Avanos Medical, Inc. (AVNS) Q1 2015 Earnings Report, Transcript and Summary

Good morning, and welcome to the Halyard Health First Quarter 2015 Earnings Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Dave Crawford, Investor Relations. Please go ahead.

Thanks, Emily, and good morning, everyone. It is my pleasure to welcome you to Halyard's First Quarter 2015 Earnings Conference Call. With me this morning are Robert Abernathy, Chairman and CEO; and Steve Voskuil, Senior Vice President and CFO. On today's call, we'll begin with an update from Robert on the progress we are making on our key priorities for 2015. Next, Steve will review our first quarter results, and then Robert will provide his perspectives on our performance and our outlook for the remainder of the year. We'll finish with Q&A. A presentation of today's materials is available in the Investors section of our website, www.halyardhealth.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 the forward-looking statements. For more information about forward-looking statements and our risk factors that could influence future results, please see today's press release and our prior filings with the SEC. Additionally, we will be referring to adjusted results and outlook. Both exclude certain items described in this morning's press release. The press release has further information on these adjustments and reconciliations to comparable GAAP financial measures. Now I'll turn the call over to Robert.

Thanks, Dave, and good morning, everyone. I appreciate your interest in Halyard Health. On last quarter's conference call, I said I'm pleased to say that we're exactly where we expected to be at this point. I'll repeat that sentiment this quarter with one exception. Sales in our S&IP business is tracking below our expectations. You will remember, we ended 2014 with strong results, but we discussed some headwinds on the horizon across 3 primary areas: Unfavorable currency exchange rates, a difficult comparison against a strong prior year first quarter and lower distributor purchasing levels following strong fourth quarter S&IP sales. Let me talk about each of these. First, unfavorable currency exchange rates that impacted our 2014 fourth quarter performance have continued into 2015. The top line currency impact for the quarter versus last year was unfavorable by approximately $10 million or 2%. Second, recycling against a strong prior year quarter, which included 12% growth in our Medical Devices segment, driven by distributor ordering in the first quarter of 2014. Looking ahead, we expect our second quarter comparison to be more favorable. Third, our results for fourth quarter 2014 included approximately $13 million of pandemic preparedness sales. During the first quarter, we saw distributors draw down this inventory build. We now believe the majority of this correction is behind us. Despite these headwinds, we ended the quarter on solid financial footing, enabling us to remain on track to execute our long-term strategy of transitioning our product portfolio to higher-margin Medical Devices. And we are affirming our 2015 outlook for total net sales guidance on a constant currency basis and full year diluted adjusted EPS. Last quarter, I talked about 2015 being the year for establishing the base of our future, centered on 3 key priorities: Completing the separation from Kimberly-Clark, positioning Halyard for future growth and delivering shareholder value. Now let me briefly discuss the progress we've achieved on each of these priorities. First, our separation from Kimberly-Clark is on track. I'm pleased with the progress we've made in establishing our functional teams and developing our capabilities, which has enabled us to exit a number of transition service agreements as scheduled. Additionally, our repackaging and rebranding efforts are progressing as expected. In fact, our first product categories, exam gloves and sterilization wrap, have been rebranded and repackaged with the Halyard logo, and the customer reception has been positive. Our second priority is to position Halyard for growth by strategically investing in the business. We ended the quarter in a strong financial position, with $166 million in cash on our balance sheet and free cash flow of $12 million. Our strong financial position will enable us to make those strategic investments, including doubling our research and development funding over 4 years. Finally, our third priority is to deliver shareholder value by generating strong cash flow and properly allocating capital. Because of the strength of our balance sheet, we repaid $50 million of our term loan on April 30 in lieu of establishing a share buyback program at this time. This action demonstrates our commitment to allocate capital to ensure we have the financial flexibility to pursue M&A activity in 2016, which we believe will enable us to transform our product portfolio toward higher-margin Medical Devices and increase shareholder value. So in summary, for the quarter, we affirm our 2015 constant currency net sales outlook and full year adjusted diluted earnings per share guidance. We're on target with our rebranding, repackaging efforts, as well as exiting our Transition Service agreements with Kimberly-Clark. Finally, we ended the quarter with a solid balance sheet and positive cash flow. Now Steve will discuss our first quarter results. Steve?

