Good afternoon, and welcome to the ICU Medical Third Quarter 2022 Earnings Conference Call. [Operator Instructions]. Please note that this event is being recorded today. I would now like to turn the conference over to John Mills with ICR. Please go ahead, sir.

Good afternoon, everyone. Thank you for joining us to discuss ICU Medical's financial results for the third quarter of 2022. On the call today representing ICU Medical is Vivek Jain, Chief Executive Officer and Chairman; and Brian Bonnell, Chief Financial Officer. We have a presentation accompanying today's prepared remarks. To view the presentation, please go to the Investor page and click on the Events Calendar, and it will be under the third quarter 2022 events. Before we start our prepared remarks, 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 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 also 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 in today's release and provided as much detail as possible on any addendums that are added back. And with that, it is my pleasure to turn the call over to Vivek.

Thanks, John. Good afternoon, everybody, and we hope you are well. Once again, it's been a quick 90 days or so since the last call, and our legacy ICU business unit revenues were again very predictable in Q3, and we did have operational performance improvements for the businesses that came with Smiths Medical. The external economic volatility in the supply chain around freight and fuel that we've been describing since mid-2021 surpassed even the Q2 2022 levels, which was hard to believe. As we said previously, Q2 was the highest peak for any time our team has been in the industry. However, the issues around raw material availability are narrowing. From a customer perspective, we felt U.S. hospital census was stable, and international underlying demand was good in all geographies in Q3. Like everyone in our industry, we wanted to start first by thanking all of our customers and their frontline workers for trusting us to serve you during these times. While Q3 revenues were generally in line with our previous comments for legacy ICU Medical, our revenues for Smiths Medical were ahead of our expectations that we laid out on the last call. And since everyone is now talking about items they would have never imagined describing in our earnings call, we'll join that group and wanted to use the time today on the call to comment on the year-over-year drivers of the 3 main legacy ICU businesses, explain the Smiths Medical revenues we achieved in Q3 and how that bridges with our comments on the last call, provide a status update on the Smiths Medical 2 buckets of challenges we've been highlighting all year, go a bit deeper on the specific items that have really hurt gross margins this year because the scale is so astounding, and it…

Thanks, Vivek, and good afternoon, everyone. To begin, I'll first walk down the P&L and discuss our results for the third quarter and then move on to cash flow and the balance sheet. Along the way, I'll provide our updated outlook for the full year for each of these areas. So starting with the revenue line. Our third quarter 2022 GAAP revenue was $598 million compared to $336 million last year, which is up 78% on a reported basis, reflecting the impact of the Smiths Medical acquisition. For your reference, the 2021 and 2022 adjusted revenue figures by business unit can be found on Slide #3 of the presentation. For the legacy ICU business, adjusted revenue for the quarter was $320 million compared to $328 million last year, which is flat on a constant currency basis and down 2% on a reported basis. Infusion Consumables was up 1% constant currency and down 3% reported. Infusion Systems was also up 1% constant currency and down 3% reported, and IV Solutions was down 1% on both a constant currency and reported basis. Overall, we were pleased with the results for the legacy ICU businesses as compared to a very strong Q3 last year. For the third quarter, Smiths Medical contributed $262 million in revenue. Compared to the second quarter, this represents a sequential quarter increase of $39 million. It is worth noting that Smiths Medical's historical financial reporting calendar resulted in 5 additional business days during the quarter as compared to legacy ICU. We estimate that these 5 additional business days accounted for approximately half of the $39 million sequential increase in revenue with the remaining increase due primarily to improvement in customer order fulfillment and reductions in back order levels, most notably within the legacy Smiths Medical, Infusion Systems and Vascular…

[Operator Instructions]. At this time, we will take our first question, which is coming from Jayson Bedford with Raymond James.

Can you hear me okay?

Perfectly.

I always feel like they need more time to digest all of the information given in these calls, but let me take a stab at it here. On the legacy Infusion Systems business, a good set of installations. You did mention you're seeing a benefit from the Smiths combination. Are you seeing some selling synergies as a result of (inaudible)?

I would say, Jayson, if you kind of look at the way the market's lined up historically, every place that used a Smiths product was using either our LVP pumps or someone else's. So we had a very good sense of where ours were. I think on the -- where it was being used in other spots, those are doors at least we have a reason to be in now where we didn't necessarily have a reason to be there before. So I would say, it's forcing us to have some conversations that -- we're allowing to have some conversations we may not have that access to before.

And the environment for capital is conducive to those discussions?

