Good day, and welcome to Avanos Second Quarter 2020 Earnings Call. All participants will be in a 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 Scott Galovan. Please go ahead.

Good morning, everyone, and thanks for joining us. It's my pleasure to welcome you to the Avanos 2022 Second Quarter Earnings Conference Call. Presenting today will be Joe Woody, CEO; and Michael Greiner, Senior Vice President and CFO. Joe will review our quarter and current business environment as well as provide an update on our key objectives for 2022. Then Michael will discuss additional details regarding our second quarter and review our 2022 planning assumptions. 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, current 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'll be referring to adjusted results and outlook. The press release has information on these adjustments and reconciliations to comparable GAAP financial measures. Now I'll turn the call over to Joe.

Thanks, Scott. Good morning, everyone, and thank you for joining us to review our operational and financial results for the second quarter of 2022. Our operational and commercial teams continue to execute well against a range of macroeconomic challenges, and we remain focused on getting patients back to the things that matter as we meet the needs of our customers. Although we fell short of consensus revenue estimates for the second quarter and are also updating our full year guidance for revenue and adjusted EPS, which Michael will discuss further, we continue to experience consistent demand throughout our product portfolio and remain confident in our ability to execute against our longer-term financial objectives as the supply chain and other macroeconomic dynamics improve. For the quarter, we achieved sales of $203 million, representing 9% actual growth or greater than 10.5% growth, excluding the negative impact of foreign exchange. We generated $0.41 of adjusted diluted earnings per share and $23 million of free cash flow. Excluding the negative impact of foreign exchange, our Chronic Care portfolio grew by just under 1% despite a 10% contraction experienced in our respiratory business due to inventory being sold through our distributor channel that had accumulated during later phases of the pandemic. Our digestive franchise delivered another solid quarter with greater than 5% growth versus prior year excluding FX. Excluding the impact of OrthogenRx and foreign exchange, our pain portfolio was down 1% with our Interventional Pain franchise growing 5% and our acute pain product portfolio lower by a little over 4% versus last year. The pain franchise had a tough prior year comparison and continues to experience a slower return to elective procedures due to staffing shortages and patient preferences. Our hyaluronic acid offerings through orthogenerics posted strong Q2 sales with a rapid adoption of…

Thanks, Joe. As you noted, even with the uncertainty that persists in the economy globally and the industry-wide macro pressures, we met or exceeded most of our first half objectives. We delivered on our gross margin improvement and free cash flow generation as well as continue to successfully execute on our OrthogenRx strategy. Additionally, our SG&A spend as a percentage of revenue sequentially reduced significantly in the second quarter, and we remain committed to ensuring full year spend remains below 40% as a percentage of revenue. Even though we have built good momentum across these objectives, we believe it is prudent to update our revenue and adjusted EPS guidance based on the continuing macroeconomic pressures, currency headwinds and increased interest expense. We now anticipate delivering net sales between $815 million and $835 million for fiscal year 2022 and adjusted EPS between $1.45 and $1.65, primarily due to further projective negative foreign exchange impact and higher interest expense totaling approximately $0.10 as well as slightly lower operating earnings due to lower gross margins in the back half of the year. Now let's review our second quarter results. Total reported sales were $203 million, up 8.9% compared to last year with adjusted EPS of $0.41. On a constant currency basis, organic growth was flat. This excludes the contribution from OrthogenRx sales in the second quarter as well as removing Maxter-generated revenue from the prior year second quarter. Chronic Care actual sales were down by $2 million versus last year at $112 million in the quarter, excluding the prior year impact of sales coming from our exited Baxter facility. We continue to see strong growth in our digestive health business with second quarter growth of 3.5% despite supply constraints impeding even further growth. Within this portfolio, NeoMed grew almost 35% domestically and over…

[Operator Instructions] The first question comes from Rick Wise with Stifel. Please go ahead.

Lots to unpack here. Maybe help us think through just in a little more detail some of the challenges facing the second half just for starters. The supply chain, yes, everybody in the industry is dealing with it. You're dealing with it. Where are you, do you feel like, in finding new suppliers? How resolvable is it? Just help us better understand -- and therefore, I assume that's the prelude to working through your backlog as well.

