Good day, ladies and gentlemen, and welcome to the Q1 2019 ICU Medical Inc. Earnings Conference Call. [Operator Instructions]. As a reminder, this call will be recorded. I would now like to introduce your host for today's conference, John Mills of ICR. Please go ahead..

Thank you. Good afternoon, everyone. Thank you for joining us today to discuss the ICU Medical financial results for the first quarter of 2019. On the call today representing ICU Medical is Vivek Jain, Chief Executive Officer and Chairman; and Scott lamb, Chief Financial Officer.

We wanted to let everyone know that we have a presentation accompanying today's prepared remarks. To view the presentation, please go to our Investor page and click on Event Calendars, and it will be under the first quarter 2019 events.

Before we start our prepared remarks, 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 risks 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 also 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 in today's release and provided as much detail as possible on any addendums that are added back. And with that, it is my pleasure to turn the call over to Vivek..

Thanks, John. Good afternoon, everybody.

The first quarter of fiscal 2019 was our first quarter after 2 years of difficult integration work, and we spent our time primarily on active customer dialogue to improve our commercial execution and implementation of some of the operational improvements to protect and improve our P&L over time and, to a lesser degree, residual cleanup efforts related to all the integration activities.

We continue to execute well through a large volume of activity and see an increasing amount of our time is now spent on external activities.

On today's call, we wanted to comment on Q1 results and discuss our current view of the business and recent performance trends; provide an update on the open residual integration issues we mentioned on the last call; outline some of the key activities and housekeeping items that we are focused on in the first half of the year; remind everyone of the first half 2019 comparison and its effect on company growth rates in the near term; and lastly and briefly, reiterate some thoughts on the longer-term value creation.

The short story on Q1 was - internally, it was an operationally easier quarter for us versus Q4 as our system integration work stabilized and our customer service levels improved. But externally, as we had said on the previous call, it was average from a commercial standpoint.

The income statement was straightforward, with revenues that were generally in line with our expectations and earnings that were a bit higher as TSA savings are being realized and the cost for the systems integration were lighter on the P&L. We finished the quarter with approximately $311 million in adjusted revenue.

Adjusted EBITDA came in at $78 million, and adjusted EPS came in at $2.58. And similar to previous years, cash decreased in Q1 as we pay out more cash in the first quarter.

Pro forma revenue was down 9% quarter-over-quarter on a constant-currency basis due to the comparison of the IV Solutions shortage in Q1 of 2018 and because we still sold a little less than we desired in that segment. Turning to the individual segments, and please use Slide 3 in the posted deck for the base comparison.

Let's start with Infusion Consumables, which is our largest business. Infusion Consumables had revenues of $121 million in Q1 2019, which implied 1% reported year-over-year growth and 3% adjusted for currency. As we said late last year, currency is having a bigger effect than it has historically, and it is helpful to call it out.

We probably expected $1 million to $2 million more in revenues here, and the variance was driven in 2 areas. First, Europe was a little lighter than we expected in Q1, and second, we have been a bit capacity-constrained in some of our oncology product line, and we just didn't get the product into the market.

And we certainly expect that to be resolved in the back half of the year. The rest of the segment was pretty much as we expected. This is a segment where the most advantaged now is a joint entity. We have largely rationalized the product portfolio and brought together the operational efficiencies of the combination.

Commercially, we have all the pieces, all the technology and all the scale to compete globally and should be able to offer more value to the customer. We continue to feel positive about this segment into 2019. The second segment to discuss is Infusion Solutions.

This segment reported approximately $92 million in revenues and, like Q4 of 2018, had a 27% decline year-over-year as the 2018 IV shortage carried through the first half of 2018 and as the unique temporary industry issues have largely been resolved.

As previously described, it's been a wild ride in IV Solutions with a huge swing in 2018 between the first half, where the trade was in a shortage position, to the second half, where the trade had a bit more stocking with weaker underlying demand.

The latest color as we're seeing it in the market was no significant customer shifts in our book in Q1 and our committed customer order volume levels were generally flat with continued erosion of our trading book as we - that we always expected to go away.

We said on the previous calls that investors should not assume that historical results should be annualized in this segment.

We've been very focused on the longer term, but we want to be clear, verbatim from the first presentation of the transaction, even if revenues are a little volatile, we're going to try to make economically rational decisions and not sell products at a loss.

