Avanos Medical, Inc. (AVNS) Q4 2015 Earnings Report, Transcript and Summary

Good morning, and welcome to the Halyard Health Fourth Quarter Earnings Results 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 Dave Crawford, Vice President, Investor Relations. Please go ahead.

Thank you, and good morning, everyone. It is my pleasure to welcome you to the Halyard Health fourth quarter 2015 earnings conference call. With me this morning are Robert Abernathy, Chairman and CEO; and Steve Voskuil, Senior Vice President and CFO. Robert will begin with an assessment of our fourth quarter and full year performance and discuss our priorities and guidance for 2016. Then, Steve will review our results and provide additional detail around our planning assumptions for the year. We will finish with Q&A. A presentation for today's call is available on the Investors section of our Web site 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 forward-looking statements. For more information about forward-looking statements and the risk factors that could influence future results, please see today's press release and our prior filings with the SEC. Additionally, we 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 will turn the call over to Robert.

Thanks Dave, and good morning, everyone. I appreciate your interest in Halyard Health. Those of you who have been following us for a while know that we've chartered a course to execute our long-term strategy of transforming Halyard into a global medical devices company. Our goal for 2015 was to lay the ground work for that transformation by completing our separation and building our capabilities as an independent organization. My management team and I are proud to say that we accomplished those goals including exiting transition services agreements, establishing IT capabilities and progressing with our rebranding and repackaging. Additionally, our medical devices segment performed inline with our expectations and we will initiate the first steps in the transformation of Halyard in 2016. With respect to our surgical and infection prevention business, we faced a difficult environment in 2015, while we expect these challenging market conditions to continue, we are committed to defending our leading share positions bringing innovation to these categories and maximizing cash flow. Against that backdrop, I'm pleased to report that we ended both fourth quarter and full year 2015 in line with our revised expectations. Fourth quarter adjusted diluted earnings per share was $0.57 and full year adjusted diluted earnings per share was $2.11. Our fourth quarter sales of $401 million put us at $1.6 billion of sales for the year. Let me provide a quick overview of our performance, and then, Steve will go deeper into the numbers. Our segment performance was consistent with the trends that we've seen throughout most of the year. Medical devices had a solid quarter with 6% growth on a constant currency basis. This marks the 3rd consecutive quarter devices grew 5% or more in constant currency. For the year, medical devices grew 3% in constant currency, which was inline with our expectations. Medical devices growth was driven by interventional pain where we continue to see robust performance from COOLIEF. In surgical pain, ON-Q volume returned to growth in the back half of the year as planned. Also, our respiratory and digestive health categories delivered growth inline with expectations. Turning to S&IP. Sales declined 9% in the fourth quarter on a constant currency basis as we cycled against a strong quarter a year ago, which was driven by pandemic preparedness sales. For the year, sales declined 7% on a constant currency basis. Last year, the S&IP markets became more challenging as input cost declined and selling prices contracted resulting in aggressive competition for market share. We expect these dynamics to continue in 2016. We ended the year with a solid balance sheet including $130 million of cash on hand, while also reducing our debt by $50 million. Our cash generation was balanced between S&IP and medical devices. In 2016, we expect to generate free cash flow in excess of $100 million driven by lower capital spending and lower separation expenses. I began by talking about how 2016 will be the start of Halyard's transformation that will take place over the next few years. This consist of three parts; portfolio, company and culture. The portfolio transformation has been the foundation of our strategy since day one. Through increased investment and research and development and strategic acquisitions, we will enhance our medical devices segment roughly 1/3rd of our business and realize our vision of becoming a leading medical devices company. The second part is transforming our company, this includes rationalizing our corporate cost through reducing our IT spend and gaining operational efficiencies that will also optimize our tax structure. The third and final part is a cultural transformation. We are no longer a small segment of a large consumer goods company being run for cash. We are a healthcare company. And we must be bold and agile. Our cultural transformation that began last year will accelerate as we produce innovations that will impact the future of healthcare. That is our vision for the future of Halyard Health. We're going to accomplish this by delivering our 2016 plan and fueling our growth pipeline. Our 2016 plan calls for delivering full year adjusted diluted earnings of $1.45 to $1.65 per share and we expect total net sales to decline 2% to 5% on a constant currency basis. In order to fuel our growth pipeline and deliver on our commitment to transform Halyard, we have three key areas of focus. The first is to accelerate investment in our pain platforms. These categories are leading our growth in the case of interventional pain and returning to growth in the case of surgical pain. We plan to build on this momentum as well as our leading market positions in non-narcotic pain therapies. We are increasing our sales and marketing resources in interventional pain to help continue to meet growing demand. In addition, we will increase our investment in physician education events and clinical evidence to help grow our categories. The second area of focus is innovation. We expect to successfully launch 10 product line extensions across S&IP and medical devices this year. We remain committed to doubling our investment in research and development enabling us to introduce new innovations, differentiate our portfolio and maintain our market leading positions. And third area of focus is acquisitions. We expect to complete our first acquisition to accelerate growth in our medical devices business and enhance our performance through operational synergies. In closing, while we appreciate the challenges ahead of us, we have built a solid foundation and are ready to lead Halyard through its next stage. We feel as confident about our strategy now as we did on day one. With that, I will turn it over to Steve.

