ICU Medical, Inc.
Q2 2014 Earnings Call Transcript

Published: 12 Aug 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to the ICU Medical Conference Call Second Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to John Mills. Sir, you may begin.

[John Mills:]

Great. Thank you. Good afternoon, everyone. Thank you for joining us today to review ICU Medical's financial results for the second quarter ended June 30, 2014. On the call today representing ICU Medical is Vivek Jain, Chief Executive Officer and Chairman; and Scott Lamb, Chief Financial Officer. Vivek will start the call with a brief overview and then Scott will discuss second quarter financial performance, and provide financial guidance for the third quarter and full year of 2014. Finally, 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, including management's belief and expectations about the company's future results. Please be aware they are based on the best available information to management and assumptions that management believes are reasonable. Such statements are not intended to be a representation of future results, and are subject to risks and uncertainties. Future results ma y 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. Please note that during today's call, we will discuss non-GAAP financial measures, including results on an adjusted basis. We believe these adjusted financial measures can facilitate a more complete analysis, and greater transparency into ICU’s ongoing results of operations, particularly in comparing underlying results from period-to-period. We have included reconciliations of these non-GAAP measures with today's release, and have provided as much detail as possible on any adjustments that are added back. With that said, I'll now turn the call over to Vivek Jain. Go ahead, Vivek.

[Vivek Jain:]

Thanks, John. Good afternoon, everybody. Hopefully, we'll have a quick call today. With one full quarter start to finish here under my belt now, I think we can start providing some more details on the plans we started to lay out on previous calls. Our second quarter results were better than expected. We generated strong cash flow and adjusted EBITDA, and we're adjusting upwards our guidance ranges for adjusted EBITDA and EPS and GAAP EPS for 2014. The revenue mix was a little bit different than expected, and we'll provide more color on that momentarily. Our second quarter largely resembled what's been going on here all year through today. Strong performance in all of our direct operations, with good growth in our direct U.S. infusion, oncology and critical care businesses, and all of our direct businesses internationally, in total, leading to 7% growth year-to-date on a direct basis. These gains have largely been offset by a 12% year-to-date decrease in our OEM results, as our channel partner continues to work to improve its current position. On the February and May calls, I laid out what I believe are the core value drivers for ICU Medical, which in summary are based on, one, our manufacturing scale in the needlefree connector category; two, the sticky nature of our products; and three, our strong balance sheet and cash-generating ability. On the May call, I tried to bookend 2 basic scenarios, both of which I believe generate improved value creation relative to where we are today. Those scenarios were framed as

[Scott E. Lamb:]

Thanks, Vivek. Before I begin, let me remind all of you that the sales numbers we are covering, as well as our financial statements, and a reconciliation from our GAAP to adjusted EBITDA and EPS are available on the Investor portion of our website for your review. As we have explained in recent conference calls, during the past two quarters, we have been evaluating comparable medical device companies, and saw the majority of these companies were providing adjusted financial measures. We have completed our review, and going forward, we will continue to report adjusted earnings per share and adjusted EBITDA. We believe that by doing so, we will provide a better view of our earnings, as we begin to exit our transition period. Going forward, we will provide as much detail as possible on any adjustments. Those key adjustments we are talking about include items, such as stock compensation expense, restructuring and possession related costs. So now, on to reporting our Q2 results. Our second quarter results were driven primarily by strength in our international and U.S. direct sales. Total revenues were $79 million in the second quarters of 2014 and 2013. Second quarter 2014 adjusted EBITDA was $16 million compared to $18 million last year. The decline was primarily due to increased R&D expenditures and a slight decrease in gross margin. Adjusted diluted earnings per share for the second quarter 2014 was $0.51 compared to $0.58 last year. GAAP net income for the second quarter was $6 million or $0.38 per diluted share, as compared to GAAP net income of $7 million or $0.48 per diluted share last year. The decrease was primarily due to a noncash-based stock compensation expense and increased R&D. Now, let me discuss our second quarter revenue performance by market segment. You can also view our detailed market segmentation in our earnings press release. For the second quarter, sales in infusion therapy decreased 2% to $55 million and represented 70% of our total sales. International infusion therapy sales increased 13%. U.S. direct sales increased 4%, but were more than offset by a 12% decrease in U.S. OEM sales. Sales in oncology were flat year-over-year at $9 million, which represented 12% of revenue. An increase in our global direct sales of 9% was offset by a 14% decrease in our OEM sales. And as Vivek already mentioned, we are addressing oncology through our restructuring efforts, and we will continue to focus on this growth area of opportunity. Sales in critical care increased 8% to $14 million and represented 17% of our sales. Sales grew across all geographies. Our second quarter sales for direct and OEM were as follows

