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

And good morning, everyone, and welcome to the inaugural KeyBanc Life Sciences & MedTech Investor Forum. My name is Matt Mishan. I'm a senior MedTech analyst. I'm pleased to be joined by CFO, Brian Bonnell; and VP of Infusion Systems, Dan Woolson, from ICU Medical, largest pure-play and infuser pumps consumables and IV Solutions. If you have any questions, there's a Q&A box on the bottom of the screen, and that goes through me, and I'll do my best to get to your questions. But from here, I think we'll just fire them off and start the chat. Welcome, Brian. Welcome, Dan. I appreciate you guys doing this.

Brian, what type of environment at the hospital is good for ICU Medical? I know you had more tied to activity level?

Yes. Matt, first of all, thanks for hosting us today. It's very much appreciated. To your question about kind of the drivers, for us, you do have to kind of keep in mind our product portfolio when thinking about the drivers, roughly 90% of our products are single-use disposables that are used on patients. So, as you suggested, our business is very much driven by hospital admissions and elective procedures. And you saw that, in 2020, as a result of COVID, especially in the second and third quarters of that year, when both hospital admissions and electric procedures were down, so were our volumes. And as we sit here today, we are still not back to what we would consider normal levels. And we think we're doing okay despite that. But ideally, we would like to see an environment where there is high employment, broad health care coverage and patient census has returned back to normal levels. For the capital piece of our business, which is kind of the remaining 10%, which is primarily the hardware portion of our Infusion Systems business, a more normal environment also means that nurses and other staff are less distracted by COVID, and we have their attention to either evaluate a conversion opportunity to our pump platform or for those accounts that we've already signed, we can actually move forward with the implementation process. We've also gotten questions around, what is the current CapEx budget environment for hospitals mean to us? And I would say, relative to some other capital equipment manufacturers, it's probably less of an issue, to be honest. I guess, we would just like to see volumes return back to normal levels. And I think we're assuming we're going to get closer to that here towards the back half of this year.

It's a good way to segment or shift. I mean, how would you characterize the transition from what you saw in December and January, which is just a surge environment to kind of what we're seeing now in February and March, where there's a lot of optimism around the recovery of hospital?

Yes. I mean, I guess, as it relates to the U.S. specifically, it seems like the transition that you're referring to is playing out very similar to the way that we thought it would. Really no surprises there. We expected volumes to fall off at the end of January as that December-January COVID surge eventually subsided, and that's what we did see. Now we find ourselves in this period of time where the -- those higher-acuity COVID patients that were in the system, during December and January, are now gone, but we haven't seen the return, at least not back to historical levels for what we would consider to be kind of the normal patients just yet. So our expectation from here forward is that as the vaccine rollout continues through the summer, we will see this gradual recovery in patient volumes as that takes place, but probably not returning to normal levels until the back half of this year. And then outside the U.S., it's kind of a country-by-country situation. There's still a number of countries, including some of those in Europe, where the path to recovery probably takes a little bit longer, or at least that's what our assumption is.

Okay. I've been saying for about 1.5 years that I thought the underlying momentum at ICU was there, you just weren't necessarily seeing in numbers yet. Could you give some background on the bottoming of the installed base of your Plum platform? I think the improved quality of your customers and some of the offsets in the business that you've been winding down?

