Avanos Medical, Inc. (NYSE:AVNS) Q1 2024 Earnings Call Transcript

Avanos Medical, Inc. (NYSE:AVNS) Q1 2024 Earnings Call Transcript May 5, 2024

Avanos Medical, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning ladies and gentlemen and welcome to the Avanos First Quarter 2024 Earnings Conference. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Thursday, May 2, 2024. I would now like to turn the conference over to Scott Galovan. Please go ahead.

Scott Galovan: Good morning, everyone and thanks for joining us. It’s my pleasure to welcome you to Avanos 2024 first 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 first quarter results, the current business environment, as well as provide an update on our transformation efforts. Michael will share additional detail regarding these topics and affirm our 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 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 first quarter 2024. First quarter results were in line with our expectations as Digestive Health continued its consistent performance and we experienced additional positive shifts in our Pain Management and our Recovery business. As we noted in our 2023 year-end earnings call, our quarterly performance for 2024 will improve as the year progresses, following a similar cadence to past years. The demand for our products remain strong and our supply chain organization is executing effectively to support our commercial strategy with our backlog at about $1 million at quarter end. This is a significant improvement over last year’s first quarter back-order levels of over $8 million.

We are continuing to make steady progress against each of our transformation priorities which both Michael and I will talk further about. 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 $166 million, 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 up 4.7% compared to a year ago. We generated $0.22 of adjusted diluted earnings per share and above $21 million of adjusted EBITDA for continuing operations. Our 3-year transformation priorities continue to drive our execution and our first quarter results provide confidence in our ability to be 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 with over 9% organic growth versus prior year. This performance was bolstered by our NeoMed 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 ENFit conversions in North America. While we are currently experiencing solid double-digit growth, we anticipate slower growth over the next few quarters as we enter the late stages of the ENFit adoption. Our legacy ENFit feeding business also posted a strong quarter, growing mid-single digits compared to the previous year. As noted during our last call, we anticipate mid to high single-digit growth organically for our Digestive Health portfolio this year 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, low-growth product rationalization and actionable M&A opportunities.

Now, turning to our Pain Management and Recovery portfolio, sales for this quarter were down approximately 1%, excluding the benefit of DRS-related [ph] sales, the impact of foreign exchange and our previously announced strategic decision to discontinue certain low-growth, low-margin products. While our overall surgical patent portfolio was down year-over-year, our combined ON-Q/ambIT portfolio was flat for the same period, in line with our expectations. The past quarter performances are indicators that our new go-to-market strategy and structure for this part of our portfolio support our low single-digit growth expectations for 2024. The slight year-over-year decline in our IVP business, excluding the positive impact of Diros revenue, was primarily due to strategic rationalization within a low-growth, low-margin product category.

The performance of our combined radiofrequency ablation portfolio grew by mid-single digits. We’re encouraged by the continued momentum seen in our IDP generator sales, driven by our renewed ASC strategy and the increasing productivity of our fully deployed new sales structure. Further supporting our ASC strategy, our new Trident product line, acquired in the Diros transaction, continues to exceed our expectations. We were able to capture upside opportunities in the first quarter and continue to scale-up manufacturing capacity in our Toronto facility to support our growth objectives, including capitalizing on our promising U.S. market launch. Our Game Ready portfolio put together another solid quarter coming off our fourth quarter results with double-digit growth this quarter compared to prior year.

Finally, our HA portfolio was flat year-over-year and consistent with our fourth quarter results. This leveling off of revenue in our HA portfolio was anticipated and aligns with our forecast of a 20% decrease in HA revenue for the full year. We remain confident in our strategies and ability to maintain this level of performance while leveraging long-term opportunities. While our first quarter performance in our Pain Management and Recovery portfolio is not yet where we want it to be, we’re encouraged by the progress we’re seeing across each of the pain businesses and I 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 4 key priorities for the next 2 years that will improve 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. We’ve made substantial progress against our transformation priorities with accelerating momentum against these priorities. Some of our first quarter highlights include meaningful stability and progress across our pain portfolio, strong early execution with our new Trident product line, continued separation efforts associated with the divestiture of our Respiratory Health business, finalizing our commercial sales and marketing organizations to support our second half growth expectations exceeding 5%, adjusted gross margin delivery approaching 60% and completing our latest share repurchase program.

