ICU Medical, Inc.
Q2 2009 Earnings Call Transcript

Published: 21 Jul 2009

[Operator:]

Welcome to the second quarter 2009 ICU Medical Incorporated earnings conference call. (Operator Instructions). I would now like to turn the call over to Mr. John Mills of ICR.

[John Mills:]

Thank you for joining us today to review ICU Medical’s financial results for the second quarter ended June 30, 2009. On the call today representing ICU is Dr. Lopez, Chairman and President, and Scott Lamb, Chief Financial Officer. We will start the call by reviewing key operating and financial achievements for the quarter, and then Scott will discuss financial results in more detail. Dr. Lopez will wrap up the call with an update on the company’s revenue and earnings targets for fiscal 2009 and a discussion of current business trends. Then the company will open the call for your questions. Before we start, I want to touch upon any forward-looking statements made during the call. Please be aware they are based on the best available information to management and assumptions that management believes are reasonable. Those 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 performance and financial conditions. With that said, I’d now like to turn the call over to Dr. Lopez.

[Dr. George Lopez:]

We are pleased to report another strong quarter of sales and profitability. In spite of the challenging economic environment, we continue to enjoy strong demand for our products worldwide, and our sales grew 10% to $53.4 million year over year. Net income increased 20% to $5.7 million or $0.38 per diluted share. A favorable product mix, improved manufacturing efficiencies, and favorable foreign exchange rates related to our factory in Mexico resulted in a more than five percentage point gross margin expansion to 48.3%. Our operating margins improved 16.2% compared to 11.7% a year ago. We ended the second quarter with $144.7 million of cash, cash equivalents, and investment securities, no debt, and generated over $26.6 million of operating cash flow for the first six months of this year. Before I turn the call over to Scott Lamb for a more detailed review of our financial results, I would like to discuss a recent accretive acquisition in more detail. On July 9, 2009, we announced a definitive purchase agreement to acquire the commercial rights and physical assets of Hospira’s critical care product line for approximately $35 million in cash, and we expect this to close in the third quarter of 2009. As you know, we have a strong working relationship with Hospira, and the recent internal initiatives that they refer to have their company focus longer term on areas outside of critical care. We believe when you factor in our existing customer base, we are now in a better position to expand distribution of these products through our additional customers and strategic partnerships. In addition, we expect our leading low-cost manufacturing combined with our expanding sales team will enable us over time to pursue expanding our market share in critical care. Taking all of these factors into account, we believe this acquisition was truly a win-win for both companies. We are now able to improve by completely employing worldwide commercial responsibility for the critical care products including sales, marketing, customer contracting and distribution. Initially we intended to hire 25 direct sales people to focus on critical care business. Some will come from Hospira’s existing sales team, and we also expect to hire additional employees to handle the added sales, marketing, service, and manufacturing responsibilities. We have been manufacturing the majority of Hospira’s critical care offerings for more than 4 years. On May 1, 2005, we acquired Hospira’s Salt Lake City manufacturing facility for approximately $32 million in cash and entered into a 20-year strategic manufacturing, commercialization, and development agreement for Hospira’s critical care product line. We assumed responsibility for manufacturing the critical care products, and Hospira retained commercial responsibilities for the products we were producing including sales, marketing, pricing, distribution, customer contracts, customer service, and billing as well as a small portion of the critical care manufacturing done today at Hospira. Upon completion of the acquisition, we will gain complete control of Hospira’s critical care product line and acquire the commercial rights to all products including Hospira’s entire critical care product line. The critical care product line includes angiography kits, vascular and cardiac catheters and monitoring systems, standard and advanced sensors, disposable pressure transducers, and Safeset blood sampling system. Once this acquisition closes, we will continue to have very strong working relationship with Hospira as approximately 40-45% of our revenue will continue to be from Hospira. I will provide additional detail at the end of the call on how expect the acquisition to impact our financial performance in 2009. Now I’ll turn the call over to our CFO, Scott Lamb.

