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

Good morning. My name is Jayson Bedford. I cover the medical technology sector here at Raymond James. Thank you. And again, welcome to the 44th Annual Raymond James Institutional Investors Conference. It's really my pleasure to have with us the CEO and Chairman of ICU Medical, Vivek Jain. Vivek has been a loyal participant at this conference for many years. At the start, it was a small supply accessory-oriented company, and he's really built this business into something that's much bigger, much broader, and a lot more dynamic and I'll let him kind of get into that. But again, thanks, Vivek, and might as well get started.

Good morning, everybody. Thank you, Jayson, for the kind words, and thanks to Raymond James, once again for having us. I've presented here many, many years ago, with my former company and then here with the exception of the COVID years has been a great event, and we enjoy very much. Thanks for making a little bit of time for ICU Medical today. Really, if you're new to the story, it's been a year of a lot of change for us. And I try to center -- the presentation is a bit dense, but there's really 4 main topics to assess us on and to understand can we execute on those 4 topics to create value. And so without getting into the slides, just to summarize them. The first is we entered a transaction with an asset called Smiths Medical last year, that asset doesn't have the amount of revenues it had a number of years ago. And so the first question is, can we recapture those revenues? It's a huge chunk of getting back the value we thought was originally there. The second piece of value is, can we continue to drive organic growth in our own legacy businesses? And do we have pricing power in those businesses to expand margins? That's the second key component of long-term value. The third is, do we have a deeper level and we do, do we have a deeper level of integration synergies across manufacturing, IT systems, support functions, et cetera, to improve our performance over time? And the last point to assess us is what's going to happen in the broader macro environment. We suffered a lot last year in an inflationary environment with fuel costs, transportation, surcharges, et cetera. Are we going to get relief in some of those items? And ultimately, the inflationary effects on the U.S. dollar currency made a big impact to us and how is currency going to shake out over the next bit of time. And so there's lots of depth in the presentation on the specific product categories, et cetera. But those 4 pieces are, I think, the highest-level drivers to assess our situation. I'll encourage you to look at our forward-looking statements and our risk disclosures at your own leisure, getting into our business. And so as Jayson said, our team over the last 6 or 7 years has taken what was a $250-ish million direct sales company to about $2.3 billion, $2.4 billion. The core of what we do is in infusion therapy with a few logical adjacencies in the critical care area. The original business that we've built on was our consumables business. And so if you think about an infusion system in a hospital as really the plumbing system, the consumables business are the pipes that deliver a drug to a motor, a pump, and then ultimately into a patient. And that consumables business is almost half the company. It's where the majority of our cash flow and margins and our economies of scale come from. The second business is the systems business, which is the pump business. That's the infusion device that takes that drug or medication or solution and pushes it into a patient. And then the third bucket is what we call Vital Care, which is the fluids, the IV solutions themselves that are usually dilutive with drugs or delivered directly, and a variety of other critical care products. If we were to step back from this and kind of size ourselves up relative to the global industry, we are the #1 non-dedicated infusion set producer in the world. So we make more pipes to deliver medications on a non-dedicated basis and anybody. Nondedicated means that is not lock and key with a pump. It's an open system that flows around a pump. We're the #2 pump company by number of pumps pumping in all different pump modalities in the planet. And in most of the vital categories we're either 1 or 2, and we can go through some of those categories also. To reflect on us a little bit, 6 years ago, we had a single customer. So we were the innovator in those pipes and the IV connectors, IV consumables. We utilized a company called Hospira to go to market. Hospira was bought by Pfizer in 2015, 2016. They were our customer. Ultimately, our core business was not their core business. The only way to solve that was to step into our customer. We acquired Hospira from Pfizer. That brought a number of those items on the chain. We did something very few American public companies do. We supersize ourselves 400% and integrated a variety of manufacturing sites and commercial operations all over the world and converted a disparate set of IT systems into a kind of cohesive organized company. We optimized that for a number of years. We did have a few setbacks, particularly in