Welcome to the ICU Medical Inc. First Quarter 2017 Earnings Conference Call. [Operator Instructions]. As a reminder, today's program may be recorded. I would now like to introduce your host for today's program, John Mills, Investor Relations. Please go ahead, sir.

Thank you. Good afternoon, everyone. Thank you for joining us today for the ICU Medical financial results conference call for the first quarter ended March 31, 2017. On the call today representing ICU Medical is Vivek Jain, Chief Executive Officer and Chairman; and Scott Lamb, Chief Financial Officer. Before we start, 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 SEC's filings for more detailed information on the risks and uncertainties that have a direct bearing on operating results and the financial position. Please note that during today's call, we will discuss 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've included a reconciliation of these non-GAAP measures for today's release and provided as much detail as possible on any addendums that are added back. In addition, the sales numbers that Scott will be covering today as well as the company's financial statements, the reconciliation from GAAP to adjusted EBITDA and adjusted EPS are available on the Investor portion of the website for your review. Now with that, I will turn the call over to Vivek.

Thanks, John. Good afternoon, everybody. Our first quarter of 2017 was a very busy quarter as we closed on the Hospira Infusion Systems acquisition and continued to drive legacy ICU revenue growth and began to move forward on the complex integration that we knew was ahead of us. We continue to execute well through a large volume of activity and operationally, we make progress every day on integrating Hospira Infusion Systems. On today's call, in addition to explaining the Q1 2017 results, I wanted to focus on our initial impression of the business lines, outline some of the highlights and challenges that we have seen in our first 100 days of owning the business, update you on some specific regulatory reviews of the business, lay out our key goals for the next 2 quarters and lastly, describe the items we're focused on for value creation and return of our capital into next year and beyond. Even excepting the defensive reasons we pursued this transaction, we believe there is real intrinsic value in the asset we have created and we want to be transparent on the plan and the work that has to happen to fully realize the opportunity ahead of us. In Q1 2017, we generated revenue generally in line with our expectations. Adjusted EBITDA and adjusted EPS were slightly above our initial expectations due to minor discrete accounting and tax benefits. It's hard to extrapolate much information from the first quarter due to the fact we only owned the business for an abbreviated February and then March and then had a number of P&L adjustments for the transaction. The short story is this. Underlying revenues were just a little better than we thought due to hanging on to some of the business that we expected to go away and…

Thank you, Vivek. As Vivek mentioned, we're pleased with our first quarter results. Let me first point out, there were a few items that positively impacted our Q1 adjusted EBITDA and EPS unique to the mid quarter timing of the Hospira closing and tax benefits of option exercises, primarily by the company's founder, as well as certain transnational-related items that affected our GAAP financials. So I will walk everyone through those as we go through our first quarter results. The largest of those was a bargain purchase gain of $63 million which is the result of the fair value of the net assets acquired exceeding the fair value paid for the net assets. The impact of the bargain purchase gain and the stepped-up market value of the acquired inventory are excluded from our adjusted EBITDA since neither have anything to do with the operational or cash earnings of the business. This unexpected purchase gain will have a positive impact on GAAP earnings this year. Now our first quarter 2017 revenue was $248 million when compared to $90 million in the same period last year. GAAP net income for the first quarter of 2017 was $56 million or $2.86 per diluted share compared to GAAP net income of $18 million or $1.08 per diluted share for the first quarter of 2016. Adjusted diluted earnings per share for the first quarter of 2017 were $1.68 as compared to $1.26 for the first quarter of 2016 and adjusted EBITDA was $50.1 million for the first quarter of 2017 compared to $32.7 million for the first quarter last year. Now let me discuss our first quarter revenue by market segment. Please keep in mind that the Q1 2017 revenue does not include the Hospira acquisition for January, since we closed the transaction February 3.…

[Operator Instructions]. Our first question comes from the line of Larry Solow from CJS Securities.

Great. Just, Vivek, perhaps you could just take - I mean, I know you don't want to sort of quantify where you stand today, but if I had to summarize it, it sounds like you're - perhaps things are a little bit better than maybe or a little bit ahead of expectations as you look at over the next few quarters. And maybe qualitatively, you can discuss it in sort of what was your biggest positive surprise and your biggest negative surprise as you have the company now for 2 months or 3 months.