Thank you, Robert. I'd like to remind everyone that our results for the fourth quarter of 2014 partially reflect the business as it existed when it was part of Kimberly-Clark, included in our 2014 results, our pre-spin cost associated with executing the spin-off. Fourth quarter sales totaled $401 million down 7% on a constant currency basis compared to a year ago, as we cycle against a strong quarter that included an estimated $13 million of pandemic preparedness sales. Exchange rates negatively affected net sales by 2% or approximately $10 million. For the quarter, volumes were down 2%, while lower selling prices also impacted sales by 2%. Lower volume in exam glove and roll good sales to Kimberly-Clark contributed the remaining 3%. Adjusted gross margin was 34% this quarter compared to 37% a year ago. The previous year's gross margin benefited from higher production volumes related to pandemic preparedness sales. While during this quarter, we reduced production volume to manage inventory levels resulting in lower fixed cost absorption. Overall, we reduced inventory by $20 million compared to the end of the third quarter of 2015. Adjusted operating profit was $41 million down from $77 million a year ago. The decrease was driven by a lower S&IP sales volume and pricing, production curtailment, increased investment in research and development and planned standalone costs due to our spin-off. During the quarter, we incurred $8 million of post spin related charges, $7 million in intangible amortization expense and $8 million for litigation matters that were partially offset by a $2 million downward adjustment of our previously announced goodwill impairment estimates. These items were excluded from adjusted operating profit margin of 10% for the quarter. Adjusted EBITDA was $51 million for the quarter compared to $87 million in the fourth quarter a year ago. As Robert discussed earlier part of our company transformation is optimizing our tax structure. Our adjusted effective tax rate for the quarter was 20% and 33% for the year. Our tax rate benefited from the passage of the research and development tax credit at the end of 2015, which was not included in our original guidance. Our tax team working with different areas of the business was able to identify qualified spending that increased our R&D tax credit substantially over the prior year that will allow us to reinvest in our business. We identified efficiently that enabled us to take the initial steps in our tax planning. Going forward, there could be increased variability in our tax rate as we implement operational changes to our business structure and processes. Some of these changes could cause an upfront increase in our effective tax rate followed by a reduction in future years. Looking at our performance on a segment basis, S&IP net sales declined 9% on a constant currency basis for the quarter with an additional 3% decline coming from exchange rates. Sales volumes were down 5% as we cycled against the strong prior year quarter. Volumes were also impacted by share loss in surgical drapes and gowns and protective apparel as well as reduced example of sales to Kimberly-Clark. Lower selling prices concentrated in exam gloves and sterilization negatively affected sales by 2%. S&IP operating profit for the quarter was $27 million compared to $48 million in the prior year as a result of lower sales volume and selling price. Higher manufacturing cost due to the production curtailment and planned standalone costs. As we discussed before, in the last few years, our S&IP markets has seen a decline in commodity prices, which has quickly translated into lower selling prices and increased market share competition. In steadier commodity environments, we've historically averaged 1 point of volume growth offset by 1 point of pricing contraction. However, in this current environment of low commodity costs, competitors have become more aggressive in passing that commodity benefit on to gain share. This dynamic resulted in 2% price loss in 2015. We expect this dynamic to continue in 2016 and to result in a 2% to 4% annual price loss. In this environment, success in S&IP will be defined by defending our leading market share position and bringing innovation to our categories while maximizing cash flow. In surgical drapes and gowns, we will defend our leading position by launching new products that meet our customers' evolving need while differentiating our portfolio. In sterilization, we will aggressively leverage the growing body of clinical evidence demonstrating that our sterilization products are significantly more effective in preventing infections than rigid containers. We believe this is a major area of concern for the healthcare industry and an example