Earnings Call Transcript - AVNS Q4 2023

Operator, Operator

Good day and welcome to the Avanos Fourth Quarter and Full Year 2023 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note today’s event is being recorded. I'd 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 Autodesk's 2023 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 fourth quarter and full year results, the current business environment, as well as provide an update on our transformation efforts. Michael will share additional details regarding these topics and our 2024 planning assumptions, we'll finish the call with Q&A. The 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 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 Scott. Good morning, everyone and thank you for joining us to review our operational and financial results for the fourth quarter and full year 2023. Net sales for the fourth quarter were $173.3 million impacted by the company's hyaluronic acid pain relief injection products as a result of continued pricing pressure due to the Medicare reimbursement changes and lower than anticipated sales across the company's North America digestive health products due to a major distributor's ordering pattern change. Net sales negatively impacted our margin profile. However, we were able to mitigate some of these top line challenges through our transformation initiatives and deliver $1.03 of adjusted EPS with adjusted gross margins of 59.1% and SG&A as a percentage of revenue of 43.3% for the full year. For the fourth quarter, we delivered adjusted gross margins of 58.6% and SG&A as a percentage of revenue of 38.9%. Separately, we remained focused on reducing our backorder and ended the year with less than $2 million back order. We have continued to reduce this through our first two months of 2024. This is a significant improvement over last year's back order loans of over $10 million serving as tangible proof that our supply chain organization is executing effectively on its transformation initiatives. As we have consistently communicated since I first presented our transformation plan at the January 2023 JPMorgan Conference, 2023 would be a bit uneven given the transformation priorities, the realignment of our commercial organization, M&A execution, and our other portfolio optimization activities. But we are continuing to make steady progress against each of our transformation priorities. Our primary focus is on getting patients back to the things that matter as we meet the needs of our customers. Our sales from continuing operations during the quarter were approximately $173 million, adjusted for the effects of foreign exchange and the impact of our strategic decision to discontinue revenue streams that did not meet return criteria specified by our portfolio transformation priority. Organic sales were down 4.5% compared to a year ago. For the quarter, we generated $0.36 of adjusted diluted earnings per share and about $32 million of adjusted EBITDA from continuing operations. For the year, our sales from continuing operations were above $673 million, adjusted for the effects of foreign exchange and as I mentioned, above the impact of our earlier strategic decision to discontinue revenue streams that did not meet our return criteria. Organic sales were down 0.3% compared to a year ago. We delivered adjusted diluted earnings per share of $1.03 and adjusted EBITDA of $99 million. Although we are disappointed with our fourth quarter sales results, we were pleased with our overall execution which was driven throughout the year by our three-year transformation priorities. This performance gives us confidence in our ability to be within the range 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. As we mentioned during our third-quarter earnings call, we anticipated that our digestive health business would have a tough comparison in the fourth quarter given the release of backorder products in the fourth quarter of last year. Additionally, we experienced distributor inventory rebalancing in the fourth quarter. As a result, our digestive health portfolio grew 3% in the fourth quarter on a constant currency basis below our full year trending. Our core portfolio continues to overperform globally growing double digits compared to the previous year, driven by the sustained expansion of our US contract standard of care offering. Separately, our new unit product line delivered another robust quarter growing mid-single digits sequentially but faced a tough comparison as the previous year benefited from the node back order relief and was flat year over year. Despite lower than anticipated sales in our fourth quarter, we are extremely pleased with the full year performance of our digestive health portfolio, growing double digits globally, excluding the slight negative impact of currency. We continue to anticipate mid to high single-digit growth organically for our digestive health portfolio and our ability to deliver above-market growth will be supported by innovations we plan to launch during the back half of the year, expansion into additional global markets with attractive growth prospects, and low growth product rationalization. Now, turning to our pain management and recovery portfolio. Sales for this quarter were down approximately 12% excluding the benefit of DRS-related sales, the impact of foreign exchange and our previously announced strategic decision to discontinue certain low growth, low-margin products. As previously communicated, our HA portfolio was the main contributor to the