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

Hello, welcome. My name is [indiscernible]. I'm associated with JPMorgan. It's my pleasure to introduce Joe Woody, CEO of Avanos.

Thank you,[indiscernible]. Thank you, everyone here in the room and those of you that are listening on the webcast. I'm very excited to update on a 3-year transformation that we've talked about here in this very room actually last year. So I want to give an indication of how we did in our first year. I'll give you a report card and then talk about what's next. One thing I would say is that the organization really accomplished a lot in year 1. We divested a portion of our business. We executed on M&A, and we did a lot of restructuring and cost out in the total company. So we'll come on to that in a bit and highlight that as we go forward. I would say that for us, as a management team, the one thing we have left in the transformation to execute on is consistent and sustainable organic growth. So I'm going to spend just a little bit of time covering our Pain Management business and talk about how we anticipate that will happen next year. So, as always, we are talking about forward-looking information. We made comments about our expected performance estimates and so forth. We encourage everyone to review our annual report on Form 10-K and quarterly reports on our Form 10-Q. In addition, we feel like it's beneficial to look at non-GAAP financial measures, but we do recommend that you reconcile that with GAAP and again, look at our filings. And of course, this is a highly regulated business. We talk about concepts and technologies that are regulated by the FDA and may or may not come to the market. So the Avanos investment thesis is something that we introduced last year, and we talked about these 4 pillars in a different way. We said, look, we have solid core categories with consistent organic growth. Clearly, in our Digestive Health business we have double-digit growth categories in high single-digit. But likewise, in the business we had -- some of our revenue was negative in growth, and we wanted to eliminate that from our profile. Both of our businesses, the Pain business and the Digestive Health business, have direct adjacencies to add growth. We've done a nice job of adding bolt-on and growth into the business in our M&A efforts, really at good returns. I think, if you listen to our earnings calls on a regular basis, we really have set out a clearly defined set of transformation priorities. Michael talks about them all the time. I join him on the calls, and we clearly let people know where we are, investors, in particular, obviously, in the transformation. And then we have a very leverageable financial position to generate high material free cash flow. And we've talked about how we want to improve our return on invested capital. So, when we came in last year, we were an $800 million global business, but our weighted average market growth rate was only 3.6%, and that really was not allowing for us to get the leverage and the drop-through that we would like from the benefit of the cost work that we did. And where we are today is a Digestive Health and Pain Management and Recovery business around $675 million, still a global business, but with a weighted average market growth rate of 5%. And we think that we can go from a $1 billion market to move into potential for $6 billion opportunities through M&A as we progress. So we still have large addressable markets, and we feel like [ we're ] right to win. But I think the way to think about this is a more simplified and focused portfolio. We have 2 scaled portfolios now. I'll just spend a couple of minutes talking about the 2 portfolios. Digestive Health, short-term feeding for the hospitalized patients is a very serious condition and needs feeding. And then we're also involved in long-term feeding for the patient that has a more chronic disease or may need feeding throughout their life, often served in the home, and we utilize DME partnerships for this part of our business. Anybody that's been following us has clearly seen that Digestive Health has a number of growth catalysts. We've been growing above the market in the U.S. driven by our ENFit conversions. You've seen a lot of positive growth from -- double-digit growth from NeoMed and our CORTRAK conversions. We see an opportunity in our international business to duplicate the success that we received in the U.S. The disease states that we address are prevalent outside of the U.S., where, for example, nasogastric feeding is still used quite a bit. So we've been growing that business at times double-digit or high single-digit growth. We're excited about the tuck-in and adjacency M&A and there's some categories that you should think about going forward. One would be pumps and then [ giving ] sets we think that we want to participate, and there's an opportunity for us in certain specialized nutrition, and then intelligent or smart feeding in the hospital setting and really outside of the hospital setting as well. Pain is refocused into the Pain Management and Recovery business. There's a high focus on orthopedic and sports medicine because [ they're ] the largest bulk of our business. Think about patients 1 in 5 in the U.S. have OA. We can now treat them in the beginning stages with RF ablation or hyaluronic acid. And then when they move on to maybe a shoulder replacement or a knee replacement, there's an opportunity for us to participate with bupivacaine pumps versus opioids and surgical process, and then, of course, Game Ready for other recovery. We restructured our commercial organization here, and we do feel like we're seeing growth catalysts in the business. We're seeing the Surgical Pain business come back to level. Game Ready did produce growth in Q4. We feel like the HA market will stabilize by the end of 2024 and then double-digit opportunities for Trident and ambIT in the ambulatory surgical centers. I think the thing to understand about this year for the Pain business is that we did experience a $13 million backlog. We moved that down to $1.5 million in Q4, and we really completed our commercial reset in Q4 of 2023. A bit later in the presentation I'm going to talk a little bit more about the green shoots that we see or the reasons to believe in this business and why we feel like it's headed into growth. We also showed this slide last year. We use it quite a bit internally in our business and we talk about it often times in our earnings call, strategic and commercial optimization. We really did a lot of optimization work, frankly, in the Pain business, but also in our Digestive Health business and International, transformation of the product portfolio, certainly the divestiture of RH and the Diros' acquisition was evident of that. We've done a nice job of removing costs in the business. I'll come on to that in a bit. And of course, we're always focused on the efficient capital allocation strategies to return -- increase our returns on invested capital. So the intent is to deliver stakeholders' value. So year 1, I think most of our report card would be an A, with the exception of Pain Management and Recovery turnaround that affects our organic growth. So I'm going to come back to that. But in Digestive Health, we continue to grow above market, nice job really in the U.S. and outside of the U.S. We exit low-margin, low-growth product categories, about $15 million in SKUs and products that we discontinued. And of course, we divested our Respiratory Health business. There was a lot of work done on the cost section on the supply chain through product focus and improving our plant execution. And we executed on $20 million in cost savings, and then we also talked to TheStreet about the fact that we've identified $15 million, and we feel very confident about that. Continued the M&A. And we did say also when there isn't M&A available that we would repurchase shares and we executed in 2023 on $40 million in share repurchases. So I'll spend just a moment on Pain Management and Recovery because, look, this is key to Avanos organic growth. And really, we can do all the things associated with our transformation. If we don't do this, it would be all for naught. And so there's 3 ways to think about this. Commercial reset, we restructured new management, new sales force, about 30% new channels. We directed it to orthopedic and sports medicine in Recovery and Pain Management. And we also refined our brand strategies and we started to invest differently in this business. We had curbed our investment as the business was turning negative. Now we're reinvesting in the business. We did experience the supply chain shortages, but we moved down from $13 million to $1.5 million in back orders. But what we did realize is that, as we lost those customers, there was a longer customer reacquisition cycle. We did see in the fourth quarter that Surgical Pain stabilized, and we feel like it's going to be set for growth. That will be the first time in a number of years that investors have been able to see that. Game Ready actually grew greater than mid-single digit in the fourth quarter. We feel very strongly about that growth. And the Interventional Pain, the business is now stabilizing, obviously, with the new channel approach, but also because we have supply available. And we did receive some favorable international reimbursement in Japan and the U.K. We have said that the HA market is not expected to stabilize until the end of 2024. But what we do expect is 6% year-on-year Pain growth, excluding HA and currency. And I'm sure in the Q&A session we can sort of clarify some of that and why we believe that. So a lot of what we see in terms of the account conversions, the momentum in the business is putting in a direction where we can be confident about mid-single digit growth next year. So here's what you can expect for year 2. We continue to invest and grow the Digestive Health business. You're likely to see some M&A in the Digestive Health segment. You can never predict obviously, M&A, but you're likely to see that inside of the next year. We do think we're going to be in a year where we can realize mid-single digit growth in profitability in Pain Management. We have plenty of M&A opportunities and a strong pipeline. I think a good track record there on valuation as well. And we'll continue to outsource and work on our business process efficiencies on the cost side. We're doing some work as well on labor efficiency and indirect spend. Lastly, we are opportunistic about share repurchases, and I've been doing that in the past couple of years. We would pay down debt if there were no M&A opportunities that arise, as you can't really judge these, but we have plenty of opportunities in a very [ full ] pipeline. So delivering on the transformation priorities does support the value creation metrics that we laid out at our New York Investor Meeting in the summer of last year. We think in 2024 we're set for a mid-single digit organic growth. Margin expansion at plus 400 to 500 basis points would put us in a 20% or north. EBITDA margin, free cash flow generation, greater than $100 million, 60% free cash flow conversion and a real opportunity to increase our ROIC from 5.8% to greater than 8%. So, I'm going to ask Michael Greiner, our CFO, to join me for a Q&A session, and we're happy to clarify anything about our recent filings or something that you see in the presentation that you like more clarification on.