That's correct, Rick. It's Joe Woody. I'll start and then of course, Mike can add anything that he would like. For us, what we have been mainly seeing in a range of resins and silicone. And that affects the ON-Q business, the Digestive Health business. In the first half, we saw some chip problems and affected COOLIEF generators that looks to be dissipating in H2. And all of that, in turn, also affects the international business. Now, to the extent that, that clears up, and as you can imagine, like other companies, we're working in a million different pathways to do that. There's also the potential for upside. But at any given time, just in the supply chain that we're in right now, other items emerge, whether it be around packaging or things as simple as ink and the list goes on from there. I think in H2, kind of our major issue is going to be around Tyvek. And we're equally working with Avamed with other companies to try to see how we can get more raw material released for medical device products. So essentially, that's what you see in the range and in the guidance change. But equally, there's an opportunity. And if that does improve, obviously, we do much better. But I don't know, Michael, if you want to add to that?

Yes, I would just add to that, that the $815 million to $835 million on revenue, although than FX, which has a meaningful impact, $5 million in the first half of the year, and we're estimating at least $5 million in the back half of the year. If those back orders clear up, then we have line of sight, getting us to the higher end of that range of that $835 million is very realistic if those back orders we're not able to secure the raw materials, as Joe just mentioned, that's needed, then more towards the midpoint, lower end would be possible.

And I would just clarify that the demand is absolutely there. We could have absolutely done more in the quarter without this type of supply chain challenge. But I think the nature of our portfolio and the size of our company hit sort of a different way, maybe not even as bad as some of the others I've seen but certainly for our size of the company and the portfolio we have, it impacted the quarter.

Yes. I mean if you look at the first half of the year, right, North America grew organically 3.5% through the first half of the year with -- even with these back orders. So it would have been much more substantial. And then international had more of the back order issue plus the FX issue, which obviously had a total impact on our revenue for the first half of the year.

And turning to OrthogenRx. Obviously, a terrific quarter. You had said on the first quarter, you expected to generate sales in excess of $70 million, you're reiterating that. And I just wanted to be -- make sure I was clear in my own mind now that we're halfway through the year, it sounds like you're feeling more confident. But how do we think about it -- sort of a two part question now, how do we think about that outlook given the reimbursement change looming for HA and just how you're thinking about that and what you've dialed into that projection? And in a sense, what's next? It seems like you're doing better than others. Maybe help us understand why that could, should and will continue to be the case. I'd appreciate it.

This is Joe. I'll get to do that. We are definitely more confident in the full year outlook. We knew with the new allowables, there would be a migration TriVisc. That happens a lot more quickly than we anticipated faster from the five shots. In fact, some of our five shot customers are -- a good portion of them want to get into the 3-shot market. We're seeing competitive moves over to ours. Short term, there is a reimbursement favorability that customers can experience because of the way we strategically went around our pricing, focusing on the wholesale. So we have to maintain a healthy ASP. We intend to add direct reps and nine reps. So we think that we sort of have this window, if you will, of six to nine months, I think, of a pretty positive tailwind in this business where we're going to see some upside and the strategy is working. We're definitely meeting the internal model, and that will be helpful. And I think that, that just sort of bodes well for also what we said about year or two and then beyond with that business. So all in all, it's turned out to be an excellent acquisition for us and one that's strategic, obviously, alongside other things that we're doing in other orthopedic areas of our business like COOLIEF and ON-Q.

Got you. Thanks again.

The next question comes from Matthew Mishan with KeyBanc. Please go ahead.

I think we may have lost Matt there. You may come back into the line. Maybe we take another question.

Just a follow-up on the TriVisc question. What specifically about TriVisc allows you to have a better reimbursement position than some of the peers in the space.

Well, primarily, it's the way that we priced our product at the wholesale level, not a lot of specialty pharmacies kind of rebating in our business, and that strategically was a way that we focus the business. So we ended up with more favorable reimbursement than all the other three injection products. Going forward, I mean, I think the differentiator is the other portfolio that we have, the conversations we can have in alternate sites or different sites like ambulatory surgical centers or places where we're selling COOLIEF. And again, we do intend to expand our channel a bit as well. Ultimately, the differentiators are going to come around with servicing, really, we've got a portal that we talked about in the script and the way that we service customers and make it easier to do business. And then we have some technology that we're working on in terms of the syringe that we think will be a differentiator as ultimately, over time, you have to differentiate that way as much of the reimbursement later on in about a year from now will be very similar.

Okay. So you're expecting to change your favorable reimbursement position to sort of come together with the rest of the industry as you kind of get through the second half of this year?

