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

Good morning, and thank you for joining us for today's session. My name is Sushil Bhandaru, and I'm an analyst in JPMorgan's Healthcare Investment Banking Group. And before we introduce you to our presenters today, we just want to call of note to the blue button at the bottom of the screen where you'll be able to submit any Q&A that you have during our session. With that, I'm pleased to introduce Joe Woody, CEO of Avanos; and Michael Greiner, SVP and CFO. With that, I'll turn it over to them to talk to you a little bit about their story.

Thank you, Sushil. I'm very excited to update on Avanos, and I'm very -- thankful for those of you that are interested in the Avanos' story and our employees have been extremely resilient throughout the pandemic in setting the foundation really for our company going forward. As always, we'll be talking about forward-looking statements, risks like cost savings, reductions and raw material. The key is we'd like you to be able to be well aware of those risks, look at our annual report, the Form 10-K and our quarterly reports. Equally, we'll be talking about non-GAAP financial measures, and those reconciliations are available on the avanos.com website, and you can click on in our Investors section. I want to start with a high-level view of the business who we are. In total, we're approaching $740 million in revenue between our Pain Management and Chronic Care business. There's a likelihood that we'll exceed that and exceed consensus for the full year on the top line. We have large addressable markets. We do business in 90 countries. Importantly, we have a tremendous opportunity in our Chronic Care business on the international level to duplicate the success that we've had in terms of market share gains there, outside of the U.S. most of our products are in leading market positions. And those of you that follow our story know that there are 3 pillars to creating shareholder value, organic growth acceleration. We believe we have a mid-single-digit organic grower in a non-pandemic situation. We've been doing a lot to optimize our cost structure in the business. And I just want to pause for a second because I think M&A is a real competency for our organization in terms of the valuations where we've made bolt-on acquisitions, the way we've integrated, the way they strategically fit and the way they work into our channels. So we'll come on to that throughout the presentation. I do like to point out always that our vision is to be the best at getting patients back to the things that matter. And again, really proud of our employees and their resilience in doing that over the last couple of very challenging years. This evolution slide is nice for some context, and it's nice if you're a new investor or if you've been following us for a while. But the portfolio of products that we have, we're a small division inside of a large consumer products company Kimberly-Clark. They decided to spin that company out in 2014. It was a different management team. That management team made their first foray into medical devices, acquiring CORPAK Medical Systems. I came into my role in the second half of 2017. And really since then, we've made 5 acquisitions. Those acquisitions are really the greater portion of our growth in EBITDA at this point in the business, and we've been very happy with that. I think the most important part of this slide is sort of at the end of the year, 2 major announcements from us. One is that we talked about launching a stock repurchase program, and that, from our perspective, shows the confidence in our business, but also is a way for us to create more capacity for M&A. And at the same time, we announced the acquisition of OrthogenRx, which we anticipate will close in the first quarter some time of this year. So we're going to talk about the franchises and talk about the pillars of our value creation before we head into the Q&A session. But I think it's worthwhile just having the 2021 report card, if you will, Again, employees very resilient. I'm very confident with where we are in the business. We've had really strong sales performance, working inside of our guidance. And again, we feel like we're going to beat the consensus for the quarter and for the full year. We've done a nice job of managing OpEx. It's been 6 quarters now, for example, with SG&A, where we've been below 40%. That's more attuned to what a medical device company should be. We are going to talk about OpEx in a few more slides. We said we were going to do an acquisition before the end of the year, and we did it in OrthogenRx, so we're deploying capital and putting these legal matters behind us throughout the year really gives more clarity on our free cash flow. So I think we're very well positioned. There's no doubt there were challenges associated with the year, and I think you're hearing that from others in this meeting. I think our team remains very focused and we've got the things that matter done. The things I think that are challenges -- that are headwinds for us are supply chain and gross margin