Avanos Medical Inc (AVNS) 2015 Q2 法說會逐字稿

Good morning and welcome to the Halyard Health 2015 Q2 earnings results conference call.

(Instructions). Please note this event is being recorded. I would now like to turn the conference over to David Crawford from Investor Relations. Please go ahead, sir.

Thank you, Frank. Good morning, everyone. It's my pleasure to welcome you to Halyard's 2015 second quarter conference call.

With me today is Robert Abernathy, Chairman and CEO; and Steve Voskuil, Senior Vice President and CFO.

Robert will begin with an assessment of our second quarter performance and the progress we are making on our key priorities for 2015. Then Steve will review the second quarter results in more detail and provide his perspective on our outlook for the balance of the year. We will finish with Q&A.

A presentation of today's materials is available in the investor section of our website, www.HalyardHealth.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 the 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 our prior filings with the SEC.

Additionally, we will be referring to adjusted results and outlook. Both exclude certain items described in this morning's press release. The press release has further information on these adjustments and reconciliations to comparable GAAP financial measures.

Now, I'll turn the call over to Robert.

Thanks, Dave. Good morning, everyone. I appreciate your interest in Halyard Health.

Today marks our first mid-year update as an independent public company. It's important milestone for Halyard and we're glad to have you here with us.

I'm going to use today's call to talk about two main topics.

First the short-term headwinds impacting our surgical and infection prevention or S&IP business that resulted in our decision to revise our annual guidance.

Second, to tell you that while we're very focused on generating better top line performance in S&IP, we remain well positioned to execute our long-term strategy of transitioning our portfolio to higher margin medical devices.

Steve will take you through a more detailed breakdown of our results and expectations for the back half of the year in a moment. But let me start by sharing some headlines from our business segments and details on our revised guidance.

As we shared in our press release this morning, our second quarter sales were down by 3% on a constant currency basis versus last year due to lower volume and sales price in S&IP. We reported $0.52 adjusted diluted earnings per share driven by growth in medical devices and a gross margin in line with our plan. We also controlled discretionary spending to mitigate increased distribution costs and the impact of lower S&IP sales.

While we were focused on cost control and have delayed or reduced some discretionary spending, we have approached cost management in a very deliberate manner to realize savings without sacrificing long-term growth.

For example, we're increasing investment in our interventional pain business to ensure we have resources to meet growing demand and further expand the market. In research and development, our new leadership team has evaluated the status of our current portfolio and is aligned on areas for increased investment. We anticipate increased R&D spending in the back half of the year.

Now let's transition to the business segments starting with a look at our S&IP business where the soft quarter impacted our overall results. S&IP's challenges can be categorized in three areas.

First, unfavorable currency exchange rates. Second, distributor inventory reductions in north America; and third, competitive pressure that has impacted both market share and price.

With respect to medical devices, I'm pleased to report the segment had a good quarter with 7% growth on a constant currency basis, compared to last year, and 5% growth including currency. As you know, our long-term strategy is to transition our product portfolio to higher margin medical devices.

We're encouraged by our performance at the mid-point of the year in our medical device segment and expect to continue on a positive trajectory throughout the back half of 2015. On an operational level the spin-off is progressing on track and we're pleased with our development as an independent company. We have recently exited a number of transition services agreements and anticipate exiting many of the large remaining agreements in the next 60 days.

As one important milestone we recently completed our IT migration where we moved from Kimberly-Clark servers to externally hosted servers. This was a critical step in our transition that moves us closer to our separation and frees up resources to begin transforming our IT call structure and preparing for potential M&A.

We're on plan with our repackaging and rebranding efforts. During the quarter, we transitioned our third category -- surgical drapes and gowns and once again the customers' reception has been positive.

Our balance sheet remains strong. We have $114 million of cash following a $50 million debt repayment this quarter. This demonstrates our focus on allocating capital in an appropriate manner while leaving ourselves the flexibility to support our long-term growth strategy of reinvesting in the business and pursuing opportunistic M&A.

