Avanos Medical Q1 2024 Earnings Call Transcript

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May 2, 2024

There are 7 speakers on the call.

Operator

Good day, and welcome to the Avanos 4th Quarter and Full Year 2023 Earnings Conference Call. All participants will be in listen only mode. Please note today's event is being recorded. I'd now like to turn the conference over to Scott Gallivan, Senior Vice President, Strategy and Corporate Development. Please go ahead.

Speaker 1

Good morning, everyone, and thanks for joining us. It's my pleasure to welcome you to Avanos' 2023 Q4 and full year 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 Q4 and full year results, the current business environment as well as provide an update on our transformation efforts. Michael will share additional detail regarding these topics and our 2024 planning assumptions.

Speaker 1

We will finish the call with Q and 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.

Speaker 1

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.

Speaker 2

Thanks, Scott. Good morning, everyone, and thank you for joining us to review our operational and financial results for the 4th quarter and full year 2023. Net sales for the Q4 were $173,300,000 impacted by the company's hyaluronic acid pain relief injection products as a result of continued pricing pressure due to the Medicare reimbursement changes and lower than anticipated sales across the company's North America Digestive Health products due to a major distributor's ordering pattern change. Net sales negatively impacted our margin profile. However, we were able to mitigate some of these top line challenges through our transformation initiatives and deliver $1.03 of adjusted EPS with adjusted gross margins at 59.1% and SG and A as a percentage of revenue of 43.3 percent for the full year.

Speaker 2

For the Q4, we delivered adjusted gross margins of 58.6% and SG and A as a percentage of revenue of 38.9%. Separately, we remain focused on reducing our back order and ended the year with less than $2,000,000 back order and we have continued to reduce this through our 1st 2 months of 2024. This is a significant improvement over last year's backward levels of over $10,000,000 serving as tangible proof that our supply is executing effectively on its transformation initiatives. As we have consistently communicated since I first presented our transformation plan at the January 2023 JPMorgan Conference, 2023 would be a bit uneven given the transformation priorities, the realignment of our commercial organization, M and A execution and our other portfolio optimization activities. But we are continuing to make steady progress against each of our transformation priorities and as always our primary focus is on getting patients back to the things that matter as we meet the needs of our customers.

Speaker 2

As I just noted, our sales from continuing operations during the quarter were approximately $173,000,000 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 priority, organic sales were down 4.5% compared to a year ago. For the quarter, we generated $0.36 of adjusted diluted earnings per share and above $32,000,000 of adjusted EBITDA from continuing operations. For the year, our sales from continuing operations were above 6 $73,000,000 adjusted for the effects of foreign exchange and as I mentioned above the impact of our earlier strategic decision We delivered adjusted diluted earnings per share of 1.03 We delivered adjusted diluted earnings per share of $1.03 and adjusted EBITDA of $99,000,000 Although we are disappointed with our 4th quarter sales results, we were pleased with our overall execution which was driven throughout the year by our 3 year transformation priorities. This performance gives us confidence in our ability to be within the range 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.

Speaker 2

As we mentioned during our Q3 earnings call, we anticipated that our Digestive Health business would have a tough comparison in the Q4 given the release of back order products in the Q4 of last year. Additionally, as we have noted, we experienced distributor inventory rebalancing in the 4th quarter. As a result, our Digestive Health portfolio grew 3% in the 4th quarter on a constant currency basis below our full year trending. Our CORPAK portfolio continues to over perform globally growing double digits compared to the previous year, driven by the sustained expansion of our U. S.

Speaker 2

CoreTrak standard of care offering. Separately, our Neomid product line delivered another robust quarter growing mid single digits sequentially but faced a tough comparison as the previous year benefited from the noted backwater relief and was flat year over year. Despite lower than anticipated sales in our Q4, we are extremely pleased with the full year performance of our Digestive Health portfolio growing double digits globally excluding the slight negative impact of currency. We continue to anticipate mid to high single digit growth organically for our Digestive Health portfolio and our ability to deliver above market growth will be supported by innovations we plan to launch during the back half of the year, expansion into additional global markets with attractive growth prospects and low growth product rationalization. Now turning to our pain management and recovery portfolio, sales for this quarter were down approximately 12% excluding the benefit of DIROS related sales, the impact of foreign exchange and our previously announced strategic decision to discontinue certain low growth, low margin products.