Well, thanks, Joe. I'll start with a few questions, and I'll turn it over to the audience to ask questions if anyone has any. To begin with, how does the preannouncement from last week impact the transformation?

I'll say a couple of things, and I think Michael would want to pick up on it. But I don't think it changes the 2025 metrics that we have in place. We certainly have said that we start from a lower base and we have some changes in 2024, but we're going to start to see that growth out of the Pain business. We feel strong about the momentum that's building. We've been happy about the Digestive Health business and the above-market growth that we have there. Likewise, even though it doesn't pertain to the -- specifically to the 3-year transformation plan, the M&A pipeline is full to enhance what we think we can do with the business. So we're confident there. Michael may want to say a few things about margin, or anything he'd really like to add.

Yes. I think the communication we had last week indicated we were sticking with our 2025 guidance levels that we provided at our Investor Day with $20 million of high-margin revenue being clawed down for '24, and obviously creating a new baseline specific to our HA platform, we would have to assume we have to make up that margin elsewhere. So we were tracking ahead on both gross margin as well as our OpEx goals, as Joe laid out, with our year 1 transformation checklist report card. We're now no longer cracking ahead based on this $20 million, and we're back in the ranges of what we laid out in [ '25 ]. So really, the way to think about it is, we gave back a little bit of what we had kind of booked for ourselves the income statement through our first year of the transformation, but that still keeps us on track for the '25 targets.

And secondly, can you elaborate on the status of the transformation plan and some of your key accomplishments?

I outlined them in the presentation, but it's worth saying again. I really give the organization an A, with the exception of organic growth. I mean, that is the last component that allows for us to have the realization of all the value metrics into 2025. And so you think about divesting a division -- the Respiratory division, acquiring Diros and putting ourselves with the Trident technology in the ambulatory surgical center. Michael did a nice job as the Chief Transformation Officer, identifying $50 million in total cost, $20 million came out in the year. And then we actually did a nice job, I think, of structuring the Pain organization and setting it so that it can grow and be more profitable. So a lot of accomplishment in a short period of time and generally met our internal metrics on the Pain business outside of the Medicare changes in reimbursement in the HA market. Would you like to add?