Good day and welcome to the ICU Medical Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to John Mills of ICR. Please go ahead.

Good afternoon, everyone. Thank you for joining us to discuss ICU Medical's financial results for the fourth quarter and full year 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 our Investor page and click on Events Calendar and it will be under the fourth 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, 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 grander 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're well. We could not be happier that 2022 is over. We are operationally running better and getting back to serving hospitals with at least an equal balance of time between internal self-help versus external customer focus. At a high level, the macro environment is easing a bit with finally some relief in the economic volatility in the supply chain that we've been talking about for 6 straight quarters. Freight, fuel and foreign exchange started to trend in a better direction at the end of Q4. And while raw material and rollover labor inflation is real, at least some of the global surge pricing has retreated albeit above historical levels. U.S. and international demand was stable in Q4 with the U.S. having the same trends as Q3 in admissions with lower acuity. Like everyone in our industry, we want to start first by thanking all of our customers and their frontline workers for trusting us to serve you during these times. We cut a lot of the boilerplate out of the script today and we'll use the time to address the following: the results for legacy ICU and compare the full year results to our original expectations at the beginning of last year, explain Smiths Medical's revenues for Q4, confirm our reporting alignment starting in 2023 which was foreshadowed on the last call and shown in the recent investor conference now with our view of revenue growth by business unit, reflecting our substantial earnings miss in 2022 with a recap of the main drivers, discuss what comes back in the short term of this year, what's still available in the medium term and what is permanent, update on the normal housekeeping items, including quality remediation and integration and separation status, outline our…

Thanks, Vivek and good afternoon, everyone. To begin, I'll first walk down the P&L and discuss our results for the fourth quarter and then move on to cash flow and the balance sheet before wrapping up the discussion with our guidance for 2023. So starting with the revenue line. Our fourth quarter 2022 GAAP revenue was $578 million, compared to $341 million last year which is up 70% 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 number 3 of the presentation. For the legacy ICU business, adjusted revenue for the quarter was $313 million compared to $330 million last year which is down 2% on a constant currency basis and down 5% on a reported basis. Infusion Consumables was down 2% constant currency and down 5% reported. Infusion Systems was up 1% constant currency and down 4% reported and IV Solutions was down 7% on both a constant currency and reported basis. Note that the Q4 revenues for legacy ICU consumables and infusion systems were negatively impacted by a onetime revenue reserve related to the Italian government payback provision. This legislation which was originally passed back in 2015 but only recently implemented, requires companies who have supplied medical devices to public hospitals in Italy to reimburse a portion of any budget overruns each year. Although we, along with others in the industry, plan to appeal the enforceability of the law and the underlying reimbursement calculations, we established a reserve during the quarter for amounts we could be required to pay going back to 2015. While this reduced our legacy ICU consumables and Infusion Systems' Q4 growth rates by 2 to 3 percentage points, the impact to revenues and…

[Operator Instructions] Our first question comes from Jayson Bedford with Raymond James.

Can you hear me okay?

Perfectly.

That was dense. There's a lot there. And I appreciate that.

So we were trying for thorough.

Yes. My head is exploding here with all of that. Just I guess maybe on the fourth quarter revenue, I get the, what, roughly $8 million decremental. But I think Brian mentioned this was offset by onetime revenue tied to Smith. Do I have this right? And then just as maybe a related question, what are you carrying in terms of Smiths backlog into '23? And is there any kind of backlog captured in what looks to be about 4% revenue growth in '23?

Yes, Jayson. Jayson, on the first question, yes, that's correct. On the Italy reserves, the amount you referred to was within the range. And we would say most of that impact was offset by some onetime revenues on the legacy Smiths Medical business, specifically within the Infusion Systems business of legacy Smiths Medical.

On the backlog question, it's been hard to triangulate, Jayson, how much of the backlog was real. It was a huge number. But even though we've worked it down, it's not like revenues went back up above historical levels, right? I think what was embedded in there was also, unfortunately, a lot of panic ordering, etcetera. And a lot of those have fizzled out now that we've been supplying more regularly so we're going get a truer sense of what the real run rate is with -- with recent losses, etcetera. At the current moment, probably on the order of $40 million or so of backlog into next year. That's kind of where it is right now. But I don't know that means additional revenue beyond what the normal rate is.

Okay. So sorry, the $40 million, is that incremental on top of what would be a normalized backlog?

No. I think backlog for us has just been like a proxy for customer service levels at this point. I don't think that I would say it's additional revenue. It didn't work that way this year as we worked on the backlog, right? I think for me, it's much more that people are satisfied with our service and delivery levels.

Okay. Okay. I think it was mentioned that price increases helped the gross margin in the fourth quarter and that will continue into '23. Is there any way to kind of frame the size of the price increases and the impact that may have on topline in '23 as well?

