Good day, and welcome to the Avanos Fourth Quarter 2018 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Dave Crawford, Please go ahead..

Good morning, everyone and thanks for joining us. It's my pleasure to welcome you to the Avanos third quarter earnings conference call. With me this morning are Joe Woody, CEO; and Steve Voskuil, Senior Vice President and CFO.

Joe will begin with a brief review of our 2018 accomplishments, followed by an update on outlook for our business and an overview of our 2019 priority. Then Steve will review our results, offer details on our financial performance and share our earnings outlook for 2018. We'll finish the call with Q&A.

A presentation for today's call is available on the Investors Section of our website, avanos.com. As a reminder, our comments today contain forward-looking statements related to the company, our expected performance, economic conditions and our industry. No assurance can be given as to the future financial results.

Actual results could differ materially from those in forward-looking statements. For more information about forward-looking statements and the risk factors that could influence future results, please see today's press release and our prior 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..

Thanks Steve. Good morning, everyone. And thank you for your interest in Avanos. 2018 was a year of transformation and achievement as we completed the S&IP sale, increased investment to accelerate growth and initiated cost savings program. I'm pleased with our performance against the five priorities outlined last year.

First build on our top-line momentum; second close the S&IP divestiture and deliver on our TSA commitment. Third, execute strategic investment to accelerate growth. Four, begin to right-size our cost structure to support our leaner, more agile business. And finally, strategically deployed capital through M&A.

I will review these accomplishments and their expansion in 2019. First, we sustained our top-line momentum in 2018. For the year, sales grew by 7% to $652 million, slightly ahead of our revised expectations. And we earned $1.93 of adjusted diluted earnings per share exceeding the high end of our outlook.

We continue to see strong demand for our Coolief, digestive health and respiratory health products throughout the year. Combined, these businesses grew 8%. Additionally, organic sales and the international markets increased from 1% in 2017 to 5% in 201 in constant currency.

As discussed during our third quarter conference call, the regulatory issues around the industry-wide drug shortage and pre-filler disruption continued to pose challenges for our acute pain customers. This coupled with the inventory consolidation initiatives of two of our IV infusion distributors impacted our overall performance for the year.

The number of customers working with our exclusive pump billing partner continued to increase as we saw a 25% increase in sales in all Leiters accounts for the quarter.

In addition, drug supply for ropivacaine is beginning to return to the market, and we expect it to take several months to work for the supply chain based on our experience last year when supply was interrupted.

We continued to see significant growth potential for acute pain, given a large addressable market of more than 20 million applicable US surgical procedures annually, and a growing demand for surgeons for effective opioid sparing pain treatment.

Our well-trained sales force is focused not only on expanding market penetration in orthopedic pain and healing, but in new growth areas for us such as OB/GYN specialties were on cue and make a meaningful difference in patients' lives by enabling opioid free c-sections and hysterectomy.

Our second priority was to complete S&IP divestiture and deliver on our TSA commitment. We are pleased to be progressing as scheduled with our TSA commitments. Our third priority was to accelerate strategic investment to drive our near and long-term growth with the goal of achieving sustainable, high single digit growth over time.

Our investments were focused on three key areas. Interventional pain, R&D and International. Let me highlight some example. First in interventional pain, our fastest-growing business, we made significant investments in Coolief, the only FDA cleared RF treatment for OA knee pain.

These investments are in advance of the expected 2020 CPT1 code for Genicular nerve ablation. To raise patient awareness of our unique and effective therapy, we launched our first direct patient television commercials and selected US market.

We are excited about the results which generated a 35% sales lift in those markets over our normal growth expectation. Also, we saw a significant increase in patient awareness. Additionally to further differentiate bullied and bolster our position in the payer community, we increased our investment in clinical research.

As a result, company driven Coolief publications have grown from just one in 2016 to unexpected seven in 2019. Three key studies when published intend to show Coolief's benefits against the use of steroids for the treatment of knee pain.

The health economic benefit for Coolief and new results for our study against hyaluronic acid for knee pain which could enable us to target this billion dollar market. We're optimistic about the study and expect to publish more details in the near future.

In addition to raising awareness, we're advocating for the adoption of reduced indoor non-opioid alternatives to help combat the opioid crisis in the US. To this end, we've strengthened our government relations efforts.

Members of my leadership team and I have met personally with members of Congress to lobby for improved reimbursement of opioid sparing therapy. We're encouraged by the Opioid Crisis Response Act which contemplates the removal of financial incentives for prescribing opioids rather than medical devices such as ON-Q and procedures like Coolief.

Furthermore, we have strengthened our reimbursement capabilities. When I started a year and a half ago, our reimbursement team was a single person. Today, we have built a team of nine primarily focused on expanding coverage for Coolief. But also working on several initiatives in our ON-Q business.

Second, we continued investing in R&D to strengthen our capabilities to commercialize new products and to build a robust pipeline of innovative medical devices. Our increased investment in breakthrough technologies is showing signs of returns.