Speaker 2

As previously communicated, our portfolio was the main contributor to the decline primarily as a result of continued pricing pressure due to Medicare reimbursement changes. We anticipated and communicated near term volatility along with the sequential and year over year quarterly declines. However, the impact in the Q4 was greater than anticipated. That being said, we believe we have the right strategies in place to capitalize on our opportunities over the long term, some benefits of which will be seen in the current year meaningfully slowing the pace of the client in that portfolio. Our overall surgical pain business was flat sequentially with our combined On Q AMBIT portfolio growing 13% versus the 3rd quarter.

Speaker 2

These are early signs that our new go to market strategy and structure for this part of the portfolio supports our low single digit growth expectations for 2024. Similarly, our IVP portfolio showed sequential gains posting 10% growth versus the Q3 excluding the positive impact of DIROS revenue as supply constraints alleviated in the latter part of Q4. We are encouraged by the double digit growth seen in IVP generator sales in the U. S. This quarter versus the prior year driven by our renewed ambulatory surgical center strategy and fully deployed sales structure.

Speaker 2

Our Game Ready portfolio performed very strongly in North America achieving double digit growth compared to the prior year boosted by capital sales. The favorable performance in North America was offset by a decline in international sales due to transient registration delays. Finally, our newly acquired Triton product line has produced results in line with our expectations. Upside opportunities were limited in the Q4 as we scaled up manufacturing capacity in our Toronto facility to support our growth objectives including capitalizing on our U. S.

Speaker 2

Market launch which kicked off in November of last year. For the full year, sales of our pain management and recovery portfolio were down approximately 11% excluding the benefit of DIROS revenue, the impact of foreign exchange and our previously announced decision to discontinue certain low growth low margin products. As previously shared, this decrease was primarily driven by our HE portfolio down almost 35% year over year. While we are disappointed by the decline of performance in our paint management and recovery portfolio in 2023, we are encouraged by the progress we saw in the second half of the year. In particular, the organic sequential improvement in our Q4 that I just highlighted reinforces our expectation of mid single digit growth for 2024.

Speaker 2

Again, this expectation excludes which we anticipate decreasing approximately 20% in 2024 versus 2023. Now moving to our 2023 to 2025 transformation priorities and efforts. As a reminder, we have 4 key priorities for the next 2 years that will optimize our go to market opportunities and meaningfully enhance our financial profile. These priorities are strategically and commercially optimizing our organization, transforming our 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. As you can see, we've made substantial progress against our transformation priorities.

Speaker 2

We're particularly excited by our commercial optimization and portfolio transformation accomplishments, which I'll review now. Later in the call, Michael will discuss the other transformation priorities he's leaving in his role as Chief Transformation Officer. In 2023, notably, we made significant leadership and go to market changes to improve our commercial effectiveness, executed the acquisition of DIROS Technologies as well as the divestiture of our respiratory health business, exited low margin low growth product categories and delivered double digit growth across our DH portfolio. While we've seen improvements in our pain business that accelerated between the 3rd Q4, we remain about 2 quarters behind our original sales expectations as I shared in January at the JPMorgan Conference. This 2 quarter delay is due to the paint commercial reset necessary to address the breadth of strategy, structure and talent changes in the paint business, although it is taking longer.

Speaker 2

Supply chain challenges impacting product availability slowed the ability of our commercial teams to execute on the new go to market strategies. The sequential sales improvements I just referenced give us confidence in our strategies as we move forward into 2024 and include the following. Our surgical pain business has reversed several years of decline to flattish results in the back half of this year supporting low single digit growth in 2024. Our U. S.

Speaker 2

TRIDENT RF launch exceeded our expectations and we were able to maintain double digit growth in our U. S. Our OUS markets. Our Game Ready business returned to growth due to renewed focus on capital sales and international expansion. We're seeing tailwinds from COOLIEF reimbursement OUS including the UK and Japan.

Speaker 2

We've addressed most of our supply and quality issues which has given confidence to our commercial team. We've established programs to help stabilize the business in the second half of twenty twenty four. While 2023 was a year of transition and transformation, we believe we established a foundation that will yield dividends in 2024 for our pain management and recovery business to gradually return to sustainable mid single digit growth over the mid to long term. Now I'll turn the call over to Michael, who will provide further insights into our 4th quarter and full year financial results.

Speaker 3

Thanks, Joe. From a continuing operations standpoint for the Q4 full year, net sales were $173,300,000 $673,300,000 while adjusted gross margin was 58.6% and 59.1% respectively. We generated $0.36 of adjusted diluted earnings per share during the quarter and 1.03 for the year. Adjusted EBITDA in the 4th quarter was $32,000,99,000,000 for the year. For the year, we generated $15,000,000 of actual free cash flow, which included one time cash outflows of $10,000,000 to settle an outstanding litigation during the Q4 and approximately $33,000,000 of restructuring expenses related to our transformation efforts as well as our RH divestiture.