I don't think we want to get too specific, there's a lot of moving parts. I just think we've been doing what we should do given the inflation that we've taken and what other industry participants clearly have been doing and I'd probably just leave it at that. We think we have good growth rates for Consumables and Infusion Systems for '23. A portion of that is priced.

Okay. And then maybe I'll ask one more and I'll let others jump in. But Vivek, you did mention the FDA inspection and I appreciate the transparency there but just what is the kind of the scope and what are they looking at? I assume this is more of a scheduled, every couple of year inspection but is there anything kind of specific that you're looking at?

I think this is a follow-up to the items that got Smiths the warning letter in the fall of '21. And we had kind of instinctively thought it was going to be a little bit later. And so every day later, it's just more time to prepare and execute. It's happening sooner. So it will be a good checkpoint to how much progress we've made over the last year certainly but it was sooner than we thought it was going to be. And so I'd rather be transparent about that.

Yes. Our next question comes from Larry Solow with CJS Securities.

Just a couple of follow-ups, Vivek, maybe just on Smiths. The quality control issues, putting those aside because some of those I realize are somewhat out of your control and hard to probably guesstimate in terms of time. But just in terms of service, order fulfillment and all that other stuff that obviously had some issues and you've been sort of chasing the ball for several quarters now. Where do you -- I'm certainly seeing a lot of improvement in the last couple of quarters. Where do you think you stand there? Like are you -- if we use a baseball analogy, are we in the middle of the inning. So where are we there before you, just on fulfillment and stuff that I feel like is probably in your control, it just may take a little longer than you originally thought.

I think we're -- and I know what team you like, I think we are halfway, I think we're halfway there. So middle innings because it is running better. You don't hear us talking about the physical logistics very much. Inventory is up $200 million. That means we're unable to produce. Now it's a different issue, how do we get the inventory down to the right level. But the other judgment is, is it all running at the right cost. So we sort of invested like crazy to buffer the supply chain and to overserve the customer to not lose more market share. That's the truth of what happened last year. But we did that at any expense and that's what pressured the P&L so much in a broad-based inflationary environment. So part of that doesn't go away, right? There's labor embedded in logistics costs. There's labor embedded in production costs. But the things that are addressable, we need to get those back before we say it's running, right. It's not just the service levels, are we running ourselves efficiently. Our operating margin sticks, right, relative to the categories we purchased.

So there is extra dollars that eventually will -- you probably can't quantify today but forgetting the freight and all the other -- the impediments to your earnings. But just there are excess expense -- like you said, you're spending at all costs. It sounds like not only a capital operating [ph].

I mean that's why we wait -- we try to go through all that minutia in the script there because that's exactly the point we were trying to...

And is that -- in that big range of earnings, you basically said it to our guidance a little bit, like you said, wider than normal. Is that just -- is that strictly -- I mean it sounds like you said basically Smiths, right about that?

It is basically Smiths' results and then inflation on the solutions portion of legacy ICU to get that back under control. We don't want to go through what we went through last year, Larry, right? And the world has not settled yet. A lot of these currencies still move in international, they are still moving. We don't want to do that.

Okay. I know on price, for competitive reasons, you can't talk too much about it. But -- and it sounds like you said, your business, there's a disproportionate business that's being impacted the most. And like you said, you're not even solutions business, you said a couple of times on today's call, essentially not even profitable, right which is not sustainable, right? So I'm curious like -- I don't know what you could say to that but you mentioned you're the third or fourth largest provider. Are the other guys -- or is there anything movement from the other -- everyone else just sitting there and waiting? I feel like even across all these other health care industries, contracts are being renegotiated? Or in its case, it just seems dramatic, like that you can't get in there for another 1.5 years. But is there any movement...

I think this is a very -- it's a topic we should not be talking about here, right? We've got our own business to run and we're going to do it for.

That's fair. Okay. Great. Last question, just on free cash flow, Brian. Can you give us some idea? It sounds like it's going to be -- we certainly improved last year from a big usage. Is it going to be just modestly positive? Is there any more color on that? And -- just kind of -- and the second question is -- last question on just debt reduction. I know originally, when the acquisition closed, we thought a couple of years you can get yourself down. Do you have any more -- any updated target on when you can reduce leverage?

Yes. I mean on free cash flow, I think the potential range for '23 is a bit wide, just given the fact that we invested so heavily in '22. And I think that's going to be largely dependent on how quickly we can get to the right inventory levels and moderate or even reduce them. And so you'll probably see most of that benefit come in the second half of the year. And then as it relates to debt paydown, I think what we just outlined in terms of guidance assumes no debt paydown this year. But I think, of course, depending on how quickly we get back to positive free cash flow generation will ultimately determine when we can begin to pay down debt. Not sure if it's this year but we just need to get to positive free cash flow first.

