Earnings Call Transcript
AVANOS MEDICAL, INC. (AVNS)
Earnings Call Transcript - AVNS Q1 2021
Operator, Operator
Good day. And welcome to the Avanos Medical First Quarter 2021 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 Dave Crawford, Vice President of Investor Relations. Please go ahead.
Dave Crawford, Vice President of Investor Relations
Good morning, everyone, and thanks for joining us. It’s my pleasure to welcome you to the Avanos 2021 first quarter earnings conference call. With me this morning are Joe Woody, CEO; and Michael Greiner, Senior Vice President and CFO. Joe will begin with an update on our business and then review the progress we’re making against our 2021 priorities and Michael will review our 2021 first quarter and provide an update on our current planning environment. 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, economic conditions and our industry. No assurance can be given as to the future financial results. Actual results could differ materially from those in 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 the 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.
Joe Woody, CEO
Thanks, Dave. Good morning, everyone, and thank you for your interest in Avanos. I’m encouraged by our team’s continued strong execution and resiliency as they respond to the challenging dynamics of our business brought on by the pandemic. Our employees remain focused and dedicated to getting patients back to the things that matter as we meet the needs of our customers. As mentioned on our last earnings call, we began the quarter with some headwinds and uncertainty resulting from rising hospitalizations and the corresponding negative impact on elective procedures. However, as we exited the quarter, we saw increasing topline momentum across our Pain Management franchise as the return of elective procedures began to reaccelerate. Looking ahead, while we’re encouraged to see elective procedure volume increasing and expected to accelerate, we continue to believe that volume is likely to remain below its full potential until the end of the year. As we examined the business environment, we are gaining confidence in the direction of our business and have better visibility to the gradual alleviation of challenges presented by the pandemic. As a result, we feel well positioned to provide financial guidance for 2021. Based on current projections, we expect net sales, on a constant currency basis, to increase 2% to 4% compared to the prior year. Also, we expect to earn between $1.10 to $1.25 of adjusted diluted earnings per share. Michael will share additional information on our financial guidance in his remarks. During the quarter, we established our first Diversity, Equity and Inclusion Council consisting of 15 global employees across all departments. The DE&I Council will build upon our We Stand Together initiative to better understand our employees’ perspectives regarding the issues of racial and gender inequality. Our DE&I initiative remains a critical effort for us to strengthen the organization and culture where all our employees want to work. Lastly, we are discussing with the DOJ a potential resolution of their investigation into MicroCool and other surgical gowns that were a part of the S&IP business when we divested in 2018. We anticipate finalizing an agreement with the DOJ in Q2 or Q3. With that as background, let me now review our first quarter results and provide you with an update on our drivers of value creation. Sales totaled $181 million, unchanged compared to the prior year, while we earned $0.23 of adjusted diluted earnings per share. Earnings were positively impacted by our disciplined cost control measures that were partially offset by increased transportation costs. Results in our Chronic Care business were mixed, and in Digestive Health, we continue to deliver mid single-digit growth in the franchise overall. In Respiratory Health, sales related to the direct treatment of patients impacted by the pandemic were similar to last year. However, overall growth was down slightly as precautionary measures taken for the pandemic impacted the normal cold and flu season uplift, significantly reducing seasonal sales related to the cold and flu season. In Pain Management, as I stated earlier, elective procedures remained suppressed at the start of the quarter as COVID-related hospitalizations spiked in some regions. The biggest headwind was to our ON-Q therapy, where a significant percentage of surgeries that ON-Q is used in require a hospital stay. Separately, COOLIEF was less impacted as it performed as an outpatient therapy. Overall sales grew sequentially throughout the quarter as procedural volume returned. Despite the early quarter headwinds caused by the new wave of the pandemic, we continue to build on our solid foundation to accelerate growth across Pain Management. Finally, let me provide you an update on our progress this quarter regarding our four areas of value creation. As a reminder, the four areas are strengthening our growth profile, expanding our gross and operating margins, driving consistent free cash flow generation, and deploying capital towards M&A. First, as we look to strengthen our growth profile, we maintained our momentum in driving market adoption and gaining share by growing both our CORTRAK and NeoMed portfolios. We are executing our strategy to establish CORTRAK as the standard-of-care for nasal gastric feeding, along with increasing the adoption of NeoMed to further address neonatal enteral feeding needs. We delivered record sales for CORTRAK hardware units in the first