ICU Medical, Inc. (ICUI) Q1 2017 Earnings Report, Transcript and Summary

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 likely will; the delayed-close countries which pass only the net economic benefit to us versus the full P&L, make revenues look smaller in certain lines; real cash operating expenses were in line with our estimates and showed minimal changes from historical levels as we implemented changes mid quarter; and a series of purchase accounting effects that added more noncash earnings than we expected. We would encourage investors to focus on the adjusted EBITDA and EPS results this quarter. We finished the quarter with approximately $248 million in revenue. It is not relevant to talk about year-over-year comparisons, as we had the business for 2 months and the delayed close, as I just mentioned. Adjusted EBITDA came in slightly over $50 million and adjusted EPS came in at $1.62. We continued through Q1 to have very solid performance in the legacy ICU product lines of infusion and oncology. After this quarter, we will stop legacy discussions as there will be full quarter comparisons, but just for reference, our legacy ICU infusion and oncology segments grew above 12% combined. Let me start with a recap of why we pursued the transaction. We acquired the Hospira Infusion business on offense to create a leading pure-play infusion company with a complementary full-line product portfolio, the ability to unify our distribution channels globally and to provide compelling economics to stakeholders over time; and we talked numerous times about the defensive reasons and the need to control our own destiny. Offensively, we felt the ability to offer the full product suite was a unique opportunity to become a big player where ICU has been the smallest player in a category dominated by multinationals. While ICU executed well over the last few years, it was getting hard to compete against the larger players. Second, we saw benefits as we, the supplier, could integrate with Hospira, the customer, to offer more value to customers. Third, we said on numerous calls that getting global is hard. This transaction gave us an opportunity to globalize in a major way. Lastly, we felt we could deliver shareholder value creation based on our team's collective experiences and the skills we have sharpened over the last few years at ICU Medical and previous companies with a similar range of scenarios. And from an intrinsic value standpoint, we're creating a pure-play asset in a category with a good industry restructure where, absent unique events, market share moves slowly just like ICU and there's an opportunity to improve performance in businesses that have been undermanaged. Okay. So moving on to what we have seen in the first 100 days and the big-picture highlights and challenges. Most importantly, it's about customers and we've spending as much time as possible out in the field in front of real customers who have to make real decisions in the categories we serve. Customers are smart and their reactions have been as good as we would've expected. I think the highest level of comments can be summarized as it's good for our health care system and the competitive environment if the new ICU Medical can be a viable competitor and we bring the historical ICU mentality of innovation and value to these categories. But we have to earn our way back in and we have to show customers that ICU can deliver. We've been pleased that the door has not been unilaterally closed and all we want and all we can ask for is an opportunity to compete. Feedback on the products has been solid. These products are necessary for the system, have been reliable for many years. It was really the commercial execution and the customer intimacy that deteriorated. We found a core group of customers who believe in the products, like the stability and frankly, just want to do their jobs of delivering patient care and are not particularly interested in the drama of one of their core suppliers. We've found good operational processes that have been driven by many of the people we have retained. At the same time, we found a mistaken perception within the business about the actual financial results, responsibility and with what - and what one has to do to justify their existence every day. Because the business was, what I would call, the rump or an orphan of a larger corporate entity, it didn't thoroughly scrutinize every decision. And aside from some of the customer distrust that was caused, it led to gaps in certain bad supplier contracts, avoidance of tough-for-people decisions, being less strategic with the company's capital and participation in markets or product lines that created no value. All of those items are totally under our control and addressable with time and intensity. Turning to the largest 3 segments of our combined business. Let me start with what I expect to be our largest business over time, infusion consumables. This is essentially the legacy ICU business plus the Hospira business which was predominantly the distribution of ICU-manufactured products and a smaller amount of unique Hospira products. This is the segment where we're the most advantaged now as a joint entity and we have the most overlap. We have already addressed the human areas of overlap and now we're hard at work on rationalizing the product portfolio and bringing together the operational efficiencies of our combined scale. Commercially, we have all the pieces, all the technology and all the scale to compete globally. Operationally, at the highest level are big decisions like closing the Dominican Republic manufacturing