a business we can talk about called our IV Solutions business. But fundamentally, we created a lot of value, recouped all of our cash from that transaction. While Hospira solved a lot of the defensive issues that we had with Alliance on a single customer, it didn't bring a lot of offense in terms of having a full portfolio in each of the parts of the puzzle, which I'll get to in a second. In late '21, we entered a transaction with a British conglomerate to buy their medical division called Smiths Medical. That made us about $2.3 billion, and that solved a lot of the product gaps that we have. At a very high level, just about everything we sell outside of a pump is $15 or less. 75% of the business is a single-use disposable, 10% of the company or so is hardware sales. So that's really primarily pumps and to a lesser degree. Temperature management systems and about 15% is IV solutions, which are the fluids that go through pumps. About $4 billion or so of equity, we were completely the opposite for many years. Some people in this room have talked to us a lot about buyback. We hoarded cash and had no leverage. We did borrow money to pursue the Smiths transaction. We currently have about $1.4 billion, $1.45 billion of net debt under 2 floating-term loans. In terms of our portfolio, if we went back in history, our original business was this non-dedicated IV sets and accessories. And so those are the little connectors that attach to a catheter into a patient and think about that as the last mile before drug enters the patient. Keeping that pipe open is very, very valuable. And that's where we were the innovator. With Hospira, we acquired the top 3 blue boxes, which is the fluids themselves, the solutions, the pump, and the lock and key dedicated sets that go through the pump. And with Smiths, we filled out the chain by acquiring all the different types of pumps. And so the LVP is the most valuable pump type. That's the primary pump in the hospital. There's also a pediatric pump that we didn't have called the syringe pump, which now we're the #1 player in, and an ambulatory pump, which is a pump used at home to deliver often oncology drugs or anti-infective drugs. And so we are now a full-line pump provider as a result of the transaction. We also didn't have the needle that goes into the patient that connects to our extension sets and that's called IV catheters. And the Smiths acquisition made us the number, depending on the given day #2 or #3 player in the U.S. market in IV catheters and then brought some of those adjacencies. And so our journey over the last 5 or 6 years was to start with one piece of the puzzle and sort of work our way up and down that chain. A little bit on the individual pieces of the portfolio themselves, our consumables businesses is core, right? That is what we center around. That's where we innovate, that's where we drive our returns. There's 4 parts of that consumables business. The first is our longest-tenured business and it's really compounded at a very nice rate over time. That's our consumables IV therapy business. That business is built on the back of a product called Clave. That Clave family of innovation is used in lots of different applications and is really the gold standard of medication delivery in infusion therapy consumables. Outside of infusion therapy, we've innovated and created some new categories in oncology, which has been a big growth driver for us over the last 5 or 6 years. Simply said, that's plumbing for expensive drugs. And so sitting between valuable things to make sure they are used fully or used safely has become a key category in of itself. And so that's been a very nice area for us. The Vascular Access and Sharp safety category came from Smiths, and that's in the consumables segment. Those are the needles that go to the patient. And the tracheostomy business, which I'll get to how we're going to report is going to be reported in our consumables segment. It's not necessarily an IV therapy product, but it shares a lot of the same characteristics on deeply customized, incredibly important clinically, and unique market to participate in. In this segment, there are a lot of near-term growth drivers, which is simply just keep doing what we're doing, growing our IV therapy, expanding, taking share. There are some short-term opportunities on price where we have the opportunity to take some price to market. And if we can get back to being a reliable supplier, we can get some of those revenues backwards is the first thing in those 4 key points I talked about in the Smiths categories. In the medium term, there are new innovations to pursue. Infusion is moving equally from the hospital, outside the hospital, ambulatory infusion having some unique customized sets that allow us to participate in those markets is important. And we need to integrate our parts and pieces with the Smiths parts and pieces. And so that drives future innovation. And then longer term, it's about being closer to the drugs. Right. So how do these pipes integrate with the drug products themselves, either on label or in dedicated delivery format? So a lot of value to be created there. Our Pump business, which is the second pillar is very much about