Earnings Call Transcript - AVNS Q2 2024

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the Avanos Medical Q2 2024 Earnings Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. This call is being recorded on Wednesday, July 31, 2024. I would now like to turn the conference over to Scott Galovan, Senior Vice President, Strategy and Corporate Development. Please go ahead.

Scott Galovan, Senior Vice President, Strategy and Corporate Development

Good morning, everyone, and thanks for joining us. It's my pleasure to welcome you to Avanos 2024 second quarter earnings conference call. Presenting today will be Joe Woody, CEO; and Michael Greiner, Senior Vice President, CFO, and Chief Transformation Officer. Joe will review our second quarter results and current business environment, as well as provide an update on our transformation efforts. Michael will share additional details 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'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, Scott. Good morning, everyone, and thank you for joining us to review our operational and financial results for the second quarter 2024. Building off our first quarter results, we delivered a strong second quarter as Digestive Health continued its solid performance, and we experienced additional positive shifts in our Pain Management and Recovery business. As we noted in our prior earnings calls this year, our quarterly performance for 2024 will improve as the year progresses. The demand for our products remains strong and our supply chain organization is executing effectively to support our commercial strategy, eliminating the significant above-normal backlog we experienced in the past 18 months. We are continuing to make steady progress against each of our transformation priorities, which both Michael and I will discuss further, 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 $172 million, adjusted for the effects of foreign exchange and the impact of our strategic decision to discontinue revenue streams that did not meet the return criteria specified by our portfolio transformation priority. Organic sales were up 2.6% compared to a year ago. We generated $0.34 of adjusted diluted earnings per share and approximately $27 million of adjusted EBITDA from continuing operations. Our three-year transformation priorities continue to drive our execution, and our second quarter results provided further evidence that we can deliver 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, growing almost 9% organically versus prior year, reaffirming our number one position in long-term, short-term, and neonate feeding. 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 currently are experiencing solid double-digit growth for the NeoMed product line and as we have previously signaled, we anticipate lower but still above-market growth over the next few quarters as we enter the late stages of the infant adoption. Our legacy enteral feeding business also posted a strong quarter, growing high single digits compared to the previous year. As noted during our last call, we anticipate continued above-market growth for our Digestive Health portfolio this year supported by innovations we have launched this quarter and are planning to launch during the back half of the year, expansion into additional global markets with attractive growth prospects, the completion of low-growth product rationalization, and actionable M&A opportunities. Now, turning to our Pain Management and Recovery portfolio, normalized organic sales for this quarter were up approximately 2%, excluding HA and inorganic sales related to our Diros acquisition. While our overall Surgical Pain portfolio was down less than one point year-over-year, we were pleased with the performance of our combined On-Q/ambIT portfolio, which grew by mid single digits for the same period, a testament to the renewed focus in this portfolio and our enhanced go-to-market strategy for On-Q and ambIT. Even without the positive impact of Diros revenue, our IVP business returned to growth this quarter with our combined Radio Frequency Ablation portfolio growing by mid single digits compared to the previous year. We are encouraged by the continued momentum seen in our IVP generator sales, accompanied by capturing higher procedural volumes. We credit our renewed ASC strategy and the increasing productivity of our fully deployed new sales structure in supporting these outcomes. Further supporting our ASC strategy, our new Trident product line acquired in the Diros transaction continues to deliver, meeting our internal growth expectations. We are capitalizing on our successful US market launch with over 100 accounts having converted to our Trident technology. Our Game Ready portfolio is also demonstrating strong momentum, posting a second consecutive double-digit growth quarter compared to the prior year. We anticipate a slightly lower growth profile from Game Ready in the back half of the year, especially given the particularly strong fourth quarter we had in 2023. Finally, our HA portfolio, while down more than 30% year-over-year, was flat and sequentially consistent with our prior two-quarter results. This leveling off of revenue in our HA portfolio was anticipated and aligns with our previously forecasted 20% decrease in HA revenue for the full year. We remain confident in our ability to maintain this level of performance as we execute on mid to longer-term strategies to gain share in the three and five shot HA categories as price stabilizes. We are encouraged by the progress and momentum we are seeing across each of the Pain businesses and 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 four key priorities for the next two years that are expected to improve our go-to-market opportunities and meaningfully enhance our financial profile. These priorities are: strategically and commercially optimizing our organization; transforming our product portfolio to focus on categories where we have attractive margin profiles and the right to win; taking additional cost management measures to enhance operating profitability; and continuing our path of efficient capital allocation to meaningfully improve our ROIC. We continue to make substantial progress against our transformation priorities. Second quarter highlights include: continued progress across our Pain portfolio; strong execution with our new Trident product line; finalizing certain of the separation efforts associated with the divestiture of our Respiratory Health business; further execution related to our company-wide cost management programs; continuing towards full optimization of our manufacturing and office footprint; and maintaining M&A discipline and a conservative leverage level of less than 1 times. Our second quarter results are a testament to the continued progress against each of our transformation priorities and we remain 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 insights on our financial results and transformation platform.

