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spk03: Good day, and welcome to the Avanos Medical First Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Dave Crawford, Vice President of Investor Relations. Please go ahead.
spk07: Good morning, everyone, and thanks for joining us. It's my pleasure to welcome you to the Abenos 2021 First Quarter Earnings Conference Call. With me this morning are Joe Woody, CEO, and Michael Greiner, Senior Vice President and CFO. Joe will begin with an update on our business and then review the progress we are making against our 2021 priorities. Then Michael will review our 2021 first quarter and provide an update on our current planning environment. We will finish the call with Q&A. A presentation for today's call is available on the investor section of our website, Avanos.com. As a reminder, our comments today contain forward-looking statements related to the company, our expected performance, economic conditions, and our industry. No assurance can be given as to future financial results. Actual results could differ materially from those in forward-looking statements. For more information about forward-looking statements and the risk factors that could influence future results, please see today's press release and the risk factors described in our filings with the SEC. Additionally, we will be referring to adjusted results and outlook. The press release has information on these adjustments and reconciliations to comparable GAAP financial measures. Now I'll turn the call over to Joan.
spk06: Thanks, Dave. Good morning, everyone. Thank you for your interest in Avanos. I'm encouraged by our team's continued strong execution and resiliency as they respond to the challenging dynamics to our business brought on by the pandemic. Our employees remain focused in the dedication to getting patients back to the things that matter as we meet the needs of our customers. As mentioned on our last earnings call, we began the quarter with some headwinds and uncertainty resulting from rising hospitalizations and the corresponding negative impact to elective procedures. However, as we exited the quarter, we saw increasing top line momentum across our pay management franchise as the return of electric procedures began to re-accelerate. Looking ahead, while we're encouraged to see the electric procedure volume increasing and expected to accelerate, we continue to believe volume likely will remain below its full potential until the end of the year. As we examine the business environment, we are gaining confidence in the direction of our business and have better line of sight to the gradual ablation of challenges presented by the pandemic. As a result, we feel well positioned to provide financial guidance for 2021. Based on current projections, we expect net sales on a constant currency basis to increase 2% to 4% compared to the prior year. Also, we expect to earn between $1.10 and $1.25 of adjusted diluted earnings per share. Michael will share additional information on our financial guidance in his remarks. During the quarter, we established our first Diversity, Equity, and Inclusion Council consisting of 15 global employees across all departments. The DE&I Council will build upon our We Stand Together initiative to better understand our employees' perspectives regarding the issues of racial and gender inequality. Our DE&I initiative remains a critical effort for us to shape the organization and culture where all our employees want to work. Lastly, we are discussing with the DOJ a potential resolution of their investigation into microcool and other surgical gowns that were a part of the S&IP business when we divested in 2018. We anticipate finalizing an agreement with the DOJ in Q2 or Q3. With that as background, let me now review our first quarter results and provide you with an update on our drivers of value creation. Sales totaled $181 million, unchanged compared to the prior year, while we earned 23 cents of adjusted dividend earnings per share. Earnings were positively impacted by our disciplined cost control measures, but were partially offset by increased transportation costs. Results in our chronic care business were mixed. In the gist of health, we continued to deliver mid-single-digit growth for the franchise overall. In respiratory health, sales related to the direct treatment of patients impacted by the pandemic were similar to last year. However, overall growth was down slightly as the precautionary measures taken for the pandemic impacted the normal cold and flu season uplift. and therefore significantly reduced the seasonal sales related to a cold and flu season. In pain management, as I stated earlier, elective procedures remain suppressed at the start of the quarter as COVID-related hospitalizations spiked in some regions. The biggest head one was to our on-queue therapy, where a significant percentage of surgeries where on-queue is used require a hospital stay. Separately, Cool Leaf was less impacted as it performed as an outpatient therapy. Overall, sales grew sequentially throughout the quarter as procedural volume returned. Despite the early quarter headwinds caused by the new wave of the pandemic, we continue to build on our solid foundation to accelerate growth across pain management. Finally, let me provide you with an update on our progress this quarter regarding our four areas of value creation. As a reminder, the four areas are strengthening our growth profile, expanding our gross and operating margins, driving consistent free cash flow generation, and