Hello welcome to the Avanos Fourth Quarter 2021 Earnings Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to Mr. Scott Galovan. Mr. Galovan, please go ahead.

Good morning everyone, and thanks for joining us. It's my pleasure to welcome you to the Avanos 2021 Fourth Quarter Earnings Conference Call. Presenting today will be Joe Woody, CEO; and Michael Greiner, Senior Vice President and CFO. Joe will begin with an update on our quarter and our business environment as well as recap progress made against our 2021 priorities and key objectives for 2022. Then Michael will review our fourth quarter and full year results and share our 2022 planning assumptions, inclusive of our acquisition of OrthogenRx, which closed on January 20. We will finish the call with Q&A. A presentation for today's call is available on the Investors section of our website, avanos.com. As a reminder, our comments today contain forward-looking statements related to the company, our expected performance, economic conditions and our industry. No assurance can be given as to 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 risk factors described in our filings with the SEC. Additionally, we will be referring to adjusted results and outlook. The press release has information on these adjustments and reconciliations to comparable GAAP financial measures. Now I'll turn the call over to Joe.

Thanks Scott. Good morning everyone. And thank you for joining us to review our operational and financial results for the fourth quarter and full year 2021. While we continue to see the impacts of the pandemic, as it relates to elective surgeries, hospital staff shortages and supply chain, we are very pleased with how our operational and commercial teams have responded to the challenging dynamics brought on by the pandemic. Across our enterprise, we remain focused on getting patients back to the things that matter as we meet the needs of our customers. I will begin with a brief review of our results for the quarter before discussing the current environment and summarize the outcomes from our 2021 priorities. We achieved sales of over $193 million for the quarter and earned $0.46 of adjusted diluted earnings per share. Our Chronic Care portfolio delivered strong results growing over 8% with our digestive franchise growing double digits in the fourth quarter and our North America respiratory business holding flat versus a tough comparison to last year's fourth quarter. Our Pain portfolio overall declined by less than 2% with our interventional pain franchise growing over 6% offset by our Acute Pain product portfolio declining by a little less than 7%. The decline in the Acute Pain portfolio was primarily driven by the timing of the return of elective procedures. For the full year, our Digestive Health, Acute Pain and Interventional Pain franchises grew by approximately 10%, 3% and almost 19% respectively. With respiratory health expected to be declining by just over 11%. As we noted in the last quarter, we anticipated continued improvement in our gross margin profile for the fourth quarter versus the third quarter. Unfortunately, headwinds related to raw material availability, inflation and shipping costs persisted. And our fourth quarter gross…

Thanks, Joe. As you noted, we have made meaningful progress against our value creation initiatives and are setting up well for a solid 2022 that will combine mid-single-digit top line growth with M&A execution. Additionally, we will show improved gross and operating margins as well as consistent free cash flow generation. Now let's begin with a review of our fourth quarter results. Total sales of $193 million was up 4.5% compared to last year. As a firm, throughout the year, we indicated full year net sales growth would range from 2% to 4% compared to the prior year. We achieved the higher end of the range with net sales increasing 3.9% on a constant currency basis compared to the prior year, excluding discontinued products manufactured in our Maxter facility. Despite the pandemic-related tailwind for Respiratory Health in the fourth quarter of 2020, Chronic Care sales increased by a little over 8% to $126 million in the quarter. Adjusting for the 2020 tailwind, Respiratory Health sales would have been flat for the quarter, in line with market growth. We did not notice any additional benefit from the Omicron variant as related hospitalizations did not increase in Q4 until the end of December, nor do we expect any meaningful impact to our closed suction catheters as hospitals continue to carry out their first line of care before placing patients on ventilators. Additionally, we believe we are experiencing a relatively normal cold and flu season. Shifting to Digestive Health. We continue to see strong growth across both of our North America and international markets, resulting in fourth quarter growth of over 17%. Within our Digestive Health portfolio, NeoMed grew almost 47% from a continuation of conversions to our ENFit technology despite supply constraints impeding additional growth. Moving to Pain Management. We delivered $68…

Yes, thank you. [Operator Instructions] And the first question comes from Chris Cooley with Stephens.

Good morning, and appreciate you taking the questions here today. Michael, maybe if you just start, help us maybe parse out a little bit more of the guide. And specifically here, I guess, two parts to the question with the addition of OrthogenRx and a pretty strong contribution there in revenue $70 million. One would just think that there may be a little bit more of a natural lift there in the gross margin. So I would hope that you could maybe help us parse out kind of the headwinds that you talked about from a macro perspective versus the underlying base business and then OrthogenRx, just as we think about the components of growth – I'm sorry, of gross margin? And then similarly, when we look at the EPS guide, while it's not explicitly called out, I guess, we can work through it, but it would be helpful to kind of get a better feel for how much you're anticipating getting from the acquisition, how much from the base business as it stands and then the incremental contribution from some of these cost savings initiatives? And I've got a quick follow-up. Thanks.