decline, primarily as a result of continued pricing pressure due to Medicare reimbursement changes. We anticipated and communicated near-term volatility along with the sequential and year-over-year quarterly declines. However, the impact in the fourth quarter was greater than anticipated. That being said we believe we have the right strategies in place to capitalize on our HA growth opportunities over the long term, some benefits of which will be seen in the current year, meaningfully slowing the pace of decline in that portfolio. Our overall surgical pain business was flat sequentially with our combined ON-Q and IT portfolio growing 13% versus the third quarter. These are early signs that our new go-to-market strategy and structure for this part of the portfolio supports our low single-digit growth expectations for 2024. Similarly, our IVP portfolio showed sequential gains posting 10% growth versus the third quarter, excluding the positive impact of Diros revenue as supply constraints alleviated in the latter part of the fourth quarter. We are encouraged by the double-digit growth seen in IVP generator sales in the U.S. this quarter versus the prior year, driven by our renewed ambulatory surgical center strategy and fully deployed sales structure. Our Game Ready portfolio performed very strongly in North America achieving double-digit growth compared to the prior year boosted by capital sales. The favorable performance in North America was offset by a decline in international sales due to transient registration delays. Finally, our newly acquired Trident product line has produced results in line with our expectations. Upside opportunities were limited in the fourth quarter as we scaled up manufacturing capacity in our Toronto facility to support our growth objectives including capitalizing on our U.S. market launch which kicked off in November of last year. For the full year sales of our pain management and recovery portfolio were down approximately 11%, excluding the benefit of Diros revenue, the impact of foreign exchange and our previously announced decision to discontinue certain low growth, low-margin products. As previously shared, this decrease was primarily driven by our HA portfolio down almost 35% year-over-year. While we are disappointed by the decline in performance in our pain management recovery portfolio in 2023, we are encouraged by the progress we saw in the second half of the year. In particular, the organic sequential improvement in our fourth quarter reinforces our expectation of mid-single-digit growth for 2024. Again this expectation excludes HA, which we anticipate decreasing approximately 20% in 2024 versus 2023. 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 will optimize our go-to-market opportunities and meaningfully enhance our financial profile. These priorities are strategically and commercially optimizing our organization, transforming our portfolio to focus on categories where we have attractive margin profiles and the right to win, taking additional cost management measures to enhance operating profitability, and continuing our path of efficient capital allocation to meaningfully improve our ROIC. As you can see, we've made substantial progress against our transformation priorities. We're particularly excited by our commercial optimization and portfolio transformation accomplishments, which I'll review now. Later in the call, Michael will discuss the other transformation priorities, he is leading in his role as Chief Transformation Officer. In 2023, notably, we made significant leadership and go-to-market changes to improve our commercial effectiveness, executed the acquisition of Diros Technologies, as well as the divestiture of our Respiratory Health business, exited low-margin, low-growth product categories, and delivered double-digit growth across our DH portfolio. While we've seen improvements in our pain business that accelerated between the third and fourth quarter, we remain about two quarters behind our original sales expectations. This two-quarter delay is due to the pain commercial reset necessary to address the breadth of strategy structure and talent changes in the pain business. Although it is taking longer, supply chain challenges impacting product availability slowed the ability of our commercial teams to execute on the new go-to-market strategies. The sequential sales improvements I just referenced give us confidence in our strategies as we move forward into 2024 and include the following. Our Surgical Pain business has reversed several years of decline to flattish results in the back half of this year, supporting low single-digit growth in 2024. Our US Trident RF launch exceeded our expectations and we were able to maintain double-digit growth in our OUS markets. Our Game Ready business returned to growth due to renewed focus on capital sales and international expansion. We're seeing tailwinds from COOLIEF reimbursement OUS, including the UK and Japan. We've addressed most of our supply and quality issues which has given confidence to our commercial team. We've established programs to help stabilize the HA business in the second half of 2024. While 2023 was a year of transition and transformation we believe we established a foundation that will yield dividends in 2024 for our pain management and recovery business to gradually return to sustainable mid-single-digit growth over the mid to long-term. Now I'll turn the call over to Michael who will provide further insights into our fourth quarter and full year financial results.