I think that's what I tried to address in the script. It was -- it felt pretty good 120 days ago. It's still pretty good. It's a little bit -- taking a little bit longer just given the week-to-week drama in the world right now that's saying, it could slow down some decision-making. So we haven't seen anything material. The other point I was trying to make there is, if you look at kind of the stuff we published, capital -- what we call capital for the combined company is 15%. But if you dig a little bit deeper, a chunk of that is software like annual software licenses and service contracts and spare parts. Actual capital not such a huge part of the company. Important obviously, because it drives future dedicated disposable share, but it's the vast majority of the company is single-use disposables.

Okay. And on the legacy consumables business, growth slowed. I realize you had a tough comp here. I think you alluded to some supply chain constraints, and I think in the past, you've called out oncology. Is there any way to either kind of quantify the impact of the supply chain constraints or at least just kind of frame the current situation and when it will be resolved?

Yes. I think there's probably 2 issues that happened. One, that's why we were trying to say, there was a little bit of intra-quarter volatility. It was a little bit soft out there in U.S. hospitals kind of mid-July, early August. Maybe, I don't know, if it was holiday travel or what, but it was a little bit less than we had expected. And that's part of what happened in Q3. And the other part is being short some of these items on oncology in 1 or 2 other areas. I would say, I don't want to give a precise number around that, but it's certainly more than $1 million over the balance of the year.

Over the balance of the year or the quarter? Sorry.

Well, saying a lot of it happened in Q3. So $1 million in the quarter is probably better.

Okay. Just on gross margin, you kind of called out the $250 million impact. I think you cited diesel, ocean freight, expedited freight. But you also mentioned that there's areas of self-help within that. Is there any way to kind of walk us through where you see the opportunity? And when we'll see an impact on gross margin?

Yes. Just to be clear, we were just saying $250 million is the absolute spend, right? And by any historical measure, spending 10% of your revenues on moving stuff around is not sort of a normal level. So it's not saying that's all incremental pain. There's lots of pieces of that you can pick at. I mean one piece that we've been very focused on, we knew we were going to have some expedited freight when we did the transaction, and we were behind even some of our own production, which had more expedite. So I don't know I'd say that the number of expedited freight costs this year was somewhere north of $20 million, $25 million. That's a very tangible thing that we need to go after. It's not all going to get solved in one quarter. It takes time to get it, but it's fully under our control, and we need to do that. And that's a big chunk of variance relative to our original plan for the year.

And seems to kind of clarify the spend, I realize we're not in a normal environment, but what is normal? Meaning if $250 million is what it was this year in a normalized environment for a business this size, what would be the normal level?

Yes. I think we want to separate IV Solutions. I don't want to get too granular, but we want to separate IV Solutions from everything else. Historically, those costs were in the 4% to 5% range for outside of solutions, and we're obviously a much higher percentage right now.

Our next question will come from Matt Mishan with KeyBanc.

Vivek, I don't want to get too granular around a single quarter, but I know a lot of people are focused on like the exit rate for this year and running that out to next year. So as I think about like low end on guidance, I'm thinking 350 to 360, and the range that takes you down to 350 is a step back from some of the progress you've made this quarter and getting closer to 360. Is there another step forward? And moving towards 2023, how should we think about like that range of outcomes for the fourth quarter?

I'm looking at it, Brian. Sorry, Matt. Good to hear every word. I think we just -- it's been a difficult year, Matt, and we just don't want to make a mistake. I think your question is 100% fair. I mean we were pretty transparent on the last call script. We got a little ahead of that from a revenue perspective. There is room to improve margins. I would feel better just saying, we stay within there and we'll address next year when we get there. if revenues didn't come through and currency got worse, there's a chance, you said -- what you just said could be right. We -- but there's an equal chance that if we do what we're supposed to do, we land where we intend to land. So I get the question. I don't want to pick in any one quarter either given what we put people through and what this year felt like.

Okay. I think that's fair. And then you talked about a few strategic efforts you were making. How are you thinking about like the timing of portfolio rationalization at this point?

There was some -- there are -- there were, there are a few countries where we have lines of business that are truly money losing. And we should address those first, if they're actionable. And so we've been doing that some spots where we had to change pricing in the market and some spots where it just makes sense to have a different go-to-market model. And so we've been focused on those because those are true negatives. And then in terms of is there something else on the portfolio rationalization front, it's not exactly the best sellers market of things in the world, which I don't think is a groundbreaking news to anybody. So I think right now, our focus is to get the assets running well in order and kind of see what the road brings, right? If there are positive cash flow contributing to the overall enterprise, we don't feel under any pressure or rush to do anything other than to maximize value.

Okay. And I don't know -- I'm not sure if Jayson asked this or not. How much was oncology constrained this (inaudible)? Any chance you can quantify that?

