Good day and welcome to the Avanos' Fourth Quarter 2019 Earnings 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 Dave Crawford. Please go ahead..

Good morning everyone and thanks for joining us. It's my pleasure to welcome you to the Avanos fourth quarter earnings conference call. With me this morning are Joe Woody, CEO; and Michael Greiner, Senior Vice President and CFO. Joe will begin with an update on our business followed by an overview of our 2020 priorities.

Then Michael will review our results, offer details on our financial performance and earnings outlook for 2020. 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 strategic financial results. Actual results could differ materially from those in the 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 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..

Thanks, Dave. Good morning everyone and thank you for your interest in Avanos. I'd like to start by welcoming Michael Greiner who joined the team at the beginning of the year and has been busy immersing himself in the business.

Michael has deep experience in change management and portfolio optimization, and we're excited to have him on board at a time when we're focused on driving efficiencies and accelerating revenue and earnings growth.

Now I'll turn to the fourth quarter results and the progress we made on our key focus areas of growing sales and executing against our strategic goals. We ended the year with a strong fourth quarter, sales increased 12% to $190 million, and we earned $0.34 of adjusted diluted earnings per share.

For the year, sales increased 7% to $698 million and we earned $1.07 of adjusted diluted earnings per share. During the quarter, our Chronic Care business delivers solid mid-single-digit top line organic growth. Growth partially benefited from the recaptured sales missed from our third quarter fact backorders.

Pain management delivered positive organic growth for the quarter. In our Acute Pain business, ON-Q sales declined by low-single-digits in-line with our expectations. In Interventional Pain as expected, performance was driven by continued double-digit growth in COOLIEF.

As we announced yesterday, the FDA cleared for marketing our new 80-Watt COOLIEF Radiofrequency System for neurological lesion procedures. This new easy-to-use system comprised of a newly designed RF generator peristaltic pump and therapy cables enables physicians to perform a full spectrum of procedures.

This advanced fully RF generator demonstrates our commitment to introduce innovation to the marketplace as the cooled RF authority. We're excited to debut our new system at the upcoming American Society of Interventional Pain Physicians Annual Meeting.

During the quarter, we continue to show clinical differentiation for COOLIEF as reported in several studies. First, at the 18th Annual Pain Medicine meeting of the American Society of Regional Anesthesia and Pain Medicine, we reported the 12-month results from a clinical study comparing COOLIEF to hyaluronic acid.

These results demonstrated that study participants who received COOLIEF experienced clinically relevant pain relief that lasted up to 12 months. In addition, the 24 months data from a clinical trial that compared COOLIEF to a steroid injection was published in the medical journal pain practice.

This newly published data demonstrates with up to two years of pain relief is possible on a single COOLIEF treatment. Turning to 2020, we plan to execute on the priorities set last year centered around positioning the Company for long-term revenue and earnings growth.

At the same time, we recognized that some of our 2019 results were below our expectations. Therefore, we're focused not only on doing what it takes to meet our long-term objectives, but balancing that with achieving near-term goals to ensure our business reaches its full potential. Our four priorities for 2020 are.

One, build sales momentum across our four product categories, both domestically and internationally. Two, integrate our recent acquisitions. Three, generate positive free cash flow. And four, realize efficiencies from our IT system.

Now, I'll cover a bit about each of these priorities beginning with our focus on accelerating top line growth across our categories. Let's begin with our pain management business. We continue to see demands for a reduction in the use of opioids and our portfolio of less elastomeric and electronic pumps offers a compelling solution in acute pain.

Through the acquisition of Summit and the portfolio of electronic pumps, we have complemented our offering to customers. So far, this addition has been well received and helped us reinforce relationships with ON-Q customers. Within ON-Q, we are leveraging our strong brand to win back customers impacted by the industry-wide pre-filler disruption.

While this remains a near to mid-term headwind, we are seeing signs of improvement. The shifting of customers to Leiters resulted again in double-digit growth sequentially and the number of customers sourcing volume through Leiters.

