John Mills – ICR, LLC Vivek Jain – Chief Executive Officer and Chairman Scott Lamb – Chief Financial Officer.

Jayson Bedford – Raymond James Matthew Mishan – KeyBanc Mitra Ramgopal – Sidoti.

Good day, ladies and gentlemen, and welcome to the Third Quarter 2017 ICU Medical, Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to introduce one of your hosts for today's conference, Mr. John Mills. You may begin..

Thank you. Good afternoon, everyone, and thank you for joining us today to discuss the ICU Medical financial results for the third quarter ended September 30, 2017. On the call today representing ICU Medical is Vivek Jain, Chief Executive Officer and Chairman; and Scott Lamb, Chief Financial Officer.

Before we start, I want to touch upon any forward-looking statements made during the call, including beliefs and expectations about the company's future results. Please be aware, they are based on the best available information to management and assumptions that are reasonable.

Such statements are not intended to be a representation of future results and are subject to risk and uncertainties. Future results may differ materially from management's current expectations.

We refer all of you to the company's SEC filings for more detailed information on the risks and uncertainties that have a direct bearing on operating results and financial position. Please note that during today's call, we will discuss non-GAAP financial measures, including results on an adjusted basis.

We believe these financial measures can facilitate a more complete analysis and greater transparency into ICU Medical's ongoing results of operations, particularly when comparing underlying results from period to period.

We've also included a reconciliation of these non-GAAP measures for today's release and provided as much detail as possible on any addendums that are added back.

In addition, the sales numbers that Scott will be covering, as well as the company's financial segments, the reconciliation from GAAP to adjusted EBITDA, and adjusted EPS are available on the Investors portion of the website for your review. Also, we're having a presentation that accompanies today's remarks.

You can view the presentation now by going to our website at icumed.com and click on the Investor Events. And with that, I will now turn the call over to Vivek..

to first enhance margins and then improve overall growth, in the best case, while better execution to improve our top line performance over time, drive operational improvements and improve cash conversions and returns.

In the worst case, we continue to fight headwinds on the top line, but we could still drive operational improvements and generate solid cash returns over time relative to the capital we deployed due to the levers I just mentioned.

And just like ICU historically, there are a number of continuing intrinsic value drivers, including high-quality or hard to reproduce production assets, sticky product categories and the opportunities for more cash generation.

But what is different from – excuse me, what is different than in our previous experience from ICU is the sheer size and scale of the work we have to do. It's very rare when the $400 million lean corporate player buys the $1 billion revenue customer.

This is a complex corporate carve-out and it's aspects of a turnaround in certain of the business lines, at the same time while being a quasi-LBO, just without any debt. We've been lucky on a few items, but it is about as challenging of a corporate project as many of us have faced.

We feel that we've been very transparent with investors on our plans over the last few years and cautious with our own expectations, and we want and need that mentality to continue. Not to talk down or talk up the circumstance, just to be realistic on what we have ahead of us.

As we've said on previous calls, the first few quarters under our ownership will be subject to all the expected difficulties of a carve-out and bumps that come along. There is a lot of execution in 2018 that has to happen well and we still have to improve or clean up certain legacy Hospira situations.

If you're an investor that wants the predictability that ICU has offered in recent years, that will be difficult to repeat over the near term, but when we get it right, long-term returns can be generated quickly like ICU. We believe that this was a logical evolution for both businesses.

We feel we've been able to put together a final transaction that didn't risk the enterprise and still left real room for value creation for investors. As always, I'd like to close when things are moving fast. We're trying to improve the company with urgency.

We're trying to take responsible actions and break some of the inertia that many companies in our position face. We may hit some bumps as we take some of these actions, but we will overcome them and emerge stronger. I really appreciate the effort of all combined company employees to adapt, move forward and focus on improving results.

And our company appreciates the support we've received from both our customers and our shareholders. With that, I'll turn it over to Scott..

Thank you, Vivek. I'll first walk down the income statement, highlight key items impacting operating performance, identify key effects of transactional accounting, and lastly, discuss our updated 2017 guidance and preliminary full year 2018 guidance.

So to begin, our third quarter 2017 GAAP revenue was $343 million when compared to $97 million in the same period last year. Please remember, the $343 million includes $16 million of contract sales to Pfizer.