Great, Chris. Thanks for the question. I'll try to get each of those in, but if I miss one, just ask it again. So I'll start with the gross margin. I think the best way to think about that because we're not going to give specifics around OrthogenRx margin profile for a range of reasons, one of which is we're not sure exactly how quick we can integrate, what we want to do with that and that may have an impact as the year goes on. But one way to think about it is the 55% gross margin, the low end of our range, a majority of that, right, over 50% of that increase from 52% this year to 55% would be the uplift from OrthogenRx. As we get more towards 56%, 57% in gross margin, a majority of that uplift is because of the good work we're doing in the normal organic efforts from a cost of goods sold standpoint, plus, hopefully, we'd get some tailwinds with inflationary pressures lessening and some of the other things we commented on in the prepared remarks. So that would be the gross margin piece. When we think about the revenue guide, 3% to 6%, $70 million obviously is an absolute number that assumes the 11 months plus one week that we would own it. So actual results of $70 million. The 3% to 6% organic guide excludes $4.5 million of Maxter revenue for our Maxter facility. So our organic guide is based off of $740 million of organic revenue from 2021. So hopefully, that helps to clarify the organic guide on the revenue piece. $70 million actual OrthogenRx that we believe we will achieve in 2022 for the period that we own it. And then on gross margin, low end of that gross margin, if we achieve that, that will be – a majority of that will be because of the uplift from the OrthogenRx acquisition as we get towards 57%, a majority will be because of the organic work that we intend to implement this year.

And just – I guess, just to clarify again, then as well, just from an earnings contribution perspective, when I think about the EPS guidance range.

Yes. So we're not going to provide that...

Okay. Fair enough. Understood. And then I guess just for my follow-on, I just want to make sure I understand your assumptions behind OrthogenRx. I believe the time of the acquisition at the end or middle of December, $130 million that you paid there at closing. It was around 2.5x 2022's estimated revenues. And so kind of that makes pretty much sense when we think about the timing. Just curious though about what you're thinking from a growth rate perspective for that business going forward?

Yes. No, great question. The growth rate is – we expect it to be moderately accretive to our organic top line growth.

Okay. Thank you very much for clarifying that. I will get back in queue.

Thank you. And the next question from Matthew Mishan with KeyBanc.

Great. And thank you for taking the questions. And I just wanted to follow up on Chris' question there for – on OrthogenRx, are there headwinds that need to be accounted for in – for to that growth rate, the move to single shot? I mean some changes in, I guess, how it's being reimbursed? Is there just some things that we need to pay attention to?

Matt, I'll maybe take that. It's Joe Woody. I think the way to think about it is that we feel like we can sort of maintain the trajectory that they're on over time. We think we can add into our direct sales force, but we sort of want that to run stand-alone for a while. And yes, we're paying attention to the reimbursement changes, which we have fully modeled and are prepared for next year. But that could mean in the second half of this year, there's a little bit of utilization change that goes on. Nonetheless, as Michael said, we're still going to be north of our growth rate – current growth rates, and it's going to be accretive to our growth.

Excellent. I just wanted to make sure I understood the gross margin trajectory, correct. What you're saying is half of the – the half of – from 52% to 55% is from OrthogenRx, not the bump from 52% all the way to 55%. Is that correct?

That's right. Exactly.

Okay. And then you said you were making some investments in SG&A and R&D to start the year. What are some of those investments and where are you putting dollars to work?

So last year, as the back half of the year, we started to see continued headwinds with gross margins. We made choices around stopping or delaying selling and marketing and R&D activities that we felt comfortable doing. I think we mentioned this on our third quarter call as well that we didn't think would have a long-term disruption in our investment profile. As we enter into this year with obviously the benefit of the OrthogenRx acquisition, other things that we believe are starting to loosen up as far as opportunities for us, we wanted to make sure we put those investments back in. So we're adding back in a couple of million of R&D that we delayed from last year and then also some key selling and marketing initiatives, we have some small launches we have for this year. We want to continue to invest behind NeoMed and the opportunity that we have there. So it's kind of spread around that, but it's primarily related to delaying of things that we put off in the last four to six months of last year.

Okay. And just last question on the free cash flow of $90 million. Is that just flowing down from EBITDA, like core? Are there some moving pieces there where were there some lump sums that you're bringing in?

No. So that's $90 million of core. In addition to that, we still have $13 million of tax receivables, some lingering CARES Act and then other tax receivables. That is not in the $90 million if we were to secure those tax receivables. That would be in addition to the $90 million, the $90 million is core. It also assumes a heavy headwind with inventory. So if we manage our inventory in a slightly different way, and/or supply chains react differently, there may be some potential upside as well. So this is all core and it doesn't include some potential upside.