[Scott Lamb:]

Before I begin, let me remind all of you that the sales numbers we are covering as well as our financial statements are available on the Investor portion of our web site as well. As doc already mentioned, our revenue for the second quarter of 2009 increased approximately 10% to $53.4 million, compared to revenue of $48.6 million for the second quarter a year ago. Net income increased 20% to $5.7 million or $0.38 per diluted share compared to net income of $4.8 million or $0.33 per diluted share for the second quarter of 2008. For the six months ended June 30, 2009, our revenue increased over 15% to $107.7 million compared to revenue of $92.2 million in the same period last year. Our net income for the 6 months of 2009 increased 67% to $12.8 million or $0.85 per diluted share, compared to net income of $7.7 million or $0.53 per diluted share for the six months of 2008. Now let me discuss our second quarter sales by product category. Sales from claves represented 40% of our second quarter total revenue and grew 16% from $18.4 million to $21.3 million year over year, and as expected were relatively flat compared to $21.2 million in the first quarter of this year. As we have mentioned on our previous conference call, due to the economic downturn, some of our customers started to more conservatively manage their inventory which resulted in flattening out of clave sales. We believe it’s a temporary trend, and our expanding relationship with MedAssets and Premier will help drive year over year growth in the mid to high single digits. Custom sets which include custom oncology, custom infusion, and custom critical care represented 34% of our total second quarter revenue and increased 7% to $18.1 million compared to $17 million a year ago. The product line improvement was due to custom oncology and custom infusion sets which when combined increased 12% year over year. This growth was offset by 20% decrease in custom critical care to Hospira which is due to their more conservative approach to management of their inventory. Excluding custom critical care, sales from critical care products decreased 7% to $8.3 million compared to approximately $9 million for the second quarter a year ago. Non-custom critical care products contributed 16% to our total sales. We are excited about acquiring the critical care product line from Hospira. In spite of the recent decline in sales during the second quarter, critical care sales for the first six months of 2009 were up 9%, compared to the same period last year. We believe these products represent a good value proposition for our customers, and we believe we have the expertise to capitalize on these opportunities. Sales from our new products which include Tego, Orbit, and oncology products increased 54% to $4.3 million compared to $2.8 million for the second quarter last year. New products represented 8% of our total sales for the second quarter of 2009, while non-custom critical care products contributed 16% to our total sales. We’re excited about acquiring the critical care product line from Hospira. In spite of the recent decline in sales during the second quarter, critical care for the first six months of 2009 were up 9% compared to the same period last year. New products represented 8% of our total for the second quarter of 2009, up from 6% a year ago. Excluding custom, oncology products more than doubled in the second quarter to $1.2 million compared to the same period last year. Total oncology products grew 32% to $3.1 million, representing 6% of our total sales compared to 5% a year ago. Our second quarter sales by distribution channel were as follows. US sales to Hospira were up 3% to $31.8 million primarily due to increases in claves and custom infusion sets which were offset by an 8% decrease in critical care. Sales by domestic distributors and direct salesforce grew 15%, from $10.7 million year over year due to strong performance of custom sets and new products. International sales were up 35% to $9.9 million due to strong contributions from clave, custom infusion sets, and custom oncology products but continue to gain traction in Europe, the Pacific Rim, and Latin America. Second quarter 2009 international sales represented 18% of our total sales compared to 15% in the same quarter a year ago. To conclude my discussion of our sales, I want to discuss a few accounting items for the second half of this year related to the critical care acquisition. Between the periods we signed the definitive agreement on July 8th and the date we close, we will defer the revenue and cost on the products we ship to Hospira. After the transaction closes, that deferred amount will get recognized over time as the product is shipped to our direct customers. Since critical care products have lower gross margins than our corporate average, our gross margin as a percent of sales will be positively impacted in the third quarter from the decrease in recorded critical care sales. After we close, as we record sales on the inventory purchase as part of the transaction, gross margins as a percent of sales will be adversely impacted until the entire purchased inventory is sold. We estimate this impact to be greatest in the fourth quarter and should have minimal impact in the following quarter. Long-term, the combination of Hospira and our gross margins for these products as a percent of total company sales should be neutral to slightly positive. Now let me review our key operating metrics. In the second quarter of 2009, our gross margins were 48.3% compared to 42.8% a year ago. The margin improvement is primarily attributable to a favorable product mix, better manufacturing efficiencies, and favorable exchange rates associated with our factory in Mexico. SG&A expenses totaled $16.5 million compared with $13.7 million for the second quarter last year. The majority of the increase in SG&A was due to our investments in sales and marketing initiatives, higher compensation and benefits cost, and higher legal patent costs. As doc already mentioned and as a result of the critical care acquisition, we will be hiring additional employees to handle the added sales, marketing, customer service, and manufacturing responsibilities. Also, we will incur additional expenses related to our manufacturing expansion in Slovakia. Doc will talk more about this strategic initiative at the end of the call. We incorporated these estimated additional costs into our updated 2009 guidance, and we expect our SG&A expense to be approximately 29-30% of total revenue for the full year of 2009. Research and development expenses were $600,000 for the second quarter of 2009 compared to $1.5 million a year ago. The decrease was primarily attributable to our focus on core projects during the quarter and the elimination of development work on a device for detecting coronary artery disease. As discussed on the previous conference calls, we’ll gradually increase investments in research and development initiatives in the second half of 2009. We expect our R&D expense to be approximately 1% to 2% of total revenue for the full year 2009. Our second quarter operating income totaled $8.7 million compared to $5.7 million for the same quarter a year ago primarily due to stronger sales and improved gross margins. Operating margins were 16.2%, up significantly compared to 11.7% a year ago. Now moving to our balance sheet and cash flow, as of June 30, 2009, our balance sheet remained very strong with approximately $145 million in cash, cash equivalents and investment securities. This equates to approximately $9.78 per share. Inventory turns are approximately 5 times a share, the same as last year. The recent increase in inventory was primarily related to our smaller European acquisition in February. We expect our inventory excluding the recent critical care acquisition to decrease by the end of the year. We also had over $185 million in working capital. Additionally, we generated $6.9 million in cash flow from operating activities during the quarter. Our capital expenditures totaled $4.7 million during the second quarter of 2009, and lastly as of today, we’re down to less than $ 3 million from $81 million in auction rate securities. Now I would like to turn the call back over to Dr. Lopez.