uniting 3 different pump platforms, our original LVP business, that we got from Hospira as well as the ambulatory and syringe pumps that came from Smith and combining them with software data analytics to participate in all classes of trade. Again, infusion here is happening beyond the 4 walls of the hospital. And ultimately, the pump is important, but what's more important is the software that sits on top of it that connects that information about where medication was delivered, that helps the hospital system measure compliance, drive reimbursement, helps the clinician measure outcomes, et cetera. In the near term for us, we need to keep innovating to get new hardware on the LVP side into the market, new software into the market. That helps drive share gains. There's some unique dynamics going on there, I'm sure we'll talk about. And on the Smiths business, we inherited a complex quality situation, which we've done before with our legacy companies, but we need to finish cleaning up the Smiths FDA situation to make sure we can compete effectively. In the medium term, we'll bring on some new hardware from Smiths. And after that, we can focus on, once the hardware platforms are stabilizing, integrating them from an IT perspective and delivering that value for convenience for our customer. The third publicly reported bucket is called Vital Care. This is some natural adjacencies, some we had on our own, which are IV solutions, which has been a challenged business, some were critical care. The Smiths businesses are the temperature management, pain kits, and respiratory business. These are all things used in the anesthesia environment in an OR with anesthesiologists or in a critical care ICU environment with our respiratory therapist. All areas we participate in the hospital. Each one of these categories has their own dynamics. For the most part, they're all logical places for us to stay in, but they also provide some opportunities what we should do in each one of these to optimize the portfolio over time. In terms of the industry structure, very consolidated, a lot of high regulatory barriers. Manufacturing assets are very substantial here. You couldn't walk into them and build them from scratch logically. Today, a lot of stickiness in the product categories. People don't like to switch these items unless they have to. There are some tailwinds. You don't have to play in the entire world. There are certain geographies that drive a lot of economic profit, and there are a number of emerging opportunities in software, home care, et cetera. Our place in the market is we're the focus player. We had the tightest and leanest portfolio. We're the innovator. We need to continue to have that commitment to innovation. We have bought assets that were troubled and turned them around from a customer perspective. We did that with Hospira. We need to do that with Smiths. And one of our lessons having been in this industry for 15 years was staying in business, keeping your nose clean with regulators and a high level of customer service innovation gives you the right to have product cycles that are incredibly long. And the speed of innovation is slow on infusion if you have the market share that share lasts for a long period of time. The businesses we bought for the most part, have had a reasonable amounts of investment into them from a Hospira's perspective. Smiths needs a little bit more investment. And we think we have a diversity of assets that we can make the right decisions on in terms of how to create value over time, and we can exit geographies that have been low value, which you heard us do on our call, we talked about exiting India and China recently. Those are 2 spots that just didn't make sense to us and we were able to take action on them. From a public company reporting perspective, the top left box is how we used to report as ICU. For a year, we reported Smiths separately in our first year of the acquisition last year. Starting right now, this quarter, those segments will all get combined. We'll report in 3 publicly traded segments. The first is consumables. On our call last week, we said we expect that segment, which is near $1 billion to be a mid-single-digit grower. There's evidence for that in infusion therapy and in oncology on the ICU business, which has compounded at a nice rate. There's evidence for that on tracheostomy we need to turn Vascular Access around. The Infusion Systems segment, which is the legacy Smiths Medical pumps plus our pumps. We also thought that segment was a mid-single-digit grower. You do some of the unique dynamics in that segment. And the Vital Care segment is probably closer to flat or plus or minus a little, really driven by what happens with IV Solutions. And so going forward, these will be the 3 pieces we report in. To take the question of this transaction, we've sit in these meetings and people ask us do you do the right thing? Would you have done it if you had hindsight, et cetera? And just to kind of recap what we thought we were getting into and what we are into. And the core question is, has the earnings power of the business changed from what we originally thought post this transaction, or post a year into this? And if I go back to