Good morning. And welcome to the Avanos' Third Quarter Earnings Conference Call. All participants will be in listen only mode [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mr. Dave Crawford, Vice President of Investor Relations. 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 is Joe Woody, CEO. Joe will begin with a brief review of our business performance and then give an update on our priorities for Q4 and 2020.

Then I will review our business unit results, and offer details on our financial performance and earnings outlook for 2019. We'll finish the call with Q&A. A presentation for today's call is available on the Investors' section of our Web site, avanos.com.

As a reminder, our comments today contain forwarding 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 statement.

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..

these include, completing the IT system and process stabilization, returning Acute Pain to growth, investing in COOLIEF and Corpak as catalysts for growth, continuing to strategically deploy capital, integrating acquired assets and delivering synergies, and executing on our cost savings targets and developing additional savings opportunities.

I will now turn the call over to Dave to walk you through the financials..

Thanks, Joe, and good morning everyone. Before I review our results in more detail, I want to first discuss the status of our IT implementation and the actions we are taking to remediate the new system and processes. Introducing the new IT system with a major milestone in our transformation and overall, we're pleased with it.

Since the August launch, we have been able to effectively take orders, manufacture products, collect cash from our sales and report our earnings. With a project of this magnitude is not surprising to encounter challenges that require temporary manual workarounds, resulting in short term decreased efficiency from the change in processes.

Overall, the peak of the number of issues is behind us and we are not seeing new ones develop. As we move forward, we're working to address three main issues; one, change management under new technology and business process; two, order-to-shipment process efficiency; and three, cash receipts and disbursements efficiency.

Rest assured we are making system stabilization and process improvement a top priority. Already, we are beginning to see the benefits of a single system and viewing our inventory on a global basis without the need for offline data reconciliation by our team.

We remain confident that over the course of the next several months, we will continue to improve performance and efficiency. Transforming our cost structures is a top priority and our IT and back office infrastructure is part of the cost savings we continue to expect to generate over the next two years.

This, combined with savings in manufacturing and other areas in SG&A, equates to the $12 million to $16 million in cost savings, which we are confident we will deliver next year. Now, let’s shift to a review of our third quarter results.

Overall, we delivered $171 million in net sales, a 4% increase compared to the prior year, and adjusted diluted earnings per share of $0.30. Sales from NeoMed and Summit Medical contributed 6% to our growth. Organic volume fell less than 1% and unfavorable product price and mix declined 1%, which offset growth from our acquisitions.

COOLIEF again grew double digits and had its highest quarterly growth this year, bolstered by our direct to patient advertising.

While we're pleased with the continued strong demand for the therapy, growth was slightly below our expectations as we have seen several customers move from multi-probe kits, standard kit, which drove an unfavorable sales mix. We continue to build a companion clinical evidence and invest in additional studies to enhance private payer coverage.

In September, the Pains Physician Journal published a large retrospective study that reinforces the clinical effectiveness of COOLIEF in treating chronic knee pain and providing long term relief.

As highlighted earlier this year, we're also conducting a large multi-centered prospective clinical trial to evaluate the effectiveness of COOLIEF compared to hyaluronic acid injection.

Clinical outcomes data, which confirms the long term effectiveness of COOLIEF for the treatment of OA knee pain have been accepted for presentations at several industry leading conferences. Four of which will take place this month.

To help disseminate this data to a broader audience, including pain physicians, orthopedic surgeons and rheumatologists, our team is holding symposium at key conferences. In acute pain, we are encouraged that ON-Q and IV Infusion delivered results in line with our expectation.

ON-Q sales were down mid-single digits for the quarter, and sales through lighters again increased by double digits sequentially. Turning into Chronic Care. As Joe discussed, performance was primarily affected by the product back orders and supply chain issues.

In addition, we saw an unexpected decline in purchases due to drawdown of inventory at certain distributors. Overall, we continue to view Chronic Care as a mid-single digit growth business. Our tracing data supports consistent growth and we have retained all of our key accounts and don't see any changes in the underlying market dynamics.

Moving to our international results. Sales were impacted by back order and supply chain issues. Mitigating these challenges was complicated by the Avanos' rebranding in some countries. Results did fall short of expectations, partly due to tenders won by our team in Latin America that have yet to be converted to orders.

