Avanos Medical, Inc. (AVNS) Q3 2016 Earnings Report, Transcript and Summary

Welcome to the Halyard Health Third Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [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. Mr. Crawford, please go ahead.

Thank you, and good morning, everyone. It is my pleasure to welcome you to the Halyard Health third quarter 2016 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 third quarter performance and discuss the progress we are making on our 2016 objectives. Then, Steve will review our third quarter results and provide additional detail on our outlook for the balance of the year. We will finish with Q&A. A presentation for today’s call is available on the Investors section of our website 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 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. Yesterday marked our second anniversary of establishing Halyard and introducing our long-term strategy of transforming into a leading Medical Devices company. I’m happy to report that we’d made meaningful advances against our goals. Let me briefly illustrate four examples. Today, Medical Devices represent 37% of our sales, up from 30% two years ago. Adjusted gross margin was 36% in the third quarter, compared to 34% in the first quarter of 2015. Research and development spending on Medical Devices is up almost 50% over the past two years and we’re well on our way to doubling our total R&D investment. And the last point is about cash, as of the third quarter of this year, free cash flow already totaled $122 million, up from $27 million for all of last year. While we have more work to do, we’re pleased with our accomplishments over the last two years. Now shifting to our results, as you will recall we outlined two priorities for the year, delivering our 2016 plan and fueling our growth pipeline. Today I’ll begin by talking about our efforts to drive growth and the strategic investments we have made, beginning with an update on our CORPAK acquisition. As you know we closed CORPAK in May and the results today are better than expected largely as a result of accelerated synergies in our headquarters and sales teams and effective integration, we now expect full year adjusted diluted earnings to range between $1.87 and $1.97 for shares. As the integration continues we’re leveraging our digested health portfolio to deepen our relationships with existing customers to create new sales opportunities and to drive growth in new geographies. CORPAK is just one of the investments that is helping fuel our growth. We continue to differentiate our portfolio through innovation and are on track to deliver on our new product launches for the year. In Medical Devices, we recently launched ON-Q track, a mobile app that enables healthcare providers to access real time patient generated data during recovery to improve patient engagement and collect outcome information. ON-Q track enables physicians to provide value based care that emphasizes the total patient experience, addresses patient outcomes and improves quality of care. Halyard’s growth investments were possible because of our strong balance sheet and our ability to generate cash. As a result of our strong cash position we anticipate repaying our CORPAK related borrowing by the end of the year and building capacity to fund additional strategic investments. Now, let me talk about our progress on our 2016 plan. I’m pleased to report, we delivered another solid quarter with adjusted diluted earnings per share of $0.48 and net sales of 398 million, 2% increase over the prior year. From a segment perspective, Medical Devices grew 15% bolstered by our CORPAK acquisition and organic growth which was at the midpoint of our guidance. As expected S&IP markets remain challenging as sales declined 4% on a constant currency basis. Net selling prices declined 3% in line with our projections. Despite these challenges, our recently launched Exam Gloves and AERO CHROME performance surgical gown have resonated well with healthcare workers demonstrating our commitment to deliver value added products. In closing, I’m encouraged by our progress to date, especially our team’s ability to identify strategic acquisition targets and to execute integration plans. While we still have work to do, we made great progress in advancing Halyard’s transformation into a leading Medical Devices company. And with three solid quarters behind us, we’re poised to achieve our 2016 objectives. With that I’ll turn it over Steve for a more detailed look at the quarter and our outlook for the balance of the year.