deploying capital towards M&A. First, as we look to strengthen our growth profile, we maintained our momentum in driving market adoption and gaining share by growing both our CorePak and Neomed portfolios. We are executing our strategy to establish CoreTrack as the standard of care for nasogastric feeding, along with increasing the adoption of Neomed to further address neonatal enteral feeding needs. We delivered record sales for CoreTrack hardware units in the first quarter and are on target to reach our goal for Neomed account conversions. On previous calls, we have discussed the progress we're making to expand the clinical evidence for Cooleaf to demonstrate its differentiation as a radiofrequency ablation therapy. Also important to this effort are independent physician-led studies being conducted. During the quarter, two independent physician-led publications on Cooleaf were published. The first concluded that the use of cooled radiofrequency was predictive of a better outcome for patients suffering from knee osteoarthritis. Additionally, another large retrospective knee series concluded that Cooley was clinically effective for both managing pain and reducing disability. Finally, we continue to execute on our international expansion initiatives. We achieved high single-digit organic growth across each of our regions during the quarter. The first time we have seen this level of growth across all of our regions in the same quarter. Also internationally, we achieved growth in both our chronic care and pain management franchises. Our second area focuses on gross and operating margin expansion. I'm encouraged by the continued cost discipline and emphasis on driving inefficiencies in our spending. However, we incurred additional transportation costs related to facilitate NeoMed growth from account conversions. We anticipate these increased distribution costs to continue into the second quarter, albeit at a slower rate. As we advance our business, we're looking at all processes throughout the lens of value creation with the goal of enhancing efficiencies by embedding this approach into our culture while more effectively meeting customers' needs. Our third pathway is to generate consistent, repeatable cash flow. Cash flow met our internal expectation for the quarter as we anticipated certain outflows relating to compensation. Taking into consideration our preliminary agreement with the DOJ, we now anticipate delivering approximately $80 million of free cash flow Cash flow will be driven by approved earnings and the discipline cost savings that I previously mentioned, as well as receiving an expected $60 million in U.S. tax refunds, primarily derived from the provisions available through the CARES Act. Finally, we continue to examine capital deployment for M&A. Our M&A pipeline remains robust, and we maintain active dialogue with a number of potential tuck-in targets, which would leverage our existing footprint, generate synergies, and enhance our top-line growth profiles. While I am optimistic about the prospect of bolstering our robust portfolio in 2021, we will remain disciplined in our assessment of targets, ensuring we generate a strong return on capital. Overall, we remain well-positioned to advance our strategies across each of these four areas of value creation as our focus on execution remains strong. This, along with our market-leading portfolio, gives me confidence we can deliver growth and margin expansion in 2021 and beyond. Now, I'll turn the call over to Michael.
spk02: Thanks, Joe. As you noted, we continue to battle a range of headwinds, and yet the team remains focused on execution and overcoming these challenges. Let's begin with a review of our first quarter results. Total sales of $181 million were unchanged compared to last year. We saw a 1% increase in volume and a 1% benefit from favorable exchange rates. Unfavorable price offset sales by 2%. The slightly higher-than-normal price impact was primarily due to the timing of discounts and allowances paid to customers. Chronic care sales grew 5% to $121 million in the quarter, as we saw mid-single-digit demand for our digestive health products. Double-digit core pack growth resulted from the execution of our standard of care strategy, while NeoMed growth came from the continuation of conversions to our NFIT technology mentioned earlier. Double-digit international growth bolstered performance driven by new channel partnerships in our Asia Pacific and Middle East regions for CoreTrack, along with share gains across Europe. Meanwhile, performance in respiratory health was down slightly due to the weaker than normal cold and flu season. Also, we continue to monitor our pandemic-related sales and the relationship between sales to distributors and trace sales from our customers. While over the past year, there has been some added variability, it does not appear from the analysis that additional inventory is currently being held by distributors. Thus, while we do expect an impact to respiratory health growth from hospitalizations declining over the next several quarters, we do not anticipate an additional headwind from distributors rebalancing their inventory levels. Moving to pain management, we delivered 60 million of sales, 8% lower compared to the prior year. The cancellation of elective procedures impacted performance, as well as lower procedural efficiency. The largest change was in OnQ, which is heavily correlated to procedures requiring some length of patient stay in the hospital. As Joe mentioned, we saw sequential growth in