ICU Medical, Inc. (NASDAQ:ICUI) Q2 2023 Earnings Call Transcript
ICU Medical, Inc. (NASDAQ:ICUI) Q2 2023 Earnings Call Transcript August 7, 2023
ICU Medical, Inc. misses on earnings expectations. Reported EPS is $-0.41263 EPS, expectations were $1.55.
Operator: Good afternoon, and welcome to the ICU Medical Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to John Mills, Managing Partner at ICR. Please go ahead.
John Mills : Good afternoon, everyone. Thank you for joining us to discuss ICU Medical's financial results for the second quarter of 2023. On the call today representing ICU Medical is Vivek Jain, Chief Executive Officer and Chairman; and Brian Bonnell, Chief Financial Officer. We want to let everyone know, we have a presentation accompanying today's prepared remarks. To view the presentation, please go to our Investor page and click on the invite calendar, and it will be under the second quarter of 2023 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 and that have a direct bearing on the operating results and financial position. Please note that during today's call, we will also be discussing 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 also include a reconciliation of these non-GAAP measures in today's release and provide 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.
Vivek Jain: Thanks, John. Good afternoon, everyone, and we hope you're well. Even with the volatility in the economic environment and some revenue variance in a few of our product lines, we are enjoying 2023 year-to-date more than last year. ICU Medical is operationally serving customers well and finding the proper balance of time between commercial focus and internal self-help, which has become most acutely about supply chain efficiency. The macro environment was broadly fine for Q2 with consistency in freight and fuel pricing and some increasing pressure from currencies in our production geographies. International demand was consistent throughout the quarter, and the U.S. was a little choppy for us with lower acuity census and admissions in April, but improved through the rest of the quarter.
Like everyone in our industry, we want to start first by thanking our customers and their frontline workers for trusting us to serve you during these times. We'll use the time today to discuss the Q2 revenue performance of our business units, provide more color below the business unit level due to certain of the results, update on the normal housekeeping items including our quality remediation, the separation from Smiths Group Systems and our next steps towards integration and synergy capture, explain our profitability and margins halfway through the year, and outline the actions we need to take near term to ensure we optimize for the medium and long term, reiterate and check our progress against the key short-term priorities we outlined at the start of the year, and take stock of where we are 18 months into the acquisition and the broader environment.
And again, we'll skip any comments on longer-term value creation, but did want to make a clearer view of what we want to be. We finished the quarter with $535 million in adjusted revenues. Adjusted EBITDA came in at $98 million and adjusted EPS was $1.88. Revenue growth was down 1% on a constant currency basis, minus 2 and a minus 2 on a reported basis, and we had improved gross margins versus Q1. We finally had a slower quarter of inventory investment into the business and believe we have peaked on that and have adjusted output to bring inventory more in line with historical levels as we are sustaining appropriate service. And the supply chain is more stable, and we have a better sense of the actual underlying revenues. Relative to Q1, the operational impact of currency is becoming more of a headwind as both the Mexican and Costa Rican local currency strengthened meaningfully against the dollar.
On the last call, we said we feel better about revenue growth for each product line where we've been historically stable, meaning Legacy ICU and revenue recapture where we're now stable, meaning legacy -- the Legacy SM portfolio. The majority of the acquired product lines are growing year-over-year, but we specifically have delays in bringing back the Vascular Access revenues to the level we wanted. The Legacy ICU portfolio of pumps and consumables has grown fine, but in Q2, we had some shortfalls in IV Solutions with a weak April combined with some of the lingering issues we had on the one product resource from visor. The Vascular Access recapture, which is ballpark about $20 million to $25 million less in revenues for the year, does impact profitability and the IV Solutions less so.
