0000883984-18-000025.txt : 20180809 0000883984-18-000025.hdr.sgml : 20180809 20180809163231 ACCESSION NUMBER: 0000883984-18-000025 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 96 CONFORMED PERIOD OF REPORT: 20180630 FILED AS OF DATE: 20180809 DATE AS OF CHANGE: 20180809 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ICU MEDICAL INC/DE CENTRAL INDEX KEY: 0000883984 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 330022692 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-34634 FILM NUMBER: 181005561 BUSINESS ADDRESS: STREET 1: 951 CALLE AMANECER CITY: SAN CLEMENTE STATE: CA ZIP: 92763-6212 BUSINESS PHONE: 949-366-2183 MAIL ADDRESS: STREET 1: 951 CALLE AMANECER CITY: SAN CLEMENTE STATE: CA ZIP: 92763-6212 10-Q 1 icui0630201810-q.htm 10-Q Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 For the quarterly period ended: June 30, 2018
 Or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from:              to
 
Commission File No.: 001-34634
 ICU MEDICAL, INC.
(Exact name of Registrant as specified in its charter)
 
Delaware
 
33-0022692
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
951 Calle Amanecer, San Clemente, California
 
92673
(Address of principal executive offices)
 
(Zip Code)
 (949) 366-2183
(Registrant’s telephone number including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
 
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
 
 
 
(Do not check if a smaller reporting company)
 
Emerging growth company o

 If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
 
Class
 
Outstanding at July 31, 2018
Common
 
20,467,529
 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):  Yes o No x
 



ICU MEDICAL, INC. AND SUBSIDIARIES
Form 10-Q
June 30, 2018

Table of Contents
PART I.
Financial Information
 
Page Number
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
 
 
 
 
 
Condensed Consolidated Balance Sheet, at June 30, 2018 and December 31, 2017
 
 
 
 
 
 
Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2018 and 2017
 
 
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2018 and 2017
 
 
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
 
PART II.
 
 
Item 1.
 
 
 
 
 
Item1A.
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 


2


PART I - FINANCIAL INFORMATION
Item1.
Financial Statements (Unaudited)

ICU MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value data) 
 
June 30,
2018
 
December 31,
2017
 
(Unaudited)
 
(1)
ASSETS
 
 
 
CURRENT ASSETS:
 

 
 

Cash and cash equivalents
$
309,097

 
$
290,072

Short-term investment securities
18,069

 
10,061

TOTAL CASH, CASH EQUIVALENTS AND INVESTMENT SECURITIES
327,166

 
300,133

Accounts receivable, net of allowance for doubtful accounts of $4,444 at June 30, 2018 and $3,311 at December 31, 2017
149,938

 
112,696

Inventories
288,950

 
288,657

Prepaid income tax
26,388

 
10,594

Prepaid expenses and other current assets
28,742

 
41,286

Related-party receivable
78,358

 
98,807

Assets held-for-sale

 
12,489

TOTAL CURRENT ASSETS
899,542

 
864,662

 
 
 
 
PROPERTY AND EQUIPMENT, net
415,727

 
398,684

LONG-TERM INVESTMENT SECURITIES
5,947

 
14,579

GOODWILL
13,348

 
12,357

INTANGIBLE ASSETS, net
134,812

 
143,753

DEFERRED INCOME TAXES
19,584

 
24,775

OTHER ASSETS
37,384

 
38,141

TOTAL ASSETS
$
1,526,344

 
$
1,496,951

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

CURRENT LIABILITIES:
 

 
 

Accounts payable
$
91,186

 
$
78,228

Accrued liabilities
111,280

 
132,064

TOTAL CURRENT LIABILITIES
202,466

 
210,292

 
 
 
 
CONTINGENT EARN-OUT LIABILITY
29,000

 
27,000

OTHER LONG-TERM LIABILITIES
31,805

 
55,326

DEFERRED INCOME TAXES
1,412

 
1,487

INCOME TAX LIABILITY
4,592

 
4,592

COMMITMENTS AND CONTINGENCIES

 

STOCKHOLDERS’ EQUITY:
 

 
 

Convertible preferred stock, $1.00 par value Authorized—500 shares; Issued and outstanding— none

 

Common stock, $0.10 par value — Authorized, 80,000 shares; Issued and outstanding, 20,460 shares at June 30, 2018 and 20,210 shares at December 31, 2017
2,046

 
2,021

Additional paid-in capital
644,389

 
625,568

Treasury stock, at cost
(20
)
 

Retained earnings
627,884

 
585,624

Accumulated other comprehensive loss
(17,230
)
 
(14,959
)
TOTAL STOCKHOLDERS' EQUITY
1,257,069

 
1,198,254

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$
1,526,344

 
$
1,496,951

______________________________________________________
(1) December 31, 2017 balances were derived from audited consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.

3


ICU MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except per share data)
 
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2018
 
2017
 
2018
 
2017
REVENUE:
 

 
 

 
 
 
 
Net sales
$
360,460

 
$
331,218

 
$
732,493

 
$
578,461

Other

 
296

 

 
792

TOTAL REVENUE
360,460

 
331,514

 
732,493

 
579,253

COST OF GOODS SOLD
208,660

 
243,452

 
431,692

 
402,246

GROSS PROFIT
151,800

 
88,062

 
300,801

 
177,007

OPERATING EXPENSES:
 

 
 

 
 
 
 
Selling, general and administrative
83,538

 
85,106

 
170,535

 
149,992

Research and development
13,575

 
12,967

 
26,161

 
24,608

Restructuring, strategic transaction and integration
18,690

 
19,921

 
40,259

 
49,322

Change in fair value of contingent earn-out
6,000

 
6,000

 
2,000

 
6,000

Contract settlement

 

 
28,917

 

TOTAL OPERATING EXPENSES
121,803

 
123,994

 
267,872

 
229,922

INCOME (LOSS) FROM OPERATIONS
29,997

 
(35,932
)
 
32,929

 
(52,915
)
BARGAIN PURCHASE GAIN

 

 

 
63,237

INTEREST EXPENSE
(130
)
 
(525
)
 
(265
)
 
(1,038
)
OTHER (EXPENSE) INCOME
(270
)
 
(2,720
)
 
756

 
(2,613
)
INCOME (LOSS) BEFORE INCOME TAXES
29,597

 
(39,177
)
 
33,420

 
6,671

BENEFIT FOR INCOME TAXES
1,457

 
2,117

 
2,509

 
12,132

NET INCOME (LOSS)
$
31,054

 
$
(37,060
)
 
$
35,929

 
$
18,803

NET INCOME (LOSS) PER SHARE
 

 
 

 
 
 
 
Basic
$
1.53

 
$
(1.87
)
 
$
1.77

 
$
0.98

Diluted
$
1.44

 
$
(1.87
)
 
$
1.67

 
$
0.93

WEIGHTED AVERAGE NUMBER OF SHARES
 

 
 

 
 
 
 
Basic
20,352

 
19,821

 
20,304

 
19,153

Diluted
21,569

 
19,821

 
21,536

 
20,312

 
The accompanying notes are an integral part of these condensed consolidated financial statements.

4


ICU MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
(In thousands)
 
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2018

2017
 
2018
 
2017
NET INCOME (LOSS)
$
31,054

 
$
(37,060
)
 
$
35,929

 
$
18,803

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Cash flow hedge adjustments, net of taxes of ($569) and $685 for the three months ended June 30, 2018 and 2017, respectively, and $4 and $685 for the six months ended June 30, 2018 and 2017, respectively
(1,801
)
 
1,119

 
14

 
1,119

Foreign currency translation adjustment, net of taxes of $0 and $8 for the three months ended June 30, 2018 and 2017, respectively, and $0 and $56 for the six months ended June 30, 2018 and 2017, respectively
(17,687
)
 
8,888

 
(2,290
)
 
10,914

Other adjustments, net of taxes of $0 for all periods
4

 
(151
)
 
5

 
(148
)
Other comprehensive (loss) income, net of taxes
(19,484
)
 
9,856

 
(2,271
)
 
11,885

TOTAL COMPREHENSIVE INCOME (LOSS)
$
11,570

 
$
(27,204
)
 
$
33,658

 
$
30,688

 
The accompanying notes are an integral part of these condensed consolidated financial statements.


