Avanos Medical, Inc. (NYSE:AVNS) Q4 2022 Earnings Call Transcript

Avanos Medical, Inc. (NYSE:AVNS) Q4 2022 Earnings Call Transcript February 21, 2023

Operator: Good day. And welcome to the Avanos Fourth Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Scott Galovan, Senior Vice President, Strategy and M&A. Please go ahead.

Scott Galovan: Good morning, everyone, and thanks for joining us. It’s my pleasure to welcome you to Avanos 2022 fourth quarter 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 quarter and the current business environment and provide an assessment of our execution against our key objectives for 2022. Then Michael will discuss additional detail regarding our fourth quarter and full year and share our 2023 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 will 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 fourth quarter and full year 2022. We are very pleased with our fourth quarter results, which built on solid execution from both our operational and commercial teams during the first nine months of 2022. Although, the macro environment remained disruptive and dynamic, we focused on what we could control and manage. The demand for our products remained strong, and although, supply chain disruptions persisted, we executed well, mitigating impacts to our financial results. We anticipate 2023 will continue to present supply chain headwinds, cost pressures and pockets of product availability challenges.

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 $217 million, representing over 14% total growth and 4.7% organic growth, both excluding the negative impact of foreign exchange. We generated $0.60 of adjusted diluted earnings per share and $29 million of free cash flow. For the full year, we grew 12%, including the impact of our acquisition of OrthogenRx and delivered adjusted diluted earnings per share of $1.65. Additionally, our gross margin for the year was 56.8%, a 450-basis-point improvement versus the prior year and we ended the year with a leverage ratio of under 1 times. These results position us to confidently execute against the transformation priorities we laid out at the JPMorgan conference in January.

Michael and I will address these priorities a bit later in the presentation. Now I will spend the next few minutes discussing our results and the product — at the product category level. On a constant currency basis, our adjusted portfolio again grew by double digits, topping 10% with NeoMed growing nearly 40%. The positive trends across our Digestive Health franchise continued as second half supply improvements allowed us to maximize North American ENFit conversions. Our legacy enteral feeding product line maintained its global mid-single-digit growth with robust double-digit year-over-year growth in North America as supply constraints alleviated in the latter part of the fourth quarter. Even though our respiratory business declined by 4% overall, our closed suction catheters grew over 8% versus the prior year.

As we noted in our third quarter call, we experienced improved ordering patterns for our closed suction catheter systems throughout the fourth quarter, specifically due to trends with pediatric viral cases like RSV and the early flu season uptick. In total, our Chronic Care business grew just under 6% in the fourth quarter and 2.6% for the full year, excluding the negative impact of foreign exchange. Turning to the Pain portfolio. For the quarter, we experienced low single-digit growth in acute pain, coupled with mid-single-digit growth in our interventional pain compared to the prior year. The demand for our products and solutions remains strong as evidenced by the double-digit growth in both Game Ready and COOLIEF sales during the quarter.

As anticipated, we continue to experience supply headwinds, particularly within our surgical pain category and we expect these headwinds to remain a factor throughout the first part of 2023. Despite some of the ongoing pressures brought about by supply chain challenges, as well as hospital staff shortages that have kept elective procedure levels reduced, our team’s resilience has ensured that our Pain solutions are available to meet the needs of our customers. Separately, OrthogenRx exceeded expectations in 2022 by delivering on our key marketing strategies. OrthogenRx’s unique patient access program, coupled with a relentless focus on service and support allowed us to expand our portfolio to self-pay patients and differentiate our brands to providers.

In parallel, our strategic pricing initiatives drove a favorable allowable of the three injection product and maintain five injection customers within the company’s portfolio. In 2023, we will expand our innovative OrthogenRx patient access program for our five injection customers to address the growing self-pay market. We also expect steady increases with the three injection self-pay program. There will be continued reimbursement volatility in 2023 and pricing discipline and accurate average sales price or ASP reporting will be a focus for OrthogenRx to deliver stability for our customers. In total, our pain management business grew 2.6% in the fourth quarter and 2% for the full year, excluding the negative impacts of foreign exchange and contributions from our OrthogenRx acquisition.

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We continue to deliver on both our gross margin and SG&A commitments during the fourth quarter. Gross margin was 55.6% in the fourth quarter and 56.8% for the full year, driven by favorable product mix, inclusive of OrthogenRx and our plants continuing to incrementally deliver on the manufacturing efficiency strategy we set forth at the end of last year. Separately, we ended the year with back orders around $8 million, slightly higher than we anticipated coming out of the third quarter. Additionally, current back orders have increased to just under $10 million and we are cautiously optimistic that we can meaningfully reduce our back order throughout 2023. Turning to SG&A. Our fourth quarter and full year SG&A numbers as a percentage of revenue were 34.2% and 38.9%, respectively, exceeding our commitment to keep SG&A as a percentage of revenue under 40% for the full year.