Thank you, Robert. Let me start by saying that I’m pleased that we have exceeded our adjusted diluted earnings per share expectations and that we’re on track to meet our planning assumptions for the year. For the quarter sales increased 2% to 398 million, including our CORPAK acquisition that contributed 3% of the growth. Favorable currency exchange rates benefited sales by 1%. Excluding CORPAK and the expected $3 million decline in corporate sales, volume was flat and selling prices were lower by 2%. Adjusted gross margin was 36% for the quarter, compared to 35% a year-ago. Margin expansion was due to our portfolio shift to Medical Devices, bolstered by our CORPAK acquisition and favorable currency exchange rates. These benefits were partially offset by lower selling prices in S&IP. Adjusted operating profit and operating margins were $43 million and 11% respectively, compared to $46 million and 12% a year-ago. During the quarter, we incurred 7 million of post-spin related charges, 4 million for acquisition-related charges, 5 million for litigation matters and 6 million in an intangible amortization expense. Adjusted EBITDA was 53 million for the quarter, compared to 56 million in the prior year. As Robert mentioned, we reported $0.48 adjusted diluted earnings per share for the quarter. Two factors strengthened our performance relative to plan; first, accelerated CORPAK synergies leave us poised to exceed our accretion expectations for the year. Therefore, we anticipate a slightly smaller year-over-year increasing in earnings related to CORPAK in 2017. Second, we’ll have some SG&A expenses hit in the fourth quarter rather than the third as originally planned. Now turning to our segment results, Medical Devices delivered another solid quarter of growth, increasing net sales 15% to 145 million, driven by 4% organic volume growth across all categories and 11% growth from CORPAK. Medical Devices operating profit was 32 million, 12% increase from 29 million a year ago. Performance was driven by higher sales volumes which were partially offset by planned higher selling expense as well as research and development spending to support growth opportunities. Moving on to S&IP, the markets remain challenging. On a constant currency basis, net sales decreased by 4% to 249 million. Our focus on Exam Gloves continues to pay off with another strong quarter of volume growth. Additionally, the Exam Glove growth was aided by higher than expected sales to Kimberly-Clark. However, this volume growth was offset by anticipated lower sales in surgical drapes and gowns. As we discussed last quarter, a significant customer transition to a GPO where Halyard is not on contract. We also saw the impact of previously communicated account losses. In total, sales volumes for the quarter decreased 1%. Lower selling prices, primarily in our Exam Gloves and sterilization categories led to 3% price loss, which was at the midpoint of our expectations. Finally, favorable currency exchange rates added 1% of growth. For the quarter S&IP operating profit was 22 million, compared to 26 million in the prior year. The impact of lower selling prices was partially offset by favorable currency exchange rates and manufacturing cost savings compared to last year. Turning to our balance sheet and cash generation, we ended the quarter with 87 million of cash on hand. Cash from operating activities, less capital expenditures or free cash flow totaled 42 million for the quarter and 122 million year-to-date. I’m pleased that we exceeded our cash flow expectations and are rebuilding our acquisition capacity faster than anticipated. For the balance of the year, we expect to continue to generate strong cash flow, which we will use to fund future growth opportunities. Finally turning to our outlook for the year, we’re raising our full year adjusted diluted earnings per share guidance to $1.87 to $1.97, up from $1.70 to $1.90. Based on current trends and our visibility and to factors that could affect our performance, we’re also updating the following key planning assumption. We now expect S&IP sales to Kimberly-Clark to be 50 million to 55 million, up from 40 million to 45 million. The balance of our 2016 key planning assumptions, which we provided on our second quarter conference call on August 3 remain unchanged. In summary, while we have more work to do we had made progress against our transformation objectives and our strong balance sheet leaves us well positioned to advance our strategic plan. With that operator we are ready to take questions.

Thank you very much. We will now begin the question-and-answer session. [Operator Instructions], our first question comes from Kristen Stewart of Deutsche Bank. Please go ahead.

Good morning, guys. This is Brittany Henderson in for Kristen, how are you?

Hey, Brittany.

Hi, Brittany.

Congratulations on a nice quarter. I know it’s early yet, but just given the momentum that we saw here in 3Q ‘16 and expectations for the remainder of the year, how should we just think about some of the puts and takes as we look forward to 2017, just given the kind of your updated thoughts on CORPAK that you highlighted in the prepared remarks as well as any kind of pricing expectations within the S&IP business for 2017 and then I have a follow up.