5


ICU MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
 
 
Six months ended
June 30,
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 

 
 

Net income
$
35,929

 
$
18,803

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 

 
 
Depreciation and amortization
35,908

 
29,906

Provision for doubtful accounts
399

 
1,925

Provision for warranty and returns
513

 
2,031

Stock compensation
11,759

 
8,805

Loss on disposal of property and equipment
360

 
3,010

Bond premium amortization
204

 

Debt issuance costs amortization
144

 

Bargain purchase gain

 
(63,237
)
Change in fair value of contingent earn-out
2,000

 
6,000

Impairment of assets held for sale
269

 

Write-off of acquired intangible
5,000

 

Other
2,167

 
1,804

Changes in operating assets and liabilities, net of effects of acquisitions:
 

 
 
Accounts receivable
(43,260
)
 
(70,606
)
Inventories
12,124

 
66,870

Prepaid expenses and other assets
3,494

 
(95,254
)
Related-party receivables
24,143

 

Accounts payable
17,459

 
8,785

Accrued liabilities
(36,387
)
 
66,479

Income taxes, including excess tax benefits and deferred income taxes
(13,268
)
 
(14,185
)
Net cash provided by (used in) operating activities
58,957

 
(28,864
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 

 
 

Purchases of property and equipment
(47,365
)
 
(27,199
)
Proceeds from sale of asset
13,000

 
2

Business acquisitions, net of cash acquired
(1,300
)
 
(157,097
)
Intangible asset additions
(4,047
)
 
(2,005
)
Purchases of investment securities
(8,480
)
 

Proceeds from sale of investment securities
8,900

 

Net cash used in investing activities
(39,292
)
 
(186,299
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 

Proceeds from exercise of stock options
12,536

 
10,944

Proceeds from employee stock purchase plan

 
1,326

Purchase of treasury stock
(5,469
)
 
(3,739
)
Net cash provided by financing activities
7,067

 
8,531

Effect of exchange rate changes on cash
(7,707
)
 
2,473

NET INCREASE (DECREASE) CASH AND CASH EQUIVALENTS
19,025

 
(204,159
)
CASH AND CASH EQUIVALENTS, beginning of period
290,072

 
445,082

CASH AND CASH EQUIVALENTS, end of period
$
309,097

 
$
240,923

 
The accompanying notes are an integral part of these condensed consolidated financial statements.


6


ICU MEDICAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(In thousands)

 
Six months ended
June 30,
 
2018
 
2017
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES:
 
 
 
  Accounts payable for property and equipment
$
2,508

 
$
6,024

 
 
 
 
  Detail of acquisitions:
 
 
 
      Fair value of assets acquired
$

 
$
881,732

      Cash paid for acquisitions, net of cash acquired

 
(157,097
)
Non-cash seller note

 
(75,000
)
Estimated working capital adjustment

 
7,512

Contingent consideration

 
(19,000
)
Issuance of common stock

 
(413,139
)
 Bargain purchase gain

 
(63,237
)
Goodwill

 
1,015

          Liabilities assumed
$

 
$
162,786


The accompanying notes are an integral part of these consolidated financial statements.

7

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)



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, 2017.
 
We are engaged in the development, manufacturing and sale of innovative medical products used in infusion therapy, and critical care markets.  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.


Note 2:    New Accounting Pronouncements

Recently Adopted Accounting Standards

In March 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. This update adds SEC paragraphs pursuant to the SEC Staff Accounting Bulletin No. 118, which expresses the view of the staff regarding application of Topic 740, Income Taxes, in the reporting period that includes December 22, 2017 - the date on which the Tax Cuts and Jobs Act was signed into law. We adopted this ASU in the prior year and it did not have a material impact on our consolidated financial statements.

In August 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The amendments in this update change both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results to facilitate financial reporting that more closely reflects an entity's risk management activities. The amendments in this update also make certain targeted improvements to simplify the application of hedge accounting guidance and ease the administrative burden of hedge documentation requirements and assessing hedge effectiveness. The amendments are effective for the fiscal years, and interim reporting periods within those years, beginning on or after December 15, 2018. For cash flow and net investment hedges existing at the date of adoption, an entity should apply a cumulative-effect adjustment related to eliminating the separate measurement of ineffectiveness to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings as of the beginning of the fiscal year that an entity adopts the update. We early adopted this ASU on January 1, 2018 and this ASU did not have a material impact on our consolidated financial statements or related footnote disclosures.

In May 2017, the FASB issued ASU No. 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting. The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. Under the ASU, an entity will account for the effects of a modification unless (i) the fair value of the modified award is the same as the fair value of the original award immediately before the original award is modified, (ii) the vesting conditions of the modified award are the same vesting conditions as the original award immediately before the original award is modified, and (iii) the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The amendments in this ASU are effective prospectively for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. We adopted this ASU on January 1, 2018 and this ASU did not have a material impact on our consolidated financial statements or related footnote disclosures.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The amendments in this update clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The

8

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

amendments in this update provide a screen to determine when a set (integrated set of assets and activities) is not a business.  If the screen is not met, it (1) requires that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and (2) removes the evaluation of whether a market participant could replace the missing elements. The amendments in ASU 2017-01 are effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The amendments in this ASU should be applied prospectively on or after the effective date. We adopted this ASU on January 1, 2018 and this ASU did not have a material impact on our consolidated financial statements or related footnote disclosures.

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. Current generally accepted accounting principles prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until after the asset has been sold to an outside party. The amendments in ASU 2016-16 eliminates this prohibition. Accordingly an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Amendments in this update are effective for annual reporting periods beginning after December 15, 2017. We adopted this ASU on January 1, 2018 and this ASU did not have a material impact on our consolidated financial statements or related footnote disclosures.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 provides specific guidance on eight cash flow issues where current guidance is unclear or does not include any specifics on classification. The eight specific cash flow issues are: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with zero coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies, including bank-owned policies; distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. The amendments in ASU 2016-15 are effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. Amendments should be applied using a retrospective transition method to each period presented. We adopted this ASU on January 1, 2018 and this ASU did not have a material impact on our consolidated financial statements or related footnote disclosures.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which amends certain aspects of recognition, measurement, presentation and disclosure of financial instruments. This amendment requires all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under the equity method of accounting or those that result in the consolidation of the investee). The amendments in this update will be effective for fiscal years beginning after December 15, 2017. We adopted this ASU on January 1, 2018 and this ASU did not have a material impact on our consolidated financial statements or related footnote disclosures.
        
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 removes inconsistencies and weaknesses in revenue requirements, provides a more robust framework for addressing revenue issues, improves comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets, provides more useful information to users of financial statements through improved disclosure requirements and simplifies the preparation of financial statements by reducing the number of requirements to which an entity must refer. This guidance requires that an entity depict the consideration by applying a five-step analysis in determining when and how revenue is recognized. The new model will require revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration a company expects to receive in exchange for those goods or services. On April 1, 2015, the FASB voted for a one-year deferral of the effective date of the new revenue recognition standard, ASU 2014-09.  On July 15, 2015, the FASB affirmed these changes, which requires public entities to apply the amendments in ASU 2014-09 for annual reporting beginning after December 15, 2017. Subsequent to the issuance of this ASU, the FASB issued three amendments: ASU No. 2016-08, which clarifies principal versus agent considerations; ASU 2016-10, which clarifies guidance related to identifying performance obligations and licensing implementation; and ASU 2016-12, which provides narrow-scope improvements and practical expedients. All of the amendments have the same effective date mentioned above.

We adopted the standard effective January 1, 2018. See Note 5, Revenue for a discussion of the impact and the required enhanced disclosures.

Recently Issued Accounting Standards

    

9

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


In February 2018, the FASB issued ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The amendments in this update also require certain disclosures about stranded tax effects. The amendments in ASU 2018-02 are effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. We are currently evaluating the impact of this ASU on the consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The amendments in this update remove the second step of the impairment test. An entity will apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment. The amendments in ASU 2017-04 are effective for the annual or interim impairment test in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. This ASU is not expected to have a material impact on our consolidated financial statements or related footnote 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. The amendments in this update 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 are currently evaluating the impact of this ASU on the consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The amendments in this update require an entity to recognize a right-of-use asset and lease liability for all leases with terms of more than 12 months. Recognition, measurement and presentation of expenses will depend on classification as finance or operating lease. The amendments also require certain quantitative and qualitative disclosures about leasing arrangements. The amendments in this update will be effective for fiscal years beginning after December 15, 2019. Early adoption is permitted. The updated guidance requires a modified retrospective adoption. We are currently evaluating the impact of this ASU on the consolidated financial statements and related disclosures.     
    