Additionally, overall purchases of ON-Q by customers who have moved to Leiters increased by double digits in 2019 compared to the prior year. In Interventional Pain, we plan to continue to invest in clinical evidence and marketing to maintain COOLIEF's double digit growth.

As I mentioned earlier, we're building a strong compendium of clinical evidence that demonstrates the value of COOLIEF to both patients and payers while differentiating COOLIEF from alternative therapies.

This year, we expect the publications of several studies in orthopedic journals comparing COOLIEF to hyaluronic acid in the treatment of OA knee pain. We're also reaching new audiences including sports medicine doctors and orthopedists through our participation in conferences and symposiums.

On the marketing front to build on last year's direct-to-patient TV ad campaign, we're focusing on driving demand and increasing awareness of COOLIEF through our social media campaign. Turning to Chronic Care, our focus remains on growing our market leading positions in digestive and respiratory health.

Chronic Care represents 60% of our business and has strong fundamentals including stable revenue growth and significant cash flow generation. The upcoming launch of our next generation enteral feeding tube Mic-Key SF demonstrates how investment and innovation helps us maintain our market leading positions.

Mic-Key SF guards against tube dislodgment through a balloon indicator that provides a visual cue when the balloon is below the recommended level. In respiratory health, our recent acquisition of Endoclear demonstrates our commitment to open innovation and provides a strategic addition to our portfolio.

Across each of our product categories, we continue to view international as an important catalyst for long term growth. In 2019, we accelerated growth the double digits in our Asia-Pacific region that we fell short of our growth plan in EMEA and Latin America.

We are confident that we can enhance our performance across these regions, but recognize that it will take longer with new teams in EMEA and Latin America compared to the more established Asia-Pac team. Our second priority is the integration of our recent acquisitions of Game Ready, NeoMed and Summit.

A more stable IT platform yields more efficient integration of our acquisitions, helping us to more quickly realize targeted synergies. Both NeoMed and Summit are performing in line with expectations and positioning us to strengthen our customer relationships.

Although our near-term focus is on integrating recent acquisitions, future M&A remains a catalyst in our overall long-term growth. With that as a backdrop, our business development team continues to identify and evaluate potential future opportunities.

Our third priority is to return the business to positive free cash flow in 2020, as we progress in stabilizing our IT systems, we will over time recapture the working capital inefficiencies experienced last year. In addition with the IT implementation behind us, we expect to return to a normalized level of capital spending.

Finally, we expect a decline in unusual or non-recurring costs following the IT implementation and completion of last year's SMIP divestiture, combined these three factors position us to be cash flow positive for the year. Our final priority is to stabilize our IT environment and realize planned operational efficiencies and cost savings.

Implementation of our global IT system was a huge undertaking and I want to thank the team for their efforts throughout this process. We've made significant inroads in addressing the challenges we faced last quarter and have a detailed roadmap to address the remaining issues.

While we work through certain inefficiencies in the first half of the year, backorder levels have closed to normalized and no additional issues have surfaced. In summary, over the course of 2019, we took significant and necessary steps to fundamentally transform our business.

We completed the separation of the S&IP business and launched the new global IT systems. We invested to drive future growth and deploy capital for three acquisitions, increasing scale across our categories.

We have the right strategy in place to create shareholder value, and I'm confident in our ability to deliver on our 2020 priorities and financial guidance. Now, I'll turn the call over to Michael..

Thanks, Joe, and good morning everyone. Let me start by saying, I'm excited to be part of the Avanos team. I spent the past two months meeting with members of our team to learn more about the business and the challenges and opportunities we face.

My short time here I've been impressed with the talent on the team and their dedication and focus on accelerating growth across each of our businesses. I look forward to partnering with Joe and the rest of the leadership team to accomplish our 2020 priorities and execute on a strategy in place.