So let me start with our Consumables business unit, which is our largest and most profitable unit. We had $237 million in revenue, which was down 1% on a constant currency basis and down 2% reported. Obviously, we need to explain a bit more here. The legacy ICU IV therapy product lines, which is the largest component of the business unit had a record quarter again in Q2 with the business being the largest it's ever been. The growth was driven by new customer implementations, good census in May and June and increased capacity and ability to serve the market with a focus on clinical differentiation and the creation of niche markets. But like Q1, that growth was offset by the Vascular Access portion of the business unit. On the last call, we said we were at the bottom here as losses occurred throughout last year and that felt very similar to the IV consumables and pump losses when we purchased Hospira when customer losses were still felt in the 4 to 6 quarters post deal.
We did not back track at all in Q2 versus Q1, but the new business adds did not bring any meaningful net improvement, so revenues were flat. Relative to our own expectations, as I just mentioned, our best estimate is that we'll be about $20 million to $25 million short here for the year relative to our plan. And to be clear, our confidence in right to win here has not changed, but it's just taking time. The losses from 2021 and 2022 were primarily due to supply chain issues and those core issues have been addressed by our team. To be even more transparent, our medium- and longer-term expectation was only to get back the minority of what was lost over the last 2 years. The other components of the business unit are oncology and tracheostomy, both of which are okay over the balance of the year and aided from increased capacities.
On the last call, we said in the near term, we believe all 4 underlying lines are improving commercially and operationally with the losses predominantly out and improved capacities, and we saw that on the revenues over the first half of the year on 3 of the lines and believe we will see sequential improvement each line for the balance of the year. But the Vascular Access delays do make it to jump over the back half comps of last year, which included some of the Q3 operational catch-up and had meaningful COVID-related syringe sales. So the overall business unit growth rate will be impacted, and we're going to have to keep talking about the individual lines until it's rectified. Moving to Infusion Systems, which is the combination of the Legacy ICU LVP pump business and the syringe and ambulatory pump businesses.
This business reported $153 million in revenues, which equated to 5% growth constant currency or 3% reported. Q2 of '22 started to get more normal last year after the miserable start of Q1 '22. The ambulatory and syringe product lines continue to be moving towards historical levels. Similar to last quarter, we saw good hardware improvement for both ambulatory and syringe pump hardware, which was offset by decreases on a year-over-year basis on ambulatory disposables as in the latter part of Q2 last year and throughout Q3 2022, we shipped so many ambulatory disposables to catch up on back orders as we improved production mid-Q2 last year. It will make Q3 a tougher comp, but regardless of that, we feel fine with our previous commentary on the business unit for the year.
On LVPs, we've talked about how it was bumpier for decision-making over the last 2 years. We hope the recent market events allow customers to move forward with evaluations and akin to some of the large non-infusion capital vendors. We don't see capital availability as a massive impediment to our types of products. We're starting to see some commercial benefits of having a full infusion device portfolio with our combined portfolio position differently versus other participants. Again, we believe over the medium term relative to our size, our competitive opportunity is solid, and we're focused on commercial execution here in a more action-oriented market. Finishing the business unit discussion with Vital Care, which had $145 million in revenues or a decline of 7% on a constant currency basis.
The entire decline in the business unit was due to IV solutions on a year-over-year basis. Really, 3 primary drivers here, first, just an unusually like April, which did not get made up for over the balance of the quarter. Second, as we mentioned in the last 2 quarterly calls, we've been a little short from Pfizer on the last remaining category from Rocky Mount, which has been hurting us for a few million a quarter; and lastly, a little light on some specialty SKUs. At least for June and July, orders look closer to normal, but the Pfizer shortage will continue to drag on given the Rocky Mount news. All of this impacts profitably slightly as IV Solutions currently deflates the corporate gross margin by ballpark 500 basis points. The rest of the business unit was generally flat as expected with temperature management up a little.
