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

Well, I appreciate you all showing up real quickly. Peter Harris from Morgan Stanley. I think I have to say this disclaimer 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. And with that, why don't we get started with us today is Vivek Jain, CEO of ICU Medical. Thanks for joining us early on a Friday morning. As I think about it and step back kind of big picture, 2.5 years ago, you acquired Smiths Medical, truly a transformative transaction for you all. I think it's been a challenging first 2 years as you expected, maybe a little bit more challenging than you expected. But from an outside in perspective, it really seems like a lot of momentum over the last 6 months. Business is more stable and even frankly, upward trending. Is that a fair assessment, how you and the team think about the situation today?

I mean first, Peter, nice CEO. Thank you from Morgan Stanley. Thanks for having us. I'm joined by my colleague, Dan Wilson, who runs our pump business, which I suspect will be a lot of the conversation today in the breakouts. So the question is it getting better, it's certainly moving in the right direction. I guess as I reflect on the last 2 years, I felt for what we were going through, we were almost getting the benefit of the doubt or too much credit, right, when we had really revenue deceleration and margin deterioration, that's when it sort of got relatively unpleasant. The opposite has happened now where we've had a little bit of revenue growth and improving margins and cash generation and a more stable balance sheet. I think those are all signs of stability. It's only been 1 or 2 quarters. I don't want to say it's a perfectly orderly line from here, but there's more right. There's a lot more going right than wrong. Right.

And what were the biggest challenges you faced in the integration?

I think we walked into a situation that we knew was going to be challenging, but it was more challenging than we had expected. And the issues over the 24-month period, it was sort of the tail end of COVID -- the middle of COVID, I guess, when we walked into it, there was a lot of just sort of the orderly blocking and tackling of supplying products, reliability, the things that customers count on you for. Then there was a series of issues around the quality systems and nothing fundamentally wrong with the products that we acquired, but just the processes and the management of the quality system itself was kind of broken. I would say the second thing. And then third, the most important thing, and that's something that takes time and sort of what we went through, we did Hospira 5 or 6 years ago, weakened customer relationships, right, as a result of the first 2 things. And those have it takes time to solidify those, right? Smart customers want to see. And in the other situation, it took us 24 months to turn around a lot of things, and that's kind of where we find ourselves.

Great. You do compete in a competitive space, particularly on the pump side. How do you think about where you all are positioned versus your global competitors today? And why is that set up such as it is? And what's the future look like, you think?

I mean it's obviously there's a number of -- it's a very consolidated market, which makes it attractive on the pump side. And there are a handful of competitors all jockeying for kind of market share gains over the next number of years because of some unique events in the industry. We feel like when we look in the mirror, for the most part, we like what we see and the difficulties of taking on Smith will be worth it to us because we believe having a full line portfolio, right, all the modalities was the first most important box to check and why we did that acquisition. And then the second thing is that the value we've added is to make sure we drive innovation across that portfolio. And a number of the largest market products have already been approved by the FDA in Plum duo. We talked about filing PlumSolo. Syringe follows that, and ultimately, the home care [indiscernible] follows that. But we think we're the only person who plays in the most high acuity critical care environments for delivering medications to MedSurg's step down to infusion clinics and ultimately with the CAD franchise that came from Smith all the way into the home. And so relative to the competitors, it's about innovation, breadth of portfolio, agility, all those types of topics.

Lastly before we jump into kind of some of the businesses and the specifics, how do you see the big picture today from a hospital environment. What is the environment? How is the missions, procedures -- and then over the last 2 years, the macro environment of supply chain inflation has obviously been challenging for you and others. Where do you think that's trending and where is it right now?

I mean 2 different questions there. The first was on the broader hospital environment. The broader hospital environment is pretty solid all year. And it's at some point -- and I've been with a number of customers over the last 10 days, 2 weeks here on the East Coast and out west and people are busy. It's an active time, which is great. And again, I don't think we're sitting here drawing and it was reflected in our guidance and comments in the year. I don't think we're drawing long collusion is going to stay that way forever, but it's pretty good right now. And then there's lots of explanation lots of hypotheses as to why. But it isn't just a domestic phenomenon. So globally, we have low exposure to Asia, but at least Europe and the other places we play Canada. We play bigger roles in. Those are very active markets, too. So good, right. much rather have it this way. The macro was exceptional in the journey of what could go wrong went wrong for 2 years. The macro items, which I would call currency interest rate was for us, it was a very specific dollar against peso, dollar against yen, caused the overall cost of funding in the transaction all sort of broke in the wrong direction as well as commodity fuels, et cetera. At the moment, it's only been a few weeks, those appear to be going in a much better direction. And so that yes, we had a lot of operational challenges, but it deteriorated so quickly. Part of that was due to kind of the external world.