Okay. Thank you very much.

Thank you.

Thank you. [Operator Instructions] And the next question comes from Rick Wise with Stifel.

Good morning, Joe. Hi, Michael. Maybe just going back to recent trends. You were emphasizing that maybe December wasn't as impacted by some of the COVID headwinds, I assume January was – just what are you seeing more specifically now we're basically 2/3 through the quarter, are you actually seeing in your business, what we're reading in the newspapers, the lessening of COVID headwinds? And are you starting to see some early encouraging signs on the elective procedure front that sort of underpin your optimism about the year?

Yes, Rick, I would say that generally, a piece of December, as everybody has reported and into January, as we've emerged into February, we're seeing a little bit of green shoots, if you will. I do think Q1 is still going to be affected in terms of elective procedures, probably getting better in the Q2 and certainly better in the second half, that's considering that we don't have any other issues or variants impacting. I think others have spoken to, and we feel like there is a bolus of procedures, especially in the orthopedic space that are going to need to get done and start coming to fruition as soon as the majority of the hospitals go back to a normalized level, and that's the big debate. The normalized level hasn't always come as quickly as everyone anticipated throughout the pandemic. And again, now there's a staff shortage component. But I do think it's looking to get better. Omicron moved through pretty quickly. I think as we exit the quarter, we will start to see a little bit of an uptick and primarily in our business, as you probably know. The biggest impact is on ON-Q, less so on COOLIEF and the Chronic Care business.

Right, right. And just maybe it's a naive question, a little bit. But obviously, your cost, you're detailing it multiple ways. Your costs are – pressures are rising, supply chain, product shortages, et cetera. To what extent are you all able to pass along? Are you talking to your customers about it? Are you negotiating with them? Just – how is that unfolding?

Yes. I think the difficulty – I mean, everyone is going to experience some compensation inflationary issues that will probably remain with us. And then some of the raw material pieces will come and go. I do think that there's an opportunity for some price increase for us throughout the year. But the majority of what we do is GPO and IDN base. And I think that's the struggle for medical devices versus as an example, a consumer products company that can pass it on a little bit more quickly. So we do have some plans that we think – that we can roll into this year, and we'll get some benefit. And then as we renegotiate contracts, I think there's a general understanding from GPOs and IDNs that not just us, but all medical device companies are going to be looking to pass along some of this transportation, some of the general raw material increases as well.

Great. And just last for me, Joe, you've been absolutely spot on and straight ahead in terms of highlighting that your M&A activities continue that you're working on multiple things. And most recently, you've captured OrthogenRx, which is clearly a compelling acquisition. As you're thinking about this year, are you as optimistic? Are you as confident? Any color on – you're hoping it's more in the first half than second half. And any incremental color about what, where, how it's going to fit in?

Yes. sure. I mean, we exited the year talking about two that were very near term. I would say that we have three bolt-ons that we're looking at, and we're looking across both the Chronic Care business and the Pain business. You never can time these things. So I wouldn't call it necessarily for the first half, but we'll do what we can. But certainly, I think we will leave 2022 with one or two additional bolt-ons of the type and variety that we've been working on. I think we're going to start to benefit from the cash flow generation and be in a good position then to do what I would see is a larger deal for us in 2023. Obviously, first, delivering and execute what we're laying out here today and meaningful for us and larger can be several hundred million. It doesn't have to be a $2 billion, $1 billion deal that probably is not realistic. But there are some bigger things that we can do that would have a greater impact on the business. So I just see another one or two this year and then looking at something larger probably next year.

Okay. And I apologize, if I could sneak in one more, I meant to ask. The OrthogenRx revenue growth outlook, the $70 million forecast. Just help me understand because I've been asked and haven't had a great answer. With reimbursement getting hit in 2023, how does it grow? How do we think about growth this year and next? And – or said differently, how does it not get impacted given that headwind? What are the offsets? Thank you so much.

Yes. Thank you Rick. For us, there's two things that benefit us. One is, we're coming from a smaller base versus some of the competitors that have larger bases. And also, the way that CMS is looking at this is they're looking at the ASP. And generally, our ASPs are in a good spot. They're definitely going to get reduce, but we're in a good spot as we stand now. And so when we speak off or Michael said on this call, still north of our Avanos growth, that would contemplate even a reduction in reimbursement. So we've built this all in, and we still think it's going to be accretive to our growth and accretive to our margins as well.

Very helpful. Thank you.

Thank you. And the next question comes from Drew Ranieri with Morgan Stanley.