We budgeted our earnings to try to anticipate bumps, and just because of variances, we're not going to reshape our value proposition to the customer. Given the increased sales due to the industry shortage from Q4 of 2017 through Q2 of 2018, we expect this segment to have significant negative year-over-year results through the first half of 2019.

We feel like we've been clear about this on previous calls but wanted to reiterate that as it will impact total company growth rate for the first half of 2019.

We have been trying to operate with transparency to customers by illustrating the generic drug-like regulatory framework, high capital expenditures and value in a healthy supply-side situation to a business that was a historical pricing anomaly.

From a value perspective, we have sacrificed short-term revenues and profits for longer-term supply contracts, which we believe offers us more NPV as it makes us a more competitive supplier over time. We have discussed on previous calls the benefits of increased production and a full manufacturing network.

So if volume does not come back, the negative margin effect over time has been on our minds, and we believe we can continue to partially offset that by moving more volume into Austin given the optionality we have with Rocky Mount.

Lastly, we continue to be vigilant here on quality as Hospira and Pfizer invested significant resources, which is mandatory to be in this business.

To finish the Big 3, let's talk about Infusion Systems, which is the business selling pumps, dedicated sets and software, which is important because it's the business that brings a lot of recurring revenues. This segment did $85 million in revenue and was, as expected, down 9% year-over-year as reported or 5% constant currency.

As we mentioned on the previous call, Q4 had the benefit of some earlier installations, and this result was exactly in line with our expectations, and we feel like we're holding our own in the marketplace.

There are no real changes in our commentary from the last few calls, with the belief that this segment is very close to bottoming out with the lowest-level installed base in the last 10 years. But we feel, given our own refreshed schedule on book, that revenues have stabilized at or above the Q3 2018 level for the near future.

To finish the discussion on the segments, since we acquired Hospira, we've been actively calling on customers and trying to illustrate the value we can add to the system and the value to the system in having us as a healthy participant. While it's a long journey, we do believe this message is resonating. Feedback on the products continues to be solid.

The products are necessary for the system and are reliable for many years. When we started the transaction with our defensive mindset for doing it, we looked at the business and saw roughly 50% of the total business, Infusion Consumables and the international portion of Infusion Systems, where we had a good offering and a right to win.

Today, with 2 years of ownership under our belt, even with the IV Solutions bumpiness, we see a somewhat better picture, where we believe we have the right to win in most of the portfolio. We never assumed it was always a straight line up, and even a little volatility doesn't turn our focus or commitment into short-term decisions.

We will continue investing in R&D, appropriate capacity expansion in our production network and into commercial resources to serve our customers. The attractiveness of the industry structure and commitment required to break through a lot of the inertia merits this point of view.

We spent a lot of airtime in integration on the previous calls and about how much work it has been, so we don't need to do that anymore. But we do want to update on some of the remaining residual issues. We made a lot of progress in Q1 on our service levels for the customer and our fulfillment rates post cutover.

We have had improvement in our customer data management, and most customer-facing technical issues are behind us. We're still dealing with a handful of issues on historical data from Pfizer and are still having to manually intervene on some internal connections between our various new ERP modules but making significant progress.

And as we've said before, our customers don't care about any of our internal integration activity unless it affects them negatively. But we care about it because it, first, offers deep value in the form of operational improvements; and two, it sort of super-sizes us for the ability to handle more on these platforms.

We saw the benefit of the TSA savings in Q1, and we began to take action in Q1 on certain deeper operational improvements, what we were calling the high-hanging fruit, as mentioned on previous calls, to help protect our P&L in the case of sluggish revenues or enhanced if revenues improve. On to other housekeeping items and key activities.

First, since the last call, we have had a number of regulatory inspections. As we said, we're on the clock. We had a full FDA inspection of our Salt Lake facility, and MDSAP inspections at 5 of our locations with another 2 to go. There were no major findings at any of our sites as a result of the inspections.

We continue to be vigilant and expect inspections of our other facilities during this calendar year, and we'll update on the calls as they happen.

Second, we have certain new product developments and, specifically, some new software applications related to our IV Systems business that have entered limited market release in OUS geographies as we try to iterate quickly. We hope to receive more feedback on our limited market releases and other consumables approvals over the next few quarters. Okay.

To come back to the topic of earnings results and how we think about the near term of 2019 and the future. It is really important to us to be clear that because of the IV Solutions shortage in the first half of 2018, our total company growth will look abysmal in the first half.