Now let me detail our revised guidance. As a result of our first-half performance in S&IP, we are lowering our overall net sales guidance for the year to between negative 1% and negative 3% on a constant currency basis. Lower S&IP sales, along with higher distribution cost and lower than anticipated commodity deflation, led us to revise our adjusted diluted EPS guidance to between $1.09 and $2.10.

Consistent with our historical results, we expect the fourth quarter to be stronger than the third quarter. Steve will give you some more color when we talk about key planning assumptions.

To be clear, my management team and I are disappointed in the mid-year results and the need to revise our guidance. We acknowledge the short-term challenges facing S&IP and are focused on generating better top line results from this business segment in the near term.

Make no mistake, while our long-term strategy is to transform our product portfolio to focus on medical devices, S&IP generates a significant amount of cash and is key to executing our strategy. Generating improved results from this segment is important.

That said, we remain confident in our strategy for three reasons.

First, because of the current performance of our medical devices and our plan to unlock future growth in this segment. Second, our expectation for sequential improvement in the S&IP business in the back half of the year. And finally, because of the strong foundation of our balance sheet.

With that, I'll turn it over to Steve for some more detail on the second quarter to and to discuss our outlook for the balance of the year.

Thank you, Robert. First, I would like to remind everyone that our results for 2015 reflect the business as it existed when it was part of Kimberly-Clark. Included in 2014 results, our [pre spin] costs associated with executing the spin-off.

Let me start with some key information from our press release.

Second quarter sales were $389 million, a 3% decrease in constant currency, compared to the prior year. Adjusted operating margin was 12.4% for the quarter, compared to the prior year of 17.2%. Adjusted EBITDA was $58 million, compared to $81 million in the prior year.

Now, taking a more detailed look at our results for the second quarter, overall sales of $389 million were down 6%, compared to $414 million a year ago. If change rates negatively impacted net sales by 3% or approximately $13 million. Volume decline contributed 1% and price decline contributed 2%. Adjusted growth margin declined from 37.5% a year ago to 35.4% as we had increased stand-alone costs and dissynergies associated with the spin-off. Favorable material costs during the quarter were offset by higher distribution costs. Unfavorable currency exchange rates and price erosion in the exam glove category.

As a reminder in the first quarter, we incurred higher distribution costs associated with the west coast port disruption and we anticipated that some of these distribution costs would continue into the second quarter.

In addition to the west coast disruption, which is now behind us, we incurred additional dissynergies associated with establishing stand-alone distribution capabilities in Australia. Going forward, we anticipate these costs will continue and impact us by approximately $2 million in the back half of the year.

For the quarter, adjusted operating profit was $48 million, down from $71 million a year ago. The decrease was driven by lower S&IP sales, higher distribution costs as well as increased stand-alone cost due to our spin-off which are tracking to plan.

During the quarter, we incurred $20 million of post spin-related charges and $7 million in intangible amortization expense that were excluded from adjusted operating profit. As a result, adjusted operating profit margin was 12.4% for the quarter.

Looking at our performance on a segment basis, first S&IP net sales declined 11% in the quarter to $255 million, down 7% on a constant currency basis. For the quarter, S&IP operating profit fell to $26 million, compared to $41 million in the prior year. As a result of lower sales volume and price, unfavorable currency exchange rates, higher distribution costs and anticipated higher stand-alone expenses.

As Robert mentioned earlier, we faced some headwinds in this segment -- Unfavorable currency exchange rates, distributor inventory reductions and competitive pressure that impacted market share and pricing.

Let me provide some additional background an each of these.

First, we continue to see the impact of unfavorable currency exchange rates. In S&IP, the top line currency impact for the quarter versus last year was unfavorable by approximately $11 million or 4%.

Second, we experienced distributor inventory reductions in North America. This resulted in decreased volume demand of approximately $4 million. We do not anticipate further reductions in the back half of the year.

Finally, moving to competitive pressure, let me talk about market share and price. While we continue to gain new accounts in surgical drapes and gowns, we were unable to offset the impact of accounts lost in 2014 in North America and Europe. The volume loss in Europe in particular was a result of our strategic decision to exit unprofitable business.

