ICU Medical, Inc. (ICUI) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2017 ICU Medical, Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce one of your hosts for today's conference, Mr. John Mills. You may begin.

Thank you. Good afternoon, everyone, and thank you for joining us today to discuss the ICU Medical financial results for the third quarter ended September 30, 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 risk and uncertainties. Future results may 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 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 also 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, as well as the company's financial segments, the reconciliation from GAAP to adjusted EBITDA, and adjusted EPS are available on the Investors portion of the website for your review. Also, we're having a presentation that accompanies today's remarks. You can view the presentation now by going to our website at icumed.com and click on the Investor Events. And with that, I will now turn the call over to Vivek.

Thanks, John. Good afternoon, everybody. The third quarter of 2017 was our second full quarter of owning Hospira Infusion Systems, and we are balancing our time between active customer dialogues to improve our commercial execution and being deeply in the midst of integration to create a single unified company. We continue to execute well through a large volume of activity, and operationally, we made progress every day on integrating Hospira Infusion Systems. On today's call, in addition to explaining the Q3 2017 results and the most recent business segment performance, we wanted to provide an update on the current status of integration and related activities, discuss our expectations for the balance of 2017, and lastly, provide a firmer view on how we're thinking about 2018 at a high level, both from an income statement and balance sheet perspective and on the drivers for value creation into the longer term. Before getting into the financial results, we did want to comment on the natural disasters that occurred in the third quarter and had such a devastating effect on so many people as well as impacting various parts of the healthcare supply chain. ICU Medical was extremely lucky in that our Ensenada facility was not impacted by the earthquake in Mexico, our Austin facility was unscathed by Hurricane Harvey, our Dominican Republic facility was spared from Hurricane Maria and our distribution centers in Florida were only down for a day or 2 following Hurricane Irma. We're happy all of our teammates remained safe, and we continue to do everything possible to continue – we continue to do everything possible to build redundancy into our manufacturing operations. Moving on to the financials. Revenues in Q3 2017 were generally in line with our expectations, while adjusted EBITDA and adjusted EPS were slightly above our initial expectations. Like Q1 and Q2, we continued to have numerous transactional accounting impacts, particularly in gross margins, which makes the results a little bit hard to follow. The short story is this. Revenues continue to be slightly better than we thought due to hanging on to some business that we expect would go away, combined with some favorability from unique temporary market dislocation. And real cash operating expenses that were slightly better than our estimates due to the actions we have taken to date have improved our 2017 results relative to our prior expectations. We finished the quarter with approximately $343 million in revenues including our contract manufacturing work. Adjusted EBITDA came in at approximately $55 million and adjusted EPS came in at $1.12, and we finished the quarter with $325 million of cash on our balance sheet. We have made progress over the last quarter in closing most countries with only Italy left to close. As a result, the other line – the other segment line has decreased and revenues by segment are starting to look more like the actual results. Turning to the individual segments, and please use Slide 3 in the posted deck for the 2016 comparisons. Let me start with what we expect will be our largest business over time, Infusion Consumables. This is essentially the legacy ICU business plus the Hospira consumables business, which is predominately the distribution of ICU manufactured products and a smaller amount of unique Hospira products. Our internal estimate, which will still not track exactly with the GAAP reported numbers, is that the segment had revenues of approximately $111 million in Q3. That again would imply the segment being down high single digits quarter-over-quarter. Legacy ICU was strong, with growth over 20% in oncology. Both legacy ICU and the legacy Hospira businesses were strong internationally, and this was offset by legacy Hospira losses in the U.S. This is the segment where we're the most advantaged now as a joint entity. We're hard at work on rationalizing the product portfolio and bringing together the operational efficiencies of the combination. Commercially, we have all the pieces, all the technology and all the scale to compete globally, and should be able to offer more value to the customer. On the previous call, we stated that we expected the Hospira losses to bottom out over the balance of this year and believe this segment will be closer to flat on a quarter-over-quarter basis – on a sequential quarter basis towards the end of the year, as the major changes occurred in the third quarter of 2016 for the legacy Hospira business. And we believe that this segment should be positioned for some growth in 2018. Today, with another quarter under our belt, we think this segment can grow mid-single digits in 2018. It's also important to spend a moment on the effects of the transaction on our results in this segment for 2017, as we did not capture the full margin in this segment due to the combination until we sold all of the pre-deal inventory Hospira purchased from ICU. That is now over. And based on our view of 2018, even with the reduced Hospira demand, we believe this will have a positive $20 million EBIT impact year-over-year as we fully recapture this margin in 2018. So we see this segment having improved revenue growth and improving margins into 2018. The second segment to discuss was our largest segment in Q3, infusion solutions. This segment reported approximately $125 million in revenues and did have some unexpected growth year-over-year due to the unique temporary industry issues that have widely been reported in the press. We have been trying to operate with transparency to customers by illustrating the generic drug-like regulatory framework, high capital expenditures and value in a healthy supply-side situation to a business that was a historical anomaly. In Q3, we continued to hang on to some legacy business longer than we expected, and on our last call, we stated that longer term, we expected losses as previously described. Our view has shifted slightly here, as we believe we can be closer to flat revenues to plus