facility that came with Hospira and a bunch of smaller items from lining up sourcing and procurement of raw materials to product standardization, et cetera. We're well positioned to compete here and by coming together, we should offer - we should be able to offer more value to the customer. The transaction clouds the measurement of performance because this segment is losing legacy Hospira revenues and gaining legacy ICU revenues. When Hospira revenues stabilize, we have the basis for growth with access to all customers with all products. It should be noted that, in 2017, we're not capturing the full margin in this business due to the combination until we have sold off all the Hospira inventory that was purchased from ICU pretransaction. The second business to talk about is infusion systems which is the business of selling pumps, dedicated sets, software and service and it's important business because it brings a lot of recurring revenues and it was the largest customer of the legacy ICU OEM business. It's hard to triangulate the revenues in Q1 into a meaningful comparison as the delayed-close countries are reported in the Other segment. We don't capture the full top to bottom of those geographies yet and as most of those regions, Latin America, parts of Europe and Asia, are predominantly pump markets for us. This probably doesn't - this segment probably doesn't have a full revenue number until Q4. But to try to add some color as to what's going on here, the losses we outlined in the revised transaction are generally coming true, the international business is holding together reasonably well and the U.S. install base will be at the lowest level in 15 years at the end of 2017. We see that as relative to where we're starting. This business is much smaller than historical levels and just improving ourselves a little can make a huge difference across the P&L. We have been focused on both our core group of loyalists here from a customer perspective as well as the situations where we have share risk and we're beginning the process of focusing on how to offset those risks. The R&D investments have been huge over the last few years and frankly, we think Hospira forgot a lot of the reasons customers like the products and we're going back to work on basic marketing and defining our integrated value to the market. Like the infusion consumables business, we've made some pretty substantial changes in the field-level commercial organization. The last segment is the one we have the least familiarity with, infusion solutions. We're really focused here on quality and capital expenditures and making sure we clean up a lot of the orphan business issues and stand-up activities. We're trying to operate with transparency to customers and illustrating the generic drug-like regulatory framework, high CapEx expenditures and value in a healthy supply-side situation to a business that was a historical anomaly. While Q1 hung on to some legacy business, we do expect this business to have declines in 2017, in line with our previously described comments. As of right now, through Q2, aggregate revenues continue to be in line with our previous expectations. Okay. So moving on to some of the key actions and updates in some other areas since the last call. First, on people. We have been recruiting actively to bring the right people into the company. We've solidified both the general management of each business segment as well as the financial support of each segment. And each segment, frankly, is larger than legacy ICU was as an entire company. Second, we've been diving into each product line and each geography to understand where we make returns and organize the decisions that need to be made. Those decisions may result in discontinuing certain product lines or even withdrawing from certain geographic markets. Each decision has to weigh the strategic merits versus the realistic financial plan. Third, we've been working on realization of the synergies we laid out at the time of the transaction and making sure we can deliver on our commitments. On the last call, we described the changes that were completed in the U.S. commercial organization and the first operational decisions, like that of closing the Dominican factory. Those actions, when fully in the run rate, lead to $25 million of annual savings. On top of that, we've now begun to scrub all other areas and making sure we have the right level of resourcing to balance quality, reliability and the geographic footprint over time. We expect to find additional savings opportunities to make sure we deliver at least the $35 million that we expected to implement in 2017 that can be fully realized in 2018. Fourth, we're hard at work on the operational elements of combining the business. In the immediate term, we will make the decisions to improve cash conversions at the expense of the P&L. If you look at the most recent balance sheet, you will see we're now carrying approximately $450 million of inventory. That is more than we need in a normal environment and we need to slow production, even if it hits profitability in the short term. In the medium term, there are numerous areas to gain efficiencies and we plan on being able to implement those tasks in early 2018. There are topics, just as one example, in logistics, the combined company spends over $100 million on warehousing and distribution. Fifth, we've been actively planning for the separation from Pfizer. As a reminder, we currently are paying Pfizer in excess of $85 million for transition service activities. The majority of those are around IT systems. We've made the big choices