quarter and are on target to reach our goal for NeoMed upon conversions. On previous calls, we have discussed the progress we’re making to expand the clinical evidence for COOLIEF to demonstrate this differentiation as radio frequency ablation therapy, which is also important in this effort our independent physician-led studies being conducted. During the quarter, two independent physician-led publications on COOLIEF were published. The first concluded that the use of cold radio frequency was predictive of a better outcome for patients suffering from knee osteoarthritis. Additionally, another large retrospective knee series concluded that COOLIEF was clinically effective for both managing pain and reducing disability. Finally, we continue to execute on our international expansion initiatives. We achieved high single-digit organic growth across each of our regions during the quarter. For the first time, we have seen this level of growth across all of our regions in the same quarter. Also, internationally, we achieved growth in both our Chronic Care and Pain Management franchises. Our second area focuses on gross and operating margin expansion. I’m encouraged by the continued cost discipline and emphasis on driving efficiency in our spending. However, we incurred additional transportation costs related to facilitating NeoMed growth from account conversions. We anticipate these increased distribution costs to continue in the second quarter, albeit at a slower rate. As we advance our business, we’re looking at all processes through the lens of value creation, with the goal of enhancing efficiencies by embedding this approach into our culture, thus more effectively meeting customers’ needs. Our third pathway is to generate consistent repeatable cash flow. Cash flow met our internal expectation for the quarter as we anticipated certain outflows relating to compensation. Taking into consideration our preliminary agreement with the DOJ, we now anticipate delivering approximately $80 million of free cash flow. Cash flow will be driven by approved earnings, the disciplined cost savings that I previously mentioned, as well as receiving an expected $60 million in U.S. tax refunds, primarily derived from the provisions available through the CARES Act. Finally, we continue to examine capital deployment for M&A. Our M&A pipeline remains robust, and we maintain active dialogue with a number of potential tuck-in targets, which would leverage our existing footprint, generate synergies, and enhance our topline growth profile. While I’m optimistic about the prospect of bolstering our robust portfolio in 2021, we will remain disciplined in our assessment of targets, ensuring we generate a strong return on capital. Overall, we remain well-positioned to advance our strategies across each of these four areas of value creation, as our focus on execution remains strong. This along with our market-leading portfolio gives me confidence we can deliver growth and margin expansion in 2021 and beyond. Now, I’ll turn the call over to Michael.
Michael Greiner, CFO
Thanks, Joe. As you know, we continue to battle a range of headwinds, and yet the team remains focused on execution and overcoming these challenges. Let’s begin with a review of our first quarter results. Total sales of $181 million were unchanged compared to last year. We saw a 1% increase in volume and a 1% benefit from favorable exchange rates. Unfavorable pricing offset sales by 2%. The slightly higher than normal price impact was primarily due to the timing of discounts and allowances paid to customers. Chronic Care sales grew 5% to $121 million in the quarter, as we saw mid single-digit demand for our Digestive Health products. Double-digit CORTRAK growth resulted from the execution of our standard-of-care strategy, while NeoMed growth came from the continuation of conversions to our ENFit technology mentioned earlier. Double-digit international growth bolstered performance driven by new channel partnerships and our Asia-Pacific and Middle East regions for CORTRAK, along with share gains across Europe. Meanwhile, performance in Respiratory Health was down slightly due to the weaker than normal cold and flu season. Also, we continue to monitor our pandemic-related sales and the relationship between sales to distributors and trace sales from our customers. While over the past year, there has been some added variability, it does not appear from the analysis that additional inventory is currently being held by distributors. Thus, while we do expect an impact to Respiratory Health growth from hospitalizations declining over the next several quarters, we do not anticipate an additional headwind from distributors rebalancing their inventory levels. Moving to Pain Management, we delivered $60 million of sales, which is 8% lower compared to the prior year. The cancellation of elective procedures impacted performance, as well as lower procedural efficiency. The largest change was in ON-Q, which is heavily correlated to procedures requiring some length of patient stay in the hospital. As Joe mentioned, we saw sequential growth in ON-Q as the hospitalization declined and elective procedural volume increased. Despite this challenge to ON-Q for the quarter, sales through Leiters increased by double digits as the partnership continues to benefit customers as a pre-fill option. With respect to COOLIEF, we’re encouraged by the results for the quarter that were essentially flat compared to the prior year. While growth was unfavorable for the first two months, we saw significant growth in March as anticipated. A