Sales in our EMEA region also trailed our forecasts, largely due to delayed uptake and market development growth in our pain management businesses. Despite this quarter's performance, the International Business remains a key catalyst in our overall growth, and we are confident we will work through these temporary setbacks.

In our Asia-Pacific region, where we had a team in place since last year, we saw double digit growth for the quarter and just below double digits for the year. We are encouraged by these results and believe there's a similar opportunity in our other regions. For the quarter, adjusted gross margin of 57% was unfavorable compared to last year.

We anticipated a lower than normal gross margin for the quarter as implementing the IT system required taking down and restarting our manufacturing facilities. Additional pressure stem from an increase in distribution costs related to alleviating customer backorders.

Adjusted operating profit totaled $21 million for the quarter compared to $25 million a year ago, as results were impacted by the decline in gross margin. Adjusted EBITDA for the quarter was $25 million compared to $28 million a year ago. Adjusted net income totaled$14 million compared to $18 million a year ago. Shifting to our balance sheet.

We ended the quarter in solid financial position with $214 million of cash on hands. Free cash flow was an outflow of $24 million due to spending on onetime items, and an increase in working capital related to the new IT system.

During the course, some electronic data invoicing to customers required temporary manual intervention, which delayed our billing process and the collection of receivables. As Joe mentioned, we revised our full year 2019 outlook, which now includes Summit Medical and Endoclear.

Due to this quarter's results, the expectation that these factors, in some part, will also impact fourth quarter, we now expect constant currency sales growth of 5% to 7%. Given the adjustment in our sales expectations, we are revising our adjusted diluted earnings per share to $1 to $1.10.

In summary, we are confident we're taking the necessary steps to create shareholder value, while focusing on our fourth quarter and 2020 priority. With that, operator, we are ready to take questions..

Thank you. We will now begin the question-and-answer session [Operator Instructions]. Our first question comes from Chris Cooley with Stephens. Please go ahead..

Good morning and appreciate you taking the questions. Just two for me, and I’ll hop in queue.

Maybe Dave, on that last point on gross margin, if you would just maybe help us parse out a little bit more the impact from the IT system integration relative to just the mix that you saw on the business and the volumes? I appreciate the schedules you guys provided.

But that would only imply about $2 million roughly of a hit from the post divestiture IT issues there in the quarter. So I just want to make sure I can kind of throw it back to kind of prior year period? And then I have a follow up on growth..

Hey, Chris, this is Joe Woody. I'll tee it up a little bit and say a few things, and then Dave can weigh in. But last year, we did experienced 65% gross margin with high productivity.

And what you're seeing in this quarter is, with the IT system, we had our plants down in the quarter and equally, we had high distribution costs as we saw this backlog, things like air freight.

And there's little bit of a mix piece, as well as NeoMed came in with a lower gross margin, we have a plan to quickly get that up to our standard gross margin. And you see a little bit of the acute pain sales down where we have a high gross margin. There's an impact there that you see.

But we still feel like for the full year that we've got gross margin for about 60% or so.

But, Dave, you want to add to some of that?.

I think as Joe indicated those were the main drivers of what moved it. I think obviously the biggest impact in our normal margin would have been having our plants down roughly a week, and then taking the time to start those plants up.

Obviously, you don't get those back up to normal efficiency day-one, especially with the new systems that the teams were operating in at those facilities. And so that probably was the biggest driver, overall, Chris, relative to having margin being down this quarter.

Obviously, we do not expect the increased distribution costs as we put together our plan. But those were necessary as we encounter some of the back orders.

And some of the back orders, so little bit more color on that was more in Chronic Care, specifically in our Digestive Health category, which had some favorable margin relative to our normal or average margin. So that was a driver as well..

And then maybe just lastly for me, and I’ll get back in queue. Very pleased to see the enhanced reimbursement for COOLIEF, and I think it's well deserved there.

Could you talk a little bit about your investments, going forward? As you talk about you may be a little bit more aggressive distribution of that technology, both for other indications here in the United States outside of the OA indication, but also international expansion. Just kind of what we should assume in terms of incremental investment.

And when those initiatives should start to contribute from a top line perspective? Thank you..