Thank you, Robert, and welcome again to our first quarter 2015 conference call. First, I'd like to remind everyone that our results for 2014 reflect the business as it existed when it was part of Kimberly-Clark. As a result, included in 2014 are pre-spin costs associated with execution of the spin-off. Let me start with some key information from our press release. First quarter sales were $394 million, a 2% decrease in constant currency compared to the prior year. First quarter results reflect higher G&A expenses associated with becoming a standalone company. These costs are on plan as we establish our functional capabilities. With that, we had an adjusted operating margin of 11.6% for the quarter compared to prior year of 18.6%. Adjusted EBITDA was $55 million compared to $86 million in the prior year. Now taking a more detailed look at our results for the first quarter. Overall sales of $394 million were down 4% compared to $411 million a year ago. Exchange rates negatively impacted net sales by 2% or approximately $10 million. Lower volumes and price each negatively impacted net sales by 1%. Adjusted gross margin fell from 38% to 34.3%. Contributing to this decline were the dissynergies from the spin-off consistent with our plan. In addition, distribution expense was higher than anticipated as a result of the West Coast dock workers labor dispute, which led to supply chain inefficiencies across our U.S. network. During the quarter, we encountered more than 1,000 containers that required some type of redeployment or special handling to minimize customer impact. Adjusted operating profit for the quarter was $46 million, down from $77 million a year ago. The decrease was driven by lower sales and gross margins mentioned earlier as well as increased G&A standalone costs, which are tracking to plan. During the quarter, we realized a $12 million gain from the sale of one of our Thailand manufacturing facilities. This gain as well as $11 million in post-spin-related charges and $6 million in intangible amortization expense were excluded from adjusted operating profit. As a result, adjusted operating profit margin was 11.6% for the quarter. Adjusted diluted earnings per share for the quarter were $0.51. Looking at our performance on a segment basis. First, S&IP net sales declined 8% in the quarter to $255 million, down 5% on a constant currency basis. The variability and the timing of distributor orders impacted our performance as customers and distributors worked through their prior quarter's inventory build. As a result, we had lower volumes in protective apparel, exam gloves and surgical drapes and gowns, primarily in North America and in Europe, Middle East and Africa, or EMEA. Net selling prices were 1% lower, driven primarily by lower prices in exam gloves in North America as favorable commodity costs continue to make this a very competitive category. For the quarter, S&IP operating profit of $20 million was lower compared to the prior year as a result of lower sales volumes in several product categories, unfavorable currency exchange rates, higher distribution costs and higher year-over-year spending on G&A related to standalone expenses. Turning to our second segment, Medical Devices. Sales for the quarter were $122 million, down 6% compared to the prior year, which equates to a 4% decline on a constant currency basis. Volumes were lower by 3%. Changes in pricing and currency each negatively impacted performance by 1%. I remain excited about the growth generated in interventional pain, up 23%, as our cooled radiofrequency business, branded COOLIEF, posted growth of 93% in North America. Volume growth in digestive health was up mid-single digits in EMEA and North America. Overall surgical pain volume declined 14%, driven in part by competitive activity in North America. Also reflected in our surgical pain results are lower IV pump sales for the quarter as sales in the prior year quarter were strong due to the timing of distributor orders in both North America and EMEA. In North America, the surgical pain market dynamics seem to be improving as we continue to execute our direct marketing and physician education programs that demonstrate the benefits and efficacy of our pain management portfolio. This, along with clinical evidence, which supports the effectiveness of our ON-Q therapy, gives us confidence that over time, surgical pain volumes will grow as more physicians seek nonnarcotic pain therapies that have proven better outcomes for patients. Segment operating profit for the quarter was $25 million compared to $31 million a year ago. Our results were driven by lower sales and higher G&A expense related to standalone costs. Turning to our balance sheet and cash generation. For the quarter, cash from operations was $40 million compared to $26 million a year ago. At quarter end, we had $166 million of cash on hand, $17 million higher than year-end despite a $20 million increase in capital spending due to investments to complete the transition from Kimberly-Clark. Overall, our capital spending is on plan. In summary, for the quarter, net sales were down 2% on a constant currency basis. We generated positive cash flow, and we ended the quarter with $166 million of cash on the balance sheet. Our solid financial profile positions us to continue to execute our strategy of transforming our product portfolio to higher-margin Medical Devices. Now I'll turn the call back to Robert to discuss our outlook for the balance of the year. Robert?