challenges associated with that, primarily around inflation and transportation and the availability of raw materials. And really, we think we could have even done a better job on the top line if elective procedures were back to 100% or there was a different way to access medical system on a global level without having further variance or really having to navigate the pandemic. In the third quarter, we sort of noted that there was a likelihood that we could fall below EPS because of the speed to which the gross margin challenge has changed. We do have the benefit of some tax, benefits that are coming our way that were planned that will put us in that range of EPS. But the gross margin, even though it improved Q3 to Q4, it didn't get all the way to the level that we would like it, although I don't think that's an uncommon theme that you're hearing in this meeting, and I'm sure we'll talk about that more in the Q&A. We're going to talk about our franchises, where we have 2 franchises, Chronic Care and Pain Management. We'll start with Chronic Care, and I apologize, I'm on Slide 7, and I haven't been naming the slides. In terms of Chronic Care, this is our largest business. It's a $1.4 billion addressable market. We've been really enhancing our leading market positions through bolt-on acquisition. This business is the largest contributor of our cash to EBITDA. This business has a tremendous international opportunity. And we believe it's a mid-single-digit grower on a consistent basis in a non-pandemic situation. And I would just kind of point you to the bottom of the slide around nasogastric feeding and neonatal feeding and the 2 acquisitions, one CORPAK we made in 2016 and NeoMed in 2019. CORPAK is a change in the standard of care and the visualization of feeding tubes. We're doing quite well there neonatal feeding and neonatal portfolio as well as the infant conversions are driving NeoMed. And I point these out because each of these acquisitions have been a high single digit or even double-digit growth on quarters, and we see a pretty good runway ahead for that. So the bottom line is that we have a pretty robust pipeline for more to bring into this channel that our selling organization can drive and take forward. And then the longer-term strategy is I certainly continue that, but we think there are things emerging like intelligent feeding there are other areas or near adjacencies to Chronic Care that will likely get in as well as we move along. I'll switch to Pain Management. I'm on Slide 8. And in terms of Pain Management, this is an area of our business that has the highest gross margins. It's also been probably the most affected by elective surgeries. Again, a large addressable market. We're focusing on a lot of Americans that are in pain or the treatment of pain after surgery. We're doing that through delivering non-opioid pain relief therapies. If you look at the top of the slide. That's really a representation of the Acute Pain segment within pain management and ON-Q and the Summit Medical product, AMIT, are really bupivacaine and ropivacaine for the treatment post-surgical pain in lieu of non-opioid in lieu of or other treatments. Longer term in this area, we're working on an electronic block that we think will obviously a lot of the technologies, and we are in patients. And later in the year, when we have an investor meeting, we're going to be able to talk more about that and we want to share the advancement of that innovation. Game Ready is coming back to life with more people about doing sports and also folks that are focused on faster rehabilitation on total knee repair. At the bottom of the slide, you see COOLIEF and OrthogenRx. I'll start with COOLIEF. This is the Interventional Pain segment of our pain business. This has been growing consistently double digit. We've introduced some new technology in this area, but the strategy is to expand our reimbursement through sites and the coverage of lives. And those of you that have been following us know that we've invested in clinical studies over the past 3 years and really at the end of '22 and into the beginning of '23. Those, for the most part, will all be published to allow us to go seek better reimbursement in Medicare and through private payers. And again, that will be around sites. And we think we have an opportunity longer term to get reimbursement in the orthopedic office space. Orthogen, we're excited about an acquisition that we made at the end of the fourth quarter fits right in the wheelhouse of interventional pain. It's in the treatment pathway for COOLIEF, in particular, the fastest-growing area, which is osteoarthritis of the knee. This links us with our customers and channels in a different way, and really will provide quite a bit of differentiation in the way these patients are treated in terms of bringing these 2 technologies together. I will also mention that OrthogenRx has a gross margin north of any of our pain products. So we're very excited about bringing this into our portfolio. And again, we think that we'll make a closure of this acquisition in the first quarter of this