We were one of eight companies from more than 250 submissions selected by the FDA for its opioid innovation challenge In addition; we continue to make strong progress across our breakthrough initiatives and are excited to be starting our first inpatient trial around new methods to treat post-surgical pain.

Turning to International, we increase our focus on this business. Restructure the leadership team and prioritize our investment around selected growth market.

Arjun Sarker leads this business and has laid out his strategic plan and growth framework which includes prioritizing geographies where we can win and build scale, acquiring top device industry talent, evaluating our distribution channels and determining how to rationalize our channel partners.

Overall, we expect internationals growth rate to accelerate each year and become a double-digit grower by 2021. These are just three areas of strategic investment we made in 2018 to position us for future growth. Transforming our cost structure was another 2018 priority.

As we've mentioned on previous conference calls, we're taking a phased approach to this transformation. As a reminder, the first phase was right sizing our organization to align with our growth model. Second was our IT restructuring where we've initiated deployment of our new ERP system.

When the implementation is completed in late 2019, it will reduce our structural cost, enable more efficient inventory management and improve the information available to speed up and enhance decision making. The third phase which is slated to begin later this year will optimize our product supply, global distribution and network and procurement.

To drive this process, two months ago I appointed Dave Ball as Senior Vice President of Global Supply Chain and Procurement. I'm excited to have Dave as a member of my senior leadership team.

In my previous experience with him, he has demonstrated the ability to optimize cost structure, drive continuous improvement programs and increased efficiencies in manufacturing site. Combining the three cost transformation phases we anticipate reducing costs by $30 million to $40 million by the end of 2021.

These savings will be initially reinvested to help accelerate our growth. Strategically deploying capital through M&A to drive shareholder value was our final 2018 priority. I am pleased with the Game Ready acquisition, it's meeting our expectations and we expect its growth to be faster than our organic growth rate.

Moreover, it strengthens our access to the orthopedic and healing call points, broadens our access to post-operative pain management market and demonstrates our disciplined approach to capital deployment. We are committed to executing deals that meet our criteria and we will remain discipline, ensuring our acquisition criteria are met.

Our pipeline remains robust and we are evaluating potential deals ranging in size that will complement our business. Now I want to highlight our four priorities in 2019. First, accelerating top-line momentum remains our top priority to drive growth. We will increase investment.

We continue to see our chronic care business as a mid-single digit grower and expect to launch multiple new products to maintain our leading share positions.

We're also investing behind our market leading core track, tube tracking technology as our goal is to establish it as the standard of care for bedside placement of small bore nazy enteric feeding tubes. Chronic care also provides the foundation for us to accelerate our international growth in the near term.

To build on our momentum in Coolief, we've already expanded our successful direct to patient advertising into 13 new and large US market. Accelerating investment for new clinical trials and expanding our sales team by 20%. We have seven clinical studies currently underway and in total 13 planned over the next three years.

During the first half of this year, we expect six-month results from the hyaluronic acid study to be published, as well as the health economic study that shows nerve ablation is more cost effective than the current standard of care. Turning to acute pain.

We're focusing on regaining growth as the drug supply gradually improves we anticipate our sales performers will begin to meaningfully accelerate in the second half of the year.

Second, on the international front, we'll continue investing in our growth framework, including strengthening our sales and marketing capabilities and hiring regional management and customer facing roles. Again, we see this business as a double-digit grower over time.

Similar to 2018, our investments will temporarily impact margin, but we expect these investments will lead to accelerated growth and significant margin expansion after 2018. Also post 2019, we will curtail our level of investment once we've established an appropriate level of support for our future growth initiatives. Turning across transformation.

This year, we will begin the third phase and execute multiple projects. These includes simplifying our current distribution network to optimize transport cost, enhancing productivity and plans to product in sourcing and the phase rollout of our new IT platform that will simplify streamline and standardize our global systems and processes.

We anticipate providing more details about the next stage of our cost takeout program during the second quarter. Overall, we expect savings of $7 million to $10 million in 2019 with the establishment of our IT infrastructure we expect additional savings of $14 million to $18 million in 2020.

And finally, deploying capital for M&A will enhance our plan. We are well-positioned to succeed in 2019 as a pure-play medical device company.

Our diverse product portfolio and leading physicians in large growing market, our scalable infrastructure, our focused on key strategic initiatives and our talented team gives me confidence we will accelerate growth. With that I'll turn the call over to Steve..

Thanks Joe and good morning everyone. Let me also say how pleased I am of our accomplishment and the effort of our teams throughout the year.

As Joe said, completing the S&IP divestiture was a major accomplishment which transformed us into a pure-play medical device company and enabled us to focus on accelerating growth and increasing investment in our strategic growth initiative. These investments are paying off and position us for success in 2019 and beyond.

Now let's begin with the review of our fourth-quarter results. Overall, we delivered sales of $170 million, an increase of 2%. Sales from our Game Ready acquisition contributed 5% of the growth.