Sure. Thanks, Larry. I think - I don't think we want to say it's better than we thought or it's worse than we thought. Like we're saying anything different than we've said before. We're not changing our view or anything else. So I'd rather just say we had the thing for 2 months in what we're reporting here. In terms of - the best thing we've seen is the product is liked by the customers. Even with the little bumps and bruises that can come in the quality stuff, the products are fundamentally good and they have a place in the marketplace and they're made well. And I think we're very pleased with that. The second thing is there's a lot of people who really care at Hospira who really care about the serving the customer well and we're really pleased with that. And we're pleased with that the customer knows it's healthier to have us as a participant. I think those are the really good things. The bad stuff is exactly what I referenced in this script which is there're some contracts that are suboptimized that we have to clean up and then we're good at those kinds of things; and there's processes that are wasteful and they're sort of just thinking you're bigger than you actually are, from an earnings perspective and behaviors that go along with that. So I think it's a little more qualitative than economic at this point on the good or bad. I'm sure there'll be economic surprises and that's why we're not really saying it's better or worse than we thought. We're trying to plan for the ability to handle such things that may come up. So...

And can you just sort of maybe help us quantify or - the stand-alone cost, did - have they - did they implement - did they start to begin in the first quarter or was actually basically not much in those numbers?

I'll let Scott add more color, but it started the day we closed. And so we were spending $8 million - $7 million to $8 million a month on buy-in services from Pfizer that started on February 3. I don't know, Scott...

Well, I'm just trying to get idea of sort of the bump up. Is it just the extra one month? Or from 2 months to 3 months? Or was there - was it sort of slow to get started in Q1?

No, no. It was full - it was even worse which is the bills started coming right away and we didn't get any collections or receivables for a while, right? Which is the cash flow point. Scott was like, we had to fund it a little bit to start and that started immediately.

So the bump up really will be just more because it's 3 months as opposed to 2? Or - because you said there'll be higher stand-alone cost in Q2 versus Q1. Is that just because of 3 months versus 2 months?

No, it's because we're ready to start standing up the business and pulling it away from Pfizer. So in order to do that, there will be some duplicative labor as we prepare to do that. That will increase the stand-up costs from quarter 1 to quarter 2.

I mean, we have to build out IT, Larry. We got to build out finance, we got to build out some of the other functional areas. You can't flip a switch and, all of a sudden, we just do it ourselves. Unfortunately, we got to run double for a little while. That's what Scott's saying. And then, we did lose a month of the sales that we got to Hospira in January in the second quarter, right? We knew that was going to happen, but it's a little bit of - now the world just actually gets to see the profitability level we had historically on Hospira, right? If we're saying that was kind of $3.5 million to $4 million of value in 1 month that we made from them, now it's clear the amount of earnings we had at risk with them, right? Because that's what we don't get in Q2 that will [indiscernible].

Absolutely, absolutely. And just if I may, one last question. You mentioned 12% growth on the sort of the - I know you won't be talking about ICU legacy going forward, but since it's our last opportunity, 12% growth in the - that's in the IV therapy and oncology, was that - is that basically a direct sales number? Or is that a good way to view that? Or...

Yes. I mean, I think it's everything minus Hospira that we would have had historically. And I think - I mean, in the last call, we said, look, it was coming in just a little bit, remember? And we were probably low teens before and it was 12% now. So it's just a tad less than we were historically.

[Operator Instructions]. And our next question comes from the line of Jayson Bedford from Raymond James.

Can you hear me okay, guys?

Yes, fine.

Perfectly.

Okay. Sorry for this simplistic question here, but just trying to put a little context around these numbers. The $248 million in revenue, do we compare that to the guide of $1.2 billion to $1.25 billion? Is that a true apples-to-apples comparison?

Yes. The anticipation was we would only have 2 months of the Hospira legacy business in quarter 1.

Okay. But that $248 million is the right number to use?

Yes.

Okay. And Vivek, you mentioned that underlying growth was a bit better than you thought. Again, just getting a little context because we're kind of a bit blind coming into the quarter, what was better than you thought?