Chris, Joe Woody, again and thanks for the question. I mean I think the way to think about it is, let me just say a couple things. One thing is that we've got good momentum in that business, again 20% growth but we were very happy about. Obviously, the result that we got, it could have been very negative.

But the team here and our consultants worked very hard to get that reimbursement final decision lifted and raised. So we now have the same reimbursement as we have today. So I wanted you have the understanding that that reimbursement had been in place and was in organic code. And then the other thing is that we now have a dialog open with CMS.

There's an opportunity for us to work with them on the Ambulatory Surgical Center overtime, which we believe would bring in orthopedic surgeons and not just interventional pain specialists. I think you can see that we'll sort of probably moderate some of the investment initially, because this is what's going to happen.

Commercial payers are generally going to react negatively and want us to complete the clinical studies that we have in place, specifically HA, and we'll have one in 2021 that is comparing standard and cool.

And in the second half, you might see us then raise a little bit of that investment in COOLIEF, but not to the extent that we did this year where we added the reps, we already got them in place, or we went extremely heavy on the DTP.

We do feel like we'll have some DTP investment in this business, because we saw that it does generate, and now I think with the reimbursement in place, more interest from physicians. But not expanding necessarily the field sales force, that's a possibility out in 2021..

And Chris, I'd add to Joe's commentary. If you think the last couple of years following us since the announcement of the S&IP divestiture, we've increased spending substantially related to investment behind COOLIEF in our international regions to get that to the level that it needed to be at.

Obviously, we're not going to give guidance right now for 2021. But I don't think we would expect to see the same level of step up in investment next year. We've kind of got it to where it needs to be. We can make some tweaks on how we spend that money in different levels. But again, shouldn't see the big step up that we've done over the last two years.

Some of the things are in place, whether it'd be, as Joe mentioned, DTP, we've done that. We've also started spending money in international to get behind this therapy with some additional resources there. So I'll leave it with just -- I think we're at a good level of spending.

And any spending that we do increases as we kind of on the margin and not the significant ramp up that we've done the last couple of years..

Yes, really the stage has been set. I mean, either way we can think about it. We got the clinical studies in place. Now, they're going to come to an end sort of HA in the middle of 2020 and COOLIEF and the standard RF in 2021. We expanded the sales force last year. We did a real big push in DTP.

And now we have the right reimbursement decision, and we can moderate our investment will be anything like it was last year..

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

First off, Joe, Dave, when we think about some of the headwinds that are impacting 3Q and are moving into 4Q.

Do you necessarily lose any of those sales, or is it just push or some of it just pushed out into 2020? I'm just trying to understand what's transitory delay versus something you may have lost?.

Yes, I'll say a couple things. And I'm sure Dave will weigh in. We do believe that the backlog issues are going to carry into Q4. Inside of that where we had inventory issues and feasibility and the cycle times really doubled from the product development all the way to sterilize it from the plant. We think that can continue.

And inside of that, there's also some rebranding going off. I'll give you a specific example, in Europe, where we are fully registered with our Avanos branding, and we have higher inventory and that was limited, and part of that limited visibility that the supply chain experienced.

So we're being, I think accurately cautious in thinking that it could continue into Q4. That said, we're making progress every day against that backlog that we had. We do think that we can lose some customers in this scenario. I think we lose them permanently, no.

But there are other issues associated with the implementation of the IT system, like credit holds and some invoicing and customer service. So that's where we are on it..

The only thing I'd add, Matt, I think as we look at it, we will experience some of this business that the product was needed and it was not available, whether it be direct or because it was getting order through a distributor, that would be a lost sale from that aspect. And that's why we're reflecting it and changing guidance.

As we work through and the back order situation is improving, hopefully, this is one thing that won't really be an issue with the beginning of next year. Though, we're still working through the back orders today..

And then just to follow up on COOLIEF. I guess what has changed from a reimbursement level like versus before the first proposal. I think the first proposal rule was a negative to hospital then you get a enhanced back up.

What's changed in that versus what you had initially? And then why do you think you didn't get -- or did you get the level of reimbursement you were expecting from physician offices and ASCs?.

So on the -- the easiest way to think about the code from hospital outpatient department is that what was proposed was $800 for the facility, and we ended up all the way back up to $1,719, which is really akin to what we see in the spine area, so that's really, really positive.