Note 3: Acquisition, Strategic Transaction and Integration Expenses

Acquisitions

On February 1, 2017, we acquired 100% interest in Fannin (UK) Limited ("Fannin") for total consideration of approximately $1.5 million. Fannin provides infusion therapy consumable products to the healthcare sector in the United Kingdom and Ireland.

On February 3, 2017, we acquired 100% interest in Pfizer Inc.’s (“Pfizer”) Hospira Infusion Systems ("HIS") business for total cash consideration of approximately $255.8 million (net of estimated working capital adjustments paid at closing), which was financed with existing cash balances and a $75 million three-year interest-only seller note. We also issued 3.2 million shares of our common stock. The fair value of the common shares issued to Pfizer was determined based on the closing price of our common shares on the issuance date, discounted to reflect a contractual lock-up period whereby Pfizer cannot transfer the shares, subject to certain exceptions, until the earlier of (i) the expiration of Pfizer’s services to us in the related transitional services agreement or (ii) eighteen months from the closing date. Additionally, Pfizer also may be entitled up to an additional $225 million in cash contingent consideration based on the achievement of performance targets for the combined company for the three years ending December 31, 2019 ("Earnout Period"). In the event that the sum of our Adjusted EBITDA as defined in the Amended and Restated Stock and Asset Purchase Agreement between us and Pfizer (the “HIS Purchase Agreement”) for the three years in the Earnout Period (the "Cumulative Adjusted EBITDA") is equal to or exceeds approximately $1 billion ("the "Earnout Target"), then Pfizer will be entitled to receive the full amount of the earnout. In the event that the Cumulative Adjusted EBITDA is equal to or greater than 85% of the Earnout Target (but less than the Earnout Target), Pfizer will be entitled to receive the corresponding percentage of the earnout. In the event that the Cumulative Adjusted EBITDA is less than 85% of the Earnout Target, then no earnout amount will be earned by Pfizer. The initial fair value of the earn-out was determined by employing a Monte Carlo simulation in a risk neutral framework. The underlying

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ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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 includes 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. We believe that the acquisition of the HIS business, which includes IV pumps, solutions and consumable devices complements our pre-existing business by creating a company that has a complete infusion therapy product portfolio. We believe that the acquisition significantly enhances our global footprint and platform for continued competitiveness and growth.

The purchase price allocation for HIS was completed during the fourth quarter of 2017.

Final Purchase Price
    
The following table summarizes the final purchase price and the final allocation of the purchase price related to the assets and liabilities purchased (in thousands, except per share data):

Cash consideration for acquired assets
 
$
180,785

Fair value of Seller Note
 
75,000

Fair value of contingent consideration payable to Pfizer (long-term)
 
19,000

 
 
 
Issuance of ICU Medical, Inc. common shares:
 
 
Number of shares issued to Pfizer
 
3,200

Price per share (ICU's trading closing share price on the Closing Date)
 
$
140.75

Market price of ICU shares issued to Pfizer
 
$
450,400

Less: Discount due to lack of marketability of 8.3%
 
(37,261
)
Equity portion of purchase price
 
413,139

Total Consideration
 
$
687,924

 
 
 
Purchase Price Allocation:
 
 
Cash and cash equivalents
 
$
31,082

Trade receivables
 
362

Inventories
 
417,622

Prepaid expenses and other assets
 
13,911

Property and equipment
 
288,134

Intangible assets(1)
 
131,000

Other assets
 
29,270

Accounts payable
 
(12,381
)
Accrued liabilities
 
(47,936
)
Long-term liabilities(2)
 
(67,170
)
Total identifiable net assets acquired
 
$
783,894

Deferred tax liability
 
(25,080
)
Gain on Bargain Purchase
 
(70,890
)
Purchase Consideration
 
$
687,924

______________________________

(1) Identifiable intangible assets includes $48 million of customer relationships, $44 million of developed technology - pumps and dedicated sets, $34 million of developed technology - consumables, and $5 million of in-process research and development ("IPR&D"). The weighted amortization period are as follows: approximately nine years for the total identifiable assets; eight years for customer relationships; ten years for the developed technology - pumps and dedicated sets; and twelve years for the developed technology - consumables. The IPR&D is non-amortizing until the associated research and development efforts are complete.


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ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(2) Long-term liabilities primarily consisted of contract liabilities, product liabilities and long-term employee benefits.

The fair value of the assets acquired and liabilities assumed exceeded the fair value of the consideration to be paid resulting in a bargain purchase gain. Before recognizing a gain on a bargain purchase, we reassessed the methods used in the purchase accounting and verified that we had identified all of the assets acquired and all of the liabilities assumed, and that there were no additional assets or liabilities to be considered.  We also reevaluated the fair value of the contingent consideration transferred to determine that it was appropriate.  We determined that the bargain purchase gain was primarily attributable to expected restructuring costs as well as a reduction to the initially agreed upon transaction price caused primarily by revenue shortfalls across all market segments of the HIS business, negative manufacturing variance due to the drop in revenue and higher operating and required stand up costs, when compared to forecasts of the HIS business at the time that the purchase price was agreed upon. After the continuing review of the product demand and operations of the HIS business, including the resulting expected restructuring activities, we forecasted our estimated Adjusted EBITDA from the HIS business in 2017 to be $35 million - $40 million, which is considerably lower than the forecast contemplated in initial negotiations with Pfizer, which resulted in an estimated fair value of $19 million related to the $225 million earn out. Restructuring costs, if incurred, would be expensed in future periods (see Note 4: Restructuring Charges). The bargain purchase gain is separately stated below income from operations in the accompanying condensed consolidated statements of operations for the six months ended June 30, 2017.

The identifiable intangible assets and other long-lived assets acquired have been valued as Level 3 assets at fair market value. The estimated fair value of identifiable intangible assets were developed using the income approach and are based on critical estimates, judgments and assumptions derived from analysis of market conditions, discount rate, discounted cash flows, royalty rates, customer retention rates and estimated useful lives. Fixed assets were valued with the consideration of remaining economic lives. The raw materials inventory was valued at historical cost and adjusted for any obsolescence, the work in process was valued at estimated sales proceeds less costs to complete and costs to sell, and finished goods inventory was valued at estimated sales proceeds less costs to sell. The prepaid expenses and other current assets and assumed liabilities were recorded at their carrying values as of the date of the acquisition, as their carrying values approximated their fair values due to their short-term nature.

On November 29, 2017, we acquired Medical Australia for total consideration of $9.0 million. Medical Australia delivers similar consumable Infusion products as our current businesses to Australia and surrounding regions. The purchase price allocation is preliminary and subject to future revision as the acquired assets and liabilities assumed are dependent upon the finalization of the related valuations.

Strategic Transaction and Integration Expenses

We incurred and expensed $18.0 million and $37.8 million in transaction and integration expenses during the three and six months ended June 30, 2018 primarily related to the integration of the HIS business. These costs primarily related to consulting, legal and the transitional service agreement. We incurred $12.4 million and $33.5 million in transaction and integration expenses during the three and six months ended June 30, 2017, respectively. The transaction and integration expenses were primarily related to our acquisition of the HIS business.

Note 4: Restructuring Charges

During the six months ended June 30, 2018 and the year ended December 31, 2017, restructuring charges were incurred as a result of integrating the HIS acquired operations into our business and include severance costs related to involuntary employee terminations and facility exit costs related to the closure of the Dominican Republic manufacturing facility, which was sold in March 2018. All material charges in regard to these restructuring activities have been incurred as of June 30, 2018. The cumulative amount incurred to date in connection with the HIS acquisition is $21.3 million. Restructuring charges are included in the restructuring, strategic transaction and integration line item in our condensed consolidated statement of operations.

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 June 30, 2018 (in thousands):


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ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
Accrued Balance December 31, 2017
 
Charges
Incurred
 
Payments
 
Other Adjustments
 
Accrued Balance
June 30,
 2018
Severance pay and benefits
$
915

 
$
2,345

 
$
(2,611
)
 
$

 
$
649

Employment agreement buyout
1,114

 

 
(191
)
 
(4
)
 
919

Facility closure expenses

 
160

 
(160
)
 

 

 
$
2,029

 
$
2,505

 
$
(2,962
)
 
$
(4
)
 
$
1,568


Note 5: Revenue

Adoption of ASC Topic 606, “Revenue from Contracts with Customers”
We adopted ASU No. 2014-09, Revenue from Contracts with Customers (ASC Topic 606), effective January 1, 2018 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting beginning after January 1, 2018 are presented under ASC Topic 606, while prior period amounts are not adjusted and will continue to be reported in accordance with our historic accounting under ASC Topic 605, Revenue Recognition.