Yes. And I'll kick things off, and Dan can comment on the Infusion Systems business and the turnaround there. But you are right in that there have been some headwinds that have masked the underlying momentum when it comes to the financials. But to answer that question properly, we really kind of need to get into each of our businesses and talk about some of the drivers of revenue and earnings, both historically and then into the future. If you start with consumables, after the Hospira acquisition, we faced a bit of a unique challenge, whereby we had acquired our distributor, who was selling our products in the market at a higher price than what ICU was selling directly to other customers. And so post-transaction, there was a period of time where the Hospira business eventually had to migrate to the ICU pricing, and we did that. It's largely behind us at this point. And going forward, for the consumables business, we're really only judging ourselves based on whether or not revenues go up. Next, if you move on to Infusion Systems, there were really 2 issues. The first was that Hospira, pre-acquisition, had a number of years of continued market share decline in their LVP pump business. And it took a while for some of that lost business to work its way out of the installed base and eventually out of our P&L. However, we were able to stabilize the installed base in Q4 of 2019, and we gained market share in both 2019 and 2020. The second impact within Infusion Systems was from the wind down of the Q Core agreement, which caused our ambulatory pump revenues, over the past 3 years, to decline by $30 million. And while that was a large impact to incur, the remaining business is down to $15 million or so annually. And so the size of that headwind is going to be much smaller going forward. But even in spite of that Q Core wind down, our Infusion Systems revenue still grew over 10% during 2020, if measured on a constant currency basis. And so the goal for Infusion Systems is to continue to capture share this year, which will, in turn, drive profitability in future years. And then within Solutions, that's probably kind of the most complicated series of events. But what it comes down to is the acquired book of business at the time of the acquisition had to be repriced, number one. Number two, there were some temporary capacity constraints in the market that we benefited from for a short period of time that eventually went away. And then number three is, we did, over the past few years, endured some negative impacts from lost absorption as volumes under our Pfizer contract manufacturing agreement declined. But for the most part, all 3 of those are really water under the bridge. We reset our expectations in the middle of 2019 when that float business went away. Almost all of the business has now been re-signed at this point. Most recently, we just re-signed a subset of customers in the fall of 2020, and that process went very well. And we just very recently extended the contract manufacturing agreement with Pfizer for another 3 years. And we -- as part of that, we have protections around volumes there. So I would say for Solutions, very similar to Consumables, it's really now about continued stability with maybe a little bit of growth into the future. And so if you take all this together, we've absorbed a lot of hits to profitability. But almost all of this is behind us now, and we actually expect to grow EBITDA in 2021. And in addition to that, as you referenced, we have also improved the quality of our customer book along the way. At the time of the acquisition, Hospira really didn't have a presence in the top 10 hospital systems in the U.S. And today, we have meaningful business at over half of those systems. So that's how I would kind of summarize it for the company as a whole. But I think it's worth taking a second, and let Dan comment a little bit more around the Infusion Systems business and the work that we've done there to really turn that around.

Yes. Thanks, Brian. Just to reemphasize maybe a couple of points Brian was making. I mean, the first point is we've stopped the historical over 10-year installed base decline in the Infusion Systems or the pump business. And capital sales cycles are long, it's 12 to 18 months. So it takes time to turn things around. A lot of work has been done in the last 2 years to build the foundation to get the right sales team in place, to get the right safety messaging in place, to get the right third-party accreditations and full strength on our value proposition. And putting all that together now, as Brian said, we've grown the installed base. We had a number of competitive conversions. And more importantly, we're shifting our customer mix. When we took over the business from Hospira, a lot of the customers were slanted much more skewed to smaller and more medium-sized customers. And now we're competing and winning in much larger, more sophisticated customers. So right now, we're holding on the largest set of bookings we've had since we've owned the business. And we're confident now that we can use this to grow the LVP business and cover the non-LVP segment that Brian was referencing.

The first thing I want to go back to is the contract manufacturing agreement with Pfizer. That, I believe, you were doing at cost. Is that the extension that you're doing, does that now provide you EBITDA as part of that arrangement?

Yes. Thanks, Matt. So good question. Yes, as part of the extension, there is better pricing under the terms. And so we expect to see a little bit of a benefit from that beginning this year. It still may not be quite what we would consider to be market pricing, but it's certainly better than the pricing we were operating under previously.

Okay. So would you consider this as an extension of the current agreement where it wouldn't necessarily be incremental to your guidance?

That's right.

Right. And then I think we could shift over to the window of opportunity that you have with the #1 cheerleader, in fact, in remediating its Alaris platform right now with the FDA, and Baxter's still finalizing its submission amidst new platform. And how you're trying to take advantage of that opening?

