Earnings Call Transcript - AVNS Q2 2025

Operator, Operator

Good morning, everyone, and welcome to the Avanos Second Quarter 2025 Earnings Conference Call. I would now like to hand it over to Scott Galovan, Chief Financial Officer. Please proceed.

Scott Galovan, CFO

Good morning, everyone, and thanks for joining us. It's my pleasure to welcome you to Avanos 2025 Second Quarter Earnings Conference Call. Presenting today will be Dave Pacitti, CEO, who will kick off the call by sharing a few leadership updates. Dave will then provide a high-level overview of our second quarter results before turning it over to Jason Pickett, who has been serving as our Interim CFO. Jason will share additional details on these topics, provide an overview of our financial results and affirm our 2025 planning assumptions, inclusive of the impact of tariffs. 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 and current economic conditions, including risks related to ongoing tariff negotiations 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 Dave.

David C. Pacitti, CEO

Thanks, Scott, and good morning, everyone. I'd like to begin today by addressing the leadership changes that we announced earlier this morning. First, it's my great pleasure to announce that Scott Galovan, previously our SVP of Strategy and Corporate Development, has been appointed Avanos' new Chief Financial Officer. In his 12-plus years with the company, Scott has been instrumental in executing our strategy, identifying and pursuing strategic acquisitions and divestitures to strengthen our portfolio and keeping Avanos focused on the future. His extensive experience in navigating complex transactions will be absolutely critical as we build on our transformation efforts. We're excited to welcome him to this role and look forward to his dynamic leadership and valuable contributions. I'd also like to take this opportunity to thank Jason Pickett for serving as our interim CFO, while we conducted our search to fill this role. We greatly appreciate his leadership and his commitment to keeping us on the right path during this transitional period. Jason will continue to lead our tax, treasury and accounting functions. Finally, I'm honored to announce that I've been appointed to Avanos' Board of Directors, working alongside our Board members to guide Avanos' strategic direction and focus on delivering long-term shareholder value will truly be my privilege. Now we will shift our comments to our quarterly results and outlook. Building off our first quarter results, we delivered a strong second quarter, anchored by continued healthy performance of our life-sustaining Specialty Nutrition Systems segment, along with continued progress in our opioid-sparing Pain Management and Recovery segment. The demand for our products remains robust, and I'm pleased with the foundation laid out by our 3-year transformation efforts. During my first 100 days, I reviewed the initiatives that we had identified and implemented within the transformation journey. I'm encouraged by the progress of these initiatives and believe these are additional opportunities to advance our optimization efforts. While still early in my tenure, I'm confident we can improve our commercial effectiveness through organizational enhancements, innovative and capital-efficient go-to-market approaches and strategic partnerships. In addition, I believe there are further operating model improvements and cost reduction opportunities through the organization that we will be addressing in the coming quarters. Next, I'm pleased to share that on July 31, we closed the sale of our hyaluronic acid product line of business. While we are not disclosing the financial terms, we are very pleased with this divestiture, which represents a meaningful step in advancing our transformation strategy and reinforcing our commitment to focused growth in our two strategic segments, Specialty Nutrition Systems and Pain Management and Recovery. Now, turning to our second quarter results. For the quarter, we achieved net sales of $175 million adjusted for the effects of foreign exchange and the impact of our strategic decision to withdraw from revenue streams that did not meet the return criteria specified by our portfolio transformation priority. Organic sales were up 2% compared to a year ago. Additionally, we generated $0.17 of adjusted diluted earnings per share and $17 million of adjusted EBITDA with adjusted gross margins of 55.7% and SG&A as a percentage of revenue of 45.2%. Finally, due to downward pressure on our market capitalization, we assessed goodwill for impairment during the second quarter and recorded a noncash impairment charge of $77 million in the Pain Management and Recovery reporting unit. Our overall execution this quarter was solid and the steady progress we made against each of our transformation priorities provides confidence in our ability to achieve the ranges of our 2025 financial guidance. With that, let me turn the call over to Jason, who will further discuss our second quarter financial results as well as our 2025 outlook.