Our adjusted diluted earnings per share for the third quarter of 2017 were $1.12 as compared to $1.35 for the third quarter of 2016, and adjusted EBITDA was $55 million for the third quarter compared to $34 million for the third quarter last year.

As a reminder, the 2017 revenue data related to delayed closed entities is not available by market segment, and as Vivek mentioned, we only have one delayed closed entity left, which is Italy.

Because of this, we're able to allocate the majority of the other revenue towards respective market segments, primarily infusion consumables and infusion systems, with other revenues being only $11 million in the third quarter versus $35 million in quarter 2. Now let's discuss our third quarter GAAP revenue by market segment.

Sales of infusion consumables were $93 million versus $83 million last year, which includes the legacy ICU infusion and oncology consumables business. IV solutions were $144 million. Excluding $16 million of contract sales to Pfizer, IV solutions sales were $128 million.

And just to reiterate, we benefited from unique industry circumstances in the third quarter. Sales of infusion systems were $83 million. Critical care sales were $13 million compared to $14 million last year and, as Vivek already mentioned, we're really happy about the launch of our new critical care patient monitor, Cogent.

The remaining $11 million in sales was primarily made up of sales to delayed closed countries and isn't traceable back to a specific market segment. For the third quarter, our GAAP gross margin was 33% compared to 53% for the same quarter last year.

The expected year-over-year decline is due to the acquisition of the Hospira business, which has historically lower gross margins and certain transaction-related items affecting our gross margin.

SG&A expenses increased for the 3 months ended September 30, 2017 as compared to the same period in the prior year, primarily due to the impact of the Hospira acquisition. This includes the cost of TSAs to Pfizer and new hires to help stand up the Hospira business.

In Q3, there was a realignment of expenses as we continued to integrate the legacy Hospira business with ICU. R&D expenses increased year-over-year due to the acquisition of Hospira, and as a percentage of revenue, R&D spend was flat compared to the third quarter of last year at 4%.

Just like there were in quarters one and two, there are temporary impacts to our P&L in quarter 3 that are both operational and transactional. So I wanted to take you through these, beginning with operational items related to decisions we've made on how to temporarily operate the business. There are two operational items to note.

As we've already mentioned, reported revenue from the delayed closed countries is not reportable by market segment and this was only an $11 million impact. The remaining delayed closed countries should close by the end of this year.

Next is gross margin, where the planned inventory reduction from product we acquired in the Hospira transaction and the decision we made to improve working capital efficiencies.

So while this helps free cash flow, it has caused a temporary loss of fixed overhead absorption in the factories that began in the second quarter and will continue into the fourth quarter this year. Now moving to the transactional items.

As we said before, the profit would have – the profit we would have recognized prior to the acquisition on sales from ICU to Hospira was delayed until that product shipped to the customer. This had a temporary effect on margins and earnings this year. However, this impact should fully be behind us beginning in 2018.

The second transactional item is the purchase price step-up of inventory purchased as a result of the transaction. As you can see from Slide number 4, when you back out the effect of purchase accounting, on a non-GAAP basis, our gross margin was 37% or four percentage points above our GAAP gross margin. We expect this to be behind us beginning in Q4.

Restructuring, integration and strategic transaction expenses were $19 million for the three months ended September 30. Restructuring expenses accounted for $3 million of this total and were primarily related to severance and the previously announced closing of our manufacturing facility in the Dominican Republic.

Strategic transaction and integration expenses were approximately $16 million and were mostly related to our acquisition of the Hospira business. We are making consistent progress on our integration as we see a clear path forward to standing up the legacy Hospira business from Pfizer and with a heavy emphasis on systems integration.

And as Vivek already mentioned, we had our first successful system cutover in a few smaller countries as we begin implementing our system cutover activities. In addition, there was a $7 million noncash adjustment this quarter to the carrying value of our contingent consideration payable to Pfizer.

This is based on reaching a certain cumulative earnings target by the end of 2019. This change is created by many factors, including the discount factor, time value of money and the probability of reaching this target.

These changes impact our GAAP earnings, but are excluded from our adjusted earnings since this has nothing to do with the operational performance of the business. Our tax provision for the third quarter was primarily attributable to higher income in the U.S. versus non-U. S.

and an allocation of transaction cost to foreign entities located in lower tax jurisdictions. We expect our annual tax benefit for 2017 to be between $5 million and $7 million.