While we’re pleased with our first quarter results and the continued progress against each of our transformation priorities, we are 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 insight on our financial results and transformation platform.

Michael Greiner: Thanks, Joe. As you shared, we are pleased with our first quarter results, results that show continued progress against our transformation and 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 in the first quarter. Our Game Ready portfolio grew double digits this quarter compared to prior year. And our newly acquired Trident product line has produced results above our expectations, capitalizing on our U.S. market launch which kicked off in November of last year and continued momentum in international markets. As expected, we continue to see price volatility in our HA business. However, we believe we have set the right strategies in place to largely mitigate unfavorable price impacts.

This quarter, our HA sales are in line with our fourth quarter and prior year through higher sales volumes. From a continuing operations standpoint, net sales were $166.1 million. We generated $21.6 million of adjusted EBITDA and $0.22 of adjusted diluted earnings per share 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 4.7% compared to a year ago. Our adjusted EBITDA grew by 34% compared to a year ago with adjusted EBITDA margin expansion of 290 basis points. Our adjusted diluted earnings per share grew by 69% compared to a year ago. This margin expansion was positively impacted by top line growth, manufacturing and operations execution and continued SG&A optimization efforts.

For the quarter, our adjusted gross margin was 59.8% which is sequentially favorable to our fourth quarter 2023 results and versus the first quarter of last year. We were able to offset inflation and HA price volatility through our transformation initiatives at the plant and operations level. We expect adjusted gross margin to be approximately 60% next quarter as well. SG&A as a percentage of revenue stood at 45.8%, reflecting an improvement of 220 basis points compared to the first quarter of last year, primarily related to our cost savings efforts to streamline the organization and reduce our external spend profile. As you know, this is part of our ongoing journey to further enhance our financial profile with continued improvements throughout 2024, ultimately leading to our 2025 goal of between 38% to 39%.

Our performance in the first 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 margin to range between 59.5% and 60.5% and SG&A as 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 $76 million of cash on hand and $177 million of debt outstanding as of March 31.

We have maintained bank debt leverage levels meaningfully below 1 turn over the past 9 quarters and will continue to be good stewards of our balance sheet. While we intend to maintain conservative leverage levels, we will actively pursue strategic M&A opportunities that align with our returns criteria as well as opportunistic share repurchases. Finally, free cash flow was negative $12 million in the first quarter, roughly as anticipated, driven by year-end variable compensation payouts and onetime cash costs associated with accelerating certain transformation efforts. We anticipate marked improvement in our free cash flow profile in the second quarter and remain confident in our ability to generate approximately $75 million of free cash flow for 2024.

Now, turning to some additional highlights specific to our transformation journey that began in 2023, in addition to product portfolio rationalization, the divestiture of our Respiratory Health business, the acquisition of Diros, share repurchases, organizational changes and meaningful cost management initiatives, we remain focused on our Digestive Health and Pain Management and Recovery business strategies, implementing further business process efficiency and cost management initiatives and actively seeking capital allocation opportunities that optimize our return on invested capital. The second year of this transformation journey is crucial for achieving the 2025 financial objectives we outlined on Investor Day which 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% to 39% and free cash flow generation of approximately $100 million in 2025, supported by these operational financial metrics, as well as consistent CapEx spend and meaningful improvement in working capital.

Operator, please open the line for questions.

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Q&A Session

Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Kristen Stewart at CLK.

Kristen Stewart: And I was just wondering if you could further expand upon your commentary around the Pain Management business and what kind of gives you the confidence that you’re going to see improved results for the balance of the year.

Joe Woody: Kristen, thanks for the question. So a couple of things. I mean inside of that, we saw Game Ready at double-digit growth. We talked about the RF business and that portfolio of RF at sort of mid-single-digit growth. It got hurt by some exits that we purposely did in that group but we also sold 80 generators during the quarter which sort of shows us that we’re trending in the right direction. We’re seeing a good adoption of the Triton technology from Diros. We see some positive things also in the international business, albeit it’s a smaller part of the business. And the other thing I would say is that, between ambIT and On-Q, that leveling off, we see real potential for low single-digit growth for surgical pain this year which is the first time in a long time.