of what we want to do and our focus will shift to implementation and execution towards the second half of this year and into next year. These will help deliver the second bucket of TSA and additional savings we talked about starting sometime later in 2018. Lastly, we've been actively deep-diving on all quality-related activities. It was an extremely busy first 100 days for the quality and regulatory teams. We had full FDA inspections at both the Costa Rica pump facility as well as the Austin IV solutions facility. Additionally, we had over 10 notified body audits at those sites plus Chicago and San Diego for legacy Hospira and Salt Lake City and Ensenada for legacy ICU. We received a 0-finding FDA inspection at our pump factory in Costa Rica and received a 5-item 483 at our Austin IV solutions facility. I would characterize the Austin items as fair, generally administrative in nature and the response to begin the closure of those items already went in weeks ago. We passed all 10 notified body audits. With all that said, we were really pleased to get the work behind us, but I would say that not everything is to my satisfaction yet and we have to err on the side of caution as the new owner, as it could still be bumpy. Just like I said for the first year at ICU, not until we have some time under our belt and we see success under our watch will we declare fundamental improvements in quality. The balance of the year is about continuing to broaden the customer dialogue; align around the various additional cost savings actions; make decisions on geographies; digging in on operational and quality review base - digging into operational and quality reviews; fully planning the IT conversions and stand-up to allow us to exit the TSAs from Pfizer; and ensure our R&D and CapEx investments are spent wisely and with discipline. So as we line up the pieces of first focusing on revenue stability and then our cost levels, it brings back the economic discussion of value creation. Since 2014, ICU Medical has been deeply focused on cash conversions and actual cash flow reflected in our capital structure. Two important drivers of this equation for the transaction are capital expenditures and tax rate. On the next call, we hope to give a better sense of these items as they make a huge impact on returns. A few high-level characterizations would be, 70% of our business or so going forward, the infusion consumables business and the infusion systems and pump business does not have as much CapEx needs as historical Hospira levels. Due to declines in volumes across the network and with having some duplicative manufacturing assets, it allows us to become more optimized here. A key decision will be the geographies we play in, as some require more CapEx than other areas. It's our expectation over time that the IV solutions segment will be the largest CapEx user for the acquired HIS businesses. Scott will talk about the tax rate more, but Hospira did bring production in attractive tax jurisdictions which should improve ICU's historical rate. The basic bookends here are very similar to the ICU story. Much like ICU in 2013 or 2014, our view is Hospira Infusion Systems has been in what we would call a prolonged transition period. During this transition periods, companies are less decisive when they're unsure about the long term. Like our experience here, we believe the Hospira business, with just some basic operational rigor, can improve its P&L in the medium to long term. Our goals are like our previous experiences, to first enhance margins and then improve overall growth. In the best case, we'll have better execution to improve our top line performance over time, drive operational improvements and improve cash conversions and returns. In the worst case, we continue to fight headwinds on the top line, but we can still drive operational improvement and generate solid cash returns over time. Those are the exact same words we used to describe the opportunity at ICU a number of years ago and in either one of those cases, along with the defensive reality, justified the transaction. And just like ICU, there are a number of intrinsic value drivers, including high-quality or hard-to-reproduce production assets, sticky product categories and the opportunities for more cash generation. But what is different than our previous experience from ICU is the sheer size and scale of the work we have to do. It's very rare when the $400 million lean corporate player buys the $1 billion revenue customer. This is a complex corporate carve-out and has aspects of a turnaround in certain of the business lines at the same time. We do get to do this from a position of strength and stability in our base business, but it's a heavier lift than ICU was as a project and the business has more product and customer baggage than we started with in ICU. We feel that we've been very transparent with investors on our plans over the last few years and cautious with our own expectations and we want and need that mentality to continue this year, so not to talk up or talk down the circumstance but just to be realistic on what we have ahead of us. Short term outperformance is not likely with this transaction and it's important that people understand that. As we've said on the previous call, the results for the acquired business in the short term will get worse before they get better, similar to our first year here at ICU. We will need to add extra run cost or investments into the business. We benefited from transactional accounting in Q1 and we did not want people to assume that now that we have the business for 3 months