of where we can win in a challenging market. Over the long-term, we expect commodity prices and market pricing will stabilize and our results will align more closely to historic norms. Turning to medical devices, our business delivered another solid quarter of growth, compared to the prior year sales increased 5% to $134 million or 6% on a constant currency basis. This marks the third consecutive quarter of growth at or above 5%. Results were driven by 6% higher volume which was partially offset by 1% of unfavorable currency exchange rates. Interventional pain delivered another strong quarter of double-digit growth fueled by continued momentum of COOLIEF in North America. Surgical pain sales increased 3% driven by increased demand for ON-Q, this marks the 3rd consecutive quarter of sequential growth for ON-Q and the second consecutive quarter of year-over-year growth. Medical devices, operating profit for the quarter declined to $21 million from $28 million a year ago. Higher volumes were more than offset by higher strategic research and development spending in increased selling expenses. Now for a brief recap of our full year 2015 results, sales totaled $1.6 billion, a 3% decline on a constant currency basis with currency negatively impacting sales by 3%. Volume and price each declined 1%; the remaining 1% decline resulted from lower sales to Kimberly-Clark. Compared to the prior year adjusted gross margin was 35% compared to 37% and adjusted operating profit margin decreased to 11% compared to 17%. The decrease was due primarily to a decline in selling prices, higher distribution expense and the addition of standalone costs. Adjusted EBITDA declined from $326 million in 2014 to $220 million in 2015. Shifting to our segments, first S&IP sales were down 10%, a 7% decline on a constant currency basis, higher exam glove of volume in Latin America and Asia Pacific was offset by lower volume in surgical drapes and gowns and North America and EMEA, facial protection in North America and exam gloves sales to Kimberly-Clark. Overall, net selling price declined primarily in our sterilization and exam glove categories. Operating profit was $98 million compared to $166 million a year ago, declining sales volumes and selling price, higher distribution and standalone cost impacted our 2015 performance. Turning to medical devices, sales increased 2% to $510 million up from $502 million. On a constant currency basis, sales increased 3% meeting our expectations. Volume increased 3% driven by strong demand in interventional pain in North America as well as solid growth in digestive health. Operating profit increased 3% to $108 million up from $105 million a year ago. The increase was driven by higher sales volume that was partially offset by higher selling and research and development expenses. As we entered 2016 with a focus on delivering our plan and fueling our growth, let me walk you through our key planning assumptions, which support the earnings and sales guidance Robert discussed earlier. Medical device sales are expected to increase 3% to 5% compared to 2015 on a constant currency basis. Excluding sales to Kimberly-Clark we expect S&IP top line sales to decrease 3% to 5% compared to the prior year on a constant currency basis. Our outlook for S&IP contemplates to 2% to 4% lower selling prices. S&IP sales to Kimberly-Clark which were $50 million in 2015 are expected to range between $40 million and $45 million in 2016. Corporate sales which were $35 million in 2015 are expected to be between $5 million and $15 million in 2016. Foreign currency exchange rates are expected to negatively affect our sales by 0.5% to 1.5%. We anticipate commodity inflation of key inputs to range between $5 million and $10 million. As Robert mentioned one of our strategic priorities in 2016 is to invest in growth initiatives. As a result, we are increasing our research and development investment to be between $35 million and $40 million. We anticipate for the year spin-related transitional costs will be between $10 million and $15 million. We forecast total transition costs for 2014, 2015 and 2016 to be in the range of $67 million to $72 million. Our adjusted effective tax rate is expected to be in the range of 33% to 35%. In summary, for the quarter and for the year, we delivered adjusted diluted earnings per share ahead of our revised guidance as well as medical device growth in line with our plan. While S&IP remains challenging, we are committed to defending our leading market share position and innovating in our categories while maximizing cash flow. We are also committed to investing for growth to shift our portfolio to faster growing higher margin medical devices. With that operator, we are ready to take questions.

