Avanos Medical, Inc.

Good morning, ladies and gentlemen, and welcome to the Avanos Medical Q2 2024 earnings call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Wednesday, July 31st, 2024. I would now like to turn the conference over to Scott Gallivan, Senior Vice President, Strategy and Corporate Development. Please go ahead.

Good morning, everyone, and thanks for joining us.

It's my pleasure to welcome you to Avanos 2024 Second Quarter Earnings Conference Call. Presenting today will be Joe Woody, CEO, and Michael Greiner, Senior Vice President, CFO, and Chief Transformation Officer. Joe will review our second quarter results, current business environment, as well as provide an update on our transformation efforts. Michael will share additional details regarding these topics and affirm our 2024 planning assumptions. We'll finish the call with Q&A. The presentation for today's call is available on the Investors section of our website, avanos.com. As a reminder, our comments today contain forward-looking statements related to the company, our expected performance, current economic conditions, and our industry. No assurance can be given as to future financial results. Actual results could differ materially from those in the 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 risk factors described in our filings with the SEC. Additionally, we'll 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 Joe.

Thanks, Scott. Good morning, everyone, and thank you for joining us to review our operational and financial results for the second quarter of 2024. Building off our first quarter results, we delivered a strong second quarter as digestive health continued its solid performance, and we experienced additional positive shifts in our pain management and recovery business. As we noted in our prior earnings calls this year, our quarterly performance for 2024 will improve as the year progresses. The demand for our products remains strong, and our supply chain organization is executing effectively to support our commercial strategy. eliminating the significant above-normal backlog we experienced in the past 18 months. We are continuing to make steady progress against each of our transformation priorities, which both Michael and I will discuss further. And as always, our primary focus is on getting patients back to the things that matter as we meet the needs of our customers. For the quarter, our sales from continuing operations were approximately $172 million. Adjusted for the effects of foreign exchange and the impact of our strategic decision to discontinue revenue streams that did not meet the return criteria specified by our portfolio transformation priority, organic sales were up 2.6 percent compared to a year ago. We generated 34 cents of adjusted diluted earnings per share and approximately 27 million of adjusted EBITDA from continuing operations. Our three-year transformation priorities continue to drive our execution. And our second quarter results provided further evidence that we can deliver within the ranges of the 2025 financial targets we established last year during our investor day. Now I'll spend the next few minutes discussing our results at the product category level. Our digestive health portfolio continues to deliver excellent results, growing almost 9% organically versus prior year, reaffirming our number one position in long-term, short-term, and neonate feeding. This performance was bolstered by our Neomid product line, which posted another terrific quarter growing double digits versus the prior year as we continue to take advantage of the strong demand for NFIT conversions in North America. While we currently are experiencing solid double-digit growth for the Neomid product line, and as we have previously signaled, we anticipate lower but still above-market growth over the next few quarters as we enter the late stages of the NFIT adoption. Our legacy central feeding business also posted a strong quarter, growing high single digits compared to the previous year. As noted during our last call, we anticipate continued above market growth for our digestive health portfolio this year, supported by innovations we have launched this quarter and are planning to launch during the back half of the year, expansion into additional global markets with attractive growth prospects, the completion of low growth product rationalization, and actionable M&A opportunities. Now turning to our pain management and recovery portfolio, normalized organic sales for this quarter were up approximately 2%, excluding HA and inorganic sales related to our DROS acquisition. While our overall surgical pain portfolio was down less than a point year over year, we were pleased with the performance of our combined OnQ and Ambit portfolio, which grew by mid-single digits for the same period, a testament to the renewed focus of this portfolio and our enhanced go-to-market strategy for OnQ and Ambit. Even without the positive impact of DROS revenue, our IVP business returned to growth this quarter, with our combined radiofrequency ablation portfolio growing by mid-single digits compared to the previous year. We are encouraged by the continued momentum seen in our IVP generator sales accompanied by capturing higher procedural volumes. We credit our renewed ASC strategy and the increasing productivity of our fully deployed new sales structure in supporting these outcomes. Further supporting our ASC strategy, our new Trident product line acquired in the DEROS transaction continues to deliver, meeting our internal growth expectations. We are capitalizing on our successful U.S. market launch with over 100 accounts having converted to our Trident technology. Our game-ready portfolio is also demonstrating strong momentum, posting a second consecutive double-digit growth quarter compared to the prior year. We anticipate a slightly lower growth profile from Game Ready in the back half of the year, especially given the particularly strong fourth quarter we had in 2023. Finally, our HA portfolio, while down more than 30% year over year, was flat and sequentially consistent with our prior two quarter results. This leveling off of revenue in our HA portfolio was anticipated and aligns with our previously forecasted 20% decrease in HA revenue for the full year. We remain confident in our ability to maintain this level of performance as we execute on mid- to longer-term strategies to gain share in the three- and five-shot HA categories as price stabilizes. We are encouraged by the progress and momentum we are seeing across each of the paying businesses and believe these are solid indicators of our ability to deliver mid-single-digit growth for 2024, excluding the 20% decline in HA revenue I just noted. Now moving to our 2023 to 2025 transformation priorities and efforts. As a reminder, we have four key priorities for the next two years that are expected to improve our go-to-market opportunities and meaningfully enhance our financial profile. These priorities are strategically and commercially optimizing our organization, transforming our product portfolio to focus on categories where we have attractive margin profiles and the right to win, taking additional cost management measures to enhance operating profitability, and continuing our path of efficient capital allocation to meaningfully improve our ROIC. We continue to make substantial progress against our transformation priorities. Second quarter highlights include continued progress across our pain portfolio, strong execution with our new Trident product line, finalizing certain of the separation efforts associated with the divestiture of our respiratory health business. further execution related to our company-wide cost management programs, continuing towards full optimization of our manufacturing and office footprint, and maintaining M&A discipline and a conservative leverage level of less than one times. Our second quarter results are a testament to the continued progress against each of our transformation priorities, and we remain focused on delivering consistent results over the coming quarters in order to meet our 2025 financial targets. Now I'll turn the call over to Michael. who will provide further insights on our financial results and transformation platform.