Speaker 3

As I just noted, adjusted gross margin for the quarter was 58.6%, which is slightly favorable compared to the Q3. We previously expected gross margin above 60% in the 4th quarter. However, with the nearly $4,000,000 underperformance in our business combined with the lower sales in our North America Pain Management and Recovery business, our mix unfavorably impacted our 4th quarter gross margin. In the 4th quarter, SG and A as a percentage of revenue stood at 38.9%, reflecting a sequential improvement of 2 70 basis points and marking the 4th consecutive quarter of disciplined spending.

Speaker 1

As you know, this is

Speaker 3

part of our ongoing journey to further enhance our financial profile with continued improvements in 2024, ultimately leading to our 2025 goal of between 38% to 39%. These improvements are driven by reduced headcount, 3rd party cost savings and business process optimization to name a few. Overall the year adjusted EBITDA margin improved to 14.7% compared to 13.3% in 2022, a 140 basis point increase year over year. Now turning to our financial position and liquidity. Our balance sheet remains strong and continues to provide us with strategic flexibility with $88,000,000 of cash on hand and $168,000,000 of debt outstanding as of December 31.

Speaker 3

We have maintained bank debt leverage levels of 1 time or less over the past 8 quarters and will continue to be good stewards of our balance sheet. As we have noted

Speaker 2

in the past, we will

Speaker 3

look to deploy capital against both strategic M and A that meets our returns criteria as well as opportunistic share repurchases. We repurchased a total of $15,000,000 worth of shares during the second half of twenty twenty three, leaving us $10,000,000 of buying power for additional shares that can be repurchased under the current forward authorization. Finally, from a free cash flow perspective going forward, we anticipate approximately $20,000,000 of capital expenditures annually, while seeing meaningful improvement in working capital, primarily through inventory reduction in both 2024 2025. As Joe noted earlier, we made meaningful progress in 2023 against our transformation priorities, including product portfolio rationalization, the divestiture of our Respiratory Health business, the acquisition of Diros, repurchasing of shares, organizational changes and meaningful cost management initiatives. As a result of these, we established a solid financial framework to build towards our 2025 goals, which I will touch on again in a few minutes.

Speaker 3

But first, let me highlight our 2024 planning expectations. As already announced, we expect 20 24 revenue in the range of 685 $1,000,000 to $705,000,000 in line with our target of mid single digit organic growth. Separately, we expect our adjusted gross margin to range between 59.5% 60.5% and our SG and A as a percentage of revenue to be between 41% 42% for 2024. Those financial metrics support an adjusted diluted earnings per share between $1.30 1 $0.45 for the year as well as adjusted EBITDA margin improvement of at least 200 basis points. As I mentioned earlier, we're excited about our transformation journey, and I'm confident we will improve on each of these metrics as the year progresses.

Speaker 3

With the Q1 starting off slow and accelerating in the back half of the year, similar pacing to what we have experienced in 2023. With regards to specific execution of our 2024 transformation priorities, we are maintaining a sharp focus on our Digestive Health and Pain Management and Recovery business strategies, as Joe just described, executing on additional business process efficiency and cost management initiatives, and will seek opportunities to allocate capital that enhance our overall return on invested capital. Year 2 of this transformation journey is critical to ensure that we can deliver on the 2025 financial metrics we outlined on Investor Day, which include consistent mid single digit growth that would take our organic revenue to approximately $750,000,000 in 2025 overall margin expansion of between 405 100 basis points supported by gross margins surpassing 60% and SG and A as a percentage of revenue being between 38% 39% and free cash flow generation of approximately $100,000,000 in 2025, supported by these operational financial metrics, consistent CapEx spend and meaningful improvement in working capital. We still anticipate consistent mid single digit organic growth for 2024 and 2025, albeit this growth rate will be off a lower base due to the decreased sales in our business that we have already discussed.

Speaker 3

That being said, we remain confident in our ability to achieve the other components profile as a result of the progress we are making against our overall transformation priorities. Operator, please open the line for questions.

Operator

Thank you. We will now begin the question and answer session. Today's first question comes from Daniel Stouder with Citizens JMP. Please go ahead.

