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

Good day, and welcome to ICU Medical, Inc.'s conference call to discuss the acquisition of Smiths Medical division from Smiths Group plc. [Operator Instructions] As a reminder, today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. John Mills of ICR. Please go ahead, sir.

Thank you. Good morning, everyone. Thank you for joining us today to discuss ICU Medical's commitment to acquire the Smiths Medical division. On the call today representing ICU Medical is Vivek Jain, Chief Executive Officer and Chairman; Brian Bonnell, Chief Financial Officer; and Christian Voigtlander, Chief Operating Officer. We wanted to let everyone know that we have a presentation accompanying today's prepared remarks. To view the presentation, please go to our Investor page and click on Events Calendar and will be under the ICU Smith acquisition event. We will be referring to this presentation throughout our prepared remarks, so please go to our Investor [ page ] right now. Before we start our prepared remarks, I want to touch upon any forward-looking statements made during the call, including beliefs and expectations about the company's future results. Please be aware they are based on the best available information to management and assumptions that are reasonable. Such statements are not intended to be a full representation of future results and are subject to risks and uncertainties. Future results may differ materially from management's current expectations. We refer all of you to the company's SEC filings for more detailed information on the risks and uncertainties that have a direct bearing on operating results 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 this potential acquisition. And with that, it is my pleasure to turn the call over to Vivek.

Thanks, John. Good morning to all, and thanks for joining this call on short notice. I'm joined here in California by Brian Bonnell, our CFO; and by Christian Voigtlander, our COO, who is joining by phone from London. We're having this call today to announce our agreement with the U.K.-based Smiths Group to acquire their medical division. I'll walk through the strategic rationale, provide a quick overview of the transaction, explain how the products come together and sketch out how we're likely to organize our business going forward. Brian will then walk through the transaction economics, return expectations and a bit on why now. I'll pick it up again to discuss how we thought about value, give some examples of growth factors and contrast this situation versus our other significant transaction a few years ago. We'll then open the call up to questions for the whole team. I will reference the transaction slides you can access on our website or by clicking the link on the press release that went out very early this morning. Let me start with the highest level strategic rationale and industrial logic on Slide 4. Most directly, combining our complementary product lines together make sense for customers. We'll be approximately a $2.5 billion revenue company with significant focus and scale in infusion therapy and some interesting adjacencies to explore. Internationally, we'll create a scaled operation. Perhaps more importantly, we'll create a leading U.S. domiciled company to add diversity and resiliency to the medical supply chain in the U.S. market. On a strategic level, this combination creates additional vectors for growth as we can go deeper into the most important clinical niches and participate in them regardless of where care is delivered. And economically, while we've profitized our previous large transaction, this acquisition allows us to leverage the heavy investments we made into integration and infrastructure. Let me run through the mechanics of the transaction, and Brian will give more detail. We will deliver $1.85 billion in cash and 2.5 million newly issued shares to Smiths for an upfront value of $2.35 billion at our recent equity price. The equity equates to approximately 10% ownership in ICU Medical. Along with that, we've agreed to $100 million in contingent based considerations tied to our equity returns, and we're also assuming certain liabilities. We expect the transaction to close in the first half of 2022, subject to customary closing conditions. A bit of why it happened this way. I guess, I'd say, everyone sort of played their cards as they had to and ultimately, logic prevailed. We respect the Smiths Group willingness to engage with us to deliver a better transaction for their shareholders after we contacted them following their early August announcement. We were able to have a very constructive dialogue. In terms of their ownership, they are subject to a 6-month lockup, but have a strong tax incentive to hold for at least 1 year. And the contingent consideration requires they hold at least 50% of their ownership to have a right to the payout. As with our previous transaction, we'll welcome new director to join on the ride with us. Okay. On to what this is all about, the products. Slide 6 is similar to the slide we used for our previous transaction, where ICU Medical migrated from being a component and nondedicated IV set player into a broader player with LVP pumps, who our components are integrated, and IV solutions. Slide 7 shows how the acquisition fills in the other gap so we can fully serve the market. We lack syringe and ambulatory pumps, and their inclusion with us creates a more vibrant competitor versus other prominent players. We're also missing the last mile of a catheter into the patient, which connects to everything else we sell, and some of the ancillary technologies that touch infusion like IV fluid warming. The combination of the Smiths Medical portfolio allows ICU to enhance our competitiveness against the larger players and provide the broad set of offerings required. To give a little more detail on the segments and slide -- on Slide 8, I think everyone is familiar with our standard reporting. We have an LVP business, a consumables business and IV solutions. The right side of the slide shows approximately what Smiths Medical has. At a high level, both firms are reasonably close in size, and we suspect both suffered from the same challenges. It's incredibly hard to be a small capital equipment company when competing with multinationals, who have a different scale or offer a broader value prop to the customer. Next on Slide 9 is how we might be organized post acquisition. This is subject to change. We think we would have a good-sized IV systems business that leverages competencies from R&D to service to our quality systems. In consumables, we would get not only the obvious last-mile products, but some other smaller consumables that we believe we can add our components or technologies to and innovate a bit. And we would have a decent-sized pillar of other complementary ICU and critical care items, and we'll use the same terminology as Smiths currently uses to describe them, vital care. All in all, we think we will have a balanced business across the segments and geographies with the left 2 pillars looking economically much more like traditional medical device companies. With that, I'll hand it over to Brian now to walk through some of the detail on the math and why now.