Thanks, Joe. As you shared, our second quarter results showed continued progress against our transformation priorities and further support our full-year targets. Since 2021, we have been delivering mid- to high-single-digit growth in our digestive health portfolio and again delivered that level of performance this quarter. Excluding the results from our HA business, our pain management and recovery portfolio experienced low single-digit growth overall. In comparison to the previous year, our game-ready portfolio saw double-digit growth, demonstrating continued momentum in this category. Separately, our pump business, including our OnQ and Ambit products, grew by mid-single digits, while our IVP products were up by low single digits. From a continuing operations standpoint, Net sales were 171.7 million. Adjusted EBITDA was 26.8 million, and adjusted diluted earnings per share was 34 cents during the quarter. Adjusted for the effects of foreign exchange and the impact of our strategic decision to discontinue revenue streams that did not meet return criteria specified by our portfolio transformation efforts, organic sales were up 2.6% compared to a year ago. Our adjusted EBITDA grew by 17% compared to a year ago, with adjusted EBITDA margin expansion of 210 basis points, and our adjusted diluted earnings per share improved by 42% compared to a year ago. This margin expansion was positively impacted by top-line growth, effective manufacturing and operations execution, and continued SG&A optimization efforts. For the quarter, Our adjusted gross margin was 59.6%, which is comparable to the prior quarter and last year. We were able to offset inflation and HA price volatility through our transformation initiatives at the plant and operations level to achieve these results. We expect adjusted gross margin to be approximately 60% next quarter as well. SG&A, the percentage of revenue is 43%. marking an improvement of 210 basis points compared to the second quarter of last year and 280 basis points sequentially. This improvement is primarily due to our cost savings efforts to streamline our organization and reduce external spending. As you know, this is part of our ongoing journey to further enhance our financial profile with continued improvements expected throughout 2024 and into 2025. Our performance in the second quarter is tracking with our expectations for the year, reflecting the success of our transformation strategy, which remains our organization's primary focus. As such, we are reaffirming our 2024 full-year guidance, with revenue in the range of $685 million to $705 million, representing mid-single-digit organic growth, adjusted gross margins to range between 59.5% and 16.5%, and SG&A is a percentage of revenue to be between 41 and 42%. These financial metrics support an adjusted diluted earnings per share between $1.30 and $1.45 for the year, as well as adjusted EBITDA margin improvement of at least 200 basis points. Now, turning to our financial position and liquidity, our balance sheet remains strong and continues to provide us with strategic flexibility with 92 million of cash on hand and 175 million of debt outstanding as of June 30th. We have maintained leverage levels meaningfully below one term over the past 10 quarters and will continue to be good stewards of our balance sheet. As we have previously shared, we continue to actively pursue strategic M&A opportunities that align with our returns criteria and will also deploy capital for opportunistic share repurchases. Finally, free cash flow was positive $22 million in the second quarter, of which approximately $15 million related to a tax refund for which we had previously recorded a tax receivable. This was an improvement of almost $29 million compared to a year ago. We anticipate continued improvement in our free cash flow profile in the second half of the year, but now anticipate that we will generate approximately 70 million of free cash flow for 2024 due to higher one-time charges and inventory than previously anticipated. The second year of this transformation journey is crucial for achieving the 2025 financial objectives we outlined on Investor Day. These include consistent mid-single-digit growth that would drive our organic revenue to approximately $730 million in 2025, gross margins surpassing 60%, SG&A as a percentage of revenue being between 38% and 39%, and free cash flow generation of approximately $100 million in 2025, supported by these operational financial metrics, consistent CapEx spend, and meaningful improvement in working capital. Operator, please open the line for questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touchtone phone. You'll hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press the star followed by the two. If you're using a speakerphone, please lift the handset before pressing any key. One moment please for your first question. First question comes from Kristen Stewart with CL King. Please go ahead.