On the physician side, really in all the categories in physician payment went down, but we don't think that that was true in the spine and true from what was -- actually what was proposed to stay the same for us in the knee. But we don't think that would inhibit the procedures.

The reason that we think there's an opportunity in the ambulatory surgical center is there's been a decision by CMS to move this into an office category, because they're just -- the part of CMS that make these decisions is uncertain, where most of these invoices happen or procedures happen.

And so we are really feeling like we have an ability to work with consultants, brand group that can quickly show that pretty much all of these procedures are in the facilities. And so moving to the facility payment, we're sort of in the 350 range today and for surgical center, there's a possibility we can move that over time to 800.

And there would be physician fee associated with, for example, orthopedic surgeon doing that in ambulatory surgical center. So every quarter this is looked at. We're going have a chance to comment on and it's probably more of a mid-term opportunity to long term for us.

And what I would say about that is that, longer term, I think what those could be interested in doing this, because they're used to bundled payments in the inventory surgical center and they're trying to get the catchment of these patients, so that ultimately they get the total knee repair.

And I don't if Dave wants to make a comment?.

I mean, the only thing I'd add too, Matt, to this is you also think from a reimbursement standpoint, we also are focused on the private payers, and that's a little bit longer of a journey. But we continue to make progress with our clinical trials -- our clinical studies, excuse me, relative to COOLIEF.

And as Joe talked earlier, we have one that's starting up comparing COOLIEF, which is standard RF. And we've already have the steroid study complete, and we'll be showing data here in the next couple of weeks with respect to the hyaluronic acid for the first full year as part of that study.

And so that journey continues with the private payers as well, which is also an important part of getting COOLIEF more fully reimbursed..

I think, it's really important what Dave said. I think everyone on the line has seen this with other technologies. You get your code with CMS and then you really have to have all of your clinical studies complete.

And for us the big one really is around July of 2020 with AJ and then further to that standard, which is really what the payers are going to be looking to. It's don't mean that we're not going to be doing business or we're not going to grow our business. But the real uptake that people are looking for sort of pushes out to the end of '20..

Our next question comes from David Lewis with Morgan Stanley. Please go ahead..

Good morning, Joe and Dave. This is Marissa Bych on for David Lewis. I have two quick questions. The first one would just be, as we think about 2020 margin expansion.

To what extent do these third quarter issues bleed into 2020 by your best estimates? And what's the right way to think about next year? I think, consensus has about 4 points of leverage at this point.

So can 2020 be 2 times or more the expansion that we're going to see in 2019, or would it be a little bit below that given the issues you have here?.

So I'll try to address that question first, Marissa. As we think about 2020, obviously, we're still putting our plans together with respect to that. You have to think there's definitely margin or leverage that we can get from our cost savings initiatives.

One of the carryovers and the impact of kind of resetting guidance here is we will have to reset compensation in some aspects for our short term incentives and sales commissions.

Those have been unfortunately favorable adjustments that we've made the last couple of quarters that we're all hoping to get added back to our P&L next year as we deliver our plan. And that will offset significant portion of the savings as we go into next year. And then you look at the -- there's going to be several moving pieces.

Obviously, we won't see uplift in spending, we kind of commented on that reflective of some of the investment. And so hopefully, we get a little bit of margin expansion from the top-line growth of the business..

And then just one quick follow up on ON-Q supply. I think we saw Hospira come back online this quarter, I want to say early October.

Is there any visibility that you have into how that impacts recovery timing? And then is mid-single digit, the right way to think about 2020? I think last time you had mentioned maybe a cadence of low-single digit to mid-single digit growth in the acute pain business over the course of next year.

If there's anything you can share with us on your expectations there, that'd be great..

Marissa, this is Joe Woody. So ropivacaine looks to be back into the market, bupivacaine is not completely back in the market. And just again for everyone's education, it's 70% ropivacaine and 30% bupivacaine. And so what that means for us is the drug is back available starting to get back available almost in entirety.

But what we really have to do is resell the business to customers that were doing business with Avella, and PharMEDium. And they've now moved on to other solutions, as we've mentioned on a couple of the other calls. And not unlike Leiters, which continues to be very successful and growing nicely.