versus 2 months in the given quarter to just simply get better. Due to the items Scott will go through, we expect Q2 EBITDA to be sequentially down from Q1. As we've said on previous calls, the first few quarters under our ownership will not be predictable and will be subject to all of the expected difficulties of a carve-out and bumps that come along. And if you're an investor that wants the predictability that ICU has offered in recent years, that will be difficult to repeat over the near term. But when we get it right, long term returns could be generated quickly like ICU. I did want to spend a moment, before closing, on our medium term goals for 2018, relative to prior commentary. First, we made no assumption of revenue growth in 2018 in our transaction model and that continues to be our assumption today. At a high level, when we look at the business, we see roughly 50% of the total business infusion consumables and the international portion of infusion systems, where we have a good offering and a right to win; and we have 50% of the business where we need to improve the situation. From a synergy perspective, we talked about having $30 million to $35 million of synergies implemented by 2018. We have a high confidence interval in that number at the moment and nothing's new with the synergies that are offered by exiting the Pfizer TSAs. Just like we've done at ICU for a couple of years now, we will use the Q2 call to update with the best financial information for 2017 and beyond and that will include an improving view of tax rate and capital expenditures. In closing, we believe that this was a logical evolution for both businesses. We feel we've been able to put together a financial transaction that didn't risk the enterprise and still left real room for value creation for investors. If you're an existing ICU investor, we appreciate your support in advance and hope you feel that these actions provide sensible capital deployment and an opportunity for increased value in the medium to long term. As always, I'd like to close with things are moving fast. We're trying to improve the company with urgency and we're trying to take some responsible action and break some of the inertia that many companies in our position face. We may hit some bumps as we take on some of these actions; we will overcome them and emerge stronger. I really appreciate the effort of all legacy ICU employees and all of our new colleagues from Hospira Infusion Systems to adapt, move forward and focus on improving results. And our company appreciates the support we've received, both from our customers and our shareholders. With that, I'll turn it over to Scott.

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. For your reference, the 2016 pro forma unaudited revenue numbers that we provided on our last call can be seen on Slide #4. Also as a reminder, revenue will be reported by the following 4 market segments. The first is infusion consumables. This includes the nondedicated sets and accessories such as the SwabCap and will include the traditional ICU IV therapy and oncology segments. Second is infusion systems which includes the infusion pump hardware, software, dedicated pump sets and service revenue; third is IV solutions; and the fourth is critical care. For the first quarter, sales of infusion consumables were $76 million and represented 31% of our total sales. Sales in infusion systems were $47 million and represented 19% of our total sales. Solution sales were $97 million and represented 39% of our total sales. As we mentioned on our last call, we're a contract manufacturer to Pfizer for certain IV solution products that we will make and sell to them at cost for at least a 5-year period. Excluding these contract sales to Pfizer of $15 million, solution sales were $83 million. During Q1, we hung on to some legacy business which we expect to decline in 2017 which is in line with our previously described comments. Critical care sales were $12 million compared to $13 million last year and represented 5% of our sales. The remaining $16 million of sales is primarily made up of sales to delayed-close countries and isn't traceable back to a specific market segment. There are some countries that are subject to deferred closings in certain foreign jurisdictions which may range from 4 to 12 months after the February 3 global closing date. For these countries, we went - we entered into an agreement, under which Pfizer will continue to operate these countries on our behalf, whereby the net economic value of those businesses comes to us. Over the next year, as we close these countries, reported revenue will increase but will have no effect on the bottom line. For the first quarter, our gross margin was 36% compared to 55% for the same quarter last year. As you can see from Slide #3, when you back out the effect of purchase accounting on a non-GAAP basis, our gross margin was 45%. The year-over-year decline is due to the acquisition of the Hospira business which have historically lower gross margins. In addition, as we've previously mentioned, for most of the rest of this year, there are 3 primary items that will temporarily put pressure on gross margins and 2 of which will affect adjusted earnings. The first is the planned inventory reduction of the inventory we acquired in the Hospira transaction to bring it in line with improved working capital efficiencies. So while this helps free cash flow, this will cause a temporary loss of fixed overhead absorption in the factories, starting in the second quarter and into the fourth quarter this year. By the end of this year, we expect to have