Okay. Well, as we always do, we’ll give guidance for the first quarter of next year, but there are some things that we have communicated about next year, specifically about S&IP pricing, what we think will happen next year and I can update now on what we think will happen with CORPAK for next year. On S&IP pricing, we communicated that we expect another year similar to this year with price loss probably in that 2% to 4% range. We will be completing our third year of renegotiating contracts; these are typically three year contracts, so expect another 2% to 4% price loss in S&IP for next year. On CORPAK obviously we are over delivering versus what we had previously communicated. We communicated to expect about $0.05 of accretion this year and $0.15 of accretion next year with a run rate that we are experiencing now and getting synergy's faster than we had anticipated, we’re expecting to get more like $0.12 this year and maybe as much as $0.20 next year. So that gap of say $0.10 incremental year-on-year might be slightly lower because we got an synergy faster this year but clearly it is a good news story on CORPAK with up to maybe $0.12 of earnings accretion happening this year and maybe as much as $0.20 next year.

Okay, yeah that’s great news. Then my second question here you mentioned the increase in free cash flow thus far this year, your commitment to evaluating further M&A opportunities. So has anything changed in terms of your broader outlook and thoughts on M&A. I think last quarter you talked about looking for deals that were about the size of CORPAK which your free cash flow that you are generating now, I guess could you and would you be willing to do something bigger at this point or I guess how you are thinking about that now?

Yeah, most of the deals that are on our radar screen now the ones that we are in active conversations are more CORPAK in size sales anywhere from $30 million up to $70 million or so but we would absolutely entertain if it was the right strategic fit in our financial hurdles in terms of expectations of the accretion and return of cost to capital that we would expect. We wouldn’t certainly entertain deals that would be larger, we believe we got the financial capability or we will at the end of this year and in the next year be able to spend $350 million in cash or so which would allow us, if you are paying 3 to 3.5 times sales as a rough indicator, we could certainly do a deal of $100 million or $150 million in sales, so I would love for a deal like that to be available to us, that would meet all our strategic objectives.

Okay, perfect thank you. I'll hop back in the queue and congrats on a great quarter.

Thanks, Brittany.

Our next question comes from Larry Keusch of Raymond James. Please go ahead.

Thanks very much. Maybe just starting with the SG&A comment I think you guys mentioned that it was a bit lower in the third quarter and then you anticipated and it sounds like it will pick up in the fourth, so maybe if you could just help expand upon on the SG&A spend.

We’ve had some phasing of SG&A, during the year we talked about that over the last couple of quarters, we always knew it was ramping up so we do expect SG&A to be higher in the fourth quarter than the third quarter. We got some spending that we are going to take on in the fourth quarter specific to getting at our high IT cost and looking at ways to get our tax situation into a better position and that spending is more about putting together the road map for the future so there will be some consulting spending that will happen in the fourth quarter related to both tax and IT. In addition to that we still got three more product launches that are coming so that is going to be higher marketing spending related to those product launches and we are continued to build out some of the capabilities in terms of filling some basic needs within teams as well as adding some more folks to support some of our growth areas in medical devices. So expect higher SG&A spending in the fourth quarter.

Okay and just on that - can you just help us understand how you are thinking about the fourth quarter. Give us some sense of either what you expect the sequential increase to look like in the fourth quarter or perhaps in another way what do you think you may have pushed out from the third quarter in to the fourth quarter to help us get some sense there. And then the other question was if you could potentially just help us understand the bridge between the prior EPS guidance for the year and the increased guidance for the year, what specifically getting you to that higher rate outside of the - obviously to be in the quarter?

Let me talk about the bridge first and then I will toss it to Steve to talk about the SG&A. In terms of the bridge itself were up $0.12 on increasing guidance over half of that is due to the CORPAK over delivery both authority been delivering the third quarter and what we see coming in the fourth quarter, so that’s over half of the step up for that $0.12 of increase in guidance. The other bit that are in there, we got a bit of currency that has helped us and we built back into the remaining fourth half. And then SG&A is the other part where we are we know what we spent through three quarters now, we know what we are ramping up in the fourth quarter but it is still going to be lower SG&A spend than we had anticipated in the plan when we gave guidance last time.