It can take several months to get folks moved over and get processed, not only with just discussions with them about doing that, but then their own processes of changing their contracts and their protocols. So we see a lot like the Leiters' process and getting them back.

And what we sort of feel like is that it's more of a flat type of a business in 2020 with low single digit growth emerging in the back half of the year. We do think, long term, potentially, we can move that up, as you suggested, so that helps to give maybe a timeline..

[Operator instructions] Our next question comes from Kristen Stewart with Barclays. Please go ahead. Hello, Kristen, your line is open. It appears we don't have Kristen. we will move on to Ravi Misra with Berenberg Capital Markets..

So just my first question, I wanted to go back to, if I could, Chris' question around gross margin. With -- just hoping you'd help us quantify some of the level, maybe directionally. Last quarter, it was a similar sales base, and you were looking at kind of 60% gross margin.

I think after that call last quarter, you said the third quarter would be a little bit below that.

Would it be fair to say that if we kind of adjust for all these margin-related call outs in the third quarter, the gross margin level would've been closer to kind of your original expectations after the 2Q call?.

Ravi I'll take that one. I mean, we definitely expected to have a sequential decline in margin given the shutdown of the plant. It's hard to exactly predict that as we think about how long they're going to be down and how quickly they get ramped up.

From a modeling standpoint, it was a challenge for the teams to effectively estimate that, given we've never done it before. But that's the biggest driver. And then what was not planned was really around kind of the distribution aspect of the business. NeoMed, as Joe mentioned, was a drag on that sequentially as well.

We're confident we can get that back up to kind of the average margin of the business as we get to the synergies over the next two years for that.

But again, I would really emphasize that plant downtime and then the startup of the plants and getting them up to a more normal efficiency was the biggest driver, and then some of the distribution costs associated with trying to relieve the backward situation at the end of the quarter, was the second piece to that..

And then just on ON-Q, I appreciate the color for 2020 around that flattish growth.

Just curious, if you can explain to us a little bit kind of what's in your control here and then what's out of your control in terms of how the hospitals go about securing that sale? Or whether you can drive contracts with your customer ahead of them to securing those bills? Just walk us through the sales process there and why it looks to be rebounding little bit?.

I mean, ultimately, as you get drug back, that's a great thing and that puts it a bit more in control for us. There is still really only one 503B that really can solve the solution for our customers. At Leiters, thankfully, we have the sole source relationship with them.

But essentially, many of these customers have likely moved on to their uses opioids, or their own local shops, or a completely different approach to treating these patients. I think we can get a greater majority of them back over time. But again, as we experienced with Leiters that timing can be several months.

In some cases, that can be up to a year for an account. The difference now though, and the positive for us, is what we know was working with us was cadaver labs, talking to surgeons, getting our education or clinical studies out. And we now have ways and avenues that are very different than one solution.

So over time, I'm very confident about us getting back to the kind of positions that you've seen in the past. So we just are really making sure that everyone understand it's just not an automatic that in the fourth quarter, you're going to see that kind of pop..

I think this is also an area we're bringing in Summit as a different solution with the electronic pump clearly has helped improve the conversation with some accounts.

And as we continue to bring that into the portfolio and our reps trained on that, it can be additive to the portfolio as well and not only retaining customers but also getting customers back and moving forward with more people adopting the therapy..

I think that's a good point that Dave makes. I mean, we are experiencing a real positive reception from customers on the Summit acquisition. They understand and we can show them pathway of our innovation on that. They're excited about the relationship with BioQ that we put in place.

So really in terms of pumps, and that's being the market leader everything coming back. We've got the best solutions in place. And frankly, we've got the best breakthrough work going on. So for that segment of the market that's outside of the longer acting local, we're going to be in good position over time, so that I'm happy about..

And then maybe just one last question, or maybe two last questions, just one easy one, the FX impact that you're now expecting for the full year. And then second, one of the questions that we've been getting on the road a lot for -- regarding the company is.

Can we get an update on the CFO search, and I don't think you guys provided one in the prepared script. So any info you can give us there. Thanks..

Yes, I'll take CFO and then I guess Dave is waving his hand, and wants to talk a little bit about currency. Look, this is still a very compelling story. It attracted me from the standpoint, look, there is complexity. We are transforming our business. We have done a lot of things. Some have gone well. Some have not.