Next year through the second half of next year, I think we feel like we're going to be favorable in the three injection area.

Do you feel like you'll be favorable through the middle of next year and then it will

Correct. It could be a little -- It could extend a little bit or if I go into eventually a more level field where you have your base of customers, and we're differentiating through basically our other portfolio the way we service, and then we're doing some things from an innovation standpoint with our syringe because I think at that point, you have to have a differentiator at that kind of a reimbursement level.

And so what's key, as Joe mentioned in the prepared remarks is we gain all these additional customers, we service them well. And once pricing is less of a dynamic in this market, we maintain the market share that we will have developed over the last few weeks and into the next few quarters.

Okay. I understand that now. And then a question around NeoMed and Digestive. It seems like NeoMed is growing. And I remember this being a larger -- from a larger base of sales from you guys. Outside of NeoMed, is Digestive contracting? Or is that still growing as well?

No. It's still -- we see it as a mid-single-digit grower on a global level. It's one of those areas affected by, I believe, Tyvek and silicon in H2. There's absolutely an upside where if we can get the right amount of raw materials, we can even do better in the Digestive Health area, which is where we primarily focus on our MIC-KEY product. But you also see CORTRAK, all that slowed a bit in North America with the staffing shortages and the ICU census. We still think that, that's a good grower for us inside of Digestive Health franchise. So you peel it all back, it's a very solid business, mid-single-digit grower with a good runway globally for the future and good actually good margins for us and a big contributor to our cash EBITDA.

Got it. And then just on the OrthogenRx, just the number in the quarter, you back into it, it's about $22 million. Is that the correct number contribution from that acquisition this quarter?

That's directionally correct, yes.

Next question comes from Chris Cooley with Stephens. Please go ahead.

Just maybe a clarifying question for me to start and then maybe a little bit bigger picture follow-up. Michael, just in regards to the guidance, you mentioned the lower end of the top line did assume continued FX headwinds. I apologize if I missed this in your prepared remarks, but did you call out what you're assuming there in terms of the incremental headwind there from a basis point perspective or maybe alternatively, could you just give us where your markers were for the major currencies coming into the quarter? And then just kind of as another offshoot kind of from a -- just a clarifying point. When we look at pricing for HA products, the way it gets published out there, I just want to make sure I'm understanding this correctly. When we look at your pricing versus, say, some of your competitors, you're assuming that discount continues. There's no additional rebates being added. So that's just going to be that price differential you think then will continue until the midpoint of the next calendar year because there's quite a bit of disparity across three to four players here just in terms of published pricing on the HA offerings at this time. Then I've got one quick kind of bigger picture follow-up.

Do you want to do the currency or you want to start with the...

Start with that.

So I think you've got the HA please right. We're not really -- we haven't really structured a lot of rebate type of business or discounted to payers and so forth. The specialty pharmacy is not a big area for us to focus. So we've benefited from that with a wholesale price that's pretty robust. And yes, it should continue into about the middle of next year, and we think that that's going to allow for us to gain share from competitors fairly significantly during that period. And I think we'll keep it with the things that we've got playing on the innovation side and then the servicing model that we want to go after. And also, one thing I didn't mention in the prior question was we're also building a cash business as well that looks like it's got opportunity for us.

And then on your other question, Chris. So we had about a $5 million headwind across the first half related to FX versus our planning model. We anticipate that we'll probably see five to seven in the second half as well. The reason for the increase is just that we're going to do $25 million, $30 million more in revenue in the second half. So that obviously has a bigger FX impact. In addition, good portions of our back orders were international related. So we have a bigger ramp in the back half of the year related to international orders. hence, the additional FX impact in the back half of the year.

I appreciate the additional color. And then just a bigger picture follow-up there. You alluded to stronger capital demand on the pain management side as we think about the COOLIEF franchise. Any way you can quantify that for us a little bit here in terms of maybe side of service where you're seeing the incremental demands relative to prior periods. Just trying to get a little bit better granular -- more granularity there around just how much incremental demand you're seeing versus kind of relative levels there.

