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

Hi, all. Good afternoon, and thank you very much. My name is Caroline Borowski, and I'm an Associate here at the JPMorgan Group. It is my pleasure to introduce Vivek Jain, the CEO of ICU Medical.

Good afternoon, everybody. Thank you, Caroline. Thanks for JPMorgan for having us. It's nice to have a live conference again, and it's -- you can actually walk around the hallways, I appreciate it. I think there's a lot of familiar faces in the room, so I'll go kind of reasonably quickly. We have updated a little bit of information in our deck. It was a long year for us last year, and so it takes a few more words to explain. I won't go through all of them, but there is some stuff that's probably worth looking at that it dives into a little bit more of what happened over the last number of months. I'd encourage you to look at our public company disclosures. We will make some forward-looking statements. And to get into it, for those of you who are new to the story, ICU Medical is really a midsized supply company built around a core of IV therapy with a select number of logical adjacencies in the critical care area. We organize ourselves into 3 segments, and I'll talk about those more during the presentation. The first 2 segments on the page are really what drives our returns and our cash flow. At our core were consumables business and those consumables largely report within our consumables segment but also in the dedicated pump sets in our IV systems segment. And then we have a Vital Care segment, which has some of those adjacencies in the critical care area, which represents a little less than 1/3 of the company. We're about $2.3 billion, $2.4 billion in aggregate. And we've come together -- on this page explains it a little bit, we've come together through a series of events over the last 6 or 7 years. And on this one slide, we try to put what's the history, what's the opportunity, what's the mix of what we do. Six years ago, 7 years ago, we were a $380 million company, really focused on a very narrow niche in IV therapy. And we were an innovator in that space, but we had a certain set of risks, of which the primary risk was a reliance on a single customer. That customer was called Hospira, and Hospira was acquired by Pfizer in 2015. In 2017, we acquired our customer, Hospira, out of Pfizer to forward integrate into the end product and to really, frankly, defend our customer and the existence of our business with them. We spent the next couple of years integrating that acquisition, created a lot of value, gave some of that value back as things went back and forth in the underlying portfolio. And then earlier last year, we completed a second large acquisition of Smiths Medical. That put us around $2.3 billion, $2.4 billion. And we went from being kind of a component supplier to a vertically integrated category participant now to kind of a full line provider, and I'll go through that a little bit more. I think the 2 kind of key points about us, and it's really the challenge, the opportunity, our core business around consumables has compounded a very nice rate of revenue growth over the last 6 or 7 years, probably 8%, 9% a year. And that's essentially all organic. There's really 1 small M&A deal along the way. And so that includes the product we sold to Hospira over those periods. The other important point is -- our free cash flow was in excess of net income for 7 out of 9 -- 7 out of the last 9 years. And in 2022, we got away from that a little bit. And the opportunity for us at its simplest essence is can we bring that revenue growth trajectory to the full portfolio. And I'll talk a little bit about why we believe we have the right to do that? And can we get back to what made us strong for all those years of generating a lot of cash and use that cash to pay down debt and transfer value to the equity side of the ledger. And the opportunity really shows itself in that dark line at the bottom of the page, when we were just a component supplier. To a large degree, we were sort of skimming the cream we were over-earning in an unsustainable way, we were 35% EBITDA margin business. As we vertically integrated in Hospira, we were around 2021, which is a more normal operating performance. With some of the challenges we went through with our acquisition with Smiths, we've been knocked down to 15% or 16%. That is essentially the variance from our original expectations to where we are right now and the opportunity is to get that blue or black line up from 16% to what's kind of a more normal level of earnings for this size company. And so the combination of revenue growth, getting the margin where it needs to be and generating free cash is sort of the wheel that we need to get back to circling around. From a mix perspective, so I talked about the different segments of the company. 75% of what we do are single-use disposables, $10 or less into the marketplace. A small amount of our business, about 10% is hardware that we have to sell because it pulls the disposables alongside of it. And 15% of our business is single-use pharmaceutical items, IV Solutions, which has really been a more difficult business that's absorbed the brunt of inflation over the last 18 months. We're about a $4 billion equity value company down, obviously, a bit the stock chart is a bit hidden in the back there and about $1.4 billion, $1.5 billion of net debt, so $5.5 billion or so of enterprise value. The logic of what we did, just to give some sense of the portfolio, if we went back in history in 2016, all we sold was that the lowest dark blue line there, the non-dedicated IV sets in accessories. That was our original business. That was our core business. We forward integrated into the other blue lines. Those items came from Hospira. That was the pumps themselves and the software, and the dedicated IV sets that run through the pump as well as IV Solutions. The light blue boxes completed the puzzle and those were the items that came from Smiths, and that was really primarily the syringe and ambulatory pumps, and the last mile