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

Thanks, Joe. From a continuing operations standpoint for the fourth quarter and full year, net sales were $173.3 million and $673.3 million, while adjusted gross margin was 58.6% and 59.1%, respectively. We generated $0.36 of adjusted diluted earnings per share during the quarter and $1.03 for the year. Adjusted EBITDA in the fourth quarter was $32 million and $99 million for the year. For the year, we generated $15 million of actual free cash flow which included onetime cash outflows of $10 million to settle an outstanding litigation during the fourth quarter and approximately $33 million of restructuring expenses related to our transformation efforts as well as our RH divestiture. As I just noted adjusted gross margin for the quarter was 58.6% which is slightly favorable compared to the third quarter. We previously expected gross margin above 60% in the fourth quarter. However, with the nearly $4 million underperformance in our HA business combined with the lower sales in our North America pain management and recovery business, our mix unfavorably impacted our fourth quarter gross margin. In the fourth quarter SG&A as a percentage of revenue stood at 38.9% reflecting a sequential improvement of 270 basis points and marking the fourth consecutive quarter of disciplined spending. As you know this is part of our ongoing journey to further enhance our financial profile with continued improvements in 2024 ultimately leading to our 2025 goal of between 38% to 39%. These improvements are driven by reduced headcount, third-party cost savings, and business process optimization to name a few. Overall, for the year adjusted EBITDA margin improved to 14.7% compared to 13.3% in 2022 and a 140 basis point increase year-over-year. Now turning to our financial position and liquidity. Our balance sheet remains strong and continues to provide us with strategic flexibility with $88 million of cash on hand and $168 million of debt outstanding as of December 31. We have maintained bank debt leverage levels of one time or less over the past eight quarters and will continue to be good stewards of our balance sheet. As we have noted in the past, we will look to deploy capital against both strategic M&A that meets our returns criteria as well as opportunistic share repurchases. We repurchased a total of $15 million worth of shares during the second half of 2023 leaving us $10 million of buying power for additional shares that can be repurchased under the current Board authorization. Finally, from a free cash flow perspective going forward we anticipate approximately $20 million of capital expenditures annually, while seeing meaningful improvement in working capital primarily through inventory reduction in both 2024 and 2025. As Joe noted earlier, we made meaningful progress in 2023 against our transformation priorities including product portfolio rationalization, the divestiture of our Respiratory Health business, the acquisition of Diros, repurchasing of shares, organizational changes, and meaningful cost management initiatives. As a result of these, we established a solid financial framework to build towards our 2025 goals, which I will touch on again in a few minutes. But first, let me highlight our 2024 planning expectations. As already announced, we expect 2024 revenue in the range of $685 million to $705 million in line with our target of mid-single-digit organic growth. Separately, we expect our adjusted gross margin to range between 59.5% and 60.5%. And our SG&A as a percentage of revenue to be between 41% and 42% for 2024. Those 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. As I mentioned earlier, we are excited about our transformation journey and I'm confident we will improve on each of these metrics as the year progresses. With the first quarter starting off slow and accelerating in the back half of the year similar pacing to what we have experienced in 2023. With regards to specific execution of our 2024 transformation priorities, we are maintaining a sharp focus on our digestive health and pain management and recovery business strategies as Joe just described, executing on additional business process efficiency and cost management initiatives. We will seek opportunities to allocate capital that enhance our overall return on invested capital. Year two of this transformation journey is critical to ensure that we can deliver on the 2025 financial metrics we outlined on Investor Day, which included consistent mid-single-digit growth that will take our organic revenue to approximately $750 million in 2025. Overall margin expansion of between 400 and 500 basis points supported by gross margins surpassing 60% and 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. We still anticipate consistent mid-single-digit organic growth for 2024 and 2025, albeit this growth rate will be off a lower base due to the decreased sales in our ag business that we have already discussed. That being said, we remain confident in our ability to achieve the other components of a 2025 financial profile as a result of the progress we are making against our overall transformation priorities.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Today’s first question comes from Daniel Stauder with JMP. Please go ahead.

