ICU Medical Earnings 2020-03-31

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PART I - FINANCIAL INFORMATION

Item1.	Financial Statements (Unaudited)

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Note 1:	Basis of Presentation

 

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S.") and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and reflect all adjustments, consisting of only normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of the consolidated results for the interim periods presented. Results for the interim period are not necessarily indicative of results for the full year. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K of ICU Medical, Inc., ("ICU") a Delaware corporation, filed with the SEC for the year ended December 31, 2019.

 

We are engaged in the development, manufacturing and sale of innovative medical products used in vascular therapy and critical care applications.  We sell the majority of our products through our direct sales force and through independent distributors throughout the U.S. and internationally.  Additionally, we sell our products on an original equipment manufacturer basis to other medical device manufacturers. All subsidiaries are wholly owned and are included in the condensed consolidated financial statements.  All intercompany balances and transactions have been eliminated.

Certain reclassifications have been made to prior year financial statements to conform to classifications used in the current year. These reclassifications had no impact on net income, stockholders' equity or cash flows as previously reported. We reclassified the usage of spare parts to separately state the amounts as an adjustment to reconcile net income to net cash provided by (used in) operating activities. The usage of spare parts was reported in the "Other" line item in the previously reported operating cash flows.

Note 2:    New Accounting Pronouncements

Recently Adopted Accounting Standards

In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Topic 350): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The amendments in this update align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software and hosting arrangements that include an internal use software license. Costs to develop or obtain internal-use software that cannot be capitalized under subtopic 350-40, such as training costs and certain data conversion costs, also cannot be capitalized for a hosting arrangement that is a service contract. Therefore, an entity in a hosting arrangement that is a service contract determines which project stage (that is, preliminary project stage, application development stage, or post-implementation stage) an implementation activity relates to. Costs for implementation activities in the application development stage are capitalized depending on the nature of the costs, while costs incurred during the preliminary project and post-implementation stages are expensed as the activities are performed. The amendments in this update require the entity to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. The amendments in this update are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The amendments in this update should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. We adopted this ASU effective January 1, 2020. This ASU did not have a material impact on our condensed consolidated financial statements or related disclosures.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this update modify the disclosure requirements in Topic 820. The amendments remove from disclosure: the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level 3 fair value measurements. The amendments also made the following disclosure modifications: for investments in certain entities that calculate net asset value, an entity is required to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly; and the amendments clarify that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. The amendments also added the following disclosure requirements: the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period; and the range and weighted average of significant

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unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information (such as the median or arithmetic average) in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The amendments in ASU 2018-02 are effective for fiscal years beginning after December 15, 2019. Early adoption is permitted. We adopted this ASU effective January 1, 2020. This ASU did not have a material impact on our condensed consolidated financial statements or related disclosures.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This update amends the FASB's guidance on the impairment of financial instruments by requiring timelier recording of credit losses on loans and other financial instruments. The ASU adds an impairment model that is based on expected losses rather than incurred losses. The ASU also amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. In April 2019, the FASB issued ASU No. 2019-04 - Codification Improvements to Topic 326, Financial Instruments - Credit Losses and in May 2019, the FASB issued ASU No. 2019-05, Financial Instruments-Credit Losses to Topic 326, Financial Instruments - Targeted Transition Relief. ASU 2019-04 clarifies and corrects certain areas of the Codification and ASU 2019-05 provides entities with an option to irrevocably elect the fair value option in Subtopic 825-10, Financial Instruments—Overall, applied on an instrument-by-instrument basis for eligible instruments, upon adoption of Topic 326. The amendments in these updates will be effective for fiscal years beginning after December 15, 2019. Early adoption is permitted as of the fiscal years beginning after December 15, 2018. The updated guidance requires a modified retrospective adoption. We adopted this ASU effective January 1, 2020. This ASU did not have a material impact on our condensed consolidated financial statements or related disclosures.

Recently Issued Accounting Standards

Note 3: Restructuring, Strategic Transaction and Integration

Restructuring, strategic transaction and integration expenses were $12.3 million and $24.4 million for the three months ended March 31, 2020 and 2019, respectively.