[Operator:]

[Operator Instructions] And the first question is from Tom Gunderson of Piper Jaffray.

[Thomas J. Gunderson:]

I just have 2 questions, I think, 2. One is the direct sales revenue were up -- or revenues were up in that sector, and you attribute it appropriately, but there's a lot of things that go into that, especially when you're realigning sales forces and assignments, et cetera. Was there anything among that bag of things that can contribute to higher revenues through direct sales that you saw come out more forcefully than the others?

[Vivek Jain:]

Tom, do you want both parts of the question? Or you want us to answer the first one first?

[Thomas J. Gunderson:]

Oh, and --yes, -- now the second part the question is smaller and that is the sales force realignment. We've seen a lot of these, investors have seen a lot of these in the last 12, 24 months. Sometimes they go well, sometimes, not so well. Can you give us a sense of the percentage of territory disruption with all the changes that you talked about?

[Vivek Jain:]

Sure, sure. So let me take those in kind of reverse order. On the direct sales impact of the changes on the quarter, these activities went into place after the quarter ended, hence our call actually being a little bit later than I'd ideally like. So I don't know if there was any impact of that on Q2. There are really changes to set up for the long-term. So there was nothing in it that affected Q2. And just to be more granular about it, international has been actually the fastest-growing part, not domestic. All of these changes are really domestic. We're going to be adding to international, but that hasn't happened yet. So it's been o U.S. that's faster. I've been through some of these sales force redefinitions in previous lives. I think this was more marginal here. We had a sales force focused on what -- when I was in the script talking about lower value segments, a lot of stuff in places where it's hard to cover with a direct sales force, alternate site, et cetera. We just eliminated a lot of those territories and their -- added a few new territories. So on the margin, it's not a wholesale revamping, it's more on the edges of each person’s territory.

[Thomas J. Gunderson:]

Got it. And on the components of growth, was there large customer focus? Small customer focus? Reorders? What kind of things where you looking at that gave you the extra boost?

[Vivek Jain:]

On the direct business, there are no large customers, so to speak, right? Our direct business is -- in the U.S., 450 different IDNs make up 90% of our business, so there's not one particular customer that's out of line, and the same thing's true for international, whether we're direct or using a local distributor, no one person accounts for a disproportionate amount of sales, unlike the OEM relationship that we have.

[Thomas J. Gunderson:]

But was there anything that surprised in the quality of the quarter? On the sales of what you had that give you a little bit larger number than...

[Vivek Jain:]

Again, I think, if there -- I'm sorry, I should have answered that more specifically. I think the critical care number was a bit of a surprise on the upside for us on a direct basis. That's also been true for the previous quarter. I'd say year-to-date in critical care.

[Operator:]

The next question is from Chris Lewis of Roth Capital Partners.

[Chris Lewis:]

I think you mentioned 15% headcount reduction. Can you just talk about where those cuts were made across the organization?

[Vivek Jain:]

Sure. I don't want to get into too many specifics. I would say a lot of the changes came out of -- kind of these lower market opportunity selling organizations that we had, that just address kind of smaller markets than our core hospital market, as well as a number of kind of corporate in-between-the-business kind of jobs that don't necessarily need to exist if we run ourselves in more vertical-oriented businesses. So I'd say the majority out of smaller sales teams and the remainder out of the corporate center.

