Avanos Medical, Inc.

Good morning, ladies and gentlemen, and welcome to the Avanos Medical, Avanos Third Quarter, 2024 earnings call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a -and-answer session. If at any time during this call you require immediate assistance, please press star 0 for the operator. This call is being recorded on Wednesday, October 30, 2024. I would now like to turn the conference over to Scott Gullivan, SVP 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 Third Quarter earnings conference call. Speaking first today will be Gary Blackford, Avanos Board Chair. He'll be followed by Interim CEO Michael Greiner. Gary will give an update on our leadership changes before Michael reviews our Third Quarter results, the current business environment, an update on our transformation efforts, and our Fourth Quarter 2024 planning assumptions. We will finish the call with Q&A. A 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 will be referring to adjusted results and outlook. The press release has information on these adjustments and reconciliations to comparable gap financial measures. Now I'll turn the call over to Gary for introductory remarks.

Thanks, Scott. I'm here today to provide a brief update on recent leadership changes at Avanos. Joe Woody has announced his decision to retire as Avanos' CEO, and Michael Greiner has been appointed interim CEO. Joe has graciously agreed to assist the company in this leadership transition, and he'll continue to consult with the company through April of next year. Joe has accomplished a great deal in his tenure as CEO. He led the strategic positioning for the company to a more focused medical device solutions company via acquisitions and divestiture of assets and businesses that were not aligned to the company's long-term strategy. Avanos is in a better position financially and organizationally today to achieve its long-term value creation goals. We're grateful for Joe's leadership these past seven years, and we thank him for his efforts and dedication to Avanos. We're also pleased to announce that Michael Greiner has agreed to serve as interim CEO for Avanos. As Avanos CFO and Chief Transformation Officer, Michael demonstrated his ability to deliver consistent results against our three-year transformation plan, and he is well positioned to step in as interim CEO. While Michael is our leading candidate to become the permanent CEO, our board wants to evaluate other candidates as well, and we'll conduct a fulsome search for a permanent CEO over the coming weeks. To enable Michael to focus on running the company, Warren Mahan has been appointed interim CFO. Many of you may remember Warren, who previously spent seven years as Senior Vice President of Strategy for Avanos and served as interim CFO before Michael joined Avanos. Prior to leaving Avanos in 2021, Warren had 34 years of experience with Kimberly Clark, Hyatt Health, and Avanos. Since leaving, Warren has continued to provide strategic consulting in support of the company's transformation agenda. We welcome Warren back as interim CFO. Change is constant in the medical device world, and the Board of Directors believes these leadership changes will allow the company to continue its strategic path of becoming a more focused organization. In closing, I'm proud of the transformation progress Avanos has made, and I'm genuinely excited about the company's promising future, powered by our team's commitment to make a difference, and by the enduring importance of our products and patients' lives. With that, I'll turn the call over to Michael.