highlight in Pain Management was double-digit growth in Game Ready, where our efforts to expand the rental of units directly from Avanos are progressing well. In addition, the business benefited from the return of sports in both North American and European markets. We continue to meet patients' needs for effective opioid-sparing pain management therapies and believe the return of elective procedures being performed in the hospital will support additional growth for this franchise. Moving down the income statement, adjusted gross margin decreased to 52%, compared to 59% last year. As we indicated on our previous earnings call, gross margin was expected to be lower given the timing of manufacturing variances and unfavorable product mix. In addition, gross margin in the quarter was also impacted by higher transportation costs to bring NeoMed products from China to the United States to meet customer demand, as well as higher than normal price declines in the timing of discounts and allowances paid to customers. We continue to expect adjusted gross margin to improve as we regain growth in Pain Management and demand for our Respiratory Health products partially normalizes to pre-COVID levels. Adjusted gross margins are still expected to range between 2019 and 2020 margin levels as mentioned during our year-end earnings call. However, we anticipate meaningful improvement in gross margin will now occur in the second half of the year, as we will continue to incur higher transportation costs to meet the sales demand for NeoMed during the second quarter. Adjusted operating profit totaled $16 million, compared to $14 million in the prior year. Performance was primarily driven by adjusted operating expense reductions, which was partially offset by the lower adjusted gross margin I just reviewed. Adjusted EBITDA totaled $22 million, compared to $20 million last year. Adjusted net income totaled $11 million, compared to $8 million a year ago, and we earned $0.23 of adjusted diluted earnings per share. Now turning to the balance sheet and cash flow statement. As Joe mentioned, keeping a healthy balance sheet and generating meaningful free cash flow remains a key go-forward priority. Our balance sheet remains solid and continues to provide us with strategic flexibility as we ended the quarter with $100 million of cash on hand, as well as $175 million of debt outstanding on our revolving credit facility. This is an improvement of $5 million versus year-end due to repayments we made during the quarter. Free cash flow represented an outflow of $9 million due to timing of payments related to employee short-term incentives and severance payments related to our restructuring announced last quarter. Overall, as Joe mentioned, taking into consideration our preliminary settlement with the DOJ, we are confident in generating approximately $80 million of free cash flow this year, which includes refunds from the CARES Act. Finally, while some unpredictability of the Coronavirus remains, the return of elective procedures and the success of the vaccine rollout enable us to provide a 2021 full year outlook at this time. Based on current trends in our business, including the expectation of elective procedures returning to normal levels by the end of the year, we expect net sales on a constant currency basis to increase 2% to 4% compared to the prior year. This includes an approximate 50-basis-point impact from the exit of a non-strategic international Chronic Care business discussed last quarter. Additionally, as we noted on our year-end earnings call, quarter-over-quarter sales results will be more variable than usual given the impact of COVID on our prior year sales and how that will impact our quarterly comparables. For the year, we expect to earn between $1.10 and $1.25 of adjusted diluted earnings per share. We expect higher earnings in the second half of the year from a pacing perspective, based on higher sales and gross margin expansion, along with the continued focus on controlling our operating expenses. In closing, we are off to a strong start for the year and we’ve made meaningful progress on our value creation pathway. I’m confident in our ability to execute on the strategy and to deliver significant free cash flow and deploy capital in a disciplined manner throughout the duration of this year and going forward.
Operator, Operator
Please open the line for questions.
Ravi Misra, Analyst
Good morning. Thank you for taking my questions. I have a couple of inquiries regarding your guidance. Mike and Joe, you're assuming normalization by the end of the year. I'm curious if that positions you at the midpoint of your guidance or the higher end. Can you clarify what your expectations are for both the low and high ends? For the high end, should we anticipate a more aggressive rebound in procedures? I have a few follow-up questions as well. Thank you.
Joe Woody, CEO
Hey, Ravi. Good morning. It’s Joe. I’ll say a couple of things and then, Michael, may want to add to it. But generally, the way I would sort of view that guidance is that, the faster electives come back, the better it can be. And Chronic Care is likely to be below the low end of our range, but pain at the high end of really the high end of our range. So we are looking at obviously the improvement, less hospitalizations, and we really do believe that things are going to improve on the electives in the second half of the year. We’re watching the speed there, because we don’t have full indication that that’s across the board from a lot of our customers. And Michael, do you have anything to add there?