Now, let me begin with a review of our fourth quarter results. As Joe shared, we delivered sales $190 million, a 12% increase compared to the prior year. Organic sales growth of 4% was driven by increased volume, while price and sales mix have minimal impact compared to the prior year.

Our acquisitions of NeoMed and Summit contributed 7% of that growth. In Chronic Care, we returned to mid-single-digit growth as we made progress in reducing backorders as Joe mentioned earlier, ending the year at a close to normalize level. In Pain management, we're encouraged that organic sales growth was positive in-line with our expectations.

Within pain management, we're continuing to see signs of improvement in our ON-Q business as sales declined in the quarter by low-single-digits. As we enter 2020, there's more work ahead for us to return ON-Q to growth. Our partnership with Leiters continues to benefit customers who moved to this option.

Sales through Leiters for the quarter increased by double-digits, sequentially. Finally, moving to Interventional Pain, COOLIEF continued to grow double-digits this quarter. International sales increased by mid-single-digits as our team work to resolve some of the headwinds that stems from the IT system implementation.

Positive performance was driven by continued strong execution and our Asia Pacific region where sales increased by double-digits for the second consecutive quarter. Overall, our international business remains a key growth catalyst for Avanos, and we're confident we can deliver consistent mid-single-digit growth in the coming year.

For the quarter, adjusted gross margin was 60%, in-line with the prior year. Sequentially, margin expanded 260 basis points, reflecting the recovery from last quarter's IT implementation that requires disrupting our manufacturing facilities and increasing distribution costs to minimize backorders.

Looking ahead, we continue to see the business assuming gross margin in the low 60s with the opportunity for expansion overtime driven by cost savings and mission shift.

Adjusted operating profit totaled $26 million for the quarter compared to $20 million last year, while adjusted EBITDA totaled $31 million, up from $22 million on higher sales volume. The incremental step up in adjusted EBITDA compared to adjusted operating profit reflects the impact of the depreciation of our new IT system.

In 2020, we expect EBITDA growth to continue to accelerate faster than EPS growth. Adjusted net income totaled $16 million compared to $14 million a year ago, and we earned $0.34 of adjusted diluted earnings per share compared to $0.30 a year ago.

Now, for a brief recap of our full year results, net sales increase the $698 million, a 7% increase compared to 2018. This includes sales from Game Ready, NeoMed and Summit, which contributed almost all of that growth. Organic sales volume was up 2% while unfavorable price and selling mix negatively impacted growth by 1%.

Performance was driven by continued strong demand in Interventional Pain from COOLIEF and growth in Chronic Care. Adjusted gross margin for the year was 60% compared to 61% a year ago.

Our 2019 adjusted gross margin reflects the net impact of cost savings programs that were offset by the impact of last quarter's IT implementation as well as recent acquisitions with a lower margin profile. Adjusted operating profits for the year totaled 76 million compared to 62 million in 2018.

Shifting to our balance sheet, we ended the year in a solid financial position with 205 million of cash on hand and significant available capital that will allow us to be opportunistic regarding M&A and other strategic investments.

While we did see sequential improvement in free cash flow, we saw increases in both accounts receivable and inventory related to issues stemming from our IT implementation.

As Joe mentioned, stabilizing and realizing the efficiencies for our IT system is a strategic priority for the year and something I'm particularly focused on, we've made significant advances with the implementation and the team continues to prioritize commercial related frontend impacts.

As we resolve these IT challenges during the first half of 2020, our focus will be on providing greater visibility into the business for our teams and eliminating manual intervention in the system, so we can more effectively manage each of our businesses and drive working capital outcomes to the levels that are appropriate for our business.

As I mentioned, my primary focus in near term is to stabilize the IT environment. Once the system is stabilized, we will be better positioned to establish the appropriate cost structure for the Company, deliver operational and working capital efficiencies as previously mentioned, as well as successfully integrate our current and future acquisitions.