[Dr. George Lopez:]

As evidenced by our operational and financial achievements for the first half of the fiscal year, we have made significant progress in executing our growth strategy, weathering the global economic recession and building value for our shareholders. Let me briefly review our recent growth initiatives. I’ll start with critical care. We’re excited about the long-term opportunities our critical care creates, and now that we have complete worldwide control over commercial responsibility for all the critical care products, we believe we will be able to eventually gain back market share. Assuming the acquisition closes on schedule in the third quarter, which is crucial to these numbers, we expect the acquisition to contribute $0.01 to $0.02 per diluted share to our earnings for our second half of 2009. Because of the GAAP accounting standards already explained by Scott that requires us to record revenue and cost differently in the third and fourth quarters of this year, we wanted to provide additional guidance on critical care revenue for 2010. Based on the current trends, we expect to generate additional revenue related to critical care in the range of $30 to $35 million for the full year of 2010. Based on the current demand for our core products both domestically and internationally as well as considering the positive impact from critical care acquisition, we are increasing our revenue targets for the full year of 2009 to be in the range of $220 to $230 million from the previous range of $215 to $225 million. We expect all but one of our product lines in 2009 to achieve growth over 2008. Again these numbers are predicated on us closing the critical care transition on time. Taking into account the improved product mix and given that foreign exchange rates remain favorable, we expect our gross margins to be in the 46-47% for the full year, compared to the previously announced guidance of 44 to 45%. Now moving to our operating expenses, as a result of the critical care position, we will be hiring more people to handle the added sales, marketing, service, and manufacturing responsibilities. Additionally during the quarter, we started our manufacturing expansion in Slovakia which is in line with our strategy to increase our geographic preference and support growth of custom products in the European markets. We chose Slovakia for several important reasons. First, it is located in the center of Europe providing us with an ideal strategic location to seamlessly distribute our products to the adjacent countries. Second, by establishing manufacturing facilities in Europe, we’ll significantly shorten our supply chain lead time, a large portion of our transportation and custom duty costs. Also, Slovakia has an educated workforce, relatively low inflation and tax rates, as well as low labor costs which will lead to further operating cost reductions. Taking into consideration the positive impact of critical care acquisition and improving operating efficiencies which will be partially offset by expected increase in patent and legal costs, we’re increasing our diluted earnings per share guidance for the full fiscal year of 2009 to the range of $1.62 to $1.71, compared to the previous announced guidance of $1.58 to $1.70. For modeling purposes, we expect our full year effective tax rate to be approximately 36%. We believe the capital expenditures including the additional investment in our facility in Slovakia will be approximately $17 million in 2009. Our operating cash flow is expected to total approximately $35 to $40 million in 2009. In conclusion, I would like to say that we are pleased with our progress we’ve made so far. We believe our company is well positioned to capitalize on our market leadership, leading industry relationships, and our critical care acquisition. Now I would like to turn the call over for your questions.