Michael Greiner, CFO
Yeah. I would just say the low end of the range, Ravi, to your question, assumes some continued headwinds in the back half of the year on both the cost side. And as Joe just mentioned, some of these electives not returning in order to hit that $10. So that’s a fairly conservative low end of the range; a lot of things would have to not go right for us in the back half of the year to be there.
Ravi Misra, Analyst
Thank you. If you could provide some insight, I have a couple of follow-up questions. First, your international growth appears to be quite strong. Could you clarify its impact on margins compared to the overall corporate average? Lastly, do you have any updates on the progress of the breakthrough designation product? Thank you.
Joe Woody, CEO
I'll begin by discussing our international business, which has performed well. We expect this positive trend to continue into the second quarter. We have made significant efforts to expand geographically by leveraging our recent mergers and acquisitions to enter new markets. The team has effectively managed distributors in EMEA and Asia-Pacific, increasing their effectiveness and in some instances, going direct while eliminating underperforming distributors. They are also very focused on medical education and clinical studies, which will drive therapy adoption in both regions. We believe this segment can initially grow at a mid-single-digit rate in a stable environment, and we are working towards achieving high single-digit growth, making it a crucial aspect of our strategy. Early in my role, we invested heavily in personnel and infrastructure in this area. Now, I'll pass it over to Michael, who can provide insights on the margin contribution.
Michael Greiner, CFO
Yeah. So remember, Ravi, good majority of the revenue we do have internationally right now is Chronic Care. We are looking to expand our pain footprint. So, by definition, our Chronic Care portfolio, by and large, is a lower gross margin profile. And then as Joe just alluded to, we are doing some key investments internationally that we think are right for the long term. So our overall margin profile, both at the gross margin levels and the operating margin levels are slightly lower than the overall consolidated companies.
Ravi Misra, Analyst
And then just on that breakthrough designation device changes…
Joe Woody, CEO
Oh! Sorry. Sorry about that. Yeah. We are progressing well and our electronic nerve block product really focused on total knee. We’re in patients now. We’re very impressed with the results. And so that portion of the development has gone well and now we’re obviously working on the FDA approval applications and how we would view reimbursement there. When we have an Investor Day, which may be toward the end of the year, we’ll highlight that and talk more about it at that meeting.
Ravi Misra, Analyst
Thanks.
Operator, Operator
The next question comes from Larry Keusch with Raymond James. Please go ahead.
Larry Keusch, Analyst
Good morning, everyone. Thank you for the question. To begin, I appreciate the guidance for 2021, although it was a bit lower than I expected. I'm trying to understand the different aspects of the business. I'm interested in your perspective on ON-Q. Is it lagging as you wait for these procedures to resume? Given your remarks on the first quarter and the exit rates, I would think COOLIEF should see significant growth this year.
Joe Woody, CEO
Yes, that's correct, Larry. COOLIEF is expected to grow significantly. Regarding ON-Q, we experienced positive growth in March and have seen continuous improvement. However, since most of our business with ON-Q is hospital-based, the recovery is slightly slower compared to COOLIEF in the hospital outpatient sector. Looking ahead to the second half of the year, we anticipate good growth, although some of that is dependent on comparisons for ON-Q, and we’re satisfied with our progress. There are some uncertainties regarding the pace of recovery for hospitals returning to full operations compared to ambulatory surgical centers. Last year, we faced criticism for suggesting that recovery would occur rapidly in the second half, only to see it slow down again due to another wave, which indeed happened. So, we are taking a cautious approach. However, I mentioned earlier that if the recovery happens more quickly, that would be beneficial for us. Michael, do you have anything to add? No, Michael has nothing further. Larry, you might have additional questions.
Larry Keusch, Analyst
Yeah. I do. Just two more. Thanks for that. I guess, Joe, on that topic about, again, your commentary of you don’t expect the full volume potential to come back until the end of the year. As you assess things, what do you think is really the biggest gating factor there? What’s driving that assumption? I mean, that is, it feels a little bit different than what other companies are assuming. It feels like most are anticipating kind of the second half is much more normalized. It sounds like your commentary is, hey, let’s wait and see what happens till the end of the year? And I guess just the second question I’ll just ask and probably for, Michael, is just how should we think about that SG&A coming back through the year?