Yes. Thanks, Matt. It's absolutely a unique period of time in the infusion pump space, as you just referenced. We feel we're very strongly positioned today, given the safety benefits of our Plum LVP pump and the value proposition. And we can really solve a number of the challenges and risks that customers face today. We've done well. We were -- successfully captured share, while the other companies were actively in the market. But I will be honest. I mean, the situation over this last year has been muted with COVID, to some extent, right? Customers, rightly so, have -- maybe were looking at infusion technology and then, obviously, had to shift their priorities to deal with COVID in caring for patients, which is critical. We're absolutely focused on it. We think we're well positioned. Over this last year, it's kind of gone in cycles, where initially with COVID, we had limited interaction with customers. I think over the summer, we actually got more traction with customers, and then it's kind of slowed down this past winter during this last surge, and now we're seeing things open up. But we're seeing this customer action open up, and we feel we're strongly positioned. And we're absolutely focused on it. We know it's a unique window, and we want to take as much advantage of it as we can.

You had talked about a backlog of installations you were hoping to do in 2021. First, the environment right now, if you're seeing the COVID-related demand come down, not necessarily being filled back up by procedural volumes recovering to normal, would seem to be a good time for hospitals to be considering implementations, they might actually have some time to do that is like this window of this March, April, May time frame, where we're transitioning a good window for implementations. And then secondly, just explain the annuity piece of the business that's tied to the infusion pump installations and what that opportunity gives you for business in consumables and solutions on top of that.

Yes. Maybe Dan can take the first part of that question, and I'm happy to talk about the economics of the Infusion Systems deal and the annuity that's part of that.

Yes, Matt, just as it relates to the implementation timing, again, we do have a strong backlog. The variability of implementing that, there will be significant variability to implementing that. I think things are opening up, which is good. However, the process to actually drive an implementation of a new customer, I mean, can take several months. There's a lot of things that customers have to do on their side from an IT pharmacy, and they've got a lot of things, and then we have to kind of work together with them. So it's a kind of multi-month process to actually get a customer live. So we're working with our customers as best as we can to get those scheduled. I think the reality is, certainly, this first half of this year, there will be quite a bit of variability to kind of predict the actual implementation timing.

And then, Matt, on the -- your question about the annuity piece of the Infusion Systems business. Our Infusion Systems business consists of pump hardware, with dedicated sets that go along with it and the related MedNet safety software. And in an average year, the pump hardware is really less than 25% of the segment's revenues. And so really the majority of the revenue and almost all of the earnings is related to the dedicated sets in software. And so that's important to understand because when we implement a new hospital customer onto our Infusion Systems platform, we recognize the revenue on day 1 for the pump hardware, but then over the next 7 or 8 years, the customer is purchasing the higher-margin dedicated sets and software. So there's a little bit of a timing difference in terms of what you see on the P&L. In addition, when we are successful in getting hospitals to switch to our Plum 360 platform, we also have the ability to win non-dedicated consumables and solutions business. And while not every pump deal has the opportunity to cross-sell, it is a big enough opportunity to be an area that we're focused on.

How do you see hospitals continuing to address health care worker safety moving forward? I mean, I think that's a priority for the hospitals coming out of this year, so you just have exhausted personnel. And then do you think that can drive an accelerated conversion of your closed system transfer to prices? And maybe just explain what those are as well.

Yes. I mean, I think even before COVID, hospitals were increasingly thinking, for a while now, about both patient and caregiver safety. And we do feel like that's good for us because it's relevant to a number of the products that we offer, whether it's the closed system transfer devices that you referred to or our ClearGuard caps for hemodialysis catheters or our MedNet safety software with interoperability. So -- and those are the types of areas where we're also spending our R&D dollars. But to your question on CSTD specifically, which are -- they're medical devices that allow for the drawing, transport and delivery of hazardous drugs, which typically are chemotherapy in nature, that help prevent toxic exposure to the caregiver. And with the exception of a little slowdown during COVID, oncology has been and really still remains our fastest-growing product line, and that's been fueled, in large part, by the USP <800> regulations that are meant to protect health care workers. And we believe that there's still further penetration available in the market. And not -- because not all hospitals have implemented CSTDs just yet, but we do expect all of them, at least in the U.S., eventually will. I don't know if COVID will, indirectly, accelerate this adoption, but we do expect hospitals will continue to remain focused on both patient and caregiver safety, and we feel like that's good for us.