I think the answer we gave there was about the quarter, which you could say, it was $1 million or something. I don't think it would be an unrealistic assumption to say if you annualize that number, that was the impact of oncology constraints this year.

And our next question will come from Larry Solow with CJS Securities.

Just a couple of follow-ups. The slowness in the U.S., July and August, could that also be -- is there -- like from what I'm hearing from a couple other companies, a little bit of a return to some seasonality could that kind of fill out that impact for you guys as well at the Hospira level or...

Possibly. It looked more like the world did pre-COVID, even a bit less than that. So it's hard to say.

Okay. That's fair. Vivek, something mentioned...

It's still a little bump even in the fourth quarter, right? That's what I was trying to say. We need to hold our market share, gain market share, create new categories, that's what we're focused on, right? We're not going to change so much standing just make sure the portfolio is in the right places with our customers.

And Vivek, you mentioned some of the strategic efforts. Can you -- and I think you said, (inaudible), I think the exit of India for one. I imagine they're all kind of the small onesies and twosies, but can you give us an idea sort of can you quantify anything just to give us a little frame of reference about some of these projects are entailing, what they're doing in terms of moving the needle at all?

I mean, I think they're all onesies and twosies, but there's a number of them, right? So we'll take that the world we live in right now. So we have to grab them if we can. Even if it's a low single-digit type of help, we've got to do it. We got to do it.

Right. Right. And the gross margin pressure, obviously, nothing new. When you -- and I think you said -- I think Brian said, expect sort of in Q4 as well. Did you -- had you -- were you building any kind of improvement on the prior expectations? I don't think so. I just want to clarify on that one.

No. Brian?

No, we weren't, Larry. So I think that...

Some of the things really changed. FX has gotten a little worse, which has changed. But I feels like, freight at least has gotten a little better. Are you guys seeing at least a little bit of an improvement there? Maybe not enough to really move the needle just yet, but maybe some light at the end of the tunnel.

We believe the long-term forecast, right, which is back half diesel price changing next year, you would believe that. But at the moment, we have not seen any, right? There's still a strong disconnect between diesel pricing and regular fuel pricing in the U.S. And ocean inbound to the U.S. from Asia, ocean is down. But we don't really use a lot of that, right? It's outbound to Europe and other spots for us and air costs have not changed at all for expedited. So air expedite is still very big. And most of that stuff that drives that big, huge logistics number is variance on air and other expedites.

Okay. Just a couple more. You mentioned on the Med Line pump, it sounds like things are midline pumps certainly progressing. So are you basically back in the market with all? Can you just kind of give us a little more color there update?

I think you mean the Med Fusion.

Med Fusion pumps, excuse me, yes, yes.

I think I'd leave it at our comments in the script, which are -- we've informed customers, regulators of the actions that need to be taken to support the product. We are out in the field working on those actions, and we are supporting existing customers to have answers. And that's probably all I would say, right? They didn't have a lot of information a number of months ago, and they're getting real support in the field today.

Got you. All right. Just last one for Brian. Just on the cash flow, I know this year has been year-to-date usage of cash, although it sounds like things are getting a little bit better. As you look out to that give you numbers, I know you said at least the inventory should start hopefully becoming even a good guy for you guys next year in terms of positive. So would you expect that -- I imagine a lot of the integration stuff and costs will wind down. So hopefully, do you expect to return to free cash flow positive next year. And over the long run, can free cash flow approach? It hasn't -- 10 years, I think I have covered the covered, but can free cash flow sort of get close to net income?

Yes, Larry. Yes, on inventory, that's been the largest area of investment for us this year. It's $150 million to date. We do see that peaking by Q1 of next year and then probably stable after that. I don't know if it goes down, but certainly stable. And that alone should allow us to see some positive free cash flow next year. And then I think while it will take a while since we are going to continue investing in the integration as well as the quality systems, yes, eventually, at some point, we do get to where free cash flow is in line with our GAAP net income.

Yes. I mean I'll pile on just 2 things. One, I think, Larry, it's also the type of inventory because the supply chain has been so screwed up per year. We find a lot more raw materials. So even though the numbers (inaudible) we have finished goods everywhere, and I make sure that's been for lots of companies. The other thing is, look, it's not lost on us, right, for -- in the midst of COVID, net income and free cash flow were pretty tight here at very good levels. And of course, we want to get back to that. And the truth is, the transaction we had to use and go beyond even ICU's -- legacy ICU's cash flow to all this together this year. That is what happened, right? And at a minimum transaction to fund itself, and that's probably a halfway goal relative to getting all the way there. Thanks, everybody. We appreciate the interest in ICU Medical. We look forward to seeing you at various conferences early next year and having a call with you in the not-too-distant future. Thanks very much. Bye.

There conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.