year. So just going to switch a little bit to talk more about the 4 drivers of our business going forward in terms of creating value, what you can expect over the next couple of years. And I'll start with one and two. First, I think that we're well positioned to deliver sales growth in very attractive markets. And second, we've been working very hard on gross and operating margin improvement through 2022. And there are a number of things, I think, that ultimately will happen positively there. But if we start with the revenue drivers. Again, today, our business on an organic level is a mid-single-digit driver. We do have double-digit focused areas within our business that are enhancing that growth COOLIEF being one as I mentioned on the prior slide. And in addition to that, there are NeoMed and CORTRAK as other areas of double-digit growth. The teams in both franchises are focused on alternative sites. And if we want to get specific about that, things are moving into the ambulatory surgical center area. So we're working on technologies, both internal and external and reimbursement pathways. Of course, executing on OrthogenRx alongside of that gross margin and that treatment pathway affords us another opportunity to grow our revenue. Second, on gross margin and operating margin. We've been working internally on a lot of efficiencies, demand planning, SKU rationalization, certainly, inventory management, waste, transportation, distribution. And a lot of those efforts have gone unnoticed because of the supply chain issues that are being highlighted at this meeting around transportation, around inflation and around the availability of raw materials. I fully believe there is not an underlying issue with our gross margin or a radical shift in what we can achieve over a longer term. But certainly, all of us are going to go into 2022 with a longer view of managing and navigating the supply chain issues. Around OpEx, we've done a great job taking $20 million to $25 million a year over the past 2 years out of the business. We've come forward to the market and said that fully 1/3 of that, we can onboard going forward and make efficiencies. And there's just a lot of room for us to keep improving there. Again, happy with where we are. So as we progress our business, a lot has been done to set the stage to create more drop-through and more cash and ultimately, more earnings. Our third and fourth, we've got a big focus on capital deployment and really wanting a strong balance sheet and want to supplement our growth. So you can know that we're going to continue to work on the bolt-on acquisitions throughout 2022. I will pause for just a moment and say I still think we have opportunity to look at our portfolio and sell either technologies or SKUs that will allow us to even build a greater capacity in our business and shape a more strategic portfolio. So you can expect that we'll be doing some of that. Again, we've mentioned the $35 million in the stock repurchase program. And so that leads you to ending a strong cash balance at the end of the year and $130 million in debt. But even post the OrthogenRx closing, we have capacity today of $350 million, and we fully believe that we can build on that going forward. Last, on margins, there are a couple of other things happening around margins that are going to enhance our business. Certainly, the top line growth that we would expect, in particular, as we start to come out of these elective procedure issues and we bring the growth on from OrthogenRx and other companies, that's going to be a great opportunity for us to expand margin. I think it's important to know that outside of the litigation, there were a lot of onetime costs associated with making what we have today, which is a pure-play medical device company, whether that was the spin or the sale of the S&IP business or the deployment of our SAP system. So those things are behind us, and we fully anticipate delivering at least $70 million in free cash flow for 2022. And again, I think we're on the right plane to deliver value to all of our stakeholders. I'll switch over to Slide 12, sort of a holding slide and say that I think that we're positioned well in our business at this point. We're going to come out of the pandemic extremely strong. I think the gross margin issues that we're facing are -- you're going to hear a lot of that over the course of the next couple of days and in the Q&A because it's something that all of the companies, not only in our industry, but others are facing, but they will eventually dissipate. We have a very full pipeline of M&A and a lot of capacity for M&A in our system. And I think that our top line has been very resilient and still provides an opportunity for a lot of growth. So the bottom line is that we've created a lot of optionality in our business to create value in multiple different ways. And we're very excited about enhancing and accelerating that as we come out of the pandemic. So I'll pause just a moment and I'm going to ask Michael Greiner, our Chief Financial Officer, to join me for the Q&A session. So Sushil, back over to you.