Due to the cumulative impact, net of tax, of adopting ASC Topic 606, we recorded a net increase of $6.3 million to opening retained earnings as of January 1, 2018. The impact is primarily related to our bundled arrangements where we sell software licenses and implementation services, in addition to equipment, consumables and solutions. Under ASC Topic 605, revenue for the equipment was recognized upon delivery and software licenses and implementation services were typically recognized over the contract term. Under ASC Topic 606, revenue for the bundled equipment, software and software implementation services are recognized upon implementation. This results in an acceleration of software related revenue, offset by a delay in the recognition of related revenue of the equipment. Under ASC Topic 605, consumables and solutions revenues were typically recognized upon delivery. Under ASC 606, consumables and solutions revenues are recognized as the customer obtains control of the asset, which is at shipping point. This results in an acceleration in the recognition of consumables and solutions revenue.

Additionally, the timing of revenue recognition for software license renewals changed under ASC Topic 606. Under ASC Topic 605, revenue related to software renewals was recognized on a ratable basis over the license period. Under ASC Topic 606, the license, which is considered functional IP, is considered to be transferred to the customer at a point in time, specifically, at the start of each annual renewal period. As a result, under ASC Topic 606, revenue related to our annual software license renewals is accelerated when compared to ASC Topic 605.

Revenues are recognized when control of the promised goods or services is transferred to the customer, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

The following tables represent the amounts by which each financial statement line item is affected in the current year as a result of applying ASC Topic 606 (in thousands):

 
For the three months ended
June 30, 2018
 
For the six months ended
June 30, 2018
 
As Reported
 
Without Adoption of ASC 606
 
Effect of Adoption
 
As Reported
 
Without Adoption of ASC 606
 
Effect of Adoption
Revenue
$
360,460

 
$
352,288

 
$
8,172

 
$
732,493

 
$
722,309

 
$
10,184

Cost of goods sold
$
208,660

 
$
207,640

 
$
1,020

 
$
431,692

 
$
430,651

 
$
1,041

Gross Profit
$
151,800

 
$
144,648

 
$
7,152

 
$
300,801

 
$
291,658

 
$
9,143


13

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
 
As of June 30, 2018
 
 
As Reported
 
Without Adoption of ASC Topic 606
 
Effect of Adoption
Prepaid expenses and other current assets
 
28,742

 
$
32,885

 
$
(4,143
)
Accrued liabilities
 
111,280

 
$
132,936

 
$
(21,656
)
Deferred income taxes
 
19,584

 
$
21,583

 
$
(1,999
)

Revenue Recognition

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

 
For the three months
ended June 30,
 
For the six months
ended June 30,
Geography
2018
 
2017 (1)
 
2018
 
2017 (1)
EMEA
$
33,867

 
$
31,905

 
$
73,391

 
$
56,858

APAC
18,410

 
15,673

 
37,034

 
27,089

LATAM
15,557

 
19,208

 
28,650

 
25,685

North America
17,810

 
16,537

 
36,945

 
28,098

Other

 

 
80

 

Total Foreign
85,644

 
83,323

 
176,100

 
137,730

United States
274,816

 
248,191

 
556,393

 
441,523

Total Revenues
$
360,460

 
$
331,514

 
$
732,493

 
$
579,253


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

 
For the three months ended
June 30,
 
For the six months ended
June 30,
Product line
2018
 
2017 (1)
 
2018
 
2017 (1)
Infusion Consumables
$
123,782

 
$
77,561

 
$
243,693

 
$
153,274

IV Solutions
135,325

 
134,414

 
279,765

 
231,784

Infusion Systems (2)
88,376

 
73,122

 
181,815

 
119,792

Critical Care
12,977

 
11,874

 
27,220

 
24,270

Other

 
34,543

 

 
50,133

Total Revenues
$
360,460

 
$
331,514

 
$
732,493

 
$
579,253

_______________________________
(1) As noted above, prior period amounts have not been adjusted under the modified retrospective method.
(2) For the three and six months ended June 30, 2018, Infusion Systems revenue includes $4.6 million and $5.9 million, respectively, in revenue recognized over time. The remainder of our revenue is recognized at a point in time. See below for details related to arrangements with multiple performance obligations.
    
Our primary product lines are Infusion Consumables, IV Solutions, Infusion Systems and Critical Care. The vast majority of our sales of these products are made on a stand-alone basis to hospitals, group purchasing organization member hospitals and distributors. Our product sales are typically free on board shipping point and ownership of the product transfers to the customer on shipment. As a result, 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.

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ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


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 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.

Arrangements with Multiple Performance Obligations

We also enter into arrangements which include multiple performance obligations. These arrangements typically consist of the sale of infusion systems equipment, along with annual software licenses and related software implementation services, as well as infusion consumables, IV solutions and extended warranties. For such arrangements, we allocate the transaction price to each performance obligation based on its relative standalone selling price. Equipment, software licenses and software implementation services are typically combined into a single performance obligation and recognized upon implementation. As annual software licenses are renewed, we recognize revenue for the license at a point in time, at the start of each annual renewal period. Consumables and solutions are separate performance obligations, recognized at a point in time.

The most significant judgments related to these arrangements include:

Identifying the various performance obligations of these arrangements.
Estimating the relative standalone selling price of each performance obligation, typically using directly observable method or calculated on a cost plus margin basis method.

Contract balances

The following table presents our changes in the contract balances for the six months ended June 30, 2018 (in thousands):
 
Contract Liabilities
Beginning balance, January 1, 2018
$
(7,066
)
Equipment revenue recognized
1,971

Equipment revenue deferred due to implementation
(2,733
)
Software revenue recognized
4,685

Software revenue deferred due to implementation
(4,845
)
Ending balance, June 30, 2018
$
(7,988
)
    
As of June 30, 2018, revenue from remaining performance obligations related to implementation of software and equipment is $6.5 million. We expect to recognize substantially all of this revenue within the next six months. Revenue from remaining performance obligations related to annual software licenses is $1.5 million. We expect to recognize substantially all of this revenue over the next twelve months.

Costs to Obtain a Contract with a Customer

As part of the cost to obtain a contract, we may pay incremental commissions to sales employees upon entering into a sales contract. Under ASC Topic 606, we have elected to expense these costs as incurred as the period of benefit is less than one year.
 
Practical expedients and exemptions

In addition to the practical expedient applied to sales commissions, under ASC Topic 606, we elected to apply the practical expedient for shipping and handling costs incurred after the customer has obtained control of a good. We will continue to treat these costs as a fulfillment cost rather than as an additional promised service.

Note 6:     Net Income (Loss) Per Share
 
Basic earnings (loss) 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

15

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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 that are anti-dilutive, where their exercise price exceeds the average market price of the common stock are not included in the treasury stock method calculation. There were no anti-dilutive securities for the three months ended June 30, 2018 and 2017. There were 1,548 and 61 anti-dilutive securities for the six months ended June 30, 2018 and 2017, respectively.

The following table presents the calculation of net earnings (loss) per common share (“EPS”) — basic and diluted (in thousands, except per share data): 
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2018
 
2017
 
2018
 
2017
Net income (loss)
$
31,054

 
$
(37,060
)
 
$
35,929

 
$
18,803

Weighted-average number of common shares outstanding (for basic calculation)
20,352

 
19,821

 
20,304

 
19,153

Dilutive securities
1,217

 

 
1,232

 
1,159

Weighted-average common and common equivalent shares outstanding (for diluted calculation)
21,569

 
19,821

 
21,536


20,312

EPS — basic
$
1.53

 
$
(1.87
)
 
$
1.77

 
$
0.98

EPS — diluted
$
1.44

 
$
(1.87
)
 
$
1.67

 
$
0.93



Note 7:    Derivatives and Hedging Activities

Hedge Accounting and Hedging Program

During the second quarter of 2017, we implemented a cash flow 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.

In May 2017, we entered into a two-year cross-currency par forward contract to hedge a portion of our Mexico forecasted expenses denominated in Pesos ("MXN"). 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 instrument is recorded at fair value on the condensed consolidated balance sheets and is 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. The total notional amount of our outstanding derivative as of June 30, 2018 was approximately 330.2 million MXN. The term of our currency forward contract is May 1, 2017 to May 1, 2019. The derivative instrument matures in equal monthly amounts at a fixed forward rate of 20.01MXN/USD over the term of the two-year contract.

