Avanos Medical, Inc. (AVNS) Earnings Call Transcript & Summary

Well, good afternoon, everyone, and thanks for joining us here for -- as we wrap up the first day of our 5-day Morgan Stanley Global Healthcare Conference, our first virtual event 2020. It's my pleasure to have this here this morning or this afternoon, sorry, Avanos Medical, both CEO, Joe Woody; as well as Treasurer, Dave Crawford. Joe has graciously offered to forgo his preamble so we'll jump straight into Q&A.

So Joe, let's start with recovery, where obviously, we've been focused in most of our sessions this morning. And I want to talk about the procedure recovery like in pain management that I felt like on the quarter, we've seen this with some other pain companies. Relative to your peers, you may have been recovering kind of a little slower than some of them. Maybe just help us understand, since June, how have July, August, September recovery trends' been, kind of month-over-month basis. And specifically in pain, basically for all your procedure-driven businesses and that's your biggest one, how has that business trended here in the last few months?

We've definitely seen an acceleration since our call. I think what we were reflecting on the call were all the uncertainties or the unknowns in terms of unemployment, in terms of deductibles, that what we would characterize as a consumer confidence and a patient fear of getting to a facility for fear of infection. We've also done a little bit of work with interviewing CFOs and looking at third-party information. And the CFOs tended to feel like that 80%, 85% might be a new normal for a while. So we were cautious but we've seen an acceleration since then and an improvement in the business.

Okay. And do you think that improvement, it is -- how does that improvement vary relative to like ON-Q and pain management versus RF? Have they been sort of super-imposable or a little different?

So a lot of momentum in COOLIEF and that continues on. I would say on the orthopedic side of ON-Q, which is 50% of our business, we've seen some acceleration. There are lots of other surgeries in ON-Q that maybe don't -- they're not far behind orthopedics but somewhat.

Okay, understood. So orthopedics within ON-Q is the leader?

Yes. ON-Q is -- so in our ON-Q business, where the paint pump is used, it's 50% of the time roughly is in orthopedic procedure. And I think I've seen the orthopedic companies saying they're getting a strong comeback, and we're seeing that in that side of the ON-Q business.

Okay. So a lot of companies back at the time of the second quarter were talking about sort of 85%, 85%, 90-ish percent of normal. Sounds like you've gotten well underway there or maybe surpassed it in certain months.

Yes. We talked about on our cost, 70% to 75%. I mean it got as bad as a 50% decline and came back in the spring. And we don't see the same acceleration of the slope but we're definitely improving month-to-month.

Okay, understood. Any reason to believe there's been any share shifts in either ON-Q in terms of how hospitals were kind of managing pain or in the RF side of the equation, how centers have managed pain? We've seen some share movements. It's obviously hard to fully understand what's happening with share right now because the numbers are iffy. But how do you feel ON-Q and RF share has sort of trended?

Definitely stable share for COOLIEF. I don't feel like we've lost any share, and with ON-Q, it's just more about getting as well the elective procedures back. If anything, we've had some key account conversions during the downturn and some -- had some new business there as well.

Okay. What about the kind of the non-procedural-driven business that's more tied to sort of census, patient attendance, things like that. So your -- the Respiratory business, you had, I think, a $10 million benefit in the second quarter. We sort of assumed in the back half of the year, that would be sort of more of a flattish business. You obviously anniversaried that and a tailwind turns into a bit of a headwind. How should we think about second half versus first half for Respiratory?

Yes. And we also had $4 million benefit, we think, in Q1, so $14 million benefit from the pandemic in H1 and we think we'll still have tailwinds. But likewise, sequentially, we feel like that we may have some headwinds because less ventilator usage is happening now, and there are other treatments and different pathways of treatment for the pandemic. That said, we're still going to have a very strong year in Respiratory. In Digestive Health, initially, we saw that element of the consumer confidence or patient fear of going in, maybe taking a -- changing their port out for feeding or having the feeding tube last longer. That's now changed as we ended the second quarter, gone into the third quarter, we've seen that pick up as well in the Chronic Care business.

Okay. So Respiratory, I think you said, you had $14 million first half. If you did kind of $9 million or $10 million second half, it would still be growth but maybe as a $5 million headwind second over first half?