Joe Woody, CEO
Generally, for us, the therapy for pain is being conducted at different sites, which adds a bit of complexity. For instance, Game Ready is gaining traction rapidly as sports return, and we are experiencing significant growth in that area, which is happening in an outpatient setting. Similarly, COOLIEF is also making quick progress in outpatient settings. We believe we are currently around 80% to 85% capacity in hospitals, and that number should increase. Our decision to adopt a more cautious approach is based on discussions with hospital executives, consultations with external experts, and feedback from our surgeons and customers. However, if the recovery continues swiftly, especially between May and July, we anticipate a strong second half of the year, which could positively impact our knee segment.
Michael Greiner, CFO
I think, Larry, one of the things to consider is that we didn’t want to revisit this range. We believe we were looking at various sensitivities regarding when things would occur, and this range allows us to account for some downside if that happens and some upside if things rebound more quickly. That’s part of our thought process regarding the range we put out for the start of the second quarter. Regarding SG&A, as you’ve noticed, we’ve maintained SG&A as a percentage of revenue in the high 30s over the last three quarters, which is our long-term goal. We believe that as we approach the second half of the year, there are some operating-side investment opportunities we are considering. If we pursue those investments, SG&A could temporarily rise to just over 40% before we achieve our long-term target in the high 30s more permanently. So, the $1.10 to $1.25 estimate also reflects these potential SG&A investments in the latter half of the year.
Larry Keusch, Analyst
Okay. Terrific. Thanks, guys. Appreciate it.
Joe Woody, CEO
Thank you.
Matt Mishan, Analyst
Hey. Good morning, guys.
Joe Woody, CEO
Good morning.
Matt Mishan, Analyst
So it’s a Friday morning after a long week. My listening comprehension skills are not that strong this morning. But I heard DOJ a couple of times in the presentation. Just, first, can you just go over, do you still have a liability there? Is that Kimberly-Clark? And did that change your free cash flow expectations for the year sitting on $80 million? I think it was $100 million previously?
Michael Greiner, CFO
Right. So I’ll say a couple of things and then I won’t go much further for now. But basically, we did reach an agreement in principle with the DOJ and we’re continuously discussing a potential resolution. We anticipate that this would be finalized in Q2 or Q3. If you’re referring to the indemnification with KCI, we have no more issues there. We settled with KCI, really was in Q4 I think of last…
Joe Woody, CEO
Last year. Yes.
Michael Greiner, CFO
You’re correct, Matt, the change in free cash flow from $100 million to $80 million relates to what we believe will be the settlement amount with DOJ.
Joe Woody, CEO
And just one other thing, if you think about this, I will step back a little bit. We’ve always talked about getting things behind us and moving forward. I think this is a big step to understand where we might be with this, which couples with putting the IT system deployment and the divestiture in IT. This also involves positioning ourselves to reduce costs in the business and move toward achieving stronger growth. Our ability to execute in a clearer manner is as significant as any type of agreement.
Michael Greiner, CFO
Yeah. Removing these overhangs we think is important.
Matt Mishan, Analyst
Okay. Excellent. And then, just gross margin trends. How do you think they’ve been improved from 1Q to the rest of the year? I believe you previously said that you’re somewhere between 19 and 20. Is that still the case? I think it is?
Joe Woody, CEO
Yeah. So, Michael is going to take you through some detail, but I’ll say a couple of things upfront. It is only about a year ago that we were in the high 50s and low 60s in the business. And these things really are temporary. As you hear more about that here in a second, pandemic-related issues, and we have a lot of confidence. We talked a little bit about these in Q4 that Q1 and Q2 would be light for us and then we would be very strong in H2. So I think that we’ve had a lot of progression in the business on the flip side of it. You can sort of look at EBITDA growing the way it did for the quarter. In this call, Michael had talked a little bit about the SG&A. So as we get this moving in the right direction, which we have the plans for and the sales coming on, we should be in good shape. But maybe, Michael, you may want to talk a little more detail about it.