Daniel Stauder, Analyst

Yes, great thanks. First question for me. You've commented that M&A is still a very important pillar but just wanted to ask with the recent updates you gave earlier this year as well as in this call, do you feel you have to wait a little bit for some stabilization before committing to acquisitions? I know you commented that share repurchases will also be a big part. Just any thoughts on how you're looking at M&A in 2024. That would be great. Thanks.

Joe Woody, CEO

Hi, Daniel, this is Joe. We thank you for the question. I mean obviously we've kept a really strong balance sheet and our leverage extremely low in this environment. That said we do think we'll conduct some sort of a bolt-on this year. Like we have in the past, we have enough capability inside to onboard these well and to get this integrated. So I don't see it detracting from us being able to deliver our plan or do some of the share buybacks if we so choose as we progress. So for pipeline, we still have to make sure we're executing in particular on the strategy we've just developed.

Daniel Stauder, Analyst

Great, and then just one follow-up on some of the HA business. You talked about it a bit as well as some of the programs you're implementing to stabilize that part of the business. But just any more thoughts on what gives you confidence in getting this to level out, or any macro color that you could give that we should think about throughout 2024 would be pretty helpful. Thank you.

Joe Woody, CEO

Yes. So, a couple of things. One is, we have been maintaining a disciplined pricing strategy purposely and strategically and we do know that ultimately some of the specialized reimbursement for a couple of companies where people are going, because they can make more money making decisions that way customers, that's going to go away as we sort of end the year. We think we can also do some things with market access to some of the commercial programs and cross-selling initiatives that we have, and there are new markets as well for us that we think that we can achieve. So again, what we believe will happen. This is a strategic area for us, because of the focus on orthopedic pain and recovery and it fits nicely into our channel, has great gross margin. We think it's a low single-digit grower once we make our way through this year.

Daniel Stauder, Analyst

Great. Thanks very much.

Operator, Operator

Thank you. And our next question today comes from Rick Wise with Stifel. Please go ahead.

Rick Wise, Analyst

Good morning, Joe. Hi, Michael. Joe, keeping pushing on the HA side of things, but I wanted to make sure I better understood your thinking about the potential for stabilization. I appreciate what you said about your strategy and your discipline, but maybe talk to us a little more depth about you talked about some of the commercial team sales changes. And did I hear you correctly, you're thinking that in the second half of this fiscal year we're going to see the business stabilize or return to growth. I want to make sure I understood what you were saying there.

Joe Woody, CEO

Sure, I see stabilization toward the end of this year towards the end of 2024. I see growth possible in 2025 and again, sort of the obviously the big target volumes have sort of remained about where they were. And so it's really the price affected by the Medicare changes that's really hurting the business and in particular I think everybody's fighting a little bit with that. In some cases, a couple of competitors have specialized pricing that's going to go way up the middle of the year and that creates more of a level playing field. And so we think with the customers that will be selling to in terms of Game Ready and really frankly, our Surgical Pain business and our Diros business that we're going to be able to get this to more of a low single-digit grower as we get into 2025. I can see it based upon some of the progress, some higher, some of the programs and the traction. But at the moment, we're also protecting our price for the longer term.

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

Dosing to consider, Rick, is that although there have been differences in volumes for three and five shots over the past year, they have remained relatively stable. The significant majority of the revenue decline has been attributed to pricing. Therefore, if volumes stay stable and we can achieve a more stable pricing environment, which we believe will occur in the latter half of 2024, then we have a solid foundation to build on as we move into 2025.

Joe Woody, CEO

One of the things, too, Rick, that we said at the JPMorgan conference was that we can achieve mid-single-digit organic growth for the total global company with this type of decline in HA and still achieve mid-single-digit growth in the other parts of the Pain business on a global level. So, we feel good about that portion of it as we manage through, quite frankly, a tough aspect with the HA piece.

Rick Wise, Analyst

Got you. On operating margins, if I'm doing my math correctly, sales and EPS guidance midpoints imply operating margin something like 14% for the full 2024 year. Maybe could you all help us think through how that's likely to set up for the first half versus the second half? In the past, you've started typically with operating margins more in the high-single-digit range. Is that the right way to think of all that to think about 2024, Michael?