of catheters into the patient. Those items connect to our core IV offerings, and it really completes the entire chain of drug delivery. We basically have everything except the drugs themselves, and Smiths brought some natural adjacencies in respiratory, fluid warming, some of the other categories you see on this slide. So to talk a little bit more about the 3 segments. We will have a combined portfolio next year, and I'll get to how we're going to report in a second. But our largest segment will be our consumables business. And our consumables business consists of 4 different lines of business, the first 2 are legacy ICU businesses. That's our infusion therapy business, which is built around a family of products called the Clave, which is sort of the gold standard for needle-free connectors. In our oncology business, which is essentially handling systems for hazardous drugs, dangerous drugs. Those 2 businesses are in the #1 or #2 position in each of their categories. So in infusion therapy, we're the world's largest dedicated non-dedicated IV set producer. In oncology, we go back and forth with another participant either 1 or 2 each year. In addition to the legacy ICU businesses in the consumables market, we're going to add a number of the Smiths products to this segment. The most synergistic logical thing to add that is core to infusion therapy is vascular access. Those are those cannulas and needles that attach to our IV connectors and pipes. And a little bit of an adjacency, but a very important consumable is in the tracheostomy market, which is essentially another pipe delivering air instead of drug but into an incredibly valuable pediatric neonate population with a lot of the same features of the IV therapy market and customization and speed of delivery, et cetera. This line of consumables products probably the highest gross margin combined segment in our company. And over the next number of quarters, and we'll try to provide more information about that. In the near term, there is a lot of momentum in our core infusion therapy and oncology business. We were a little constrained this year from a capacity perspective. Those constraints are off, and we can compete very effectively across the globe right now. And so we want to continue that momentum. There is some price opportunity on our legacy business as we're the market share leader. We have the ability to make sure we're awarded properly for that. And that's something we didn't frankly, have to do very much over the last number of years. And so I think that's certainly a very hot topic today. And on some of the Smiths businesses in the near term, it's been very much about stability of supply, right? These are sensitive, fragile patient populations to make sure we can robustly supply the market will lead to getting a lot of share that we gave up or for customers who didn't serve coming back to us. In the medium term, the vascular access market is probably the most competitive market where we gave back some share. We need to get that back. There's a series of new innovations across this portfolio that are evolving as the way drugs are delivered, whether it's in the home environment, outside environment, et cetera, and the delivery mechanisms on the physical side of the pump, the set and the way they touch the pace and are evolving and there's some innovation there. And we need to integrate the legacy ICU components, the things that are our brands and differentiated into the Smiths products to keep them fresh and to give us a reason to expand the addressable wallets there. Longer term, the value is really about being closer to the pharmaceutical items themselves. And so a number of these oncology products are getting written into various delivery specs of unique drugs. A number of the pump products are also doing that. I'll talk about that in a second, but moving as close to the pharmacy as you can also drives value across this entire segment. So that's our consumables segment. Our pump business, top to bottom now legacy ICU had the large-volume pumps. That's the most valuable part of the infusion pump puzzle across the world because that pump mechanism uses a dedicated set. It's a razor/razor-blade model. The second most valuable part came from Smiths, which is the ambulatory pump that's more of a home care pump or a patient-controlled analgesic pump postoperatively. That also uses a dedicated consumable razor blade along with the pump and a syringe pump is a freestanding pump that's largely used again in a very sensitive pediatric population. Prior to the Smiths transaction, we only provided large-volume pumps and didn't have the full line to compete as effectively as we could. If we look at it from a market share perspective, with just a number of pumps pumping in the world, we're the #2 player. And so the story of our company, if you don't remember anything else we're the #1 nondedicated set company in the world, #2 pump company world. In the near term, it is about innovation, and it's been a number of years since we've had a hardware and software refresh. We're actively working on that in our large volume parenteral pumps. And near term to us means 0 to 18 months. We need to continue some of the share gains we've had on the LVP that opportunity exists in the market today. And the business we bought from Smiths came with a series of FDA challenges, a warning letter and some other items that we're very actively remediating, we need to do that to have a full launch of those products into the market. In the medium term, some of the Smiths hardware platforms will have a refresh, both on the hardware side and some innovation around the disposables, some of that disposal innovations happened already. And in the longer term, the real value here is uniting these products, whether they're in the hospital, whether in the home, whether in a step down [Indiscernible] clinic with a unified IT platform that keeps it simple and ultimately, how do we integrate that IT to when instance of drug delivery is happening no matter where it's happening and we're laying that back to a payer, provider, pharma