The progress our team has made today gives me confidence that went to the second half of the year with these challenges mostly behind us. Now, let's move to our 2020 outlook and key planning assumptions. Based on current trends in our business, we expect net sales on a constant currency basis to increase 5% to 7% compared to the prior year.

For the year, we expect to earn between $1 and $1.20 of adjusted diluted earnings per share. The following two planning assumptions are incorporated into our sales and earnings guidance. One, foreign currency translation is not expected to have an impact on 2020. And two, adjusted effective tax rate is anticipated to range between 25% and 27%.

In conclusion, I'm excited to be part of this team and look forward to driving value creating outcomes that help the business realize its full potential.

We are focused on the right drivers to create long-term shareholder value and I believe we will identify additional drivers once we start to leverage the capabilities associated with the implementation of our new IT system. Operator, we're ready for questions..

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Larry Kirsch with Raymond James. Please go ahead..

Joe, I guess first question just starting out with you. So, it sounds like there are a number of factors that are impacting On-Q and I guess as I tally them up, I see just challenges in getting customers that had switched away, back onto the On-Q pump, moving customers onto Leiters, as you certainly discussed.

And then, I guess there's probably some competitive pricing dynamic out there. So could you talk about the different dynamics in the business and whether you still expect to get the pump back into growth mode in the second half of the year? And then I have a follow-up..

Thanks, Larry. So a couple things, on a global basis, Acute Pain was a low-single-digit negative business for the quarter and in North America that was low to mid-single-digit, we did show sequential improvement.

And we've outlined that the biggest issue really around the return of a Acute Pain the growth is moving customers that we're filling with PharMEDium, as an example and another 503B's over two Leiters. And when we do that, we definitely see strong growth. I think we've got in the slides there. We talked about double-digit growth amongst those customers.

Secondary to that, we're seeing some real positive reception. Customers on the Summit acquisition and the electronic pump, as we move into kind of the middle of Q2 and into the summer, we think that that will be strong, we set our aim is for level growth this year in that business.

It's possible to get H2 into some growth, and we again are seeing a lot of customers queue up for Leiters and even larger customers wanting to come back. So, I think it's possible and we are showing improvement..

Okay, that's definitely helpful. And I guess two other quick ones here. So just Michael, perhaps if you could just speak to, what are the inefficiencies that you are anticipating in the first half from the ERP implementation and how do you get past those? And then secondly, just on the LRP, I know that's still sitting out there.

Certainly, it would feel like that those goals are extended or maybe not doable at this point.

But again, how should we be thinking about the LRP that's still sitting out there?.

I think what I'm going to do is, Michael has been doing a lot of work on the inefficiencies in IT and really grabbed the bull by the horns that he wants to say a couple things and then I'll come back to your second question..

Thanks, Larry. So, in the first half of the year, as we talked about in prepared remarks, we're very focused on ensuring we don't have some of the self-inflicted fool faults.

We had in the back half of last year and the team has been incredibly diligent on those kind of frontend commercial related activities, whether that be on the manufacturing and supply chain front, or just on the core analysis we do with our customers.

But I don't anticipate the first half to have any of those types of issues, but I'm more excited looking forward to is, what will start to be able to use the system for the second half of the year.

And that's really leveraging it for what we spent all the money to do in the first place, which is to get down frontend analysis with customers be able to make some strategic choices that we haven't had the information available, and to make sure that we're using the system broadly across the Company.

That's going to create a lot of training needs in this first half of the year.

We did a bunch of training out of the gate a couple years ago, many of those folks have moved on for one reason or another and one of the things that we've identified, as simple as it seems that a lot of people, new people are in the seats using the system and we need to reinvigorate that training so that we're using the system as intended..

And Larry, can you just repeat the LRP question or the guidance question you have..

Yes. Now the question, Joe was, obviously, that that three year LRP is, was sitting out there and, again, just trying to wrap my arms around whether we should still be thinking about that, as those objectives is doable.