those first 4 points, if we can execute on those. I think our view is the earnings power of the business hasn't changed is what we thought, but we did lose some time in getting there. And to reflect on it which I think is good about what we did and where we are now, we thought we had paid 2x revenues or 12x EBITDA, which was rich for us in the transaction. Given the results to date, it's closer to 2.5x or just under 2.5x of revenues, which by historical standards in medical devices at a reasonable gross margin, you could still create value at -- we haven't had to spend as much on restructuring and remediation as we originally thought. But we had to deploy cash to build inventory. And so that needs to come back, so it doesn't become purchase price, right? And we're very focused on that. We had -- inventory levels are too low. We had to deploy more capital against the situation to build back adequate safety stock, so we could go back and get that share with customers. We're very specific about that. First -- the first bucket of revenue recapture, the lines of business that went away. They were in these 3 areas that are on the slide. Our cost of serving customers have been incredibly high, and so the production environment supply chain, everything that could go wrong sort of went wrong in a single year, and we needed to fix the quality system. So there's a bunch of stuff. I think what we feel today, the latest view and we tried to address this on the call, is our operations are running quite well. And so we have adequate inventory on hand. We've able to compete in every corner of the world on every product line. We have made significant investments in quality and the quality story continues to improve. And ultimately, it's about running ourselves better to get kind of the third and fourth bucket from the first list I talked about. A lot of other items hit us in '22 on currency, on fuel, on decision-making hospitals. But ultimately, it's a lot of those items 1, 2, 3, and 4 are under our control in terms of self-help to go get right independent of these challenges. I think our priorities for '23 are about continuing with our legacy ICU consumables growth. We want to improve the performance, obviously, of the asset we bought. We need to run ourselves better, which reduces air freight. That starts to get margins to go in the right direction if we fix the quality system that impacts the amount of cash we spend on remediations. And we want to be reliable to our customers more than anything else and get back to positive free cash flow. I sort of fast-forwarded on the slide earlier, but it showed a couple of things. It showed our core consumables business has compounded at 6% or 7% over 8 years in a row. And that for 6 of the last 8 years, we had net income in excess. So we had free cash flow in excess of net income, and we got away from that last year, right? And with the capital we had to put in inventory and the remediation, we have the opportunity to improve that and get back to that and more free cash flow generation leads to debt paydown, changing of the balance sheet, et cetera. And we need a little bit of time to kind of get some strategic actions done on the rest of the portfolio. If we can do all that in '24, we think it sets us up to have the entire portfolio growing. There are a number of important contract renewals that happen next year. We are pursuing new product approvals and a variety of things on the innovation front that should make their way into the markets by next year. And there's a bunch of these self-help synergies and manufacturing consolidation, real estate, a bunch of functional areas, et cetera, to keep driving margins and get back to that free cash flow in excess of net income, which was all the original capital allocation intent to turn value from debt to the equity side of the ledger, et cetera, and have a little bit of leverage on the business and return the rest of capital to shareholders when healthy. So it's been an interesting journey. It was a hard story last year. This is the same slide we've shown here for years in '23 versus the last few years. It's hard to say exactly what the capital environment is in the customer base. We haven't seen capital as a constraint yet. Obviously, hospitals are suffering a little bit on their P&L. They also did very well in the last 2 years. And so it's finding customers who recognize that and can make decisions to move forward. Interest rates are a hit right now, probably to $225 million of increased interest expense beyond what -- certainly beyond what we had originally thought. We do have a high inventory level to work down into cash right now. People are getting on with making decisions. And we feel pretty good about the state of affairs in our pumps and consumables business, which drive a lot of our returns. We've got a turnaround Vascular Access, and we got to get a little bit smoother from a production standpoint, but there's a number of things under our control to make that happen and ultimately to get back to real free cash flow generation and value creation. So that's a story on ICU Medical. I appreciate your interest. Happy to answer any questions here, Jayson, or do it in the breakout.