[Chris Lewis:]

Okay. And then on the OEM channel, can you just maybe walk us through in a bit more detail what you're seeing from Hospira now? Has that improved? Stayed about the same? Or potentially declined since, I think, maybe, you came on board and going forward? It sounded like some of your prepared remarks were a little more positive than they were 3 months ago. So maybe just talk us through your expectations for that segment over the next 12 months?

[Vivek Jain:]

Sure. Again, in the beginning of the year, right when I got here, the trend with our OEM partner was not great. They're really working hard on improving where they are. I think the rate of decrease has been substantial in the first 2 quarters of this year. You can see that in the year-over-year comps. I think what I care about is are they -- is the curve flattening out sequentially? Is it becoming more normalized? It is becoming a bit more normalized, but we are being cautious. I mean this thing on oncology was a bit of a divergence than we thought. And you heard maybe that -- in the last quarters' comments that we were taking another look at that. I think it's appropriate for what we've seen. You can look at the publicly reported pump companies' results. I think just as we said at the beginning of the year, we are planning for it to potentially be bumpier in the back half, and I think that's the right kind of frame of mind, and the right way to price out our own infrastructure as a company, if we make that assumption today.

[Chris Lewis:]

And then, for your revenue guidance, I think if you just annualize the first half of the year, it gets you above the high-end of the guidance. So walk us through the expectations for the remainder of this year, and why you didn't bring that expectation up?

[Vivek Jain:]

Really, 2 reasons. One is the question you just asked on what's going on with our OEM partner, right? We want to make sure we're being appropriately cautious there. The changes over the last 2 or 3 years really surprised ICU, for lack of a better word, and I want to make sure we're thinking about that right. And the second reason is we just tinkered with our selling organization, and that always leads to a little bit of bumps, and I want to make sure we are being mindful of that too. I don't think there's any other science in it behind that. As I said when I got here, I really cared about cash flow and we're focusing on what drives cash in the short-term. And over the long term it's absolutely about revenue growth, that's what we should be talking about. We're just not quite there yet.

[Chris Lewis:]

Great. And then, just on the M&A front, can you talk about the appetite there, potential markets or products you think would be most attractive and the best fit for the company.

[Vivek Jain:]

I would generalize that answer and just say, "Look, you feed what is working" and what is working for us is the international opportunities right now. And to the extent there's an opportunity to put capital to work to keep broadening that, I'm not a big believer in jumping 3 steps up the stairs at once, right? It has to have some value with what we do as a manufacturing company or some value to what we do from a channel perspective. And if it fits with one of those and it's international, I think we're more interested in looking at it. I think the odds of finding an attractive deal that fits those parameters domestically is probably pretty low, to be candid.

[Operator:]

The next question is from Jayson Bedford of Raymond James.

[Jayson T. Bedford:]

I guess maybe, Vivek, can you just talk about the changes in the U.S. selling team? I guess, can you frame what the organization looked like from a number of reps and a focus versus what it looks like today?

[Vivek Jain:]

Sure. We had 4 or 5 different U.S. sales forces, all organized in different parts of infusion therapy. So that's kind of what it was at the highest level. We had a number that I felt was woefully subscale on oncology, and a number of heads that was woefully subscale in core hospital, so regular old, up the middle U.S. hospitals. By combining that group of oncology and hospital people and adding some funding to it -- create new positions, we get to a headcount that I find more acceptable to call on U.S. hospital with. I don't know what the end state looks like, but it's some number that's 40-ish, 40-plus people doing that -- I would say, in oncology or in core hospital, we had on the range of 20 people or less than 20 people calling on some of those markets. And that's just -- it's too small to cover the country effectively.

[Jayson T. Bedford:]

I'm sorry, on a net basis, did you add to the U.S. team? And if so, by how much?

[Vivek Jain:]

On a net basis, we will be down in heads because we removed some of our smaller sales forces to U.S. hospitals. We will have more people calling on core IV products and oncology products than we've had before. So we will have, as I said in the prepared remarks, in oncology, we'll literally have double the amount of people calling than we had before. But some of those people were with the company already, right, a part of the hospital team.