Sure, Chris. Yes, one of the things actually there's a benefit, I think, is that as the chip shortage took hold in the first half, there was an opportunity for the channel in the connect with existing customers and get penetration or bringing active accounts back. I think the other thing that also drives that is the continued study that are coming out, definitely as they published. But also now, as everybody knows, I think we're in the OA space, so that's a strong grower for us for those sites that are treating in OA. And the quantification is really that we think there's a tough comparator as we all came out of the first aspect of COVID and then when we bounced back in this quarter last year, in Q2 last year with procedures, but as we get into the second half, there's definitely some better comparatives for us. We certainly see that quantifying in terms of double-digit, growth in the teens again for Q3 and Q4, and we just have a big demand for the capital. And so we have a backlog for these units. And I think the team is doing a nice job selling the capital. So that's where it's all coming from.

[Operator Instructions] Next question comes from Drew Ranieri with Morgan Stanley. Please go ahead.

Maybe just the -- keep it on the HA topic for my first one. But Joe, I'd be kind of curious to hear more about some of the innovation that you're putting behind the product. I know that there was eventually like a single injection product coming. But can you go into a little bit more detail about what you precisely mean by innovation and the service model? And also as the cash pay, kind of, struck me. Just kind of curious how that would work in the HA market? And then I had a follow-up.

So we've talked a little bit in the script about the Harmony portal just making it easier for customers to do business with us to order to get reimbursement assistance, that's one thing. I mean the next thing that we're doing on the differential side and innovation after sort of the reimbursement changes is technology that going to allow for the injection to be guided more precisely into the areas of the need to get the best effect. And so it's sort of known that if you're not in the right space when you make this injection, you get less of an impact, which is why sometimes I think patients experience may be no pain relief for just a couple of weeks, what others experienced two months or more of pain relief. So I think that will be a differentiator. And then the other thing I think is just where we can go with some of the access and sites. And then I think that a lot of the folks that are believers in HA are going to want to have the ability to have patients come in that want relief and want to pay cash for that relief. And so there's opportunities there really in most all of the sites where we are for that. And we'll be talking a little bit more about that as it sort of unfolds towards the end of the year. But that's where we are on that.

Okay. And just maybe on the injection for accuracy. Is this going to be just around using kind of ultrasound and improving like the needle, the injector or anything else there?

It's more related to a guidance of the needle.

Okay. And then maybe for Michael, a couple of questions here. But when we kind of look at your organic guidance, for EPS. I mean I get that some of this is FX, some of this is interest. But when you're looking at the change from the prior guidance, the 2-point organic guidance reduction. Can you maybe just talk about how that flows through into EPS and maybe what the change is there. And also on gross margins, I mean, it looks like it's going to be flat year-over-year in the back half. Could you maybe just give us a bridge between second half and first half of how you're thinking about the macro factors? And maybe where could there be like a specific relief area that you can control versus just kind of the macro uncertainty?

Yes, fair questions. So on the EPS side, the biggest reason for the call down was the higher interest expense, the FX impacts and then a little bit on the lower operating earnings. And those lower operating earnings are primarily through the lower gross margin in the second half. We will offset the lower revenue organically that you just referenced. We will offset that through OpEx challenging and OpEx savings. So revenue down on the organic side, offset by more favorable OpEx. The other piece is then that relates to the ultimate EPS guidance change were higher interest expense, FX and a little bit of the lower gross margin. Does that help with that part of the question, Drew?

Yes, it does.

And then when you think about the march from first half to second half gross margin, the biggest piece of that is inflationary factors. So if you noticed on our balance sheet, our inventory is up about $19 million. That's more than we anticipated. That obviously has an impact on free cash flow as well, but we -- as we have opportunities to buy raw materials, we're doing that in pockets that we know don't have dating concerns. So we're -- we've been a little bit looser on that. But also that inventory that is now capitalized. That's going to -- as we sell and work through the back order in the back half of the year, we are going to be releasing in the cost of goods sold, higher priced inventory, and therefore, that's going to have a big impact on our gross margin in the back half of the year. Now as we work through that, and we start to have a little bit more normalized raw material purchasing as we enter into 2023. That drag that's not capitalized on our balance sheet, obviously reverses meaningfully.

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

Thanks. I just want to thank everybody for their continued interest in Avanos. And while we're very pleased with our overall execution this quarter, given the uncertainty in this environment, we are committed to creating meaningful shareholder value and believe our 2022 results are building the foundation to deliver on that commitment. I'm confident that the priorities that we've detailed combined with our market-leading portfolio and attractive markets position us for consistent sales growth, margin expansion and significant free cash flow generation as we enter the back half of 2022, and we'll probably see a lot of you in the fall investor meeting. So thank you very much. Bye-bye.

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