ICU Medical, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Amounts below are in U.S. dollars; financial statement figures are in millions unless otherwise noted.
Business context
On February 3, 2017, ICU Medical acquired Pfizer’s Hospira Infusion Systems (HIS) business, substantially expanding the company’s infusion products, operations and workforce. The acquisition included IV solutions and infusion systems, among other products. Consequently, year-to-date 2017 results include about eight months of HIS revenue, and comparisons with 2016 are not like-for-like. ICU also acquired Fannin (UK) Limited in February.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $343.2 | $97.1 | $922.5 | $283.7 |
| Gross profit | $111.6 | $51.3 | $288.6 | $150.6 |
| Gross margin | 32.5% | 52.8% | 31.3% | 53.1% |
| Operating income (loss) | $(3.7) | $22.5 | $(56.6) | $69.2 |
| Net income | $0.1 | $18.8 | $18.9 | $53.6 |
| Diluted EPS | $0.01 | $1.09 | $0.92 | $3.13 |
| Cash from operations | Not stated for quarter | Not stated for quarter | $69.9 | $68.7 |
Revenue growth primarily reflects the acquired HIS business, not a comparable increase in legacy business sales. For Q3, revenue mix was 42% IV Solutions, 24% Infusion Systems, 27% Infusion Consumables and 4% Critical Care. Legacy Critical Care revenue declined 7.9% year over year in the quarter.
Management attributed lower gross margins largely to HIS’s historically lower margins, purchase-accounting inventory step-up (about four percentage points in Q3 and seven points year to date), and temporary unfavorable absorption associated with planned inventory reduction. Operating results also included substantial acquisition-related integration and restructuring costs and earn-out remeasurement expense.
Cash, debt and liquidity
- At September 30, cash and cash equivalents were $300.6 million; short- and long-term investment securities totaled $24.7 million at amortized cost. Cash plus investments was reported as $325.3 million, down $119.7 million from year-end 2016.
- Nine-month operating cash flow was $69.9 million. Investing cash outflow was $237.3 million, including $157.1 million for acquisitions and $51.7 million for property and equipment. Cash and cash equivalents fell by $144.5 million over the period.
- September 30 debt was a $75 million variable-rate, interest-only Pfizer seller note, due February 2020. On November 8, 2017, ICU repaid it in full and entered a five-year, $150 million secured revolving credit facility, with leverage and fixed-charge coverage covenants.
- Management said existing cash and expected operating cash generation should fund operations for the next twelve months. Estimated 2017 capital expenditures were approximately $80 million.
Material changes, outlook and risks
- Acquisition accounting: ICU recognized a $71.8 million bargain-purchase gain for the nine months, including $8.5 million in Q3. Purchase-price allocation remained preliminary and subject to revision. The gain was attributed principally to expected restructuring needs and lower HIS forecasts than those assumed when the transaction price was negotiated.
- Earn-out: Pfizer may receive up to $225 million based on combined-company adjusted EBITDA for 2017–2019. The liability rose from an acquisition-date estimate of $19 million to $32 million at September 30; remeasurement losses were $7 million in Q3 and $13 million year to date.
- Integration and restructuring: Nine-month restructuring and strategic transaction/integration expenses were $68.0 million. The company expected to complete HIS-related restructuring by year-end 2017; material charges for the described activities had been incurred by September 30.
- Tax and other unusual items: The nine-month effective tax rate was reported as negative 66%, affected by the bargain-purchase gain, geographic income mix and a $12.6 million discrete tax benefit from equity awards. The acquisition also increased depreciation and amortization and diluted share count.
- Legal and regulatory exposure: HIS-related saline products are subject to purported U.S. antitrust class actions and government inquiries, including a Department of Justice investigation and a New York Attorney General subpoena. The matter involves indemnification claims between ICU and Pfizer; ultimate outcomes and financial effects are uncertain.
- Operating risks: Management identified integration and customer-retention challenges, intense competition in pumps and IV solutions, extensive drug and device regulation, manufacturing and product-quality demands, reliance on major customers and distributors, and foreign-exchange exposure. A 10% euro exchange-rate movement was estimated to affect relevant net balance-sheet positions by about $5.8 million; the company did not hedge its euro exposure.
- No specific revenue or earnings guidance was provided in the filing. Management described growth opportunities from the expanded portfolio but cautioned that integration, execution, market and regulatory risks could affect results.
Most important facts for investors to verify
- How much of revenue, margins and cash generation is attributable to acquired HIS versus ICU’s legacy business, and whether HIS integration improves profitability.
- Final HIS purchase-price allocation and the assumptions behind the bargain-purchase gain and $32 million earn-out liability, including the potential for payments up to $225 million.
- Progress and remaining costs of restructuring, Dominican Republic facility closure, production transfers and integration; confirm the expected completion timing.
- Liquidity and capital needs after repayment of the Pfizer note, including revolving-facility availability, covenant headroom, capital spending and working-capital requirements.
- Developments in the saline antitrust litigation and government investigations, related Pfizer indemnification claims, and any resulting exposure or operational disruption.