In January 2018, we entered into an additional six-month cross-currency par forward contract that extends our current hedge of a portion of our Mexico forecasted expenses denominated in MXN. The total notional amount of this outstanding derivative as of June 30, 2018 was approximately 183.9 million MXN. The term of the six-month contract is May 1, 2019 to November 1, 2019. The derivative instrument matures in equal monthly amounts at a fixed forward rate of 20.43 MXN/USD over the term of the six-month contract.
    
The following table presents the fair values of our derivative instruments included within the Condensed Consolidated Balance Sheet as of June 30, 2018 and December 31, 2017 (in thousands):


16

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
Derivatives
 
Condensed Consolidated Balance Sheet
Location
 
June 30, 2018
 
December 31,
2017
Derivatives designated as cash flow hedging instruments
 
 
 
 
 
Foreign exchange forward contract:
 
 
 
 
 
 
Accrued Liabilities
 
$
306

 
$
187

 
Other long-term liabilities
 
265

 
402

Total derivatives designated as cash flow hedging instruments
 
 
$
571

 
$
589


The following table presents the amounts affecting the Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2018 and 2017 (in thousands):

 
 
Line Item in the
Condensed Consolidated Statements of Operations
 
Three months ended
June 30,
 
Six months ended
June 30,
 
 
 
2018
 
2017
 
2018
 
2017
Derivatives designated as cash flow hedging instruments
 
 
 
 
 
 
 
 
 
 
Foreign exchange forward contracts
 
Cost of goods sold
 
$
261

 
22

 
$
496

 
$
22


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

 
 
Amount of Gain (Loss) Recognized in Other Comprehensive Income on Derivatives
 
Amount of Gain Reclassified From Accumulated Other Comprehensive Income into Income
 
 
Three months ended
June 30,
 
 
 
Three months ended
June 30,
 
 
 
 
 
 
 
2018
 
2017
 
Location of Gain Reclassified From Accumulated Other Comprehensive Income into Income
 
2018
 
2017
Derivatives designated as cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign exchange forward contract
 
$
(2,109
)
 
$
1,826

 
Cost of goods sold
 
$
261

 
$
22

Total derivatives designated as cash flow hedging instruments
 
$
(2,109
)
 
$
1,826

 
 
 
$
261

 
$
22




17

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
 
Amount of Gain Recognized in Other Comprehensive Income on Derivatives
 
Amount of Gain Reclassified From Accumulated Other Comprehensive Income into Income
 
 
Six months ended
June 30,
 
 
 
Six months ended
June 30,
 
 
 
 
 
 
 
2018
 
2017
 
Location of Gain Reclassified From Accumulated Other Comprehensive Income into Income
 
2018
 
2017
Derivatives designated as cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign exchange forward contract
 
$
514

 
$
1,826

 
Cost of goods sold
 
$
496

 
$
22

Total derivatives designated as cash flow hedging instruments
 
$
514

 
$
1,826

 
 
 
$
496

 
$
22


As of June 30, 2018, we expect approximately $0.3 million of the deferred losses on the outstanding derivatives in accumulated other comprehensive income to be reclassified to net income during the next 12 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;
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
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.

During the first quarter of 2017, we recognized an earn-out liability upon the acquisition of HIS from Pfizer. Pfizer may be entitled up to $225 million in cash if certain performance targets for the combined company for the three years ending December 31, 2019 are 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 includes other assumptions including the market price of risk, which was calculated as the 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, as discussed further in Note 3: Acquisition, Strategic Transaction and Integration Expenses. At each reporting date subsequent to the acquisition we re-measure the earn-out using the same methodology above and recognize any changes in value. If the probability of achieving the performance target significantly changes from what we initially anticipated, 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 table provides a reconciliation of the Level 3 earn-out liability measured at estimated fair value as of December 31, 2017 to June 30, 2018 (in thousands):
 
 
Earn-out Liability
Accrued balance, December 31, 2017
 
$
27,000

Change in fair value of earn-out (included in income from operations as a separate line item)
 
2,000

Accrued balance, June 30, 2018
 
$
29,000



18

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The fair value of the earn-out at June 30, 2018 changed from the fair value calculated at December 31, 2017 due to a change in the underlying cumulative adjusted EBITDA forecast, and changes in certain assumptions used in the Monte Carlo simulation, as detailed in the below table.

The following table provides quantitative information about Level 3 inputs for fair value measurement of our earn-out liability as of December 31, 2017 and June 30, 2018. Significant increases or decreases in these inputs in isolation could result in a significant impact on our fair value measurement:
Simulation Input
 
As of
June 30, 2018
 
As of
December 31, 2017
Adjusted EBITDA Volatility
 
25.00
%
 
26.00
%
WACC
 
8.25
%
 
8.75
%
20-year risk free rate
 
2.91
%
 
2.58
%
Market price of risk
 
5.20
%
 
5.99
%
Cost of debt
 
4.72
%
 
4.08
%

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.

The assets related to our Dominican Republic manufacturing facilities were classified as assets held-for-sale as of December 31, 2017. These assets are separately stated in our condensed consolidated balance sheet. The fair value of these Level 3 assets was determined as part of the HIS business valuation and was based on a market approach using comparable building and land sales data and the analysis of market conditions.

There were no transfers between Levels during the six months ended June 30, 2018.

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):
 
Fair value measurements at June 30, 2018
 
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
$
18,069

 
$

 
$
18,069

 
$

Long-term
5,947

 

 
5,947

 

Total Assets
$
24,016

 
$

 
$
24,016

 
$

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Earn-out liability
$
29,000

 
$

 
$

 
$
29,000

Foreign exchange forwards:
 
 
 
 
 
 
 
Accrued liabilities
306

 

 
306

 

Other long-term liabilities
265

 

 
265

 

Total Liabilities
$
29,571

 
$

 
$
571

 
$
29,000



19

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
Fair value measurements at December 31, 2017
 
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
$
10,061

 
$

 
$
10,061

 
$

Long-term
14,579

 

 
14,579

 

Total Assets
$
24,640

 
$

 
$
24,640

 
$

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Earn-out liability
$
27,000

 
$

 
$

 
$
27,000

Foreign exchange forwards:
 
 
 
 
 
 
 
Accrued liabilities
187

 

 
187

 

Other long-term liabilities
402

 

 
402

 

Total Liabilities
$
27,589

 
$

 
$
589

 
$
27,000

    
Our assets measured at fair value on a nonrecurring basis consisted of the following (Level 1, 2 and 3 inputs as defined above) (in thousands):
 
Fair value measurements at December 31, 2017
 
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:
 
 
 
 
 
 
 
Assets held-for-sale
$
12,489

 
$

 
$

 
$
12,489

Total Assets
$
12,489

 
$

 
$

 
$
12,489

    
Note 9: Investment Securities

Our investment securities currently consist of short-term and long-term corporate bonds. Our investment securities are considered available-for-sale and are “investment grade” and carried at fair value. Available-for-sale securities are recorded at fair value, and unrealized holding gains and losses are recorded, net of tax, as a component of accumulated other comprehensive income (loss). Unrealized losses on available-for-sale securities are charged against net earnings when a decline in fair value is determined to be other than temporary. Our management reviews several factors to determine whether a loss is other than temporary, such as the length and extent of the fair value decline, the financial condition and near term prospects of the issuer, and for equity investments, our intent and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. The amortized cost of the debt securities are adjusted for the amortization of premiums computed under the effective interest method. Such amortization is included in investment income in other income on our condensed consolidated statements of income. There have been no realized gains or losses on their disposal. Realized gains and losses are accounted for on the specific identification method. The scheduled maturities of the debt securities are between 2018 and 2020. All short-term investment securities are all callable within one year.
    