The short story message has not changed for us. Our differentiated Legacy ICU businesses are doing well, and we're focused on regaining a portion of the lost revenues in the acquired categories that are outlined in our investor presentations. Of the 5 product families we highlighted in that slide, ambulatory pumps, syringe pumps, vascular access, tracheostomy and temperature management all except vascular access are improving year-over-year and all are still below historical pre-COVID levels. We need to get all 5 improving consistently. We stated on the last call how we were impacting the self-inflicted challenges on many of the businesses. And we believe in Q2, we would have all 3 business units growing year-over-year and hit the bottom of the acquired products that were going backwards.
We came up a few million short on revenue in vascular access to deliver that for consumables, and we add more variants and IV solutions than anticipated. However, we've become more reliable for customers with very minor exceptions and are able to engage in rebuilding trust and service as the products have always been well liked and any improvement in underlying demand and improving census work in our favor. But improving that service level to the customer, which was exacerbated in the broader environment last year, has increased our inventory levels to more than what's required to run the business day to day, similar to some other health care categories or even other industries. As we mentioned on the last call, we need to focus here to get back to the cash generation we want.
That brings some short-term headwinds, but it's the right thing to do from a value perspective. Very specifically, we have been building inventory, both raw materials and finished goods since the beginning of 2022. The rate of build finally slowed in Q2 with the more recent months showing improvements. Brian will go through the specifics, but we have tried to do this in the right way without disrupting the supply chain and without significant capital to restructuring here. Okay. Let me get through the housekeeping items, and I'll bring it back to results and our priorities. On quality, as we've mentioned on the previous earnings calls, we're completely engaged and our teams are working hard to resolve the FDA warning letter in our acquired company and related inspectional observations.
Our efforts to complete related quality system improvements and associated remediations are on track. We've made heavy investments into remediation and believe the majority of remediation work be done over the next few months and spend will ramp down. Same speech on the warning letter, the existence of a warning letter while I'm desirable is the regulatory agency trying to move the ball forward, and we've talked about how these regulations give us the right to participate. Regardless of where it appears in the P&L, we're spending heavily, so making progress here is extremely important. In Q2, we did transition away from Smiths Group's IT systems and are fully separated from all TSAs with better stability. We're now focused on the eventual ERP integration.
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Standing on our own is the first step towards real integration next year to capture the next wave of synergies in manufacturing, supply chain and functional support over time. It's also important to the extent we want to be able to make any decisions on the underlying portfolio. Over the first 6 months of the year, we've taken the first steps towards certain manufacturing consolidations, and real estate adjustments and there's likely more to come, all of which will be additive to gross margins medium and longer term, but they take some time to get implemented. Moving the ERP integration forward is important because it allows us to optimize some duplication in our physical logistics and service networks. In terms of the balance of the year and being 50% of the way to the midpoint of our EBITDA range, given what we need to do to improve inventory efficiency and having less vascular access sales than we'd like, we didn't want investors to think we had the flexibility realistically towards -- to be towards the higher end of our previous guidance range.
While gross margins have been improving year-to-date, they will be impacted as we slow down the factories below current demand levels. So we're tightening it up a bit. We need to run a smoother operation even if customer service levels are high, we can't run an inefficient production environment, and Brian will go through the details. 18 months into the acquisition and the broader economic environment, we've worked -- we have resolved production, logistics, operational -- delivered operational stability have growth in most of the businesses and are working hard to ensure a clean bill of health and quality. Our priorities for 2023 remain unchanged, delivered revenue growth as expected in our differentiated business units while progressing the key product platforms, progress our quality remediation and ensure quality for patients and high compliance for regulatory authorities, respectively, focus on cash flow again by improving working capital and addressing the available items on the P&L, whether above or below the line.
Lay the groundwork via separation and then integration for capture of the remaining synergies and rationalize the portfolio, which becomes easier after it's separation and being stable. Just to be extremely clear on the medium-term state we're looking for. We want our consumables and systems businesses to be reliable growers with an industry acceptable profit margin with the tightest and most optimized manufacturing network and each with a multiyear innovation portfolio. Over the last few years, we took an innovative component supplier and have scaled it to a global leading player where those efficiencies should be available to us over time at our size. There is no confusion within the company in the pursuit of that goal, and we'll maximize the remainder of the portfolio as the individual contractual or strategic situations arise.