[Operator:]

(Operator Instructions). The first question comes from the line of Stephen Simpson with Northland Securities.

[Stephen Simpson:]

I was curious if you were able or willing to break out, at least on a relative basis, the impact of those factors you mentioned on gross margins, the various factors that played into the GM, which ones were more significant or less so?

[Scott Lamb:]

The two most significant are the favorable product mix and the favorable exchange rate with our factory in Mexico. Each one represents about 200 basis points of difference, and the rest comes from lower freight and efficiencies.

[Stephen Simpson:]

Could you give us an updated number on how many sales people you have on staff as of at the end of the quarter?

[Dr. George Lopez:]

100.

[Operator:]

(Operator Instructions). The next question comes from the line of Mitra Ramgopal with Sidoti.

[Mitra Ramgopal:]

If I had to start with critical care, if you could just recap a little of the acquisition as to what made you decide to be more involved in a business given that maybe a year ago we weren’t sure in what direction you wanted to go to in critical care. Maybe you can just help us in terms of why you think it’s attractive for you.

[Dr. George Lopez:]

We think it’s attractive for a number of reasons. One, we think that there is growth potential with focus, if we focus on the business. It wasn’t Hospira’s primary focus especially with Project Fuel. They were focusing on their core products, so we think there is growth potential there especially internationally. That’s number one. Number two, it is a combination of our margins. It’s favorable in terms of the economics. In business, it’s not a very high margin business compared to our standard margin. By combining the margins, it makes it attractive. Those are the two main reasons, and the third reason is we think that we can expand our presence with a salesforce by hiring 25 more sales people that can do double duty. We can expand our sales force and sell some of our products in the critical care unit.

[Mitra Ramgopal:]

How much of the growth are you really looking for in terms of just doing a better job with the existing base of customers you have in critical care versus pushing new product through Premier and MedAssets?

[Dr. George Lopez:]

The former. First of all, hold on to your existing customers and then expand within that existing customer base. In Europe, we think there is an opportunity to change distribution models and increase market share, but a third of the sales are international.

[Scott Lamb:]

For right now, Mitra, the $30 to $35 million that we talked about for 2010, that’s what we are looking at this point as far as added sales coming from critical care.

[Mitra Ramgopal:]

In terms of the guidance that you provided this afternoon, how much of it are you counting on from Premier and MedAssets given that you probably have gotten the last grade of visibility on your Premier relationship?

[Scott Lamb:]

We have not broken that out, but a lot of the growth is definitely coming from both our Premier and MedAsset relationship. Those are continuing to help drive sales, and we mentioned before, the fourth quarter is when we expect that we should see some significant sales coming from Premier. Premier should kick in in the fourth quarter.

[Mitra Ramgopal:]

With the critical care transaction, we should assume any real change in your relationship with Hospira—all the contracts in place, etc.?

[Dr. George Lopez:]

No change in all that. We still have a great relationship with Hospira, and it should get better.

[Operator:]

At this time, we have no further questions in the queue. I would like to turn the call back over to Dr. Lopez for any closing remarks.

[Dr. George Lopez:]

Thank you very much for joining us on this conference call, and we look forward to talking to you in October.