Great. Any questions on big picture for anybody? If not, I'll jump into the 3 businesses you have? All right. So starting with consumables. Look great in the recent quarter after mixed results with the legacy ICU products strong and maybe a Smiths product is a bit weaker. Is this business going in the right direction and why should investors believe it's kind of turned around.

I mean the ultimate proof is in consistency of results. For the last 2 years, the legacy ICU business is in the consumable stack, which is probably 60%, 70% of that pillar have been clicking along very nicely for the reasons we described in the last call, which are about creating new niche markets, innovation wins that happen on the pump side, dragging consumables and finally getting a little bit of price internationally. On the half -- on the biggest chunk of that, which is infusion therapy. Oncology, which is the other legacy ICU business, we had some self-inflicted challenges last year, but it feels like the underlying market there back to your previous question, is improving. And I don't really know that's more screening or diagnosis or I haven't looked at drug scripts, et cetera, lately, but volumes seemed pretty good there for the people in the system, et cetera. So those 2 businesses have been growing, will continue to -- the challenge over the last 2 years is they were masked by what was going on in the Smiths portion of the consumable stack, which was vascular access and tracheostomy and all that really happened in Q1 was that finally flipped, which is last year, we were saying, okay, vascular access were getting stable, getting stable after a year of losses. And now we've started to grow off of that base. And that growth, all of a sudden, you see the whole picture a little bit differently. And I think we continue to feel good about the growth, not at the level it was last quarter for everything in the base was easy, right, but at least sustained this year into next year, et cetera.

Moving to Infusion Systems. You've had some recent share gains in the LVP pump market. You've got a new pump out there with the Pluma pump and the life fuel safety software. Maybe talk a little bit about the landscape, and then also talk about would be helpful kind of early feedback from the customers on that new pump.

The pump market is a valuable market. That's why everybody is talking about it. It's a large TAM. And because of some of the unique dynamics with the players, there hasn't been a lot of a refresh in that market. And the next number of years is going to be basically a doubling up or greater of what would be a normal market. And that's why there's sort of this land grab going on. That's why we wanted to have the full portfolio, and that's why we wanted to have the innovation. It is a good time to be a customer because there's lots of things to review out there. I grew up in this business when there was a monopoly player and it's so much easier to operate in that environment. And so it's good to be a customer you can evaluate all the technologies, meaning the products have to win on the merits of their technology. The feedback we've received in our new technology is great, right? And I think people like it and for us, and try to -- there's a big incumbent advantage in this business where just the power of inertia is very strong and increased the existing player. But there are folks who want new technology and, frankly, believe in what our value prop is, which is very much around safety, accuracy, clinical excellence, workflow, speed, cybersecurity, interoperability like those are all of our sort of code words and we see people embrace those topics, we find ourselves in a very good position. if people are just sort of doing a market check and not interested in the safety aspects of the device, the things that made volumetric pumps, the market share leader in this country. Originally, we probably won't get it. And so I guess, we look at it and say the majority of the market in this current situation will stay with the incumbent, but there is going to be enough change that can create a lot of value for us, too.

And when do you start seeing revenue flow through from the new platform in your mind?

I mean, these pumps are complicated items. They require a lot of technical evaluation on the front end, which is why there's a long time between the conversation starting and something closing. And then there's a long time between signing a contract and actually implementing it. That whole journey could from first conversation to actually installing could take 18 months. Usually, it's half-half. It takes like 6 to 9 to get somebody signed up, and it's a minimum of 6 to 9 to get it installed. So middle, back half of next year or something like that.

Okay. Very helpful. Last division is Vital Care. That business has been a bit flat recently. Half of its segment is IV Solutions. How do you think about the pricing in that space. Both you and your competitor have important GPO renewals upcoming. What is the status of those renewals? And what are your expectations for price increases to help offset some of the inflation you've absorbed?

I mean it's a very important item, right? -- the -- if you try to unpack what happened to us over the last 2 years, there's really 3 different things. One was the macro items we talked about, which at least feel better. The second was we bought something that was 10%, 15%, 20% of underperforming on the revenue side. And the third and a huge chunk of it was the inflation we absorbed. Our issue has been that we haven't been able to recoup the value of that inflation from the customer that takes time to do that. And so it's hard to follow the logic in an essential item concentrated market. Why is that hard to do? but it's because we sell into these long term, we had historically sold under these long-term fixed price contracts. The new contracts have been updated at the GPO level, but that's really only a hunting license. You still have to go down to the individual customer and make the deal and the individual customers lots of opinions that sometimes start with, hey, what inflation, there's no inflation. The stuff we got was permanent, right? You have to reeducate and so I think certainly, the majority of market participants are feeling that pressure, and we kind of believe logic should prevail on an essential item in our own model and in the guidance we've ballpark roughly acknowledge out there for next year implied in that is some price improvement for us.