The core premise of the acquisitions was to enhance the product offerings for the categories that drive our returns as well as add logical adjacencies, predicated on the same characteristics, sticky categories, low capital intensity, single-use disposables and opportunities to innovate and participate in a logical industry structure. These portfolios make sense together, and we're working on how to integrate them either literally or economically when sensible, and we're focusing on all lines to show up with improvements on the P&L. While the pandemic introduced substantial volatility, strategically, we do think the weaknesses in exposed in the health care supply chain add to the argument for all participants to be healthy and stable, which has been our commentary since we became a full-line supplier.
We produce essential items that require significant clinical training, hold manufacturing barriers and in general, are items that customers do not want to switch unless they must. The market needs ICU Medical to be a reliable supplier and the combination positions us better. Our company has emerged stronger from all the events of the last few years. We've gotten knocked down a bit, but we're getting closer to the top of the hill to drive value out of the combination. Thank you to all the customers, suppliers and frontline health care workers as we improve each day. Our company appreciates the role each of us must play. And with that, I'll turn it over to Brian.
Brian Bonnell : Thanks, Vivek, and good afternoon, everyone. To begin, I'll first walk down the P&L and discuss our results for the second quarter and then move on to cash flow and the balance sheet. Along the way, I'll provide our updated outlook for the full year for each of these areas. So starting with the revenue line. Our second quarter 2023 GAAP revenue was $549 million compared to $561 million last year, which is down 2% on a reported basis or 1% on a constant currency basis. For your reference, the 2022 and 2023 adjusted revenue figures by business units can be found on Slide number 3 of the presentation. Our adjusted revenue for the quarter was $535 million compared to $547 million last year, which is down 2% on a reported basis or 1% constant currency.
Adjusted revenue for consumables was down 2% on a reported basis or 1% constant currency. Infusion Systems was up 3% reported or 5% constant currency and Vital Care was down 8% reported or 7% constant currency. As you can see from the GAAP to non-GAAP reconciliation in the press release, for the second quarter, our adjusted gross margin was 39%, compared to the first quarter gross margin of 38%, this represents a sequential improvement of 1 percentage point, driven primarily by the mix benefit from lower sales of IV solutions. Similar to the first quarter of this year, the second quarter gross margin reflects the benefits from; one, reductions in expedited freight, along with lower diesel prices and lane rates; two, the impact from recently implemented price increases; and three, higher manufacturing absorption from recent increases in finished goods inventory levels.
As we mentioned on our last earnings call, there are a few items that will affect gross margin over the back half of the year that will partially offset the improvements we realized during the first half. The first is the impact of lower manufacturing absorption as we continue to reduce production volumes over the remainder of the year. During the second quarter, we made progress in slowing the build of inventory levels as the Q2 increase of $27 million was roughly half of the recent historical average increase of approximately $50 million per quarter. Over the back half of the year, we expect to further slow the build of inventory levels and then maintain or even slightly reduce those levels to help drive positive free cash flow. As a result, the benefit from higher production levels as we increase inventory will not continue for the remainder of the year.
The second item is the impact from scheduled plant shutdowns during the second and third quarters as part of the IT TSA separation from Smiths Group as well as the annual maintenance shutdown of the Austin IV solutions manufacturing plant as contemplated in our original guidance. So while we are pleased to see the positive trajectory in gross margins for the first half of the year, the combination of lower volumes and recent plant shutdowns will impact the rate over the remainder of the year. And as a result, we expect the full year gross margin rate to be approximately 37%, consistent with our original guidance. On previous calls, we talked about our desired long-term gross margins, and the primary drivers towards that improvement continue to be; one, manufacturing absorption benefits from volume increases towards historical levels for our acquired product lines, plus continued growth for the Legacy ICU differentiated products; two, price increases as our multiyear contracts renew; and three, synergies from the integration of our manufacturing and distribution networks and service.