Restructuring

During the three months ended March 31, 2020 and 2019, restructuring charges were $7.2 million and $0.8 million, respectively. Restructuring charges for the three months ended March 31, 2020, were primarily related to severance and costs related to office and other facility closures.

During the year ended December 31, 2015, we incurred restructuring charges related to an agreement with Dr. Lopez, a member of our Board of Directors and a former employee in our research and development department, pursuant to which we bought out Dr. Lopez's right to employment under his then-existing employment agreement. The buy-out, including payroll taxes, is paid in equal monthly installments until December 2020.

    

The following table summarizes the details of changes in our restructuring-related accrual for the period ended March 31, 2020 (in thousands):

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	Accrued Balance January 1, 2020				Charges Incurred				Payments				Accrued Balance March 31, 2020
Severance pay and benefits	$	3,878			$	3,111			$	(2,620	)		$	4,369
Employment agreement buyout	460				—				(186		)		274
Facility closure expenses	1,211				4,062				(3,501		)		1,772
	$	5,549			$	7,173			$	(6,307	)		$	6,415

Strategic transaction and integration expenses

Note 4: Revenue

Our primary product lines are Infusion Consumables, Infusion Systems, IV Solutions and Critical Care. The vast majority of our sales of these products are made on a stand-alone basis to hospitals and distributors. Revenue is typically recognized upon transfer of control of the products, which we deem to be at point of shipment.

Payment is typically due in full within 30 days of delivery or the start of the contract term. Revenue is recorded in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We offer certain volume-based rebates to our distribution customers, which we record as variable consideration when calculating the transaction price. Rebates are offered on both a fixed and tiered/variable basis. In both cases, we use information available at the time and our historical experience with each customer to estimate the most likely rebate amount. We also provide chargebacks to distributors that sell to end-customers at prices determined under a contract between us and the end-customer. We use information available at the time and our historical experience to estimate and record provisions for chargebacks.

We also warrant products against defects and have a policy permitting the return of defective products, for which we accrue and expense at the time of sale using information available at that time and our historical experience. We also provide for extended service-type warranties, which we consider to be separate performance obligations. We allocate a portion of the transaction price to the extended service-type warranty based on its estimated relative selling price, and recognize revenue over the period the warranty service is provided.

Revenue disaggregated

    

The following table represents our revenues disaggregated by geography (in thousands):

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	For the three months ended March 31,
Geography	2020				2019
Europe, the Middle East and Africa	$	37,928			$	32,378
Other Foreign	60,521				51,361
Total Foreign	98,449				83,739
United States	230,158				247,193
Total Revenues	$	328,607			$	330,932

    

    

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The following table represents our revenues disaggregated by product (in thousands):

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	For the three months ended March 31,
Product line	2020				2019
Infusion Consumables	$	123,507			$	120,580
Infusion Systems	88,380				84,282
IV Solutions	104,291				113,182
Critical Care	12,429				12,888
Total Revenues	$	328,607			$	330,932

Contract balances

The following table presents our changes in the contract balances for the three months ended March 31, 2020 and 2019 (in thousands):

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	Contract Liabilities
Beginning balance, January 1, 2020	$	(4,855	)
Equipment revenue recognized	1,802
Equipment revenue deferred due to implementation	(3,990		)
Software revenue recognized	1,235
Software revenue deferred due to implementation	(2,664		)
Ending balance, March 31, 2020	$	(8,472	)
Beginning balance, January 1, 2019	$	(4,282	)
Equipment revenue recognized	448
Equipment revenue deferred due to implementation	(1,343		)
Software revenue recognized	345
Software revenue deferred due to implementation	(1,593		)
Ending balance, March 31, 2019	$	(6,425	)

    

As of March 31, 2020, revenue from remaining performance obligations related to implementation of software and equipment is $6.8 million. We expect to recognize substantially all of this revenue within the next three to six months dependent on implementation restriction due to COVID-19. Revenue from remaining performance obligations related to annual software licenses is $1.6 million. We expect to recognize substantially all of this revenue over the next twelve months.