Thanks, Vivek, and good morning, everyone. I'm also very excited to announce this deal. Just as Vivek walked you through the strategic rationale for this transaction and the profile of the combined company, I'm going to cover the financial implications, which are also very compelling. As you can see on Slide #10, to finance the transaction, we have secured a commitment for a $2 billion senior credit facility, which includes $1.7 billion in term loan commitments and a $300 million revolver commitment. Once syndicated, we expect the $1.7 billion of term loans to consist of a combination of simple and straightforward Term Loan A and Term Loan B. In addition, at closing, we expect to use approximately $300 million of on-hand cash to fund the remaining cash consideration of $150 million plus a combination of transaction expenses and acquired cash. At closing, we expect pro forma net leverage to be approximately 3.1x. Obviously, this leverage profile is much different than how we've historically run the business as we operate in a highly regulated industry, and maintaining adequate liquidity and balance sheet capacity is critical to our success. Our philosophy here has not changed, and our #1 capital allocation priority in the near term will be to delever. That's why we've chosen to finance this transaction with prepayable term loans. Even with meaningful investments during the first 3 years for integration, we still expect to be able to delever down to 1.5 to 2x after 3 years, facilitated by the strong free cash flows of the combined company. And we view this leverage of 1.5 to 2x as an appropriate level of permanent debt for our business, assuming that debt capital markets remain relatively attractive long term. And while nothing specific is contemplated at this time, this deleveraging could be further accelerated in the event of any noncore divestitures if compelling. After delevering to this sustained level of permanent debt, any free cash flow would be available for either M&A or return to shareholders. And given the day-to-day liquidity needs of the combined company as well as the environment in which we operate, we would expect to maintain at least $250 million of cash on hand. We believe this transaction will create significant value for shareholders, and I would like to highlight some of those value drivers on Slide #11. First, we expect the combination of the 2 companies to result in meaningful earnings accretion and attractive returns. Our baseline view of the adjusted EBITDA run rate of Smiths Medical before synergies is around $190 million. This is consistent with their historically reported results under an IFRS basis of presentation of around $230 million, but adjusted downward by approximately $25 million to conform to U.S. GAAP accounting standards, which do not allow for capitalization of R&D expenses as well as the impact from returning to more normal demand levels for certain product lines that have benefited from COVID. Moving further down the P&L. In the first year after closing, we expect adjusted diluted earnings per share to be almost $11. This assumes approximately $25 million in realized first year synergies. The $11 of adjusted EPS represents over 40% accretion relative to a stand-alone ICU scenario. Also, we expect ROIC to be around 6.5% by the end of year 3, with further expansion in the out years as integration spending subsides, synergies are fully realized and free cash flow begins to accelerate. We expect to deliver at least $50 million of cost synergies, and we anticipate these will be fully realized by the end of the third year. Here, we expect to leverage the significant investments in infrastructure made as part of the Hospira integration and should see savings in areas such as IT, sourcing and supply chain, amongst others. Additionally, it's worth noting that while we believe there is the opportunity for some cross-selling opportunities as a result of combining the businesses, they have not been contemplated in our current model. Moving on to Slide #12 and why now. I think it's helpful to step back and recognize that this transaction is a natural progression of what we've been building over the past 4 or 5 years. In fact, we originally thought that 2020 was going to be the year where we took on more after finishing the Hospira integration, addressing the reset in the IV Solutions business and optimizing our supply chain network. But COVID came along and required our full attention as it did for Smiths Medical as well. But today, we feel even more prepared because we have the opportunity to leverage the investments in the Hospira integration, the financial capacity from our strong free cash flows and the capabilities of our team, all of which allow us to handle more. It's difficult to create something of this scale in mature markets. There are not many medical device companies left between $5 billion and $15 billion of market cap, as most have either been acquired or jumped the gap with their own strategic transactions. While we enjoy our balance sheet, it's unrealistic to think we would run a business long term with our current capital structure. So we had to cross the threshold to take on some leverage to create a company that's materially different than where we started our journey. We believe this transaction will create significant value for both our shareholders and customers. And I'm very much looking forward to welcoming the Smiths Medical team and working to bring our 2 companies together. I'll now turn the call back over to Vivek.

