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

All right. Yes. Perfect. Let's get started. This is Peter Harrison from Morgan Stanley's Investment Banking division. With me today from ICU is Vivek Jain. Before I get started or we get started, I'll need to do the disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Great. With that out the way, let's go ahead.

That was excellent. Thanks for having us.

Look, I thought I'd start with one of the more exciting things you guys have done this year, the Smiths Medical acquisition. Can you remind us -- talk a little bit of the Strategic rationale for the deal and a little bit of flavor of how it's going so far?

Sure. Again, first, thanks for having us. For those of you who are new to the ICU story, we are an infusion therapy focused medical device company that really does all things related to what you would see in ICU environment, a hospital and an infusion pump and the various pipes that deliver medications to a patient in that setting. Earlier this year, we closed on an acquisition of a division of a U.K. listed company called Smiths Group. We bought their medical division, which is called Smiths Medical and Smiths really checked 3 important boxes for us. In that chain of infusion that I was just describing and think about that as the plumbing near a patient in a hospital if you have a drug, a pipe that delivers that drug, a motor, a pump that delivers in a needle that goes into the patient. We had 2 gaps real -- 2 primary gaps in our portfolio. The first was we didn't have all the types of motors, all the types of pumps. We participated only in the LVP pump, the large value parenteral pump area. And Smiths had some of the pumps that were used in home care or pediatric, so the ambulatory pump or syringe pump. Smiths also had -- the second point, Smiths also had the needles, the catheters, the last mile into the patient where we had the entire value chain except that connection and our core consumables, IV consumables connect to those items literally and clinically. And lastly, we were about $1.3 billion revenues prior to the transaction. We were probably a bit too global for our own good, and Smiths brought a heavier portfolio of international business, which allowed us to get the right amount of infrastructure in kind of each geography of the world.

Great. So the immediate results have been a bit different than you might have expected. Maybe go into what has been your takeaway as you look at the business? What have you learned and maybe bridge those variances from your original expectations?

Yes. It's been a challenging couple of months. The performance of our company post transaction hasn't been exactly in line with what we thought it was going to be in January and February when we started this year. And some of that is due to reasons I'll get into in a second from the acquisition, but I think it's important to start with some of that is actually due to stuff that was on the legacy ICU pre-transaction business. And there's really 2 things on the legacy side that have been different than what we thought during the year. They are boring, but they're real. The first is fuel costs. A portion of our business is very sensitive, in particular, our IV solutions business is very sensitive to transportation costs. We've absorbed $30 million to $35 million of increased fuel costs that we couldn't pass on. And the second thing, we are a global supplier on legacy ICU that manufacturers in the Americas and sells globally, and we probably had about $15 million of currency impact. And so going back to the original question from where we thought this year would be to where we are is about 20%, 25% difference, $100 million of incremental EBITDA, $50 million that are from those 2 issues, the balance are from a series of really basic operational quality and fulfillment issues related to the Smiths business.

How do you think about the future once you have the businesses grounded, maybe some -- some semblance of where fuel costs go and got the integration more to completion?

I mean I think the -- if we go back and think about our journey over the last few months was this amount of energy and effort we've exerted on the transaction is worth it. I think we reflect and say absolutely strategically still makes sense to do. And so if we look at our businesses, and we'll start to report them in a combination between what legacy ICU was and migrate the Smiths businesses into our reporting framework. Our first business we'll talk about is our infusion pump business, and we've gone from having a single pump modality to having a meaningful amount of share in each of the pump modalities and globally being the second largest pump provider in the world by installed base. And so I think that positioning for us, allows us to wrap ourselves around the way care may be delivered in any given geography, meaning some of those pumps have applicability into home care, more complex drugs, areas where there's underlying growth of high-value treatments, where we have the leading market share position of the products that make sure those medications make it to patients. It also points us in the direction of growing patient populations in home care and some other areas where the reimbursement wins around the world are following that to get patients out of the hospital. And so I think clearly, from a pump perspective, if we have -- we're playing in all the modalities and all the right spots, and then we can ultimately connect that with IT that brings all the information about medication delivery regardless of care setting together that's valuable to a payer, drug company, IDN, et cetera. In our other pillar -- main pillar of our consumables segment, we did have gaps in that last mile to the patient on the catheter products. The Smiths offering really closes that portion of the portfolio for us and makes us much more well-rounded and competitive in that side. And we've gone from having only part of the answer, certainly, the U.S. market having the whole answer. So I think once we get through the kind of the roughness we're experiencing, the portfolio makes sense to customers.

