AVNS - NYSE

Good morning, ladies and gentlemen, and welcome to the Avanos Medical, Avanos Third Quarter 2024 Earnings Call. [Operator Instructions] This call is being recorded on Wednesday, October 30, 2024. I would now like to turn the conference over to Scott Galovan, SVP, Strategy and Corporate Development. Please go ahead.

Good morning, everyone, and thanks for joining us. It's my pleasure to welcome you to Avanos' 2024 Third Quarter Earnings Conference Call. Speaking first today will be Gary Blackford, Avanos Chair, He'll be followed by Interim CEO, Michael Greiner. Gary will give an update on our leadership changes before Michael reviews our Third Quarter results, the current business environment and update on our transformation efforts and our fourth quarter 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 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 Gary for introductory remarks.

Thanks, Scott. I'm here today to provide a brief update on recent leadership changes at Avanos. Joe Woody has announced his decision to retire as Avanos' CEO, and Michael Greiner has been appointed Interim CEO. Joe has graciously agreed to assist the company in this leadership transition and he'll continue to consult with the company through April of next year. Joe has accomplished a great deal in his tenure as CEO, he led the strategic positioning for the company to a more focused medical device solutions company via acquisitions and divestiture of assets and businesses that were not aligned to the company's long-term strategy. Avanos is in a better position financially and organizationally today to achieve its long-term value creation goals. We're grateful for Joe's leadership these past 7 years, and we thank him for his efforts and dedication to Avanos. We're also pleased to announce that Michael Greiner has agreed to serve as interim CEO for Avanos. As Avanos' CFO and Chief Transformation Officer, Michael has demonstrated ability to deliver consistent results against our 3-year transformation plan, and he is well positioned to step in as Interim CEO. While Michael is our leading candidate to become the permanent CEO, our Board wants to evaluate other candidates as well, and we'll conduct a fulsome search for a permanent CEO over the coming weeks. To enable Michael to focus on running the company, Warren MacHan has been appointed interim CFO. Many of you may remember Warren who previously spent 7 years as Senior Vice President of Strategy for Avanos and served as interim CFO before Michael joined Avanos. Prior to leaving Avanos in 2021, Warren had 34 years of experience with Kimberly Clark, Halyard Health and Avanos. Since leaving, Warren has continued to provide strategic consulting in support of the company's transformation agenda. We welcome Warren back as Interim CFO. Change is constant in the medical device world, and the Board of Directors believes these leadership changes will allow the company to continue its strategic path of becoming a more focused organization. In closing, I'm proud of the transformation progress Avanos has made, and I'm genuinely excited about the company's promising future. powered by our team's commitment to make a difference and by the enduring importance of our products in patients' lives. With that, I'll turn the call over to Michael.