And even though that is suboptimal and we said on the last call we wish we were selling $50 million or $60 million more in IV Solutions annually, from our perspective, we see strong differentiation in our most differentiated businesses of IV Consumables and IV Systems, a belief that we'll absolutely maximize profitability in our business, like we always have, and a view that we have a safe and a strong balance sheet that can protect shareholders and be deployed for value creation since we are still a pretty small company.

This thinking continues into the short term of Q2, where we continue to be cautious on the volatility in IV Solutions and as we continue to work through some of the increased supply chain costs from the integration and recent volatility, balanced against other operational improvements we've made.

As we've done in the last few years, we'll update any view on the full year on our Q2 call. And again, it's early in the year, and a lot of things could change between now and December.

And all of this is in a consolidated industry structure with a number of intrinsic value drivers, including high-quality or hard-to-reproduce production assets, sticky product categories and the opportunities for more cash generation.

In the best case, we'll have 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 can still drive operational improvements and generate solid cash returns over time relative to the capital we've deployed due to the levers we just mentioned. As always, I'd like to close with 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 and our physicians 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 receive both from our customers and our shareholders. And with that, I'll turn it over to Scott..

Thank you, Vivek, and good afternoon, everyone. To begin, I will first walk us down the P&L and then talk a little about cash and the balance sheet. As we mentioned on our last call, we're going to begin reporting the effects of FX on revenue going forward now that it is meaningful to do so.

So to begin, our first quarter 2019 GAAP revenue was $331 million compared to $372 million or down 11% over last year or 9% on a constant-currency basis. For your reference, the 2018 and 2019 pro forma unaudited revenue numbers, which exclude contract manufacturing sales to Pfizer at cost, can be seen on Slide #3 of the presentation.

Our pro forma revenue for the quarter was $311 million compared to $354 million last year, down 12% or 9% on a constant-currency basis. Infusion Consumables were up 1% or 3% on a constant-currency basis, but this increase was offset by IV Solutions, which we primarily sell in the U.S., down 27%.

Infusion Systems was down 9% or 5% on a constant-currency basis, and Critical Care down $1 million, 10%, or 8% on a constant-currency basis. Adjusted diluted earnings per share for the first quarter of 2019 were $2.58 compared to $2.29 for the first quarter last year.

Our tax rate this quarter was favorably impacted by excess tax benefits related to equity compensation, and we continue to estimate our tax rate for the full year to be in the range of 21% to 23%. And finally, adjusted EBITDA increased 6% to $78 million for the first quarter of this year compared to $73 million last year.

Now as you can see from Slide #4 of the presentation, for the first quarter, our adjusted gross margin was 43.9% compared to 42.1% for the first quarter last year. The largest driver for the year-over-year 180 basis point increase was product mix driven by Consumables.

Now when we bought Hospira, we were originally targeting a consolidated 40% gross margin, and we've been pleased with the 43% to 44% margins we've seen over the past year. But we think Q1 levels were on the high side for a couple of reasons.

At the moment, we have some incremental supply chain costs as we try to improve our fulfillment levels and rapidly rebuild depleted inventory. And it takes time for that to make its way into and out of the P&L. Second, we have planned factory shutdowns in the summer just as we have the last few years.

And lastly, we are still small, and product mix is a big driver. On any given quarter, if we have more pump capital or skewed mix, margins can change. As expected, year-over-year SG&A decreased approximately $12 million and went from 23% to 22% of revenues.

The decrease came primarily from TSA savings as a result of separating from Pfizer and standing up the business on our own. R&D expenses were basically flat year-over-year at approximately 4% of revenue and should remain at 4% to 5% in 2019.

Restructuring, integration and strategic transaction expenses were $24 million in the first quarter versus $22 million last year. This was primarily related to our final Pfizer separation cost and cleanup that included a noncash write-off of approximately $13 million in related assets.

Now that most of our significant system cutovers are complete other than our self-contained manufacturing facility in Austin, we will see these integration costs decline as we move through 2019. In addition, there was an $8 million noncash adjustment this quarter to the carrying value of our contingent consideration payable to Pfizer.

And as a reminder, this is based on reaching a certain cumulative earnings target by the end of 2019. 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. Now moving on to our balance sheet.

Similar to last year and as expected, cash and investments decreased by $69 million in the quarter to $315 million. Net working capital increased due to a temporary increase in DSOs as a result of the system cutover, and inventory also increased as we work to optimize our safety stock levels.