Hi, thanks for taking my question. I was wondering if we could just focus a little bit on the pain management side of the business. It seems to be showing some nice green shoots there. Just in terms of HA and how that's been progressing, it sounds like that's in line with your expectations. Just want to double-check that. And what do you see as a longer-term kind of growth outlook for the pain management business overall as we look out beyond this year?

Hey, Kristen. Thanks for your question. It's Joe Woody. I think and have said before that mid-single-digit growth at the global level as you move into 25 is possible for the pain business. Some positive things definitely have happened. Inside of the surgical pain business, we did see mid-single-digit growth between AMBIT and ONQ. Obviously, that business held back a little bit by the IV infusion business. IVP We saw growth in that business, which is positive. We see good momentum there, game ready, two quarters of double-digit growth. And so we're happy, and we're obviously standing up to the second half, which is a step up in those businesses, so we do see the momentum. We are seeing with HA pricing stabilizing. At the same time, volume's increasing. It's a little bit all over the place, but generally double-digit type of volume growth each quarter. We've added 1099s in the business, and we obviously are going to make it through at the end of the year through all the comparators and see that as a low single-digit type of grower for us with a really strong gross margin. And, again, we've said part of our strategy. So we're working our way there. We've definitely made the improvements. And just to reiterate, we do see that as more of a mid-single-digit grower in the longer term.

And, Kristen, just one final thing. You know, we're down 30%. In Q2, we'll be down generally in that range in Q3 for HA. And then in Q4, we did about $11 million last year. We anticipate doing around $11 million this year in Q4 to Joe's point. That would make you kind of flattish. But that would have five consecutive quarters starting with the $11 million in Q4 last year through all four quarters of this year should we execute against what I just laid out. of somewhere between $10.5 million, $11 million per quarter. And that will level us off in this kind of $42 million annualized level, which, to Joe's point, going forward, we think we can start growing that low single digits as price stabilizes. And we are seeing that with the allowables, the quarterly allowables, which is all good news.

Perfect. And then CMS had come out with a proposal to break out – reimbursement for OnCue. I was wondering if you could just provide some thoughts there on what you think that could do for the business.

Yeah, that's something that we've worked on for, geez, about four years, I think, on both sides of the house and being a part of talking about the OnCue product. So the outpatient perspective payment, you know, we were assigned a unique code for OnCue. That will, we're making comments on the actual payment up until September 9th, of this year, and then January 1, we'll understand what our payment will be. I think that over the longer term, there's a potential for us to get that business back to where it was for us at its peak, and that's significant for us. It may not be for a larger MedTech company, but I think it's a positive. It's a little early for us to predict the immediate impact and the adoption levels, but having reimbursement where you've only been sort of working as a hospital with a DRG should ultimately be a positive for the business.

Okay, thank you for taking the questions.

Your next question comes from Rick Wise with Stiefel. Please go ahead.

Good morning, Joe. Hi, Michael. Maybe starting off with your comments about digestive health and Neomed. Obviously, as I think you said, in recent quarters, Neomed continues to deliver a solid double-digit growth, despite being in the later phases of NSAID conversion. Just remind us how much more NSAID conversion runway is left. You know, when do we think it tails off and How do we think, or maybe you could comment on upcoming digestive health product launches? And is all that math work to, you know, as we start thinking about 25, can it sustain mid to high single digit growth trajectory that we've seen, you know, without NeoMed conversion being so excellent?

Yes, I mean, and NeoMed can remain double-digit, we think, throughout this year and into the early portion of 2025. It's not like it's going to drop off tremendously, though. We see it as a high single-digit global grower for a foreseeable runway for us. So that's a positive for the business. I mean, we're, as an example, converting 100-ish accounts, if you will, this year. Something similar to that, maybe slightly less next year. So again, a high single-digit grower there. We're getting of note, too, our international business grew 11% for the quarter, and a big portion of that was legacy DH, which is continuing to grow. We see it as a mid-single-digit, long-term to high-single-digit, depending on the quarter, solid business, and we do have the launches that could enhance that. We also do have, obviously, bolt-on M&A that we've talked about, and a large pipeline that we see enhancing that. mid-single digit to high-single digit in the long term in any given quarter.