Thanks, Gary. Good morning, everyone, and thank you for joining us to review our operational and financial results for the Third Quarter of 2024. As Gary just mentioned, over 1 year ago, we announced a transformation plan to optimize our portfolio, refocus our commercial operations and improve our margin profile. This quarter marked a significant milestone in our transformation as we successfully completed the conveyance of 2 respiratory health plans to AirLife as well as continued our efforts to rightsize our cost structure and enhance our operating profitability, and also generated meaningful free cash flow, ultimately positioning the company to more effectively and efficiently deliver shareholder value creation. Although we are pleased with our transformation progress, we fell short in the third quarter of our stated objective of mid-single-digit organic growth, which also negatively impacted gross margin for the quarter. Our pain portfolio, particularly surgical pain, was the primary driver of this underperformance, partially offset by another strong quarter in Digestive health. In spite of these mixed results, we have continued to help patients get back to the things that matter. So far this year, we have supported over 1 million patients and overcoming a wide range of challenges from postsurgical pain management and recovery, using our ON-Q catheter-based therapy and Game Ready solutions to addressing short- and long-term enteral feeding needs with our CORTRAK and MIC-KEY brands. We are very committed to making a positive impact in these patients' lives. Now switching to financial highlights for the quarter. We generated approximately $170 million of sales from continuing operations, $0.36 of adjusted diluted earnings per share and approximately $31 million of adjusted EBITDA from continuing operations or almost 18% of adjusted EBITDA margin. 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 1.1% compared to a year ago. Now let me spend the next few minutes discussing our results at the product category level. Our Digestive Health portfolio continues to deliver consistent results, growing almost 3% organically versus prior year, reaffirming our #1 position in long term, short term and NeoMed feeding. Digestive Health performance was supported by continued double-digit growth in our NeoMed product line as we continue to take advantage of the strong demand for ENFit conversions in North America, while also capturing opportunities from a competitor's backorder. 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 ENFit adoption cycle. Demand for our legacy enteral feeding business remained healthy, growing at market level during the third quarter compared to the previous year. We expect continued above-market growth for our Digestive Health portfolio, will be supported by product innovations, global market expansion and inorganic growth opportunities. Now turning to our pain management and recovery portfolio. Normalized organic sales for this quarter were up a little over 1%, excluding HA and inorganic sales related to our Diros acquisition. While overall pain portfolio grew year-over-year, we are disappointed by the performance of our surgical pain portfolio and softness in our North America COOLIEF offering. The setback in our surgical pain portfolio was centered around our ON-Q product line. which was affected by transient execution and supply issues stemming from backorder challenges at one of our pre-fillers early in the third quarter. Additionally, while we have maintained key customer relationships and prioritized supply for these Tier 1 one ON-Q customers, we have experienced higher-than-expected turnover this year of customers. We are actively working to reengage them. These headwinds muted the strong performance of our ENFit products, which has grown in excess of 30% in each of the last 4 quarters, capitalizing on the procedural shift to the ASC. Our IVP business posted double-digit growth for this quarter compared to the previous year. We continue to see momentum in our IVP generator sales, capturing higher procedural volumes especially within our Semtech and Trident product lines. We credit our renewed ASC strategy and the increasing productivity of our fully deployed new sales structure and supporting these outcomes. Additionally, we are encouraged by the progress of our COOLIEF offering internationally, leveraging reimbursement tailwinds in several countries, including the U.K. and Japan. Our Trident product line acquired in Diros acquisition a year ago, continues to deliver against our internal growth expectations. We are capitalizing on our successful U.S. market launch with over 130 accounts having converted to our Trident technology. Our Game Ready portfolio posted its third consecutive quarter of double-digit growth compared to the prior year. As noted during our last call, we anticipated a lower growth profile from Game Ready in the fourth quarter given the particularly strong fourth quarter we experienced in 2023. However, actual revenue results for the fourth quarter will be in line with the first 3 quarters of 2024. Finally, our HA portfolio, while down year-over-year, was flat and sequentially consistent with our prior 3 quarter results. This leveling off of revenue in our portfolio was anticipated and aligns with our previously forecasted 20% decrease in HA revenue for the full year. We expect fourth quarter revenue for our HA portfolio to be north of $10 million, which would mark the fifth consecutive quarter at this level of performance. While we continue to execute on mid- to longer-term strategies to gain volume share in the 3 and 5 shot HA categories, we continue to experience pricing pressure, which is currently offsetting the volume share gains we are in. Now margin expansion was positively impacted by continued SG&A optimization efforts and a favorable outcome from a Canadian customs duty refund matter. Adjusted SG&A as a percentage of revenue was 39.8%, marking an improvement of 180 basis points compared to the third quarter of last year and 320 basis points sequentially. This improvement is primarily driven by our cost savings efforts to streamline the organization and reduce overall spend as part of one of our transformation pillars. For the quarter, our adjusted gross margin was 58%, which is comparable to last year. We were able to partially offset inflation and HA price volatility through transformation initiatives at our plants and operations level. We expect adjusted gross margin to be approximately 59% for the fourth quarter, as we see better product mix and savings initiatives that were delayed during the third quarter implemented in the fourth quarter. As I already shared, our performance in the third quarter tracked slightly behind our expectations. That being said, our organization's primary focus remains our transformation priorities as we address transient challenges that are likely to provide a slight headwind into the fourth quarter. As a result, we anticipate the following outcomes for the fourth quarter. Revenue in the range of $175 million to $180 million, representing a low to mid-single digit organic growth, adjusted gross margin of approximately 59% and approximately 40% of adjusted SG&A as a percentage of revenue. These financial metrics support and adjusted diluted earnings per share between $0.38 and $0.43. Now turning to our financial position and liquidity. Our balance sheet remains strong and continues to provide us with strategic flexibility with $89 million of cash on hand, and $162 million of debt outstanding as of September 30. Supporting our cash on hand, free cash flow was positive $20 million in the third quarter. During the fourth quarter, we anticipate generating approximately $30 million of free cash flow as well as receiving $30 million of cash from AirLife, primarily due to final transfers of the remaining assets related to our RH divestiture. As a result, we expect our year-end balance sheet to have net debt of approximately $20 million and a leverage ratio of under 1/4 turn. As we have previously shared, we continue to actively pursue strategic M&A opportunities that align with our returns criteria and also deploy capital for opportunistic share repurchases. Now finally, moving to our 2023 to 2025 transformation priorities and efforts. As a reminder, we have 4 key priorities 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 ability 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 important progress against these transformation priorities. Third quarter highlights include, but were not limited to, finalizing separation efforts associated with the divestiture of our respiratory health business with the conveyance of our Magdalena and Nogales 2 plants to AirLife as well as the transfer of the Australia and New

