sell extra capacity throughout the year, which helped us in a variety of levels. But ultimately, we're not 100% sure on the extra orders that we did have in pumps, whether those will be pumping and using dedicated set. So the real value creation there continues to be to focus on taking market share and growing the installed base that's running the pumps regularly. Brian, [ anything ]...?

No, I think that's exactly right.

And that's a good segue into the next question. I guess as we sort of start to see the vaccines roll out and a normalized environment, hopefully, this coming year, how does a normalized sort of state help ICU's business and results the most? And where would that be seen?

Yes. I think for us, earnings, value, revenue is global, more of the value and earnings come from the U.S. market. And to the extent the U.S. can find some stability around admissions and procedures, that's where we felt the most pain in '20. And to the extent that things normalize in '21, that should be an uplift for us. And so when we put out guidance next month, the way we've thought about it is there will be some caution around the COVID impact and procedures certainly in the first half of the year. But at some point, our view is vaccinations happen, life gets back to normal, and we can add in what we think are our wins, plus a more normal, stable environment, which net-net, should lead to some growth, '21 over '20.

Great. And obviously, each of the business segments are -- undergo various dynamics and such. And so maybe it would be helpful to go a bit deeper on each sort of outside of the COVID sort of impact. And so if you start with IV Systems, obviously, recalls have been a big topic. And -- but how has ICU executed during this period?

Yes, we came from this industry and the team here, Brian and I, others have been in this pump business for a long time. And it's been kind of peaks and valleys for all the suppliers. I think COVID has muted or dulled some of those peaks and valleys a bit because hospitals had to focus on delivering care and the zillion other things that they've been fighting on every front. That said, some of the current challenges have at least added a bit of tailwind to us and created a better environment than we've had in a long time. And we feel like we're executing well against that. And our heavy investments in quality, stability and people have been recognized. It's not as good as it could be in COVID-free environment, but we're not that big, and we don't need that much to feed on to deliver attractive growth. And so for us, that led us to focus very much in the pump business on where do we have a clinical or technical story that resonates with customers and try to exploit those situations very specifically. There are still people even in the midst of the COVID environment that recognize the case for change that can see the value of what our offering, either stand-alone or combined, is and those are the opportunities that we've been running to the ground.

Great. And then if we move on to the IV Solutions. I know you touched on the challenges in 2019. But of late, results have seemed more predictable. And so what's changed? And why should investors feel more comfortable today?

I think the thing we feel good about in solutions is when we entered this business, we walked into a situation where the customer base was really alienated and treated very poorly for bunches, stuff that's too far in history to talk about now. But 3.5 years later, I think we feel like we turned that around where customers are really satisfied with us. And with what happened both in the shortage in the category as well as the ability for local producers to serve customers well during COVID, our reason to exist became very clear. And ultimately, those things manifest in our ability to roll our business and get under contracts for the next number of years. So the stability was happening anyway. COVID assisted that and people realized it can't be at risk on a number of these items. Everything we sell is needed to deliver care. Everything we sell, you need a lot of stability and predictability on. And we put up our own capital, both in terms of inventory and holdback and other things for serving our customers well. And I think that's all been in the pot of why we've been more stable in solutions. And it's not sort of a business you can just randomly choose. I want to sell a few codes and be in or -- it's a little bit like a regulated utility or power business. Like you have to compete at scale, you have to have a full line, and you have to have production assets. It's a difficult thing to just turn on a dime, turn on a time line.

Okay. That's very helpful. And then as we move to the consumables side, and so what happened with oncology in 2020?

It's a little bit hard for us to fully understand because we never sort of thought oncology would be elective. But it felt like that for parts of the year. Obviously, there's publicly traded companies that are fully in the lab business or the screening business, and we studied those results, and we saw they felt pressure on people coming into the system. It's -- and it's more of a U.S. phenomenon because it seems in the international markets, has returned very much to normal. The U.S. still seems to have less people coming into the system from an oncology perspective as reflected by us sitting around it and being in the middle of each of the mixing of the drugs,than there was a year ago. It's getting better, but it was sluggish in the back half. And I'm not sure we have a perfect explanation as to why that's the case.

And as we sort of look to other growth drivers of the business, can you touch on areas such as specialty?

Yes. I think value sits in these like clinical niches and trenches or value sits where you have massive scale in a particular category, and we need to do both. So generally speaking, in IV therapy, consumables, we have big scale. We compete on price, value, clinical, global distribution, et cetera. But these niche categories where you're really changing clinical outcomes, driving a certain result are very valuable. That area around dialysis is a global growing category where even if a small fraction of the people who come into dialysis clinics use a dialysis catheter, they need them to work well and work effectively, and we have a product that improves the performance and outcomes for people in that situation. There's lots of examples of different areas like that, and we need to continue to invest and drive innovation because there is a lot of value that can be created if you can find the right spots in those. And I think a number of our team have experience in a variety of industries -- a variety of these health care disposable categories on kind of these marginal and incremental innovations. And we just need to keep chipping away at them and making them impactful in the overall portfolio. Again, we're not that big. And so a $500 million consumables business, if we can find some of these spots that are breakout $5 million or $10 million or $15 million opportunities, can make a big difference to our P&L.

Absolutely. And do you mind touching on the international opportunity on the consumables side?