Thanks, Gary. Good morning, everyone, and thank you for joining us to review our operational and financial results for the third quarter of 2024. As Gary just mentioned, over one year ago, we announced a transformation plan to optimize our portfolio, refocus our commercial operations, and improve our margin profile. This quarter marked a significant milestone in our transformation as we successfully completed the conveyance of two respiratory health plans to air life, as well as continued our efforts to right-size our cost structure and enhance our operating profitability, and also generated meaningful free cash flow, ultimately positioning the company to more effectively and efficiently deliver shareholder value creation. Although we are pleased with our transformation progress, we fell short in the third quarter of our stated objective of -single-digit organic growth, which also negatively impacted gross margin for the quarter. Our pain portfolio, particularly surgical pain, was the primary driver of this underperformance, partially offset by another strong quarter in digestive health. In spite of these mixed results, we have continued to help patients get back to the things that matter. So far this year, we have supported over one million patients in overcoming a wide range of challenges, from post-surgical pain management and recovery, using our On-Cue catheter-based therapy and game-ready solutions, to addressing short- and long-term enteral feeding needs with our CoreTrack and Mickey brands. We are very committed to making a positive impact in these patients' lives. Now, switching to financial highlights for the quarter, we generated approximately 170 million of sales from continuing operations, 36 cents of adjusted diluted earnings per share, and approximately 31 million of adjusted EBITDA from continuing operations, or almost 18 percent of adjusted EBITDA margin. 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 1.1 percent compared to a year ago. Now, let me spend the next few minutes discussing our results at the product category level. Our digestive health portfolio continues to deliver consistent results, growing almost 6 percent organically versus prior year, reaffirming our number one position in long-term, short-term and neonate feeding. Digestive health performance was supported by continued double-digit growth in our Neomed product line as we continue to take advantage of the strong demand for NFIT conversions in North America, while also capturing opportunities from a competitor's backorder. 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 cycle. Demand for our legacy NREL feeding business remained healthy, growing at market level during the third quarter compared to the previous year. We expect continued above-market growth for our digestive health portfolio will be supported by product innovations, global market expansion and inorganic growth opportunities. Now, turning to our pain management and recovery portfolio, normalized organic sales for this quarter were up a little over 1 percent, excluding HA and inorganic sales related to our DEROS acquisition. While our overall pain portfolio grew year over year, we were disappointed by the performance of our surgical pain portfolio and softness in our North America Cool Leaf offering. The setback in our surgical pain portfolio was centered around our OnCue product line, which was affected by transient execution and supply issues stemming from backorder challenges at one of our pre-fillers early in the third quarter. Additionally, while we have maintained key customer relationships and prioritized supply for these Tier 1 OnCue customers, we have experienced higher than expected turnover in our next tier of customers. We are actively working to reengage them. These headwinds muted the strong performance of our ANVIT products, which has grown in excess of 30 percent in each of the last four quarters, capitalizing on the procedural shift to the ASC. Our IVP business posted double-digit growth for this quarter compared to the previous year. We continue to see momentum in our IVP generator sales, capturing higher procedural volumes, especially within our Ascentec and Trident product lines. We credit our renewed ASC strategy and the increasing productivity of our fully deployed new sales structure and supporting these outcomes. Additionally, we are encouraged by the progress of our Coolief offering internationally, leveraging reimbursement tailwinds in several countries, including the UK and Japan. Our Trident product line, acquired in the DEROS acquisition a year ago, continues to deliver against their internal growth expectations. We are capitalizing on our successful U.S. market launch, with over 130 accounts having converted to our Trident technology. Our Game Ready portfolio posted its third consecutive quarter of double-digit growth compared to the prior year. As noted during our last call, we anticipate a lower growth profile from Game Ready in the fourth quarter, given the particularly strong fourth quarter we experienced in 2023. However, actual revenue results for the fourth quarter will be in line with the first three quarters of 2024. Finally, our HA portfolio, while down year over year, was flat and sequentially consistent with our prior three 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 expect fourth quarter revenue for our HA portfolio to be north of $10 million, which would mark the fifth consecutive quarter at this level of performance. While we continue to execute on mid- to longer-term strategies to gain volume share in the three- and five-shot HA categories, we continue to experience pricing pressure, which is currently offsetting the volume share gains we are achieving. Now, margin expansion was positively impacted by continued SG&A optimization efforts and a favorable outcome from a Canadian Customs Duty Refund matter. Adjusted SG&A as a percentage of revenue was 39.8%, marking an improvement of 180 basis points compared to the third quarter of last year and 320 basis points sequentially. This improvement is primarily driven by our cost savings efforts to streamline the organization and reduce overall spend as part of one of our transformation pillars. For the quarter, our adjusted gross margin was 58%, which is comparable to last year. We were able to partially offset inflation and HA price volatility through transformation initiatives at our plants and operations level. We expect adjusted gross margin to be approximately 59% for the fourth quarter as we see better product mix and savings initiatives that were delayed during the third quarter implemented in the fourth quarter. As I already shared, our performance in the third quarter tracks slightly behind our expectations. That being said, our organization's primary focus remains our transformation priorities as we address transient challenges that are likely to provide a slight headwind into the fourth quarter. As a result, we anticipate the following outcomes for the fourth quarter. Revenue in the range of $175 million to $180 million, representing low to mid-single digit organic growth, adjusted gross margin of approximately 59%, and approximately 40% of adjusted SG&A's as a percentage of revenue. These financial metrics support an adjusted diluted earnings per share between $0.38 and $0.43. Now, turning to our financial position and liquidity, our balance sheet remains strong and continues to provide us with strategic flexibility with $89 million of cash on hand and $162 million of debt outstanding as of September 30th. Supporting our cash on hand, free cash flow was positive $20 million in the third quarter. During the fourth quarter, we anticipate generating approximately $30 million of free cash flow, as well as receiving $30 million of cash from AirLife, primarily due to final transfers of the remaining assets related to our RH divestiture. As a result, we expect our year-end balance sheet to have net debt of approximately $20 and a leverage ratio of under a quarter turn. 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. Now finally, moving to our 2023 to 2025 transformation priorities and efforts. As a reminder, we have four key priorities that are expected to improve our -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 ability 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 important progress against these transformation priorities. Third quarter highlights include, but we're not limited to, finalizing separation efforts associated with the divestiture of our respiratory health business with the conveyance of our Magdalena and Nogales II plans to AirLife, as well as the transfer of the Australia and New Zealand international operations. Maintaining above market growth in our enteral feeding business, benefiting from strong and competitive conversion tailwinds in North America that are expected to continue into Q4. Capturing procedural volume growth for our IVP portfolio, strong execution for our AMBIT product line, further execution related to our company-wide cost management programs, and maintaining M&A discipline on a conservative leverage level of less than one term. And as of last Friday, we've received an FDA approval for our CoreGrip SR Nasal Bridal System, our third FDA approved 510K pre-market submission this year. As you know, we kicked off our transformation journey at our June 2023 Investor Day and have executed on the majority of these key initiatives. Nonetheless, the full benefit of these initiatives is currently being tempered by inconsistent top line results. To address this challenge, we are continuing to adjust our -to-market approach, invest in payor and reimbursement strategies, enhance the quality of our selling and marketing organization, and selectively enter international markets to achieve consistent -single-digit top line growth that is required to support the full financial outcomes of our transformation efforts. Operator, please open the line for questions.