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

Thank you. Good morning, everyone.

Good morning, Larry.

Robert, I was hoping that we might start with M&A, obviously, you have been articulating the strategy quite clearly since you spun the company back in 2014, I'm just wondering if you can again at a high level give us any sort of update as it might relate to timing, and again, how are you thinking about the criteria around deploying your capital?

Yes. We're very excited about M&A this year; in fact, we've identified completing our first acquisition this year as one of the key priorities for the company. We are optimistic that we'll be able to have an acquisition in the first half of this year that will fit very nicely within our current portfolio of products. We've talked all along about the acquisitions that we're looking at now would be in the medical devices area and areas like digestive health, respiratory care and pain management. We see this first acquisition and probably acquisitions to follow in the next year or so to be more of the tuck-in acquisitions to really give us the ability to deliver synergies both manufacturing synergies as well as selling synergies and to get some synergies around our headquarter operations. We are in active discussions now and I'm very optimistic about being able to announce our first acquisition some time soon.

Okay. That's really helpful. And then, just a quick follow-on to that and one for Steve. Just again, I think you talked about having fire power of roughly $500 million, is there anyway that we should calibrate our expectations sort of size range for that first deal. I suspect you are very focused on that first one being strategically obvious and I'm just wondering about size? And then, the second question for Steve is, it looks like you're now including some commodity or cost inflation for the outlook for 2016, I'm just curious what's driving that, and again, any sensitivity to if oil prices start to rise how quickly does that translate into cost increases for your business?

Great. Let me start with the fire power and potential size of the acquisitions. We've said all along with now $130 million of cash on hand on the balance sheet and $250 million undrawn revolver that we do have capacity to go up and use roughly $500 million or so and we're at the low end of our debt covenants now. And if you think about the sort of multiples of sales that people are paying that would allow us to buy a company that would be sort of $50 million up to $150 million in sales and that's the -- that's sort of the target zone that we're looking at now. In terms of the commodity pricing there has been some movement there as you now we've talked about increase in our polymer price this year that happened at the first of the year. I do think that will start to may be cause people to pause a little bit in terms of the very aggressive nature of some of the contracts as we get into this next round of contract negotiations, but certainly we're seeing that pass along to us and we'll certainly take that into account as we look at future contract negations and Steve I'll let you jump in on that as well.

See, all I would add Larry is the increase is primarily related to the polymer side in particular the spread that our suppliers add to the base cost of the monomer and with the constrained polymer supply in North America we saw it over the course of 2015. And we had our first announced price increase as of January 1 this year, all related to that spread. And we still think there is some risk in that spread as there is some profit taking by suppliers. So that's the driver of the year-over-year increase.

Okay. Terrific thanks guys.

Thanks Larry.

Our next question comes from John Gillings of JMP Securities. Please go ahead.

Hi, guys. Thanks for taking the question. Can you hear me okay?

Yes. We hear you John. Thanks.

Okay. So, first one, I just want to follow-up on Larry's question about M&A. So, obviously, we've come into an environment that's a little bit more challenging for raising capital that sort of activity. Can you just give us some color on how the environment may have affected or changed the kinds of negotiations that you're having, or how people are reacting to that in your discussions?