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Note 5: Leases

    

Leases

We determine if an arrangement is a lease at inception. Our operating lease assets are separately stated in operating lease right-of-use ("ROU") assets and our financing lease assets are included in other assets on our condensed consolidated balance sheets. Our lease liabilities are included in accrued liabilities, and other long-term liabilities on our condensed consolidated balance sheets. We have elected not to recognize an ROU asset and lease liability for leases with terms of twelve months or less.

Lease ROU assets and lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. Most of our leases do not provide an implicit rate, therefore we use our incremental borrowing rate, which is the rate incurred to borrow on a collateralized basis over a similar term based on the information available at commencement date. Our lease ROU assets exclude lease incentives and initial direct costs incurred. Our lease terms include options to extend when it is reasonably certain that we will exercise that option. All of our operating leases have stated lease payments, which may include fixed rental increases. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.

    

Our leases are for corporate offices, sales and support offices, a distribution facility, device service centers and certain equipment. Our leases have original lease terms of one year to fifteen years, some of which include options to extend the leases for up to an additional five years. For all of our leases, we do not include optional periods of extension in our current lease terms for the exercise of options to extend is not reasonably certain.

The following table presents the components of our lease cost (in thousands):

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	For the three months ended March 31,
	2020				2019
Operating lease cost	$	2,791			$	2,430
Finance lease cost	29				—
Short-term lease cost	54				96
Total lease cost	$	2,874			$	2,526

    

The following table presents the supplemental cash flow information related to our leases (in thousands):

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	For the three months ended March 31,
	2020				2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	2,457			$	2,219
Operating cash flows from finance leases	$	29			$	—
Right-of-use assets obtained in exchange for lease obligations:
Operating leases	$	19,094			$	98
Finance leases	$	800			$	—

    

    

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The following table presents the supplemental balance sheet information related to our operating leases (in thousands, except lease term and discount rate):

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	As of March 31, 2020				As of December 31, 2019
Operating leases
Operating lease right-of-use assets	$	50,430			$	34,465
Accrued liabilities	$	7,544			$	7,362
Other long-term liabilities	45,166				28,896
Total operating lease liabilities	$	52,710			$	36,258
Weighted Average Remaining Lease Term
Operating leases	7.3 years				6.0 years
Weighted Average Discount Rate
Operating leases	5.06		%		5.57		%

The following table presents the supplemental balance sheet information related to our finance leases (in thousands, except lease term and discount rate):

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	As of March 31, 2020
Financing leases
Financing lease right-of-use assets	$	789
Accrued liabilities	$	188
Other long-term liabilities	601
Total financing lease liabilities	$	789
Weighted Average Remaining Lease Term
Financing leases	4.0 years
Weighted Average Discount Rate
Financing leases	4.32		%

        

As of March 31, 2020, the maturities of our operating and financing lease liabilities for each of the next five years is approximately (in thousands):

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	Operating Leases				Finance Leases
Remainder of 2020	$	7,195			$	174
2021	10,021				218
2022	9,309				218
2023	8,494				218
2024	8,094				25
2025	4,816				—
Thereafter	14,906				—
Total Lease Payments	62,835				853
Less imputed interest	(10,125		)		(64		)
Total	$	52,710			$	789

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Note 6:     Net Income Per Share

 

Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period plus dilutive securities. Dilutive securities include outstanding common stock options and unvested restricted stock units, less the number of shares that could have been purchased with the proceeds from the exercise of the options, using the treasury stock method. Options and restricted stock units that are anti-dilutive are not included in the treasury stock method calculation. There were 15,333 and 9,998 anti-dilutive securities for the three months ended March 31, 2020 and 2019, respectively.

The following table presents the calculation of net earnings per common share (“EPS”) — basic and diluted (in thousands, except per share data): 

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	Three months ended March 31,
	2020				2019
Net income	$	16,834			$	30,998
Weighted-average number of common shares outstanding (for basic calculation)	20,780				20,527
Dilutive securities	727				1,024
Weighted-average common and common equivalent shares outstanding (for diluted calculation)	21,507				21,551
EPS — basic	$	0.81			$	1.51
EPS — diluted	$	0.78			$	1.44

Note 7:    Derivatives and Hedging Activities

Hedge Accounting and Hedging Program

The purpose of our hedging program is to manage the foreign currency exchange rate risk on forecasted expenses denominated in currencies other than the functional currency of the operating unit. We do not issue derivatives for trading or speculative purposes.