Thanks, Brian. While we're proud of that scorecard, this is an intimidating journey to go through. I thought, again, similar to that last large transaction that we should talk about how we thought about value and how we could get shareholders comfortable with what we're doing. Last time, with the Hospira transaction, we had specific earnings and knock-on impacts if we lost Hospira as a customer, so it's easy to do the return calculation. We were paying below book value for a capital-intensive business, where significant remediation dollars have been invested and where our equity used in the purchase was supported by our sales to them. This situation is different. The competitive landscape has evolved over the last few years. And we believe that the strategic or competitive value of having the complementary pieces is high. Alongside that, we have some businesses that look very traditional in systems and consumables and some that are extremely important to the customer but don't have the same return profiles, so some diversification is important. Then there's the reality of both the current offer they had in hand and the reality of available assets. Depending on how you valued it, they held an offer with $1.8 billion of cash upfront and anywhere between $200 million or more in equity. And the situational reality also applies. It's not lost on us that everyone in the category has been a little stuck. Shareholders should take comfort that since our mid-2019 IV Solutions reset, we have explored all the ways to pursue value, and controlling our own destiny seemed the most actionable. I guess that's the fancy way of saying returns will be lower than the Hospira deal, but it's a different type of opportunity with a lower capital-intensive business, where we can access new areas for growth. Just a couple of quick examples of things we believe that will matter for customers. First, on Page 14, the supply chain has been very choppy in dealing with many of these categories. Some of these items are lower value with bad market dynamics, and we think we can offer stability. As we said in every conference call over the last few years, many of the large U.S. systems have come back to us. And we believe in combining -- and we believe combining with Smiths adds even more security than national supply chain. If you pick an example like the pandemic, the combination will supply everything from syringes to pumps to breathing circuits and ventilators. We also believe the combination allows us to focus more deeply on the most valuable clinical areas. I'll show 2 quick examples. First, on the next slide, we think we have all the products to add safety and value to the most hazardous and complex drugs in oncology. But ultimately, what this is really about is growing more integrated with the entire drug preparation to delivery process wherever it happens. If we can bring safety to each aspect with better workflow, the market will reward us. On Slide 16 is another example of a high-value clinical niche. Syringe pumps are core to pediatric and NICU care. Both companies offer complementary products, whether in the infusion therapy or respiratories that are differentiated, just another quick example of the subverticals within the walls of the hospital. I thought it would be worth a minute to contrast this lift versus what we had to do with Hospira on Slide 17. And Christian is on the line and can answer anything at the end. It's a different kind of lift than Hospira. Hospira came with literally no support infrastructure, took over 15 months to close all the countries, had massive IT TSAs. And we had to scale up dramatically, cost a fortune. But it was our -- but it was businesses and factories that we understood, and we were already doing business with them as our largest customer. This is a bit different. While not as clean as buying a fully