Thanks, Steve. We continue to focus on delivering our plan for the year. Our full year constant currency top line net sales growth remains within guidance, even though we now expect constant currency S&IP sales to be at the low end of our flat to negative 1% guidance. While we're only one quarter through the year, exchange rates remain volatile and we anticipate that the currency headwind will continue. We now anticipate negative foreign currency translation to impact sales at the high end of our 2.5% to 3.5% range. Additionally, we anticipate the currency impact on operating profit will be at the high end of our $10 million to $15 million range. Despite the unfavorable currency outlook, we continue to expect full year adjusted diluted earnings per share to fall within our guidance of $2.30 to $2.50 per share. Turning to capital allocation. We now anticipate capital spending to range between $70 million and $75 million for the year. The increase in capital expense will be offset by a reduction in a receivable associated with our headquarters in cash from operations. The net cash investment for the year is expected to remain within our previously guided range of $55 million to $60 million. Now I'll briefly highlight our remaining 2015 key planning assumptions which we affirm. Device sales are performing in line with our expectations, and we anticipate sales growth of 2% to 4% compared to 2014 on a constant currency basis. We anticipate cost deflation to be in the range of $25 million to $30 million for full year 2015. As we continue to execute on our long-term strategy to support product innovation and product adjacency expansion, research and development investment is expected to be in the range of $30 million to $35 million. As we establish our functional teams and capabilities, we continue to exit transition service agreements. In 2015, we anticipate spin-related transitional costs to be in the range of $45 million to $55 million, and we continue to forecast the total amount for 2014, 2015 and 2016 to be in the range of $60 million to $75 million. Our adjusted effective tax rate for 2015 is expected to be in the range of 37% to 39%. We continue to focus on our key priorities of successfully completing the separation from Kimberly-Clark, transitioning our product portfolio towards higher-margin medical devices and delivering shareholder value. So in summary, we're on plan with establishing our functional teams and exiting transition services agreements and completing our rebranding and repackaging programs. We have a solid financial profile, including $166 million in cash on our balance sheet at quarter end and positive cash flow. And we affirm our 2015 full year net sales on a constant currency basis and adjusted diluted EPS guidance. We'll now open the call for questions. Emily, we're ready for our first question.

[Operator Instructions] Our first question is from David Lewis of Morgan Stanley.

This is actually John Demchick in for David. So what are the -- start off with the maintenance of the EPS guidance range in light of, I guess, some of the gross margin pressures and then also lowered expectations for S&IP and the larger impact from FX? It appears there's a few, I guess, larger pressures in the business that may not have been initially contemplated, so I guess, a few parts to that. How did gross margins come in relative to your expectations and -- following the step-up cost? And how should that we expect going forward? And I mean, it sounds like the step-up cost from scale may have been relatively in line, but distribution costs from the West Coast ports slow down caused additional costs. So I was just wondering if you could maybe quantify some of that and the expectation of whether that distribution cost, I guess, carries through for any of the balance of the year? And then also, if gross margins are a bit lower than expected and the S&IP and FX pressures are a bit worse, what offsets those to keep the top end of guidance, I guess, in play? I imagine term loan repayment acts as part of that.

Great. Let me start with our margins. Clearly, the margins were lower than we would have expected predominantly because of the impact from volume and price, mostly in our S&IP business. So as I said, that's the one area that's below our expectations going forward. But everything else, we feel like we're on target. We're where we expected to be. So that hit to -- from volume and price was clearly below plan. And the distribution cost was unanticipated. As we look forward, we think the distribution impact is behind us. There might have -- might be a little bit of carryover that we would see in the second quarter, but we don't anticipate long-term impacts on our gross margin from distribution. And we do expect the volume of price to get back on plan broadly across all our categories. So what offsets it? Clearly, we've got a few things that would go negative on our earnings per share. There's clearly an offset there as we move to the lower range of sales for S&IP. That was a pretty tight range. We had a range there from a flat to minus 1%. So if you move that from kind of a negative 0.5% down to minus 1% range, that impacts about $6 million. So we know we've got to offset that. But I'm very encouraged by our device sales and the mix in our device categories, the rapid growth of our COOLIEF interventional pain. We've got a lot of confidence in growth and devices to help us offset that. We're also seeing continued strength in terms of other aspects of our business to be able to offset the -- that shortfall from the S&IP sales.

John, the only thing I would add is that the term loan is not going to be a big driver from an earnings standpoint because we have to amortize a portion of the original issue discount into that savings. It's probably about $0.01 for the year.

Very helpful. And just a follow-up on, I guess, the surgical pain results. I guess, given the dynamics with Pacira's EXPAREL, in their CRL, maybe we would have expected the results to, I guess, not be quite as negative as they were. This quarter, I mean, obviously, you don't have the visibility on their approval timeline. So I was curious what you've seen, I guess, since the CRL was issued in terms of off-label use and if the trends have moved more positive and then kind of what you're expecting to see in that segment for the balance of the year.

Yes. As I look at the balance of the year, we saw a large drop kind of early last year. So we're going to have more favorable comparisons in the surgical pain business for the rest of the year. We do expect this business to return to growth. I think, certainly, the key messages around use of nonnarcotic surgical pain medications is resonating at hospitals and with physicians. As we look forward, we're not seeing a big shift immediately from any of the news that's come out from Pacira on our business. So we're continuing to have more and more clinical evidence that shows the positive impacts, lower cost and use from using our ON-Q product forms, and we'll continue to share that message broadly.