Speaker 4

Yes, great. Thanks. First question for me. You've commented that M and A is still very important pillar, but just wanted to ask with the recent updates you gave earlier this year as well from this call, Do you feel you have to wait a little bit for some stabilization before committing to acquisitions? I know you commented that share repurchases will also be a big part.

Speaker 4

Just any thoughts on how you're looking at M and A in 2024 would be great. Thanks.

Speaker 2

Daniel, is Joe. We thank you for the question. I mean, obviously, we've kept a really strong balance sheet and our leverage extremely low in this environment. That said, we do think we'll conduct some sort of a bolt on this year like we have in the past. We have enough capability inside to onboard these well and to get these integrated.

Speaker 2

So I don't see it detracting really from us being able to deliver our plan or actually do some of the share buyback if we so choose as we progress. So full pipeline, we still want to make sure we're executing in particular on the strategy around digestible.

Speaker 4

Great. And then just one follow-up, some of the business, talked about it a bit as well as some of the programs you're implementing to stabilize that part of the business. But just any more thoughts on what gives you confidence in getting this to level out or any macro color that you could give that we should think about throughout 2024 would be pretty helpful. Thank you.

Speaker 2

Yes. So a couple of things. One is we have been maintaining a disciplined price strategy purposely and strategically. And we do know that ultimately some of the specialized reimbursement for a couple of companies where people are going because they can make more money and making decisions that way. Customers that's going to go away as you sort of end the year.

Speaker 2

We think we can also do some things with market access through some of the commercial programs and cross selling initiatives that we have and there are new markets as well for us that we think that we can achieve. So again, what we believe will happen, this is a strategic area for us because of the focus on orthopedic pain and recovery. And it fits nicely into our channel, has great gross margin. We think it's a low single digit grower once we make our way through this year.

Speaker 4

Great. Thank you very much.

Speaker 1

Yes.

Operator

Thank you. And our next question today comes from Rick Wise with Stifel. Please go ahead.

Speaker 5

Good morning, Joe. Hi, Michael. Joe, I hate to keep pushing on the side of things, but I want to make sure I better understood your thinking about the potential for stabilization. I appreciate what you said about your strategy and your discipline, But maybe talk to us a little more depth about you talked about some of the commercial team sales changes. And did I hear you correctly, you're thinking that in the second half of this fiscal year, we're going to see the business stabilize or return to growth.

Speaker 5

I just want to make sure I understood what you were saying there.

Speaker 2

Sure. No, I see stabilization the end of this year, toward the end of 2024. I see growth possible in 2025. And again, sort of the obviously the biggest part of volumes have somewhat remained about where they were. And so it's really price affected by the Medicare changes that's really hurting the business.

Speaker 2

And in particular, I think everybody is fighting this a little bit with in some cases a couple of competitors have specialized pricing that's going to go away about the middle of the year and that creates more of a level playing field. And so we think with the customers that we'll be also selling to in terms of Game Ready and really frankly our surgical pain business and our DIROS business that we're going to be able to get this to more of a low single digit grower as we get into 2025. And I can see it based upon some of the progress, some higher some of the programs and the traction. But at the moment, we're also protecting our price for the longer term.

Speaker 3

The other thing to consider, Rick, is that volumes, although different in 35 and how these have developed over the last year, 3 shot and 5 shot, they've been relatively stable. The majority, heavy majority of the revenue decline has been due to pricing. So the volumes can remain stable and we can get pricing into a more stable environment, which we believe will happen as Joe just mentioned in the back half to exiting 2024 then we have something to build on going into 2025.

Speaker 2

One of the things too Rick that we said at the JPMorgan conference was that we can achieve the mid single digit organic to the total global company with this type of decline in and still achieve mid single digit growth in the other parts of the paint business on a global level. So we feel good about that portion of it as we manage through quite frankly is a tough aspect with the HAPs. Got you.

Speaker 5

On operating margins, if I'm doing my math correctly, sales and EPS guidance midpoints imply operating margins something like 14% for the full 24 year. Maybe could you all help us think through how that's likely to set up for the first half versus second half? In the past, you've started typically with operating margins more in the high single digit range. Is that the right way to think of all that to think about 2024, Michael? Yes.

Speaker 3

So you're right. I mean, I think we'll be a little bit north of 14%, but you're in the range there. And yes, first half is always going be lower than the second half. I'd like to believe we can at least squeak in 10% operating profit in the Q1. But yes, that will be our lowest operating profit quarter and then it will build a couple of few hundred basis points per quarter from there.