Will there be an LRP update? Just again, just try to put that into context right now given where the business is?.

Definitely, and we communicated a bit of that at JP Morgan. We definitely believe that EBITDA can be in the mid 20s and operating margin the low 20s, and that for example, high single digit is possible for our business over a number of years. Obviously M&A and our performance can enhance that.

What we want to do though and we also did communicate that's going to be over a longer period of time than we originally laid out, obviously the big change in fortune there being the acute pain market dislodgement that we're dealing with which has changed the timeframe there.

And so, what we want to do is probably in the summer after we go through our strategic process with our board of directors is update and refresh, uh, the LRP. And that also gives Michael a chance to, you know, not only ingrain initially in the business, but run through his strategic cycle with us.

Get a couple of quarters under his belt and then we'll likely be talking about a new numbers then..

Next question comes from Matthew Mishan with KeyBanc. Please go ahead..

And thank you for taking the questions. Just a first one for a clarification.

What is the M&A contribution to the constant currency revenue growth this year?.

You're talking about for 2020?.

Yes..

About 3.5 points of growth, Matt..

Okay, excellent. So, it's about 1.5 to 3.5 organic..

A good range, absolutely..

And then just Joe, Michael, how did you approach guidance this year kind of versus the last several years? And I guess how much cushion have you put in this plan?.

A couple of things I can say and then let Michael add because you know, it's important that Michael put his eyes on things and it's nice having an outside view coming in. But if you think about our Q4, it was strong, but there was some seasonality. There was some recovery in Chronic Care, the backlog.

And we've talked about I think in the release and outlined about a point or sort of growth in IV infusion. That said, we still think that the implied organic growth if you take out the unusual factors, we ended the year sort of 2% to 3% organic growth, but we have seasonality in the business.

You have to balance the risks and the opportunities and we see our chronic care businesses in mid single digits, top line grower. We obviously are happy with COOLIEF remaining at a double digit. There's a little bit of a change in our outlook on international being more of a mid single digit grower.

We just still think it can get to high single digit over time. So it's actually a catalyst for our business. So that was some of the thinking on the top line. Let Michael maybe give you his views and sort of how he's also viewing EPS a little bit..

Okay, great. Thanks Joe. I think to add to what Joe was just saying. We've learned a lot over the last two years. So a lot of the effort I made in the first month is to really understand.

What were some of the puts and takes that we experienced? What were some of the things that could have been avoided? What are some of the competitive dynamics? And let's make sure we capture with Warren, who as you know did a great job as interim for the last handful of months. Let's make sure that we capture the puts and takes as we go into 2020.

So, by no stretch do I think, are we putting out guidance that is super conservative, if that's where your question was headed, but I do think we've done a very good job of looking at the various factors as we enter answer the year to make sure that we understand what are some of the downsides and headwinds, but also what are some of the attractive tailwinds that could kick in, especially as we get to the back half of the year..

Last thing I would say, Matt, I think we're well prepared to compete against Medtronic and we've proven that so far, but you do have that to consider. And then we also have here on entering Acute Pain. So, for all the upsides that we actually, in fact, do have an opportunities, we're balancing that risk..

And I just wanted to clarify that you guys made a point where you still think you are a low 60s gross margin company.

Do you think you're going to be at 60% plus gross margin? And does the plan imply that for 2020?.

I think that's impossible. Michael is welcomed to share some of his views, but we have a lot of things, distribution costs won't be the same in 20th example. We've got a lot of COGS efficiencies that we're working on. So I think that's possible.

Michael, you want to add your thoughts?.

Yes, I think that there's upwards of 125 basis points or more of cost savings initiatives that we're executing against. Now, obviously, all those have to come through. And of course, there is some headwinds, including some headwinds, as we think about the revenue with the acquisitions we did, which are all below our corporate level, gross margin.

But the sense that we are absolutely a low 60% gross margin player with opportunities for a couple hundred basis points above that a little bit midterm, I think it's absolutely realistic..