ONCU as the hospitalizations declined and elective procedural volume increased. Despite this challenge to ONCU, for the quarter, sales through lighters increased by double digits as our partnership with lighters continues to benefit customers as a pre-fill option. With respect to Cooley, we're encouraged by the results for the quarter that were essentially flat compared to prior year. While growth was unfavorable for the first two months, we saw significant growth in March as anticipated. A highlight in pain management was double-digit growth in Game Ready, where our efforts to expand the rental of units directly from Avanos is progressing well. In addition, the business benefited from the return of sports in both North American and European markets. We continue to meet patients' needs for effective opioid-sparing pain management therapies and believe the return of elective procedures being performed in a hospital will support additional growth for this franchise. Moving down the income statement, adjusted gross margin decreased to 52% compared to 59% last year. As we indicated on our previous earnings call, gross margin was expected to be lower given the timing of manufacturing variances and unfavorable product mix. In addition, gross margin in the quarter was also impacted by higher transportation costs to bring Neonet products from China to the United States to meet customer demand. as well as higher-than-normal price declines in the timing of discounts and allowances paid to customers. We continue to expect adjusted gross margin to improve as we regain growth in pain management and demand for our respiratory health products partially normalizes to pre-COVID levels. Adjusted gross margins are still expected to range between our 2019 and 2020 margin levels, as mentioned during our year-end earnings call. We anticipate the meaningful improvement in gross margin will now occur in the second half of the year as we will continue to incur higher transportation costs to meet the sales demand for Neomed during the second quarter. Adjusted operating profit totaled $16 million compared to $14 million in the prior year. Performance was primarily driven by adjusted operating expense reductions, which is partially offset by the lower adjusted gross margin I just reviewed. Adjusted EBITDA totaled $22 million compared to $20 million last year. Adjusting net income totaled $11 million compared to $8 million a year ago, and we earned $0.23 of adjusted diluted earnings per share. Now turning to the balance sheet and cash flow statement. As Joe mentioned, keeping a healthy balance sheet and generating meaningful free cash flow remains a key go-forward priority. Our balance sheet remains solid and continues to provide us with strategic flexibility as we end the quarter with $100 million of cash on hand, as well as $175 million of debt outstanding on our revolving credit facility. This is an improvement of $5 million versus year end due to a repayment we made during the quarter. Free cash flow represented an outflow of $9 million due to the timing of payments related to employee short-term incentives and severance payments related to our restructuring announced last quarter. Overall, as Joe mentioned, taking into consideration our preliminary settlement with the DOJ, we are confident in generating approximately $80 million of free cash flow this year, which includes refunds from the CARES Act. Finally, While some unpredictability of the coronavirus remains, the return of elective procedures and the success of the vaccine rollout enables us to provide a 2021 full year outlook at this time. Based on current trends in our business, including the expectation of elective procedures returning by the end of the year to a normal level, we expect net sales on a constant currency basis to increase two to 4% compared to the prior year. This includes an approximate 50 basis point impact from the exit of a non-strategic international chronic care business discussed last quarter. Additionally, as we noted on our year-end earnings call, quarter over quarter sales, results will be more variable than usual given the impact of COVID on our prior year sales and how that will impact our quarterly comparables. For the year, we expect to earn between $1.10 and $1.25 of adjusted diluted earnings per share. We expect higher earnings in the second half of the year from a pacing perspective This is based on higher sales and gross margin expansion, along with a continued focus on controlling our operating expenses. In closing, we are off to a strong start for the year, and we've made meaningful progress on our evaluation pathway. I'm confident in our ability to execute on this strategy and to deliver significant free cash flow and deploy capital in a disciplined manner through the duration of this year and going forward. Operator, please open the line for questions.
spk03: We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Ravi Misra with Barenberg. Please go ahead.
spk09: Well, hi. Good morning. Thank you for taking the question. So just a couple of questions on me. On the guidance front, Mike and Joe, just wondering, you know, you're kind of assuming a normalization by the end of the year. Just wondering, does that kind of get you to the midpoint of your guidance or the high end? Can you help us think about, you know, what What's contemplated kind of on the low and high end? I mean, should the high end kind of include getting more aggressive in terms of more aggressive rebound of procedures? And I have a couple of follow-ups. Thanks.