Michael Greiner, Senior Vice President, CFO, and Chief Transformation Officer

Thanks, Joe. As you shared, our second quarter results showed continued progress against our transformation priorities and further 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 this quarter. Excluding the results from our HA business, our Pain Management and Recovery portfolio experienced low single-digit growth overall. In comparison to the previous year, our Game Ready portfolio saw double-digit growth, demonstrating continued momentum in this category. Separately, our Pump business, including our On-Q and ambIT products, grew by mid single digits while our IVP products were up by low single digits. From a continuing operations standpoint, net sales were $171.7 million, adjusted EBITDA was $26.8 million, and adjusted diluted earnings per share was $0.34 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 2.6% compared to a year ago, our adjusted EBITDA grew by 17% compared to a year ago, with adjusted EBITDA margin expansion of 210 basis points, and our adjusted diluted earnings per share improved by 42% compared to a year ago. This margin expansion was positively impacted by top-line growth, effective manufacturing and operations execution, and continued SG&A optimization efforts. For the quarter, our adjusted gross margin was 59.6%, which is comparable to the prior quarter and last year. We were able to offset inflation in HA price volatility through our transformation initiatives at the plant and operations level to achieve these results. We expect adjusted gross margin to be approximately 60% next quarter as well. SG&A as a percentage of revenue was 43%, marking an improvement of 210 basis points compared to the second quarter of last year and 280 basis points sequentially. This improvement is primarily due to our cost savings efforts to streamline our organization and reduce external spending. As you know, this is part of our ongoing journey to further enhance our financial profile with continued improvements expected throughout 2024 and into 2025. Our performance in the second 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 margins 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 $92 million of cash on hand and $175 million of debt outstanding as of June 30. We have maintained leverage levels meaningfully below one turn over the past 10 quarters and will continue to be good stewards of our balance sheet. As we have previously shared, we continue to actively pursue strategic M&A opportunities that align with our returns criteria, and will also deploy capital for opportunistic share repurchases. Finally, free cash flow was positive $22 million in the second quarter, of which approximately $15 million related to a tax refund for which we had previously recorded a tax receivable. This was an improvement of almost $29 million compared to a year ago. We anticipate continued improvement in our free cash flow profile in the second half of the year, but now anticipate that we will generate approximately $70 million of free cash flow for 2024 due to higher one-time charges and inventory than previously anticipated. The second year of this transformation journey is crucial for achieving the 2025 financial objectives we outlined on Investor Day. These 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% and 39%, and free cash flow generation of approximately $100 million in 2025, supported by these operational financial metrics, consistent CapEx spend, and meaningful improvement in working capital.

Operator, Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. The first question comes from Kristen Stewart with CL King. Please go ahead.

Kristen Stewart, Analyst

Hi, thanks for taking my question. I was wondering if we could just focus a little bit on the Pain Management side of the business. It seems to be showing some nice green shoots there. Just in terms of HA and how that's been progressing, it sounds like that's in line with your expectations. Just want to double-check that. And what do you see as a longer-term kind of growth outlook for the Pain Management business overall as we look out beyond this year?