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

Yes. So, you're right. I mean I think we'll be a little bit north of 14%, but you're in the range there. And yes, first half is always going to be lower than the second half. I'd like to believe we can at least tweak in 10% operating profit in the first quarter. But yes, that will be our lowest operating profit quarter and then it will build a couple of a few hundred basis points per quarter from there.

Rick Wise, Analyst

Thank you.

Operator, Operator

And our next question today comes from Kristen Stewart with CL King. Please go ahead.

Kristen Stewart, Analyst

Hi. Thanks for taking the question. I just wanted to clarify, Michael, you talked about the 2025 kind of goals for the full year. Are you still reaffirming that $750 million target, because we are growing at a lower base now? Or is it just the mid-single-digit that you're reiterating?

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

The mid-single-digit growth is what I was trying to express. Our original target of $750 million remains accurate. However, we currently do not believe that this target is achievable given the growth rates we are observing. We still expect mid-single-digit growth, but it's from a lower base of $20 million due to the HA impact.

Kristen Stewart, Analyst

Okay. And separately, how do you feel about free cash flow generation and getting to that over $100 million of free cash flow in 2025? What are kind of some of the measures that you're looking forward to achieve that objective?

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

Yes. I mean, if you think about this year, we had $50 million of total cash outflow for litigation settlements restructuring the RH divestiture that will be around $25 million to $30 million in 2024. And in 2025, we'll have hopefully minimal to no one-time cash payments. So that's a huge tailwind. On top of that, our operational cash flow will be improving and just by nature of the revenue going up mid-single digits and the margin improvement through cost management. And then on top of that, we've got working capital opportunities in inventory. As you know, we've struggled a little bit with our inventory management over the last couple of years for a range of reasons, some macro and some self-inflicted. We have about $25 million to $30 million of inventory opportunity between now and the end of 2025. So if we execute on each of those pieces which are many of them are very much in our control, I feel very good about the $100 million opportunity in free cash flow over 2025.

Kristen Stewart, Analyst

Okay. Perfect. And then last question just on the IVP portfolio. Can you maybe just talk through if you have any supply constraints still there with Tom Cooley? And then on the Trident launch in the US, I think you mentioned that was better than expected. Can you maybe just provide additional color on that?

Joe Woody, CEO

Yes. So again, we saw about a 10% growth versus the third quarter in the business. And the quality issues in the supply chain issues are behind us. We were also happy with the capital sold in the fourth quarter that lends itself to the next year. The Diros business has really been exceeding our expectations in terms of a launch. But just to remind everybody that we sell into the US, which is a new market now, and we're going to be double-digit for the full year globally, high double-digit but it can take you six months or so to get those accounts up and running for the full revenue streams. But we think there is going to be a big contributor to the business this year. And again it will be high double digits as it has been.

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

And Kristen, just one wanted to so the 10% Joe is referring to is the sequential growth Q3 to Q4 specific to our RF business. So that includes CoolWave, our standard RF probes. And as Joe just mentioned, the capital sales that do not include Diros. Diros grew more than 10% Q3, Q4.

Kristen Stewart, Analyst

Okay. Perfect. And then the organic growth expectation for this year, I just want to make sure that does not include Diros or does that include Diros?

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

It includes Diros against the time period that we owned Diros. So the back half of the year does not include any revenue in the first half of the year or the first half of the year through partially in the third quarter where we did not own Diros. So it's pure organic growth.

Kristen Stewart, Analyst

Okay. Perfect.

Operator, Operator

Thank you. And this concludes our question-and-answer session. I'd like to turn the conference back over to the management team for any closing remarks.

Joe Woody, CEO

So, look, our primary focus is getting the precise execution that we need in the business. We have successfully executed the product ex-US. Investing in orange is the RH business and acquiring technology with Diros. We obviously approved an additional share repurchase program and delivered most of our financial objectives. I think we've established the necessary foundation to deliver on the midterm financial commitments and confident that our transformation priorities coupled with our market-leading portfolio are attractive markets that position us for sales growth, margin expansion, and meaningful free cash flow generation. So we appreciate everybody's continued interest in ours, and I'm sure we'll speak further throughout the week. Thank you.

Operator, Operator

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines. Have a good day.