Excluding Game Ready, we saw another quarter of double-digit growth in interventional pain, driven by our continued investment in direct-to-patient advertising and the increased adoption of Coolief. In Digestive Health, demand remains strong for our core pack and legacy and real feeding products.

In Respiratory Health, growth was below its normal mid-single digit rate due to the expected reduction in our lower margin oral care business.

Growth was offset by the expected lower volumes in acute pain due to the continuing regulatory issues impacting the industry-wide drug shortage and drug pre fillers, along with the impact of inventory consolidation between several of our IV infusion distributors.

During the quarter, our ON-Q franchise performed ahead of expectation, but was offset by our lower margin IV infusion category. Overall, these factors resulted in lower sales volumes of 2%. Unfavorable product mix and lower selling prices impacted results by 1%.

For the quarter, adjusted gross margin of 60% was in line with our expectation and compared favorably to 55% last year, which included costs previously allocated to the S&IP business. Sequentially, adjusted gross margin contracted due to last quarter's above-average manufacturing performance in the planned downtime in our manufacturing site.

Adjusted operating profit came in at $20 million for the quarter, compared to $7 million a year ago and operating margin was 12% compared to 4% last year, as last year's results were impacted by $30 million of cost allocated from discontinued operation. As we discussed, we continued to increase investment for near and long-term growth.

A higher level of investing, coupled with the expected the synergies from the S&IP divestiture impacted operating profit. Adjusted EBITDA for the quarter was $22 million compared to $64 million a year ago as a result from last year included discontinued operation. Adjusted net income totaled $14 million compared to $35 million a year ago.

For the quarter, we earned $0.30 of adjusted diluted earnings per share which was above our expectation. Two factors contributed to our strong performance. First, net sales came in above expectation, largely driven by chronic care as we continue to see distributors hold an elevated level of inventory in our digestive health product.

We expect during the first quarter, inventory will revert to its normal level. Second, we saw a favorable adjusted tax rate due to a change from our initial assumption when the final purchase price allocation for our S&IP divestiture was completed. Now for a brief recap of our full year 2018 result.

Net sales totaled $652 million, an increase of 7% compared to the prior year, including Game Ready which contributed 3% of the growth. As a reminder, due to the divestiture, we were required to allocate shared costs previously allocated to the S&IP business entirely to continuing operations in the prior - and for the first four months of 2018.

Prior to closing the transaction on April 30, 2018, four months of these previously allocated costs to S&IP totaled $37 million and were allocated to continuing operation. For the full year of 2017, these allocations totaled $116 million. As a result. Our year-over-year comparisons are skewed.

With that for the year, we delivered adjusted diluted earnings per share of a $1.93 compared to $2.35 in the prior year. Shifting to our balance sheet. We ended the year in a strong financial position with $385 million of cash on hand. Our balance sheet remains strong and we are well-positioned to invest in future growth initiatives.

Now let me turn to our 2019 outlook and the key planning assumption. Based on current trends in our business including our expectation for improved acute pain performance beginning in the second half of 2019, we expect net sales on a constant currency basis to increase 6% to 8% including Game Ready compared to the prior year.

As I've mentioned in 2019, we're making investments in our growth initiative, most of which will happen during the first half of the year. During the first quarter, we're expanding our Coolief direct-to-patient television advertising into new markets and are continuing to build our international team.

Overall, we expect our investments for the first half of 2019 to exceed our second half investment. Also in the back half of the year, we expect cost savings to build as we transition our focus from IT implementation to cost savings program.

Given the acceleration of investment for the year, we expect to earn between a $1.15 and $1.35 of adjusted diluted earnings per share. In summary, I'm confident our increased investment will accelerate our growth. We have a strong financial profile and a disciplined approach to deploying capital to drive organic growth and execute M&A.

With that operator, we are ready to take question..

[Operator Instructions] Our first question comes from Larry Keusch with Raymond James. Please go ahead..

Thanks. Good morning, everyone. Joe, I was hoping that maybe you could talk a little bit about the drivers or the components of this 6% to 8% growth.

And I guess as part of that what I'm really trying to understand is how are you mapping out ON-Q for the year?.

So, Larry thanks for the question. We've said before that ON-Q is progressing quarter-to-quarter; we actually beat our internal goals in Q4. Drug is coming back especially on the ropivacaine side but really the second half is where we see the growth there.

Remember that our business outside of the drug supply was about 7% to 8% organic growth for the year. And the drivers are real similar mid-single digit or chronic care was real also really happy with for CORPAK and at its highest sales in the fourth quarter for us.

And we think have an opportunity make that standard of care for hospitals and visualization for the placement of feeding tubes. Coolief continues to double digit growth in the overall business and then higher double-digit growth in Coolief.

The investment that Steve outlined in the script, we're taking advantage of going into 13 more markets and direct-to-patient. These clinical studies are going to help us with commercial payers. I think differentiate us alongside as well of another platform coming out in the summer, a new platform in that category.

So all of the same elements if you sort of thought back to H1 2018 install that growth or sort of in place for us and the drivers remain the one sort of unknown is the exact plan of when the drug comes back and the filler comes back fully for acute pain. And remember also for us Game Ready is about 3% organic growth for the year for 2019..

