Avanos Medical, Inc.

financial targets at our investor day on June 20th to be held at the convene 101 Park Avenue location in New York City now I'll turn the call over to Michael who will continue to lead these efforts in his expanded role as chief transformation officer and will further discuss our first quarter financial results thanks Joe before diving deeper into these transformation efforts I'll provide additional color to our first quarter results

Total reported sales for the first quarter was $191.7 million, a decrease of 2.9% compared to last year. Adjusted EBITDA for the quarter was greater than $26 million compared to $23 million a year ago, with EBITDA margin improving 200 basis points versus last year. Adjusted net income for the quarter totaled almost $13 million compared to $12 million a year ago, translating to $0.27 of adjusted diluted earnings per share versus 25 cents a year ago. We ended the quarter with 96 million of cash on hand and a leverage ratio of 0.8. As Joe already noted, we delivered on both our gross margin and SD&A as a percentage of revenue targets. Our gross margin for the quarter was 56.4%, a 50 basis point improvement versus the prior year, primarily driven by the positive impact of our manufacturing efficiency programs. We anticipate second quarter gross margin to be slightly improved versus the first quarter. Separately, SD&A's percentage of revenue improved by 140 basis points versus the prior year primarily related to our cost savings efforts to streamline the organization and reduce our external spend profile. As with gross margin, we anticipate our SD&A levels will be largely similar during the second quarter versus the first quarter. with material improvement expected in the second half of the year as our cost management transformation efforts begin to accelerate. As we previously shared, 2023 will be a transition year, given our product portfolio rationalization and cost management initiatives. And the first quarter was an example of this unevenness, with slightly lower revenue than anticipated across some of our product categories, while profitability measures were either in line or exceeded our expectations. In summary, we are pleased with our first quarter execution in total and remain confident in our ability to meet our previously announced guidance for the year of earning between $1.60 and $1.80 of adjusted diluted earnings per share, while delivering at least $60 million in free cash flow, excluding the one-time cash costs associated with the restructuring efforts, expected to total approximately $25 million. Finally, including the current year impact of the approximately $35 million annualized impact of product portfolio rationalization, the company anticipates organic revenue growth to be low single digits. Now, turning to our transformation priorities, which are designed to shift our product portfolio over time into a higher growth portfolio, leveraging our cornerstone product families in digestive health, as well as our orthopedic pain and recovery-focused products. In addition, These priorities will right-size our cost structure and enhance our operating profitability, allowing us to generate significantly greater annual free cash flow over the next three years, while meaningfully improving ROIC over this transformation horizon. As already shared, we expect to realize approximately 10 million of savings in 2023, while anticipating 45 to 55 million of gross cost savings by 2025, most of which will be achieved in 2024. I will end with reiterating what I shared at the end of my prepared remarks for the year-end earnings call. We are excited to embark on our transformation journey and are confident we will improve on each of our financial metrics as 2023 progresses, with a slow start for the first quarter followed by acceleration in the back half of the year, similar pacing to what we experienced in 2022.

Operator, please open the line for questions.

We will now begin the question and answer session. To ask a question, you may press star and 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star and 2. At this time, we will pause momentarily to assemble our roster. The first question comes from David Turclay from JMP Securities. Please go ahead.

Yeah, great. This is actually Danny on for Dave. So just a quick one on gross margin. It was a nice increase during the quarter, and you noted some of that benefited from manufacturing efficiencies and improvement in supply chain. But I guess our question really is more around looking ahead, how should we think about benefits to gross margin for the full year? More specifically, how much of the improvement should we expect from the exiting of lower margin product lines and other portfolio rationalization efforts versus continued improvement in the supply chain that you've seen? Thanks.

Yeah, thanks, Dan, for the question. We still anticipate, as we said previously, we will have 100 basis point improvement on our operating margin for the full year. And given the uncertainties of the moving pieces, we weren't sure if that was going to come from gross margin or from our SG&A as a percentage of revenue or total op-ex spend. But I do think as we move through the year, the 56.4 that we started with in the first quarter, which we were very pleased with the overall execution that you pointed out, should land higher for the full year.

Great. Thanks. And then just one follow-up just on free cash flow.

It was an outflow of about $11 million this quarter, and you had called it out as a focus for 2023. So just cadence throughout the year on what we should expect going forward and any other considerations there would be great. Thank you for the questions.