20

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Our short and long-term investment securities consisted of the following (in thousands):
 
As of June 30, 2018
 
Amortized Cost
 
Unrealized Holding Gains (Losses)
 
Fair Value
Short-term corporate bonds
$
18,069

 
$

 
$
18,069

Long-term corporate bonds
5,947

 

 
5,947

Total investment securities
$
24,016

 
$

 
$
24,016

 
 
 
 
 
 
 
As of December 31, 2017
 
Amortized Cost
 
Unrealized Holding Gains (Losses)
 
Fair Value
Short-term corporate bonds
$
10,061

 
$

 
$
10,061

Long-term corporate bonds
14,579

 

 
14,579

Total investment securities
$
24,640

 
$

 
$
24,640

    
Note 10:     Prepaid Expenses, Other Current Assets and Related-Party Receivables

Prepaid expenses and other current assets consist of the following (in thousands): 
 
 
June 30, 2018
 
December 31, 2017
Deposits
 
$
431

 
$
21,940

Other prepaid expenses and receivables
 
13,897

 
4,208

Prepaid insurance and property taxes
 
2,045

 
2,580

VAT/GST receivable
 
5,577

 
8,097

Deferred tax charge
 
1,912

 
1,326

Other
 
4,880

 
3,135

 
 
$
28,742

 
$
41,286


Related-party receivables consist of the following (in thousands):

 
 
June 30, 2018
 
December 31, 2017
Third-party receivables due from Pfizer
 
$
66,651

 
$
36,425

HIS business acquisition related
 
11,707

 
62,382

 
 
$
78,358

 
$
98,807


Third-party receivables due from Pfizer relates to trade accounts receivable that has already been collected from customers by Pfizer on our behalf. HIS business acquisition related receivables include amounts due from Pfizer related to the manufacturing and supply agreements and amounts we prepaid to Pfizer for operational expenses under the transition services agreement.

Pfizer became a related party to us when we issued 3.2 million shares of our common stock as partial consideration for the acquisition of HIS. On February 3, 2017, we entered into a transitional services agreement and two Manufacturing and Supply Agreements ("MSAs") with Pfizer (see Note 19, Collaborative and Other Arrangements). During the three and six months ended June 30, 2018, the revenue for goods manufactured for Pfizer was $19.5 million and $37.6 million, respectively. During the three and six months ended June 30, 2017, the revenue for goods manufactured for Pfizer was $21.0 million and $35.7 million, respectively. For the three and six months ended June 30, 2018, the cost of product manufactured by Pfizer for us was $22.6 million and $39.8 million, respectively. For the three and six months ended June 30, 2017, the cost of product manufactured by Pfizer for us was $26.3 million and $38.8 million, respectively.


21

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 11: Inventories
 
Inventories consisted of the following (in thousands): 
 
June 30, 2018
 
December 31, 2017
Raw material
$
78,716

 
$
82,397

Work in process
53,121

 
42,304

Finished goods
157,113

 
163,956

Total inventories
$
288,950

 
$
288,657

 
Note 12:     Property and Equipment

Property and equipment consisted of the following (in thousands): 
 
June 30, 2018
 
December 31, 2017
Machinery and equipment
$
211,648

 
$
220,999

Land, building and building improvements
208,182

 
206,846

Molds
56,187

 
56,253

Computer equipment and software
44,821

 
44,408

Furniture and fixtures
8,285

 
7,361

Instruments placed with customers*
39,038

 
15,812

Construction in progress
83,788

 
57,144

Total property and equipment, cost
651,949

 
608,823

Accumulated depreciation
(236,222
)
 
(210,139
)
Property and equipment, net
$
415,727

 
$
398,684

______________________________
*Instruments placed with customers consist of drug-delivery and monitoring systems placed with customer under operating leases.

Depreciation expense was $13.6 million and $27.8 million for the three and six months ended June 30, 2018, respectively, as compared to $14.4 million and $22.6 million for the three and six months ended June 30, 2017.
    
Note 13: Goodwill and Intangible Assets, Net

Goodwill

The following table presents the changes in the carrying amount of our goodwill (in thousands):
 
 
Total
Balance as of December 31, 2017
 
$
12,357

Goodwill acquired
 
1,300

Other
 

Currency translation
 
(309
)
Balance as of June 30, 2018
 
$
13,348


Intangible Assets, Net

Intangible assets, carried at cost less accumulated amortization and amortized on a straight-lined basis, were as follows (in thousands):

22

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
 
Weighted
Average
 
June 30, 2018
 
 
Amortization
Life in Years
 
Cost
 
Accumulated
Amortization
 
Net
Patents
 
10
 
$
18,606

 
$
11,537

 
$
7,069

Customer contracts
 
9
 
5,319

 
5,082

 
237

Non-contractual customer relationships
 
9
 
55,979

 
9,929

 
46,050

Trademarks
 
4
 
425

 
425

 

Trade name
 
15
 
7,310

 
1,340

 
5,970

Developed technology
 
11
 
81,963

 
11,379

 
70,584

Total amortized intangible assets
 
 
 
$
169,602

 
$
39,692

 
$
129,910

 
 
 
 
 
 
 
 
 
IPR&D
 
 
 
$
4,902

 

 
$
4,902

 
 
 
 
 
 
 
 
 
Total intangible assets
 
 
 
$
174,504

 
$
39,692

 
$
134,812


 
 
Weighted
Average
 
December 31, 2017
 
 
Amortization
Life in Years
 
Cost
 
Accumulated
Amortization
 
Net
Patents
 
10
 
$
17,064

 
$
10,970

 
$
6,094

Customer contracts
 
9
 
5,319

 
4,892

 
427

Non-contractual customer relationships
 
9
 
55,080

 
6,562

 
48,518

Trademarks
 
4
 
425

 
425

 

Trade name
 
15
 
7,310

 
1,096

 
6,214

Developed technology
 
11
 
81,846

 
7,571

 
74,275

Total amortized intangible assets
 
 
 
$
167,044

 
$
31,516

 
$
135,528

 
 
 
 
 
 
 
 
 
IPR&D
 
 
 
$
8,225

 
 
 
$
8,225

 
 
 
 
 
 
 
 
 
Total intangible assets
 
 
 
$
175,269

 
$
31,516

 
$
143,753


Intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives. During the three and six months ended June 30, 2018, intangible asset amortization expense was $4.0 million and $8.1 million, respectively, as compared to $3.9 million and $7.3 million for the three and six months ended June 30, 2017, respectively.

As of June 30, 2018 estimated annual amortization for our intangible assets for each of the next five years is approximately (in thousands):

Remainder of 2018
 
$
8,327

2019
 
15,964

2020
 
15,820

2021
 
15,517

2022
 
15,378

Thereafter
 
58,904

Total
 
$
129,910



23

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 14:     Accrued Liabilities and Other Long-Term Liabilities

Accrued liabilities consist of the following (in thousands): 
 
 
June 30, 2018
 
December 31,
2017
Salaries and benefits
 
$
23,706

 
$
20,745

Incentive compensation
 
25,286

 
40,682

Accrued product field action
 
8,285

 
11,810

Third-party inventory
 
2,014

 
4,284

Consigned inventory
 
1,118

 
5,210

Accrued sales taxes
 

 
6,291

Restructuring accrual
 
1,018

 
1,290

Contract liabilities
 
6,460

 
3,326

Accrued other taxes
 
1,798

 
2,771

Accrued professional fees
 
13,710

 
13,319

Legal accrual
 
2,425

 
3,538

Outside commissions
 
1,191

 
725

Warranties and returns
 
3,051

 
3,360

Accrued freight
 
6,748

 
5,696

Other
 
14,470

 
9,017

 
 
$
111,280

 
$
132,064


Other long-term liabilities consist of the following (in thousands): 
 
 
June 30, 2018
 
December 31,
2017
Unfavorable contract liabilities
 
$
20,468

 
$
40,148

Contract settlement
 
2,500

 

Benefits
 
1,678

 
2,104

Contract liabilities
 
1,528

 
7,099

Other
 
5,631

 
5,975

 
 
$
31,805

 
$
55,326


Note 15:     Income Taxes
 
On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was enacted into legislation, which includes a broad range of provisions affecting businesses. The Tax Act significantly revises how companies compute their U.S. corporate tax liability by, among other provisions, reducing the corporate tax rate from 35% to 21% for tax years beginning after December 31, 2017. Our accounting for the Tax Act is incomplete. As noted at year-end, however, we were able to reasonably estimate certain effects and, therefore, recorded provisional adjustments associated with the toll charge on undistributed foreign earnings and profits and revaluation of deferred taxes. We have not made any additional measurement-period adjustments related to these items during the quarter. However, we are continuing to gather additional information to complete our accounting for these items and expect to complete our accounting within the prescribed measurement period.

Income taxes were accrued at an estimated effective tax rate of (8)% and (182)% for the six months ended June 30, 2018 and 2017, respectively. Those rates differ from that computed at the federal statutory rate of 21% for the six months ended June 30, 2018 and the federal statutory rate of 35% for the six months ended June 30, 2017.