Yeah, Larry just picking up on the OpEx side, I think rough guidelines I think $5 million to $10 million incremental sequentially for the fourth quarter. And as Robert said it is a mixture of some capability investment and as I think we talked about all year, we have been kind of catching up from a vacancy stand point as we gone quarter to quarter. So there will be some incremental expense there as well.

Okay and that 5 to 10 you said is operating expense, but is that just SG&A?

Correct.

Okay, perfect. Okay thanks guys appreciate it.

Thanks Larry.

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

Good morning, hi guys just a couple of quick questions here, maybe just starting with Steve, Steve just looking at some of the segment your operating profit for S&IP this quarter declined I think 15% which we didn’t see that trend in the second quarter. I know we have been dealing with these pricing issues all year but just kind of interested in why operating profit fell so sharply in the third quarter versus the second and I'm assuming CORPAK helped make up the difference of the broader business. But maybe just talk about that and also in light of that you now Robert in all conference you talk, very broadly about the ‘17 margins, I think you talked about kind of flattish margin commentary for ‘17, I just wanted if you just sort of update those comments right now, and I have a really quick follow up.

Yeah, on S&IP I think we benefited in the first half by the volume sides, we have been ahead of plan for the first quarters of course weak comps versus prior year but the price decrease side effect pretty much right on, that was same the third quarter, we saw all the price drops through and we didn’t have the benefit on the volume side and saw that piece correct a bit more so that’s where you see some of the gross margin impact in the quarter from an S&IP standpoint and you’re right on devices you kind of get the benefit of CORPAK adding in and then on overall benefited twice in our mix as well with sort of covers up so S&IP side. If you think about 2017 I think we haven’t got lot of guidance yet but I think from our standpoint where we are today we see it looking like it does today but subject to things like currency and commodities which we still have to get better forecast and inputs on the uncontrollable for 2017.

Yeah, let me talk a little bit about the margins because I did mention at the conference. We are really pleased with gross margins so far we are up 130 basis points year-to-date. So feel good about our longer term goal of driving improvements in gross margin, clearly some of the gross margin improvement is coming from mix as CORPAK acquisition has added 90 basis points of gross margins into the overall of your business but with that mix with CORPAK we always have to start by talking about price loss in S&IP we are expecting another 2% to 4% price loss next year so if you balance price loss in S&IP along with the CORPAK like it has been said and improved shifting of the mix toward higher margin medical devices, I do think it is going to be relatively flat year-on-year next year compared to this year.

Okay thanks Robert and Steve just one quick question your fourth quarter implied guidance I think it is pretty stable if frankly with the third quarter, it is just not dramatically easier comp because the fourth quarter was pretty soft year for you, you have been conservative all year frankly in your sequential quarterly performance, is there some fourth quarter conservative some sort of comp placed into that implied guidance, I am just think you could do a little better frankly in light of the easier comp in fourth quarter 2015, thanks I will jump back in queue.

Yeah, certainly we hope to do better by think on the other side we still have some variables we talked all year about the impact some of the account losses accumulating giving some of that in the third quarter still expecting some of that in the fourth quarter, but certainly we hope to be on a higher side of the guidance range from a volume standpoint in S&IP certainly.

Yeah, as I look at the guidance, I would say we had to hit the midpoint of the guidance that we just issued. We’d need a $0.45 fourth quarter. Second quarter of this year we had a $0.45. We just had a $0.48 now. We’ve got some additional SG&A spending that I just talked about this coming in the fourth quarter. So, I think that $0.45 as the midpoint of the range feels about right.

And Robert sorry, just on a revenue growth perspective kind of - same kind of question. Robert, if you think specifically on revenue growth versus earnings in the fourth quarter?

Yeah, revenue growth is, we typically have slightly higher sales in the fourth quarter, not dramatically higher. But fourth quarter is usually our highest growth for the year. I think the real unknown is S&IP, because we communicated last quarter that we had a major customer hospital group tenant who had shifted from one GPO to the next and the GPO that they shifted to, we’re not on contract there. We’re continuing to see losses of those tenant hospitals as they shift out away from Halyard products to their new supply. So that will buffer fourth quarter a little bit. Earlier in the year in S&IP we've said think about roughly a 1% volume loss. We're now saying think more like that being flat year-on-year in terms of the volume loss. But the tenant, the shift away from the tenant hospitals is the big unknown there, David.