And also on that roughness, there has been some regulatory -- open regulatory challenges. How are they progressing? How they've impacted product shipments? And how do you see that resolving in the near medium term?

Anybody who's -- a lot of value has been created in these infusion industries and anybody who's followed it is they've also been -- there's been a lot of land mines appropriately so on these infusion devices. They are the last -- they are the last mile into the patient, right, of how a dangerous drug gets there. And a lot of value has been created as market participants have fallen in and out of the category. The business we bought from Smiths did have some regulatory challenges and it was challenges around the basics that our team has been through in the infusion industry for a number of years, and those ultimately about the regulator trying to ensure safety in the devices. And Smiths had fallen down in a couple of areas, specific to the device on software and use cases, and it also fallen down on the general maintenance and performance of their quality system. I think on both of those topics, our team has experience across multiple companies, basically 2 out of the 3 folks in the industry. We all came from the what is now the market share leader and then we acquired Hospira Infusion Systems from Pfizer and had to go through a lot of the same challenges. So it's our third time seeing this movie. I think we feel pretty comfortable. And I think even in the 9 months or 8 months that we've owned this business, we made a lot of progress on the regulatory front, and that will become self-evident as we work through the issues with the agency.

So you're probably the only management team I can think of who've done 2 really material carve-outs, one being Hospira, as you just mentioned, the other being Smiths. How do you think about the integration of the 2? Or what is similar, what is different and what's been more -- which is more challenged because as we all know, separations are probably the heaviest lift we do -- you all do as managers.

Sure. I think a lot of these corporate transactions, bankers will talk about, oh, they're easy.

I did not.

And it doesn't actually work like that. We've -- our team has been together through a number of large corporate separations or spin off the creation of CareFusion in 2009 and then Hospira out of Pfizer, this portion of Smiths. And I think there are some similarities, but there are some things that are different amongst them. What we undertook as a team we had to buy Hospira from Pfizer as a defensive move at ICU because they were our primary customer, and they were not running themselves well. And the only way to improve that was to step into our customer. That was a relatively unusual thing we did. We're a $300 million revenue company, bought a $1.2 billion, $1.1 billion revenue company in all sorts of geographies, and it just standed up from scratch around the world, IT systems, people, infrastructure, et cetera on different IT systems, different underlying processes. Smiths is a little easier that way, that we have the full infrastructure in every corner of the planet to catch what we're taking on here. And we already run a common IT architecture as they do. Smiths is a little different and more complicated in that it has more manufacturing sites, more diversity of product lines and different businesses. And we have to tease them apart in a little bit different fashion than Hospira, which came with fewer sites and fewer manufacturing geographies.

All right, helpful. Look, we've talked a lot about the challenges of the deal, but talk about the excitement, what excites you? A lot of synergies here. What are the nature of the synergies? How do you think about the amount? And I guess, importantly, how are you tracking towards the targets you put out there?

We did this going back to the original rationale in the first question here. Clearly, economic synergies were an important driver for us. And we thought about those largely through the cost side and the way we described the original transaction. And there were sort of what I would call 3 buckets of cost. The first was on general commercial go-to-market stuff around the world where we had duplicative go-to-market infrastructures. We had said those types of synergies will be realized in the first year. That's largely happened. Those are on the order of $15 million to $20 million. There's a second bucket of noncommercial synergies of support functions, systems, outsourced vendors being consolidated procurement, raw materials, things like that. That's another $5 million to $10 million that's in flight as we speak. And the third bucket is a very valuable one, which is the consolidation of manufacturing sites and locations. That takes longer to do because you have to have enough inventory on hand, you have to be healthy from a quality perspective to make sure the regulator is happy et cetera, before you start moving things, that's more of a 2024 activity, and that would be the gap that gets us or the items that get us to 50 or above. I think we feel on track for all of those.