And next year, by taking advantage of the Hospira transaction that provides opportunities to lower our tax rate through lower tax jurisdictions, we believe our tax rate should be at historical low and be approximately 27% to 29%. This does not consider any potential impact from the health tax reform bill that we are currently evaluating.

Now moving on to our balance sheet and cash flow. We continue to be very focused on cash earnings and free cash flow, and in this quarter, we were able to generate $74 million of free cash flow and ended the third quarter with $325 million of cash with a $75 million note to Pfizer.

This positive cash flow was driven primarily by a reduction in working capital, and though helped by $11 million of inventory purchase accounting, we still reduced inventory by $81 million in the third quarter and increased terms to 2.5x.

Now while we don't expect to bring inventory levels down the rest of this year at this rate, we continue to work towards improving our working capital. In the third quarter, we spent $25 million on CapEx, and for the full year, we expect to spend approximately $80 million, which does include investing in IT integration and infrastructure.

And this week, we entered into a new five-year senior secured revolving credit facility with various lenders, including Wells Fargo as lead, for $150 million with an accordion feature that enables us to borrow up to an additional $100 million. Borrowings are at LIBOR plus an applicable margin lower than we were paying Pfizer.

At the same time, we paid off our $75 million note to Pfizer using existing cash. We felt paying off the note to reduce our expense and adding this as insurance was the right thing to do. We should end this year with approximately $300 million of cash, no debt, and by the end of next year, approximately $400 million of cash.

Now based on our results through the first nine months of this year and expectations for the remainder of this year, we are modifying our adjusted EBITDA expectations from the previous range of $180 million to $190 million, to $195 million to $205 million.

We are also modifying our adjusted EPS guidance from the previous range of $3.80 to $4.20 to the range of $4.20 to $4.80. For 2018, we now believe we can hit an adjusted EBITDA midpoint of $250 million for the calendar year, with a range of $240 million to $260 million. We expect adjusted EPS to be in the range of $6.05 to $6.65.

And just to walk through the math on Slide 5, which is exactly what we presented on our last call, we believe the true normalized 2017 finish is between $185 million and $195 million.

To that, we would add first the $20 million of intracompany profits Vivek described in the consumables segment; second, our previous goal of $35 million of 2018 operational synergies; third, a normal expectation for legacy ICU, now Hospira plus ICU consumable earnings growth of $10 million; and a reasonable assumption for TSA savings in 2018, which we would call $10 million today, with most of these savings coming in the back half of the year.

We would then subtract from that the losses of $10 million to $20 million we expect in the infusion systems and IV solutions segments. We think the losses will be felt more in the first half of 2018, leading to a better back half run rate.

These next few months for us are important as we cut over systems at additional sites and continue to manage our way through the complexity of the task. But once complete, this will give us a very efficient integrated system with the ability to flex up as needed, and allows us to focus even more on the other aspects of the business.

And with that, I'd like to turn the call over for any questions..

[Operator Instructions] And our first question comes from Jayson Bedford from Raymond James. Your line is now open..

Good afternoon, can you hear me okay?.

Perfect..

Okay, all right. There's a lot to ask here, and as much as I want to ask you about the high-hanging fruit in 2019, I'm going to ask you some more near-term questions. I guess, first, in terms of – there's no change to the revenue guidance of, what, $1.2 billion to $1.25 billion.

What is the revenue that you reported in the third quarter that mirrors the annual guidance? I'm just – there's a few different revenue numbers here and I just want to make sure I have the right one.

And what's the revenue number you're using for the buck – for the $1.12 in adjusted EPS?.

So Jason, basically that would be the reported $343 million combined, less the $16 million for the contract manufacturing to Pfizer..

Okay.

Was that 320 – okay, and that's what you're using to calculate the $1.12 in adjusted EPS, right?.

Well, that's the – I think you asked what's the basis of the revenue guidance. It was without the contract manufacturing revenue, right? It doesn't – we don't make any money in that business. It doesn't contribute anything to EPS..

Right. There's no carve-out or – it doesn't contribute and there's no carve-out of that business..

Okay. Okay. Vivek, maybe on the systems. That was the one area where you came in a little shy of our expectation. I think you mentioned that you are working on things.

What helps you grow that business towards the back half of 2018?.