Jason M. Pickett, Interim CFO

Thanks, Dave. I'll spend the next few minutes discussing our second quarter results at the segment level. Our Specialty Nutrition Systems portfolio continues to deliver above-market results, growing 5% organically versus prior year, reaffirming our #1 position in long-term, short-term and neonatal enteral feeding. Demand for our long-term enteral feeding products remain strong, and our underlying growth continues to beat market levels. However, as anticipated and shared during our first quarter earnings call, our second quarter performance was tempered by the timing of distributor orders captured in our first quarter results resulting from our go-direct transition in the United Kingdom. Our short-term enteral feeding portfolio posted another quarter of double-digit growth globally during the second quarter. These results were fueled by the continued expansion of our U.S. CORTRAK standard of care offering, inclusive of our newly launched CORGRIP tube retention system designed to reduce the risk of tube migration and dislodgement. Finally, our neonatal solutions business delivered another excellent quarter, growing greater than 12% compared to the prior year. As we had previously signaled, we anticipate lower but still above-market growth for our NeoMed product line over the next few quarters as we enter the late stages of the ENFit adoption cycle in North America. From a profitability standpoint, operating profit for our Specialty Nutrition Systems segment for the second quarter was nearly 18%, reflecting the impact of tariffs and transient unfavorable cost absorption. We believe the dynamics we have just discussed provide a foundation for us to deliver mid-single-digit organic revenue growth for our Specialty Nutrition Systems portfolio in 2025, driven by core commercial execution, new product innovations and further global market expansion opportunities. Now turning to our Pain Management and Recovery portfolio. Normalized organic sales for this quarter were up 3.4%, excluding the impact of foreign exchange and our previously announced strategic decision to withdraw from certain low-growth, low-margin products. Our radiofrequency ablation, or RFA business continues to deliver excellent results, posting near 14% growth this quarter compared to the previous year. We are experiencing sustained growth in our RFA generator capital sales, which enables us to capture higher procedure volumes, especially within our ESENTEC and TRIDENT product lines. We credit our renewed ASC strategy and the increasing productivity of our fully deployed new sales structure in supporting these outcomes. Additionally, we are encouraged by the progress of our COOLIEF offering internationally, leveraging reimbursement tailwinds in several geographies, including the United Kingdom and Japan. Our Surgical Pain business was down compared to prior year, but generally in line with our expectations. While the implementation of the reimbursement decision afforded by the NOPAIN Act is taking longer than anticipated, and we are devoting more effort to understanding and addressing coverage denials, the NOPAIN Act provides hospitals and caregivers with improved options to administer non-opioid postsurgical pain relief. We are excited to support better patient care through our ON-Q and ambIT product line offerings. Finally, our Game Ready portfolio posted slightly lower revenues than a year ago. We are working to enhance our go-to-market model, primarily in North America to improve performance and expand profitability within our portfolio. Operating profit for our Pain Management and Recovery segment, excluding the noncash goodwill impairment charge previously mentioned, grew nearly $2 million from a year ago during the second quarter, demonstrating our recent top line and cost management execution. Although we had some mixed results across our Pain Management and Recovery segment during the second quarter, we are encouraged by the continued progress we saw, particularly within our RFA product line, which continues to make solid organic gains. Finally, our hyaluronic acid injections and intravenous infusion product lines reported in Corporate and Other declined over 20% during the second quarter, primarily due to continued pricing pressure on our 3- and 5-shot HA categories. As Dave mentioned a few minutes ago, we divested the HA business at the end of July. Moving to our financial position and liquidity. Our balance sheet remains strong and continues to provide us with strategic flexibility with $90 million of cash on hand and $105 million of debt outstanding as of June 30. We have maintained leverage levels meaningfully below 1 turn for several quarters and will continue to be good stewards of our balance sheet. Free cash flow for the quarter was negative approximately $4 million, driven by the timing of tax payments as well as higher capital expenditures supporting our supply chain initiatives. We anticipate generating approximately $40 million of free cash flow for the year, including the impact of tariffs, which I'll address in a few minutes. From a capital allocation standpoint, and as we have previously shared, we have closed on two smaller transactions that support our Specialty Nutrition System strategy, and we are actively pursuing acquisitions that align with our returns criteria. Now turning to our 2025 outlook. Given our robust first and second quarter sales performance, along with favorable currency positions, we are reaffirming our full year revenue estimate of $665 million to $685 million, inclusive of the impact of our hyaluronic acid divestiture. We remain confident in our Specialty Nutrition Systems segment's strength for the duration of the year and continued market share gains in our RFA segment. Now regarding tariffs. While the environment remains volatile and fluid, we still estimate approximately $15 million in incremental tariff-related manufacturing costs for the year, primarily related to products with country of origin from Mexico and China, consistent with our initial estimate. As a reminder, in the first quarter, we incurred $1.5 million of tariffs, which were capitalized into inventory and amortized in the second quarter through cost of goods sold. For the second quarter, we incurred over $8 million of tariffs, which we will be expensing in the third quarter. The second quarter tariffs were negatively impacted by increased China origin goods shipments with some incurring the 145% tariff rate prior to the U.S. administration reducing the China origin tariffs to 30%. Our team continues to implement a range of strategies focused on tariff mitigation actions, including internal cost containment, pricing actions where appropriate, leveraging previously issued temporary tariff exemptions for portions of our portfolio and lobbying efforts with AdvaMed and other third parties that have interactions with the administration. Lastly, we have accelerated supply chain investments and are targeting a complete exit from China-sourced NeoMed products by the second half of 2026. As we noted in our first quarter earnings call, we entered 2025 with challenging market conditions for some of our product categories, currency headwinds and other global macroeconomic factors like tariffs. Despite these challenges, currency conditions have improved, our strategic segment growth is healthy, and our cost management discipline remains strong. We still face uncertainty on the full impact of tariffs on our profitability and free cash flow, but we are pleased with our commercial progress thus far this year. As a result, the company is maintaining its 2025 adjusted earnings per share estimate range of $0.75 to $0.95, inclusive of the impact of our hyaluronic asset divestiture.