And I think that the interview candidates can see that. And then we're actually getting to a point where you start to look out a year from now, we get a lot of these things that are headwinds in our rearview mirror. We had been close with a candidate that we just didn't fully get to agreement on that we thought we were home with.

In the meantime, Warren who -- MacHan who was the CFO of the division, is doing an outstanding job. Also, Dave is taking on some of those roles and doing a great job for us along with the team. We have a good list now and we're now progressing with the next in line and a few new candidates.

So I think our new sort of target you can never predict these things like M&A as to get something done by the end of the year. It may not have squeezed completely into the fall. But happy with the slate I'm seeing. And then Dave, if you want to mention….

Yes, on your currency question, Ravi. Currency has been a slight headwind less than a point pretty much all year long. It's going to be less than a point we would anticipate this year of a headwind to the business..

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

So I just wanted to go back to COOLIEF I just wanted to understand the reimbursement, because it is kind of confusing.

So the 1,700 that the new rate is for hospital outpatient, how does that compare to kind of the average reimbursement that was in place? Because my understanding was that you could book some modifiers, and so the average reimbursement that the typical hospital outpatient could get was actually, I guess, generally higher.

I guess, what's kind of like where the net reinforcement has -- I guess, it's higher than generally speaking.

But just, I don't know if you have a sense for where it is now relative to what's an average kind of hospital was getting?.

Yes, so very similar to the average that the hospital was getting, we're going to be at $1,719 for the facility and about $153 for the physician.

The difference is that we can't do multiple nerves beyond three, that's the package that you get as lot of this is going through bundling, as you know, and sort of one payment for everything on the procedure. We've worked a lot with our existing customers.

And obviously, a lot of them were directly involved in the help that we had between the hill and also our consultants to look and do this. And I think we're in a space now where we feel very comfortable that they're going to utilize this procedure for the knee in HOPD.

And you know, we are now out of a situation, I think I saw you're right up where it could have been somewhat similar, but it could have been obviously bad for us had this gone the other way and those knees weren't available to us..

So the way to think about it is, it removes kind of that downside risk.

And so this is net-net, a positive and kind of can keep you growing COOLIEF at that double digit pace from here on out?.

Yes. And then I think the other thing it does for us as the studies come through, we now have a leg to stand on. We go into these commercial payers and talk to them and say, look, CMS has a code for this. And obviously, if you managed Medicare, you sort of have to follow that along with Medicare.

And you get out a year from now, towards the end of this year and beyond in 2021, when all these studies are done, then it becomes very powerful. But I think you're thinking about it the right way..

And you mentioned there was a shift from the multi probe kits to standard kits, and that was kind of an adverse next.

What exactly was that? And is that something that you'd expect to continue?.

So we sell a single probe kit that if you're doing burns on a knee or back, you just use that, you place it once to a burn and then you place it two or three other times, depending upon the number of burns that are necessary for the procedure.

An alternative and at a higher price point is our multi probe kit that allows the physician to place all three or four probes at one time, and do the burns at the same time. It's a more efficient process for the physician. You can do more patients that way. But we do charge a premium.

So we saw, unlike in the years past where we'd actually moving people to that multi probe kit, we saw more people go back to the standard kit, which is less expensive options for them. Tough to say whether or not it will continue as we go forward.

It wasn't a significant headwind, but it was one that definitely impacted versus our expectations for COOLIEF..

And then my last question is, what is the organic growth guidance? For the full year, I think you've obviously revised the range. I think last time organic was around 2% to 4%.

If I'm looking at it correctly, is it now around down 1% to up 1% for organic?.

You got it right, Kristen..

And then just in terms of next year, it sounds like some of these issues are likely to persist into early in the year. So it sounds like we should expect some continuation to these headwinds. And then as we look into late 2020, some moderation.

So just kind of think of next year as kind of an improving trend, I guess, when you guys ultimately 2020 guidance?.

Yes..

Our next question comes from Lawrence Kirsch with Raymond James. Please go ahead..

This is John Hsu on for Larry. I just had a couple. If we could just stay on Kristen's question for a second, just as far as the changing guidance, I think you took things down by 3% at the midpoint. Can you just walk us through the backorder impact? You said that's about 80 basis points, I believe.

But then distributor destocking, international sales shortfall, partially offset by Endoclear.