Our next question comes from Matthew Mishan with KeyBanc.

Kind of a follow-up to that previous question. I guess, when is the IT implementation scheduled to occur? And how are you thinking about portfolio rationalization and potential asset sales ahead of that IT implementation?

Sure, Matt. This is a little bit different than our other deals where we had to literally integrate, cut over and integrate on day 1. Here, we take control of the system and we can run it on our own and support it which is good because it still is even shaky a little bit in the fourth quarter. That will happen most likely if everything stays on schedule in the April, May time frame. Once we separate, then we have control of it and it's our choice of how quickly to pursue the next action which is the integration, that integration is valuable to us because it leads to all these next level synergies that we were outlining on the call. So we would like to do that sooner rather than later. It doesn't come for free. There's a cost to doing that. Let's remember what we went through with Hospira. But certainly, being separate allows more degrees of freedom of what we want to do on pieces of the portfolio because we actually have a system that we can make choices about what can go or stay with a given business. I don't want to -- I would say, big picture, systems are secondary in terms of creating value in that discussion versus business performance, returns, etcetera and having everything going in the right direction. So it's a component. It's not the sole driver in the line you're going down.

Okay. I think that's fair. And then I think you answered this question in a different way -- I'll ask it a little bit differently. You have a wide range. I get that you want to be conservative and the macro is still fairly uncertain. Just can you point to 2 or 3 of the major swing factors that would get you from the low end to the high end, as you kind of look at like the big moving pieces?

I think if you were to start with kind of the more macroeconomic items, certainly, FX, we saw in '22 what an impact that can have in a negative direction. And so certainly, that's something that can have a meaningful impact to our results. And then on the commercial side, I think that there's probably some opportunities there, especially within the legacy Vascular Access business, that could probably -- where we probably have some upside if we are able to get back some of that business that could.

We tried to give the exact bridge the missing 100, right, the missing 100 -- the $100 million variance, Brian, there's examples in gross margin, right? Some of the gross margins up is permanent, right? Labor is permanent -- labor is staying permanent for 2 years. Some of the raw material increases are absolutely permanent. And then there's some surge stuff that is going to go away. There is the macro on FX and fuel but it always comes back to revenues, right? And we have $100 million less of high-margin revenues that went away. We've got to figure out how to get those back. That's how we get the overall return to where we want it. And we kind of say, what were those buckets of what was missing? You can make your own call and the individual components there and the market structures of those categories. The ones that we feel are self-inflicted, there's no reason we shouldn't be out there trying to take those market shares back. The ones that have competitive challenges, we have to execute and go win.

Is that separate -- I think I caught a comment where you said you were going to maintain a higher level of inventory that could help on -- for onboarding new customers. I guess I'm just -- when I hear that, it seems like you guys are going to go after revenue growth incremental to customers you already have. But I guess it's also to a point, I mean, by having that higher inventory, do you think you can get back some of the customers -- some of the sales that you may have lost with existing customers? Is that completely two separate items or a single item with the inventory?

Well, it's a little bit of what we experienced with Hospira, right? We bought a situation that was challenged and we went on a global apology tour. And if you want to get some pieces of business back, you do have to make commitments about your reliability and your ability to supply because people only left because they couldn't get the product from Smiths. And so we do have to show better levels of inventory and we do have to make some commitments around it. So that's just called putting more money into the transaction, right? That's what I was saying we lost time and we cost a little bit more capital but we have to get a return on that by getting the business back.

And then last one. I hate to ask a near-term question like this but it just -- it does seem like you had a good November, December and then January and February what it seems like from an outside perspective, it seems relatively steady. Is this kind of the steadiest environment you guys have seen in a very long time? And is that translating to more confidence in the business?

I don't know if that's a short-term question. That is a question about how does this feel versus 2021, '22. I think on the legacy ICU business, the Consumables business is the biggest it's ever been. And so that has compounded nicely. We feel okay. The LVP business, it's the biggest it's been since we've had it. We're still disappointed we didn't kind of get as much as we would have liked over the last few years. I would say both those businesses has been reasonably predictable for the last 3 or 4 or 5 quarters and the issues that made them even slightly unpredictable there, the lack of supply in oncology, etcetera, are all being improved. I don't want to say it's exactly they're smooth with the Smiths portfolio yet. But it's like anything. We've had our control on it for 3 or 4 quarters. So yes, it is getting better each day but there's still a lot of work to do on the Smiths portfolios, right? We'll judge that if we can get those lost revenues back.

This concludes our question-and-answer session. I would like to turn the conference back over to Vivek Jain for any closing remarks.

Thanks for your continued interest in ICU Medical. We're glad '22 is over. We look forward to '23 and we look forward to updating you very soon because Q1 call will be here before we know it. Thanks, everyone. Appreciate it.

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