I think the international opportunity has -- again, I don't want to dismiss it. It's awfully important from a scale and revenue perspective. It doesn't drive earnings today. We need to get bigger internationally to make sure it drives commensurate earnings, but these categories like oncology, like connectivity, like software, don't exist in a lot of international markets. And so the opportunity to create those categories is very valuable to us. And that will change our profit levels in some of those markets. I don't think you'd find a company our size that has the amount of international sales that we do. We need to continue to add scale there because the categories themselves are growing at a faster rate than they are in the U.S. market.

Great. And as we sort of move to the IV systems, what do you see as the growth drivers there outside of the recall?

I think in the pump market, it's really about workflow, software, patient safety, comfort for the nursing staffs, comfort for the IT staff, cybersecurity and infection control and outcome and billing. It's a whole bunch of drivers. The recall is a unique thing at this moment, but you still have to win in all of those other categories. And for us, the criteria that were on the slide we showed in the deck around cybersecurity, around concurrent delivery, which is clinical, or around safety rating, those are the features that we really think differentiate us outside of whatever market things are going on. And those are the things that we've invested our marketing time and energy in since we bought the business to reground the customer base on and reeducate everybody at what the opportunity with our products are.

Great. And then moving to the -- on the margin side. What are some of the opportunities you see for expanding the gross margins over time?

Yes. I think on the -- if you think about margin expansion and operating margins specifically, the fact is we do run pretty lean. And so if you think about opportunities on the SG&A line, there's probably not a lot there. And so to your question, we do think if there is opportunity, it's going to be around the gross margin line. We probably, back a few years ago, we were kind of in the low 40s in terms of gross margins. Not sure if there is an opportunity to get back to that level in the near term, but there is some opportunity to improve relative to where we are today. And I think that opportunity comes in a couple of different forms. One is just in terms of product mix, our highest margin product lines tend to be our fastest growing. And so just over time, there should be a little bit of expansion coming from that. And then secondly, I think as we grow revenues, there's an ability to really leverage our cost infrastructure. So the -- although we do run lean from a cost standpoint, the benefit of that is you can also leverage that cost infrastructure and really drive a lot of that additional gross margin to the bottom line. And I think specifically, what that means is as you grow revenues, you get more product running through our plants. We also have the ability with some growth in our IV systems business to really us use our scale and drive some gross margin expansion there. And also in our international businesses, where there's kind of a fixed cost associated with just running in each of those countries. And the more business you can get running through there, obviously, helps in terms of margins.

Great. And just one sort of add-on to that. I mean, as you capture more of the international opportunity and it's higher contribution to your overall revenue, how do you see that sort of impacting margins over time?

I think that's going to be -- it's going to be generally favorable. I mean I think we are -- as we talked -- we've mentioned before, we're probably a little more international than we should be. And we don't necessarily -- we're not at scale in many of the countries in which we operate. And so to the extent we can get incremental volumes of business going through each of those countries, I think that the -- it's going to be a net positive impact to gross margins.

Great. Maybe moving on to capital deployment. I mean how are you guys thinking about the allocation across sort of capital return to shareholders versus M&A versus reinvestment in the business?

It's obviously a very hot topic for us. I think our base model is if we can, like we did for those 22 quarters in a row, prove that we're resilient and can grow our businesses, even if our industry and our growth is in line with our industry of mid-single digits or something, if we can supplement that with a little bit of M&A from our organic free cash flow, that's a perfectly safe model for the environment that we're going to be in. And I think that is the de facto base case. If there's something, we did a transaction that very few small companies would do, if there's something that we can be more nimble on or more scale in nature, we'll look at them. They're hard to get done. But I think -- I don't think we're averse to it. I think right now, we're focused on what's the base case in this environment, and we certainly have the balance sheet and resources to do that.

Great. And as you kind of evaluate these opportunities, the M&A opportunities, I mean, what criteria are you most focused on?

I mean it's situational. Obviously, we watch what's going on. And everybody says they're disciplined until they're not. I think our bias has been, if you look at our transaction history here, where we work before and kind of what our backgrounds were, we've been pretty cautious, and I think we've proven that we're determined to stay in those bounds. Easier said than done sometimes, but I think that's certainly our bias. So for us, we actually are a bit -- the cost of capital is important, but it's not the only consideration. We are a bit old school in what is the right ROIC, repayment, words like that, that don't get said that much anymore. Or frankly, days we feel aren't relevant to anybody anymore, but we believe will be.

Great. And I think just to close out the queue, the last question here. How important is product breadth to winning share in the pump market in the long run? Can you just -- you feel like you can hold your current position just with the LVPs? Or will you need to broaden your portfolio to sort of -- to other pump types to sort of maintain that foothold?

I mean 30 -- different answers for the U.S. globally, right? In the U.S., 35%, 40% of the market has individual solutions. So I think we feel very comfortable that there's a real case for that in the U.S. as long as you can deliver on the IT side of the equation. And then it's really a country-by-country answer because certain countries use different modalities more than others. And so the countries that are less LVP oriented, obviously, would be more difficult for us to get a meaningful foothold in. But where the returns come in the U.S., I think we feel pretty solid about where we stand today.

Great. Well, thank you very much. That concludes the Q&A. I hope everyone has a great day.

Thanks, Raphael, for having us. Thanks, JPMorgan, and I appreciate everybody making time for ICU Medical. Thanks.

Great.