By the end of this year, we expect to have about $450 million in cash. In the first quarter, we spent $29 million on CapEx for general maintenance, system integration and capacity expansion.

As we said on our last call, we still expect to spend, this year, similar to what we spent last year or approximately $100 million as we continue to spend on additional IT system integration and capacity expansion.

We have fully separated the Hospira business from Pfizer and have only our Austin manufacturing site left to fully integrate onto a single IT system. And now that we are running on single integrated IT platform, we are better prepared to improve the long-term efficiencies of our business and now have a proper platform to scale up when needed.

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

[Operator Instructions]. And our first question comes from the line of Larry Solow with CJS Securities..

Vivek, I know you don't guide quarterly per se, but - and clearly, you're sort of sticking with your second half guidance of certainly improving on a year-over-year basis.

But just as we look out just sequentially, sort of broad brushing all your segments, do you - and I know BD and Baxter both reported sort of a little bit softer Q1s as well, but both expects sort of improvement in the back half of the year.

Do you - on a sequential basis and not just from easier comp, do you share that enthusiasm? Or any color on that?.

I mean, I think we felt like Q1 was average on the last call, and I think we're probably a little more cautious, Larry. All in progress are our own stuff. I don't - from a macro perspective, we haven't seen senses changed that much, and in the U.S., we saw the big drivers like employment and stuff. We don't know it's going to get much better.

So there are opportunities for new market creation in some of the categories we're in, and we're really focused on those. We're not, I'd say, competing in the same exact way. That obviously offers growth in some of our lines. In some of the more competitive lines, we feel like it's a tighter market.

So we're probably a little more cautious, and we didn't really try to stack the deck or build the year up from our guidance. We just - we kind of - we landed kind of proportionally. We thought we were, but there is volatility in Solutions, and we have put [indiscernible] money in the fulfillment stuff, which doesn't show up right away.

And so we have to cover that with some of these other operational improvements or find a little bit more growth..

Right. And how about just on the Systems piece? I know you said it was sort of in line with your expectation, and they're impacted by currency more than you really got in the segments or end markets.

But is that a little bit more than I thought it would be sequentially? I know you mentioned you have some strong differentiation there as well as, obviously, Consumables.

What - as you look at maybe not the next couple of quarters but sort of next couple of years, what are the impediments to growth of them sort of - just obviously, it's a sticky market, which helps and hurts you.

So other than that, why can't you at least sort of grow with the market?.

Certainly, I think it's a more competitive market than it's been probably in the last decade. It's a good time in the market in that regard. I do feel like there's assets in the business that are - worked for us, which is that the business, if you're focused on it, really has a strong incumbent advantage that all participants benefit from.

But then it's our job to develop a strong case for change on the features and merits of the product and its value, sometimes on its own and sometimes integrated with other things we can offer. And that's the basis in which we compete.

But fundamentally, our story on the Plum family of products and the things that we have been investing our R&D dollars into is around safety and workflow and the themes that people are willing to make change for on infusion or at least willing to continue to work with you if you're holding some book. And I mean that's the point we were making.

We felt like historically, the company we bought got away from some of those points. The product was very solid in that regard, and we released - gotten back out there with some of the guidelines and other things you've seen, have tried to reestablish ourselves in those topics..

And our next question comes from the line of Jayson Bedford with Raymond James..

A few questions. Hey, Vivek, maybe just a follow-up on the Systems side. There was, I think, a competitive - competitor recall during the quarter.

Do you see that as an opportunity?.

I think this whole industry lives in a glass house, right? We should be very careful on comments there. I feel like one of the things we learned at our experience in this industry was just it's a competitive advantage to making sure you're in a good regulatory position.

I wouldn't jump to any major conclusions that, that situation changes the landscape dramatically because all these companies are competing, and they have lots of resources and kind of an infinite amount of infrastructure and financial flexibility to deal with the problems. So we still have to win.

The product still has to be better, right? I mean historically, I think people did well because others fell down. I don't really think that's going to be the case anymore, right? We have to actually win proactively. That's how we feel about it..

Okay. Fair enough. Just on the Consumables side, you mentioned you're capacity-constrained with respect to oncology. I think you made a reference to this will be resolved in the second half of the year.

Is that kind of when you expect supply to meet demand? Or are you - is this still going to - dynamic still going to impact Q2?.

It's still probably going to impact Q2 a little bit. I think 2 things happened. One, the underlying growth is still great. It was still great in this quarter. It's just been slow bringing on a few tools.