Great. So moving on from revenue. From a customer service standpoint, you guys are operating better than at any point since the acquisition for your recent comments. Do you think you're underearning relative to your peers today?

I think for the last 3 quarters' calls, we've sort of said by any benchmark, if you write down the numbers on a piece of paper, we would be 400 to 500 basis points lower EBITDA margin than the comparable group, right, not that there's a necessarily perfect comparable group. And we came from the industry, right? We came from the company that was a leading player renewed the profit margins and the markets change. But it still should be better than where we are. And that's a function of all the things that we've been trying to lay out on the calls, which starts to recouping some of the -- about hits we took in inflation, synergizing the manufacturing network, getting on a single instance of Oracle fixing the quality, which is taking a lot of expense and cash. Obviously, some is below the line some above the line -- but we tried to make it simple, say we think we're under earning by 5 points. We didn't say how long it takes to get those 5 points, well we try to schedule the items that are in that bucket. And unfortunately, that was post the gravy on the original transaction. is the stuff we have to pull out of our back pocket to get where we want it to be.

And can you be a little bit -- if you're able to be a little bit more specific on that time line to close that gap and get to where you want to be?

I mean -- I think minimum range, I mean, I think it's going to take at least the earliest that you might see it is the end of next year, the safe assumption would be a year after that. So somewhere in the 15- to 24-month time frame, we get everything done.

All right. The other driver of the transaction was synergies. You've always talked about 2 ways of synergies, which are worth about $50 million. Maybe talk about where you stand in that journey of getting those synergies, how are you tracking versus your original expectations? And how much opportunity is there still out there?

Yes. I think embedded in that comment on under-earning and getting to where we think we should be. Is recognition or achievement of that wave 2 synergy, so sort of embedded in that number. To me, it's like people spend a lot of time on synergies and they put numbers out there like if we achieved our round 1 synergies, but we missed our earnings by $100 million who cares, right? It's what you should be doing every day. And so I think we've done a good job of removing costs certainly in the first 24 months on everything from quality to the facilities to sites, et cetera. But if you're still not getting where your supposed to be, it doesn't really -- who cares, right? Doesn't matter -- it's much more about now we have to use the second wave of stuff to get to the right operating market.

Okay. Recently, we've seen people struggle with IT systems and ERP, et cetera. You brought together over the last handful of years, 3 different businesses. Where are you in that IT journey of integration of the systems and...

Not recently always, right. We are in the midst of our ERP conversion of the Smiths acquisition, Oracle to ours. We cut it over in the early part of August for North America, U.S., Canada. Like all your peer conversions, it was bumpy, not as bumpy as we went through with Hospira and we're sort of cleaning up today. I think -- I don't know what the right analogy is, think about it like changing your library -- every book in your library needs a new number, right, with a new card catalog system or a new electronic system or whatever year you're born in. And doing that for all of your products in all your sites and all your systems and all your registrations, all your licenses all at the same time. And things don't always transfer right, and you spend a lot of time cleaning that up, and that's sort of what we're in the midst of. I think takes a couple of weeks. I suspect customers are doing okay because we notified them in advance. Probably they buy ahead a little bit. Shipments were a little sluggish in August, and you catch up over the next so do it early in the quarter.

All right. On free cash flow, obviously, you've been making some significant investments since the acquisition. I don't think you as kind of 1 off the acquisition or not, but how should we expect that time -- that spending to wind down? And how do we think about ICU's ability to generate cash -- material cash over time?

I mean the numbers are permanently etched into our memory of what we had on the initial slide of the transaction, right? What we thought revenues are going to be what we thought EBITDA was going to be what we targeted for free cash flow. And it went the other way. We had to invest more at the outset, right? And that investment to a large part, went in 2 areas they went into inventory, then it went into quality. The inventory investments are over outside of any inventory needed to grow the business. And so that inventory excess, which was about making sure you didn't lose any business with the customer having adequate inventory end-to-end kind of prepare for what was delayed ultimately that EU MDR, that inventory is largely out of the system. There's a couple of million bucks in there, and that's reflected in our increasing cash balance. The other part quality is waning. We're still spending money on it. It was half in '23 of what it was in '22. I don't know, '24 will be quite half, but at least that line is going in the right direction. And the management team's incentives are about cash. So we don't care whether it's dumped -- people dump a lot of things below the line, just that, but it's still cash, right, and that cash can go to help the equity shareholders. So we are focused on free cash flow. We're not at the level we wanted to be originally, but it is improving. And now it has to come more from the synergies and operational side than just the balance sheet, which was helpful over the last year. It was only helpful because it was problematic. Right.