It's three things really in my mind, Jayson. It's – one, it's product stability and we think the new – the Plum 360 is the only infusion platform along with the other pumps in our family that have been through the new FDA process. We really believe in them, but there are areas for improvement there and we're working on that.

So kind of full product stability would be number one. Two would be time and seat of new sales people. We've changed a lot there and a little bit just like when we got to ICU, adequate time for people to get their legs under them. And three is calling on a wider swath of customers. Hospira was very inward looking where its historical business was.

And our first job is to make sure we try to do our best to secure our historical business and that the losses we've outlined were assumptions made about things we are going to come out of that base. But as – and they didn't necessarily go out and call beyond their borders.

And once we can get our legs under us, we should be doing the same thing, right? So product, people and kind of intensity towards the customer..

Okay. As we look to 2018, within your framework, it looks like you're kind of normalizing the base for $10 million of, let's call it, excess profits due to the dynamic in the IV solutions market.

So is the assumption that this shortage dynamic will be cleaned up by year end? And then secondly, it doesn't look like you're assuming any real benefit from that in 2018.

Have you been able to secure any longer-term contracts that gives you a little bit more confidence in kind of the growth profile in 2018 and 2019?.

I think, Jayson, it's really an important question. On the first part, our assumption, and we don't know the exact days and we're not going to guess what is happening with other industry participants, and by the way, we want a healthy industry.

Our assumption is people will get healthy and their business will come back at full strength, and so we have to assume that, that's going to be because we don't know whether that's – what day it is, but for our assumption, it's better to be conservative and assume it would happen soon.

In terms of contracts, the point I was trying to make in the prepared remarks, maybe it was too much, was we have been able to secure some long-term contracts and we traded away a little bit of value to get those long-term contracts. And that reflects both in the revenue line and in the margins of that business.

There's not a ton of margin in there, but it does mean we have that business for the next number of years, which keeps the factories full and adds value.

And I think we said before, we thought the losses would continue in solutions and now we're saying there's a reasonable chance, certainly excluding this stuff that happened recently, to be closer to flat in the business. So yes, that means we did make an assumption on getting some more revenues there..

Okay. And so the bad guy in 2018, meaning the lost contracts, is more on the systems side than the solution..

Probably a little heavier on the systems side now, yes..

Okay. And then maybe lastly for me and then I'll let someone jump – someone else jump in. The kind of implied fourth quarter EBITDA comes down a little bit from the third quarter levels.

Is that just a function of using the benefit of this IV solutions dynamic in the third quarter and less so in the fourth quarter?.

Probably two things, mostly that and then we're also trying to hire like crazy and we're adding people to the P&L right now. And a lot of the stand-up functions, we want to make sure we have space to do that, right? And so we're recruiting, and it's tight out there to get all the people we want, but we're very active in doing that.

So there's new people coming to the company every day..

Okay, thanks for taking the question..

Thanks Jason..

Thank you. [Operator Instructions] Our next question comes from Matthew Mishan from KeyBanc. Your line is now open..

Hey, good afternoon and thank you for taking the questions..

It’s the first new voice on the call, its four years and welcome..

Its – I’m happy to be covering the company even through all of this.

Is the way to think about that Austin facility that it just has very high fixed costs and low variable costs, and that the incremental business that you're getting just flows through it at a very high rate at that plant?.

I think if you're asking is there increased absorption and value if you're filling up something more, yes, there is. It is a heavy – I mean, I would joke like we're the utility company. It is a heavy industry; it's got a lot of fixed cost. And if you have an airplane that's flying around that's not full, that's expensive.

And yes, there is value in filling it up, but it's also what's the revenue per seat you're getting. You want to make sure you do that responsibly to fill it up for a long time, and that's kind of the set of trades we're analyzing every day out there..

Okay.

And then, can you give us a sense of what the available capacity is in Austin and where you're at now compared to that available capacity?.

I think it's a bigger conversation than Austin, right? Because we have Austin, which we own, and we also have this five plus two agreement with Pfizer for the Rocky Mount facility.

And I would just say, across those two sites used to operate at lights out capacity to serve the country, and that changed a lot with what Hospira went through, but we still have either indirect ownership or direct contractual relationship to access to all of those assets.

And there still is unutilized capacity out there, which is a shame in all this, of what's going on. It's just – it's not – you literally can't turn the tap on and off every day, right? You have to plan these cycles and there are high labor rates, high quality, high regulatory, and you can't turn it off and turn it on in a day.