Great. And that's on the cost side. Maybe talk about the magnitude of top line synergies. What was the overall growth of Smiths Medical when you bought it, and how do you envision in the future as part of the combined entity with the power of the cross-selling and the breadth of the portfolio?

I think it's -- of course, we have to believe that there's value commercially from putting these portfolios together. And the original sense here was it makes sense for the customer. It's been difficult to see on the Smiths businesses historically, and they published an annual or semiannual financial report and broke out their business into 3 segments, but it's hard to follow where the growth was because at least at a headline level, that number was generally flat for 5 or 6 years in a row without a lot of color on what was happening in between -- underneath. And if you look a little bit underneath, the franchises I described that complete us were the things that were actually growing in a positive way for the most part. In the infusion pump segment, Smiths' position in ambulatory infusion pumps has good underlying industry growth because home care delivery is going up, oncology delivery is going up regardless of setting and anti-infective uses via infusion is increasing. And we have the #1 position with those 3 trends driving behind us. If we combine that with some of the things we've done to improve our own LVP platform, we feel like the pump business, clearly, with the gaps filled in syringe and ambulatory and LVP has the right to win across the spectrum and has the economies of scale, if #2 globally would service IT infrastructure, et cetera. And so while we didn't really go talk about revenue synergies, that conversation makes more sense today than it has in a long time. On the consumables part, Smiths had gone a little bit backwards, on the Vascular Access products. There -- by bringing our clinically differentiated IV consumables together with the Smiths products, there is an opportunity to bring more value to the customer, both clinically, right, as with evidence-based work around how the products add safety to the equation for the patient, but also economically in a way in this environment that makes sense to them. And so I think those are the 2 areas where there's the most natural logical revenue synergies between the business. And then I think longer term, these areas about the value of IT in the home care environment, the value of participating in some of that drug value chain to the home. Those are interesting new revenue areas, growth areas and adjacencies for us to migrate into a bit after we have the house in order from the basic transaction.

Makes sense. Last question from me on Smiths. You talk about the what I call kind of pump-to-patient strategy, which had filled out. It also came with some probably less core product wise that doesn't -- don't fit -- doesn't fit that strategy. How are you thinking about some of those respiratory tip management? The Vital Care portfolio fits less well into the strategy you articulated a bit ago. How do you think about those product portfolios and will we think about seeing portfolio rationalization from ICU over time?

I mean I think with our team, if you've seen our track record across again a couple of companies, we've always tried to do the logical thing of what we think we can own and make a difference in and what maybe somebody else could. I think the challenge on that one is, we, too, want to maximize value and you maximize value when the businesses are being run well and performing well. And right now, they still -- some of those things need a little bit of work to perform better. That doesn't mean we wouldn't be opportunistic if the right situation came up. It's also a small group of people. We have to -- it's the same people doing that work is doing the integration. And so we have to be judicious on ultimately, it is value, right? If there's value there, we'll shift and find a way to get it done. I think we are thinking about that. Critically, that obviously allows us to think differently about the balance sheet and words like buyback and other things, we don't have the flexibility to do at the moment, but we could in certain scenarios. So it's on our minds.

So I was going to pivot to the kind of the rest of the legacy business of the combined company. Let me pause any questions from the audience? Okay. Look, you have a bunch of different business. You have some capital and consumables; you have the solutions business. How do you think about the gross margin profile of the overall business and your various product lines? Because it's a different construct than a lot of companies, people are familiar with.