or minus a little for 2018. At the outset of the acquisition of Hospira, and even more when we had to make the transaction adjustment, we believe that we have lost a substantial amount of contracted business and significant production volume in a fixed cost manufacturing environment. The recent events, combined with a logical integrated value proposition, have enabled us to improve the amount of business we have under longer term contract and will allow us to further fill up the factory we acquired in Austin with more volume. From a value perspective, we've been willing to sacrifice short-term profits for longer-term supply contracts, which we believe offers us more NPV as it makes us a more competitive supplier over time. Practically speaking, this means you should not assume that Q4 gets even better than Q3 of this year. We've been very focused on the longer term, but we want to be clear. Verbatim from the first presentation of this transaction a year ago, we are going to make economically rational decisions and not sell products at a loss. We continue to hold excess capacity, but we're kind of like a utility company. We can't just turn it on or off, because it requires heavy labor and quality investments as well as long-term partnerships to make it successful. In the medium term of 2018, we see this business with more stable revenues, particularly if we exclude some of the temporary gains here in Q3, with more stable volume as we run a more robust production environment. Lastly, we continue to be vigilant here on quality even as Hospira and Pfizer invested significant resources, because it's mandatory to be in this business. To finish the big 3, I'll move to infusion systems, which is the business of selling pumps, dedicated sets and software, which is important because it's a business that brings a lot of recurring revenues and it was the largest customer of the legacy ICU OEM business. Our internal estimate is the segment delivered $91 million in revenues, which would imply being down in the high single digits range as the losses we outlined previously are happening. The international business is holding together reasonably well, and we continue to expect this segment to bottom out in the U.S. sometime in 2018 with the lowest level installed base in the last 10 years. Relative to where we're starting as a new owner, this segment is much smaller than historical levels and just improving ourselves a little can make a huge difference across the P&L. We've been focused on both our core group of loyalists here from a customer perspective as well as the situations where we have market share risk and are beginning the process on focusing on how to offset those risks. We think Hospira forgot a lot of the reasons customers liked the products and we're going back to work on basic marketing and defining our value to the market. This segment has a high amount of resources and structural costs to support it, much more so than the other businesses in ICU given that it's capital equipment. We've been very aggressive in rightsizing structural cost to align with the current reality. For IV systems, our view is unchanged from our previous position, with this segment continuing to having declines through the middle of 2018. I did want to spend a moment on critical care, which we have not really spoken about since the Hospira acquisition. It should be noted that our new Cogent critical care monitor has been released in the U.S. market and is being used or evaluated in a number of hospitals across the country in cardiac bypass and heart valve surgeries as well as in the general ICU environment. We're cautiously optimistic about the new product helping us build more value in this segment. Customer interest and clinical feedback has been positive on both the ease-of-use and the ability to monitor patients using multiple technologies on the same platform. To finish the discussion on segments, since we acquired Hospira, we have actively been calling on customers and trying to illustrate the value we can add to the system and the value to the system in having us as a healthy participant. While it's a long journey, we do believe that this message is resonating. The feedback on the products continues to be solid. The products are necessary for the system and have been reliable for many years. On the last 2 calls, we said, at a high level, we looked at the business. We saw 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 in 50% of the businesses, we saw the need to improve the situation. Today, heading into 2018, we see a somewhat better picture where we believe we have a right to win in the previous group but also in our IV solutions segment, and we finally have the new critical care products in the field. That leaves the domestic portion of our infusion systems segment as the key challenge area and we're working hard to address that business. Okay. On to the integration and related activities. There's nothing really new on cost savings; just about everything we wanted to do has been done. Commercially, we're on track to close our small acquisition in Australia later this month and begun our 3-way commercial integration there. The vast majority of our country commercial leadership has been secured. We are recruiting for certain open seats. With these teams, we've been very focused on upping our commercial intensity, changing the execution and improving the customer intimacy that deteriorated over the last few years in Hospira along – at Hospira in these business lines. We've had a great number of new experienced teammates join us. We continue to dive deeply into all quality-related activities. I said previously that not everything was to my satisfaction yet, and we have to err on the side of caution as the new owner and it still could be bumpy. We went through a lot in the first 100 days of this year with full FDA inspections at our acquired manufacturing sites and ongoing activities to ensure our continued positive standing with legacy ICU sites. Now that we have had more time under our belt, we've seen a few things we need to improve in the infusion systems business regardless of our inspection status. We are adopting a mindset of transparency around all historical issues and we believe it's important for regulators, customers and suppliers to see us continuously improving. Infusion devices are amongst the most scrutinized products from a quality and regulatory perspective, and we take our responsibility in this area very seriously. We believe it's better to take actions swiftly as the new owner, and we have initiated some corrective actions to ensure the highest quality of our infusion systems products in the field. As we said before, we're cautious here with our budgeting and are attempting to build in conservatism on our P&L to handle these bumps. We see these as a normal part of being in the business, they're contemplated in our guidance and there are no special P&L items or carve-outs. On the integration activities of IT, the cutovers and the GSA separation