independent company, it's pretty close. It has one global close, much fewer TSAs and scope and existing infrastructure in the same IT systems. That doesn't mean it's a layup. It comes with more lines of business and more factories, which will take some time to integrate. But we do not believe it will consume us like the Hospira integration did. Lastly, on people, on Slide 18, our team is battle tested on these topics. For Christian, Virginia, Brian and Blake, they've lived to the standup of CareFusions, Vital Signs, Vyaire, et cetera. And along with everybody on the left side of the page was core to the Hospira integration. And every person on that left side has been here since we started the Hospira journey. For our business and quality leaders, we take comfort that we're walking into businesses and challenges where we have significant experience. The product categories are in the circle of what we understand, and our team has had direct experience with them. A couple of years ago, we used to say on these calls that we were big enough to be big and small enough to be small. Even at a much larger size, we think we can keep that small feel and focus and culture that's made our teams stick together. I believe customers will substantially benefit from this alignment, much the way they did when Hospira Infusion Systems and ICU came together. I wanted to bookend the 2 basic scenarios as I see is the range of plans unfolding for this acquisition. In the best case, we'll have better execution to improve our top line performance, drive operational improvements and focus on cash conversions and returns. In the worst case, we continue to fight headwinds on the top line, but we can still drive operational improvement and generate solid cash returns over time. Either one of those cases is value-creating relative to where we are today. It's just too soon to know where the pieces will fall to perfect this scenario. We believe either scenario ought to drive enough cash flow generation to justify the transaction. Okay. Nearing the end here, it's important to outline what we expect in the near and medium term, and outline is as follows. Our next checkpoint will be at the JPM conference in January. We'll have more color on timing and our business alignment by then. The first few quarters after closing could be bumpy as we start to integrate the operation. Cash flow will show up sooner than in the Hospira acquisition. Lastly, we think it could be a lot like our original story. Once all the actions have been taken and the pieces are in place, we expect to generate returns very quickly. In closing, we believe that this was a logical evolution for both businesses. We feel we put together transactions, didn't risk the enterprise and still left real room for value creation for investors. If you're an investor who like the vertical that ICU operates in, perhaps even like the management team but were uncomfortable with the valuation upside, maybe this transaction can provide the catalyst to show you the path to investment. And if you're an existing ICU investor, we appreciate your support in advance. We hope you feel that this action provides sensible capital deployment and an opportunity for increased value in the medium to long term. As always, I'd like to close with things are moving fast. We're trying to improve the company with urgency. We're trying to take responsible action and break some of the inertia that many companies in our position face. We may hit some bumps as we take on some of these actions, but we believe we'll overcome them and emerge stronger. I appreciate the effort of all ICU employees and our future colleagues from Smiths Medical to adapt, move forward and focus on improving results. Our company appreciates the support we receive from both our customers and our shareholders. With that, we'll open it up to any questions.