The effective tax rate for the six months ended June 30, 2018 differs from the federal statutory rate of 21% because of the effect in the mix of U.S. and foreign incomes, state income taxes, tax credits and the impact of a contract settlement. The contract settlement resulted in a tax benefit of $5.7 million, which is treated as a discrete item. The effective tax rate during the six months ended June 30, 2018 also included a tax benefit of $11.2 million related to the excess tax benefits recognized on stock option exercises and the vesting of restricted stock units during the period, which is treated as a discrete item and excluded from determining our annual estimated effective tax rate.

24

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The effective tax rate for the six months ended June 30, 2017 differs from the federal statutory rate of 35% because of the effect the mix of U.S. and foreign incomes, state income taxes, tax credits and impact of the gain on bargain purchase. The tax effect of the gain on bargain purchase is treated as a discrete item part of purchase accounting and is not a component of the income tax provision. The effective tax rate during the six months ended June 30, 2017 also included a material tax benefit of $9.9 million related to the excess tax benefits recognized on stock option exercises and the vesting of restricted stock units during the period, which is treated as a discrete item and excluded from determining our annual estimated effective tax rate.
Note 16:     Long-Term Obligations

Five-year Senior Secured Revolving Credit Facility ("Credit Facility")

During 2017, we entered into a Credit Facility with various lenders for $150 million, with Wells Fargo Bank, N.A. as the administrative agent, swingline lender and issuing lender. As of June 30, 2018, we had no borrowings and $150 million of availability under the Credit Facility. The Credit Facility matures on November 8, 2022.

Debt Covenants

The Credit Facility contains certain financial covenants pertaining to Consolidated Fixed Charge Coverage and Consolidated Total Leverage Ratios. In addition, the Credit Facility has restrictions pertaining to limitations on debt, liens, negative pledges, loans, advances, acquisitions, other investments, dividends, distributions, redemptions, repurchases of equity interests, fundamental changes and asset sales and other dispositions, prepayments, redemptions and purchases of subordinated debt and other junior debt, transactions with affiliates, dividend and payment restrictions affecting subsidiaries, changes in line of business, fiscal year and accounting practices and amendment of organizational documents and junior debt documents.

The Consolidated Leverage Ratio is defined as the ratio of Consolidated Total Funded Indebtedness on such date, to Consolidated Adjusted EBITDA, as defined under the Credit Facility Agreement, for the most recently completed four fiscal quarters. The maximum Consolidated Leverage Ratio is not more than 3.00 to 1.00.

The Consolidated Fixed Charge Coverage Ratio is defined as the ratio of: (a) Consolidated Adjusted EBITDA less the sum of (i) capital expenditures, (ii) federal, state, local and foreign income taxes paid in cash and (iii) cash restricted payments made after the closing date, to (b) Consolidated Fixed Charges for the most recently completed four fiscal quarters, calculated on a pro forma basis. The minimum Consolidated Fixed Charge Coverage Ratio is 2.00 to 1.00.

We were in compliance with all financial covenants as of June 30, 2018.
    
Note 17: Stockholders' Equity

Treasury Stock

In July 2010, our Board of Directors approved a common stock purchase plan to purchase up to $40.0 million of our common stock. This plan has no expiration date. During the six months ended June 30, 2018, we did not purchase any shares of our common stock under the stock purchase plan. As of June 30, 2018, the remaining authorized amount under this purchase plan is approximately $7.2 million. We are currently limited on share purchases in accordance with the terms and conditions of our Credit Facility (see Note 16: Long-Term Obligations). 

For the six months ended June 30, 2018, we withheld 23,611 shares of our common stock from employee vested restricted stock units in consideration for $5.5 million in payments made on the employee's behalf for their minimum statutory income tax withholding obligations. Treasury stock is used to issue shares for stock option exercises, restricted stock grants and employee stock purchase plan stock purchases.

Accumulated Other Comprehensive Income (Loss)

The components of accumulated other comprehensive income ("AOCI"), net of tax, were as follows (in thousands):


25

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
 
Foreign Currency Translation Adjustments
 
Unrealized Gains on Cash Flow Hedges
 
Other Adjustments
 
Total
Balance as of December 31, 2017
 
$
(14,578
)
 
$
(365
)
 
$
(16
)
 
$
(14,959
)
Other comprehensive income before reclassifications
 
(2,290
)
 
391

 
5

 
(1,894
)
Amounts reclassified from AOCI
 

 
(377
)
 

 
(377
)
Other comprehensive income
 
(2,290
)
 
14

 
5

 
(2,271
)
Balance as of June 30, 2018
 
$
(16,868
)
 
$
(351
)
 
$
(11
)
 
$
(17,230
)
 
Note 18: Commitments and Contingencies

Legal Proceedings

Beginning in November 2016, purported class actions were filed in the U.S. District Court for the Northern District of Illinois against Pfizer subsidiaries, Hospira, Inc., Hospira Worldwide, Inc. and certain other defendants relating to the intravenous saline solutions part of the HIS business. Plaintiffs seek to represent classes consisting of all persons and entities in the U.S. who directly purchased intravenous saline solution sold by any of the defendants from January 1, 2013 until the time the defendants’ allegedly unlawful conduct ceases. Plaintiffs allege that the defendants’ conduct restricts output and artificially fixes, raises, maintains and/or stabilizes the prices of intravenous saline solution sold throughout the U.S. in violation of federal antitrust laws. Plaintiffs seek treble damages (for themselves and on behalf of the putative classes) and an injunction against defendants for alleged price overcharges for intravenous saline solution in the U.S. since January 1, 2013. On July 5, 2018, the District Court granted defendants’ motion to dismiss the operative complaint, but is allowing plaintiff to file a second amended complaint. On February 3, 2017, we completed the acquisition of the HIS business from Pfizer. This litigation is the subject of a claim for indemnification against us by Pfizer and a cross-claim for indemnification against Pfizer by us under the HIS Purchase Agreement.

In addition, in August 2015, the New York Attorney General issued a subpoena to Hospira, Inc. requesting that the company provide information regarding certain business practices in the intravenous solutions part of the HIS business. Separately, in April 2017, we received a grand jury subpoena issued by the United States District Court for the Eastern District of Pennsylvania, in connection with an investigation by the U.S. Department of Justice, Antitrust Division. The subpoena calls for production of documents related to the manufacturing, selling, pricing and shortages of intravenous solutions, including saline, as well as communications among market participants regarding these issues. The Department of Justice investigation is the subject of cross-claims for indemnification by both us and Pfizer under the HIS Purchase Agreement. We have coordinated with Pfizer to produce records to the New York Attorney General and the Department of Justice.

In April 2018, the U.S. Department of Justice issued a HIPAA subpoena to Hospira, Inc., requesting production of documents and records regarding the manufacturing, production, testing, quality and validation of the Sapphire™ infusion pumps, sets and related accessories distributed by the Company.  We are coordinating with Pfizer to produce the requested records to the Department of Justice. 

In March 2018, a dispute with a product partner resulted in a redefinition of our contractual arrangement and in the rights and remedies determined under such arrangement. The resolution of the dispute resulted in a $28.9 million net charge to the condensed consolidated statement of operations.

From time to time, we are involved in various legal proceedings, most of which are routine litigation, in the normal course of business.  Our management does not believe that the resolution of the unsettled legal proceedings that we are involved with will have a material adverse impact on our financial position or results of operations.

Off Balance Sheet Arrangements
 
In the normal course of business, we have agreed to indemnify our officers and directors to the maximum extent permitted under Delaware law and to indemnify customers as to certain intellectual property matters or other matters related to sales of our products.  There is no maximum limit on the indemnification that may be required under these agreements. 

26

ICU MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Although we can provide no assurances, we have never incurred, nor do we expect to incur, any material liability for indemnification.

Contingencies

We have a contractual earn-out arrangement in connection with our acquisition of the HIS business, whereby Pfizer may be entitled up to an additional $225 million in cash upon achievement of performance targets for the company for the three years ending December 31, 2019 (see Note 3: Acquisition, Strategic Transaction and Integration Expenses). The amount to be paid cannot be determined until the earn-out period has expired.
    
Commitments

Rental expense under our non-cancellable operating lease agreements was $2.9 million and $5.7 million for the three and six months ended June 30, 2018, respectively, as compared to $1.8 million and $3.0 million for the three and six months ended June 30, 2017, respectively.    
    