from Pfizer, we have now shifted from integration planning to execution. Philosophically, as the founder of ICU used to say, We're trying to measure twice and cut once. These IT systems migrations are complex, filled with legacy issues and require great caution. I've personally been burned in prior experiences when these projects become more transformational than migrational, and we've seen even the best-in-class industry companies we admire very much have issues with systems. So we've been very deliberate and have started the execution phase in what we call the outer perimeter, countries and regions where we have less profit at stake, but have to implement many of the same processes that we do here in the U.S. market. We have cut over a number of European countries to our instance of Oracle. And while things are working smoothly, we did learn a lot that will help us as we build up to the larger countries. The next large cutover for us is Canada early in the New Year, and we'll give an update of that on the year-end call. Our current thinking regarding timing is unchanged as we expect that we will not be off these systems, the Pfizer systems, until the end of the third quarter of 2018. Right now, in the U.S., we are first quickly addressing a lot of the processes and behaviors that can help improve customer service and customer satisfaction in this market environment. Since the last call, we've continued to add in-house capabilities. Okay. To bring this all back to the topic of short-term results, how do we think about the medium term of 2018 and longer-term value creation? Due to hanging on to some of the legacy Hospira business longer than we thought, the favorability from some of the unique temporary market dislocations plus the cost-saving initiatives to date, we're modifying our 2017 adjusted EBITDA range to $195 million to $205 million versus the $185 million midpoint we had previously issued. Scott will walk it down through EPS. When we revised the transaction, we had talked about a goal of achieving a $250 million adjusted EBITDA run rate by the end of 2018. We appreciate investors indulging us with the run rate concept as we were trying to get our arms around a fluid situation. Today, we think we can tighten up our view and believe we can achieve between $240 million and $260 million in adjusted EBITDA in 2018. If we have more information on the year-end call, we'll provide it then. It's hard to put an exact number on it, but even if we finished above or at $200 million for 2017, we don't view all of that as recurring business, given some of the temporary market issues. We believe our actual recurring business is more in the $185 million to $195 million EBITDA range. And to that, we would add all the pluses and minuses that we discussed on the last call for 2018. Scott will walk through a refresh of that table. While adjusted EBITDA is a useful metric, given all the noise of the transaction, it's important to get these real cash expenses of integration behind us and focus on the real free cash generation for the longer-term value creation. We talked on previous calls on how we would sacrifice margins this year and in the short term to improve working capital and the balance sheet. In Q3, we added $85 million of cash when EBITDA was $55 million due to certain working capital improvements. In the last few days, we've closed on a $150 million unfunded credit facility and we have paid back Pfizer the $75 million seller note with cash on hand. We believe we'll finish the year with net cash close to $300 million and no debt. Nothing is new since the last call on CapEx and tax rate. We believe that our working capital and inventory efficiencies will continue, and our goal, excluding any unique events, is to have $400 million in net cash at the end of 2018, which approaches our pre-deal levels. We continue to think about it as if ICU is still adding the same amount of annual cash to the balance sheet and Hospira is paying for its own integration, albeit the cash isn't coming in that exact same fashion. Longer term, heading into 2019, there continue to be items that we would call the high-hanging fruit or synergies depending on IT separation that allow us to get more efficient with our processes and infrastructure. We have to execute well in 2018 to allow for these to be available. If we could also have the strongest balance sheet possible at the end of 2018 with over $500 million of liquidity that we can use to help returns along with these high-hanging items, we think we have a case for continued value creation. Big picture to us, if we can get our cash back to pre-deal levels, we essentially gave up 17% of our company to double our EBITDA, solve our strategic overhang, create a more valuable asset, and when we prove can integrate, we will have earned the right to think broader. But for today, we're solely focused on the task at hand. Our goals are just like our previous experiences: to first enhance margins and then improve overall growth, in the best case, while 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 could still drive operational improvements and generate solid cash returns over time relative to the capital we deployed due to the levers I just mentioned. And just like ICU historically, there are a number of continuing 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 from – excuse me, what is different than in 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 it's aspects of a turnaround in certain of the business lines, at the same time while being a quasi-LBO, just without any debt. We've been lucky on a few items, but it is about as challenging of a corporate project as many of us have faced. 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. Not to talk down or talk up the circumstance, just to be realistic on what we have ahead of us. As we've said on previous calls, the first few quarters under our ownership will be subject to all the expected difficulties of a carve-out and bumps that come along. There is a lot of execution in 2018 that has to happen well and we still have to improve or clean up certain legacy Hospira situations. 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 can be generated quickly like ICU. We believe that this was a logical evolution for both businesses. We feel we've been able to put together a final transaction that didn't risk the enterprise and still left real room for value creation for investors. As always, I'd like to close when things are moving fast. We're trying to improve the company with urgency. We're trying to take responsible actions and break some of the inertia that many companies in our position face. We may hit some bumps as we take some of these actions, but we will overcome them and emerge stronger. I really appreciate the effort of all combined company employees to adapt, move forward and focus on improving results. And our company appreciates the support we've received from both our customers and our shareholders. With that, I'll turn it over to Scott.