[Jayson T. Bedford:]

And just, I guess, from a market perspective, in oncology, how quickly do you think that category is growing?

[Vivek Jain:]

I think it's a different answer, depending on where you are in the world. Europe and certain part -- the high-value parts of other geographies have actually been ahead of the U.S. on a value of closed-system transfer devices. And so, I think the fastest growth is actually Europe, and then certain parts of Asia. The U.S. is probably behind that. I think the U.S. is easily a 5% to 10% growth market, if not better, and the international markets are double-digit growth markets.

[Jayson T. Bedford:]

Okay. That's helpful. And then maybe, Scott, can you comment on gross margin? I realize there's probably a mixed dynamic here with critical care, but just even looking at the business -- and this maybe too shortsighted, but looking at it sequentially, revenue was up, critical care was a bit more, but gross margin took a step back. And I'm just wondering, if you can just walk us through the weights on margin this quarter?

[Scott E. Lamb:]

Yes, again, it was primarily driven by -- you already mentioned. We were down in infusion therapy, 2%. We were up in critical care. And as we've said on previous calls, our critical care has an average gross margin that's south of the corporate average. So that, in combination with a very small, one-time charge in the second quarter, that brought our gross margins down. And I think that mix going forward for the remainder of this year will help keep margins at approximately a 49% range.

[Operator:]

The next question is from Mitra Ramgopal of Sidoti.

[L. Mitra Ramgopal:]

First, Vivek, you mentioned one of the things you identified was the international markets sort of lacked the infrastructure that it needed. How a long of a process do you think that will take in terms of getting it up to where you would like it to be?

[Vivek Jain:]

It depends how much we can do with organic investment, and that's why we have to free up P&L dollars to make those investments. It's the one thing we control in playing the cards that we have. The other thing that can accelerate it is if you can allocate and deploy capital to do some of the international opportunities. So let's leave the second one off for the time being, say we can't find good areas to deploy capital. I don't believe that's the case, but for arguments sake. Just to get some people and a team ramped up and effective in a country, it takes 6 months, 9 months, some amount of time. So again, I wish it was running and ready to go tomorrow, but if we don't start today, it's only more time wasted. So I think we're really trying to set up the world for the future growth, '15, '16 and beyond. We've got to get the people that we need in here today, just like we've got to fix and give the U.S. teams the best chance to execute commercially today, all right? And then if we could supplement within organic, we'll do it. But we can't count on that.

[L. Mitra Ramgopal:]

And again, the focus is mostly Europe or is it also Asia?

[Vivek Jain:]

Asia is actually the fastest-growing region for us by a long way. It's amazing to me what the team here has been able to cultivate [indiscernible] distribution relationships and a very small direct operation with a limited number of people in Asia. It's really amazing.

[L. Mitra Ramgopal:]

And coming back to the critical care segment, I know it exceeded expectations a little. Are we seeing the new products having an impact yet? Or is that without new products?

[Vivek Jain:]

Nothing, no new products. I mean those are what -- a lot of the big R&D spend is going on right now. And candidly, as I said in the last call, we haven't really tinkered with critical care very much. So I'm glad that we've found kind of the natural state here for at least 2 quarters in a row, but part of the question -- the previous question as to why we are still being cautious on the back half of the year, is we just don't necessarily see the underlying demand trends in critical care footing up to what's going on, so it's probably better to be cautious about that right now.

[L. Mitra Ramgopal:]

And finally, I think you had mentioned R&D, we should see the spending sort of come down a little starting 2015. That's really a sense that you feel comfortable that the investments you've made this year, you'll be pretty much able to roll out the products, et cetera, and you just don't need to invest as much?