Yes. We have a bit of time. Glad to see there's more pluses in '23 than any other year. So that's pretty bullish. I guess we sat here last year, Vivek, and I was a little naive as to the host of issues that the industry was going to face. You mentioned that the earnings power potential here with Smiths hasn't changed, but can you maybe walk through some of the permanent and some of the transitory costs that you incurred in '22? And what sticks going forward? And how do the transitory cost kind of fall off, if you will?

I mean this chart, and I should have talked about it, that's the 4 points pre-transaction, we are 20%. EBITDA margin has gone to 16%. So 4 points on $2.3 billion is $100 million almost. It's hard to segment exactly what is Smiths transitory versus ICU. So I would just put them in the bucket of saying we had $100 million of variance from our original -- we sat here last year with Jayson, and we thought we were going to make $450 million plus. We made $360 million. That $100 million of variance was $25 million of FX. We debate whether that's permanent or not. The only way you can solve that permanently, you can resolve that issue internationally is to raise prices in the international market. $25 million was freight and diesel cost that is improving at the moment. And the balance was lost revenues that itemized, and we need to get those back. So there's a bridge we've tried to talk about in our scripts that goes exactly those issues.

And arguably, gross margin is the most important lever to profitability in this business. Gross margins have gone from kind of low 40s to mid-30s here. You alluded to price as a factor in improving margins. But what else besides, I guess, price and better top-line growth, what else can you do to boost margins?

I mean I think there's probably 3 or 4 really valuable components of that. I mean all these businesses don't descale well. So if you lose share, your production volumes go down, that hurts in the factory. So the first is you get revenues back, fill up your factory still. We have available capacity in a number of these categories, get all the plants humming. Number one. Number two, price, as you said, number three consolidate manufacturing. And so there's a number of sites over time that we don't need. And there is real value in moving some of the work south of the border when necessary or moving things to existing factories. And so driving more synergies. And then the fourth is improving your bill of health from a quality perspective with an IT integration, so you don't need to spend the same amount of money on different systems that we're going to run ourselves. That will happen when systems cut over happen and we get a clean bill of health from the FDA.

Part of the secondary opportunity with Smiths was revenue synergies. You're selling into the same customer base. You don't talk much about it, but I'm curious now that we're a year in, have you been able to realize any revenue synergies from the combined business?

I mean to be transparent about it, in the original transaction documents, we assumed no revenue synergies, right, on the assumption that, that was sort of upside to where we would land. I would say today, just some concrete examples there have been examples where Smith sold syringe -- the Smiths installed base on syringe pumps and it's opened the door for us up on the full pump line. So we can give concrete examples of that. And there are examples where our position in consumables has allowed us and our health now on the supply side has allowed us to have a better conversation around the Vascular Access products. I would say it's in both directions. It's not just because their portfolio enabled us to open doors in both ways, our portfolio gives us the right to repair theirs, just takes -- you have to be healthy for more than 2 or 3 months from a supply perspective to make it happen.

And you mentioned it in your presentation, but the LVP dynamics and innovation. So you guys have been at a bit of an advantage over the last couple of years just given some market dynamics. Can you talk about -- have you been able to realize the share capture that you had hoped over the last couple of years?

The market share leader is on temporary, has the inability to place pumps in the U.S. market right now. We experienced that at previous companies when the market share leaders were down, usually, the other participants had rapid share gains. That hasn't happened right now, I would argue a little bit because of COVID. So we've had -- we've picked up maybe 4 points of share, 5 points of share over the last 2, 2.5 years from 14 or 15 in year '20. I would say while fine is still disappointing to us because we think there's an opportunity to write for more. So it's an area we're very focused on, and we appear to have more time on that.

And when the competitor comes back to the market more freely, do you expect a little bit of a tailwind from an industry perspective? My sense is there's been a bit of paralysis over the last couple of years.

Yes. I mean, I think we would advocate -- it's the same story the competitor does what they should do, which is we will return, right? And that message is the public message to customers, we would love people just to get on with the decision. So clarity would be great one way or the other, so the decisions can get made, we would certainly advocate for that.

Okay. And then maybe last one before we break. The debt load is a little bit bigger than you've historically carried. I guess, visibility into cash flow, maybe not as much this year, but going forward is quite high. What else can you do to lower that debt load and maybe tie in the fact that you did mention kind of strategic action on the portfolio?

I mean I think our company previously was unlevered. So it's not a little bit different. It's a lot -- we went from plus $600 million to $1.5 billion net debt. It's -- there should be some amount of leverage on this type of company. And I think our vision was 2x was the right amount of leverage, and we're a little bit north of 3 right now, I think we would -- if values were right, we would sell a few smaller assets and generate free cash flow to keep 2x on the business would be our long-term capital structure. I couldn't tell you what's the optimal to get there. It's not that far away.

Perfect. We're bumping up against their time. So with that we have a breakout downstairs in [indiscernible].