Joe Woody, CEO

Thanks for your question, Kristen. It's Joe Woody. I believe mid single-digit growth at the global level for the Pain business is achievable as we approach 2025. We've observed some positive trends. The Surgical Pain segment experienced mid single-digit growth with ambIT and On-Q, although the IV infusion business has constrained that growth a bit. However, we saw positive growth in the IVP sector, which indicates strong momentum. Game Ready has demonstrated two quarters of double-digit growth, and we are optimistic about the second half, anticipating improvements in these areas. While growth has been somewhat variable, we generally expect double-digit volume growth each quarter. We've expanded our team and anticipate ending the year with a low single-digit growth rate and a robust gross margin. This aligns with our strategic goals, and we are making significant progress. Looking ahead, we expect to maintain a mid single-digit growth trajectory in the long term.

Michael Greiner, Senior Vice President, CFO, and Chief Transformation Officer

And Kristen, just one final thing, we were down 30% in Q2. We'll be down generally in that range in Q3 for HA. And then, in Q4, we did about $11 million last year. We anticipate doing around $11 million this year in Q4. To Joe's point, that would make it kind of flattish, but that would have five consecutive quarters, starting with the $11 million in Q4 last year, through all four quarters of this year, should we execute against what I just laid out of somewhere between $10.5 million and $11 million per quarter. And that'll level us off in this kind of $42 million annualized level, which, to Joe's point, going forward, we think we can start growing that low single-digits as price stabilizes. And we are seeing that with the pricing structures.

Kristen Stewart, Analyst

Perfect. And then, CMS had come out with a proposal to break out reimbursement for On-Q. I was wondering if you could just provide some thoughts there on what you think that could do for the business.

Joe Woody, CEO

We have been working on this for about four years, focusing on the On-Q product. Regarding the outpatient perspective payment, we received a unique code for On-Q, which allows us to comment on the payment until September 9 of this year. By January 1, we will have a clearer understanding of our payment situation. I believe there is potential to restore this business to its peak levels over the long term, which is important for us. While it may not be significant for a larger medtech company, it's a positive development for us. It is still early to predict the immediate effects and adoption rates, but having reimbursement in place, as opposed to relying solely on a hospital's DRG, should ultimately benefit the business.

Kristen Stewart, Analyst

Okay. Thank you for taking the questions.

Operator, Operator

Your next question comes from Rick Wise with Stifel. Please go ahead.

Rick Wise, Analyst

Good morning, Joe. Hi, Michael. To begin, could you share your thoughts on Digestive Health and NeoMed? As you mentioned, NeoMed has shown impressive double-digit growth in recent quarters, even as it approaches the later stages of ENFit conversion. Can you remind us how much ENFit conversion is still ahead? When do you expect it to decrease? Additionally, could you discuss the upcoming Digestive Health product launches? As we look towards 2025, do you believe we can maintain the mid to high single-digit growth trajectory that we've experienced, given that NeoMed's conversion has been so successful?

Joe Woody, CEO

Yes, NeoMed can maintain double-digit growth throughout this year and into early 2025. We do not anticipate a significant decline. Instead, we expect it to grow at a high single-digit rate for the foreseeable future, which is a positive for the business. This year, we are converting around 100 accounts, and we expect something similar, possibly slightly fewer, next year. Our international business also saw an 11% growth this quarter, primarily driven by legacy DH, which continues to expand. We view it as a mid to high single-digit growth business in the long term, with potential enhancements from upcoming launches and planned bolt-on acquisitions. Therefore, we expect sustained mid to high single-digit growth over the long term in any given quarter.

Michael Greiner, Senior Vice President, CFO, and Chief Transformation Officer

We are preparing for both CORTRAK and CORGRIP launches in the short to midterm. This will help provide additional support for the mid to high single-digit growth in the legacy business.

Rick Wise, Analyst

Got you. And, Joe, you mentioned again the M&A pipeline in so many words. A couple of things here. You both highlighted your financial discipline around M&A. What's that mean? How do we understand that? Does that mean prices continue to be too high or you're just not finding the right fits? So, just a couple of questions tucked in here. But speaking of tuck-in, is there an opportunity still later this year for tuck-in M&A? Is it likely to be in Digestive Health? And I might be wrong, but is this the first time I'm hearing you even lightly touch on the possibility of share buyback, or is that just a theoretical notion and you're prioritizing M&A? Thank you.