Yes. We haven't seen a lot of change in terms of the environment. There are people that are prepared to be in the process to bid just as we are. The properties that we're looking at, they're good companies with growth rates, margins at or above our current growth rate and margins for our medical devices category. So these are the sort of product lines or companies that are going to be desirable. But we're seeing pretty active marketplace right now.

Okay. That's helpful. And then just looking at the tax side, you mentioned that there might be some increased variability may be some upfront costs with savings coming later on, can you just help walk us through some of the just broadly some of the types of things you're looking at doing on the tax side and where you think that could go over the next several years, so we can kind of get a sense if you get the 500 basis points of operating margin you've been talking about getting over five years, what sort of kind of juice could be added by what you could do on the tax side?

Yes. Let me start then I'll kick it over to Steve. I'm really pleased with what we're seeing in our tax rate progress so far. Obviously, some of it has come from the research and development tax credit, but others have just come from the start of us proceeding down our roadmap of improving our overall tax. So I think there is a good sound right there in terms of we are starting to make some progress. And clearly, the tax line is below that 500 basis points of improvement that we need to get from things like IT and other areas but we're clearly pleased with the fourth quarter progress what we saw in the tax area. Steve let me, let you jump in.

Yes, sure. John, we are very aware that our tax rate is still well ahead of our peers and so as Robert said that was and remains a key part of our go forward strategy is getting more efficient there. We're not going to share a lot of details on the strategies themselves, but relative to the volatility or potential variability of the tax rate we recognize we've got deferred assets and tax liabilities around the world and anytime you being to look at structures all of those have potential for revaluation. That's really just what we're calling out there.

All right. That's helpful. Thanks guys.

Thank you.

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

Good morning. Robert just a couple of things, I wanted to just focus on, let me start with Steve on oil, I guess I think one thing we get for investors is, oil was supposed to be a tailwind that's obviously turned into a headwind. I wonder if you could just sort of parse it. Is the primary issue that while oil costs are going down and your input cost should go lower on top of that you had this issue of losing scale and input power post the Kimberly-Clark days; is that really the principle issue? I think investors just really want to understand how oil has become an incremental headwind, is it just the purchasing power?

It could -- that could be a portion of it. I just think the fact that that there is a constraint in capacity right now in North America as allowed the biggest producers to pass along pretty severe margin increases just to give you a sound bite on that, over a year ago, about 80% of what we paid was for the monomer itself and about 20% was for the spread -- the profit for the producers like Exxon. Now, that's 50:50. So the monomer is 50% of our total cost and their margin -- their spread is 50%. So they have more than offset the decline in the monomer price by just passing on price increases in the spread. That's a very different phenomenon than what we've seen in the past. So it's really almost as if the monomer cost as decoupled itself from the actual pricing.

Okay. Very helpful. Maybe just one more strategic view and then a quick one for Steve. So Robert the two things that have changed since the IPO as it relates to S&IP, it feels like one obviously is this oil dynamic, which I think you've eloquently explained. The second is, there is notion of new competition, distributor competition sort of entering your business. So what you think is the new structural growth rate for S&IP?

Well, I think as Steve said in his section earlier, we do expect it to return to that more normal level of volume up 1% and price down 1%. We think that happens after we've completed the full three years of renegotiating prices at the lower commodity prices. The one exception to that could be gloves just based on the nature of the glove market. But, across all of the medical non-wovens businesses, like drapes and gown and face mask, apparel, we do expect returns to that sort of 1% up, 1% down level over time.

Okay. Go ahead. Sorry, Robert.

You would expect if you maintain your leading market share positions, which is clearly a strategy that we've articulated that we would grow with the market, these are fully penetrated categories. But, if you expect hospital utilization particularly in acute care hospital is going to grow in that sort of 1% a year that ought to give you that volume growth then it's a matter of making sure that you don't eat it up with price loss as we did in 2015 and as we are going to experience gain in 2016.