spk06: Hey, Robbie. Good morning. It's Joe. I'll say a couple things, and then Michael may want to add to it. But generally, the way I would sort of view that guidance is that, you know, the faster electives come back, you know, the better it can be. And chronic care is likely to be below the low end of our range, but pain at the high end, greater than really the high end of our range. So we are looking at obviously the improvement, less hospitalizations. We really do believe things are gonna improve on the electives in the second half of the year. We're watching the speed though, because we don't have full indication that that's across the board from a lot of our customers. And Michael, do you have anything to add there?
spk02: Yeah, I would just say the low end of the range, Robbie, to your question, assumes some continued headwinds into the back half of the year on both the cost side and, as Joe just mentioned, some of these electives not returning in order to hit that $1.10. So that's a fairly conservative low end of the range. A lot of things would have to not go right for us in the back half of the year to be there.
spk06: Agreed.
spk09: Great, thanks. And then maybe just if you can help, I'll ask my kind of follow-ups altogether. Just if you can help us understand, you know, your international growth was pretty strong. Just can you help us understand the kind of impact to margin there in terms of how it compares to the overall corporate average? And then finally, any updates on the kind of progress on the breakthrough designation product? And that's it for me. Thank you.
spk06: So I'll start with just talking about the international business, good performance. We see that continuing into Q2 as well. There's been a real focus on geographical expansion through bringing the M&A that we've been able to conduct into those markets and entering new markets. I think that team's done a nice job of managing distributors in EMEA and Asia-Pac, getting more out of them, in some cases going direct and eliminating distributors that aren't living up to our standards. And then they're very focused on medical education and clinical studies. And so that's therapy adoption that they're really both in ASIAPAC and EMEA that they're getting. So again, we think it's in a non-pandemic situation, a mid-single-digit grower that we're working toward, high single-digit, an important lever for us. Early on in my tenure, we did a lot of investment in people, the structure in that area. And Michael's looking like he wants to talk a little bit about the margin contribution.
spk02: Yeah, so remember, Robbie, a good majority of the revenue we do have internationally right now is chronic care. We are looking to expand our pain footprint. So by definition, our chronic care portfolio, by and large, is a lower gross margin profile. And as Joe just alluded to, we are doing some key investments internationally that we think are right for the long term. So our overall margin profile, both at the gross margin levels and the operating margin levels, are slightly lower than the overall consolidated companies.
spk09: And then just on that breakthrough designation device, can you just... Oh, sorry.
spk06: Sorry about that. Yeah, we are progressing well. And our electronic nerve product really focused on total knee. We're in patients now. We're very impressed with the results. And so that portion of the development has gone well. And now we're obviously working on the FDA approval applications and how we would view reimbursement there. When we have an investor day, which may be toward the end of the year, call it fall or about the time that we would roll out an LRP, a new LRP, we're going to highlight that and talk more about it in that meeting. Thanks. Yep.
spk03: The next question comes from with Raymond James. Please go ahead.
spk04: Hey. Good morning, everyone. Thanks for taking the question. I guess to start off, sorry, I'm just thinking about the guidance for 2021, and thanks for now beginning to provide that. I guess it was a little bit lower than I was anticipating, and I'm just, just as I'm trying to parse through the various moving pieces of the business, I'm curious at how you're thinking about that on cue. Is that sort of, a bit of a laggard as you're waiting for these procedures to come back, because I would assume that, given your commentary on the first quarter and the exiting rates, Cool Leaf should be a pretty substantial grower for the year.
spk06: Yes, that's right, Larry. I mean, Cool Leaf will be a substantial grower. And with respect to OnCue, we saw positive growth in March. We've seen continued acceleration. But because the bulk of our business is in the hospital with OnCue, It's coming back a little bit slower than the hospital outpatient department with Cooley. But again, we do see moving into the second half, you know, good growth, obviously. Some of that's obviously related to Comparator for OnCue. And we're pleased with the progression and the things, you know, where we're headed with the channel partners and what's going on with lighters. We had some of that in the commentary. I think the biggest thing in my mind is just Some of the unknowns on the range, you know, it's the, you know, with relation to how fast the hospitals do come back with all the procedures as opposed to ambulatory surgical setting. And if you think about last year, I think we caught a little bit of heat saying that things weren't going to come back as fast as they did in the second half, and then they might even slow again with another wave, and that did happen. So we're being cautious there, but I did say, I think, in the first question that to the extent that the electives come back in a much faster manner, that's upside for us. And I don't know, Michael, if you have anything to add. No, Michael doesn't have anything to add, but I know, Larry, you may have a couple more questions.