On the problematic side, I don't know if the regulatory environment is tougher, just as you talked about on IP, the same as it ever has been. But what is the status of your various open regulatory items, including the SMITHS Medical warning letter, FDA inspections, et cetera. we've made a lot of investments.

And again, the issues around the things we acquired, ICU had a very clean -- very clean bill of health, right, after Hospira, it took us a few years to clean that up, very stable. SmithS had a warning letter that was really about 3 Cardinal common sense, whatever you want to call them, things you don't do in a medical device world, right? If you make a commitment about remediating your products in the field, meaning if you have a product problem and you said I'm go to the agency, I'm going to go fix it, you have to go fix it. Doesn't all be fixed in 1 day. It doesn't mean you have to start that process. Two, you have to make sure you're adequately tracking complaints, so there's no patient harm, right? If you have an adverse event, you need to document that you need investigating to understand it, you need to make a decision based on it or a very fair request. And the third is you need to prove that your processes around changing things and particularly in a world where you're short everything in 2021, 2022 and you're changing in raw materials, components, some of these regulated devices, you have to document your changes and test before you put something to the market. And I think the business we bought fell down in those 3 areas. And we've invested heavily in all of them heavily in fixing it at the customer site. Heavily in migrating the Smiths quality system to our legacy system and then redesigning and retraining on all the barriers processes in the factories. And this doesn't -- just isn't just like a office thing, this ultimately touches human beings that are assembling something on a floor, thousands and thousands of miles south of the border, right? And everybody has to be moving in the same direction. We feel pretty good about it. It's kind of a wait and see mode, right? Each day that goes by, we get stronger. My generic comment was most good companies have these things cleaned up 3 years after issuance. Even the Hospira had cleaned up 3 year factors.

Perfect. So we've talked a lot about the business side of the equation, shifting a little to the financial side. Despite the positive momentum we've seen, you were recently downgraded by Moody's, I think, due to a view of sustained elevated leverage. How do you think about that move? What is your plan to pay down debt? And how do you think about priorities of capital allocation?

I think the Moody's thing -- I'm not sure I fully understand it because cash is going up and the leverage is going down, but that's -- it's not worth sort of bickering with City Hall, right? For Joe job is to deliver the results. I think we said in the call, the biggest item in the last 18 months was what's the right amount of cash to feel secure on if you had to invest more in quality or in the infusion industry is kind of littered with land mines. And I think we got down to $100, $200 million of cash, right? We were feeling that's very, very tight with what we've been able to do in January we're back up above $300, and that's probably a safe amount of cash to run the business globally with -- and therefore, net debt was $1.3 billion against an improving EBITDA outlook, we felt like we're getting to a better place where if there is excess cash, which is why these quality and remediation costs come need to come down, that excess cash should go to debt pay down. That money, obviously, we didn't do the right type of -- we didn't do the right type of financing in the transaction and the term loan funding is like in the quarter all in. And trying to make that go away. It's obviously very valuable. So we're focused on it.

Is there a leverage level you're focused on? Or how do you guys think about the right balance sheet composition?

It's hard for us as a company that until we did this sat with excess cash and no leverage and no one ever said a word about it. But as a quasi kind of industrial should be mid-single-digit grower, right? There should be some leverage on the business. I think that number certainly has a 2 in front of it 2, 2.5 or something, not the high 3s where we were. So it's not that it's a couple of hundred million dollars away, like $300 million away, which if we can resolve through other means or strategic stuff, we would obviously do if it was available to us, but it's -- the gap isn't that big.

Okay. You just referenced that, but I was going to ask the question. There are businesses in your portfolio that I think are perceived as less core than others or maybe even noncore. How do you think about monetizing those? Or what's the plan with those assets?

I mean there are -- we've been relatively transparent. There are a few things that if the right situation became available, we would explore it. One, it takes 2 to tango. And two, I think it hasn't really been a seller's market of assets until kind of more recently as rates -- the prospect of rates come down. And if you're -- you have all these Scarlet letters of a warning letter and other things, right, it's nice to maybe get some of those things resolved. Look a bit cleaner have a few quarters or particularly under your belt and then maybe you have a better conversation. So if it's available to us, we would explore it, it hasn't been -- I don't want to make anybody think it is. It has to be also -- can't be value destructive. That doesn't actually solve anything it.