Okay. So it sounds like you get back to something like flattish growth maybe 2018 and beyond after the 2015 through 2017 renegotiation years just let me know if that's kind of close enough for government work. And then, Steve just a quick one, free cash flow outlook for 2016 and I will jump back in queue. Thank you.

Yes. Free cash flow for 2016, as I think Robert and I said, even at the JPMorgan conference, it's somewhere north of $100 million that's a pretty big increase year-over-year, but we have lower capital spending as we come off 2015 which was unusually high with some of the spin related capital then also for absent of -- as many spin-related cost, so somewhere north of $100 million.

All right. Our next question comes from Kristen Stewart of Deutsche Bank. Please go ahead.

Hi. Thanks everyone for taking the question. I was just wondering if you can go back to some of the new products that you are talking about, what gives you I guess the confidence that some of the new products can really turnaround the S&IP business when it comes there?

Yes. Great question, Kristen. So it's fun to talk about innovation. We do have 10 product launches scheduled this year. They are predominantly sort of line extensions, if you will. But if significantly higher than what we've seen in past year, so as we have been ramping up the R&D spin particularly in some of the medical devices area. But also, in S&IP, we are able to bring more innovation to the marketplace. The 10-line extension, some of those are in S&IP and some are in devices we don't detail that this early in the year because we like to hold that as sort of a big announcement at our sales conferences which are happening this next month and then to be able to launch those at the appropriate times during the year. But, we are excited about the innovation we are bringing to the marketplace.

Okay. Then, how shall we just think about the gross margin I guess balancing out all of the -- I guess price reductions and some of these new products as well as some of the input costs?

Yes. I will talk about S&IP first, then, I will talk about medical devices second. S&IP we're certainly going to continue to see margin pressure as the price loss continues this year and into next year. We have always got strong cost savings programs to help offset some of that and we will continue to focus on making sure we get the right mix to be able to drive holding margins or at least minimizing the loss of margins in our S&IP business. In medical devices, we expect margins to stay strong. They were a bit choppy this year as we had some timing of our R&D expenses and some write-offs due to some manufacturing issues. But we still expect our margins in our devices business to hold in that sort of low 20% range and be very strong going forward.

Okay. And then, just on operating margin level, but just from a gross margin level, do you think that, I guess we are -- where which we see those go in a consolidate basis for Halyard?

Yes. The gross margins will be most impacted in S&IP due to the price loss. And then, a lot of the claw back that we'll get will actually be below gross margin with our cost savings. So I would expect to see some lower gross margins in S&IP, but not so in our medical device area.

Okay. And the -- sorry, go ahead. Excuse.

I will let Steve jump in there.

We're just going to add, as Robert summarized we have the two dynamics. You have the accretive uplift of the medical device business growing and then the price flow through on S&IP and part of that price flow through offset by cost savings. So we see -- there is going to be some -- I will say flat to downward pressure on gross margin for 2016 of that price for 2016 on S&IP dominates the accretive benefit of the growth and devices.

Okay. And the medical device tax was that in your SG&A, I don't think it was that significant but fine if you could comment?

Yes. With SG&A that's right Kristen.

Okay. Perfect. Thanks very much.

Thanks Kristen.

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

Great. Thank you for taking my questions.

Hi, Matthew.

First on S&IP. You just -- above and beyond the price increase, the pricing impact, it looks as if you're expecting volume declines of about 1% before the Kimberly-Clark business. Can you give us a little bit of color on what's driving that in 2016 and I believe in 2015, a lot of that was really very tough comp coming off of the pandemic preparedness?

Yes. So as we look at that -- you are exactly right how you categorize it. We see a 2% to 4% decline in price. And then a 3% to 5% that we are guiding for the total sales of the S&IP business which we gave you a 1% loss in volume. We will continue to see decline in our sales to Kimberly-Clark, our S&IP sales that's going to make up a portion of that. But we are also continuing to see very competitive environment. We lost some market share last year and while we are focused on defending our leading share positions, bringing innovation to the categories and maximizing cash flow. We do expect that competitive environment to continue particularly in a couple of key areas like sterilization ramp where we had a major patent that expired two years ago now. So we will continue to see some price -- I mean some volume pressure in that category.