Our next question comes from Chris Cooley with Stephens..

Just want to circle back on your comments as it pertains to the increase in accounts receivable and inventory just during the fourth quarter.

Just hoping you could kind of help us frame how much of that was transitory when we think about the cash flow in the 4Q? And while it sounds like the LRP guidance is tabled till late summer, early fall, just thoughts on cash flows as we go through the year both in terms of the cadence and the amount of cash flow, we could see there for 2020?.

Yes, a couple of tips and then let Michael take that. He's been working really hard in this area as well. But we did have a sequential improvement as about $13 million and obviously fewer unusual costs.

But Michael, do you want to take to that?.

Yes, I think there's a couple things on anything working capital related and the systems that we have built some manual workarounds in the near-term, to ensure that the things working capital that aren't we're wanting to be are starting to move forward. But that's obviously not a sustainable solution.

So as I look through 2020 one of the reasons that we have confidence and having positive free cash flow for the full year is the fixes that we're putting into the system, being able to ensure that we have timely collections on AR, and make sure that we're managing our payables appropriately.

With regards to inventory, one thing we're not going to do this year is fall short of products at any stage. So if we have to have a little extra build at any given time to make sure that we're meeting front end demands, we will do that. So we're not making any commitments on working capital improvement with regards to inventory this year.

Although I will tell you the manufacturing facilities are definitely focused on that. But with AR and AP, we are absolutely putting in sustainable fixes, and we do anticipate seeing improvements in both of those current asset and current liability categories..

That's really helpful. If I could just squeeze one other quick questions and I'll get back in the queue. Just, we think about the COOLIEF growth in the quarter, continuing to see double-digit growth there.

Could you give us some additional color as to the types of accounts or where you're seeing the greatest amount of growth? Just curious candidly if there's been any change in the end market environment that you're sensing in terms of purchasing patterns or utilization? Thanks..

So obviously there's still the greater portion of the growth of that. Not the growth but the business itself is in the spine area, but the higher growing areas, osteoarthritis of the knee. And I think that the positive CMS reimbursement that we received towards the end of last year is helping us outline.

And our primary customer is still the interventional pain specialists, but these studies are drawing in a lot of orthopedic surgeons and we're working behind the scenes to try to get reimbursement in the ambulatory surgical center, which would be an even greater catalyst for that business..

And if you'd like to ask a question, please press star then one. Our next question comes from Kristen Stewart with Barclays. Please go ahead..

I was just wondering if you could maybe help us just frame in terms of the previously identified $30 million to $40 million in restructuring savings. I know some of that we've kind of seen comes through and being reinvested with the number last year was $7 million to $10 million. The numbers for 2020 have been kind of moving a little bit.

How should we just think about that in terms of what the numbers are going to be for 2020, and really some of that probably will be reinvested? And then just going forward, how much of that will actually flow-through the bottom line or that will be earmarked to go forward through investments or just need to be reinvested that into the business? Thanks.

And I have a follow-up..

Yes, Kristen. Just a couple of things. And I think Michael was going to want to weigh in on this, but we've really been getting the costs in each year. And they've obviously primarily been COGS-related to date until we stabilized our IT system, but obviously we have costs headwinds coming in like short-term incentive in other areas.

And we talked a little bit at JP Morgan about really the inflection point being in 2021.

Michael, do you want to add?.

Yes. No, I think that's right, Joe. I mean just numbers wise anticipate $12 million to $16 million of cost savings in 2020. But as Joe just referenced, there'll be quite a bit of offsetting of those.

So net savings will be quite a bit less and then $11 million to $14 million or so in 2021, and we have some good line of sight that most of that will drop to the bottom-line..

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

Just maybe a few for me here. Just first for Joe.

Just for COOLIEF for 2020, what's embedded in guidance in terms of growth for that product? And what assumptions sort of were made around the Medtronic entering the market?.