Okay and just quick follow-up on that one.

So is it fair to assume that your assumptions built into that 6% to 8% growth for ON-Q are sort of similar trends in the 1Q from the 4Q or do we have to see some improvement there? And then are we actually normalized from your vantage point right now in the second half of the year and then I guess lastly question on M&A.

You mentioned the pipeline was robust, again any thoughts on your expectations to be able to get a deal done in 2019. Thank you..

Yes. So we expect improvement from Q4 and obviously the big lever, Larry, is the acute pain and to the extent that we get into growth let's say in the end of the first half and start to see a better position for H2. That would be a big impact for the current plan.

On M&A, our criteria remain the same sort of we're focused in and around the channel and pain. Obviously and also enhancing the portfolio and the chronic care business. We did get the one acquisition done in Game Ready which we're very pleased with the performance and think that's going to enhance orthopedic pain and healing.

We actually had another one that we were very close to and through diligence we decide to back off. So the good news is we have a good discipline around that being the right deals for shareholders. We have two sets of deals for 2019. We have a number of sort of let's call it for Packer Game Ready, more accretive deals, deals with [Indiscernible].

We also have a good batch of growth deals that are important as well for our business. I'm very confident that we would basically can transact at least one deal in 2019 if not more..

Our next question comes from Mattew Mishan with KeyBanc. Please go ahead..

Hey, good morning, Joe and Steve. Yes, first question is how confident are you guys return to growth in the first quarter of 2019? And that these like 4Q issues are going to be relatively transitory.

And can you talk a little bit about the headwind you're going to be lapping in the flu?.

So I'll start and Steve you can sort of add anything, if he wants. One thing we talked about all the way back to Q3 is that Q1 it has the potential to be softer for us because you've got the cold and flu season coming through particularly in respiratory and then we obviously start to work our way out of that in Q2.

We also talked about the ON-Q recovery still with us even though the drug for ropivacaine is back; it's working its way through the distributors. We did see a little bit of inventory build in digestive health in Q4 that could have a Q1 impact.

And in our investment peaks in Q1 because we're taking advantage of getting back into these direct-to-patient areas.

Obviously, we have some spend around those clinical studies that we outlined and actually driving next week a big global sales meeting that is very important in getting the training out across the whole world really for our initiatives for the year. But maybe Steve wants to comment a little bit further..

Yes. Just a little more color on the top line on the first quarter, Matt. Certainly, we will have growth in total in the first quarter with Game Ready on top. I think from an organic standpoint, we'd like to be flat as we go forward. I think that might be a bit of a challenge if part of it is the still ramp up on the acute pain side.

And one of the things I talked about on the call as we had --we have some distributor inventory building and chronic care towards the back end of the year.

I think we're going to see that start to bleed out in the first quarter, it ran little bit softer in addition to the flu impact, the year-over-year flu impact ran little bit softer on the chronic care side in the first quarter.

And I think a combination of the flu comp the destocking by distributors and the acute pain sides are going to put the pressure on organic growth sequentially. But could then clearly as Joe said, you look forward over the quarters as acute pain ramps back up and we have mid-single digit expectations for chronic care in a full-year basis.

And then obviously a big Q4 as you have acute pain fully back on the gas and have the seasonality and so forth. That's what kind of brings you back from a full year guidance standpoint..

Okay. And then on Slide 9, I noticed that you have the cadence of savings from your cost initiatives. But it does that annual savings reinvested for growth.

Are all of those savings like not dropping down and going to be reinvested or are there a portion of that's going to drop down in the margin?.

Yes. First of all, we're getting the savings. So the savings are real, that 7 to 10 portion of which is in the gross margin side of portion of which is in the SG&A side, all actions and all referring real savings which we about to build upon as we see on Slide 9 going forward.

But we are investing this year all of that back into the business in one way or another. And if you think about just step back on take SG&A as an example, you really have three things on SG&A in 2019.

One is you got some reset of targets from softer sales performance that we talked about in the past on 2018, significant investment behind Coolief and international as Joe talked about on the remarks.

And then depending on what's your comp is some additional SG&A related to Game Ready for that half year that we pick up if you look year-over-year standpoint.

So the savings are real, but savings are coming through, but we're choosing just given the opportunity we have - on Coolief with that CPT code coming in 2020 to be on the gas from building that business this year..

Yes. I think the only thing I would add, Matthew, Steve outlined it very nicely. It was a strategic decision on our part because we've talked about getting back to mid-single digit, but our real goal is high-single digit and then double digit.

And we just have such an opportunity right now with the CPT code, with the direct to patient advertising and even some things that we're doing across the other businesses particular also international which by the way grew high or mid-single digit for the fourth quarter, and going to improve from there for the full year.

And so obviously putting the people in place there. These are things that are going to really get us to that high-single digit in the longer term. So again that is very strategic decision..