Okay. Could you help me differentiate between the non-woven sales that I think we are in [corporate] [ph] last year and then you are starting to call out the -- and I don't believe you called it out specifically last year and guided the sales to Kimberly-Clark, which I think in the industrial business. And it's the reason why you are calling it out now, is that because you expect that to decline in -- as you go to 2017?

Yes. We do decline last year, we expect it to decline again this year and it might likely decline the next year. So, as we look at it's a low margin business, it's the sales of gloves to Kimberly-Clark used predominantly in industrial areas as you mentioned. But I think breaking out allows us to focus more on the core businesses where we are selling into acute care hospitals and the healthcare business as supposed to what we are selling to Kimberly-Clark. So we are just factoring that number out, so you can see it. We just want to give more visibility to that number. The corporate sales -- those are real good of materials, non-woven materials used in Huggies diapers. We did some machine conversions this last year to allow us to transition our machines to make the medical devices blue fabric that we make. And therefore, Kimberly-Clark will need less of the materials from us going forward.

Yes. Matthew for 2016, those two combined contribute negative 2 point to growth so that's part of the reason for calling out. It's fairly significant -- for the consolidating number.

Okay, great. Just last question for me, was there any change in surgical pain management I guess in January and February after, because I think Sierra had their warning letter resolved sort of mid-December or so that wouldn’t have had any impact on the fourth quarter, but could you see any change in that business in January and February after that result?

Yes. We haven't talked a lot about first quarter of course but even through all of last year as they had changes in terms of what as approved and not approved in the lawsuits withdrawn. We haven’t seen a big change. I think the key message there is people do understand that narcotic pain issue is real more and more physicians more and more hospitals are hearing the concerns and high cost-related to addictions and readmissions and discomfort nausea and the like. So the key messages are being heard and we're now starting to see the growth of our business and we feel good that the business has returned to growth.

All right. Thank you very much.

Thank you.

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

Good morning Robert, good morning everybody.

Good morning, Rick.

Robert, I wanted to come back to med device operating margins, obviously down sequentially for this from the facts that you talked about, but help us better understand -- I understand about some of the pressures may be but, how about better understand the incremental investment spending, I mean did you add two new sales people -- just two new sales people the R&D, help us understand what happened uniquely in the fourth quarter and how we think about the potential positive impact that that could have of that investment in 2016 and beyond?

Yes. Let me talk about fourth quarter and sort of macro first. And then, I'll get more specific to people that we've added, extra spending particularly in our interventional pain area that's the growth -- the rapid growth the COOLIEF. There is a couple of big factors that happened in the fourth quarter in medical devices, one of those is sort of facing of R&D spending another was facing of our sales incentives, the timing of that. But the biggest portion was a write-off in our respiratory care area, we had a manufacturing mistake and we contained the problem within our distribution area but it was a pretty substantial write off that will not reoccur. So once you back that out now let’s talk about the positives coming from the R&D spending and the additional sales, ramp up of capabilities. We have added over a dozen people to our interventional pain business, we feel good about that there are, some of those are in research, some are in selling, as the business growth we’re building stronger and stronger capabilities in that area and the leading indicators in that area of physicians trained and generators placed would certainly say we're going to continue to see strong growth in our COOLIEF and interventional pain businesses.

Okay. May be for Steve, just thinking about your free cash flow, I mean if I'm looking the numbers right you had something like $27 million of free cash flow in 2015 you’re talking about $100 million in 2016. I understand some of the components, but can you just walk us through help us understand the bridge that gets you to that, to those numbers?

There is two big parts out and then I'll pass it over to Steve [Technical Difficult] two big parts, the one-time cost associated from separated from Kimberly-Clark and the capital spending we had a very high capital spending because we had to convert a major piece of manufacturing equipment to be able to make the medical devices grade of blue fabric. So this year we see reducing capital spending back to our more normal levels and much lower one-time expenses. We signal that one-time expenses being in that $10 million to $15 million rate this year. So Steve?