I don't know that we said the core growth was and - Jayson, maybe I didn't say it right. I feel like the results were in line with our expectations. We grew a bit more because we hung on to some - well, so when we revised the transaction, remember, we said we're going to - the business was - had lost some key customers and that revenue was going away. Not all of that revenue went away which is why we did a little bit better. I don't know that it was something fundamental. The business is still - it's hard to say the word growth. All the business lines are still shrinking. Let's be very candid about that, right? So they didn't shrink as much as we thought they would; it's not really growth.

Fair. I guess I'm asking, though, in which segment was it better than you expected, I guess?

There was probably less shrink across the board. I think it was probably a tad better in consumables and solutions versus the hardware business.

Okay, okay. And I'm still...

But as we get normal here, Jayson, once we can close those deferred-close countries, once we have it in the full quarter, then - we published at the last call and it's in Scott's attachment here, the historical, then we can go back and compare segment by segment quarter-over quarter. But it's just not going to look normal for a while.

Right. I guess one question. I'm still a little confused on the recognition of the delayed countries. I realize they're reported in other, but was the bulk of that revenue going to be attributed to infusion systems? Can you - is there any way to kind of allocate it within the 4 sets that you defined? And also, are we're going to have this underlined for the rest of the year?

So as we mentioned already, it's going to take 4 to 12 months to close these delayed-close countries. The sales are primarily in the infusion systems business; there could be a little bit of consumables in there as well. And as those countries close, we'll be able to characterize and - the revenue that is under other at the moment and those will find their way into the correct market segments.

And I might be overstepping my depth here, but it's a little bit of we're getting past the net economics from those countries. We're not necessarily getting past the full P&L. So what's really happening in the country is probably more revenues than we're seeing transferred to us in the net economics line. That's why the infusion systems number, in particular, looks really strange relative to historical results, just based on these 2 months.

Okay. Okay, that's fair. That helps me out. The - just on the quality side, the 0 findings in Costa Rica, sounds like you had a few items in Austin. But it sounded, generally, these are a bit better than - against historical Hospira. So is this kind of the green light, if you will, from the FDA? Is this a trigger that can accelerate some cost-cutting in these facilities?

No. I mean, I don't think we - we don't correlate successful quality outcomes with cost-cutting. Like those are not related in my mind. I think those successful inspections are just another check-the-box item that a customer expects us to have done. And I'm pleased that the investments that both Pfizer and Hospira made were worthwhile, but it wouldn't surprise me if there's other things they're. I mean, you just - you got to own these things for a while until you get really comfortable from a quality perspective. And volumes are already down and so we've kind of been addressing the volume-related issues in the factories which are tough things to do, but that's separate and distinct from the quality and reliability cost which we need to be solid there. That's not an area that we're particularly interested in, in reductions.

Okay. And I don't mean to be redundant with this, but just in terms of the messaging on 2018, no change to the goals that you provided last quarter, but you're more confident in the synergies. Is that a fair characterization?

Yes. And I think, again, you've seen us in action, right? I think, on Q2, we're going to come back and say, “Here's our best view of the world.” I just don't think we're quite there yet.

Our next question comes from the line of Mitra Ramgopal from Sidoti.

A few questions. First, Vivek, I believe you mentioned you expect consumables segment to eventually become probably the biggest piece of the pie. And I was just wondering which segment or segments you think might fall off as a result.

I don't - Mitra, I don't think anything is necessarily going to fall off. We were just trying to illustrate largest to smallest and it's the business - that's where we combine supplier with customer. And so we naturally have the most duplication and the most synergy there and that's where we should be focused on, we should be able to squeeze out returns and value faster than the other segments that we weren't participating in. And so that was - and it's larger and it's a truly global segment and we have global distribution that we never had before as ICU and we're not even capturing all the earnings in that business this year because they had so much inventory on hand which should be a good guide to us once we're through that. So it wasn't about something dropping off. It was - that's where - if you looked at the deal, you better believe you have some synergies in that area because that was an area of overlap.

Right. No, thanks for clearing that up. And one thing I just want to get your view on as it relates to customer relationships. I know when you first got there, you had to spend a lot of time mending or repairing relationships, et cetera. Now, more than one year in now with the Pfizer deal, are you starting to see some additional or incremental value creation as a result of those relationships being maintained?

I would say, again, it was - it comes with some baggage. I think the clock kind of got reset to 0, maybe not all the way to 0, but we got to go earn it again. I think you've got to assume we've got to go earn it again.