So if we got more long-term contracts, we certainly have more capacity to manage that. We're not going to get tapped out on the capacity side..

All right. Excellent. And then maybe like a longer-term question. I think you guided to $400 million of cash at the end of next year.

First off, is that $100 million of free cash flow or there's some other moving pieces there to be thinking about? And then I think last quarter, you thought – you mentioned that if you end – you exited 2018 with a strong balance sheet, you could use it to help returns.

What does that fully mean? What does give you the best shareholder return? Share repurchase, acquisitions or would you consider a dividend?.

Why don't I do the second part first and then I'll turn over to Scott on the cash flow, right?.

So just simply put, Matt, yes, that's just free cash flow, primarily..

Okay. On the employment, look, I mean in the time the management team has been here, when there was dislocation in the market, we walked into it and bought back and the like. And when we thought there was something else to do with it, we hoarded cash, and I think we're going to do the same attitude here.

And this industry, the history of infusion, has had lots of shocks across the system, so you got to be carrying maybe a little bit more around with you than you would do in other lines of business. And so we've got to make sure we have that amount and then beyond that, we can do what we see fit.

I don't think we would mislead anybody that we're interested in some M&A activity for the next 12 months at all. We have to really get through this integration. We don't – we wouldn't – it's the same people on the call and others, right? We wouldn't be able to manage it..

All right, thank you very much, Vivek. And very happy to be covering the company..

Yes, thank you..

Thank you. And our next question comes from Mitra Ramgopal from Sidoti. Your line is now open..

Hi, good afternoon. Just a couple of questions. Vivek, I know you have a lot going on in terms of near term, and I think one of your highest priorities is getting – expanding the sales force, getting the right people in place, et cetera.

Just wondering on the product side, if you feel you need to do something on that front or you're very comfortable with what you have right now..

I think in the segments that we said where we felt more optimistic about today, in IV consumables, in IV solutions, I think we feel really great about the products we're holding today. They're well-established brands and are getting resourced and pushed better than they have in many years.

On the IV systems business, we feel very good about our products. There is continued investment in software and technology around the core mechanical devices and we are investing a lot in that because that's where we see the value driver over the next five to 10 years.

And so there, we have to continue to innovate and we are committed to that innovation. We feel very good about the hardware in the systems business. We need to keep innovating and investing in the software part of that business..

Okay. And on the international front, I know pre-Hospira, you had just gotten a few new distribution agreement, especially Terumo. I was just wondering if that is something a little more on the back burner until you sort of deal with the heavy lifting near term or is that something you're looking to....

I think they're on the campus today, not that we have a campus, but I think they're in the building today. Super important. We all spend time on it. No less priority, very valuable market, we need to deliver there..

Okay. And finally, just from a competitive standpoint, I know when you first did the deal in terms of Hospira, they were losing share. You had a lot of relationships to mend or repair, so to speak.

As you look out now to 2018 and beyond, do you feel more comfortable in terms of now instead of playing defense, you can actually be a little more aggressive in terms of regaining or expanding your market share?.

Just to be clear, we still are losing business here. We lost market share in some – in these – in two out of the three categories in the third quarter, right? So it's not over and some of it continues into next year. I feel like it's too early to say right now. We never rationalize the transaction by talking about revenue growth assumptions.

We talk about the balance sheet assets we're getting, the margin we could squeeze out of it. And not necessarily even playing offense, just if we could tie or hold the score relative to what was going on at ICU, we had to do it. I think that's kind of all we'd say about it today, still..

Okay. And then finally, I guess, this is more of a long-off question in terms of Pfizer, the relationship there. Obviously, it's your largest shareholder.

Is it pretty much being a hands-off relationship since you've done the deal?.

I have nothing but positive things to say about the alignment with them.

There's a thousand things that happen every day in countries where they're running our systems or we have to interact with them or get things done with them and others, obviously, general business bumps that happen back and forth, but they've been nothing but super supportive, super supportive..

Okay, thanks again for taking the questions..

Thank you. At this time, I'm showing no questions in the queue. I'd like to turn the call back over to Vivek Jain for further remarks..

Thanks, everybody, for investing the time to learn about ICU's third quarter. We look forward to wrapping up this year getting into 2018. We hope everybody has a great holiday season and we'll be talking to you in February. Thanks very much..

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day..