Could you just maybe walk us through those three pieces that gets us to the new range from the old one?.

John, as you look at that, clearly, we have the impact that's rolling through this quarter relative to our expectations, which is about half of bringing that down. And then you have the continued piece relative to potential risk on the back orders going into the fourth quarter, that's partly reflected in there.

As we look at Chronic Care and the start of the sales in October, we continue to see some of the distributors pulling down what would have on their sales and look to be adjusting our inventory. So we're reflecting that into the guidance as well.

We talk to those distributors and they've communicated, they're going to get back to a more normal level or start rebuying at a more normal monthly level. But October was off to a little bit of a slower start similar to where we saw the end of last quarter. And then the other piece is international.

So we had some tenders won in the first half of the year. And we have been counting on those to come through. A lot of those were Mexico. But with the government change that we have not seen those orders come through unfortunately.

And then some of the acceleration we had hoped for with respect to the EMEA pain management business, both in acute pain and the interventional pain that is falling short of expectations. We had hoped to cover some of that with a little bit stronger Chronic Care sales, but that's an opportunity that was not now going to present itself.

So those pieces are pretty much the bigger drivers of the revision relative to guidance, with the hardest part to predict is really how we address the backorders into the earlier questions. What part of those sales that we actually missed, because we didn't have product available for our customers..

And then I also got the comments that you still feel very confident with the focus on IT that you can get the savings of the $12 million to $16 million in 2020. But can you just speak to the confidence in the long range margin targets. I think you thrown out there that you expect EBITDA to move to the mid-20s range, but exiting 2021.

So just where we are now, do you expect that to shift at all?.

I'll say couple of things, and I think maybe Dave will make a comment or two, because that's generally like the plan and the metrics that they intact. And so we're clearly behind with this quarter and what we're seeing will continue into Q4. The main driver, obviously, has Acute Pain, which started on the supply dislodgment that we've talked about.

We definitely need to accelerate organic growth. We're committed to the cost up, but we believe that now we need to go further, and you can expect more cost out coming from us. I don't see the peak metrics being reached on margin in 2021, but I do see that overtime we can get there.

And then there's sort of three things that change that as a variable; obviously, to the extent that we can accelerate the organic growth; number two, the more costs beyond what we've already talked about; and number three, obviously, the things unique about a company of our size, is the M&A and the capacity that we still have in the 400 and 450 range.

So it's going to be getting there a bit of a different way and the timeline, obviously, slightly different as well..

[Operator instructions] Our next question comes from Rick Wise with Stifel. Please go ahead..

I'm joining -- jumping between calls, and I want to go back to the IT question again, I know you've answered it in part. But I just want to make sure I'm clear. What -- you know, the system came on in August so it was before the end of last quarter. And I'm not quite clear what happened.

Did it not have whatever the issues were didn't come up immediately? And how confident are you that the IT issues have peaked? I mean, just help us understand your visibility on that and how completely you feel like you've de-risked it? Thanks so much for the incremental color..

Yes, no problem. This is Joe Woody. One of the things that I think about as we are up and running, working, we're billing customers, we're closing our business, we now understand that loss of visibility that we had in supply chain.

And Rick, earlier on the call we were talking about what essentially causes a problem was the inventory cycle times doubled from the plant, to the sterilizer, the customer. Another piece inside of that is that we're having branding going on.

So the level of how your inventory versus Avanos inventory in international where you're not registered became a factor as well, and so was largely Chronic Care related. I've seen tremendous progress since August 1 in the go-live.

And these teams were basically the big change process, kind of where they're learning new terminology, they're learning new systems. There's a training element to it. And it feels like that we're really getting our hands around this, but we're being very conscious about, in particular, the INTERNATIONAL side of these backlogs.

In the event that we carry on, in fact, we have a backlog right now into Q4. Internally, we sort of characterize it as and if you want a football analogy is that, we were running the wishbone with an old IT system and we're now running the run and shoot. And that caused a lot of issues.

But the most major really was that inventory of build and the ability to see the inventory. We just recently been visiting with our Board, and we show them what we're doing in the ward room. So I do think that we're going to be out of this thing as we get into Q1, but we obviously need to be cautious in Q4..