[Vivek Jain:]

Well, I think in the dream world, right, you'd love to have as much money as you'd like to invest there. I think the company has invested heavily last year and this year, and we've kind of taken stock of the programs that are in right now. How much can we push through and get done as fast as we possibly can? And that's kind of the mentality that, that team is running with right now. And so we are not putting any constraints, candidly, on what they're doing. We want to see stuff get finished this year, if possible. Even if that means they don't properly launch, get into the market, et cetera, to the middle of next year, the bulk of the spend items, the testing, the trials, et cetera, let's get them done right now. I'm not a huge one to kind of worry about what's the right percentage of sales in R&D. I mean, I can make the argument our OEM revenues ought to be excluded from that calculation to get to the right metric. But I don't think this is -- like, the company is not big enough where those percentages matter, it's just the absolute amount of dollars to keep infusion therapy or oncology going once the critical care spend comes off.

[Operator:]

[Operator Instructions] And the next question is from Larry Solow of CJS Securities.

[Lawrence Solow:]

Vivek, last quarter you mentioned it may be necessary to build a little of your infrastructure out in terms of readying yourself to have a better ability for integration of acquisitions. Have you made any steps to -- on that front?

[Vivek Jain:]

I think we've made the internal operational steps, in terms of getting our handle on the systems, finances, infrastructure, the way we analyze, look at the business, report on it, talk to each other monthly about it. That was -- those all may seem like routine things, they were big changes from -- to a certain degree what went on here. In terms of adding heads, a little bit in IT and some other areas, there's been some infrastructure added. We need to get that stuff at a level where I feel like we can handle capital deployment. There's still probably a few roles I would need to add. That's not done yet. I would say it's in process.

[Lawrence Solow:]

Okay. And I know you don't -- we touched on oncology, and I know you don't want to necessarily give guidance on product line, but in terms of the sort of flat sales year-to-date, is it just a function of the issue, Hospira and the OEM, or is there -- or is it also just timing and other slower adoption in the market? Or other things that cause you to, obviously -- perhaps you were under covered and you realigned your sales force, but it just -- all of a sudden, just coming to a head today? Or is this something that's been building?

[Vivek Jain:]

I think oncology has been underserved in both dimensions. And so, look, I don't think we should be, like, angry at ourselves in a direct basis. It's still been around 8% or 9% growth year-to-date. I think it should be better than that, but -- that's not a terrible number in today's health care environment. There's a big difference between that and Hospira. I don't think we fully appreciated [indiscernible] that's why we're changing it up a little bit. I do think on a Hospira level or an OEM level, excuse me -- again, last year was a pretty transition year for the company, and we need some of those items to get lapped and cleaned up to make sure there's a right amount of product sitting with everybody, et cetera. And I think you'll see a rebasing over time. I think the macro trends around oncology are still really, really positive. And the guidelines are moving more and more in the areas of driving safety, which is great. And we sit at the intersection of that. So for me, I want more people at this company focused on it, not less. And I think we need a little time, from an OEM basis, for it to look normal there. Two, that partner is a great oncology company, right? So I feel like that product sits well there.

[Lawrence Solow:]

Got you. And just lastly, just to confirm, so essentially, you -- in your prepared comments, I missed the very beginning, you said you're net of the 15% cut, and then the increase and realignment of sales force and the expected R&D cuts, you're running modestly or are somewhat ahead of the -- your goal of reducing expenses $10 million in '15. Is that correct?

[Vivek Jain:]

I think we said it a little bit differently. I think we -- on the last call, we said we held ourselves to at least $10 million. The actions we've taken should get us a long way away to $10 million. On top of those actions, there is decreasing R&D spend, most likely next year over this year. And there's a bunch of other operational stuff, of how we're cleaning up our distribution channel, the other people that we've decided to give money to over the years, to clean up some of those activities. Those are above the $10 million but we're not putting a number on it, because we view those as the net number we'd ultimately like to give depending on where the OEM business also shakes out to next year. We're trying to shape the cards we have today, manage our own situation, then figure out how do we build on to it.

[Operator:]

The next question is from James Terwilliger of Newport Coast Securities.