So everything is pointing in the right direction. We feel like we’ll be able to point to some further evidence in Q2 and we’re standing by the perspective that, outside of HA which kind of runs through by Q4, we’ve got a mid-single-digit grower now in that pain business for the full year.

Kristen Stewart: That’s perfect. And then I was wondering if we could switch gears and just talk a little bit about your appetite for M&A. You mentioned the low leverage ratio and plenty of firepower to kind of do deals. How should we be thinking about potential transactions as we look out over the next 12 to 18 months?

Joe Woody: We’ve been primarily focused in digestive, as we laid that out and, again, the types of bolt-ons that we’ve been doing. We’ve actually passed on a couple of transactions that we thought were — 2 things really, multiples were a bit high but also when we looked internally and through third parties at some of the growth perspectives of the businesses, they didn’t really seem to be there. And we feel like, in this stage of our execution, that’s not really where we want to be. But the pipeline itself is robust around digestive. That’s probably where you’d likely see something first coming from us.

Operator: [Operator Instructions] The next question comes from Danny Stauder at Citizen JMP.

Daniel Stauder: So the first question is just on gross margin. It’s nice to see the improvement. And then you also gave some 2Q commentary that points to another good quarter. But how should we think about gross margin for the rest of the year? You noted that you have been able to offset some of the impacts from HA. But what is baked in or what is assumed as far as HA stabilization in the back half of the year? And what gets you to the higher end of your guidance range?

Joe Woody: So the gross margin for the year, quarter-over-quarter, will be fairly stable, give or take 100 basis points. To your point, Danny, in the back half of the year, we do anticipate gross margin points to be above 60%. As you know, our back half of the year is our heavier revenue part of the year and the mix in the back half of the year is a little bit more favorable. And third, it gives us another few months for a continuation of the cost savings and other initiatives we’re doing at the plant. So very pleased with the first quarter in confidence, as we announced on the call today, around where we should be in 2Q, somewhere around 60%. And then we should be heading north of 60% as we get into the back half of the year based on the few things I just mentioned.

So we’re doing all the right things in the plants. Mix is obviously helpful. HA, to your point, is going to be very stable through the year. We’ll be doing somewhere between $9 million and $12 million per quarter, each quarter and that lines up with the negative 20% decline in HA that we had indicated on the year-end earnings call.

Daniel Stauder: Great. And then just as a follow-up, focusing on Game Ready double-digit growth in the quarter, another strong quarter but could you just give us any more color on what’s driving this to be a little bit above your growth expectations? And then, just given the quarter and what you’re seeing as far as trends, do you still think that mid-single-digit growth is what it could be this year? Or any color there would be great.

Joe Woody: Sure. No, Game Ready obviously driven by sports medicine and orthopedic procedures. I think you’re seeing some of the relationships with distributors and some of the work we’ve been doing on our direct force starting to pay off. But on top of that, we’re making some strides in the international markets as well with Game Ready, where he had been a little bit more passive before. We definitely see Game Ready as a mid-single-digit grower. And then as I was saying earlier, if you take HA out of the equation until we settle out on the pricing element of that probably in the Q4-ish range, we’re more and more confident on the mid-single-digit growth of the Pain Management and Recovery business at mid-single-digit growth for the full year.

Michael Greiner: One thing just to add to that is on the – one thing to add, Danny, on the Pain business, it primarily hurt us in the first quarter in Pain with our IV infusion and needles, kits and trays product families. Those are less focused on, obviously, historically. We do have some things throughout the year that we will refocus some energies there and strategies there. But those were the 2 categories, IV infusion which is in our surgical pain grouping and needles, kits and trays which is in our interventional pain grouping. That hurt us in the first quarter from a total growth standpoint but we don’t anticipate that to be the case as we enter the back half of the year which is further supportive of and tying to Kristen Stewart’s earlier question, further supportive of what we’ll be able to do in the back half of the year in Pain in total.