Michael Greiner, CFO
Yeah, Matt. Great question. The reality is we didn’t all of a sudden just become a 53%, 54% gross margin company, right? So there’s a range of things that happened over the last few quarters that have suppressed our gross margins in a temporary manner, some self-inflicted, which we’re fixing; some have been exogenous events that we’re working through. But when you look at the first half of the year to the second half of the year, we see an opportunity for greater than 500 basis points of improvement in the second half of the year. Those are temporal items, transitory items around price and product mix, the revaluation of manufacturing variances, and then this NeoMed freight issue that we’re dealing with. That is important for our long-term growth prospects for NeoMed, but also, unfortunately, has us incurring higher than anticipated freight costs from China where NeoMed is manufactured. So the second half of the year, we feel really good about especially given that we know good portions of the headwinds into the second half of the year are directly related to temporary items from the first half. When you think about first quarter to second quarter, we do anticipate significant improvements, although not what we’re going to see in the second half, but significant improvement primarily related to improved product mix.
Matt Mishan, Analyst
Okay. What is the pathway to achieving gross margins of over 60% from this point?
Michael Greiner, CFO
Absolutely. We believe that in the second half of the year, we will experience a quarter or two that will demonstrate gross margins exceeding 60%.
Matt Mishan, Analyst
Okay. That’s great. What unfavorable discounts and allowances did you see in the quarter?
Michael Greiner, CFO
Yeah.
Matt Mishan, Analyst
Could you elaborate a little bit on what those were?
Joe Woody, CEO
Just, generally, we’re not backing off of our business, which has experienced fluctuations around negative 1% to plus 1% overall in pricing. This situation is largely influenced by the timing of rebates and discounts with some of our customers. Therefore, I don't foresee this as a long-term concern either.
Michael Greiner, CFO
Yeah. The price issue that we had in the first quarter was not related to changes in how we go to business or giving away price. It related more to the timing of the products, respiratory and others in the back half of the year, and these are just catch-up refunds that we had to get in place that we didn’t capture as timely not knowing what some of the measurement criteria was, given the different changes in revenue that we saw.
Matt Mishan, Analyst
Okay. And then reimbursement and the ASCs for COOLIEF, has that moved the needle for you guys?
Joe Woody, CEO
I wouldn’t say, yeah, I think we talked about that having an impact in the back half of the year. We’re doing a full breakdown assessment of all of the ASCs and looking at how they’re structured and which ones you want to go into to be efficient and profitable about the way that we go about it. But I would think that as you get into Q3 and Q4, we’ll see some benefit there.
Matt Mishan, Analyst
Okay. And lastly, regarding Game Ready, it’s the first time you’ve mentioned it in a while. Is that because of a new product or has something changed that has brought Game Ready to the forefront?
Joe Woody, CEO
So a couple of things. One, definitely sports have come back where there are sports injuries. But we have also been very focused on a drop-ship program that the team put together did a nice job with, as well as the rental business and bringing that up to speed and making better connections with our customers and also making that efficient as part of the also the synergies as we finish that off last year with Game Ready. So, really three things there and we’re happy with that momentum.
Matt Mishan, Analyst
Okay. Thank you very much.
Joe Woody, CEO
Thank you.
Operator, Operator
The next question comes from Rick Wise with Stifel. Please go ahead.
Rick Wise, Analyst
Good morning.
Joe Woody, CEO
Hi, Rick.
Rick Wise, Analyst
How you doing? And just to start off, first, with a sort of a little shorter-term question I’ve been asking every company this quarter, the same thing, just to better understand recovery plan. Like many others, January and February were softer, as you said, Joe, sounds like March had a nice snapback. Have those trends continued into April or accelerated or are they on a path? So sort of a two-part question; if that’s the case, are we on path to sequentially higher second quarter sales or no, second quarter is going to look a lot like the first two-month sales or margin perspective. You clearly are expecting a stronger second half. But just to help us get in the right sort of thought mode for the second quarter as we try to model it correctly?
Joe Woody, CEO
We believe we are witnessing some sequential improvement from Q1 to Q2. Our business typically performs better in the second half of the year. In Respiratory Health, we are seeing the expected trends. The Digestive Health segment remains stable, and, as mentioned earlier, our International business is off to a strong start. We are seeing positive growth in the ON-Q business, with even faster improvement in the Interventional Pain segment since it operates in the hospital outpatient department. Overall, we are moving in the right direction, and we anticipate even stronger performance in the second half of the year.
