ICU Medical, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. ICU Medical develops, manufactures and sells products for infusion therapy and critical care. The company completed its acquisition of Pfizer’s Hospira Infusion Systems (HIS) business in February 2017, so period comparisons reflect different acquisition timing and integration effects.
Key financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $360.5 million | $331.5 million | $732.5 million | $579.3 million |
| Gross profit / margin | $151.8 million / 42.1% | $88.1 million / 26.6% | $300.8 million / 41.1% | $177.0 million / 30.6% |
| Operating income (loss) | $30.0 million | $(35.9) million | $32.9 million | $(52.9) million |
| Net income (loss) | $31.1 million | $(37.1) million | $35.9 million | $18.8 million |
| Diluted EPS | $1.44 | $(1.87) | $1.67 | $0.93 |
| Operating cash flow | Not presented quarterly | $59.0 million | $(28.9) million |
- Q2 revenue increased 8.7%; first-half revenue increased 26.5%. Revenue growth reflected the HIS acquisition, new customers and, for IV solutions, elevated demand associated with market shortages in the first quarter.
- Q2 gross margin improved to 42.1% from 26.6%; management attributed the improvement primarily to the prior-year HIS inventory purchase-accounting step-up rolling off, increased factory absorption and favorable product mix.
- First-half operating cash flow was $59.0 million. Property and equipment purchases were $47.4 million; net cash from operating activities less these purchases was approximately $11.6 million.
- At June 30, cash and cash equivalents were $309.1 million and investment securities were $24.0 million. Current assets were $899.5 million versus current liabilities of $202.5 million.
- No borrowings were outstanding under the $150 million revolving credit facility, which had $150 million available and matures in November 2022. The company reported compliance with its financial covenants. The $75 million Pfizer seller note had been repaid by year-end 2017.
Material changes and unusual items
- Product-line revenue for Q2 was $123.8 million in Infusion Consumables, $135.3 million in IV Solutions, $88.4 million in Infusion Systems and $13.0 million in Critical Care. Consumables benefited from new customers; Infusion Systems growth also reflected deferred-close HIS entities being assigned to that line in 2018 rather than “Other” in 2017.
- Q2 selling, general and administrative expense was $83.5 million, down slightly year over year; first-half expense rose to $170.5 million, primarily from HIS integration, including higher IT, compensation, legal and travel costs. First-half research and development expense was $26.2 million.
- Restructuring, strategic transaction and integration expense totaled $18.7 million in Q2 and $40.3 million for the first half. Most related to HIS integration; management said material HIS restructuring charges had been incurred by June 30.
- A $28.9 million charge in the first quarter arose from resolving a dispute with a product partner and redefining contractual rights and remedies. The company said it was no longer subject to future minimum purchase obligations under that arrangement.
- The HIS acquisition earn-out was remeasured to a $29.0 million liability at June 30, up from $27.0 million at year-end. Pfizer may receive up to $225 million in cash depending on combined-company performance through 2019.
- The company adopted ASC 606 using the modified retrospective method, recording a $6.3 million increase to opening retained earnings. The standard increased reported Q2 revenue by $8.2 million and gross profit by $7.2 million; first-half revenue by $10.2 million and gross profit by $9.1 million, compared with amounts without adoption. Prior-year figures were not recast.
- First-half net income included an $11.2 million tax benefit from excess tax benefits on share-based awards and a $5.7 million tax benefit related to the contract settlement. The effective tax rate was negative 8%; accounting for the Tax Act remained incomplete.
Outlook, risks and contingencies
- Management estimated 2018 capital expenditures of approximately $70 million, principally for U.S. manufacturing and information technology. This is an estimate, and actual spending may differ substantially.
- Management said existing cash and expected future operating cash flows should fund operations for the next 12 months. It expected to keep $138.9 million held by foreign subsidiaries permanently reinvested outside the U.S.
- Risks include dependence on a relatively small number of distributors and manufacturing customers, customer ordering variability, integration of HIS, competition and pricing pressure, supply and production disruptions, foreign exchange exposure, and regulatory or product-quality matters. A 10% euro-dollar exchange-rate movement was estimated to affect specified net euro-denominated balance-sheet items by approximately $7.6 million; the euro exposure was not hedged.
- Legal matters include saline-solution antitrust litigation and related government inquiries, plus a DOJ subpoena concerning Sapphire infusion pumps and related products. The court dismissed the operative antitrust complaint on July 5, 2018 but permitted an amended complaint. The filing describes indemnification claims between ICU Medical and Pfizer; management did not believe unsettled proceedings would materially adversely affect financial position or results, but outcomes remain uncertain.
- No specific revenue or earnings guidance was provided in the filing.
Important facts for investors to verify
- How much reported growth and margin improvement reflects ongoing performance versus acquisition timing, purchase-accounting effects, market shortages and ASC 606 revenue timing.
- The underlying cost and expected completion of HIS integration, and whether the stated improvement in gross margin can be sustained.
- The assumptions behind the $29.0 million earn-out valuation and the potential cash obligation of up to $225 million.
- The financial and operational exposure, indemnification allocation and possible outcomes of the antitrust, government inquiry and product-related proceedings.
- Whether the company’s approximately $70 million capital-spending estimate, liquidity expectations and foreign-exchange risk assumptions remain appropriate.