When our team joined ICU, we were a 55% gross margin company with 35% EBITDA margins. And today, we're a 37% gross margin company with less than 20% EBITDA margin. So that's not in the right direction. The goal, obviously, is to look like a normal device company. And we don't look like a more traditional normal device company because of the diversity -- because of the diversity of our portfolio. And so we have 2 lines of business in legacy ICU. The infusion pump business and the consumables business that I would say look much more typical of a device company and solutions portfolio, which looks more like a generic drug or kind of the lower end generic drug portfolio. And if you blend those 2 things together, you get the 37%. For anybody who's interested, ICU Medical prior to our acquisition of Hospira in 2017 was a publicly traded company. And if you looked up our 10-K, you would see our corporate gross margins were 55% with the consumables business that's half the size of our current business today. And so there has been a readjustment. And so we need to think a little bit more critical about what's the right way to report in addition to what you do with any assets, but what's the right way to report on a business unit or segment basis to kind of provide a little bit more transparency around that.

Yes. That's helpful. Yes, I've said in a couple of these today, and we talked about supply chain challenges, inflation, maybe a little of time talking about how those challenges impacted ICU and of those kind of broad buckets, what categories have been most impacted?

I think a lot of these things on the supply chain side have been going on for the last 18 months or 2 years, right? And I think if you read our earnings transcript, we were talking about it a long time ago, and we, frankly, were dealing with it every day and executed very well in 2020, 2021 towards the customer in fulfillments and reliability, et cetera. This year, I think it was the compounding effect of what was going on in the market and taking on Smiths at the same time that sort of knocked us back a little bit. I mean the supply chain issues, again, they're born to hear about, too. You name it as a paper resin, aluminum foil, electric components, single silicon and go up and down the list of 100 items that have been short over the last 2 years, all of which are used in a regulated -- FDA-regulated product, you can't change components quickly, and therefore, you have to adapt and rush through solutions in a safe manner. And so it's been a challenge to do that. That has been one part of the discussion. The other part has been really a conversation that certainly a lot of our team didn't have a lot of history around physical logistics and fulfillment and the cost of -- to serve there, right? We've lived under a world and our industry was highly valued because the pump and consumables business is a multiyear annuity business that's sold under long-term fixed price contracts with kind of negligible inflation. And the opposite of that happened, right, both on the top line you don't have as much pricing power in some of these long-term contracts and all this inflation and distribution cost going on, that's not going to be permanent. Cost will get in line the next round of contracted cycles or anything in between, but I think it's been both the raw material availability and the physical fulfillment that have been a little bit upside down this year.

Yes. You've been in the large volume pump market for many years. It's a pretty unique dynamic in med tech, lots of recalls because of the importance of the product. Maybe talk a little bit about the current competitive landscape that you see right now?

It's an unusual time right now because everybody has their own specific issues in the market. One of the players has had some difficulty with the FDA in terms of keeping the product under an active 510(k) and is this selling under exemption, one of the players has been taking some new approvals and has finally started to get them. But ultimately, things don't move very fast in the infusion industry, right, unless there's a real systemic shock. And so I think the challenge of the moment is as for all participants, it's been much more about just the inertia of decision-making at hospitals that haven't wanted to tackle anything on the pump side during COVID or with their own nursing shortage, et cetera. That finally feels like it's coming to a bit of closure, and we certainly are encouraged for all participants that decision-making looks like it's going to start again, right? It's been frozen a little bit for 18 months, 2 years.

And so what opportunity would your legacy pump remains in the next couple of years to drive share, drive value? How you think about the legacy pump you have, they will transition to the next gen?

I mean I think our current product is the product we feel very proud of with the Plum platform. I think there's a ton of independent work done out there, various agencies like ECRI, KLAS, UL, all these independent certifications. You can look at the various ratings of our product. The market share studies, which show that we believe we have been a share taker over the last number of years. Now we were a major Hospira, the business we want was a major -- back to why we had to do the transaction was a major share loser. It used to be the #1 pump in the country many years ago, and we're starting to get back what shouldn't have been gone in the first place. Given the -- in normal years, pre-pandemic and pre some of the other issues I just addressed, in a normal year, there's probably $500 million of capital, maybe a bit more $550 million to $600 million of capital sold annually of devices. Ballpark, I would guess that number has been more like $150 million a year, $200 million a year each of the last 2 years, maybe a bit more than that in 2020 in the pandemic. So there is a number of years now that haven't had proper refresh because of what went on, and I think all participants are kind of jockeying for position around that aging installed base.