Note 19:     Collaborative and Other Arrangements
    
On February 3, 2017, we entered into two MSAs, (i) whereby Pfizer will manufacture and supply us with certain agreed upon products for an initial five-year term with a one-time two-year option to extend and (ii) whereby we will manufacture and supply Pfizer certain agreed upon products for a term of five or ten years depending on the product, also with a one-time two-year option to extend. The MSAs provide each party with mutually beneficial interests and both of the MSA's are to be jointly managed by both Pfizer and ICU. The initial supply price, which will be annually updated, is in full consideration for all costs associated with the manufacture, documentation, packaging and certification of the products.  
    
On February 3, 2017, as part of the HIS business acquisition, we entered into an agreement with Pfizer, whereby Pfizer will provide certain transitional services to us for finance, business technology, regulatory, human resources, global operations, procurement, quality and global commercial operation services ("Enabling Function Services"). We pay a monthly service fee for each service provided, and share equally with Pfizer in certain set-up costs and, as applicable, service exit costs. Our share of the set-up costs and service exit costs, in the aggregate, are not to exceed $22.0 million. The service fees are subject to a fee cap of (i) $62.5 million during the initial twelve month period and (ii) $31.3 million during the subsequent six month period. Only the Enabling Function Services are subject to the fee cap, any services provided after expiration of the agreement or services that are not Enabling Function Services may result in service fees outside the fee cap. The service fees are intended to reasonably approximate Pfizer’s cost of providing the Enabling Function Services. We may terminate, in whole only, any particular service and the fee cap would be reduced proportionate to the services terminated. Partial reduction in the provision of any specific service may be made but only with the prior written consent of Pfizer.

On February 3, 2017, as part of the HIS business acquisition, we also entered into a reverse transitional services agreement, where we will provide to Pfizer certain transitional services ranging in term from three to eighteen months. Services include support for real estate, research and development, infrastructure, logistics, quality, site operations, safety, commercial and finance, and regulatory support services.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following information should be read in conjunction with the condensed consolidated financial statements and accompanying notes in this Form 10-Q, as well as the audited consolidated financial statements and related notes for the fiscal year ended December 31, 2017 included in our Annual Report on Form 10-K.
    
When used in this report, the terms “we,” “us,” and “our” refer to ICU Medical, Inc ("ICU") and its subsidiaries included in our condensed consolidated financial statements unless context requires otherwise.

Overview

We are one of the world's leading pure-play infusion therapy companies with global operations and a wide-ranging product portfolio that includes IV solutions, IV smart pumps with pain management and safety software technology, dedicated and non-dedicated IV sets and needlefree connectors designed to help meet clinical, safety and workflow goals. In addition, we manufacture automated pharmacy IV compounding systems with workflow technology, closed systems transfer devices for preparing and administering hazardous IV drugs, and cardiac monitoring systems for critically ill patients.

27



Our primary customers are acute care hospitals, wholesalers, ambulatory clinics and alternate site facilities, such as clinics, home health care providers and long-term care facilities. We sell our products in more than 95 countries throughout the world.

We categorize our products into four main product lines: Infusion Consumables, IV Solutions, Infusion Systems, and Critical Care. We have presented our financial results in accordance with the following four product lines with our primary products listed.

Infusion Consumables

Infusion Therapy

Clave® needlefree products, including the MicroClave, MicroClave Clear, and NanoClave brand of connectors, accessories, extension and administration sets used for the administration of IV fluids and medications.

Neutron® Catheter Patency Connector, used to help maintain patency of central venous catheters.

SwabCap® Disinfecting Cap, used to protect and disinfect any needlefree connector, including competitive brands of connectors.

Tego® Hemodialysis Connector

NovaCath® and SuperCath® Peripheral IV Catheters

Closed System Transfer Devices (CSTD)

ChemoLock® Closed System Transfer Device (CSTD) is a Pharmacy preferred CSTD used for the preparation and administration of hazardous drugs.

ChemoClave® CSTD, is an ISO standard and universally compatible CSTD used for the preparation and administration of hazardous drugs.

Diana™ hazardous drug compounding system, used for the preparation of hazardous drugs.

IV Solutions
    
Sterile Solutions - IV solutions, normal saline, Ringers etc. is used to replenish fluids and electrolytes by IV infusion.

Irrigation Solutions - Used externally on open wounds to hydrate the wound, remove deep debris, assist with visual examination, to prevent infection and improve healing.

Nutritionals - Solutions that feed vitamins, minerals and other natural therapeutic substances directly into the blood stream. We are committed to helping our customers deliver more comprehensive patient-care therapies, delivering an extensive source of nutrients for patients who cannot consume a normal diet.

Infusion Systems

Infusion Pump Hardware - Our current pump platform includes four infusion pumps:

Plum 360™: The Plum 360™ infusion pump is a ICU Medical MedNet™ ready large volume infusion pump with an extensive drug library and wireless capability.

LifeCare PCA™: The LifeCare PCA™ infusion pump is a ICU Medical MedNet™ ready patient-controlled analgesia pump.


28


SapphirePlus™: The SapphirePlus™ infusion pump is a ICU Medical MedNet™ ready large volume infusion pump with an extensive drug library and wireless capability. The SapphirePlus is designed and manufactured by Q Core.

Sapphire™: The Sapphire™ infusion pump is a compact infusion system used in ambulatory and hospital settings. The Sapphire™ infusion pump comes in multi-therapy and epidural-only configurations. The Sapphire is designed and manufactured by Q Core.

We offer the ICU Medical MedNet™ safety software system, which is designed for hospitals to customize intravenous drug dosage limits and track drug delivery to help prevent medication errors.
    
Critical Care

Hemodynamic Monitoring Systems.

Cogent® 2-in-1 Hemodynamic Monitoring System
LiDCO LX1TM Noninvasive Hemodynamic Monitoring System
CardioFlo® Hemodynamic Monitoring Sensor
TriOx® PICC Minimally Invasive Venous Oximetry Sensor

SafeSet® Closed Blood Sampling and Conservation System.

Transpac® Consumable Blood Pressure Transducers.

Q2 Plus™ CCO/SvO2 (continuous cardiac output/oximetry).    

The following table summarizes our total worldwide revenue by domestic and international markets by amount and as a percentage of total revenue (in millions, except percentages):
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
$
 
% of Revenue
 
$
 
% of Revenue
 
$
 
% of Revenue
 
$
 
% of Revenue
Domestic
$
274.8

 
76
%
 
$
248.2

 
75
%
 
$
556.4

 
76
%
 
$
441.5

 
76
%
International
85.7

 
24
%
 
83.3

 
25
%
 
176.1

 
24
%
 
137.8

 
24
%
Total Revenue
$
360.5

 
100
%
 
$
331.5

 
100
%
 
$
732.5

 
100
%
 
$
579.3

 
100
%

The following table sets forth, for the periods indicated, total revenue by product line as a percentage of total revenue: 
 
Three months ended
June 30,
 
Six months ended
June 30,
Product line
2018
 
2017
 
2018
 
2017
Infusion Consumables
33
%
 
23
%
 
33
%
 
26
%
IV Solutions
38
%
 
41
%
 
38
%
 
40
%
Infusion Systems
25
%
 
22
%
 
25
%
 
21
%
Critical Care
4
%
 
4
%
 
4
%
 
4
%
Other
%
 
10
%
 
%
 
9
%
 
100
%
 
100
%
 
100
%
 
100
%

We manage our product distribution in the U.S. through a network of three owned distribution facilities, as well as, through direct channels, which include independent distributors and the end users of our products, and as original equipment manufacturer suppliers. Most of our independent distributors handle the full line of our products. Internationally, we manage our operations through the Netherlands, which utilizes international regional hubs and we also manage our operations through independent distributors.


29


A substantial amount of our products are sold to Group Purchasing Organization member hospitals. We believe that as healthcare providers continue to either consolidate or join major buying organizations, the success of our products will depend, in part, on our ability, either independently or through strategic relationships to secure long-term contracts with large healthcare providers and major buying organizations.  As a result of this marketing and distribution strategy we derive most of our revenue from a relatively small number of distributors and manufacturers.  Although we believe that we are not dependent on any single distributor for distribution of our products, the loss of a strategic relationship with a customer or a decline in demand for manufacturing customers' products could have a material adverse effect on our operating results.
 
We believe that achievement of our growth objectives worldwide will require increased efforts by us in sales and marketing and product acquisition and development; however, there is no assurance that we will be successful in implementing our growth strategy. Product development or acquisition efforts may not succeed, and even if we do develop or acquire additional products, there is no assurance that we will achieve profitable sales of such products.  Increased expenditures for sales and marketing and product acquisition and development may not yield desired results when expected, or at all.  While we have taken steps to control these ri