[Operator Instructions] Our first questions come from the line of Larry Solow with CJS Securities.

Congratulations. Vivek, can you maybe just discuss from a high level sort of a historical sales performance, maybe just on the core infusion products? Obviously, it sounds like there's a little bit of a benefit from COVID the last year or so. Can you maybe just give us a little bit of from a high-level perspective, it looks like sales have been kind of flat on an overall basis, but perhaps there's been some strengths and weaknesses within that.

Yes. Sure. I mean, when you talk about their kind of core syringe and ambulatory infusion business, Larry, I think our view is it's performed reasonably well. I mean, they, too, have had changes in the underlying competitive market, but they've executed well there. And I think we feel pretty good about that. I think it's been -- like our business with some of the challenges we had in our LVP segment, we had a number of things going backwards or onetime in nature, whatever it may be. And I think they suffered from some of those same trends. But in the core syringe and ambulatory markets, I think we believe they have more pumps pumping today than they had a number of years ago. And I think that same issue with lots of different pieces moving up and down in the other segment also -- other segments also applies. And for us, it's kind of getting the whole thing tilted towards the growth areas.

How about the geographical spread? It looks like, certainly, they're a little bit more weighted internationally. Is there some overlap there? And then perhaps is there some strength in certain geographical regions that will help for future? I know you're not building in any cross-selling or revenue synergies. But perhaps there will be some, especially on a geographical basis? Is that a possibility?

Yes, I think it's a good question. I mean, I think we've been pretty transparent that at some level, we're more global than we'd like to be at our size, right? When Hospira came all of a sudden, we picked up large market shares in Latin America and some spots in Asia, et cetera. And those are hard to manage if you don't have a certain scale. I think this really helps us justify kind of the core infrastructure required to participate in a lot of those international markets. It closes the map on Europe probably in a very nice way because I think we pick up some spots that we weren't participating in. And I think ultimately, as much as the U.S. drives a lot of returns for companies, it is a global game, and we're big enough or we need to compete with the scale everywhere, and it certainly helps us.

Okay. And just lastly, on the free cash flow conversion. It sounds like your expectations are certainly very high, and I know you mentioned you expect to sort of reap some benefits on at least on the cash flow side sooner than Hospira. Is there a free cash flow conversion sort of similar to what yours has been recently, which has improved dramatically, obviously, over the last couple of years?

Yes, Larry, this is Brian. And you're correct about that in that we're very proud of the fact that over the past 18 months, we've seen significant improvement in ICU's free cash flow conversion. And I think Smiths Medical, their historical cash flows would be of a consistent level and so -- and pretty good overall. So we -- that's what gives us confidence in the free cash flow going forward. I think in the first few years, we are going to invest some of that into the integration. But after we get beyond years 2 and 3, we'll be able to utilize that to pay down our debt.

Our next questions come from the line of Matt Mishan with KeyBanc Capital Markets.

Congratulations on getting the deal done that seems for best for many parties. Vivek, how do you think about the revenue growth profile of the company following this deal? Are there growth drivers you're acquiring? Or is this something that improves your competitive position with revenue synergies down the road for you?

Yes, I think it's -- Matt, I think it's just kind of that industrial logic is solid across the product set, across the go-to markets and all the geographies across the production environment, right? We can really specialize in a lot of things to add kind of reliability and quality to the system. In terms of revenue growth, different answer for different pieces, right? Some of the spots in consumables, what we showed in that pro forma consumables pillar, we think we can really make a difference on over time. It will take a little bit time when we can make a difference. In the systems segment, adding the complementary pieces that we didn't have certainly makes it more compelling for our customers. And we can apply the innovation that we've been working on, on software, et cetera, across all the modalities, which is a good thing. Ultimately, we have to believe that leads to some revenue improvements. And so I think the left 2 pillars are the natural place where we need to believe that we can improve the growth rates of our underlying business and the right hand pillar are good businesses with varying growth rates up and down there, and we just need to figure how to tilt that whole thing upwards.

And then of the systems business, where you have pro forma $850 million in sales, on the LVP side, there's recurring revenue and service going on. How would you break down what the capital equipment is of the systems business versus the recurring revenue in that area with everything you've acquired?

I'm not sure that we would necessarily have perfect insight into that exactly. And I think a safe assumption, Matt, would be probably I think you know our percentage of capital versus dedicated sets. It's probably a little less than that just in their mix of business, but not materially. Ballpark, that would be the right answer. I think the real interesting thing in that Infusion Systems segment on the left bar is the cost to serve the customer is so high, and the systems business being small capital equipment company is really heard. And to have the infrastructure required and the commercial effort and the clinical is a big deal. And having the ability to leverage all those things is very valuable for the customer.