To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge, and the hedges must be highly effective in offsetting changes to future cash flows on hedged transactions. The par forward contract is designated and qualifies as a cash flow hedge. Our derivative instruments are recorded at fair value on the condensed consolidated balance sheets and are classified based on the instrument's maturity date. We record changes in the intrinsic value of the effective portion of the gain or loss on the derivative instrument as a component of Other Comprehensive Income and we reclassify that gain or loss into earnings in the same line item associated with the forecasted transaction and in the same period during which the hedged transaction affects earnings.

In March 2020, we entered into a one-year cross-currency par forward contract that extends our current hedge of a portion of our Mexico forecasted expenses denominated in Pesos ("MXN"). The total notional amount of this outstanding derivative as of March 31, 2020 was approximately 473.2 million MXN. The term of the one-year contract is November 3, 2020 to December 1, 2021. The derivative instrument matures in equal monthly amounts at a fixed forward rate of 24.26 MXN/USD.

In November 2018, we entered into a one-year cross-currency par forward contract that hedges of a portion of our Mexico forecasted expenses denominated in MXN. The total notional amount of this outstanding derivative as of March 31, 2020 was approximately 265.3 million MXN. The term of the one-year hedge is November 1, 2019 to November 3, 2020. The derivative instrument matures in equal monthly amounts at a fixed forward rate of 22.109 MXN/USD.

The following table presents the fair values of our derivative instruments included within the Condensed Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019 (in thousands):

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	Derivatives
	Condensed Consolidated Balance Sheet Location		March 31, 2020				December 31, 2019
Derivatives designated as cash flow hedging instruments
Foreign exchange forward contract:
	Prepaid expenses and other current assets		$	—			$	2,366
	Accrued liabilities		(1,006		)		—
	Other long-term liabilities		(512		)		—
Total derivatives designated as cash flow hedging instruments			$	(1,518	)		$	2,366

    

The following table presents the amounts affecting the Condensed Consolidated Statements of Operations for the three months ended March 31, 2020 and 2019 (in thousands):

		Line Item in the Condensed Consolidated Statements of Operations		Three months ended March 31,
				2020				2019
Derivatives designated as cash flow hedging instruments
Foreign exchange forward contracts		Cost of goods sold		$	692			$	155

    

We recognized the following (losses) gains on our foreign exchange contracts designated as a cash flow hedge (in thousands):

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		Amount of (Loss) Gain Recognized in Other Comprehensive Income on Derivatives								Amount of Gain Reclassified From Accumulated Other Comprehensive Income into Income
		Three months ended March 31,										Three months ended March 31,
		2020				2019				Location of Gain Reclassified From Accumulated Other Comprehensive Income into Income		2020				2019
Derivatives designated as cash flow hedges:
Foreign exchange forward contract		$	(3,192	)		$	1,010			Cost of goods sold		$	692			$	155
Total derivatives designated as cash flow hedging instruments		$	(3,192	)		$	1,010					$	692			$	155

As of March 31, 2020, we expect approximately $1.0 million of the deferred losses on the outstanding derivatives in accumulated other comprehensive income to be reclassified to net income during the next twelve months concurrent with the underlying hedged transactions also being reported in net income.    

Note 8:    Fair Value Measurement

 

Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There are three levels of inputs that may be used to measure fair value:

•	Level 1: quoted prices in active markets for identical assets or liabilities;

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Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; or

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•	Level 3: unobservable inputs that are supported by little or no market activity and that are significant to the fair values of the assets or liabilities.