Okay, that's fair. And I don't know if this was mentioned before, but Scott, the mix that you're seeing regarding domestic versus international, could you give us a sense of what that looked like in the first quarter?

It's a little difficult at the moment to break that out, just because of the other revenue in the delayed-close countries. Traditionally, Hospira legacy was about 80-20 and ICU legacy was about 75-25.

Yes. I mean, I think it's a - Mitra, I think it's a better comparison. You need - you should think about solutions as a U.S.-only business, right? So we should subtract that out of the total company revenues. We're not spending one ounce of brainpower on anything outside of the U.S. in that line of business. And then what's the right mix of international versus domestic for the disposables and the pump business is the way we think about it.

[Operator Instructions]. Our next question comes from the line of Chris Lewis from Roth Capital.

Vivek, in your prepared remarks, you talked quite a bit about rationalizing the product portfolio over time. Can you elaborate on kind of what that process entails? What specific segments within the portfolio today do you think present the most opportunities with that over time?

Sure. I think, Chris, the areas we have duplication require the most rationalization and you're forced - we're forced into that rationalization if we're collapsing the manufacturing network at the same time, right? If - so if we're moving disposable productions to 2 plants instead of 3, it's a very natural time to be looking at that. And the more rationalizations we can have there, there's a whole bunch of workflow that drops out of the process if you're standardizing on a lower number of SKUs. And so we had a lot, they had a lot. And it's - each one of them comes with its own regulatory, its own labeling, its own downstream kind of commitments. And so if we could take some off the table, we ought to do that. It probably first starts in the area of overlap in the infusion consumables, then it's probably in the part we know best which is the sets in the pump business. And after that, it'll be on geographies. And so we talked about product rationalizations. There's also geographical rationalization of where we want to participate.

And on the hardware business, specifically in the U.S., I think you talked about some changes within the sales force. What specifically kind of are you attempting to change within the sales force? Is it adding additional resources? Or is it just upgrading the resources that you have in place today?

I mean, I think it's just making sure that the seats are valuable and we're getting people who deeply care and the most engaged and committed people we can get in every single seat. And we downsized a bit and we believe we've retained the ones who are the most committed and the most engaged and the best at what they do, very much like we did here. And it's giving - making them successful with a clarity of purpose around what the company is supposed to do. Some kind of basic core marketing. I mean, the thing was in such flux for a long time, it just wasn't - the downstream effort to the sales organization wasn't supported that well. And I think that's basic blocking and tackling that we got to do better.

And in terms of kind of the dynamic around losing customers in that hardware business, do you see a point this year where that bottoms out? Or is this something that's going to linger perhaps into '18? I'm just trying to get a sense of kind of how we should think about that market in the U.S. and can kind of the cadence going forward.

I mean, I - right now, I'd prefer - it's tough. I'd prefer not to vary from our previous comments which, when we said - in the revised transaction, we said some of those customer losses will continue into early '18. I think that's the more appropriate thing to say right now. And as each day goes by, we'll have better information, but I don't think we want to vary from that right now.

Great. And Scott, I understand there's a lot of moving parts on the gross margin line going forward, but any kind of guidance you can provide on just generally where gross margins, accounting for all the moving parts, come in ballpark-wise in the second quarter?

So you're right. There are a lot of moving parts. If you look at on a GAAP basis, we came in at 36%. There's going to be additional pressure on 2 fronts. One is the reduction of inventory and the effect that, that will have on the factories and the loss of overhead absorption. And the second is the fact that the profit that we got on sales to Hospira in January, those profits go away temporarily until much later in the year. And so those 2 items are going to put continued pressure on the gross margins. And I think, as we've said, as we put another quarter under our belts, we'll have better information in our second quarter call. But directionally, that's going to - what's going to put a lot of the pressure on our gross margins.

And can I just add to that? I mean, we're not going to make choices to maximize this year, right? We're trying to make choices to maximize next year. We want to maximize the $450 million of inventory and it takes time to get that down, right? We're not trying to do something to be heroes right now. It's really about setting us up for the future.

And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Vivek for any further remarks.

Great. Well, thanks, everybody and we appreciate you making the time to learn about ICU Medical and our first quarter post our acquisition. We look forward to updating everybody on our second quarter call and that's it for now. Thanks very much.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.