The other color I would add, Rick, to Joe's response is. The system itself is working appropriately and to our expectations. It's really the biggest thing is those change in processes and getting used to, obviously, a different system, trusting the system that's in place.

You're seeing reports that are slightly new and people are having to learn and adjust to those, and making sure that they have confidence in what is being generated out of it. As they do see that and it's backed up with information from other teams, that's where we're getting really the benefit of going forward.

If I just throw a couple of examples, though, it took us pretty much the entire month of August to close the books. That was essentially cut in half for the month of September. As we've gotten familiar with this, we're seeing more efficiencies on looking at things from a global basis. So it is working appropriately.

And we are making significant improvement in efficiency. And so unfortunately, we've probably had a little bit more issue than we anticipated relative to some of the cycle times. When we kick this thing off on August 1st, we were shipping orders to an equivalent level almost immediately, or just within a few days.

It really became an issue relative in September and trying to replace and refresh the inventory at our distribution centers and internationally..

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

I was wondering if you guys could just give an update on your cash flow expectations for the year.

And just going forward just seems like -- and I'm just curious if there is going to any added expense just with the IT infrastructure changes, or anything like that? And then just how we should just think that cash flow generation profile of this company?.

I'd say the biggest impact in cash flow in the third quarter unfortunately was working capital. One of the processes things that changed relative to receivables impacted that, and we definitely saw an increase in our receivable, we're working to get that back.

So that as we go through and get back to a more normal level, we'll be a positive impact to cash flow, whether it all comes back in the fourth quarter, I believe in the next year, and we'll see how that happens. So the team is definitely working on it. I think you've see a big reduction in capital spending.

So we're getting new more normalized level there that happened in the third quarter. We did have some elevated onetime costs around some of the things that we're doing from an acquisition integration standpoint. We had some higher legal cost. We're beginning to hopefully get the level where you start to wind those down as well.

And so as we get into next year, we're definitely looking to have favorable cash coming into the door as opposed to going out as we build our plan..

And then just go back I was just want to make sure I heard clearly on the ON-Q side. Joe, I think you had said for ON-Q next year, you were saying that could be even more of a flattish business.

Sounded like maybe a little pressure earlier in the year as drug supply makes its way back into the channel, and then kind of exiting the year more a little bit of a low-single digit growth, and then maybe looking out more into 2021 get back more to that kind of mid-single digit growth profile, sounds like COOLIEF is still now intact with reimbursement.

Looking like it's flat or maybe even a little better with what's currently in place.

Does that sound about right? And maybe Chronic Care probably still you're confident kind of that mid-single digit growth profile?.

Yes, you got it right..

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

Just a quick one for me. You guys mentioned that cycle time to sterilization has been extended.

Are you guys having issues with contract sterilization and running into some delays there?.

Not to the scale that you see some of the other medical device companies.

We've got a couple of smaller product lines, one would be, micro cup as an example, where we're seeing a little bit of an issue in Q4, but not at magnitude, because the team has done a good job of having multiple sterilizer, you know, companies that we work with and also geographic location, so less of an extent for us, as you know that that is a big trending issue for most medical device companies right now..

And then I apologize to the employees that Avanos asked -- for asking this. But would you guys have like extra downtime to get these back orders in place around some of the holidays.

Would you have some like extra days available that might not be accounted for manufacturing?.

Look, I mean, the teams -- it’s a good question. The employees are doing a great job. On the IT deployment, there have been a lot of 24/7 weekend work going on. There's a war room where folks are here pretty late night and work in the weekend, so that's definitely going on..

All right, keep up the good work. And Joe, I think you need to update your football references too..

This concludes our question and answer session. I would like to turn the conference back over to Joe Woody for any closing remarks..

Thank you. Thank you everybody for their interest in Avanos. I, along with all of our management employees, share our tremendous passion about this business and what we're doing. Sometimes, it isn't easy because of the magnitude of what we're doing.

We shared a great deal of information today, because we want to make sure that all our investors understand where we're making progress, and what we're doing to overcome the hurdles.

I and the team remain committed to our strategy of accelerating organic growth, pursuing M&A and taking out costs, and following a number of necessary changes to our business. We're focused on key drivers of growth and fully competent in our ability to achieve our Q4 and 2020 priorities. Thank you very much for your support..

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