Okay, got it. And lastly on free cash flow, it was another outflow for the fourth quarter.

What is still driving that, what are your expectations for 2019 and some of the major moving pieces for that free cash flow? And with the 2018 outflows that changed any of your dry powder expectations for M&A?.

Yes, great question. Maybe I'll just walk right through those pieces. So you're right. From a Q4 standpoint, negative free cash flow really three bigger pieces in side, there are CapEx is one, we spent $18 million on CapEx big piece of that is IT.

And that will be a carryover theme as we talked about 2019 as we get that kind of disproportionate amount of CapEx investment for IT behind us. Q4 we also had a large tax payment, so that was a factor and then finally you see from the press release still pretty high separation and restructuring cost roughly $14 million in the fourth quarter.

So those combined were the drivers for the negative Q4. As you look to 2019, you say how that going to last or maybe positive in total. I expect it will be negative probably in Q1 and Q2 and then turning positive in Q3 and Q4. And the drivers in the first half are very similar to what we just talked about in Q4.

You're going to see the rest of the CapEx spending fall in mostly in those two quarters on the IT side.

Normal capital spending beyond that, but the increment for IT, now still the higher separation and restructuring costs through the first half as we get the full disconnect from the OMI segment offsetting that benefits from the businesses top generating cash..

And just to pick up your question about capacity. We believe our capacity is about $650 million at the moment. However, the things can changed that right like EBITDA generating acquisitions et cetera. So overtime, we don't see a change in our strategy for deploying capital for M&A..

Our next question comes from Jonathan Demchick with Morgan Stanley. Please go ahead..

Hello. Thanks for taking the questions. I had a quick question just on the earnings guidance. And mainly I guess how wide the range is. I was just hoping to get a little bit of a better understanding of what can kind of drive us to really both ends of the ranges. I think it implies a couple of points of potential like margin variation.

And so just looking for like what you guys are expecting on the margin side?.

Jonathan, just a couple of things. I mean obviously that wide that dispersion of keeping our eye on the acute pain, obviously, we're also making those investments that we've talked about and they're front end loaded. That's kind of the main perspective as Steve looks like he wants to make comment..

Yes, I would say, as we always probably say this time a year, we'd be disappointed to be on the low end of that range. But at the other time we're early in the year; we got a lot of assumption on the top line based on that recovery in acute pain which we have confidence in.

But we want to see that prove itself out here as we go a couple quarters into the year.

I think from an OpEx standpoint, we talked about some of the key drivers on the investment side and depending on the top line, we've got some discretion on how we deploy, although I'll say we're going to deploy some of that investment early in the year as we talked about on the conference call to get a fast start on the interventional pain side..

Some of our benefits have been tax related and we think we'll go to a more normalize tax rate as well. So really, all the above..

Understood and just a couple quick ones on Coolief, just really trying to understand a couple different parts of it. Like how much of those businesses I guess focused on the knee versus spine and how is each one of those, I guess growing.

And then also, you maybe talked about the CPT code into next year, I just wondering what level of reimbursement you think is necessary there to really be, I guess, as market expands as you're hoping for..

Right. So today it still the greater majority, Jonathan, of the business is spine, we obviously also have a shoulder and hip in that business.

The big opportunity is the in fact, in the near term, I would say, inside the next couple of weeks here, we're going to be reporting some data on the risk and supplementation trial, and what our pain relief looks like in six months and we're very encouraged and optimistic about that.

But at the moment, we're also providing invoices, we've had committee meetings, we have additional meetings with Medicare, and there will be the proposed rule for OA coverage for the knee in July of 2019, and we've got a big strategy with physicians, patient, societies, et cetera. And the final rule is going to be published in 2019.

And essentially, it really needs to be moving the code up from sort of the low 100s for the surgical center to more up towards a $1,000 or so would be an excellent outcome and there's sort of mid outcome would be more like in the 700 range and obviously having the physician fees go up as well.

That's another reason we're investing, I think everyone needs to clearly understand that because these studies are going to be very impactful, very important. They're going to make major statements and I think that's what commercial payers want and what the Medicare wants in order to make decisions like this..

Our next question comes from Kristen Stewart, with Barclays. Please go ahead..

Hey, guys. Good morning. Just wanted to go back to kind of the revenue assumption for this year. If I kind of think about that mid single digit growth for the chronic care business about a 3 percentage point I guess contribution overall to Game Ready for the full year, it's probably like $17 million incremental within the pain business.

It sort of gets me to this call it 3% growth for organic pain. And I would assume that interventional Coolief probably is double digits. So that seems to imply ON-Q down maybe something in the mid-single digits.

Is that kind of fair in terms of back of the envelope for On-Q expectations for 2019?.

No, that's not the way we're reviewing it at all. I mean I actually see the possibility that we get back to some small positive growth in ON-Q and maybe as early as Q2, but we actually see the greater majority in H2, couple of reasons, one will be back to the full supply.

Remember also there's still going to be 30% of the market, if ropivacaine not available to the end of the year. Frankly, we too have some pretty soft comparators as well in H2, so we see growth in ON-Q for the full year..