That's right. And the other thing about that is we still are talking to various governments around the world in both Europe and Asia and in the United States, of course, about stockpiling orders. We've been very careful with allocations there because we don't want the comparables to be sort of out of control. But we'll call those out, and that's a possibility that we see some upside there as we negotiate our way through those.

Okay. And then, Joe, for some of the flu companies I've sort of been asking ahead since it's early. But how are you thinking about flu season? I think when COVID started, everyone thought the flu season would be very virulent. Now just looking at the southern hemisphere trends, people are now saying, "Well, maybe it was social distancing and masking, the fourth quarter or the flu season won't be as interesting." How are you thinking about -- what are your hospital executives and customers telling you about flu season?

Well, first of all, we didn't see a lot coming out of Australia, which is what we look to and you refer to that. It's hard to tell what kind of flu season that we're going to have because of the precautions that everyone's taking. It appears it may be mild. I mean, 2 years ago, we had a mild flu season and that was a several million dollar impact, about a $3 million impact. But the orders associated with the pandemic and the stockpiling wars are probably kind of make up for that, I would think, even in a mild case.

Okay, all right. So let's just move on from COVID for a little bit and talk about some fundamental dynamics. So I want to go back to -- it feels like this -- everything feels like years ago but this really feels like [indiscernible] So you talked about the 2018 Analyst Day, talked to a bunch of goals, right, moving towards high single-digit growth, improving GMs, getting back to OM expansion. I'm just kind of curious generally, Joe, where are you on some of those goals and how have they been impacted COVID?

I mean, COVID-19 has definitely set us back. First, it was the acute pain dislodgment that most are familiar with, then we had a very strong Q1 and we're well on our way to our internal goals. But we really think that we can still achieve low 60s gross margin, and we can improve our operating margin into the teens and then on our way over time into the 20s. That's about 2 or 3 years out now, though, given what we've had to deal with here with COVID-19. But we're making good progress and we've got a lot of good programs right now in our cost programs, really on COGS, SG&A. And we're experiencing what a lot of people, I think, are experiencing. The OpEx and the way you viewed it before the pandemic is completely different because we're able to achieve a lot of business goals without the same spend in OpEx. And meetings like we're having right now, as an example, to convert accounts or to reach customers.

Yes. So I'm saving you money already?

You are.

So let me understand this. So exiting [ '21 ] with some of these goals, I think it was mid-60s OM, now you're sort saying low 60s. When you say this dynamic of OpEx, in a post-COVID world, I think about having much more flexibility in the middle of the income statement. So why can't you do a little better? I mean it sounds like long term, you can get back to all those targets you gave us in '18, but it doesn't sound like you can get to those targets by the end of '21. Is that more just -- just help me to understand? Is that's just the base of revenue simply just not going to be as high as you would have wanted, which is going to impact GMs and impact OMs?

That's right. But at the same time, we are looking at our OpEx differently. We're looking to accelerate obviously from where we are. There's things around in SG&A. We've got a tremendous amount of COGS programs going on in the business. So we're definitely looking to accelerate. We'll probably talk more about some newer cost programs either later in the year or early next. But we've definitely been put out a bit from the pandemic, and obviously, you referred to and you're right, the acute pain top line.

Yes, okay. So if you were thinking of getting to some of these targets by the end of '21, is it just a decent placeholder to say, "We now think we can get to these targets at the end of '22?"

Sort of more towards we're thinking '23. But we are working to accelerate but we would point more to '23. And the reason is we're sort of unclear at the moment anyway, what's going to happen with a vaccine, what's going to happen with this 80%, 85% of electives that we were talking about. It's the duration that's hard to judge to the extent that, that ends more quickly and we go back to what was normal and improve from there, that's kind of a little bit of a different story.

Okay. And also some of this is -- I'm making this all about COVID. But from 2018, the pain franchise was at a different place in 2020 than you thought it would have been even without COVID. Isn't that the other -- so there's the COVID dynamic and then there's the fundamental piece [indiscernible] pain franchise. And those are the 2 principal forces?

Yes.

Okay. Understood. So what -- your new CFO, cost rationalization was a big focus of this. Obviously, on the spin, he gave us the first [indiscernible] to focus on the spin. It was all going to be about cost rationalization. Every spin has a huge component of cost rationalization. When you look back, Joe, what -- besides pain, was there anything else besides the pain franchise that's sort of prevented taking more cost out faster? And what can Michael do to sort of really get you back on track and take those costs out faster?