[James Terwilliger:]

Scott, just real quick, I've got 2 quick questions. Some of us this has been answered but I did miss some of the call and I apologize. The first one, at a high-level, in the critical care business. I know you guys have worked hard historically to stabilize this business after the acquisition. And in my opinion, it seems like you have achieved a stabilization effect here for the last 6 months. Do you guys feel that you've stabilized this business? And how are the pricing trends in the U.S., because I know that this is an area where your competitors have cut price aggressively against ICU?

[Vivek Jain:]

Sure. It's Vivek, I'll give you my view of that. I don't think 2 quarters makes a long-term trend, so I'm pleased to see that we've had the same amount of sales I would say relative to where the business was 3 or 4 years ago. Stabilized is sort of a bit of a stronger word than I'd probably use. Pricing is not really the issue to me in this business, I think the market structure is actually pretty attractive as an industry structure. [indiscernible] price is very much in line with value. I think that our challenge has been to execute well and sell well and innovate well. And we've made committed investments to do that. They have not gotten over the finish line yet. I think the company's actually committed an amazing amount of resources to critical care from a P&L perspective over the last number of years, relative to what's going on in the revenue line.

[James Terwilliger:]

Okay. And then very quickly, moving on to oncology. I know this has been discussed before, but just so I'm correct. To me, this seems to be one of the best or brightest future growth drivers for your company going forward. It's a division that I'm very -- and have historically been very excited about. Do you continue to feel the same way about the growth outlook within oncology? And at the same time, could you remind me again of the changes in the sales force? I thought earlier in the call, you talked about maybe reallocating some of your sales and marketing capital to maybe better support oncology?

[Vivek Jain:]

We did, absolutely, and to try to do that globally. And so, oncology is absolutely a core growth driver for this company. Oncology is a bigger and faster growth opportunity for -- in our opinion, outside of the United States than it is inside of the United States, right now, from a growth rate perspective. I think, certain legislation and awareness was adopted faster outside the U.S. In the U.S., it still remains a terrific opportunity, where the tailwinds of education, guidance, clinical, et cetera, all coming together. We were going to market with roughly 17, 18 people in oncology. With the changes that we've made we're going to have about 35 people, plus a management layer exclusively focused on IV products to the hospital and oncology products. So we feel like we've added a lot more resources to it. It may well be bumpy over the next quarter or 2, as this transition period laps itself, et cetera, and just the changes we've made on a direct basis, but it's an area that we're allocated. We have to make decisions and our decision is we're allocating more resources towards it for the reasons I just described.

[Operator:]

And the next question is from Chris Lewis of Roth Capital Partners.

[Chris Lewis:]

Just one thing. On the adjusted EPS guidance number, did you change your methodology there? And if you did, can you walk us through the change?

[Scott E. Lamb:]

Yes, it's pretty simple, Chris. So what we did last quarter versus this quarter; last quarter, we had excluded depreciation from the adjusted EPS calculation and we've put that back in, we think that that's more relational to ongoing operations.

[Chris Lewis:]

Okay. And then going off of that, is there a reason you're taking out the stock-based comp, given kind of the recurring nature of that expense?

[Scott E. Lamb:]

Sure. That's because we had some inducement shares this year in bringing on the back. And so, that was an unusual granting of equity. And so therefore, we thought it best to take those out. That way, on a comparison basis, we're looking at more of a comparable EPS number.

[Vivek Jain:]

I mean, 2 points of that. I mean, I think you can look at the historical proxies here, et cetera. It was largely a homegrown enterprise, where it was never an unusual outlier in terms of equity grants that changed with some new people coming into the company. And so, it doesn't necessarily make for a fair comparison this year. And then, maybe philosophically, that equity grants here were held in a very small group -- that will probably change over time, as we try to be a little bit more mainstream. And we need to, in attracting people, et cetera, to the company.

[Operator:]

And at this time, I'd like to turn the call back over for closing remarks.

[John Mills:]

Thank you very much for everyone's time today. And we look forward to updating you on our progress during our third quarter call. Thank you.

[Vivek Jain:]

Thanks, everybody.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today's program. You may now disconnect. Good day.