Okay. And then how are you guys just thinking about the longer term forecast? Do you guys out one last year at the Investor Day, sounds like you're investing maybe a little bit more near term help kind of drive the performance over the longer term and maybe that's why 2019 EPS came in a little bit below where the Street was expecting.

But how confident do you still feel about some of those numbers you gave in terms of the margin performance the business. Is this near term kind of reinvestment, should we think about that is really truly a sustained permanent level for reinvestment that is really needed to get you to that mid to high single digit growth profile. Thanks..

So a couple things on the top line, and then I think Steve wants to make a few comments. But remember outside of acute pain, we had a 7% to 8% organic growth performance on the rest of our business international is coming out. There's no doubt that we are investing a bit in the business because we want to take advantage of some real opportunities.

And obviously our goal - getting quickly to high-single digits quickly as we can anyway. And obviously I think we understand that M&A enhances; the one thing I would say is I think Steve wants to make comment or he certainly looks like he was very on.

But we are going to get despite the investments $7 million and $10 million out this year than 14 and 18. We've also done well in 2017 as well. So that all starts to kick in, we back off the investments. We'll have to keep this level of investments in these areas going forward past 2020, we sort of get to a point where we get the job through.

Obviously, M&A will enhance some of the short fall that we've experienced from the acute pain top-line.

Steve?.

Yes, no, Joe captured it. This is not something we see increasing in 2019 and then sticking. If you think about the things like direct-to-patient with the CPT code coming.

That has great ROI in the year we do it but also have lot of stickiness in terms of raising awareness, and we're doing it as much as to raise the awareness and build the brand and have that visibility. So when the CPT code comes and reimbursement approved, we can be out on the front foot.

And so but that's not something that you just continue to scale up. And likewise other areas like clinical, I think as Joe came in and said, hey, 2016 which is one clinical study, and we were targeting 7 to publish this year and that we sponsored. That's more what we need to take advantage of kind of the unique opportunity that we have right now.

And it's kind of the same thing we saw in our --, as we think back in the story to when R&D was 1% of sales and we kind of got it up to sustainable level and plained out and in fact kind of trimmed out nicely. SG&A seeing the same thing.

We've got to get the just especially given the growth opportunities in international in Coolief, get that investment in now and then I expect it will be curtail and playing out if you go forward..

And so the LRP targets are those still firmly in place and achievable?.

Yes, those are still the targets that we're using internally as our goals. And so no change on that side. We'll update if we think if there is a material change at some point, but right now those are still the targets we're shooting for..

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

Hi guys, it's Drew on for Rick. Thanks for taking the question. I guess I just had several questions O-Q that I'll just pass them together. But Joe you've talked before about in 2018 you converted several hundred orthopedic surgeons to On-Q and that was a year that hindered by the drug shortage.

So can you talk about your expectations for 2019 that conversion with supply resolution in sight? And just with supply recovering, you touched on this a little bit but can you give us a little bit more detail on progression for ON-Q growth for the year especially since you had meaningful sales acceleration in the second half, but what is meaningful mean to the Avanos team?.

So for us I mean obviously meaningful first step as we getting back to mid-single digit growth and full year there is a potential for some of that's competitor, but also the drug is coming back.

The same level of physician conversion and decisional seems to be happening around total new and orthopedic space, but we're also very focused in C-section, and then also working a little bit around rib fracture. And we're getting good traction here.

So as the supply comes back that's why we feel strong about H2 because we are getting those conversions. And as you know, there is still a good series of patients - sorry physicians that are starting for the five day for their patients in the touch ratable nature of the ON-Q.

The other thing I think it's a market is learning, and I think investors are learning is it often times of these long lasting locals. There are still questions on duration and drug leaching involves and things like that. But they're using both products really in a lot of cases. So we do feel like when drug supply then that is one drug supply is back.

And we already have a relationship obviously with the Leiters for the filling that we'll be in a good spot to get to back to where we were sort of in the H1 actually H2 2017 and part of H1, 2018..

Got it. And then just on the opioid addiction innovation challenge.

Can you talk maybe about potential timing on the potential product or milestones that we should book through look to in 2019? And then just maybe some timing around some of the breakthrough products that you're also working on?.

Yes, so the award was around utilizing AI technologies for better visualization for physiologists just a really a physician using ultrasound to place the catheter which would be a speed an ease to use component to the actual procedure itself. Our breakthroughs are moving along in our internal milestones.

We have a couple that are in human now, which is great progress for us. But like we said, it's really sort of a 2022 kind of impact on the business. But still important because we're working towards sustainability in our growth..

Our next question comes from Ravi Misra with Berenberg Capital Markets. Please go ahead..

Hi, good morning. Joe, Steve, I was hoping you could help us kind of parse out some of the cadence around the revenue growth. I mean, it sounds like from an organic perspective, you're saying no flat seems to be kind of a - as hope for scenario in the first quarter. But any kind of commentary on the remainder of the year would be helpful.