I think it -- when I look back, I think about the complexity and the time of the TSAs for OMI and then deployment of the IT system, making it longer to get those costs than we would have liked to. But Michael has come onboard. He's a very strong business partner. He -- first thing he did was he jumped on the IT issues and solved them very quickly. We feel like that's in our rearview mirror. He's had a focus on cost and a focus on improving cash flow. And he's made immediate impacts there. And he's very strategic. So we're very happy with the relationship, and I think he can help us take it across the line really on the cost side.

Okay. The earliest we can hear back from you, it sounds like early next year, you may come back. Is it going to be like a new -- thinking about just providing a new LRP or a new sort of 3-year time line? Is that the way to think about it?

That's right. A new LRP, what we would have liked to have done in a perfect world was come out in the fall here right about now actually, and be talking about a new LRP. I think we need to get into or finish off Q3 and Q4, look at the duration into 2021. We would like to be able to come out mid-2021, as an example, with the new LRP. We're already, as you can imagine, doing the work on that. The variable that I'm sure everybody is dealing with is the duration of the pandemic and then how quickly and hopefully we don't go backwards from here.

Okay, understood. And I know it's early but I've asked a lot of companies to kind of help me qualitatively with 2021. And if I pushed you to say, look, 2020 is sort of the lost year. But if you look at '21, a lot of investors trying to compare '21 and 2019. How do you think about '21 growth relative to 2019? How do you think about '21 margins relative to 2019?

So we definitely believe that we'll get into some level of growth. Obviously, again, it goes back to the duration, and then obviously, an improvement on our operating margin because of the cost programs that we have in play. And so also, as we've been in the work from home, we've still been able to get the synergies from our acquisitions and things like closed sites. So we're going to improve our margin, and we're going to intend to improve it each year obviously as we get to our goals.

David, if I could just add one other thing. I think one benefit to next year is going to be the fact that we should see the pain business recover, which is obviously a much higher gross margin than the Respiratory Health business, which will have some challenges, given the strong performance this year. And so from that standpoint, I think you'll see a mix shift that will benefit gross margin that will hopefully uplift the overall margin for the company as well.

Okay. The -- is it crazy to assume -- I just look at my model. Companies are anywhere from sort of flat '21 revenue versus 2019. I have in my model, '21 revenue up 9% versus 2019. I mean does that seem sort of insane? Should '21 be up upper single digits or mid-single digits over 2019?

I think we're going to have to look at a -- probably a wide range. Everyone's going to be forced to do it. At the moment, we can see a clear path to low single digit, and obviously, things can happen to improve that but we definitely see growth.

And I have -- I don't have margins up dramatically but I have margins up in '21 versus '19 kind of up 1 point. I mean, can you get back to, I think, your goal would be just show margin improvement in '21 versus '19? I mean, is the point shocking, is the growth?

No, no. I do believe that's very achievable.

Okay, good. So that's -- at least the model is working at the time being. Okay. Let's -- so we talked about pain. Pain's impacted the growth rate, Joe. Pain's impacted the recovery on the cost side. So an interesting announcement happened, I think, the week before conference, which was you sort of -- you have an individual now that's going to sort of think about the pain franchise. Either it's more globally or more holistically, help me understand what that announcement should mean for investors.

So we're bringing the 2 franchises, Acute Pain and Interventional Pain into 1 franchise, the Pain Franchise with 1 leader. And this leader, Bill Hayden, specifically has a lot of expertise in strategy and upstream marketing. And so if you think about what's going to drive that business, obviously, reimbursement is important in COOLIEF, in the orthopedic setting, in the ambulatory surgical center. Those could be key catalysts for our business. And then doing things like expanding our channel into orthopedics, using 1099s, finding a more profitable way to drive the business in Acute Pain. At the same time, what he's going to do is review the strategy, but there'll be efficiencies that we can gain from having one business. All of that, you can imagine, corporate costs, all of the areas that are supporting the business, even in some areas of channel and marketing will be some efficiencies for us.

So let's also go back to the structural issues that impacted pain these last few years. Where are we here? Obviously, the transition to Leiters is a huge component of that, like 15%, 20% now versus for maybe then before, it was, I think, 30%. So identify that the 2 or 3 fixes you laid out for people a year ago. Where are you on those?