company, et cetera. That's a longer-term project. That's probably 3-plus years out. But really, our pitch is to have a unique device that's the most accurate, the most precise for its intended use and the smarts to be in the IT that connects these things regardless of where the drug delivery event is happening. The third segment that came from Smiths, they had called Vital Care. I think we call it some opportunities to improve essential categories. We're going to take our legacy IV Solutions business, which about half this category, our legacy Critical Care business and add it to the Smiths temperature management, respiratory and anesthesia tray categories. Each one of these categories is a unique business. We either need to frankly add to it, make them bigger over time, make them more robust, or figure out other ways to maximize their value. But the market structure around all of these, with the exception of solutions are very good market structures, low capital intensity, high-return businesses if run right. This is a little bit of a build on the slide we've used for years. No matter how good our underlying assets may be, industry structure matters a lot in our minds. And the industry structure is very attractive here, right? It's a consolidated industry structure, high regulatory barriers, very hard to reproduce manufacturing assets. If you run yourself well, the vast majority of these revenues should be recurring and sticky if you don't have any self-inflicted challenges, I'll get to some of those in a second. There are some tailwinds and guidelines around that lead to increased utilization for us. And some of these underlying products, particularly on the pump side have software applications that are new markets that are being developed. For us, we are the focused player at $2.5 billion of revenue or so. We're the smallest player amongst the big guys, but it's big enough to be big, small enough to be small, and we can compete in any corner of the world. We have to drive innovation, which has been our core, and we have to rebuild the customer trust with the Smiths assets the same way we did with Hospira a number of years ago. We have a variety of assets to play to make logical decisions on value. And we're rapidly figuring out -- know and figuring out in executing where in the world and which geographies do we want to play in because not all of them are created equal. Just a quick slide on the way we're going to report going forward before I get into some more of the specifics on some of the things that we encountered in 2022. ICU Medical reported in 4 segments of which we generally talked about 3. We talked about IV systems, which is our pump segment; our IV consumables segment; our solutions business and our critical care. Going forward, starting in Q1 of this year, we'll talk about a combined Infusion Systems segment, which is really the combination -- I'm sorry, I'm going to the middle of our first of our LVP infusion pumps, the ambulatory pumps and the syringe pumps. That's about a $700 million segment. The consumables segment will take the top 2 dark bars in infusion therapy and oncology and add the other items I already talked about in vascular access and tracheostomy, that will be about $1 billion segment. And the Vital Care segment is kind of the light green remainder, about a $600 million segment. The vast majority of our cash [Indiscernible] comes out of the $1 billion segment and the $700 million up pump systems segment. Okay. A little bit on what do we go through last year, both on the transaction and then in the broader market. I don't think there's a nice way to sugarcoat it. The transaction we did last year was harder than we thought it was going to be hard, it was harder than we expected. We thought we had paid 2x revenues and 12x EBITDA. And I think with the revenues that didn't come through the way we expect it is probably closer to 2.5x revenues and certainly a higher multiple of EBITDA, it's a little harder to measure as things become co-mingled. And equally problematically, we had to deploy additional cash to the situation. And most of that cash went into 2 areas: remediation, which we made a lot of progress on and fixing a variety of FDA issues and into inventory build in the supply chain, partially because the environment, partially because of asset we inherited. At the same time, a series of revenues went away. And I wanted to give a little bit of specifics on those revenues. This is probably more detail than we've done historically. Ballpark, $100 million, $150 million of revenues went away. A large chunk of that was self-inflicted. And by self-inflicted, it was because there were production problems not making a dedicated set. Well, no one's going to buy a pump if you can't sell a dedicated set or some of the basic raw materials to make these very valuable products like in tracheostomy or patient warming. We've remediated a lot of those items. The other category that went away with some of the Vascular Access products, that requires a little bit more intervention. Those are true competitive losses and some of the lower demand due to COVID and syringes, et cetera, on vaccines. That's less in the self-inflicted bucket, but still a big piece of value that went away that we need to focus on getting back. The operations around Smiths, the supply chain, fulfillment, logistics, et cetera, were really broken. And there was a lot of intervention needed in terms of expensive expedited freight to offset customer backorders, et cetera. And there was a lot of effort and energy expelled in the quality systems and needed attention. I mean you can't -- I'm like thinking what else is possible out here, right? This list went on and on. Where we find ourselves today, a ton of investment has gone on. We've significantly improved the quality levels. The entire operational network is running much smoother, albeit it's a bit higher cost. And ultimately, you have to get price to offset some of those costs. Can't do that until you're serving people well. But it's a much, much more stable environment today than we were 