And then maybe just a second one on some of these Coolief study that you're putting together and the timelines on that.

Would we kind of expect something potentially as soon as less or how should we think about the publication around those?.

So the publication is forthcoming, we're having the data worked on now and then we'll do likely putting a press release out of some sort in the next couple of weeks. And again, we're very optimistic on that, so coming soon.

And on the revenue growth, yes, we have Steve outline sort of kind of getting to from a negative perspective organics and more level-ish Q1. And then the desire obviously from there, there's a significant move up that we feel confident about, actually. But probably low to mid-single in Q2 and then moving up from there.

Again, all of the drivers are in place on the businesses outside of the acute pain. And obviously, you're seeing - we talked about strong performance in international in Q4 and that's important - an important part of our plan.

So obviously lever being the faster that drug is fully back in the market or the faster progression with the movement through the distributor channels through the [mechanisms and corners] of the world, the better than that thing can be..

Yes, I think that's exactly right. The - and sort of the reverse of 2018, 2018 the fourth quarter hurt because that's typically a larger seasonal impact on ON-Q, we have the throttle back to sales team based on drug availability. And so if I kind of reverse that into 2019, we've got high expectations for the back half of the year.

And I'd say as Joe said signs look positive, that is coming that way..

Great. Thanks. And then maybe just one - maybe two follow-up. Just on the gross margin kind of profile. Kind of appreciate, you're saying that there was - there's some kind of timing issues in the fourth quarter around plan.

How do we then kind of consider the ramp in 2019, I mean, our - is kind of the 60s, the low-60s still the right place to think about this or are you trying to say that with sales increasing as the year goes on that gross margin should improve?.

Yes, unbalanced low-60s is the right place. Kind of picking up your point, if we got softer volume in the first quarter, you may have some more absorption in the first quarter. So you might expect to - on relative scale, a little bit lighter gross margin there and stronger towards the back half where you're producing more.

I'd say we're also conscious that we built some inventory in 2018, that's one area we want to bring that down. We've got some rebranding activity that has to flow through the supply chain, as well as the warehouse optimization.

So we're going to be a little bit cautious there, but from a gross margin standpoint, I would think of the later volume early part of the year is going to be a little softer than the back half it will have higher volume..

Our next question comes from Chris Cooley with Stephens. Please go ahead..

Hi, good morning and thank you for taking the questions. I just want to revisit the OpEx kind of guide that puts some pluses here and kind of trying to reconcile that with the adjusted earnings.

And am I thinking about this correctly then in terms of the savings that you are to realize in 2019, you're essentially assuming that you're going to be reinvesting about $7 million to $8 million of that sounds like more so towards Coolief or about $0.10 to $0.11 that would have dropped through.

And then similarly, I'm trying to think about the tax guide here. I noticed the upper bound was 25%, which is a little bit reflects why the growth abroad was. But that would seem to imply about $0.02 to $0.05 in incremental earnings headwind relative to what we had been modeling previously from an effective tax rate standpoint.

Am I kind of reconciling the math there correctly? And then I've got one quick follow-up..

Sure. On the OpEx side. Yes, you're in the right zip code. We're reinvesting that savings largely towards Coolief and international maybe that's the right order of magnitude to think about.

On the tech side, 2018 we had talked about this probably a couple of calls but we had pretty big benefit mid-year from the auctions exercise of some past executives that in the new tax world allowed us about 200 basis points benefit to ETR in 2018 and then as you saw we talked about here in the call a little while ago that some additional benefit in the four quarter related to purchase price allocation from the sale.

And that's sort of reset our level set against that, that's what brings me back into that 23% to 25% guidance range. Now our goal is still to go lower than that over time and so we still have that we talked in the past some planning opportunities that we're putting in place.

I would say we're targeting more for 2020 once we get passed of the IT implementation because there is some IT, I think about invoicing changes and so on. That's from IT implication there that we got to be a little bit careful about doing in 2019 given the IP transformation.

But that hopefully that helps Chris in terms of --we're not taking our foot off the pedal from the tax standpoint but we can get some fortunate benefits this year that are repeatable..

No, appreciate the additional color and then I just wanted to go back to Coolief. I think it's great you are moving forward now both with the DTC, but also expanding the salesforce and you mentioned I think in your prepared remarks you're increasing the headcount by approximately 20%.

Could you just remind us where you are now both domestically and how you maybe see that salesforce ultimately scaling as you more aggressively go after the ortho indications? And well I'm assuming there's going to be heightening focus on in office procedures as we enter 2020. Thank you..

Yes. We really haven't disclosed the exact number of salesforce, but obviously giving you percentage and when we do that it's a combination of clinical people and selling bodies.

But you're right it's sort of gearing up because we have frankly a lot of opportunities to deal with our spine business and our shoulder business and our hip business, but I wanting it to be ready for the CPT code that when it comes out to be able to drive that especially with the right reimbursement and then obviously we've talked about the study that we're going to be having a press release and making that more public in the near term.