Which is a great segue to your next gen pump. Obviously, Connected Care is a theme that we hear a lot about these days. What is the current status of your next-gen LVP pump? And kind of what are the bells and whistles that will bring that the Plum series doesn't have today?

I mean I think, again, we typically don't talk about R&D projects until they're approved and it's easy to get burned on timelines in this infusion industry. I would just say you can look at our income statement, there we've been spending $20-plus million a year. The only way we can actually spend that is if you're doing hardware and software development. We're trying to bring it to fruition, right, over the next period of time. I think for us, there were a few features of the current product that we would like to see -- address user interface screen, number of channels, speed to -- improving speed of the overall workflow, et cetera. So I think the things you'd expect the next-generation device to address.

And what are you seeing with the FDA these days? How -- is it picking up, slowing down? What's the decision-making process look like because it's so important for your space.

I -- it's hard to know exactly. I don't think they're different than anybody else. I think they have been very short staffed too. I think they have seen attrition. They're trying their best. They are being very responsive where they can be. But you can see that there's -- they don't have as many people writing on some of these things, too. So I think much safer to bet on things taking longer there and still get a real commitment to try to do the right thing, but it certainly is taking longer to work through the system.

What are the drivers of your legacy business? What has been driving that growth? How did COVID impact it? I mean how do you think about kind of the steady state going forward for the consumables -- legacy consumables business?

I think in the consumables business, which is -- those are the pipes, that's our original core business. That's -- those are the pipes that connect the pump to the patient or the drug to the pump above or below the pump. That has been a very much an innovation business. It's been very much a service business and supply business. And I think we brought to bear all 3 of those things in a clever way and in a fast way that helped grow that. And if you looked at a sheet of paper and wrote out the numbers, I think that business has compounded from -- when our team showed up there on a direct basis, we were probably $200 million or maybe less. And then we obviously bought Hospira, which gave us $100 million. That business is near $600 million today. So that's compounded at a nice rate over a 5- or 6-year period. It drives the majority of our cash flow. Frankly, I think some of the value of that is masked by some of the other challenges around but continuing to make sure we have adequate production supply there and have the best commercial orgs, et cetera, and continue to globalize that business has gotten more and more global for us and create the little niches where there's $20 million, $30 million, $40 million pockets of growth, which means a lot to us, we're not that big.

On that note, I'll wrap up with 2 questions. One, how do you think about your balance sheet today? And how does it tie to -- you've been active in M&A, how should investors think about ICU on the M&A front and the near term?

I mean I'm just looking at some of the folks in the room. We had a different conversation about balance sheet for most of the year as I worked there, which was we were kind of net cash holders for a long time. And we had no leverage and $575 million of cash and a much smaller market cap. And that obviously didn't make sense either. Today, we find ourselves with about $1.4 billion of net debt, probably a tad more than we would ideally like. But again, we think through getting ourselves healthy, getting back to what was our core, which is solid free cash flow generation and/or any of the other things you brought up before, that can quickly change. I think we are a different company than we were, and we should have some leverage, 2 or 2.5x net whatever, put the rest of the cash and buyback and with the additional ability to lever up for future M&A. I don't think that's a realistic conversation on future M&A at least for another year or so until we get the basics running well.

Okay. Look, we have 1.5 minutes left. So lastly, why should an investor care about owning ICU today? And what's ahead that gets you excited?

Yes. I think the categories we operate in are absolutely essential to care. And they're highly consolidated markets where the majority of values created in the U.S., Canada and a handful of other value-oriented -- value-rich markets where we're, frankly, big enough to be big, but small enough to be small, where we can compete on a very customized basis for a midsized customer, and we give into a big guy in any fight anywhere in the world and the categories aren't going away, and it's very difficult for new entrants to disintermediate them. And if you have pricing -- a little bit of pricing power and improving volumes and scale, that can create a lot of economic value would the balance sheet put to work in the right way. It's a compelling investment in this kind of environment.

Great. And with that, we will wrap up. And we appreciate you attending the conference. Thanks again.

Thanks for having us, Peter. I appreciate it.