[Operator Instructions] Our first question comes from the line of Kristen Stewart of CL King.

I wanted to just start off on the pain business and the supplier constraints within ON-Q specifically, how long do you think that these supplier constraints are going to be lasting? And how should we think about the longer-term growth rate for ON-Q in the portfolio, especially as we look out into FY '25?

Yes. Thanks, Kristen. So the primary supply challenges we had with ON-Q in the quarter related to lighters, and that was in the first half of the third quarter. Those resolved themselves as the quarter went on. But as you know, if we miss a procedure that has an ON-Q attribute, we're not going to get that procedure back. So it has an impact in quarter. And so we have to get some of those customers back. And obviously, depending on what the uptake of procedure volume is in the fourth quarter, that will have an impact on ON-Q as well. Longer term, we are excited about the ON-Q prospects, primarily because of No Pain Act, which we've talked about previously. So we will find out in the coming weeks what our reimbursement will be around ON-Q, and we'll be able to have a much more thoughtful view as to what that will do to impact ON-Q going forward. We know that No Pain Act is a positive, no doubt about it. We just aren't quite yet sure exactly how positive and the actual reimbursement rate will be a big determinant in that.

And then how should we just think about the company's longer-term goals and objectives that wasn't mentioned on today's call and just thinking ahead to FY '25, if you still feel comfortable with seeing an acceleration to mid-single-digit growth? Or if we should think about this more as a low to mid-single-digit growth profile sort of company given kind of the 4Q performances in that range.

Yes. So a couple of things. Great question. We're not commenting on '25 right now. We will be doing that as we attended JPMorgan conference in January. Other than ON-Q and North America softness in COOLIEF, we actually had very good performance throughout our product portfolio. So we continue to analyze coming out of Q3 with the softness in ON-Q, which was about $3 million. And then there is a little over $2 million in softness with North America COOLIEF. The rest of the portfolio is operating as intended. But we do need to take a step back and think about what the No Pain Act will be for ON-Q going forward, as I just shared with your initial question. And then also what is the right growth profile for the company going forward. But we are acting as intended through the rest of the transformation, and you can see that in the remaining parts of the income statement. And so we'll have a more wholesome update in the early part of January for 2025.

[Operator Instructions] Your next question comes from the line of Danny Stauder of Citizens JMP.

Just so for my first one, I want to ask on 2025, but I'll keep it high level. You talked about a number of items, but could you just give us some primary tailwinds to sales to be thinking about? What are the major products, the product launches or anything else we should keep in mind as we look to next year?