Daniel Walker Stauder, Analyst

Congrats on the great quarter. And Scott, congratulations on the new role. First one, just on the 2025 guidance. You reaffirmed full year on the sales line, and that's inclusive of the HA divestiture. So that's impressive and great to see. But I was hoping you could just give us some more high-level color on what you had previously assumed for HA in the second half of '25 and what that implies for S&S and Pain Management as we model out the back half of the year?

Scott Galovan, CFO

Sure, thanks, Danny. We are happy to confirm our outlook for the year, considering the effect of HA. We will not recognize revenue for five months in that area due to the sale. We are satisfied with the performance of SNS and PM&R, which have continued to do well. While we aren't revealing the exact impact of the lost HA revenue, we are confident in reaffirming our guidance for both the top line and bottom line.

Jason M. Pickett, Interim CFO

Yes. Danny, I also add, currency headwinds are not as material as we'd anticipated. So that's been a great answer that allows us to follow up with that growth in the strategic segments that we have.

Daniel Walker Stauder, Analyst

Okay. Great. Appreciate that. And then I guess a little bit more specific on the RF ablation business, really strong quarter. You touched on some of the dynamics there, but would still love some more color on what's driving growth there? And how sustainable do you feel this is in the second half of '25 and into '26. Just anything you're seeing? Any more color would be great.

David C. Pacitti, CEO

Yes, this is Dave. I've had the opportunity to be with the team and attend several pain conferences, which has given me a better understanding of the market. During my time with physicians, customers, and our field team, I've noticed that many customers perceive us as a dedicated RF solution company. While there are competitors with a wider range of pain offerings, our focus is specifically on RF ablation. We offer a complementary 3-tiered solution that aligns well with what physicians need from our portfolio. Our long-standing commitment to this space, combined with our recent 3-tiered offering, has created significant momentum in RF ablation, which we expect to continue. I am confident in our team's performance and the progress we are making, and I feel optimistic heading into next year. Since we are dedicated to this area, it has become clear that we are viewed as the RF company, reflecting what I've gathered from my field experience. Overall, our 3-tier solution is quite strong.

Jason M. Pickett, Interim CFO

Yes. From a numbers perspective, we experienced 13.8% growth quarter-over-quarter for the RFA. Our increase in generator sales has been a significant factor, leading to substantial pull-through. When we sell a generator, we are also selling the higher-priced margin probes that we offer. This trend is not only applicable to new sales but also to existing customers who retain their generators and continue purchasing from us. This success can be attributed to our sales team, which effectively services customers and differentiates our products from competitors.

Daniel Walker Stauder, Analyst

Great. I have one last question regarding the HA divestiture. How should we consider its impact on the income statement over the long term, particularly concerning the gross and operating margins? We appreciate that you've reaffirmed the bottom line guidance and understand there are various factors influencing the remainder of 2025. However, as we look further ahead, what do you anticipate the margin levels to be without HA? Do you think it will remain relatively neutral, considering some of the initiatives you have in place?

Jason M. Pickett, Interim CFO

Yes. What I would say, Daniel, is when we looked at what was coming in the back half of the year, as we've mentioned to you that we were running the business more from a cash perspective. So we were trying to maintain the revenue. We were potentially lowering our sales prices to make the business work. So ultimately, when we look at the financials for the rest of the year, not a material impact on the bottom line when it comes to the HA divestiture. We're able to make up anything that we are losing there or on the revenue side with our strong strategic performance in those segments. So HA, not a material number that we're seeing all the way down to the bottom line.

Scott Galovan, CFO

Yes. The challenge in that business was not volumes. It was more price. And so obviously, from a profitability perspective, as we continue to see pressure on margins in HA, the impact there going forward from just EPS and EBITDA perspective is limited.

Operator, Operator

And we now have our question. This comes from Dan Stauder from Citizens JMP.

David C. Pacitti, CEO

Yes. Thanks, everyone. Thanks for the questions today. In closing, I'm really proud of the progress Avanos has made in transforming our business as demonstrated by our hyaluronic acid divestiture. I'm generally pleased with our bright future, driven by the dedication of our teams and the vital role our products really play with our customers, which is great to see and really getting back to patients and back to things that matter. So we appreciate your continued interest in Avanos, and thanks again for the questions.

Operator, Operator

Thank you. This concludes our conference call for today. Thank you all for participating. You may now disconnect.