Joe Woody, CEO

Yeah. Just on share buyback real quick, we've done $25 million, but we've not announced any new share buyback program.

Michael Greiner, Senior Vice President, CFO, and Chief Transformation Officer

Rick, so, we've done $85 million. We mentioned it over the last year and a half. We've done $85 million over the last year and a half.

Rick Wise, Analyst

Right. But again, I'm saying, Michael, sort of...

Michael Greiner, Senior Vice President, CFO, and Chief Transformation Officer

Yeah, so we're always looking to see if we have opportunistic capital to deploy for share repurchases. We currently are done with all of our authorizations, so we'd have to go back to the Board and get a new authorization at this point in time.

Joe Woody, CEO

And then to pick up on these other issues, Rick, yeah, it's possible that we do a bolt-on, and we're working on a number of them. You can never predict the timing. It's not been really about for us this year. A couple that we've taken a pass on in terms of price, it's been more of when we get into the diligence and look at the technology. And there's some complications there for us that would cause us to pull back, but you could see something from us. And we've been in this environment a little bit cautious with the balance sheet, the less than one times leveraged, but it's paid off to do that, I think to be conservative, but we do have a robust pipeline still and it would be more Digestive Health oriented.

Rick Wise, Analyst

Thank you so much.

Operator, Operator

Your next question comes from Daniel Stauder with Citizens JMP. Please go ahead.

Daniel Stauder, Analyst

Great. Thank you. So, just first one on Pain Management. Game Ready is up double-digit again, which is great to see, but could you just give a little bit more color on what is driving this growth? Then, you noted it should ease in the back half of the year. First, what does that imply on a full-year basis? And why do you expect the growth rate to come in a little bit? Is this just a factor of prior year comps, or is it something related to trends you're seeing? Thanks.

Joe Woody, CEO

Daniel, thanks for the question. I think you have a little bit of everything, but what I would say is we're getting a good benefit from the international business and adoption at the international level and a little bit like the DH business. I see Game Ready as a high single-digit, consistent, but sometimes a double-digit in a given quarter type of growth. And we're doing a number of things with looking at our rental program changing and adding the structure to our selling organization. So, you're seeing some of the benefit from that. And yes, there's some comparator issue, but over the longer term, high single-digit to a double-digit depending on a given quarter.

Daniel Stauder, Analyst

Great. And then, just staying with Pain Management, but turning to COOLIEF. You noted RF grew mid single digits and I believe that was excluding Diros. But could you just talk about some of the updates as far as what you're seeing within cross-selling or cross-channel benefits as you've rolled out the new product? Thanks.

Joe Woody, CEO

We are observing significant strength in Diros within the IVP segment, and we will discuss this further in the next quarter. The Standard RF line has performed well this year due to the transition to ambulatory surgical centers. COOLIEF is starting to recover as the supply chain issues are resolving, and we are addressing the initial disappointment it caused for our customers. Our new selling structure is gaining traction each quarter, and we have achieved record sales of generators. This indicates that the long-term prospects for COOLIEF are positive, particularly since three out of four generators sold are for COOLIEF, which typically requires 90 to 120 days to become operational. Therefore, you can expect to see improvements across the board. We have also indicated that the business can consistently yield mid to high single-digit growth over the long term. However, one factor affecting the IVP business is the recent discontinuation of several products in the NKT area, which includes supplies like needles, kits, and trays—these are very commoditized, but we are navigating through this challenge as well. Consequently, as we prepare our numbers for the second half, you will definitely see a sequential increase.

Daniel Stauder, Analyst

Great. Thank you very much.

Operator, Operator

And there are no further questions at this time. I would now like to turn the call back over to Mr. Joe Woody for closing remarks.

Joe Woody, CEO

Just want to thank everybody. Obviously, our focus is on the precise execution of the transformation plan. We've successfully executed these product exits, divested Respiratory Health, and acquired valuable technology with Diros, increasing our shareholdings and a repurchase program, and made a lot of progress that we're sharing with you today. We believe the results have established a foundation to meet our mid-term financial commitments. With our transformation priorities, market-leading portfolio, and our attractive markets, we think we're well-positioned for '25. So, we thank you for your interest in Avanos and look forward to talking to you all more. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.