We think that's going to be an impact as well so mainly getting ready for that but also frankly some of those investments are just helping us enhance the existing core business as well..

Yes and thinking ahead to we get that CPT code in the future and we do have a stronger orthopedic call point to that point where we might see ON-Q and Game Ready and truly evolve hitting into that orthopedic space.

And we want to make sure we're playing that game ahead by getting a team in place now, getting scaled up so as that comes to fruition we're not playing catch up on what is a great opportunity for us..

Our next question comes from JMP Securities David Turkaly Dave - with JMP Securities. Please go ahead..

Thanks, good morning. I think you mentioned beefing up your reimbursement expertise folks tonight and I think you said that primarily focus on Coolief.

I'm just wondering from a broad stroke is there any way to kind of categorize for Coolief and ON-Q? What does the reimbursement landscape look like today and maybe even if that's a percentage you can throw out but something to give us an idea of what kind of percent of those procedures both the Coolief and ON-Q are getting covered today?.

So just Dave this is Joe Woody, ON-Q covers for the DRG and it's-- there's no real problem although we had some government affairs work going on to see if we can expand better reimbursement into the inventory surgical center.

And in terms of Coolief, it's pretty much covered by most commercial payers, but it's in the hospital setting with the interventional pain specialist and so what we're driving to is trying to get this available to the inventory surgical center and the orthopedic surgeons especially for the OA treatment for the knee.

Where we invest in reimbursement is sort of two-fold at the government affairs level and working with consultants and obviously working with folks on the hill, I mean reimbursement specials but then also sort of day-to-day embedded in the interventional pain business would be specialists that work with the commercial payers to sort of show our study, show the comparison of our technology, and linked at pain relief, the outcomes of the health economics that we invest in as well there.

But just broadly what we have said is that a big catalyst for the business would be reimbursements in the inventory surgical center for OA and the study that we'll be talking about in the near term on business supplementation which is the injections of synovial fluid into the knee that you would normally get in orthopedic surgeon, that's a billion dollar market for us.

And if we have better results, then that's where you sort of have a catalyst for the business..

Our next question is a follow-up from Kristen Stewart with Barclays. Please go ahead..

Hey, guys. Just wondering if you could help out maybe just talk about the cadence for earnings for the year because it does seem like you are reinvesting a fair amount back into the business.

Should we think about those reinvestments being more front half loaded which I suspect they are so how should we just think about the cadence from a revenue perspective?.

Yes, if I kind of flipped we have an unusual year that's year from a profile.

We talked about the revenue a bit already later in the first quarter, as we get drug supply back and we have a little bit of chronic care destocking distributors, ramping up as we go through the quarter with a larger back half and a larger finish taking advantage of the seasonality and drug availability.

On the OpEx side, we talked a little bit about it on the prepared remarks. But R&D will be heavier in the first half than second half, just more the timing of projects than anything else. So we'll have more events in the first half, and OpEx profiles similarly. So we're on the market right now in 13 markets.

In fact, we're in Atlanta on TV right now with Coolief. And so we wanted to get an early start on both the sales force hiring and the DTP and that's going to pull more OpEx as well into the first half including the first quarter.

So if I'm profiling the earnings, our earnings are definitely going to be softer in Q1 and then build as you go forward as the OpEx kind of ramps, starts to taper off and the revenue begins to pick up..

Okay, that's helpful.

And then could you maybe just comment just broadly on how you think about some of the potential risks with new drugs coming on the market for ON-Q later this year and to what extent you have built that into your forecast or whether it's the case of you believe there's just so much overwhelming demand for non-opioid use that feel like there's still a long runway approach for the ON-Q franchise.

Thank you..

I think the market is big enough, $4 billion and there is differentiation between the products. So again, for us, it's five days but the touch ratable nature and the other thing is, and I think the market is learning and the physicians are learning that in lot of cases they use both so they use these technologies at the same time.

We're very different, I mean they all have homes, I mean the long lasting locals and obviously there are formulas that the surgeons use themselves and then obviously we have a competitor in the market now and one coming.

That what will be different about those products is that they still going to have an issue on duration, there are some issues around drug leasing and falls and just the number of procedures or the type procedures they're available.

So I don't think it from - for our goals anyway for this market which is to hit mid single digit growth than the high and drive it through a much focused area around totally C section and then we'll see moving into rib fracture as well. I think there's room for everybody..

At this time, there are no further questions and this will conclude our question-and-answer session. I would now like to turn the conference back over to Mr. Joe Woody for any closing remarks..

I'd like to thank everybody for your interest in Avanos, and I think you can tell from our discussion today that we're confident in the business outlook and essentially our ability to achieve these goals. Fundamentals are solid and we're well positioned to deliver, we think value for our shareholders.

As a reminder, Steve will be presenting next Wednesday at the Raymond James Institutional Investors Conference in Orlando. And there is information on how to access that presentation on the investor relations section of our website avanos.com. Thank you very much..

The conference has now concluded. Thank you for attending today's presentation and you may now disconnect..