Speaker 5

Great. And just I'm going to sneak in one more. On a more positive note, the suggested business doing well. You talked about second half product launches. Maybe talk about some of those products, the kind of impact they have.

Speaker 5

Does this sustain the current performance or has the potential to accelerate? How should we think about it? Thank you.

Speaker 2

It's more sustaining in terms of the Mickey area, maintaining our technology position and helping us there primarily. And then we do see continued growth in NeoMed this year as an example, that leadership position in the legacy business and then we still see good runway ahead for CoreTrak frankly and for NeoMed.

Speaker 5

Thank you.

Operator

And our next question today comes from Kristen Stewart with CL King. Please go ahead.

Speaker 6

Hi, thanks for taking the question. I just wanted to clarify, Michael, you had talked about the 2000 or 2025 kind of goals for the full year. Are you still reaffirming that $750,000,000 target because we are growing at a lower base now? Or is it just the mid single digit that you're reiterating? The

Speaker 3

mid single digit, yes. What I was trying to convey was what we originally laid out was a 750,000,000 are correct. And that 750 is not we don't believe currently attainable with the growth rates we see. But we still believe that the growth rates we're going to have are mid single digits. It's just off of that $20,000,000 lower base due to the impact.

Speaker 6

Okay. And separately, how do you feel about free cash flow generation and getting to that over $100,000,000 of free cash flow in 2025? What are kind of some of the measures that you're looking for to achieve that objective?

Speaker 3

Yes. I mean, if you think about this year, we had $50,000,000 of total cash outflow for litigation settlements, restructuring, the RH divestiture, that will be around $25,000,000 to 30,000,000 dollars in 2024 and then 2025 we'll have hopefully minimal to no one time cash payments. So that's a huge tailwind. On top of that, our operational cash flow will be improving just by nature of the revenue going up mid single digits and the margin improvement with the cost management takeout. And then on top of that, we've got working capital opportunities in inventory.

Speaker 3

As you know, we've struggled a little bit with our inventory management over the last couple of years for a range of reasons, some macro and some self inflicted. We have about $30,000,000 $25,000,000 to $30,000,000 of inventory opportunity between now and the end of 'twenty five. So if we execute on each of those pieces, which are many of them are very much in our control, I feel very good about the $100,000,000 opportunity and free cash flow over 2025.

Speaker 6

Okay, perfect. And then last question, just on the IBP portfolio. Can you maybe just talk through if you have any supply constraints still there with Coolief? And then on the Trident launch in the U. S, I think you had mentioned that was better than expected.

Speaker 6

Can you maybe just provide additional color on that?

Speaker 2

Yes. So again, we saw about a 10% growth versus the Q3 in the business and the quality issues and the supply chain issues are behind us. We're also happy with the capital sold in the Q4 that blends itself to the next year, the following year. DYROS has really been exceeding our expectations in terms of a launch, but we just remind everybody that we sell into the U. S, which is a new market now and we're going to be double digit for the full year globally, high double digit.

Speaker 2

But it can take you 6 months or so then to get those accounts up and running for the full revenue streams. But we think DRS is going to be a big contributor to the business this year. And again, it will be high double digit as it has been.

Speaker 3

And Chris, Kristen, just wanted to so the 10% Joe is referring to is the sequential growth Q3 to Q4 specific to our RF business. So that includes Coolief, our standard RF probes and as Joe just mentioned, the capital sales. That does not include DYROS. DYROS grew more than 10% Q3, Q4.

Speaker 6

Okay, perfect. And then the organic growth expectation for this year, I just want to make sure that does not include Diros or does that include Diros?

Speaker 3

It includes DIros against the time period that we owned DIros. So the back half of the year, it does not include any revenue in the first half of the year through partially in the Q3 where we did not own DERO. So it's pure organic growth.

Speaker 6

Okay, perfect. Thank you very much.

Operator

Thanks. Thank you. And this concludes our question and answer session. I'd like to turn the conference back over to the management team for any closing remarks.

Speaker 2

So look, our primary focus is getting the precise execution that we need in the business. We have successfully executed product exits divesting in RH's business and acquiring technology with DYROS. We obviously approved an additional share repurchase program and then delivered on most of our financial objectives. I think we've established the necessary foundation to deliver on the midterm financial commitments and confident that our transformation priorities coupled with our market leading portfolio in attractive markets does position us for sales growth, margin expansion and meaningful free cash flow generation. So we appreciate everybody's continued interest in Avidus.

Speaker 2

I'm sure we'll speak further throughout the week. Thank you.

Operator

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.

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