Yes, that’s a pretty good breakdown. So if you take the 2015 free cash flow, I'll just round it to 30 and then add back that CapEx for 2016 should be more on that 2% to 3% to color roughly half of the number that we saw in 2015 and then that difference between transitional pause being over $40 million for 2015, and then, down to that guidance range of 10 to 15 for 2016. So that pretty much gets you to that 100 plus.

But it's pretty encouraging, I mean clearly, we are generating strong cash, the cash is allowing us to execute our strategy, the cash on the balance sheet now, it's more than $130 million allows us to get that first acquisition done this year. So we are very pleased with that kind of growth.

Yes. Robert, obviously, 2015 turned out to be a more challenging year than you would have hoped, I'm sure. You've given us -- it seems like things are sort of balance, stabilize, couple of questions that to the led to the outlook for 2016, on one hand, you got this reinvestment cost essence, cost rationalization, operating efficient initiative, the new investment, more sales people et cetera. How confident are you in the guidance you've given us this range relative to the experience you had in 2015. I'm sure you want to get it right this year?

Yes. I think that's the right way to categorize it, Rick. We did stumble out of the gate last year. We over promised and under delivered. We don't want to do that again. But we have rolled up a plan that is within the guidance we've given. We feel good about the plan and our ability to deliver on that plan. But there clearly lessons learned last year.

Thank you.

[Operator Instructions] Our next question is a follow-up from Kristen Stewart of Deutsche Bank. Please go head.

Hi, again. Just going back to M&A, I know you talked about having things kind of lined up sounds like in the queue, but how should we just think about M&A contribution, should we think about it as acquisitions that should add accretive to growth, or should we think about acquisitions that may be accretive over the next two to three years, how should we just think about these products coming in from a tuck-in perspective from replacement point of view?

Thanks Kirsten. The way we think about it is certainly, it should be accretive by the end of year two both cash accretive and EPS accretive. But -- and to do that and return higher than our cost of capital which should be 8% to 9%. We clearly see the need to get synergies quickly, both manufacturing synergies and synergies around product line selling. And so that's how we think about it. So think about certainly accretion by the end of year two.

Okay. And is that for the larger size deals, or is that for even small deals on -- accretion from a cash basis or --

We think about it for all deals.

ROIC?

Yes. We would think about that for smaller deals as well as larger deals. At this point, most of the deals we look -- we are looking ahead as I mentioned earlier more of the tuck-in size, $50 million up to $150 million of sales and across that full range certainly we would expect them to be accretive by the end of year two.

Okay. Thank you.

Thank you, Kristen.

Our next question is from Dave Turkaly of JMP Securities. Please go ahead.

Hi. Thanks. I just have one really quick follow-up and obviously, ON-Q you said a couple of good quarters here, I was wondering if you could just maybe share your outlook for that franchise and your guidance. And then sort of, what you expect over the next couple of years, do you think we continue to see year-over-year growth in that low to mid-single digit range? Thanks a lot.

Thanks Dave. Yes. I think that's the right way to think about it. We think of ON-Q having, was in decline and then it started to return to growth. We will start to get some numbers that are a little tougher comparisons. We had some pretty low numbers there to compare against in the back half of this last year. But the fact is, it is growing sequentially and we had two really good quarters. I think the key messages are being heard by physicians and by hospital administrators people understand the options now of how to deliver non-narcotic pain relief. So we are optimistic about the growth in profiling much as you described.

Thank you very much.

And this concludes our question-and-answer session. I would now like to turn the conference back over to Robert Abernathy for any closing remarks.

Yes. Thank you. And thank you for your interest today in Halyard Health. I'd also like to point out that Steve and Dave will be presenting next Monday afternoon March 7 at the Raymond James International Investors Conference in Orlando, Florida, information about how to access the presentation can be found on the Investor Relations section of our Web site halyardhealth.com. Thanks everyone. Appreciate it.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.