And it's also worth noting, there is a high degree of variability in the gross margin rates of individual product families across our portfolio. Adjusted SG&A expense was $110 million in Q2, and adjusted R&D was $22 million. The adjusted operating expenses were down 2% year-over-year and generally in line with Q1 and reflect acquisition synergies and as well as our usual focus on SG&A cost management, which has more than offset inflationary pressures. Moving forward, we expect total adjusted operating expenses as a percentage of revenue to remain around Q2 levels for the remainder of the year. Restructuring, integration and strategic transaction expenses were $12 million in the second quarter and related primarily to integration of the acquisition.
Adjusted diluted earnings per share for the quarter was $1.88 compared to $1.37 last year, an increase of 37%. The current quarter results reflect net interest expense of $24 million, which is an increase over the prior year of $9 million and equates to just under $0.30 on a per share basis. For the full year, we continue to expect net interest expense of approximately $100 million. In the second quarter, the adjusted effective tax rate was 8% and includes benefits from the release of tax contingencies as a result of the expiration of various tax statute of limitation periods, which contributed approximately $0.25 per share. We expect the second half adjusted tax rate to be more in line with our normalized tax rate of 23%. Diluted shares outstanding for the quarter were $24.4 million.
And finally, adjusted EBITDA for Q2 increased 16% to $98 million compared to $85 million last year. Now moving on to cash flow and the balance sheet. For the quarter, free cash flow was a net outflow of $18 million, which reflects our continued investment in the 3 key areas of the business that we highlighted for the past several calls. The first is higher levels of inventory to bolster safety stock and allow for onboarding of new customers where, as previously mentioned, we invested $27 million in additional raw materials and finished goods inventory during the quarter which is approximately half of the recent historical average. The second was quality improvement initiatives for legacy SM. And during the quarter, we spent $13 million on quality system and product-related remediation, and the third area was acquisition integration, where, as previously mentioned, we spent $12 million on restructuring and integration.
Additionally, we spent $18 million on CapEx for general maintenance and capacity expansion at our facilities as well as placement of revenue-generating infusion pumps with customers outside the U.S. For the remainder of the year, the aggregate level of spending on these items will decrease with the largest decrease coming from the continued moderation of inventory builds. Additionally, we should see slightly lower spending in the back half of the year for both quality remediation and restructuring and integration, while capital expenditures will likely increase over the remainder of the year compared to a light first half with total CapEx spending for the full year estimated to be in the range of $80 million to $100 million. And just to wrap up on the balance sheet, we finished the quarter with $1.6 billion of debt, and $198 million of cash and investments.
Consistent with our usual cadence, we are updating our full year guidance for adjusted EBITDA and adjusted EPS. For the full year adjusted EBITDA, we are narrowing our previous guidance range of $375 million to $425 million to a range of $375 million to $405 million. This reduction in the top end of the previous guidance range reflects lower vascular access revenue relative to our original expectations, some operational flexibility as we work through aligning production with demand and the impact of lower volumes in the IV solutions business. For the full year adjusted EPS, we are narrowing our prior guidance range of $5.75 to $7.25 per share to $6 to $6.85 per share, which includes the same drivers as adjusted EBITDA, plus the previously mentioned $0.25 tax benefit recognized in the second quarter.
In summary, we feel good about the earnings we delivered for the first half of this year, and we're seeing progress on inventory levels to improve free cash flow. On the revenue line, the majority of our businesses are increasing in size, but we recognize that the score is measured on the total, and our focus is on eliminating the negatives. For gross margin, we have a number of opportunities to drive improvement over the long term. And on SG&A, we've demonstrated our ability to operate efficiently. We remain convinced of the longer-term opportunity, financial returns and our ability to tackle the remaining issues. And with that, I'd like to turn the call over for any questions.
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