inventory levels in line with our expectations. Second, in January, during the first quarter prior to closing the transaction, ICU shipped 1 month of product to Hospira and recognized gross profit on those shipments. However, in February and March, the profit we would have recognized prior to the acquisition now gets delayed until that product ships to the customer. This will have a temporary effect on margins and earnings in the second and third quarters of this year until we start shipping this product to our customers. For these reasons, we expect our gross margins to be bumpy for the rest of this year. And then, third, the purchase price step-up of inventory purchased in the transaction had a 9 percentage point impact to our GAAP gross margin. We will continue to see this type of impact into the third quarter until we have finished shipping this inventory. As we have previously mentioned, we expect to begin realizing synergies and COGS next year for the actions we're taking this year, such as the closure of our factory in the Dominican Republic. SG&A expenses increased for the 3 months ended March 31, 2017, as compared to the same period in the prior year, primarily due to the impact of the Hospira acquisition. We do expect to improve SG&A in absolute dollars through synergies and standing up the business over time, but in the short term, we will have duplicative headcount as we prepare to exit the TSAs. To be clear, we expect expenses to go up before they start to come down. R&D expenses increased for the 3 months ended March 31, 2017, as compared to the same period in the prior year due to the acquisition of Hospira and were 5% of revenues this quarter compared to 4% for the first quarter last year. Restructuring and strategic transaction expenses were $29 million for the 3 months ended March 31, 2017. Restructuring charges were $8 million and these were - these charges were related to severance and announced plant closure. Strategic transaction expenses were $21 million for the 3 months ended March 31 and were mostly related to our acquisition of the Hospira business. Our tax rate benefit was approximately 22% in the first quarter of 2017 as compared to a 25% tax rate expense in the first quarter last year. A principal driver of this reduction in tax rate included the treatment of the onetime bargain purchase gain of $63 million net of deferred tax which I already explained and which did not impact the tax rate negatively as a result of GAAP reporting. Additionally, other significant tax benefits included excess tax benefits recognized on stock option exercises of approximately $8 million, research tax credits and the mix of taxes in domestic versus foreign jurisdictions, partially as a result of the Hospira acquisition, all of which contributed to the overall tax benefit for the quarter. We obviously don't expect to have a negative tax rate every quarter, but do believe our time to have a better tax rate - that over time, we should have a better tax rate than historical ICU. Now moving on to our balance sheet and cash flow. Like we have been for the past few years, we're very focused on cash earnings and free cash flow. But this year will be a difficult year for free cash flow due to the acquisition. In this quarter, as you'll see on our cash flow statement, we had to inject working capital into the business, as it came with no AR and the prefunding of operating cash to Pfizer which is in our current assets and that we will eventually get back as we close the delayed countries and exit TSAs; and we have the expenses associated with the transaction. As of the end of March, our balance sheet remained strong with cash and cash equivalents of approximately $200 million and net cash of $125 million. We believe and want to be clear that earnings for Q2 will be down from Q1. The key drivers include, one, the 1-month loss of gross profit on product ICU traditionally shipped to Hospira that we got in January; two, reduced volume in our factories and the loss of fixed overhead absorption as we bring down our inventory levels; and three, stand-up cost of new hires as we prepare to stand up the business from Pfizer. This is why, from announcing the deal back in October to today, we have been saying that 2017 is unlikely to be sequentially predictive. For the year, there's no change in estimate since our last guidance and as we've done previously, we will update everyone on our second quarter call. Now with all that said, we're deeply focused on positioning the company for the best 2018 and beyond as possible. On this call, we've stated that we have a high degree of confidence in the previously described synergies. We have been actively planning for full separation from Pfizer, as the current construct of costs cost us more than it would cost us - cost to do it ourselves. And in 2018, we'll be clear of many of the accounting impacts, such as the delay of capturing our full margin of our consumables business, as one example. We have a lot of work ahead of us integrating the 2 companies. And as we've said before, 2017 will be a year of integration, but we have a clear path to create a very strong combined company that will be a fully integrated, leading pure-play infusion therapy business. But once we have all the pieces in place, we're very excited about the value-creating opportunity for all shareholders of the combined company and we look forward to keeping everyone updated on our progress on our second quarter earnings call. And with that, I would like to turn the call over for any questions.

[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.