Yes. So I'll start with Digestive Health business. We have our legacy business which will be supported by our Coregrip SR launch amongst 2 other launches that we'll have throughout next year. Our legacy DH business is at the market, a 3% to 4% grower, we've been growing faster than that in many quarters due to taking share. And these launches are important in order to ensure that we can continue to grow at least at the 3% to 4% rate and higher as we take share. That's part of the enteral feeding business. The other part of our enteral feeding DH business is our NeoMed product line for neonates, as you know, that's been growing very healthy for a couple of years now. We have signaled for a bit of time that we're in the later innings of the ENFit conversion cycle for NeoMed it has lasted longer than we anticipated, which obviously is great, and we will be achieving over $100 million in revenue in NeoMed for the year at some point in December. So we're excited about that. That growth rate, though, will come down a little in 2025, which we have anticipated and have already signaled. When you look at our pain management recovery business, we look primarily at 4 buckets. I'll start with HA. This is the fourth quarter in a row where HA has been between $10 million and $11 million of revenue. We anticipate fourth quarter to have a similar level of revenue. And then we expect to continue to have good volume share gains in '25, but we're currently assessing what is the pricing impacts between our 3 and 5 shot markets going into 2025. If you look at the new allowables pricing that was just published, 5 shot was up 3 shot was down. And so there's various strategies that we're deploying against both our 3 and 5 shot offering in both Medicaid, Medicare and the commercial set. So we've got some work to do to understand what are the pros and cons of our pricing strategy going into '25. But on a volume basis, we've done a very nice job on the HA side. Our IVP business, which consists of 3 different platforms, has been growing quite nicely. We had a double-digit growth rate this quarter. Our new acquisition from Diros has performed as expected, if not slightly better. So we're excited about that offering and what we can capture and share of volume of procedures in the ASC setting. COOLIEF is doing very nicely, internationally. As I noted earlier, in North America, it was a little softer internationally with reimbursement tailwinds, particularly in the U.K. and Japan. We're growing COOLIEF nicely, so we're excited about our IVP part of our portfolio. Game Ready has had 3 consecutive quarters of double-digit growth. The fourth quarter will not have percentage growth just because of the tough comp we have in the fourth quarter of last year, but we will have absolute dollar value revenue growth similar in the fourth quarter for Game Ready. So that is stable and growing. We're excited about the opportunity at Game Ready in '25 and beyond, and our surgical pain business. Ambit has been growing 30% plus, as we noted in our prepared remarks, and we're excited about the share that it's taking in the ASC and ON-Q, we do think is set up for stabilization at worst and hopefully some growth given the No Pain Act and reimbursement positive news that we'll be receiving as we enter into 1/1/25. We like where we're positioned with this portfolio. But as I said to Kristen's question, we do need to do some more work over the coming weeks and into the early part of next year to be able to lay out an appropriate 2025 financial metrics and more to come on that in early January.

And just one follow-up. So just on Game Ready. It's been a few strong quarters here, and you talked a little bit about that. But any more color you can give us on what's driving this growth? Is it some of it due to 2023 comps? Or do you feel this is more steady state solid performances. And then any notable drivers we should keep top of mind as we look into next year in this category?

Yes. No, it's a great question. So a little bit of it is the comps Danny, as you pointed out. just as the tough comp for Q4 will mute some of the percentage for Game Ready in Q4. But if you look at the absolute dollars, it is growing year-over-year in total for the year. We expect to have similar growth in total for 2025. We are deploying some new strategies in Game Ready around a direct-to-consumer approach, which we are currently testing and currently are very pleased with some of the early feedback we're getting. We're also deploying additional strategies with orthopedics in Game Ready of rental model that is a little more seamless than the current rental model that we currently deploy, which can be clumsy at times for us because that's not our expertise. So we think we have the right strategies in place for Game Ready, and we're excited to lay out additional strategies in 2025 to help support further growth in that category.

And there are no further questions at this time. I would like to turn the call over to Michael Greiner for closing remarks.

Great. Thank you. So our primary focus, as you guys know, continues to be the execution of the strategic transformation plan that we outlined 15 or so months ago at Investor Day. As we've previously talked about, we've successfully executed product exits. We divested our RH business and hit an important milestone this quarter with that divestiture. We acquired some great technology with Diros, and we supported our valuation through various share repurchase opportunities opportunistically, which we will continue to do going forward. And we've made significant progress from a margin standpoint, free cash flow generation standpoint towards our financial objectives. We look forward to presenting at the JPMorgan conference in January with a more holistic review of our transformation priorities, along with, as I just shared the full year financial metrics for 2025. Thank you for your continued interest in Avanos.