spk04: Yeah, just two more. Thanks for that. I guess, Joe, on that topic about, again, your commentary of, you know, you don't expect, you know, the full volume potential to come back until the end of the year. as you assess things, what do you think is really the biggest gating factor there? What's kind of driving that assumption? I mean, that is, it feels a little bit different than what other companies are assuming. It feels like most are anticipating, you know, kind of the second half is much more normalized. It sounds like your commentary is, hey, let's wait and see what happens till the end of the year. And I guess just the second question I'll just ask, and probably for for Michael is just how should we think about that SG&A coming back through the year?
spk06: So generally, you know, for us, the therapy and pain, they're done at different sites. It's a little bit more complex. For example, Game Ready is coming in very quickly as sports come back, and we're getting a lot of growth there, and that's done in an outpatient setting. Again, Cool Leaf coming together quickly in the outpatient setting. So we feel like we're at sort of an 80, 85% maybe range in the hospital right now, and that should climb. Our decision to sort of be a little bit more conservative on that is based upon talking to hospital executives. We've used some outside consultants. We've talked to our own surgeons and customers and our customer base. But again, if this quickly comes back and call it May, June, July, and we think that H2 will be strong, then that could be good potential for us in the Anki space.
spk02: Yeah, I think, Larry, one other thing to consider is we didn't want to come back and revisit this range, and we believe that we were appropriately looking at the various sensitivities of when things would occur, and this range allows us to capture some downside if that were to occur, and obviously some upside if things were to come back quicker. So that's part of our thinking just as far as how we thought about the range and putting it out here in the second quarter, start of the second quarter. With regards to SG&A, as you've noticed, the last three quarters we've had SG&A as a percentage of revenue in the high 30s, which ultimately is our long-term goal there. We do believe, as we enter the back half of the year, there are some investment opportunities on the operating side that we are considering. If we were to do those investments, SG&A would increase probably just north of 40% again temporarily before we get to our longer-term goals of the high 30s in a more permanent way. So that 110 to 125 also considers that we would be doing some of these SD&A investments in the back half of the year.
spk04: Okay, terrific. Thanks, guys. Appreciate it.
spk06: Thank you.
spk03: The next question comes from Matthew Mission with KeyBank. Please go ahead.
spk08: Hey, good morning, guys. So it's Friday morning after a long week. My listening comprehension skills are not that strong this morning. But I heard DOJ a couple of times in the presentation. Just first, can you just go over, do you still have a liability there? Is that Kimberly Clark? And did that change your free cash flow expectations for the year? Because I think I heard $80 million, and I think it was $100 million previously.
spk06: Right. So I'll say a couple things, and then I won't go much further for now. But basically, we did with the DOJ agree in principle, and we're continuously discussing a potential resolution. We anticipate that that would be finalized in Q2 or Q3. And if you're referring to, I think, the identification with KCI, we have no more issues there. We settled with KC. Really, it was a Q4, I think, of last year. Last year, yes.
spk02: And you are correct, Matt. The change in free cash flow from 100 to 80, relates to what we believe will be the settlement, ultimately the settlement amount with OJ.
spk06: And just one other thing, I mean, if you think about this a step back a little bit, we've always talked about getting things behind us and moving forward. And I think this is a big step to understand where we might be with this. And this couples with, you know, putting the IT system deployment and the divestiture of SNIP. And then obviously positioning ourselves, you know, where we get a lot of cost out of the business and heading into a place where we're going to get stronger growth. So our ability to execute in a more clear manner is as big as any type of agreement. Yeah, removing these overhangs we think is important.
spk08: Okay, excellent. And then just growth margin trends, you know, how you think they've improved from 1Q to the rest of the year. I believe you previously said that you're somewhere between 19 and 20. Is that still the case?
spk06: Yeah. So Michael's gonna take you through some detail, but I'll say a couple things up front. It was only about a year ago that we were in the high 50s and low 60s in the business, and these things really are temporary, and as you hear more about them here in a second, pandemic-related, and we have a lot of confidence. We talked a little bit about these in Q4, that Q1 and Q2 would be light for us, and then we would be very strong in H2. So, I think that we've had a lot of progression in the business. On the flip side of it, you can sort of look at EBITDA growing the way it did for the quarter. In this call, Michael's talked a little bit about the SG&A. So, as we get this moving in the right direction, which we have the plans for, and the sales come on, we should be in good shape. But maybe, Michael, you may want to talk a little more detail about it.