Earn-out Liability

In 2017, we recognized an earn-out liability upon the acquisition of HIS from Pfizer. Pfizer was entitled up to $225 million in cash if certain performance targets for the combined company for the three years ending December 31, 2019 were achieved. The initial fair value of the earn-out was determined by employing a Monte Carlo simulation in a risk neutral framework. The underlying simulated variable was adjusted EBITDA. The adjusted EBITDA volatility estimate was based on a study of historical asset volatility for a set of comparable public companies. The model included other assumptions including the market price of risk, which was calculated as the weighted average cost of capital ("WACC") less the long term risk free rate. The initial value assigned to the contingent consideration was a result of forecasted product demand of our HIS business. At each reporting date subsequent to the acquisition we remeasured the earn-out using the same methodology above and recognized any changes in value. As of December 31, 2019, it was determined that we did not meet the necessary performance targets that would require payout of any of the HIS earn-out liability.

In the fourth quarter of 2019, we recognized an earn-out liability related to the acquisition of Pursuit Vascular, Inc. ("Pursuit"). Pursuit's former equity holders are potentially entitled up to $50.0 million in additional cash consideration contingent upon the achievement of certain sales and gross profit targets for specific customers. The earn-out paid will be calculated as a percentage of gross profit achieved during the earn-out period against a pre-determined target gross profit, not to exceed $50.0 million. We used a Monte Carlo simulation model to determine the fair value of the earn-out liability. The Monte Carlo simulation model utilizes multiple input variables to determine the value of the earn-out liability including historical volatility, a risk free interest rate, counter party credit risk and projected future gross profit, see below simulation input table related to Pursuit. The historical volatility was based on the median of ICU and a certain peer group. The risk-free interest rate is equal to the yield, as of the valuation date, of the zero-coupon U.S. Treasury bill that is commensurate with the term of the earn-out. The counter party credit risk is based on a synthetic credit rating of B1. If the probabilities in the model significantly change from what we initially and subsequently anticipate, the change could have a significant impact on our financial statements in the period recognized. Our contingent earn-out liability is separately stated in our condensed consolidated balance sheets.

The following tables provide a reconciliation of the Level 3 earn-out liabilities measured at estimated fair value (in thousands):

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		Pursuit
		Earn-out Liability
Accrued balance, January 1, 2020		$	17,300
Change in fair value of earn-out (included in income from operations as a separate line item)		—
Accrued balance, March 31, 2020		$	17,300

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		HIS
		Earn-out Liability
Accrued balance, January 1, 2019		$	47,400
Change in fair value of earn-out (included in income from operations as a separate line item)		(7,700		)
Accrued balance, March 31, 2019		$	39,700

The fair value of the earn-out was the same at March 31, 2020 as the fair value calculated at December 31, 2019 as the underlying target forecast did not change.

The following tables provide quantitative information about Level 3 inputs for fair value measurement of our earn-out liabilities:

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Pursuit Earn-out

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Simulation Input		As of March 31, 2020			At Acquisition November 2, 2019
Revenue/Gross Profit Volatility		20.00	%		20.00	%
Discount Rate		15.00	%		15.00	%
Risk Free Rate		1.55	%		1.55	%
Counter Party Risk		6.00	%		6.00	%

HIS Earn-out

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Simulation Input		As of March 31, 2019			As of December 31, 2018
Adjusted EBITDA Volatility		30.00	%		30.00	%
WACC		8.25	%		8.25	%
20-year risk free rate		2.63	%		2.87	%
Market price of risk		5.47	%		5.24	%
Cost of debt		4.35	%		5.25	%

Investments and Foreign Currency Contracts    

The fair value of our investments is estimated using observable market-based inputs such as quoted prices, interest rates and yield curves or Level 2 inputs, which consisted of corporate bonds.     

The fair value of our Level 2 forward currency contracts are estimated using observable market inputs such as known notional value amounts, spot and forward exchange rates. These inputs relate to liquid, heavily traded currencies with active markets which are available for the full term of the derivative.

Our assets and liabilities measured at fair value on a recurring basis consisted of the following (Level 1, 2 and 3 inputs as defined above) (in thousands):

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	Fair value measurements at March 31, 2020
	Total carrying value				Quoted prices in active markets for identical assets (level 1)				Significant other observable inputs (level 2)				Significant unobservable inputs (level 3)
Assets:
Available for sale securities:
Short-term	$	20,115			$	—			$	20,115			$	—
Total Assets	$	20,115			$	—			$	20,115			$	—