Avanos Medical, Inc. (NYSE:AVNS) Q2 2023 Earnings Call Transcript

Avanos Medical, Inc. (NYSE:AVNS) Q2 2023 Earnings Call Transcript August 9, 2023

Avanos Medical, Inc. misses on earnings expectations. Reported EPS is $0.24 EPS, expectations were $0.34.

Operator: Good morning, everyone, and welcome to the Avanos Second Quarter 2023 Earnings Conference Call. All participants are in a listen-only mode. [Operator Instructions] After today’s prepared remarks there will be opportunity to ask questions. [Operator Instruction] Please Note, today’s call is being recorded. At this time, I’d like to hand the floor over to Avanos CEO, Joe Woody.

Joe Woody: Good morning, everyone. This is Joe Woody. We’ve asked the New York Stock Exchange, and they agreed to halt our trading as our results were inaccurately reported by one news outlet and possibly more. Our total results inclusive of respiratory health were $199.8 million in revenue and we delivered $0.37 of EPS. Throughout the day today, we’re going to work with the various agencies and news outlets to correct the information. Now I’m going to turn the call over to Scott Galovan to begin our prepared remarks. Thank you.

Scott Galovan: Good morning, everyone, and thanks for joining us. It’s my pleasure to welcome you to 2023 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 and expectations for the remainder of 2023 as well as provide further insights around the strategy we laid out at our Investor Day in June. Mike will provide additional detail regarding these topics and provide an update of our 2023 planning assumptions given our respiratory health business discontinued operations. We’ll 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 GAAP financial measures. Now I’ll turn the call over to Joe.

Joe Woody: Thanks, Scott. Good morning, everyone, and thank you for joining us to review our operational and financial results for the second quarter of 2023. We are pleased with our second quarter. We noted in our year-end earnings call and reiterated at our Investor Day in June, our quarterly results for 2023 would be uneven given the timing uncertainties associated with our transformation plan, which included some of the transactions we announced just prior to our Investor Day. The demand for our products remain strong, and although supply chain disruptions have lessened, we continue to experience ongoing product supply challenges and the effects of inflation throughout our supply chain. Coming into the year, we anticipated that 2023 will continue to present supply chain headwinds and pockets of product availability challenges, but that many of these headwinds would ease as we reached the back half of the year.

We still believe this to be the case with our anticipated year-end back order levels to be around $3 million, down from over $10 million at the beginning of the year. 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, we achieved sales of $169 million from continuing operations or down approximately 1% compared to last year. Excluding both the negative impact of foreign exchange and the $5 million impact related to our previously announced decision to eliminate revenue that was not meeting our returns criteria, organic growth was favorable 2.6% from quarter. We also generated $0.24 of adjusted diluted earnings per share and almost $23 million of adjusted EBITDA from continuing operations during the quarter.

While our adjusted gross margin was almost 60% and our SG&A as a percentage of revenue was 45.1%. Actual sales for the quarter, inclusive of our respiratory health business was $200 million or 2.5% growth. Also excluding the adjusted revenue items I just referenced. SG&A as a percentage of revenue was 40%, supporting an adjusted EBITDA margin of almost 16% for the quarter. Now I’ll spend the next few minutes discussing our results at the product category level. On a constant currency basis, our Digestive Health portfolio grew almost 17% bolstered by our med product line, which posted another strong quarter versus the prior year as we continue to take advantage of the demand for NFI conversions in North America. Our legacy intra-feeding product line grew double digits globally, primarily driven by the continued expansion of our U.S. CORTRAK standard of care offering.

As noted during Investor Day, we continue to deliver above-market growth and leadership in our core digestive health markets and are poised to sustain this momentum through innovations that we plan to launch over the next 12 months. Expansion into high potential global markets and actual M&A targets in large, attractive adjacencies. Turning to our pain management and recovery portfolio. Actual reported sales were down close to 11% for the quarter, with soft results across our interventional pain, game ready and 5-shot HA product categories each of which were down at least 5% versus the prior year. Separately, our surgical pain pump business was flat for the quarter, excluding the negative impact of foreign exchange and low growth, low-margin products we are no longer selling in this category.

As I shared earlier, we continue to experience supply headwinds within these businesses, although we expect these headwinds to ease during the second half of this year. Alleviating these supply chain challenges is critical to supporting our pain management and recovery portfolio sales lift in the second half of the year. Finally, our HA portfolio experienced a weaker-than-expected first half. However, this softness was primarily concentrated in our 5-shot or GenVisc products. 5-shot market has specific pricing and competitive dynamics that are not as prevalent within the 3-shot market. TriVisc, our 3-shot offering continues to align with our overarching orthopedic call point strategy and is largely meeting our internal performance expectations.