Okay. Thank you very much.

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

Hey, good morning and thank you for taking my questions.

Thanks, Matt.

Hey, could you walk us through the commodity environment, I think, sequentially I think you saw several of your base raw material prices moving higher through the third quarter and into the fourth quarter as far as expectations go, but you were able to keep your commodity inflation guidance unchanged.

Yeah. We get - sometimes we get lucky. We had one go up and one go down. So, Polymer - Polymer has been the one that's been going negatively for us and almost equally offset by night trial, which is used in exam gloves going the other direction. So, they offset each other this last quarter and we had very little impact on earnings as a result of commodities. So, and we were expecting that to stay the same in the fourth quarter as well with very little impact on our earnings based on commodities. So, sometimes you get lucky and one goes one way and one goes the other. Sometimes you get unlucky and they both go in the wrong direction.

Okay. Fair enough. And then I don’t know if I missed it or not, but could you give us an update on the negotiations around the Novation, MedAssets contract? And if it's - if it’s sourced all three players versus the indoor source previously, what kind of impact would that have on you?

Yeah, it's a good question. We've been talking about that for the last couple of quarters. For those on the line, this is our largest GPO contract. It's our - it's our surgical contract with what was Novation and MedAssets, now the combined entity Vizient. That contract is being negotiated now. nothing new to report. We're in kind of the final stages of negotiating that contract. We've been on a dual contract, a dual contract with Novation, a dual contract with MedAssets. There will be some pressures for that to be multi, meaning all three suppliers would be on the contract. If that is the outcome, I actually don't think it will have any significant impact on our business. We're already positioned in hospitals. Hospitals prefer typically to stay with the trusted supplier that they are using. So we're not expecting any - any big shifts in terms of market share swings resulting from going from - the potential of going from a dual contract to a multi.

Okay, great. And then you talked a little bit about - about ON-Q track. But can you talk a little bit also about some of the clinical work you're doing around the interventional pain portfolio?

Yeah, we've - we've had some - some nice clinical work that was completed this last quarter in osteoarthritis and the clinical work is just now being - being published, but very strong clinical results showing significant pain reduction scores. That clinical work will be used to - to further reinforce reimbursements so that we have a stronger position on getting reimbursements from the payers. And so we're excited about that outcome and you'll hear more about it over the next quarter.

Okay, great. Thank you very much and it was a nice quarter.

Thank you.

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

Thank you. Good morning and congratulations as well on the very nice continued progression there in the business.

Thank you, Chris.

Just two maybe remainders for me here this morning. Could you just give us a little bit more of an overview on the general business trends you're seeing in the medical device portfolio kind of across the various pillars there, 4% organic growth, very solid as you mentioned at the midpoint of the guide, but - but off modestly sequentially, just maybe help frame up for us kind of what we should expect to see just from a volume standpoint here through the back half of the year and if anything in particular is standing out in the 3Q? And then I have one quick follow-up.

Yeah. Just as a reminder for folks that are listening, we have - we have four kind of pillars as - as Chris just referred to in our medical device area. Two of those are our respiratory care and digestive health. Our fully penetrated categories, mature categories, they're low single digit. Growers tend to grow with hospital utilization and surgical procedure utilization. Then we have two areas that are growing faster. That's our pain management area. So, our pain business is, ON-Q in particular is a mid-single digit grower and then our - our chronic pain business, the key part of that is our COOLIEF and COOLIEF is a double-digit grower. So, when you net all those together sort of low single digit for respiratory and digestive mid-single digit for ON-Q, the biggest part of our surgical pain business, and COOLIEF the biggest part of our - our interventional pain business. That’s how you net out in that three to five range where we're hitting roughly a four now. You layer on top of that the acquisition of CORPAK and you get an accelerated growth. So, 4% of the base business feels right and that's what you should expect in the fourth quarter. And then - and then ongoing where we continue to look for those right acquisitions to more rapidly shift the mix of our portfolio of our margin medical devices.