spk02: Yeah, Matt, great question. The reality is we need to all of a sudden just become a 53, 54% gross margin company, right? So there's a range of things that happened over the last few quarters that have taken our gross margins, suppressed them in a temporary manner. Some self-inflicted, which we're fixing. Some have been exogenous events that we're working through. But when you look at the first half of the year to the second half of the year, almost 500 basis points, greater than 500 basis points of opportunity for us in the second half of the year were Temporal items, transitory items around price and product mix, the revaluation for the manufacturing variances, and then this NeoMed freight issue that we're dealing with that is important for our long-term growth prospects for NeoMed, but also unfortunately has us incurring higher than anticipated freight costs from China where NeoMed is manufactured. So second half of the year we feel really good about, especially given that we know good portions of the headwinds into the second half of the year on gross margins relate directly to temporary things in the first half. When you think about first quarter to second quarter, we do anticipate, you know, improvement, significant improvement, although not what we're going to see in the second half, but significant improvement primarily related to improved product mix.
spk08: Okay. Like, what would you, what's the pathway? Is there a pathway back to 60% plus gross margins from here?
spk02: Absolutely. Yes. And we believe that we will see a quarter or two in the back half of the year that will show those 60% plus gross margins.
spk08: Okay. And then you called out unfavorable discounts and allowances in the quarter. Can you elaborate a little bit on what those were?
spk06: You know, just generally, we're not backing off of it. Our business has been sort of negative one plus one percent overall in price, and this has more to do with timing, you know, of rebates and of discounts with some of our customers. So I don't see this long term either.
spk02: Yeah, the price issue that we had in the first quarter was not related to changes in how we go to business or giving away price. It related more to timing. of the products, respiratory and others, in the back half of the year, and these were just catch-up refunds that we had to get in place that we didn't capture as timely, not knowing what some of the measurement criteria was, given the different changes in revenue that we saw.
spk08: Okay. And then reimbursement in the ASCs for Cooley, has that moved the needle for you guys?
spk06: You know, I wouldn't say yet. I think we talked about that having an impact in the back half of the year. We're doing a full breakdown assessment of all of the ASCs and looking how they're structured and which ones we want to go into to be efficient and profitable about the way that we go about it. But I would think that as you get into the Q3 and Q4, we'll see some benefit there.
spk08: Okay. And then just lastly, game ready. I mean, it's like the first time you mentioned game ready in a while. Is that due to any kind of new product or? You know, what's changed where, like, game ready all of a sudden is at the forefront?
spk06: So a couple things. One, definitely sports have come back where there are sports injuries, but we have also been very focused on a drop ship program that the team put together and did a nice job with, as well as the rental business and bringing that up to speed and making better connection with our customers and also making that efficient as part of also the synergies as we – you know, finish that off last year with game ready. So really three things there and we're happy with that momentum.
spk08: Okay. Thank you very much.
spk06: Thank you.
spk03: The next question comes from Rick Wise with C4. Please go ahead.
spk10: Good morning. How you doing? Just to start off first with a sort of a little shorter term question I've been asking Every company this quarter, the same thing, just to better understand recovery trends. Like many others, January, February were softer, as you said, Joe. Sounds like March, a nice snapback. Have those trends continued into April or accelerated or are they on a path? And so sort of a two-part question. Are they, if that's the case, are we on a path to recovery? sequentially higher second quarter sales or no, second quarter is going to look a lot like the first from a sales or margin perspective. You clearly are expecting a stronger second half, but just to help us get in the right sort of thought mode for the second quarter as we try to model it correctly.
spk06: Sure, Rick. I mean, we feel like we will see and are seeing some sequential improvement from Q1 to Q2. Obviously, our business is a stronger H2 performer in noting that. And kind of the way that, you know, that I think about it is kind of we're seeing, you know, respiratory health as expected. Our digestive health business is pretty consistent. And the internationals we talked about earlier in the call also starting off strong and performing. and we are seeing improvement in the OnQ business, but faster improvement in the interventional pain business because it's in the hospital outpatient department. So things are headed in the right direction, but clearly we do think they'll be much stronger even in H2.