And then just more broadly on oncology, I think, I mean, it declares this. Do you put together a broader solution that you're able to bring to the hospital from like patient -- from like pharmacy to patient, and a piece of that is your Diana compounding platform. I mean, just curious, what's the early feedback on Diana? And what's the early feedback on the broader solution that you're capable of bringing into a hospital?

Yes. Thanks, Matt. We believe -- certainly believe, as a company, one of our strongest value propositions is to oncology. If it is at the one setting where a lot of our products do work together. And we can -- as you mentioned, we can go from preparation with our Diana, plus our solutions to administration and delay with our closed system cancer devices, our Plum 360, to all of it. I mean, other side, all the communication with MedNet interoperability, right? So we have, really, a complete set of offerings specific to oncology. And that entire workflow does really resonate with customers. It allows them to keep a closed system, which is extremely, extremely important when you're talking about the handling of hazardous expensive drugs. So it's -- one of our key value propositions we're absolutely focused on and does resonate with customers. You referenced Diana specifically. Diana is really help as an IV workflow solution, and it's really an early -- still early conversion market. We're still creating -- had the product in market. We're making some more refinements that are coming later this year, but it's definitely a key part of that entire oncology value proposition.

Is oncology -- when I think about pumps in the hospital, I think about pumps, universal, the hospital systems like to use like a single pump. Is it -- do you have the potential to drive adoption in oncology? Maybe hospitals will use 2 different sets of pumps, 1 in oncology and 1 on your broader floor?

In some cases, you will, Matt. And then outside the U.S., actually, more of our business is more slanted towards the oncology centers, in some parts, particularly in Europe versus maybe some of the general wards today. In the U.S., it tends to be more of a whole house, but you absolutely do have the opportunity to kind of carve out specific niches in certain circumstances.

Interesting. How should we think about the IV Solutions business going forward? I think, Brian, you talked about it earlier. I think you've leveled set-ed it, but also added some pieces to better the offering, and so I think that's a positive. But also longer term, it seems like it's gone from a business that was undercapacity to potentially overcapacity.

Yes. I think our views on our solutions business are pretty consistent with what they have been recently. In the undercapacity situation, in the solutions market that you alluded to, it was really only temporary, and that was resolved back in early 2019. And at that time, we reset our expectations and our guidance for the business and said, you should expect that business to be $80 million of revenue per quarter. Since then, we've completed the re-sign process for a subset of our Solutions customers, which we completed in September of last year. We did extend our contract manufacturing agreement with Pfizer that I alluded to earlier, for another 3 years, and we have some guaranteed minimum volumes there. And the market today is acting pretty normal. So I think going forward, we do expect to see continued stability, which we've now seen for the past 6 or 7 quarters, plus maybe a little bit of growth when you layer in some of the additional offerings that you referred to.

Okay. And then I caught on another one of these that you have a distributor relationship in Japan that's starting to come to fruition. Is that Terumo? Like I remember you're talking about that like years ago. And why is that now just starting to work?

Yes. So Japan is a market where we've seen some recent strength, particularly in our CSTD business. And so -- and as you alluded to, we do work with a distributor partner in that market. And I think our recent success there is driven largely by favorable market dynamics and how those align with the products that we have, specifically, where drugs are highly valued and health care worker safety is a priority, then CSTDs will also be valued. And I think that's what we're seeing here, because Japan seems to meet really both of those criteria. And I'm not sure it's much more than that.

Okay. Is that a distributor relationship or an OEM relationship?

It's a distributor relationship.

Right. On the margin side, I feel like once you get through a lot of the installations of the pumps, mix is going to start driving better gross margins. How should we think about the progression through 2021? And then what kind of long run -- what kind of long-term runway do you see on the margin side?