And just one quick last question. We've heard a lot recently, I guess, from hospital reports that volumes appear a bit improved in the environment. I just was wondering what you guys have kind of seen when you start obviously backing out some of the onetime pressures from the pandemic spending and stuff like that given you guys have more daily use items. How do you view the overall volume environment with hospitals?

Yes, we're reading the same numbers everybody else has. We definitely felt the surgical procedure reduction in January and February. Total quarter down 2.6% for surgical procedures. Our business ties more closely to surgical procedures than it does to overall utilization. We did see those numbers trend up in March and hopefully, continuing into second quarter. But so far, it's -- it hadn't been a big sea shift in terms of major shift away in terms of huge volume lift associated with that. But we're encouraged by the numbers we're seeing from a number of reports.

[Operator Instructions] Our next question is from Dave Turkaly of JMP Securities.

And I know you mentioned sort of clinical evidence for your surgical pain business. I guess, I was wondering how you see that market today? Sort of what do you think your penetration is there? And are there additional surgeries for you to go after? And to do so, do you need to do these kind of studies to kind of broaden that market?

Yes, we have indication for general surgery for our pain products, unlike some competitors who are only indicated for some very small surgical procedures. So we have our products being used broadly across surgical procedures. But predominantly, they're being used for larger procedures, open chest surgeries, hips, knees, things like that. So there's always opportunities for the category to continue to grow. We have -- we were seeing rapid growth of the category. So if you look at our key competitors and our sales, this is a category that roughly doubled last year. Unfortunately, all that -- all or most of that growth came from the competitor. So we think that idea of nonnarcotic pain is something that's now very much in the dialogue at hospitals and that is, as physicians look for alternatives to our competitors' products, we believe they'll start looking more closely at our product categories.

And then I know quarterly guidance is not something you guys are willing to do. But as we kind of look at the way this year now sets up, would it be fair to say this is kind of a low bar in terms of your earnings? I mean, I think it's almost implicit based on the reiteration of the guidance. But sequentially, as we look forward, improvements in both sort of the revenue growth and the earnings profile, would that be fair?

That is fair. We need to have 3 strong quarters. We've obviously gotten off to a slower start than we anticipated in terms of earnings per share. So we need 3 strong quarters now to deliver. We have looked through our guidance range. We looked at top ends of ranges and bottom end of ranges to ensure that we are confident that we have the ability to hit either one. So we like the range where we are and feel confident that as business goes up or down, we're going to stay within those ranges.

Our next question is from Henry Reukauf of Deutsche Bank.

Maybe just a little follow-up on that last one. Would we -- on the way earnings progress over the remainder of the year, should you need 3 strong quarters? But should they kind of be incrementally improving generally?

Henry, that's exactly how we think of it: Is this going to improve as the year goes on? We're continuing to build capabilities. We're continuing to see our key messaging and surgical pain to resonate with physicians. So we would expect to see some strengthening of that business over time. We expect that our interventional pain business, which has been the fastest-growing business for us over the last couple of years -- so it's in a growth trajectory. So it would be building as the year moves through as well.

Yes, and typically, we have a stronger fourth quarter, and that's typically where we get some benefit from cold and flu and a little bit of seasonality there.

And that's just the -- so you have a little bit of fourth quarter pull-through into first quarter and that's -- so this is just a weak quarter going forward? And then you -- this is the weak quarter because there's some fourth quarter pull-through and then you gradually improves as the year goes on. That should be the general trend, right?

Yes, it is. And then kind of back to the really tough things from the first quarter in our S&IP business, that $13 million of pandemic sales that happened in the fourth quarter that -- then that inventory was drawn down in the first quarter. And then those surgical procedures, I'm fairly optimistic. If folks delayed surgeries in January and February, you would certainly think those surgeries happened during the rest of the year. If somebody was going to have a knee replacement and it got canceled because of snowstorms in Boston, you'd certainly think those procedures do happen in the year, that there would be some catch-up there.

[Operator Instructions] There are no further questions. This concludes the question and answer session. I'd like to turn the conference back over to Robert Abernathy for any closing remarks.

Thank you, Emily. Well, thank you for your interest today in Halyard Health. I'd also like to point out that Steve and I will be presenting this Wednesday morning at the Deutsche Bank Health Care Conference in Boston. Information about how to access the presentation can be found on the Investor Relations section of our website, halyardhealth.com. I'm excited about our progress, and I'm excited about what we're achieving and look forward to continuing to execute our plan in 2015. Thanks, everyone.

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