So, we are continuing in double-digit growth with COOLIEF. To date, David, we have not seen strong competition from COOLIEF. We've now has a press release when I believe last night introduced a new console and technology that we think is even further advanced.

So we -- between that and the fact that we're the only COOLIEF technology right now approved for treatment of OA in the knee, we feel pretty strong about that COOLIEF growth.

It looks -- is there anything further you wanted to?.

No..

Michael is just agreeing with me..

Okay. And just two more for me, I'll ask them both upfront. Joe, I think you may have said this, but I think about the back half of the year, organic growth in the third quarter versus the fourth quarter, 4% in the fourth. For the second half of '19, organic growth came out around 2%.

Is that the right way to think about how you think this business is entering 2020? And then for Michael, your guidance sort of implies flat EBIT margin in 2020, you said low-60s GM. So is the right way to think about SG&A two points of deleverage here something around the 42% range? Thanks so much..

Yes, David. And I'll take the first part and Michael will take the second part of the call. But when you think about the 4% organic in Q4 and what you're looking at for Q3, and we did talk a little bit on it earlier on the call about IV infusion being about a point.

We do think our implied organic growth without the unusual factors is more like 2%, 3% entering the year. Obviously, there is seasonality in our business, especially on the pain side of the business that we take into effect as we go through Q1 and Q2. So that's how we see entering the year.

And then Michael?.

Yes. So I think you were directionally correct on your assessment of the math. We do anticipate EBITDA on an absolute value to grow strongly double-digits, teens double-digits. And we do anticipate EBITDA margin to increase about 100 basis points..

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

Hi, this is Emily on for Ravi. Thanks for taking my question. Just to start with the new FDA-approved 80-Watt COOLIEF system.

Can you just briefly talk about what the new features for those are and what benefits they bring?.

Yes. This is Joe. It has a better interface for our customers. It does allow for faster throughput of the procedures in a more broad utilization of the probes. So just think of it as sort of a state of the art console that's going to allow for a faster and better procedure.

So we're excited about it, especially given the fact that we now have another entrant in COOLIEF in Medtronic. We think it's a jump in technology..

Okay. Thank you. And if I could just ask one more, R&D was a bit lower than we had anticipated. Was there any reason for this and how can we think about R&D for 2020? Thank you..

Just a couple of things. And I think Michael wants to say something. But essentially, our target is to be at 6% of sales for R&D. It can change in any given quarter obviously due to just project spend. And we're looking at reviewing projects and what their returns are. At the same time, we also invest alongside an open innovation like BioQ.

So -- and that was a $5 million investment a couple of quarters ago to get in the electronic state of the art pump into the Acute Pain business. But our intention is to maintain to that 5% to 6% range.

Do you know want to add?.

No, nothing to add..

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

Hi, Joe and Michael. It's Drew Ranieri on for Rick. I just wanted to start on M&A integration, just with the IT stabilization continuing to progress.

Could you talk about maybe the steps for M&A integration and where could you capture potential revenue synergies? And as the IT system stabilizes, how are your thoughts evolving on growth and profitability of the prior transactions? Should we think about their growth rates and profitability as continuing to meet your expectations or could we potentially see an acceleration in 2020 and 2021?.

So, the way we view the integrations is that obviously as you can imagine, we have three major project teams going on plus some of the things that we're doing on our own structure.

But the bulk of those benefits happen as we begin H2, as we stabilize the IT system and really get the benefits of those synergies really as we're sort of ending the year and into the second half.

We do think that -- and I think CORPAK is a good example of this that we can enhance profitability, certainly gross margin and sales for these acquisitions. And NeoMed is an example on the gross margin side.

Michael, anything?.

Yes. Joe, I think as you asked about the integrations from a systems standpoint, most of that synergy is really a cost synergy and our ability to leverage the system and business processes.

I then also as I mentioned earlier in the back half of the year, as we start to leverage our new system from an analysis standpoint, those are the types of things that will lead to insights that we'll hopefully have some revenue outcomes, positive revenue outcomes.