Hi, Joe and Michael. Thanks for taking the questions. Just a follow-up on the OrthogenRx question that Rick had. Can you maybe just talk a little bit more about the components of growth? I mean how you're thinking about the three and five injection markets and your ability to drive growth there? Is OrthogenRx – is it all about just expanding the customer base? Or is this largely kind of a mix benefit of moving five to three injections?

So a couple of things. One, we – just a reminder, we will be able to develop if we choose to a single injection, but that's sort of in the future. But if you think about the growth, pretty good growth from the existing sales force. Ultimately, we want to put this into our group. So there's an opportunity for expansion and growth there so that we're both selling together the products. I think the other thing to think of is that there are a lot of physicians, a good percentage of them that believe that three to five is a better route because oftentimes, in a single injection, the pain relief is not very long and so if it's spread out over a period of time. And then additionally, we have different call points that we think are going to be interested in this product, Interventional Pain, where we call with COOLIEF, the various pain clinics that we work with on a different basis. So we feel like there's a good runway of growth for us and also longer-term to think to contemplate whether or not we would develop a single. So we don't feel like the runway or the projections or what we're talking about being north of our current growth rate would require us to have a one injection in there.

And then just maybe a little bit more kind of on the strategy, combined strategy with OrthogenRx and COOLIEF, I mean how does this product fit-in with COOLIEF. I think there was data that you were developing for COOLIEF first HA, but just kind of curious if this uplifts COOLIEF sales or there could be potentially some cannibalization between the two products? Thank you.

I think ultimately, it's going to help both ways. So the 1099 group that is selling currently Orthogen and then our COOLIEF direct group, when we start to think about calling on interventional pain clinics and orthopedic surgeon offices and Ambulatory Surgical Centers. So you can also think about the fact that we're working internally and externally on another approach to something COOLIEF-related for Ambulatory Surgical Centers. So I don't think that certain modalities are going to disappear. We've kind of seen that with corticosteroids. They're here. They're not as effective, but there's usually a cycle in different viewpoints of treatment. I don't think HA is going to go away, but I think that there's an interesting market in total, which we're going to spend a lot of time in and develop on treating OA of the knee. And so we sort of have two forays now cooled frequency RF, hyaluronic acid and then there are other technologies that we're considering and looking at either for open innovation investments or potential acquisitions. So I think there's going to be sort of a pathway. It actually starts with kind of going in and looking at the patient and seeing about an opportunity to lose weight or to exercise, and it sort of moves to the Advils and Aleves and then on to steroids and then HA. So I think that it's a good place for us to be where we can build a competency.

Got it. And sorry, just one last one for Michael. And I'm sorry if I missed this. But how should we be thinking about 2022's tax rate and share count kind of given that you have the $30 million repurchase authorization outstanding? Thank you.

Yes. The share count I would think kind of flat, slightly down versus last year. And then the tax rate, you guys are getting the kind of 26%, 27% rate. Normalized onetime opportunity we had from the tax planning strategy in the fourth quarter that was discrete and one-time in nature that won't repeat. There was a good opportunity around the Maxter closure that we had, the 26%, 27% rate in 2022 and likely into 2023 still remains appropriate.

Thank you.

Thank you. And we have another question from Chris Cooley with Stephens.

Thank you for taking the follow-up. Just maybe one other quick one as we think about generation of cash in the course of the year. I know in prior presentations, you have mentioned an evaluation of the existing portfolio and potential monetization of some of those assets to help provide additional growth capital for the business going forward. Any update on your thoughts there as we enter the new year? Are you comfortable with the portfolio as you have it here today? Or alternatively, do you see some opportunities to prune and enhance the growth and margin profile and as a result, have more capital for these tuck-ins? Thank you.

I think there's more opportunity for us. And I think Maxter is kind of a good example to think about in terms of we saw something that was gross margin dilutive and we decided to exit. I think there's opportunities for us to sell some other SKUs and other portions of our business that aren't attractive or a part of the strategy on the go forward that would be beneficial to us and the metrics that we're driving alongside of the strategy. And we're continuously looking at the portfolio and getting honed in and more specific. So there's more of that, I think, to come. And that should benefit us, I think, on a future M&A or on future M&A opportunities as well.

Thank you.

And this concludes the question-and-answer session. I would like to turn the floor to Joe Woody for any closing comments.

I'd just like to thank everybody for the continued interest in Avanos, and we're very pleased with the execution in 2021 given certainly an uncertain environment. We're certainly committed to creating shareholder value and anticipate 2022 is going to begin to deliver on that commitment. I'm confident the products we've detailed, combined with our market-leading portfolio and attractive markets, position us for sales growth, margin expansion and positive free cash flow as we continue into 2022 and look forward to talking to all of you more about this. Thank you.

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