Michael Greiner, CFO
Remember too from a comparable standpoint, ON-Q and COOLIEF will both have very attractive comparables versus last year's second quarter. So those will be good numbers. Sequentially, Rick, as Joe mentioned, we are starting to see some nice improvement there as well, which is good. Also recall that the flipside is that our respiratory business, in particular, closed suction catheters, had a very strong Q2 and Q3 last year. So those will be much tougher comps at the beginning of the pandemic last year.
Rick Wise, Analyst
Got you. And to ON-Q specifically, so just appreciating the in-hospital aspect, as you’ve emphasized, we should see better ON-Q in the second quarter because of the recovery trends you’re already seeing. Is that the right way to say?
Joe Woody, CEO
Yeah. Yes. That’s correct. One of the ways that we sort of evaluated that, I think investors can evaluate it is, as orthopedic procedures in the hospital versus ASC comeback at that level, we are somewhat aligned with that.
Rick Wise, Analyst
Got you. And I want to come back to your M&A pipeline comments, Joe, from sort of two aspects. I mean, it’s always intriguing. You’re very clear about your robust pipeline. And just as an outsider, I’m always fascinated. What, and I know it’s obvious, I appreciate it’s very complex price, willingness to sell, timing, all sorts of things go into it. But help us understand why you haven’t moved even faster. Is it something internal to Avanos right now that you waited until you just felt better about recovery or whatever IT systems or people? Or is it that, or is it and have valuations been too high? I’m just trying to understand what might release the floodgates, which could potentially be very exciting, obviously, in terms of potential growth and leverage and outlook?
Joe Woody, CEO
Our disciplined approach has been about waiting for the pandemic to ease. We also faced some execution challenges that we have been focusing on, and we communicated to our investors that this would be our priority. I believe we have demonstrated progress in this area over the last six quarters. Now, we are actively pursuing several potential targets. Valuation won't be a barrier for us since we are engaging with privately owned businesses in sectors that align with our goals and will enhance our operations. We are not bound by the multiples some deals demand. Therefore, when we do finalize deals, we expect to present good value, similar to what we have achieved in the past.
Rick Wise, Analyst
Got you. And just to follow-up on that. So we should be cautiously hopeful optimistic that you could get one or more of these across the finish line this year or is that too much doubtful? Thanks.
Joe Woody, CEO
That's quite challenging. I mean, predicting these is impossible. I would love to do two. However, we are definitely making a strong effort to accomplish at least one, and we'll see what happens. We have a solid history, so we’ll see where we end up by the end of the year.
Rick Wise, Analyst
Sounds great. Thank you again.
Joe Woody, CEO
Thank you.
Operator, Operator
The next question comes from Marissa Bych with Morgan Stanley. Please go ahead.
Marissa Bych, Analyst
Hi. Good morning and thanks for taking the question. I’m sorry to go back to gross margins, but I just wanted to push a little further on the transportation impact. It seems like COGS this quarter were about $8 million higher than consensus estimates. What was the relative impact of the transportation of NeoMed and kind of relative to that $8 million total higher COGS? And was there anything else lingering from last year or really any other kind of one-time impacts that you would call out? Thank you very much.
Joe Woody, CEO
I think Michael is going to talk about this a little bit and I just want to make a comment about the NeoMed, the positive side of this. But go ahead.
Michael Greiner, CFO
Yeah. About a third of that $8 million, if you’re looking at absolute dollars, related to NeoMed, another third or so related to the revaluation that we had for the manufacturing variances, and then we had a little bit of that price impact that we just talked about with Matt’s question. So that was laid out, and then there was some mismatch, but those are the three primary chunks of that $8 million higher up from a COGS absolute value standpoint.
Joe Woody, CEO
And just on the why side of it. I think it was the right thing to do; if you can imagine the ports in California, supply chain. These prices are crazy right now. But we have converted ahead of our expectations NeoMed customers, and this will be a payoff in the second half and then 2022. So doing that, I think, is the right thing to do for more sustainable growth in the business, but obviously not happy about the price of that transportation. We may have a little bit more of it, not quite as much in Q2, but it will absolutely subside in the second half.