And that recall, which had kind of no financial impact to us a couple of months ago, you saw, we did have to swap out some parts, some new parts from old parts. And that probably grabbed a little bit of inventory from us that would have been able to be commercially sold and get that extra $1 million we wanted and expected in the quarter.

That's the downside of being a little bit small, right? But that's what it was..

Okay. On Solutions, you mentioned volatility.

And I realize it's tough to gauge quarter-on-quarter here, but is supply and demand fairly matched right now? And is the volatility you're talking about here either on price or short-term share, gain or loss?.

I think it's probably more on we believe that there is adequate and, perhaps, excess supply in the marketplace, and so that's different than before. And there is obviously a short-term share thing that's going on that's probably a bigger driver than the other topics. So the first and second points there.

And it's our job to make sure we continue to be competitive or rational in the face of that..

Okay. And then I guess my last one here. You mentioned that if the - obviously, since volumes don't pick up, you bring manufacturing from Rocky Mount.

Where are you in that status? And would you be ready to produce products in Rocky Mount in the fourth quarter? Or is that more of a 2020 event?.

No.

Austin, you mean?.

Sorry, yes. Sorry..

So CapEx has been heavy into Austin. We haven't taken our foot off the gas on that. By the time it's validated and up and running, it's going to be into next year. But it's still is - nothing happens quickly here. It's still plenty of runway for us to step down Rocky Mount and move more into Austin if we so desire. So we have the flexibility..

And our last question comes from the line of Matthew Mishan with KeyBanc..

I was going to start off with the IV Solutions and just make sure I understand it a little bit more.

Is this now the normalized level of sales for IV Solutions going forward? Or are customers still holding back purchases because inventory is too high?.

I'm not sure we have a perfect answer. Our situation is a little different probably. I think the trade is probably a little bit more normalized. We still have a little bit of that trading float business that's out there that's obviously rapidly deteriorated over the back half of last year.

There's still a little bit of some of that left, and there's some of the share trading that's going on out there. So I don't know that we can exactly say this is the new normal, and I don't want to make a mistake on that. I feel like that's the one sentence we really got wrong here, where we thought, towards the last year, it'd be somewhere else.

So we don't want to declare something where we are right now..

Okay. I think that's fair enough.

And can you also give us a sense of the percentage of sales directionally at Austin versus Rocky Mount?.

I don't know if we want to give an exact number, but I - it was like - I'm looking at Scott, 3:1 and, plus or minus, 15%, 20% variance on that or something. Most likely 10% variance on that..

I mean - yes, you can - I mean, you can back out the MSA contracts of the Pfizer on your own to kind of get close to that answer..

Okay. And on capital allocation, it's kind of like the bigger piece of the story going forward.

But I'm just curious, if M&A activity doesn't necessarily materialize, when do you think about either share buyback or dividend?.

Dividend? Haven't heard that word in a long time. I don't know. We don't know. I mean we would say people were very patient, which we appreciated, with us in the 3.5 years that we didn't do anything with the cash we had at a much smaller enterprise value.

And the broader world seems like it's a little bit more bumpy right now, so it feels prudent to us to kind of see where things settle out a little bit before we have to decide on that. I don't think we're one of the big guys that has the luxury of saying we can absolutely commit to buy back and still do everything else.

We wouldn't have that ability, so - and we believe people would want us to, if logical, deploy it effectively..

And we do have a follow-up question from the line of Larry Solow with CJS Securities..

Quickly, just a follow-up, a housekeeping for Scott. What was the - you mentioned [indiscernible] over the year, unchanged guidance.

But for the quarter, what was that rate?.

Let's see. On a GAAP basis, it was - I've got that..

Yes, the GAAP basis, I can figure out.

It's in the press release, right? But what about on a non-GAAP?.

Non-GAAP, I think, was - just a sec..

And that does conclude today's question-and-answer session..

Oh, hang on..

Hang on a second. We're getting.....

7%..

My apologies..

Larry, are you there? You got it? We may have lost Larry. Okay. So the answer to that was 7%, Larry. So we benefited, as Scott said, from some of the equity comp stuff in the quarter. Okay. Well, thanks, everybody. We appreciate it. A quicker call today. We'll try to keep it that way.

And we look forward to updating everybody as well as on the full year in our Q2 call. Thanks very much for the support of the company. Bye..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. And everyone, have a great day..