Thank you, Vivek. I'll first walk down the income statement, highlight key items impacting operating performance, identify key effects of transactional accounting, and lastly, discuss our updated 2017 guidance and preliminary full year 2018 guidance. So to begin, our third quarter 2017 GAAP revenue was $343 million when compared to $97 million in the same period last year. Please remember, the $343 million includes $16 million of contract sales to Pfizer. Our adjusted diluted earnings per share for the third quarter of 2017 were $1.12 as compared to $1.35 for the third quarter of 2016, and adjusted EBITDA was $55 million for the third quarter compared to $34 million for the third quarter last year. As a reminder, the 2017 revenue data related to delayed closed entities is not available by market segment, and as Vivek mentioned, we only have one delayed closed entity left, which is Italy. Because of this, we're able to allocate the majority of the other revenue towards respective market segments, primarily infusion consumables and infusion systems, with other revenues being only $11 million in the third quarter versus $35 million in quarter 2. Now let's discuss our third quarter GAAP revenue by market segment. Sales of infusion consumables were $93 million versus $83 million last year, which includes the legacy ICU infusion and oncology consumables business. IV solutions were $144 million. Excluding $16 million of contract sales to Pfizer, IV solutions sales were $128 million. And just to reiterate, we benefited from unique industry circumstances in the third quarter. Sales of infusion systems were $83 million. Critical care sales were $13 million compared to $14 million last year and, as Vivek already mentioned, we're really happy about the launch of our new critical care patient monitor, Cogent. The remaining $11 million in sales was primarily made up of sales to delayed closed countries and isn't traceable back to a specific market segment. For the third quarter, our GAAP gross margin was 33% compared to 53% for the same quarter last year. The expected year-over-year decline is due to the acquisition of the Hospira business, which has historically lower gross margins and certain transaction-related items affecting our gross margin. SG&A expenses increased for the 3 months ended September 30, 2017 as compared to the same period in the prior year, primarily due to the impact of the Hospira acquisition. This includes the cost of TSAs to Pfizer and new hires to help stand up the Hospira business. In Q3, there was a realignment of expenses as we continued to integrate the legacy Hospira business with ICU. R&D expenses increased year-over-year due to the acquisition of Hospira, and as a percentage of revenue, R&D spend was flat compared to the third quarter of last year at 4%. Just like there were in quarters one and two, there are temporary impacts to our P&L in quarter 3 that are both operational and transactional. So I wanted to take you through these, beginning with operational items related to decisions we've made on how to temporarily operate the business. There are two operational items to note. As we've already mentioned, reported revenue from the delayed closed countries is not reportable by market segment and this was only an $11 million impact. The remaining delayed closed countries should close by the end of this year. Next is gross margin, where the planned inventory reduction from product we acquired in the Hospira transaction and the decision we made to improve working capital efficiencies. So while this helps free cash flow, it has caused a temporary loss of fixed overhead absorption in the factories that began in the second quarter and will continue into the fourth quarter this year. Now moving to the transactional items. As we said before, the profit would have – the profit we would have recognized prior to the acquisition on sales from ICU to Hospira was delayed until that product shipped to the customer. This had a temporary effect on margins and earnings this year. However, this impact should fully be behind us beginning in 2018. The second transactional item is the purchase price step-up of inventory purchased as a result of the transaction. As you can see from Slide number 4, when you back out the effect of purchase accounting, on a non-GAAP basis, our gross margin was 37% or four percentage points above our GAAP gross margin. We expect this to be behind us beginning in Q4. Restructuring, integration and strategic transaction expenses were $19 million for the three months ended September 30. Restructuring expenses accounted for $3 million of this total and were primarily related to severance and the previously announced closing of our manufacturing facility in the Dominican Republic. Strategic transaction and integration expenses were approximately $16 million and were mostly related to our acquisition