We remain committed to this financial metric as we enter 2023 and Michael will provide additional insight when he discusses our 2023 planning assumptions. Our final two priorities for 2022 were to demonstrate our ability to deliver consistent repeatable free cash flow and capital deployment via M&A. For the fourth quarter, we generated $29 million of free cash flow despite continued inventory and supply chain headwinds. Our ability to consistently deliver free cash flow is critical to support our other strategic growth and capital allocation initiatives and has been identified in our priorities for 2023 and beyond. While we are disappointed, we have been unable to announce another acquisition since OrthogenRx in early 2022, we remain engaged in active dialogue with a number of potential tuck-in targets with the objective of leveraging our existing commercial infrastructure, generating synergies and enhancing our topline growth.

We have been disciplined in our approach around strategic fit, evaluation and due diligence, and believe that discipline is critical for long-term ROIC enhancement. On top of the early success of OrthogenRx, it is worth noting that our most recent acquisitions of NeoMed, Game Ready and Summit Medical, our ambIT device averaged double-digit growth in 2022. Quickly summarizing 2022. Our primary objectives were centered around consistent organic growth. delivering on our OrthogenRx strategy, making meaningful improvements in our gross margin profile and demonstrating our ability to deliver material free cash flow. With organic growth in the middle of our range, excluding the unusual impacts of FX, OrthogenRx exceeded our internal expectations.

Gross margin improved by 450 basis points. We delivered free cash flow of $72 million or approximately $50 million greater than last year’s free cash flow, excluding the CARES Act refunds, we solidly delivered against our primary objectives, which as noted earlier, effectively laid the groundwork for our longer term transformation efforts. We outlined these transformation efforts in our JPMorgan presentation in January. In that presentation, I described four key priorities over the next three years that would optimize our go-to-market opportunities and substantially 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.

Now I will turn the call over to Michael, who will help lead these efforts in his expanded role as Chief Transformation Officer and will elaborate on both the near and longer term goals of these efforts.

Michael Greiner: Thanks, Joe. As you noted, we are very excited to embark on our transformation journey and believe our execution over the past 18 months has created a solid foundation to build upon. Before diving deeper into these transformation efforts, I will provide additional color to our fourth quarter and full year results. Total reported sales for the fourth quarter and full year were $217 million and $820 million, increases of 12.4% and 10.1%, respectively. Adjusted diluted EPS for the quarter was $0.60 and $1.65 for the full year. Additionally, as Joe already noted, we delivered on both our gross margin and SG&A as a percentage of revenue commitments, with full year gross margin at 56.8% and SG&A as a percentage of revenue for the full year at 38.9%.

We also successfully executed on our OrthogenRx strategy during the year and generated over $70 million of free cash flow ending the year with $128 million of cash on hand and a leverage ratio of less than 1. Excluding the negative impact of foreign exchange, Chronic Care sales grew by almost 6% for the quarter, with Digestive Health growing over 10% and our closed suction catheter systems growth exceeding 8%. Within our Digested Health portfolio, NeoMed grew nearly 4% globally, again fueled by strong execution of customer conversions to our ENFit technology. Although, our closed suction catheter business should return to healthy growth, as we noted what happened during our third quarter conference call, our Oral Care sales were down almost 27%, as we intentionally walked away from contracts with unattractive margin profiles.

Within Pain management, we grew 2.6% for the quarter, excluding the contribution of OrthogenRx and the negative impact of foreign exchange. Our interventional pain business grew 6% with our acute pain products growing a little under 1%. As Joe summarized earlier, we had another solid revenue quarter and overall positive financial contributions from OrthogenRx. Game Ready and our COOLIEF water cooled RF system both grew double digits for the quarter, partially offset by a decline in our surgical pain products. Adjusted EBITDA totaled $45 million, compared to $33 million last year and adjusted net income totaled $28 million, compared to $24 million a year ago, translating to $0.60 of adjusted diluted earnings per share versus $0.50 a year ago.

In summary, 2022 was a strong year for the company, with adjusted gross margin improving 450 basis points compared to last year this year, while adjusted EBITDA margin exceeded 20% in the fourth quarter. Additionally, we delivered on our internal EBITDA, operating profit and adjusted diluted EPS targets, while further strengthening our balance sheet, even after allocating over $170 million towards M&A and share repurchases. As Joe noted earlier, our recent execution has positioned us to embark on the transformation efforts we outlined at the JPMorgan conference. Our transformation priorities are designed to shift our product portfolio over time into a higher growth portfolio, leveraging our cornerstone product families in Digestive Health and interventional pain.

Additionally, these priorities are aimed at rightsizing our cost structure and enhancing our operating profitability with EBITDA margins ultimately exceeding 22%, while generating annual free cash flow of $100 million. Our three-year transformation assumes primarily organic efforts that we have visibility against and strategies that are in our control. While still early, we have made some impactful decisions already, including leadership changes. Kerr Holbrook was promoted to Chief Commercial Officer, leading our combined Chronic Care and Pain franchises with a focus on realizing efficiencies and synergies within our commercial teams. Additionally, my role was expanded to include senior leadership oversight over this critical initiative through the transformation management office.