spk02: And remember, Rick, too, just from a comparable standpoint, OnQ and Cooleaf will both have very attractive comparables versus last year's second quarter, so those will be good numbers. Sequentially, as Joe mentioned, we are starting to see some nice improvement there as well, which is good. And then also recall the flip side is that our respiratory business, in particular our closed suction catheters, had a very strong 2Q and Q3 last year. So those will be much tougher comps, you know, at the beginnings of the pandemic last year.
spk10: Gotcha. And to un-Q specifically, so just appreciating the in-hospital aspect, as you've emphasized, we should see better on cue in the second quarter because of the recovery trends you're already seeing. Is that the right way to say it?
spk06: Yes. Yes, that's correct. And, you know, one of the ways that we sort of evaluate it that I think investors can evaluate it is as orthopedic procedures in the hospital versus ASC come back at that level, we're somewhat aligned with that.
spk10: Gotcha. And I want to come back to your M&A pipeline comments, Joe, from Phil. sort of two aspects. I mean, it's always intriguing, you know, and you're very clear about your robust pipeline. And just as an outsider, I'm always, as an analyst, I'm always fascinated, you know, what, and I know it's, obviously I appreciate it's very complex, price, willingness to sell, timing, all sorts of things go into it. But help us understand why you haven't moved even faster, right? Is it something internal to Avanos right now that you waited until you just felt better about recovery or whatever IT systems or people, or was it that, or have valuations been too high? I'm just trying to understand what might release the floodgates, which could potentially be very exciting, obviously, in terms of potential growth and leverage and outlook.
spk06: Yeah, it's more of our disciplined approach and waiting for the pandemic to subside. And obviously, we had some other execution issues that we've been highly focused on. And we really told our investors that's where we would be focused. I think we've delivered that sort of, let's call it, over the last six quarters. But now we're in high gear. We're talking to a couple of different potential targets. And in terms of valuation, that's not been a holdback for us because we are – hanging around the same kind of places that we have been with private equity, with privately owned businesses and areas that we want to participate that would enhance our business and be accretive where we're not having to look at the kind of multiples that you see in some of the deals. So I think we're going to come forward with when we do come forward with deals, you know, with good value like we've been doing in the past.
spk10: Gotcha. And just to follow up on that. So we should be cautiously hopeful, optimistic that, that you could get one or more of these across the finish line this year? Is that too much to hope for? Thanks, Jeremy.
spk06: No, that's not too much. I mean, you can never predict these. I'd love to do two, but, you know, we really are pushing hard to do one for sure, and we'll see where we land. You know, we've got a good track record, so we'll see where we land at the end of the year.
spk09: Sounds great. Thank you again.
spk06: Thank you.
spk03: The next question comes from Marissa Byich with Morgan Stanley. Please go ahead.
spk01: Hi, good morning, and thanks for taking the question. I'm sorry to go back to gross margins, but I just wanted to push a little further on the transportation impact. It seems like COGS this quarter were about 8 million higher than consensus estimates. What was the relative impact of the transportation of Neomed kind of relative to that 8 million total higher COGS, and was there anything else in the mix like COVID-19 overhead expense lingering from last year or really any other kind of one-time impacts that you would call out. Thank you very much.
spk06: I think Michael's going to talk about this a little bit, and then I just wanted to make a comment about the NEOMED, the positive side of this, but go ahead.
spk02: Yeah, so about a third of that, Marissa, the $8 million, if you're looking at absolute dollars related to NEOMED, another third or so related to the revaluation that we had for the manufacturing variances. And then we had a little bit of that price impact that we just talked about with Matt's question. So that was if you lay out. And then there were some nits and nats. But those are the three primary chunks of that $8 million higher from a COGS absolute value standpoint.
spk06: And just on the why side of it, I think it's the right thing to do. If you can imagine the ports in California, China, things going on in the supply chain. These prices are crazy right now, but we have converted ahead of our expectations, and this will be a payoff in the second half and then 2022. So doing that, I think, is the right thing to do for more sustainable growth in the business, but obviously not happy about the price of that transportation. We may have a little bit more of it, not quite as much in Q2, but should absolutely subside in the second half.