On the flip side, going back to your days of CareFusion, obviously that I see you've been -- I don't know if the word here to acquire is fair or not, but you've been a acquirer of assets over time. Are you happy with the portfolio you have today? Are there gaps you'd like to fill through M&A? Or how do you think about that tooling your tool kit?

I think with what we've been through, it's certainly not on the agenda to pursue anything of scale. For the most part, everything we needed in-house, right, to your portfolio question. We have our eyes on a few little gaps in the consumables area that are always. People always innovating stuff that we didn't figure out on our own to grab some of those, if possible. But I think we feel pretty good about what we have. And we'd rather say, okay, maybe we have to up organic R&D a little bit because there are some of the stuff in Dan's world on IT and software costs a lot to finish that. If we could get the balance sheet to the ratios we talked about, and we could come out and say, we'd love to return capital to shareholders in some other means with the optimal amount of leverage on the business and do things organically. I think that's a good formula were a couple of hundred million dollars away from it from the target.

That makes sense. I think it's mostly been resolved given they sold down recently, but maybe give the group the investors and a little update on where Smiths Crews ownership stake in ICU resides today? And how does their ownership stake, if at all, impact their earnout opportunity under the merger agreement.

I suspect the people in the room may know more about that than we do. We just sort of get a note at the end of the day, saying we've exited. And so -- and most I hear from people like Kin to people in the room. So I think -- I believe they're out, fully. And you'll see in the 10-Q, the language change that as a result of them being out, they're not entitled to the earnout anymore.

Okay. Helpful. As we wrap this all up, how do you think about the second half of '24 and then '25? Any specific concerns or on the flip side, things that get you particularly excited about the next 1.5 years or so?

I mean, I think from a business standpoint, in the very short term, we need to make sure this ERP, it's finished properly, right, which we're very close to doing. The normal bumps and bruises of trying to make sure we deliver on our commitments for the balance of the year. I think bigger picture for next year, it's very much about that $1 billion consumable, $1 billion-plus consumables stack, making sure all 4 pieces are going in the right direction. I think we feel pretty good about that. And then a lot of value comes down of what happens in this pump market and what value can we grab and create because that is very -- each opportunity there has a very high amount of NPV associated with it. And so what's -- while obviously complicated stressful and other stuff, what's fun about it. It's a large addressable market where there's a lot of action going on. And we're at the -- we're in the game with what we think is a novel new technology with a good portfolio. And I think that's the thing we're most excited about is -- are we capable over the next because that action is largely going to go down over the next 30 months right? And that's -- even though 30 months sounds like a long time, it's a relatively narrow window. It's gonna go fast. It's going to come back. It's been 30 months right since we did that, felt very long. Since we did the transaction, and I think we're excited about what's our -- that's the opportunity.

Yes. I think you summarized it, but I'll leave unless there's questions from the audience, I'll leave with 1 final question. Your company, to my perspective, seems to be on real momentum right now. You're integrating well. You're getting some [indiscernible] behind you. Why should an investor care to invest in ICU today and why is now the opportunity to really get in there and experience the upside that you and the management team see.

I mean I think that's the core of the question of all these meetings, right? a couple of months ago, we're hosting 1 of those busters. And I said, I think this -- and I kind of did it with my own checkbook at some level, right? I said I think the upside is better than the downside. I mean the valuations changed a bit, right, since then. But I think we still have to have that belief, and we have that belief because we can see the items that are under our control, the synergies, the quality stuff the integration items, right, the real estate and the list is long, right? And again, we're not specifying a date, but we know those things are out there for us to do. Second, we feel like finally, and it's only been 3 weeks, 4 weeks. Some of the macro stuff is at least at our backs instead of our face. And then the third is we have innovation and the shots on goal on this big market rate that's going to go on over the next 2.5, 3 years. And the combination of those 3 things, I think, does yield something that's materially superiorly are today. I can't guarantee what day, can't get guarantee what time, et cetera. But when I reflect on a lot of mid-cap device names, which has been a tough investment class, us, maybe we've been worse or whatever, but it's -- there hasn't really been a lot of crown jewels in there, right? I think we look at our portfolio and say our -- for all of the difficulties of the transaction, our portfolio makes logical sense. What we've created one of the world's largest set and pump companies, the only -- what should be a pure-play company in that, that should be valuable. And in a big game, a lot of stuff going on where we have innovation and some self-help. That's why I think we -- we're excited about the next 24, 30.

Right. I think you should be. So thanks for the unless questions from the audience. Appreciate the time. Appreciate you joining the conference, and have a good day.

Thanks for coming out at 7:00 a.m. I know it's painful and day certainly was for me.

Thank you very much.