We expect volatility will continue to be a factor in both of these HA markets for the next several quarters as we face strong 2022 comparables and continue to experience the related swings from entering the ASP reporting environment in Q3 2022. Despite this volatility, we believe we have the right strategies in place to capitalize on our HA opportunities. Our pain management and recovery business results have not met our expectations over the last year. However, we are confident in our new strategy outlined during Investor Day. This strategy connects our pain brands across the patient life cycle and sets the stage for sustainable mid-single-digit growth as we enter 2024 and with gross margins exceeding 60%. Our investments in the pain management and recovery business will be very selective over the short to midterm as we focus on securing consistent organic financial results.

Now moving to an update on our 2023 priorities and transformation efforts, which includes some of the initiatives that I just described. As we originally outlined in the beginning of the year and further highlighted in June during Investor Day, we have 4 key priorities for the next 3 years that will optimize our go-to-market opportunities and meaningfully enhance our financial profile. These priorities include 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.

We continue to execute well against these priorities as evidenced by our recent divestiture and acquisition activity, implementation of our new go-to-market strategy for our pain management and recovery business, margin improvement additional portfolio optimization decisions and delivery on our transformation program expense savings. In addition, our Board has recently approved a $25 million share repurchase program. This will not impact our ability to continue to execute our tuck-in acquisition strategy, but rather provides us flexibility to allocate capital towards repurchasing shares that we believe are meaningfully undervalued versus our internally calculated intrinsic value. Finally, I’d like to thank everyone who participated in our Investor Day on June 20 and the subsequent feedback we received from many of you.

Now I’ll turn the call over to Michael, who continues to lead these efforts in his expanded role as Chief Transformation Officer and will further discuss our second quarter financial results.

Michael Greiner: Thanks, Joe. Before providing color on our discontinued operations reporting related to the sale of our Respiratory Health business, I’ll first provide additional color and detail around our consolidated second quarter results. Total reported sales for the second quarter on an actual basis was $199.8 million, an increase of 2.5%, excluding the negative impact of foreign exchange, and the impact of low margin and low growth products we have ceased selling. From a continuing operations standpoint, net sales were $169.4 million. Adjusted gross margins were 59.9% and adjusted net income for the quarter totaled $11 million, translating to $0.24 of adjusted diluted earnings per share. Adjusted EBITDA for the quarter was $23 million, in line with prior year.

Separately, we ended the quarter with $82 million of cash on hand and a leverage ratio of less than 1. Looking at our total results, including respiratory health, gross margin for the quarter was 56.7%, and or 270 basis points lower than prior year, primarily driven by the unfavorable impact of the Mexican peso as well as unfavorable product mix impact, mostly related to softness in our HA portfolio. Sequentially, gross margin improved by 30 basis points. Separately, SG&A as a percentage of revenue improved by 60 basis points versus the prior year and 160 basis points sequentially, primarily related to our cost savings efforts to streamline the organization and reduce our external spend profile. Adjusted diluted earnings per share were $0.37 and adjusted EBITDA totaled $31.8 million or 15.9%.

Now focusing on our continuing operations results. Adjusted gross margin for the quarter was 59.9% and which reflects the benefits of our portfolio optimization decisions. SG&A as a percentage of revenue was 45.1%, an improvement of 100 basis points versus the prior year and a sequential improvement of 280 basis points. We anticipate SG&A as a percentage of revenue to be approximately 43% to 44% for the full year from a continuing operation standpoint with substantial improvement in 2024 ultimately leading to our 2025 goal between 38% to 39%. Adjusted diluted earnings per share were $0.24 versus $0.26 a year ago with adjusted EBITDA margin of 13.5% compared to 13.4% in 2022. For the first 6 months of 2023, the impact of discontinued operations totaled $19 million of EBITDA reduction.

We anticipate the full year impact to be approximately $40 million which also is directionally representative of the annual stranded cost impact for the RH divestiture. These stranded costs include allocations from shared service functions, shipping and freight synergies and loss of scale in our international operations, among other fixed costs. Through 2024, we will offset a portion of these stranded costs via our transition services agreements with Air Life. Additionally, we are accelerating and expanding our existing cost reduction program to mitigate the majority of the remaining stranded costs, expecting approximately $30 million of incremental cost reduction by the end of 2025. We remain estimated $10 million to $15 million of go-forward dissynergies.