of the Hospira business. We are making consistent progress on our integration as we see a clear path forward to standing up the legacy Hospira business from Pfizer and with a heavy emphasis on systems integration. And as Vivek already mentioned, we had our first successful system cutover in a few smaller countries as we begin implementing our system cutover activities. In addition, there was a $7 million noncash adjustment this quarter to the carrying value of our contingent consideration payable to Pfizer. This is based on reaching a certain cumulative earnings target by the end of 2019. This change is created by many factors, including the discount factor, time value of money and the probability of reaching this target. These changes impact our GAAP earnings, but are excluded from our adjusted earnings since this has nothing to do with the operational performance of the business. Our tax provision for the third quarter was primarily attributable to higher income in the U.S. versus non-U. S. and an allocation of transaction cost to foreign entities located in lower tax jurisdictions. We expect our annual tax benefit for 2017 to be between $5 million and $7 million. And next year, by taking advantage of the Hospira transaction that provides opportunities to lower our tax rate through lower tax jurisdictions, we believe our tax rate should be at historical low and be approximately 27% to 29%. This does not consider any potential impact from the health tax reform bill that we are currently evaluating. Now moving on to our balance sheet and cash flow. We continue to be very focused on cash earnings and free cash flow, and in this quarter, we were able to generate $74 million of free cash flow and ended the third quarter with $325 million of cash with a $75 million note to Pfizer. This positive cash flow was driven primarily by a reduction in working capital, and though helped by $11 million of inventory purchase accounting, we still reduced inventory by $81 million in the third quarter and increased terms to 2.5x. Now while we don't expect to bring inventory levels down the rest of this year at this rate, we continue to work towards improving our working capital. In the third quarter, we spent $25 million on CapEx, and for the full year, we expect to spend approximately $80 million, which does include investing in IT integration and infrastructure. And this week, we entered into a new five-year senior secured revolving credit facility with various lenders, including Wells Fargo as lead, for $150 million with an accordion feature that enables us to borrow up to an additional $100 million. Borrowings are at LIBOR plus an applicable margin lower than we were paying Pfizer. At the same time, we paid off our $75 million note to Pfizer using existing cash. We felt paying off the note to reduce our expense and adding this as insurance was the right thing to do. We should end this year with approximately $300 million of cash, no debt, and by the end of next year, approximately $400 million of cash. Now based on our results through the first nine months of this year and expectations for the remainder of this year, we are modifying our adjusted EBITDA expectations from the previous range of $180 million to $190 million, to $195 million to $205 million. We are also modifying our adjusted EPS guidance from the previous range of $3.80 to $4.20 to the range of $4.20 to $4.80. For 2018, we now believe we can hit an adjusted EBITDA midpoint of $250 million for the calendar year, with a range of $240 million to $260 million. We expect adjusted EPS to be in the range of $6.05 to $6.65. And just to walk through the math on Slide 5, which is exactly what we presented on our last call, we believe the true normalized 2017 finish is between $185 million and $195 million. To that, we would add first the $20 million of intracompany profits Vivek described in the consumables segment; second, our previous goal of $35 million of 2018 operational synergies; third, a normal expectation for legacy ICU, now Hospira plus ICU consumable earnings growth of $10 million; and a reasonable assumption for TSA savings in 2018, which we would call $10 million today, with most of these savings coming in the back half of the year. We would then subtract from that the losses of $10 million to $20 million we expect in the infusion systems and IV solutions segments. We think the losses will be felt more in the first half of 2018, leading to a better back half run rate. These next few months for us are important as we cut over systems at additional sites and continue to manage our way through the complexity of the task. But once complete, this will give us a very efficient integrated system with the ability to flex up as needed, and allows us to focus even more on the other aspects of the business. And with that, I'd like to turn the call over for any questions.