Yeah. So the first quarter for free cash flow was definitely going to be the lowest. It was going to be what we ended up with for the quarter was going to be dependent upon how much execution we had on the transformation and cost savings plan. So we spent As you'll see in the one-time cost in the non-GAAP reconciliation, we spent about $7.5 million in cash in the first quarter for those activities. And, of course, revenue was a little bit softer than we expected. anticipated. So the combination of those two had free cash flow a little bit lower than we anticipated in the first quarter. That will be our lowest free cash flow quarter for the year, putting aside some tax payments that we may have. So we should see an improvement in free cash flow through the rest of the year.

Great. Thank you very much.

The next question comes from Rick Weiss from Stifel. Please go ahead.

Good morning, Joe. Just to start us off, so far this earnings season, we've heard a lot from much larger companies, obviously, talking about just in general, the macro environment, still challenging, but less of a headwind, supply chain stabilizing, stabilized, et cetera, et cetera. It'd be really interesting to hear your perspectives on how that, you know, is that really happening, you know, in the world of Avanos? How did they trend in the quarter? You know, how, what are you seeing so far in second quarter and sort of how does this all wrap into your outlook for the year? Thanks.

Yeah, Rick, I mean, a couple things, and I noted the other earnings calls as well, and a lot of the larger companies have the broader portfolio, to your point. But they did, inside of that, inside of those comments, say that they still, you know, made it clear that there were some issues. So for us, specifically, you know, OnQ and some catheter availability is hurting us there generally. We really had it across the board, though, even in our Coolidge product line, our Ambit product line, somewhat in digestive health, although we did move a lot of that through in the quarter. It's definitely going to improve. It'll still be with us in Q2. We do agree that the second half is likely going to be much, much better given that these things are going to disappear for us. But again, you know, for us, we probably had four to five million more that we could have pushed through if we were all the way clear on our backlog.

I think the other thing, too, Rick, to add to that is, you know, our confidence in reiterating our previously announced guidance is high because we do think the storm clouds are clearing, and some of the things that we missed this quarter were very specific to us, our raw materials, our input costs, but we think we have visibility to those things clearing, giving us confidence to being able to still achieve our full-year guidance outcomes.

And if you do think, you know, you've been following us for quite some time, and we do have a portfolio that unfortunately starts, as Michael has outlined, slow, with Q1 being the weakest, And even if you think about last year, we sort of progressed as each quarter went, and then a very large third and fourth quarter.

Yeah, no, that makes sense. Thanks to you both.

And Michael, maybe this is a question for you. On the interventional pain side, if I'm doing the back of the envelope math correctly, I may not be. Please don't hesitate to correct me. It looks like what I would call the base X-orthogen RX pain management business was down sequentially 25% versus the fourth quarter. I know that seasonal, sequential, you know, figure, whatever, down 5% or 10%. Is that the backlog? Is that component? Is there something else going on? And just maybe I missed your language. Is pain more uniquely affected here or you're seeing less of a recovery? You know, any extra color would be great.

Yeah, no, that's helpful. So it's a couple things. It's one where you just hit on, which is there is some component and access to material issues there. But in particular, game ready had a very strong fourth quarter and a less than optimal first quarter. So a big part of the math that you're doing is game ready attributed. In addition, standard RF was also down. That was more attributable to to the availability of product. Cool leaf was by and large a push 4Q to 1Q. So primarily our RF and our game ready are the pain points, no pun intended, for the week 4Q to 1Q transition and interventional pain.

Gotcha. And just last for me, Joe, I hate to keep being the one, but what can I do? Asking the M&A questions. But I know that you had hoped to have at least one transaction announced before the upcoming June Investor Day, if I remember your words correctly. We're a month or so away from it. Any additional color of your May front? And, you know, just help us, bring us up to date.

Yes, we do feel like we're going to be able to talk about an additional bolt-on, but for the orthopedic pain business, something that would help us in the ambulatory surgical center strategic area. It's also possible that we'll be able to say some things more explicitly about the portfolio that would be a significant change for us. So we feel pretty good about that. You know, a lot of times we hit it and it's hard to predict these things, but we're working very hard to make that happen because I think that will be very key for the investor day.

Thanks again.

Yep. As a reminder, if you have a question, please press Start, then 1. I don't think there's anybody else queued up, operator.

Yes, sir. There are no more.

Oh, sorry. Hold on. Yeah, Matt just got in.

Let's let Matt ask his question.

I'm sorry, I think I had an issue getting into the queue at first. Just wanted to ask on guidance on thinking about the cadence sequentially. I think you guys kind of hinted at a little bit of a softer first quarter relative to the low single-digit organic guide. Just wanted to think about the rest of the year, how it plays out. I know you said that the second half would likely be stronger, but also just maybe breaking out pain management versus chronic care and what you'd expect to see as a base case for the rest of the year.