Future M&A, of course, would enable additional stranded cost absorption. As a result of the Respiratory Health divestiture, which we anticipate will close early in the fourth quarter, we expect adjusted diluted EPS between $1.05 and $1.15 for the year, with gross margins around 60% and adjusted EBITDA margins of approximately 15%. Including the current year impact of the approximately $17 million annualized impact of product portfolio rationalization that we previously discussed. Company anticipates comparable organic revenue growth to be low single digits for the year. As previously communicated, the cost management aspects of our transformation program will total between $45 million and $55 million of gross savings by 2025. We now anticipate approximately $20 million of those savings in 2023, with the majority of the remainder to be executed in 2024.

These savings do not contemplate the elimination of the stranded cost that I just described, which will be addressed separately. Our preliminary view for 2024 anticipates that we will deliver mid-single-digit revenue growth across our portfolio with adjusted gross margins of approximately 60%. Separately, we expect to reduce SG&A as a percentage of sales to 40% to 42% as a result of our cost takeout efforts and anticipate generating adjusted EBITDA of between $120 million and $140 million. These ranges will be negatively or positively impacted by our ability to accelerate our pain growth story and our cost management efforts. With regards to free cash flow, we now anticipate annual free cash flow of approximately $60 million as a result of higher interest and tax payments and weaker-than-anticipated performance in our pain management and recovery portfolio.

This estimate also excludes onetime restructuring cost for this year. We remain confident in our ability to deliver approximately $100 million of free cash flow for 2025 and this assumes $25 million in tax payments, $20 million in capital expenditures and $15 million in interest payments. In closing, we will continue to execute on each of our transformation priorities and have a laser focus on both the digestive health and pain management and recovery business strategies. We believe that execution of these portfolio strategies, combined with our other transformation priorities will support delivering mid-single-digit organic revenue growth, gross margins exceeding 60% and adjusted EBITDA margins greater than 20% and free cash flow generation of approximately $100 million that I just shared.

Finally, we will remain prudent stewards of our balance sheet, pursuing margin accretive tuck-in acquisitions and opportunistic share repurchases. Operator, please open the line for questions.

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Q&A Session

Operator: [Operator Instructions] Today’s first question comes from Rick Wise with Stifel. Please go ahead.

Rick Wise: Thanks for all the detail and the clarity and a lot to absorb and thank you, but you gave us a lot of good data. I want to start off just — Michael, you said it very clearly in giving us a first look at 2024, that paying growth acceleration or reacceleration cost reduction, are the two critical pillars. If I understood your words, correct me if I’m wrong, to achieving that growth. Maybe take us through — I’m going to guess cost reduction is more in your control — just give us even more detail about why you’re confident that you can achieve your goals and some of the specific actions so we can understand that. And maybe just — I’m just looking at your Slide 7, where you talk about the pain portfolio being challenged.

If you’d be so kind, take us through each piece and help us understand your action plan that’s going to — you wouldn’t say it if you didn’t have a plan and I didn’t believe it, I’m confident that’s going to help us more credibly understand and believe that pain growth can reaccelerate in ’24. And that’s sort of my first and second question.

Michael Greiner: And I’ll just — I’ll turn it over to Joe in a second to talk about the pain strategic approach and tie that back to what we shared on Investor Day and why we are confident our ability to execute mid-single digit next year. What I was trying to convey on the EBITDA and the cost and the pain growth, 120 to 140 is our current preliminary early view of 2024. The lower end of that range would mean we didn’t execute as well as we wanted to on the pain growth and/or the cost management efforts, which I agree are in our control, maybe we’re a little bit slower. Maybe there were some things that occurred through the transition agreements that had distracted for a short period of time in the early half of the year. And so we had to get at some of those cost management efforts and the back half of 2024.

So these 2025 targets, we feel really good about because one, we have programs in place like you just described, and the 2024 range, we feel really good about. But whether we’re at 120 or 140 will be entirely dependent upon our ability to grow mid-single digits in the pain category, which Joe will talk about in a minute and the quickness at which we get at these cost management programs. Those programs will happen, right. It’s just can we get it done in March or do we get them done in July.

Joe Woody: And Rick, this is Joe Woody, just to kind of pick up on the pain growth for 2024. I mean if you think about this quarter, the company either way, we’re about sort of 2.5-ish percent organic growth when you remove all the noise, and what we’ve said is this, we’ve unfortunately continued in IVP and acute pain with pretty significant supply chain issues. This is before we talk about the new initiatives. So we’re almost sort of without those kind of at a 4 or 5-ish type of growth as an overall Avanos in the new Avanos go forward the continued operations. If you look at it, that way. The other thing I would say is we’re very confident in bringing Diros in, and that’s going to give us an opportunity to play in the ambulatory surgical center.