[Operator Instructions] And our first question comes from Jayson Bedford from Raymond James. Your line is now open.

Good afternoon, can you hear me okay?

Perfect.

Okay, all right. There's a lot to ask here, and as much as I want to ask you about the high-hanging fruit in 2019, I'm going to ask you some more near-term questions. I guess, first, in terms of – there's no change to the revenue guidance of, what, $1.2 billion to $1.25 billion. What is the revenue that you reported in the third quarter that mirrors the annual guidance? I'm just – there's a few different revenue numbers here and I just want to make sure I have the right one. And what's the revenue number you're using for the buck – for the $1.12 in adjusted EPS?

So Jason, basically that would be the reported $343 million combined, less the $16 million for the contract manufacturing to Pfizer.

Okay. Was that 320 – okay, and that's what you're using to calculate the $1.12 in adjusted EPS, right?

Well, that's the – I think you asked what's the basis of the revenue guidance. It was without the contract manufacturing revenue, right? It doesn't – we don't make any money in that business. It doesn't contribute anything to EPS.

Right. There's no carve-out or – it doesn't contribute and there's no carve-out of that business.

Okay. Okay. Vivek, maybe on the systems. That was the one area where you came in a little shy of our expectation. I think you mentioned that you are working on things. What helps you grow that business towards the back half of 2018?

It's three things really in my mind, Jayson. It's – one, it's product stability and we think the new – the Plum 360 is the only infusion platform along with the other pumps in our family that have been through the new FDA process. We really believe in them, but there are areas for improvement there and we're working on that. So kind of full product stability would be number one. Two would be time and seat of new sales people. We've changed a lot there and a little bit just like when we got to ICU, adequate time for people to get their legs under them. And three is calling on a wider swath of customers. Hospira was very inward looking where its historical business was. And our first job is to make sure we try to do our best to secure our historical business and that the losses we've outlined were assumptions made about things we are going to come out of that base. But as – and they didn't necessarily go out and call beyond their borders. And once we can get our legs under us, we should be doing the same thing, right? So product, people and kind of intensity towards the customer.