Super. And then just as a follow-on maybe for Steve, Steve you mentioned that you have some plans to spend in the fourth quarter really investing now for future growth when you think about the investments to consolidate on the IT side, as well as to lower the effective tax rate over time from a planning perspective. Could you just remind us again kind of what the potential savings that you think you could realize over the next three to four years would be on the IT side and kind of help us think about how we kind of gate that going forward? And then similarly as you looked at the S&IP portfolio now, two years is just anniversary that time flies when you are having fun I guess, but any thoughts on that portfolio? Is that - I realize the acquisition focuses on the device, but is the S&IP portfolio right-sized as it stands today? Then I’ll get back in queue. Thank you.

Sure. I’ll throw the second one over to Robert. But just on the top tax rate in IT and then you asked about tax rate, but just to mention we're still targeting our guidance for this year 33% to 35% as we've talked about in past calls some of the investments we're making now and assessment has helped drive that lower certainly down towards the lower 30s. So, that is something I hope we'll be able to talk about when we do start talking about guidance for next year. On the IT side, we've talked in the past about needing to recapture the lost basis points that came with the spin and build out with a standalone infrastructure, clearly making progress on the portfolio shift part of that basis point recapture through the growth of the device business and now with the additional growth of the CORPAK business. The IT piece is part of getting at that remainder and certainly over the next few years it’s still our anticipation or goal to drive some efficiency in IT as we've talked about before our spend both in direct IT, but also the ancillary costs of running three [Indiscernible] are pretty heavy. So, we look at this investment to start setting the table for a progression that can get after a good portion of those remaining basis points. So, we are not ready to profile that out over the next couple of years. What we are actually doing right now is to help establish with that profile, as well as the investment, because we know there is going to be some investments required in order to execute that part of the transformation. So, I’d say more to - more to come on that one as we better define what the next few years will look like.

And Chris, I’ll take the one on whether S&IP is right-sized and I’ll answer it two ways. One is, is it the right size in terms of us meeting the needs of the business. It’s a billion dollar business for us. We're - we're in the categories where we want to compete. Those are the surgical supplies categories, as well as exam gloves. We have leading market share, number 1 or number 2 market share across each of those categories. So, yeah, we think the business is a good size, right size. It gives us a lot of scale and brand recognition within hospitals. In terms of right size from a spending standpoint, we believe it's right-sized there as well. We’ve taken a couple of opportunities over the last five years to really take the headcount to the right level as we've seen margin erosion occur. In addition to that, we’ve looked at the spending levels across things like marketing research and development, clinical affairs, and we believe that we've gotten those right-sized as well. If I had to say what I tweak a little bit we are spending a bit more on research and development than we have in the past. That's an area that was under-invested as part of Kimberly-Clark. So, as part of our goal of doubling our research investment, we are increasing our - our research spending in S&IP. But it's still a low research in relative to the industry. We’ll only spend about 1% of sales on S&IP research. But that’s an appropriate amount for us to be able to refresh the products and bring innovation to the marketplace.

Understood, thanks again.

Thank you.

[Operator Instructions] Our next question comes from Rick Wise of Stifel. Please go ahead.

Hey, guys. It's actually Jamie Fritz on for Rick. Congrats on the good quarter. Maybe just focusing on ON-Q for a minute, I know you've had some easier comps to date and now your company gets some a little bit tougher profile there. Maybe just talk about the outlook for ON-Q, what your expectations are there, what's driving that and in terms of market dynamic and your competitor on that front? And you mentioned you - you continue to see this as a mid-single digit grower. Just maybe talk about your confidence in the sustainability of that over time?