We also announced that internationally, we would cease selling certain products in our acute pain category and smaller product categories with insufficient profitability. As noted earlier, we have also walked away from customer contracts with low margin as we exited 2022. While these strategic decisions will result in an annualized revenue loss of approximately $35 million, we were not set up to win or grow profitably in these markets or categories over the long run. Our cost savings initiatives will primarily offset stranded costs associated with these product categories. In total, we expect to realize approximately $10 million of savings in 2023, anticipate $45 million to $55 million of gross cost savings by 2025, most of which will be achieved in 2024.

We will present a refined view of our transformation program at our Investor Day on June 20th to be held at the Convene 101 Park Avenue location in New York City. Although 2023 will be an uneven transition year, given the product portfolio rationalization and cost management initiatives, we anticipate improving our operating and EBITDA margins by at least 100 basis points. Separately, we expect to earn between $1.60 and $1.80 of adjusted diluted earnings per share for 2023, while delivering at least $60 million in free cash flow, excluding the one-time cash costs associated with the restructuring efforts expected to total between $20 million and $25 million. Finally, including the in-year impact of the approximately $35 million annualized product portfolio rationalization decisions, the company anticipates comparable organic revenue growth to be low single digits.

As I mentioned earlier, we are excited to embark on our transformation journey and I am confident we will improve on each of these metrics as the year progresses with the first quarter starting off slow and accelerating into the back half of the year, similar pacing to what we experienced in 2022. In summary, given our consistent execution over the back half of 2021 and throughout 2022, and considering this current global macro and industry specific environment remains uneven, we believe this is the appropriate time to proactively and strategically optimize our commercial organization, portfolio and cost structure. Operator, please open the line for questions.

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Q&A Session

Operator: The first question today comes from Rick Wise with Stifel. Please go ahead.

Rick Wise: Good morning, Joe. Hi, Michael. Let me — a lot to tackle here. I think that I am going to start with the transformation commentary. And sorry, Michael, to make you say it again, did I hear you correctly, it’s $10 million cost reduction this year and the large portion of next year? I am sorry, I just went by quickly. And maybe you could just — whatever you will correct my words, if they are wrong, but just help us understand better where the costs are going to come from, were the — what’s involved, how quickly you can get at them, and to what extent, especially in the early part, is this going to be a net positive, offsetting other cost and inflation, et cetera, pressures? Sorry for the long start.

Michael Greiner: Yeah. No. No. That’s okay. Hi, Rick. So, yes, approximately $10 million in 2023, a majority of the remainder amount, of between $45 million and $55 million in 2024. So just to answer that first part of your question. Where a majority of these savings are coming from is a mix of things. We will be outsourcing some opportunities. We will be rebidding on a lot of third-party contracts. We will be eliminating third-party resources as we announced through the reorganization of naming Kerr Holbrook, the Chief Commercial Officer. There was a duplication of roles. Some of those roles have already been eliminated. We will also just continue on the path that we have done in the last couple of years with looking at trimming T&E and other areas as well.

Some of those things like outsourcing will take into the back half of this year to figure out the right partner to figure out the right way to do that without being disruptive and so a majority of those savings won’t take place until 2024.

Rick Wise: Got you. Exciting stuff as it all unfolds. Your supply chain back order situation, maybe you could give us a little more color on the back order, what drove the higher than expected back quarter in fourth quarter and the increase early this year? Is it — I don’t know, is it particular product supply shortages or — and again what’s your optimism on resolution working through that now?

Joe Woody: Yeah. So, Rick, this is Joe, and Michael is welcome to comment as well. But we did a nice job at the end of the quarter, reducing our backlog, and obviously, that shows in the revenue, but then it built back up again. So it’s close to $10-ish million right now. It will come down though, quarter-by-quarter. We think it will come down pretty significantly in the second half. But three areas right now. It’s heavily weighted to just of health at the moment and particularly there’s the tieback issue. I think everybody knows that DuPont’s building a new plant. It will be up and running in Europe but not until the fourth quarter. So that’s some of it. In our case, we also have a supplier of catheters for ON-Q and ambIT where we actually could be producing more revenue and the underlying demand is there, but that’s going to stick with us through the third quarter of this year.

And then there are still electronic components that are issues across the Board that does impact COOLIEF. Now that said, when we look out, we do see by the time we get to Q3 that most of that will be in the rearview mirror and that’s why Michael has talked about a progression somewhat similar to this year. But the ambul and what — as I listened to Michael, the element of the transformation is to eliminate SKUs to make some changes further in our portfolio. We believe that we can build ourselves into a consistent mid-single-digit growing business as we enter 2024, and obviously, the second half will be stronger than the first.