Okay. As we look to 2018, within your framework, it looks like you're kind of normalizing the base for $10 million of, let's call it, excess profits due to the dynamic in the IV solutions market. So is the assumption that this shortage dynamic will be cleaned up by year end? And then secondly, it doesn't look like you're assuming any real benefit from that in 2018. Have you been able to secure any longer-term contracts that gives you a little bit more confidence in kind of the growth profile in 2018 and 2019?

I think, Jayson, it's really an important question. On the first part, our assumption, and we don't know the exact days and we're not going to guess what is happening with other industry participants, and by the way, we want a healthy industry. Our assumption is people will get healthy and their business will come back at full strength, and so we have to assume that, that's going to be because we don't know whether that's – what day it is, but for our assumption, it's better to be conservative and assume it would happen soon. In terms of contracts, the point I was trying to make in the prepared remarks, maybe it was too much, was we have been able to secure some long-term contracts and we traded away a little bit of value to get those long-term contracts. And that reflects both in the revenue line and in the margins of that business. There's not a ton of margin in there, but it does mean we have that business for the next number of years, which keeps the factories full and adds value. And I think we said before, we thought the losses would continue in solutions and now we're saying there's a reasonable chance, certainly excluding this stuff that happened recently, to be closer to flat in the business. So yes, that means we did make an assumption on getting some more revenues there.

Okay. And so the bad guy in 2018, meaning the lost contracts, is more on the systems side than the solution.

Probably a little heavier on the systems side now, yes.

Okay. And then maybe lastly for me and then I'll let someone jump – someone else jump in. The kind of implied fourth quarter EBITDA comes down a little bit from the third quarter levels. Is that just a function of using the benefit of this IV solutions dynamic in the third quarter and less so in the fourth quarter?

Probably two things, mostly that and then we're also trying to hire like crazy and we're adding people to the P&L right now. And a lot of the stand-up functions, we want to make sure we have space to do that, right? And so we're recruiting, and it's tight out there to get all the people we want, but we're very active in doing that. So there's new people coming to the company every day.

Okay, thanks for taking the question.

Thanks Jason.

Thank you. [Operator Instructions] Our next question comes from Matthew Mishan from KeyBanc. Your line is now open.

Hey, good afternoon and thank you for taking the questions.

It’s the first new voice on the call, its four years and welcome.

Its – I’m happy to be covering the company even through all of this. Is the way to think about that Austin facility that it just has very high fixed costs and low variable costs, and that the incremental business that you're getting just flows through it at a very high rate at that plant?

I think if you're asking is there increased absorption and value if you're filling up something more, yes, there is. It is a heavy – I mean, I would joke like we're the utility company. It is a heavy industry; it's got a lot of fixed cost. And if you have an airplane that's flying around that's not full, that's expensive. And yes, there is value in filling it up, but it's also what's the revenue per seat you're getting. You want to make sure you do that responsibly to fill it up for a long time, and that's kind of the set of trades we're analyzing every day out there.

Okay. And then, can you give us a sense of what the available capacity is in Austin and where you're at now compared to that available capacity?

I think it's a bigger conversation than Austin, right? Because we have Austin, which we own, and we also have this five plus two agreement with Pfizer for the Rocky Mount facility. And I would just say, across those two sites used to operate at lights out capacity to serve the country, and that changed a lot with what Hospira went through, but we still have either indirect ownership or direct contractual relationship to access to all of those assets. And there still is unutilized capacity out there, which is a shame in all this, of what's going on. It's just – it's not – you literally can't turn the tap on and off every day, right? You have to plan these cycles and there are high labor rates, high quality, high regulatory, and you can't turn it off and turn it on in a day. So if we got more long-term contracts, we certainly have more capacity to manage that. We're not going to get tapped out on the capacity side.