6 months ago. From a macro perspective, there was a number of other things that hit us at the same time in '22. Brian, we can talk about it in the Q&A afterwards, but obviously, the rates going up does have some negative pressure on us on the nonhedged portion of our debt. Foreign exchange was a really big deal to us. Finally, that appears to be going a little bit better of a direction. Fuel costs were a big detriment. And so of our $100-ish million variance from what we intended for the year last year, almost $50 million of it was FX and fuel costs. So very important to us what happens in those items. There was a little bit of a COVID hangover on decision-making, et cetera, and some of the kind of broader supply chain issues caught us, but they've been resolved as they talk about capacity coming back online. So there was a lot of stuff around the transaction, a lot of stuff about the macro environment. I think no one is happier than last year other than us, and we start this year on much better footing from a fulfillment, customer satisfaction standpoint and at least some tailwinds on some of the items that were going to the wrong direction last year. To give a little bit of kind of a near term this year, medium-term next year view as we see the world today. For 2023, I think we finally feel we have opportunity for legacy ICU consumables growth in an unconstrained fashion. We were really supply constrained for the last year. We've got a real opportunity on the legacy Smiths businesses to improve ourselves where there were those self-inflicted wounds or we didn't serve customers well. Because we're serving customers well, some of the variance on expedited costs get reduced. The pump business where it's been difficult to see some of the improvements we've made over the last number of years has finally had a lot of the items that obscured that an ambulatory pump deal historically had to shake out and it is rebased now with the Smiths products at their lowest level last year to finally start compounding at that revenue growth rate that we've seen in our consumables business than we'd like to see in our pump business. We've improved the overall quality system. We are actively trying to get the warning letter remediated this year. And ultimately, it's just like our Hospira situation, we got to prove ourselves reliable to the broader customer market and get some of the share back. Obviously, if we do that, we return to a positive cash flow situation. There is a little bit of residual inflation we need to manage. Currency and fuel cost will be what they can be. But we finally have a little bit of time to breathe and can think about some of the other strategic actions that can unlock some value or help clean up the balance sheet. We didn't have a lot of time for that last year. And if you kind of fast forward, we hope to be standing here next year having a bit of a different conversation saying, with another year under our belt, we can get all parts of the portfolio growing. There's a very important set of contract renewals that happen towards the end of next year in the legacy ICU pump solutions and set businesses that probably impacts 50% of our cash flow, making sure that those are managed properly are very important. The whole supply chain across both legacy businesses should be performing optimally. There's a new wave of synergies. We've proven that we're able to integrate with some of the stuff we did historically at the previous company worked out at what we did with Hospira. There's another wave of synergies here once we consolidate IT in terms of manufacturing, IT, finance, real estate, et cetera, we need to capture those synergies. And again, if you believe what you see in the charts, fuel and FX and some of these other things may be breaking better by 2024, get back to free cash flow in excess of net income and ultimately return to the original model. The original model was to do with the old-fashioned way to turn the debt side of a ledger into equity, right? To pay down debt, build that equity, have a reasonable amount of leverage on the business and return capital to shareholders. So it's not that complicated to us. We just need to get the time in place to make that happen. And then I'd close with -- I think this is the exact same for anybody who's been here. I think a number of you I see have been here multiple years in a row watching us, this is the exact same slide each year that we've ended with, and I think we were pretty realistic in '20 or '21 and '22. What was coming I think as we enter '23, there's a lot of noise out there about what's the capital environment like. Right now for us, we don't see any change. It appears to be sort of business as usual, business is normal. We're not seeing a reactive behavior one way or the other. We do have some interest rate exposure. I don't want to sugarcoat that. I hope people are building that into their models. Obviously, we can generate cash, pay down the nonhedge portion, do other ways or find other ways of doing that, that accretes in value. We had very, very high free cash flow generation. We entered years with high inventory levels, so we're entering with an exceptionally high inventory level right now. Some of the COVID hangover appears to be abating that allows for better decision-making. We have the opportunity to keep growing our pump and consumables business. There's a few spots that we need to turn around in Vascular Access. We do have a little bit of headwinds as the production environment -- we had to hustle so much this year to remediate fill-up factories, get product into the channel. We need to produce a little less next year that has a bit of a negative environment. But I think all in all, if we kind of look at the things that hurt us in '20, particularly the currency, the fuel and the lack of fulfillment and the expedited cost of doing that. A lot of those things appear to be moving in the right direction right now. So we appreciate people learning about the company. We appreciate JPMorgan for having us. We're happy to answer any Q&A. Thanks for your interest.