Marissa Bych, Analyst
Okay. Great. And my one follow-up would just be on COOLIEF. You touched on this. But can you give us any more detail on how the COOLIEF growth has improved into April relative to the strong growth that you saw in March? And is that more driven by growth in new accounts or more of a reacceleration in the existing accounts that you’ve had? And thank you very much.
Joe Woody, CEO
Yeah. It’s actually accelerated from March into April. So we’re seeing that continue. We did sell a number of capital consoles even last year during the pandemic. So there are new accounts coming in with our new technology, but even new customers. But as you can imagine, there’s also a backlog of spine and osteoarthritis knee patients coming through. So it’s really two things. And then, obviously, we have some easy comparables, but just generally, we’ve done well with new customers as well. I think we’re ready for the next question.
Operator, Operator
The next question comes from Chris Cooley with Stephens. Please go ahead.
Chris Cooley, Analyst
Thank you. Can you apologize, I am headed on the trunk. Congratulations on a solid quarter. Just two quick wins at this point from me, first, some clarification perspective, could you talk about your conservancy thinking about transition versus a year? Just want to be clear about that commentary that really centers predominantly related to the ON-Q portfolio plus these businesses, obviously, showing some strength now. Just wanted to clarify that? Just that’s one question and my follow-up question is the bigger picture, just when we think about margin targets longer term, could you help us think a little bit you talked about 60% gross margins earlier on Matt’s question still be and striking distance pricing power for these businesses and realizing greater operating efficiencies. Is there anything structured just to preclude you from stepping up the op margin into cash flow type characteristics, the business versus where we were previously? I know you’re not giving guidance here now, just thinking about things conceptually as we think that longer-term seen that you have greater operating efficiencies now, especially with new IT systems, just want to think about op margin and cash flow longer term as well? Thank you.
Joe Woody, CEO
Thanks, Chris. And I’ll say a couple of things about ON-Q and then let Michael talk about some of the margin elements and cash flow and some things that we are excited about. But, generally, with respect to ON-Q, we’re happy with the following things. One, Leiters continues to be growing at a significant rate. We’re adding new customers. As a percentage-wise, the business that we had managed under long-term medium is, we’re actually approaching that same level now. We are getting growth out of Summit and the electronic pump and starting to see that that can be beneficial to us for customers that want that solution versus the elastomeric pump. And we’re very excited about the orthopedic channel partners that we’re putting in place where, again, a greater portion of ON-Q is used there and looking to sign up more of those relationships over time. So I think we’re heading in the right direction. I think to the extent that electives come back in the hospital faster, that’ll be a plus for us. And then Michael, did you want to talk about that?
Michael Greiner, CFO
Yeah. Just longer term on the margins, we’ve talked about in the fall that we’ve had three quarters in a row now where SG&A is being in the high 30%. We believe that ultimately that is where we should live longer term. That being said, in the back half of the year, we may have some spend in selling and marketing that we think is smart for longer-term revenue opportunities. And so we may see a Q3 or Q4 where SG&A is a little bit higher than the high 30%s. Similarly gross margin, where we’ve had some of these temporal things that we’ve talked about. We’ve got 500 plus basis points of tailwinds going into the back half of the year for these temporary things. So we do anticipate seeing Q3 or Q4 or maybe in both quarters being greater than 60%. So these pieces have it all fit together perfectly yet, Chris, but you can see how we can get there in these various pieces as operating expenses, as well as gross margins and how that lends itself to where we want to take ultimately even an operating margin longer term. To your question around, could we be even better than that, given some of the efficiencies that we’re building into the organization? I think with M&A as well as continuing to learn over this next few quarters around where some of the key smart spend is, there is marginal opportunity to have margins probably higher than what we’ve talked about previously. But we’ll lay that out in a more holistic view, as Joe mentioned in the fall, when we issue a new three-year LRP.
Chris Cooley, Analyst
Thank you very much.
Joe Woody, CEO
Thank you.
Operator, Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Joe Woody, CEO, for any closing remarks.
Joe Woody, CEO
Thank you. I just want to thank everybody for your continued interest in Avanos. While we’re executing well in an uncertain environment, we are committed to creating shareholder value. I’m confident the priorities that we detailed today combined with our portfolio and attractive markets we’re in represent a strong foundation for sales growth, margin expansion, and positive free cash flow in 2021. So I look forward to continuing to report that out throughout the year. Thank you.
Operator, Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.