spk01: Okay, great. And my one follow-up would just be on coolies. You touched on this, but can you give us any more detail on how the Coolief growth has improved into April relative to the strong growth that you saw in March? And is that more driven by growth in new accounts or more of a re-acceleration in the existing accounts that you've had? And thank you very much.
spk06: Thank you, Marissa. Yeah, it's actually accelerated from March into April. So we're seeing that continue. And we did sell a number of capital consoles even last year during the pandemic. So there are new accounts coming in with our new technology, but even new customers. But as you can imagine, there's also a backlog of spine and osteoarthritis of the knee patients coming through. So it's really two things. And then obviously we have some easy parables, but just generally we've done well with new customers as well. Okay.
spk00: I think we're ready for the next question.
spk03: As a reminder, if you have a question, please press star, then 1. Our next question comes from Chris Cooley with Stevens. Please go ahead. Mr. Cooley, your line is open, and you may ask your question.
spk05: Thank you. Can you apologize? I had it on mute. Congratulations on a solid order. Just two quick ones at this point for me. First, from a clarification perspective, when you talk about your conservancy, thinking about the transition throughout the course of the year, I just want to be clear about that commentary. That really centers predominantly related to the on-cube portfolio. The rest of these businesses are obviously showing some strength now. I just wanted to kind of clarify that. That's just the front kind of point one. My follow-up question will put a bigger picture. Just when we think about margin targets longer term, you hinted about a new LRB. Help us think a little bit. You talked about 60% gross margins earlier in that question still being within striking distance, pricing power for these businesses, and realizing greater operating efficiencies. Is there anything structured you think could preclude you from stepping up the out margin into cash flow type characteristics of the business versus kind of where we were previously. No, you're not getting guidance yet now. Just thinking about things conceptually as we look ahead longer term, seeing that you have greater operating efficiencies now, especially with the new IT systems. I just want to think about out margin and cash flow longer term as well. Thank you.
spk06: Thanks, Chris. And I'll say a couple things about OnQ and then let Michael talk about some of the margin elements and the cash flow and some things that we are excited about. But generally, with respect to OnQ, we're happy with the following things. One, Leiders continues to be growing at a significant rate. We're adding new customers. As a percentage-wise, the business that we had managed under Avellan-Formidium, we're actually approaching that same level now. We are getting growth out of Summit and the electronic pump and starting to see that that can be beneficial to us for customers that want that solution versus the elastomeric pump. And we're very excited about the orthopedic channel partners that we're putting in place where, again, a greater portion of OnQ is used there and looking to sign up more of those relationships. over time. So I think we're headed in the right direction. And I think to the extent that electives come back in the hospital faster, that'll be a plus for us. And then Michael, did you want to talk about that?
spk02: Yeah, just longer term on the margins, you know, we've talked about in the fall that we've had three quarters in a row now where SG&A has been high 30%. We believe that ultimately that is where we should live. longer term. That being said, in the back half of the year, we may have some spend in selling and marketing that we think is smart for longer term revenue opportunities. And so we may see a Q3 or Q4 where SDNA is a little bit higher than the high 30s. Similar to gross margin, where we've had some of these temporal things that we've talked about, we've got 500 plus basis points of tailwinds going into the back half of the year for these temporary things. So we do anticipate seeing Q3 or Q4 or maybe in both quarters being greater than 60%. So these pieces haven't all fit together perfectly yet, Chris, but you can see how we can get there in these various pieces as operating expenses as well as gross margins and how that lends itself to where we want to take ultimately our EBITDA operating margins longer term. To your question around, you know, could we be even better than that given some of the efficiencies that we're building into the organization, I think with M&A, as well as continuing to learn over this next few quarters around where some of the key smart spend is, there is marginal opportunity to have margins probably higher than what we've talked about previously. But we'll lay that out in a more holistic view, as Joe mentioned, in the fall when we issue a new three-year LRP. Thank you very much.
spk00: Thank you.
spk03: This concludes our question and answer session. I would like to turn the conference back over to Joe Woody, CEO, for any closing remarks.
spk06: Thank you. And I just want to thank everybody for your continued interest in Avanos. And while we're executing well in an uncertain environment, we are committed to creating shareholder value. I'm confident the priorities that we detailed today, combined with our portfolio and the attractive markets we're in, do position us for sales growth. margin expansion and positive free cash flow in 2021. So look forward to continuing to report that out throughout the year. Thank you.
spk03: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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