But on the front-end of our integrations, especially systems-related, those are going to be all cost-focused synergies..

Got it. And then just on back to COOLIEF, just with the new 80-Watt system.

Can you touch on maybe the opportunity there in the near-term? Is it about converting existing accounts? And how quickly could that happen or is it more about getting adoption from new accounts? And just to tell us it's in there, does the 80-Watt system really kind of help you drive adoption or start to drive adoption in the ambulatory surgical center?.

I think a couple of things. One is, I think you'll see some upgrade opportunity. People are going to want the newer system for the efficiencies. I also think it's a good way now that we have another entrant into the market to differentiate ourselves.

From that perspective, really the ambulatory surgical center component in this is more about reimbursement. And then it is about technology. So once there is a reimbursement that makes economic sense, for example for orthopedic surgeons, I think that there is an opportunity for us to expand into ambulatory surgical center..

[Operator Instructions] Our next question is a follow-up from Matthew Mishan with KeyBanc. Please go ahead..

Thank you for taking the follow-up. In the press release you talked about a couple -- in the script, you talked about a couple of the surveys, the one specifically with COOLIEF versus HLA or hyaluronic acid at 12 months versus six months.

Could you go into a little bit more detail on how big the difference in pain relief was for COOLIEF at the one year mark versus HLA?.

Yes. Matt, it's very similar to the corticosteroid study. And then obviously at the midpoint I believe that sort of showed the 12 months. And then as the study went on, we're able to talk about a 24-month pain relief. So I think it's pretty strong, pretty significant. And if you think about HA, in some cases that may work a few weeks or a few months.

So I think there's a really strong economic story as well. Again, how that becomes a catalyst for us in our business is oriented to reimbursement in the ambulatory surgical center. We're going to have -- and that's why we're doing the data by the way. The clinical studies are going to allow for that.

So it's going to allow for us to have a better conversation with commercial payers. So it's a several year process, but it's a good thing for us in the future..

Okay. And then last one for Michael. I think a lot of the stuff you're talking about is exiting momentum, exiting 2020 with a lot of momentum on the cost side.

Could you also talk to your expectations on the potential re-price long-term debt at the end of the year? And then also, how do you get the tax rate closer to peers, I think 25% to 27% was a little bit of a surprise?.

Yes. Great, Matt. I'll take the tax one first. So the tax one, definitely longer term we anticipate being in that 23%, 25% range. We have a couple of years here where from a tax standpoint, we're in a loss position. We're not able to benefit from things like foreign tax credits. There's a variety of things going on there as well with guilty.

And so it's just -- this is a little bit of a temporal factor for our taxes. Cash taxes, however, will continue to be very low. And so that's what I tend to focus on more than the effective tax rate which can bounce around a bit. But from a modeling standpoint, I anticipate longer term 23% to 25% effective tax rate.

With regards to our debt, we do have the opportunity. You correctly state around ability to re-price our debt at the -- in the fall time period. Dave and I will closely monitor where the markets are at that point.

What our capacity needs are from an M&A standpoint and what our strategy looks like from M&A whether that be tuck-in or larger types of opportunities. So that will all be -- all of those factors will be incumbent upon what we do from that standpoint.

But I do anticipate that we will look at that piece of our capital structure in the fall when the opportunity to re-price arises..

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

I want to thank everybody for your interest in Avanos. As you can tell, I'm confident in the business outlook and our ability to deliver against the priorities that we have outlined today and continue to outline. I believe in the solid fundamentals of this business and that we are well positioned to create value for our shareholders.

Also, Michael and Dave will be at the upcoming Raymond James Institutional Conference in Orlando. And the three of us will be at the Barclays Global Healthcare Conference in Miami Beach. I believe that's the week after that meeting.

Information about how to access the presentations can be found on the Investor Relations section of our website at avanos.com. Thank you..

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