And then just following up on that, I mean, as you look at the combined platform, where you take your LVP and then you take their syringe, and I'm assuming their ambulatory pain pump, how long would it take you to integrate the LVP with their pain or syringe pumps as part of a broader platform?

I think their ambulatory and syringe pumps, it would take a couple of years to get that integrated into a common IT platform. But we have the people who can do it, right? We've had an incredible consistency and team in that area for a lot of years. And they've been hard at work on our own products that we've started to talk about a bit more. We think we can add value to that portion of the equation, certainly.

All right. And just last one. On the term loans and the credit facility, what is the interest rate we should be expecting around that, ballpark?

Weighted average interest rate that we've assumed is in the low 3%. So 3.1%, 3.2% in that area.

Our next questions come from the line of Jayson Bedford with Raymond James.

So just, I guess, a few questions. First on the revenue growth commentary. I guess on Slide 9, you referred to the left 2 pillars. And the belief there, if I'm correct, is that you can improve the growth profile of the current businesses, which I think have probably grown 4%, 4.5%. Is that a fair read?

I think if you're going to spend $2 plus billion, Jayson, at some point, you have to believe you can impact the revenue. So I think we do think we have the right to win with the full suite of products on those 2 left pillars. So we have to believe we can grow the revenues. I think what we're saying, we didn't put anything in the model for that, and it will take a little bit of time as always. But we grew the company again finally from a revenue perspective here last year. We think we're on track to do that this year. And I think that would certainly carry through to our expectations for what a combination would be.

And just -- I think I heard, though, you expect to improve the growth rate is what I guess -- what I'm referring to. And that's the assumption, right?

Again, we didn't build in anything for that. But certainly, over time, right, we have to have that ambition.

Okay. Fair enough. And I realize you're not assuming any cross-selling synergies, but could you walk us through or maybe give us some examples of potential cross-selling synergies?

Sure. If you pick the vascular access arena, our Clave needle-free connectors literally screw onto an extension set, which connects to a PIVC catheter. It'd be a lot simpler for some customers to just get those things in one spot. And it's the same person that's usually talking about those types of things. And so we can go deeper and kind of give more focus to the customer by bringing some of those things together. That would be a very kind of simple and clear example, right?

Fair enough. You mentioned that you plan to keep over $200 million in cash. Will you still be looking at tuck-in deals? Or does this take you out of the market for a bit?

I mean, I think when we did the Hospira deal, we said we weren't doing thing. That was actually 1 or 2 things we would have liked to have done, and we were consumed with the integration. Generally speaking, you never want to say never. I think the same logic applies here with the exception of maybe very small stuff that brings a geography or technology or something like that.

Okay. Just on the margin side and the profitability, Brian, you mentioned it, but just looking for a little more detail on bridging the $190 million in EBITDA mentioned in the deck to the 2 30 referenced a month ago. And I'm just wondering, depending on the D&A assumptions, it does imply op margins come down a bit. And is that, again, due largely to accounting differences in Europe versus the U.S.?

Yes, that's going to be the majority of the difference between the 2 30 and what we see as the EBITDA run rate around the time of the transaction close. And while that does imply perhaps a bit of EBITDA margin compression at first, we would expect over time for it to actually result in a little bit of an expansion opportunity.

Okay. Okay. And then I guess just lastly, and I apologize if I missed this, but when is the Smiths vote? I'm just thinking, is there a potential where TA goes higher here and it just becomes a little bit of a bidding war?

I think I would simply respond to that and say, it is a free market, and we put the best foot forward. I tried to describe how, to the extent I could, the background of the transaction and the way I think everybody kind of played the cards the way they should. And we did the best. I'd just say, we did the best we could, Jayson.

There are no further questions at this time. I'd like to hand the call back over to management for any closing comments.

Thanks everybody for doing this on short notice. We try to keep it quick. We look forward to our new colleagues. We can see some folks dialing in on line here. We look forward to our new colleagues meeting us, welcome us. The ICU team looks forward to partnering with you and making a great company for customers around the world. Thanks, everybody. We appreciate it very much.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. We appreciate your participation, and have a great day.