Yeah, so great question. So Q2 is going to look largely similar, give or take, to Q1. There'll be some pushes and takes there, but largely similar to Q1. As we said, I think gross margin will be improved, given that we've got some programs that are picking up momentum. And then back half of the year will be very strong, both on the gross margin and the OPEX side. What we'll do in Investor Day in 45 days is give a little more specific layout. We'll kind of pre-talk about Q2, given that it will be June 20th, and then we'll lay out the back half of the year with more detail, inclusive of some of these transactions we think we'll be able to get over the finish line to talk about June 20th.

All right, great. And then just a quick follow-up. I'm not sure if you said in the prepared remarks if there was any change around the orthogen expectations for the rest of the year. Does guidance still contemplate relatively flat full-year sales versus last year, or has there been any type of change? Thanks very much.

No, there's been some change there. You know, we talked about really a combination, if you will, of 10% decline in orthogen in the HE part, primarily in the five-shot area. as well as the game ready and even the acute pain sector and the acute pain on cue being tied to supply chain. So there is that potential that's kind of folded into our, but we're still lining up to our full year guidance. And, you know, one thing we've talked about a lot in this HA environment that we're in is that there's ebbs and flows quarter to quarter where customers go away for a bit, they're chasing the best reimbursement and they come back, but it's really going to all kind of even itself out by the end of the year.

So just to clarify quickly, are you still contemplating like flat orthogen sales until last year?

No.

Okay.

No, we're not contemplating flat.

No. Okay. All right.

Tribisk will be flat to better versus last year or meaningfully better to last year. FiveShot will be down versus last year. We aren't confident yet. We have a sense of exactly what that mix will look like. But in total, it'll be down versus last year.

Okay. I guess lastly for me, would you point to any product areas as a potential offset to guidance given low single-digit organic was unchanged and it seems like Orthogen might be a little bit lower.

Yeah, digestive in particular. We also believe there's upside in acute pain as we get visibility to the supply chain issues. And then international as well, we think we have some pockets of strength internationally that have not been fully accounted for.

All right. Thanks very much for taking the questions. Appreciate it. Thank you.

The next question comes from Drew Ranieri from Morgan Stanley. Please go ahead.

Hi, Joe and Michael. Thanks for taking the questions. Just another on Orthogen for a moment, but I hear you on the five injection and three injection market, but just curious maybe on the five injection, is the decline at all more of just a mix shift into the three injection? Can you give a little bit more color there? And then I had a follow-up. Thanks.

Yeah, yeah. I think there's really two things. I mean, one is some Customers clearly with the reduced reimbursement in that segment, which a lot of it is non-orthopedic segment, it's more of a pain center segment, are leaving the business. The other component of that is that we had a competitor that had a special code in the first quarter. I believe that's going away in Q2 as they start reporting too. So you have a number of customers that kind of moved over for a bit to take advantage. We benefited from that obviously in Q4, but we didn't in Q1. That all settles out, and our intention is to maintain the base that we'll have of five, but we're growing and stabilizing in the three, and we actually have another focus that's inclusive of additional 1099s, new structure, a new VP of sales coming in to focus on the orthopedic space, not only in HA, but in the Amateur Surgical Center with some of our other products, and then the bolt-on that we alluded to in the earlier comments. Got it.

Thank you, Ed. And then just another follow-up to one of Rick's questions on M&A, but kind of in response to his question, you mentioned there could be more of a portfolio move. It sounded like more of a divestiture than anything. So are we kind of hearing you right into analyst day that that could be something that's still on the table? And should we think about that as a multiple of what you're doing already in kind of the product rationalization for 2023? Thanks for taking the questions.

If we were to do a divestiture, it would be a multiple of the product rationalization, so that's a fair assessment.

Gentlemen, there are no more questions at this time.

Again, I want to thank everybody for the continued interest in Avanos. We feel the demand and fundamentals of our products remain strong. We are committed to obviously creating meaningful shareholder value through thoughtful strategic capital allocation. We believe the 22 results have built the necessary foundation to deliver the commitment that we have and are confident in the priorities that we've detailed in the transformation program, combined with our market-leading portfolio and attractive markets. This all positions us for growth, margin expansion, and cash flow, as we've outlined and as Michael has talked about in the transformation process. We do look forward to seeing everybody at the June 20th Investor Day to be held at the convene 101 Park Avenue location in New York City. Have a great rest of your week. Thank you for your interest. Bye.

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