Yeah. Good question. We are - we are facing some tougher comps back and we were really declining in sales. We were - we've lacked all those. So, now we're in the quarters where - where we were - had returned to growth this time last year and we do have suffered comps. But - but we've got some - some real tailwinds in the industry as more and more people are aware of the issues related to narcotic pain medications and there's just more pressure on physicians and hospitals to get away from using narcotic pain medications. We’re continuing to very strongly market the fact that ours can give you 3 to 5 days of non-narcotic pain, surgical pain relief. We continue to be encouraged by the fact that there's a lot of upside potential in this business as we look at surgical procedures, large incision surgeries like - like trauma surgeries, the knee replacement surgeries that our ON-Q product is only used in less than 10% of the surgeries where we believed that it would be appropriate to be used. So, we still see a lot of growth potential in there and expectation of kind of mid-single digit growth for ON-Q going forward. It’s certainly supported by the sort of trends and the issues within the industry.

Okay. Great. And then maybe just focusing again on the uptick in R&D spending and you’ve talked about your 10 products that you plan to launch this year and on track with that. Should we think about the cadence of new products as accelerating from here and what does that do to the business?

Yeah, so on the R&D spending in our medical device area as part of Kimberly-Clark we were spending less than 3% of sales. We're now spending closer to 5% of sales with an idea to move that up closer to 6% of sales over time. So, - so we're exactly on track where we wanted to be to significantly increase the spending across the full business, but particularly in medical devices. In terms of what to expect, most of the product launches this year have been adjacencies or line extensions, if you will. And over time what you'd expect is that with the research spending that we're going to have more new to the industry, new to Halyard products that are being developed. We're putting a lot of focus on medical devices particularly in the pain management area, we’ve formed a new group and hired some outstanding talent and formed a group that we call the Pain Center of Excellence to really focus on opportunities to dramatically expand our pain management technology area. So, the research spending should lead to not just more product launches, but more meaningful product launches.

Great, thanks so much and congrats again on the quarter.

Thanks, Jamie.

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

Thanks and I know that you have mentioned manufacturing cost savings in your operating margin profile for both businesses and I'm just curious if you might be wanted to give us a little more color on there, whether I know you mentioned some of the input costs on the S&IP side, some IT initiatives, maybe some efficiencies post the spend, but I'm just trying to understand if you have opportunities to kind of improve margins ahead looking at that cost profile?

Dave, I do believe we have opportunities to improve even further, but this year has been a good year, if you look at year-over-year comparisons. We typically deliver about 1% cost savings in our S&IP business to offset some of the price loss. This year in particular it's running at that level or slightly higher, because we had some added costs last year from the West Coast dockworkers strike and some other things that were disrupted in the business. We haven't had those sort of external factors like the dockworkers strike this year. So, we’ve seen some nice comparisons to prior year in terms of our cost savings in manufacturing and supply chain. Long-term we’ll continue to focus on better utilization at our plants, better labor utilization, reduced waste, higher manufacturing output; we're also focusing on more efficient distribution of our products. That's a good bit of where the cost savings are coming as well. But, yeah, going forward, I would, I would say, continue to count on that sort of 1% cost savings in S&IP that’s coming from our supply chain.

Great, then on the ON-Q, the track, I’m just curious what were customers asking for that and I guess if you could give us any comments on specifically how you think maybe that could impact your position in the market or your growth rate ahead from that product?

Yeah. Dave, if you said are they asking for, what they've been asking for, for the longest period of time is a better way to measure pain scores. You think of the sophistication of hospitals and medical devices in terms of your pain scores, you're still given a little chart with us - with a frowny face on one hand and smiley face on the other end and you're asked to - to ask what your pain score is. And more and more physicians, once you're out of the hospital, they don't know your pain score because there's not someone there that’s recording that. So, they wanted more sophistication. They want more feedback on whether their procedure that they're using is better in terms of pain management than other procedures. So, this is a way to get real-time data that's got patient or customer engagement and it gives feedback to the physicians, so that they can know real-time how those pain scores are progressing in that first week following discharge from the hospital. So, it's been really well received. The physicians are very interested in these numbers. And so, as we're trialing it out now where we believe it's not going to be about making a lot of money selling an app, this is all about us being able to better demonstrate clinical outcomes, because the pain scores and showing that our ON-Q really is the most effective clinical treatment.

Thanks a lot.

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

Well, thank you again for your interest in Halyard Health. I appreciate you joining us on the call today. Thanks, everyone.