Great. Thank you, Joe. And great to see you Mike. Joe, so I know there was a couple of articles published this morning in advance of the session that you wanted to just provide some brief comments on.

I'll say a couple of things, and Michael can as always add what he would like to. But generally our presentation went out on to our website overnight before the presentation that we're killing right now. And there were a couple of write-ups that had some inaccuracies in them. One is we do believe that in terms of consensus, we will likely beat our consensus for the quarter and for the year. And we're also going to make our EPS range. So we're correcting that as we speak right now. But Michael, do you want to add anything to that? .

Yes. So just the revenue on consensus is $743 million. Right now, as we're closing the books, we're north of that. And then as Joe said, EPS, inclusive of the tax benefit, as we talked about in the presentation, we'll be in that $1.10 to $1.20 range. .

Great. And then, Joe, you mentioned the supply chain and some gross margin issues during 2021. Any other comments or statements you wanted to make, especially in light of the discussion at the conference? .

Yes. I've noticed that a couple of the companies gave some pre-releases and then talked about factories being shut down, the availability of raw materials, certainly the exorbitant transportation cost. And so for the areas that we've gone forward in some of our initiatives, it's tough to kind of cover all of that. And I don't see that going away for a while. I think that's going to be with us well into 2022. We're going to get a little bit of an issue with people sinking some of these channels -- distribution channels, and it's going to only probably exacerbate some of these issues. But we clearly do not believe that we have a fundamental underlying issue with our gross margin. We call a little bit of heat coming out earlier in the year saying that we could see this coming. And I think folks thought that we had an issue underlying in the business. Do you want to add anything to that?

Yes. And to the point around the issues, even with those issues, we still made progress from Q2 to Q3, Q3 to Q4 because some of those issues were also some of our own pain points. We're fixing those. But some of these other exogenous events that Joe is talking about raw materials, inflation, those are items that we do anticipate will continue into 2022. That being said, we will continue to make progress in '22 against gross margin, just maybe not as much as we would hope to at this point in time. .

Great. And our final question would be around the acquisition of OrthogenRx. Any other commentary to add there or thoughts on potential M&A opportunities in 2022?

I'll just say something I think about and then Michael can probably have some things that he's thinking about. But I think we're going to be in a very unique position in terms of treatment of OA [ within the knee ] We have important clinical papers coming out about already out really on 2-year pain relief. Yes, I don't believe that steroids or [indiscernible] going away as a part of the treatment pathway and it kind of starts with the leave and add bill on exercise and things like that. But the unique is of bringing those 2 things together and working on the reimbursement and the ability to have a better relationship with the opinion leaders in the orthopedic space and expand our channel 1099 just a great opportunity for us. And Mike and team, I think, did a nice job with the acquisition. Michael, you want to add?

Yes. No, I think it's a nice acquisition to your point, Joe, it's nicely within what we're trying to do around COOLIEF. It creates a great interventional continues to develop our interventional pain opportunity set. So we're excited about that. And as Joe mentioned in the presentation, even with that acquisition, we have significant dry powder available to do additional M&A. And we anticipate that we'll be able to get at least another 1 or 2 closed in 2022 that we're currently looking at. So we're excited about strategically how we think about M&A. The fact that we have dry powder to do that. And as Joe noted, we're going to start generating some meaningful free cash flow, so starting to put back and drive powder on the balance sheet versus the last few years where we've been using a lot of cash to the balance sheet for a lot of the items that we need to cover off on that strategy, becoming who we are now in a stand-alone medical device company. .

Understood. And we actually have a question from the audience. Should investors think of you being willing to sell higher-margin, slower growth businesses in order to bring on faster growth businesses even if that incurs a bit of dilution in the process?

Yes. I think nothing is off the table. I think one of the things that we're looking at probably less complexity than when we sold the S&IP business, but there are some opportunities for us to put some things we think over time into folks, the better hands, they could do different things with the business. But at the same time, would take that position where we are with capacity and build it up. And obviously, as Michael pointed out, as the revenue comes up and generating cash flow positioning us well to get things that are more strategic and tighter. And so it's a great position to be in, and it offers a lot of optionality for a business of our size. We have a lot of ways that we can move the levers and that would be one of them that you should think about as an investor.

The only thing I'd add, Joe, is we often joke that we give us your elevator pitch on Avanos and it's a few minutes long because we've got 4 very different businesses, each in their own right are very attractive businesses. You wouldn't necessarily look at them and say, "Hey, they should all be together." And so should opportunities avail themselves. We think there's better owners, as Joe just said, for some of these assets. And we also think there's assets out there that we're better owners of and so it's really a capital allocation plan. So the question is spot on trading out things that maybe were not as best positioned to own and bringing in things that we have better assets already in place that we can build around.

Great. I think that concludes our Q&A session. Joe, Michael, thank you very much for the time.

Thank you, Sushil. You made very easy for us. Appreciate It. .

Great. Thanks for having us.