Thank you so much. Ladies and gentlemen, you will now begin the question and answer session. Should you have a question, please press the star followed by the number one on your touch-tone phone. You will 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 number two. And if you're using a speakerphone, please lift the handset before pressing any keys. And one moment, please, for your first question. Our first question comes from the line of Kristen Stewart of VL King. Your line is now open.

Hi, thanks for taking the question. I wanted to just start off on the PAME business and the supplier constraints within OnQ. Specifically, how long do you think that these supplier constraints are going to be lasting, and how should we think about the longer-term growth rate for OnQ in the portfolio, especially as we look out into FY25?

Yeah, thanks, Kristen. So the primary supply challenges we had with OnQ in the quarter related to lighters, and that was in the first half of the third quarter. Those resolved themselves as the quarter went on. But as you know, if we miss a procedure that has an OnQ attribute, we're not going to get that procedure back. So it has an impact in quarter. And so we have to get some of those customers back. And obviously, depending on what the uptake of procedure volume is in the fourth quarter, that'll have an impact on OnQ as well. Longer term, we are excited about the OnQ prospects, primarily because of the No Pain Act, which we've talked about previously. So we will find out in the coming weeks what our reimbursement will be around OnQ, and we'll be able to have a much more thoughtful view as to what that'll do to impact OnQ going forward. We know that No Pain Act is a positive, no doubt about it. We just aren't quite yet sure exactly how positive, and the actual reimbursement rate will be a big determinant in that.

Okay, and then how should we just think about the company's longer term goals and objectives that wasn't mentioned on today's call? And just thinking ahead to FY25, if you still feel comfortable with seeing an acceleration to -single-digit growth, or if we should think about this more as a -single-digit growth profile sort of company, given kind of the four Q performances in that range?

Yeah, so a couple things. Great question. We're not commenting on 25 right now. We will be doing that as we attend the JPMorgan Conference in January. You know, other than OnQ and North America softness and Cool Leaf, we actually had very good performance throughout our product portfolio. So we continue to analyze coming out of Q3 with the softness in OnQ, which was about 3 million, and then there is a little over 2 million in softness with North America Cool Leaf. The rest of the portfolio is operating as intended, but we do need to take a step back and think about what the No Pain Act will be for OnQ going forward, as I just shared with your initial question. And then also, what is the fight growth profile for the company going forward? But we are acting as intended through the rest of the transformation, and you can see that in the remaining parts of the income statement. And so we'll have a more wholesome update in the early part of January for 2025. Okay,

thanks.

Thanks

very much. Thank you so much. And again, if you would like to ask a question, please press star 1. Your next question comes from the line of Danny Stouter of Seasons 3 MP. Your line is now open.

Yeah, great. Thank you. Just so for my first one, I'm going to ask on 2025, but I'll keep it high level. You talked about a number of items, but could you give us some primary tailwinds of sales that we should be thinking about? You know, what are the major products? What are the, you know, product launches or anything else we should keep in mind as we look to next year?