Yes. So I guess when we think about opportunities for margin expansion, we do feel like most of that opportunity is on the gross margin line for the most part. We have squeezed out most of the SG&A synergies that we expected from the Hospira transaction. And today, we do tend to operate pretty lean. So not much more on the SG&A line. But on the gross margin line, our guidance range for this year was 38% to 39%. And that assumed some margin pressure from the implementation of the competitive pump deals that we won last year within the Infusion Systems business, along with some that we expect to win and implement this year. So we've given ourselves a little bit of room there. Going forward, in future years, we do see an opportunity for expansion, and that should be driven by, number one, the pull-through of dedicated disposables and software from the pump market share capture that we've recently won and expect to continue to win. Second, improved product mix because our higher-margin consumables business, we expect to continue to grow at a faster rate than the other businesses. And just improved plant absorption from higher volumes going through our plants as volumes return to pre-COVID levels and we get some growth on top of that. So in the medium term, I'm not sure yet we really see a clear path to getting to, let's say, the mid-40s. But certainly, we think that here, over a number of years, we can get to the gross margin, perhaps in the low 40% area.

Okay. Is there a concern going forward? Or are you now potentially seeing any inflationary activity or supply chain charges?

On the -- as it relates to supply chain shortages, no. Nothing that concerns. I mean, at ICU, the management team here is kind of a product of our collective experiences. And we know that staying in business within infusion is a competitive advantage. So we try to protect ourselves by being vertically integrated. We make our own tools. We do our own manufacturing. We operate our own distribution centers, and we drive our own trucks. And so that does give us a little bit of protection when it comes to things like supply chain and having product availability, because we do want to make sure that we're there for our customers when they need us. And that vertical integration, I think, also helps to protect us a little bit from price increases and some of the inflationary pressure that companies can sometimes feel.

Okay. I think resin is a big input for you guys. Is oil a potential concern? Or is it a small piece of COGS?

Resin is an important raw material for us. But the pricing around resin, because it's considered as specialty chemical, doesn't tend to track as closely to oil, as you might expect.

Okay.

It's its own market.

Okay. Excellent. And then on M&A, maybe for background. You guys were previously linked with Smith Medical for a while. I guess, why would that have been a good acquisition for ICUI?

Well, I mean, I guess, as we evaluate any acquisition opportunity, there's certain things that we would look for from a strategic standpoint. I suppose this would include improving our product portfolio, and therefore, making us more valuable and more relevant to our customers. And we also would look to give ourselves a little bit more scale in some of the foreign countries where perhaps we find ourselves subscale today. And so I mean, the transaction that you referenced, those would help us certainly gain scale outside the U.S., and I'm sure there's a few of their product lines that would integrate very nicely into our product offering. But the fact of the matter is there's a number of other transactions that also check those same boxes, provide those same benefits. And we're going to spend our time on whatever M&A opportunities are available and actionable.

Okay. Last question. As you get through this in 2021, what do you think your end markets look like in 2022?

I mean, I guess what we're -- if you think about it by business unit, I would say what we're looking for out of each of them, starting with Solutions, that business is going to be driven up based on what's happening within the economy, what people have in terms of access to health care and patient census in hospitals. Consumables, it's a little bit more than that. It's not only patient census, but it's about us creating kind of new categories similar to what we've done with CSTDs and Pursuit Vascular. And then within Infusion Systems, that could be interesting because to us, it doesn't seem like the normal level of annual refresh for pumps happened in 2020. Certainly, it felt very much below average. And if this were to continue in 2021, then you have to assume there's some sort of catch-up at this point. Maybe that happens in 2022, maybe it happens over a longer period of time, not sure, but there's some interesting dynamics in play as it relates to that business. So that's kind of where we see things, or at least those are the most important drivers to us when we think about 2022.

Okay. Dan, Brian, thank you very much. We appreciate for your time. I hope you have a good day.

Thanks.

Thank you, Matt.