Yeah, we are, to your question about launches, we are preparing for both core track and core grip launches over the short to mid-term here. To Joe's point, that'll help to provide some extra fuel for that mid- to high-single digit growth in the legacy business.

Gotcha. And, Joe, you mentioned, again, the M&A pipeline in so many words. A couple things here. You know, you both highlighted your financial discipline around M&A. What's that mean? How do we understand that? Does that mean prices continue to be too high or you're just not finding the right fits? So, just a couple of questions tucked in here. But speaking of tuck-in, is there an opportunity still later this year for a tuck-in M&A? Is it likely to be in digestive health? And I might be wrong, but is this the first time I'm hearing you even lightly touch on the possibility of share buyback, or is that just a theoretical notion and you're prioritizing M&A? Thank you.

Yeah, just on share buyback real quick, we've done $25 million, but we've not announced any new share buyback program.

So we've done $85 million. We mentioned it over the last year and a half. We've done $85 million over the last year and a half.

Right, but again, I'm saying, Michael, yeah, sort of beyond that.

Yeah, so we're always looking to see if we have capital to deploy for share repurchases. We currently are done with all of our authorizations, so we'd have to go back to the board and get a new authorization at this point in time.

And then to pick up on these other issues, Rick, yeah, it's possible that we do bolt on and we're working on a number of them. We can never predict, though, the timing. It's not been really about for us this year on a couple that we've taken a pass on in terms of price. It's been more of when we get into the diligence and look at the technology. and there's some, you know, ahas there for us that would cause us to pull back. But you could see something from us. And, you know, we've been in this environment a little bit cautious with the balance sheet, you know, the less than one times levered. But it's paid off to do that, I think, to be conservative. But we do have a robust pipeline still, and it would be more digestive health oriented.

Thank you so much.

Once again, if you would like to ask a question, please press star 1 on your touchtone phone. Your next question comes from Danielle Sautter with Citizens JMP. Please go ahead.

Great. Thank you. So just first one on pain management, game ready. So double digit again, which is great to see. But could you just give a little bit more color on what is driving this growth? Then you noted it should ease in the back half of the year. And first, what does that imply on a full year basis? And Why do you expect the growth rate to come in a little bit? Is this just a factor of prior year comps, or is it something related to trends you're seeing?

Thanks. Daniel, thanks for the question. I think you have a little bit of everything, but what I would say is we're getting a good benefit from the international business and adoption at the international level. A little bit like the DH business, I see GameReady as a high single-digit consistent, but sometimes a double-digit in a given quarter business. type of growth. And we're doing a number of things with looking at our rental program, changing and adding structure to our selling organizations. So you're seeing some of the benefit from that. And yes, there's some comparator issue, but over the longer term, high single digit to a double digit, depending on a given quarter.

Great. And then just staying with pain management, but turning to Cool Leaf, you noted RF grew mid-single digits, and I believe that was excluding DROs. But could you just talk about some of the updates as far as what you're seeing within cross-selling or cross-channel benefits as you've rolled out the new product? Thanks.

Yeah, I mean, we're seeing in just IVP in general a lot of strength in DEROS, and we'll be talking even more about that sort of next quarter as the quarters move on. Standard RF because of the shift to the ambulatory surgical center, quite strong this year. Cool Leaf is starting to come back, more leveling off from the supply chain issues and some of the disappointment that gave our customers. But they're starting to come back and the new selling structure is really coming up to speed every quarter that we move along. And we've actually sold a record number of generators. That tells me that the longer term for Cool Leaf, which are three out of every, three of four, of four, three are Cool Leaf generators. So that means that it takes a while to get those up and running. You know, it can be 90 days to 120 days. That is coming, and so you'll see that all across. And then the longer term, we've said, that's a consistent mid-single-digit to high-single-digit overarching business. So what's kind of pulling it down a little bit, too, when you look at the IBP business, is we did exit or discontinue a number of products in the NKT, which is the supply space in the NKT area, which is the supplies, the needles, kits, and trays used And the procedure is very commoditized. But we're working our way through that as well. So you'll definitely, because of the fact that we're standing up to the numbers for the second half, see the increase sequentially.

Great. Thank you very much.

Once again, if you would like to ask a question, please press star, then the number one on your touchtone phone. And there are no further questions at this time. I would now like to turn the call back over to Mr. Joe Woody for closing remarks.

Just want to thank everybody. Obviously, our focus is on the precise execution of the transformation plan. We've successfully executed these product exits, divested RH, and acquired valuable technology with Theros, increasing our shareholdings in a repurchase program, and made a lot of progress that we're sharing with you today. We believe the results have established the foundation to meet our midterm financial commitments with our transformation priorities, market leading portfolio, and our attractive markets. We think we're well positioned for 25. So we thank you for your interest in Avanos and look forward to talking to you all more. Thank you.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.