Yeah, so I'll start with digestive health business. You know, we have our legacy business, which we supported by our core group, SR Launch, amongst two other launches that we'll have throughout next year. Our legacy DH business is a, at the market, a 3 to 4% grower. We've been growing faster than that in many quarters due to taking share. And these launches are important in order to ensure that we can continue to grow at least at the 3 to 4% rate and higher as we take shares. So that's part of the enteral feeding business. The other part of our enteral feeding DH business is our Neomed product line for neonates. As you know, that's been growing very healthy for a couple of years now. We have signaled for a bit of time that we're in the later innings of the NFIT conversion cycle for Neomed. It has lasted longer than we anticipated, which obviously is great. And we will be achieving over 100 million in revenue in Neomed for the year at some point in December. So we're excited about that. That growth rate though will come down a little bit in 2025, which we have anticipated and have already signaled. When you look at our pain management recovery business, we look primarily at four buckets. I'll start with A.J. This is the fourth quarter in a row where A.J. has been between 10 and 11 million of revenue. We anticipate fourth quarter to have a similar level of revenue. And then we expect to continue to have good volume share gains in 2025. But we're currently assessing what is the pricing impacts between our three and five shot markets going into 2025. If you look at the new allowables pricing that was just published, five shot was up, three shot was down. And so there's various strategies that we're deploying against both our three and five shot offering in both Medicaid, Medicare and the commercial set. So we've got some work to do to understand what are the pros and cons of our pricing strategy going in 25. But on a volume basis, we've done a very nice job on the AHA side. Our IVP business, which consists of three different platforms, has been growing quite nicely. We had a double digit growth rate this quarter. You know, our new acquisition from DEROS has performed as expected, if not slightly better. So we're excited about that offering and what we can capture and share of volume of procedures in the ASC setting. Coolief is doing very nicely internationally. As I noted earlier, North America was a little soft, but internationally with reimbursement tailwinds, particularly in the UK and Japan. We're growing coolie nicely. So we're excited about our IVP part of our portfolio. Game Ready has had three consecutive quarters of double digit growth. The fourth quarter will not have that percentage growth just because of the tough comp we have in the fourth quarter of last year. But we will have absolute dollar value revenue growth similar in the fourth quarter for Game Ready. So that is stable and growing. We're excited about the opportunity to Game Ready in 25 and beyond. And our surgical pain business, you know, Ambit has been growing 30% plus as we noted in our prepared remarks. We're excited about the share that it's taking in the ASC. And onQ, we do think is set up for stabilization at worst and hopefully some growth given the no pain act and reimbursement, you know, positive news that we'll be receiving as we enter into -1-25. So we like where we're positioned with this portfolio. But as I said to Kristen's question, we do need to do some more work over the coming weeks and into the early part of next year to, you know, be able to lay out a an appropriate 2025 set of financial metrics and more to come on that in early January.

That's great. I appreciate that. And just just one follow-up. So just on Game Ready, you know, it's been a few strong quarters here and you talked a little bit about that. But any more color you can give us on what's driving this growth? You know, is it some of it due to 2023 comps or do you feel this is more steady state solid performances? And then, you know, any notable drivers we should keep top of mind as we look into next year this category. Thanks.

Yeah, no, it's great question. So a little bit of it is the comps. Danny, as you point out, just as the tough comp for Q4 will mute some of the percentage for Game Ready and Q4. But if you look at the absolute dollars, it is growing year over year in total for the year. We expect to have similar growth in total for 2025. We are deploying some new strategies in Game Ready around a direct consumer approach, which we are currently testing and currently are very pleased with some of the early feedback we're getting. We're also deploying additional strategies with orthopedics in Game Ready, a rental model that is a little more seamless than the current rental model that we currently deploy, which can be clumsy at times for us because that's not our expertise. So we think we have the right strategies in place for Game Ready and we're excited to lay out additional strategies in 2025 to help support further growth in that category.

Great. Thank you very much.

Thank you so much. And there are no further questions at this time. I would like to turn it over to Michael Kreiner for closing remarks.

Great. Thank you. Our primary focus, as you guys know, continues to be the execution of the strategic transformation plan that we outlined 15 or so months ago at Investor Day. As we previously talked about, we've successfully executed product exits. We've divested our RH business and hit an important milestone this quarter with that divestiture. We required some great technology with DEROS and we supported our valuation through various share repurchase opportunities opportunistically, which we will continue to do going forward. And we've made significant progress from a margin standpoint, free cash flow generation standpoint towards our financial objectives. We look forward to presenting at the JPMorgan Conference in January with a more holistic review of our transformation priorities along with as I just shared the full year financial metrics for 2025. Thank you for your continued interest in Avanos.

Thank you presenters, ladies and gentlemen. This includes today's conference calls. Thank you for your participation and you may now disconnect. Have a great day.