So maybe we can start off with -- you touched on this during your presentation. A large portion of your variance comes from the macroeconomic factors of foreign exchange rate and fuel. What is the current status of this? And are you seeing any relief around that?

I think -- and Brian should comment, too. But on currency, which was a really big deal, rates are obviously better today than they were 4 or 5 months ago. They're still not in the place they were when we started last year. If everything I think, stayed constant where we are right now, we would see some benefit certainly in the back half of the year, but on a front half basis, things like the euro, things like the yen are still worse than they were at the beginning of last year. Diesel fuel was up 80% from early '22 levels. It's down 30%, 40% from that level now, so it's up 40% or 50%. But I think those at least are going in the right direction. But I'm not sure certainly in the first one, we'll have a benefit for the full year yet.

And just given the historical 8% organic growth in consumables, do you believe that will continue moving forward?

I mean I think you have to innovate, right? And we're -- you have to create new markets. And that's the thing we're most proud of, right? The markets we've been able to create in oncology, the markets we've been able to create in some of the specialty categories around dialysis care and others are very valuable. The underlying growth rate of the category, census is not 8. It's only 8 because you either take market share or you find new opportunities to create pockets of value. And I think when we look at our set of incremental and they're small innovations in consumables, there's enough to keep us busy for a number of years. I think the deeper question for us, and we believe and why we took on this work is the legacy Smiths Vascular Access products and consumables also have the right to perform better than they were. And if we can integrate our products with some of their offerings, there's no reason we don't have a right to win in those spots.

And maybe moving on to the contracts. You mentioned that there's a 2024 rollover of key contracts. How important is that?

I think it's exception -- devices, broadly speaking, us in particular, the beauty of our types of businesses where we sold under long-term fixed price contracts with 0 inflation. And so that was a very attractive industry structure. That's sort of been turned upside down now. And while you can get incremental price the real value comes when an entire industry or contract piece of business has put out there. And it just happens to be that the 2 big ones in the U.S. come next year. So some of our businesses are upside down, we need to make sure that, that's recognized properly. It's very important.

Makes sense. And in terms of some headwinds for 2023, are there some that are kind of worthy of additional discussion or mention?

I mean I think Brian should talk about the balance sheet part of it because it's a real issue. I think we went through so much. The only other one in my mind is, and it's been -- and it's a day-to-day issue is, we ramped up production so much to catch up to the demand on Smiths and fulfilling the backorders. And between building the inventory we need the inventory level we're carrying the safety stock, what's the right level of build this year? And if we slow down a bit, does that have a little bit of negative absorption probably plus the cash plus the working capital, but a little bit of a hit on planned productivity. And so that's still a work in progress. That's probably one headwind that's out there. I don't [Indiscernible]

Yes. I mean in terms of macroeconomic factors, Vivek mentioned that a few of them like FX and fuel, while headwind this year are at least abating a bit. The one that's really not and will continue to be a headwind into '23 is interest rates. And based on current forward curve when you apply that to the unhedged portion of our debt, that will be a little bit of a headwind in '23 relative to '22.

Great. And in terms of kind of returning to positive free cash flow in 2023, what are some of your capital allocation priorities in the near and more longer term?

I think if you start with our capital structure and what we think would be ideal for us. For a number of years, we had no debt on the balance sheet. We think a company of our size, especially in a normal interest rate environment should have some amount of debt. For us, we think maybe 2 to 2.5x net leverage would be appropriate based on the size and scale of the business. Currently, our net debt is higher than that. And so until we get down to that level, I think our first priority would be debt pay down. We didn't do that in '22 because of the fact that we were investing heavily into the acquisition, the integration and some of the remediation, including fairly significant investment in inventory, but that is certainly the priority going forward. And then once we're able to pay down debt, get down to that targeted net leverage, then we would look to return capital to shareholders.

Great. And I just want to open it up in case there's any questions in the room as well.

Can you discuss your manufacturing [indiscernible]. Are you manufacturing everything or you're outsourcing?

I think our philosophy, and that's part of what we encountered with the Smiths transaction, culturally, we were a company at legacy ICU hyper focused on vertical integration, doing everything ourselves, even our own sterilization. We put up CapEx year in and year out to not be reliant on any outside service that we didn't absolutely positively need to be. And some of the Smiths products have been heavily outsourced to third-party manufacturers. It's a synergy to us to bring those in. That is our core competency with available capacity in parts of the network. So we would much rather see logical work coming in inside then going outside. And we've been willing to put up the money to do that.

Hospira historically had some kind of a problem with manufacturing [indiscernible]