All right. Excellent. And then maybe like a longer-term question. I think you guided to $400 million of cash at the end of next year. First off, is that $100 million of free cash flow or there's some other moving pieces there to be thinking about? And then I think last quarter, you thought – you mentioned that if you end – you exited 2018 with a strong balance sheet, you could use it to help returns. What does that fully mean? What does give you the best shareholder return? Share repurchase, acquisitions or would you consider a dividend?

Why don't I do the second part first and then I'll turn over to Scott on the cash flow, right?

So just simply put, Matt, yes, that's just free cash flow, primarily.

Okay. On the employment, look, I mean in the time the management team has been here, when there was dislocation in the market, we walked into it and bought back and the like. And when we thought there was something else to do with it, we hoarded cash, and I think we're going to do the same attitude here. And this industry, the history of infusion, has had lots of shocks across the system, so you got to be carrying maybe a little bit more around with you than you would do in other lines of business. And so we've got to make sure we have that amount and then beyond that, we can do what we see fit. I don't think we would mislead anybody that we're interested in some M&A activity for the next 12 months at all. We have to really get through this integration. We don't – we wouldn't – it's the same people on the call and others, right? We wouldn't be able to manage it.

All right, thank you very much, Vivek. And very happy to be covering the company.

Yes, thank you.

Thank you. And our next question comes from Mitra Ramgopal from Sidoti. Your line is now open.

Hi, good afternoon. Just a couple of questions. Vivek, I know you have a lot going on in terms of near term, and I think one of your highest priorities is getting – expanding the sales force, getting the right people in place, et cetera. Just wondering on the product side, if you feel you need to do something on that front or you're very comfortable with what you have right now.

I think in the segments that we said where we felt more optimistic about today, in IV consumables, in IV solutions, I think we feel really great about the products we're holding today. They're well-established brands and are getting resourced and pushed better than they have in many years. On the IV systems business, we feel very good about our products. There is continued investment in software and technology around the core mechanical devices and we are investing a lot in that because that's where we see the value driver over the next five to 10 years. And so there, we have to continue to innovate and we are committed to that innovation. We feel very good about the hardware in the systems business. We need to keep innovating and investing in the software part of that business.

Okay. And on the international front, I know pre-Hospira, you had just gotten a few new distribution agreement, especially Terumo. I was just wondering if that is something a little more on the back burner until you sort of deal with the heavy lifting near term or is that something you're looking to...

I think they're on the campus today, not that we have a campus, but I think they're in the building today. Super important. We all spend time on it. No less priority, very valuable market, we need to deliver there.

Okay. And finally, just from a competitive standpoint, I know when you first did the deal in terms of Hospira, they were losing share. You had a lot of relationships to mend or repair, so to speak. As you look out now to 2018 and beyond, do you feel more comfortable in terms of now instead of playing defense, you can actually be a little more aggressive in terms of regaining or expanding your market share?

Just to be clear, we still are losing business here. We lost market share in some – in these – in two out of the three categories in the third quarter, right? So it's not over and some of it continues into next year. I feel like it's too early to say right now. We never rationalize the transaction by talking about revenue growth assumptions. We talk about the balance sheet assets we're getting, the margin we could squeeze out of it. And not necessarily even playing offense, just if we could tie or hold the score relative to what was going on at ICU, we had to do it. I think that's kind of all we'd say about it today, still.

Okay. And then finally, I guess, this is more of a long-off question in terms of Pfizer, the relationship there. Obviously, it's your largest shareholder. Is it pretty much being a hands-off relationship since you've done the deal?

I have nothing but positive things to say about the alignment with them. There's a thousand things that happen every day in countries where they're running our systems or we have to interact with them or get things done with them and others, obviously, general business bumps that happen back and forth, but they've been nothing but super supportive, super supportive.

Okay, thanks again for taking the questions.

Thank you. At this time, I'm showing no questions in the queue. I'd like to turn the call back over to Vivek Jain for further remarks.

Thanks, everybody, for investing the time to learn about ICU's third quarter. We look forward to wrapping up this year getting into 2018. We hope everybody has a great holiday season and we'll be talking to you in February. Thanks very much.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day.