Meanwhile in sterilization, we've seen two new entrants in the last 18 months use aggressive discounting. Despite these challenges, we have lost little market share and are defending our position through customer education and product innovation. As we think about the balance of the year, we will continue to vigorously defend our leading market share position in this category.

With respect to net selling prices, they were 3% -- lower 3% driven primarily by exam gloves in North America. As an independent company we have heightened our focus on building our exam glove business. As a result, exam glove volume increased in the second quarter.

Customer reaction to our new Aquasoft Glove has been positive, especially in Asia-Pacific. However, competition in this category remains intense. Lower nitrile costs and market pressures have caused price to deteriorate and we expect this continue through the balance of the year.

To put the example of decline in pricing in perspective, the change in net selling in other S&IP categories was less than 1% for the quarter.

Let's now turn to our medical devices segment where all categories had solid results for the quarter.

Sales were up 5% to $127 million, compared to the prior year or up 7% on a constant currency basis. Results were driven by 7% higher volume which was partially offset by 2% of unfavorable currency exchange rates.

Interventional pain posted another robust quarter, up 33% overall, with cool leaf posted 68% growth in North America. As Robert mentioned we are increasing our investment in this segment to build upon our momentum.

Within the surgical pain category, we're seeing encouraging signs as the market dynamics appear to be improving. In the second quarter, on cue volume stabilized and improved sequentially.

Medical device's operating profit for the quarter improved 34% to $33 million, compared to $25 million a year ago. Our results were driven by higher sales and lower G&A expenses reduced to reduced G&A expenses reduced to lower litigation costs.

Let's turn to our balance sheet and cash generation.

For the quarter, cash from operations was $16 million,, compared to $58 million a year ago. The decrease was the result of operating results and changes in working capital, including an inventory build as part of the brand transition and the asset reconfiguration in our non low end facility. At quarter end we had $114 million of cash on hand, down from the year-end 2014 balance of $149 million primarily due to the $50 million debt repayment. Our debt repayment demonstrates our commitment to allocate capital responsibly and to ensure we have the financial flexibility to pursue our growth agenda.

Robert has already shared our revised full-year net sales and adjusted diluted earnings guidance. Now I'd like to review the key planning assumptions that we have revised and built into that updated guidance.

We're at the mid-point of the year. And S&IP sales are below our expectations. We anticipate continued lower pricing and volume for the balance of the year versus prior year. As a result, we now expect S&IP sales to decline 3% to 5% for the year on a constant currency basis. Based on our commodity outlook, we now anticipate less cost deflation in key inputs of $20 to $25 million.

Turning to capital allocation we now expect capital spending to be at the low end of the $70 million to $75 million for the year. This is slightly above our long-term target of 3% of net sales due to spin-related projects.

Now I'll briefly highlight our remaining 2015 key planning assumptions which we affirm.

Device sales are performing in line with our expectations and we anticipate sales growth of 2% to 4%, compared to 2014 on a constant currency basis. To support product innovation in our medical devices segment, we anticipate research and development investment of $30 million to $35 million. Exchange rates remain volatile and we anticipate negative foreign currency translation to impact net sales at the high end of the 2.5% to 3.5% range Additionally we expect a negative currency impact of operating profit at the high end of our $10 million to $15 million range.

For 2015, we anticipate spin-related transitional costs to be in the range of $45 million to $55 million and we continue to forecast the total amount for 2014, 2015 and 2016 to be in the range of $60 million to $75 million. Our adjusted effective tax rate for 2015 is expected to be in the range of 37% to 39%.

In summary, we have a heightened focus on improving S&IP results for the balance of the year. Medical device performance as well as our separation are on track. And we remain in a solid position to execute our long-term growth strategy.

I will now turn the call back to Frank and we will take any questions.

Thank you. We will now begin our question answer and session. (Operator Instructions).

At this time we will pause momentarily to assemble our Roster.

First question comes from David Turkaly from JMP Securities. Please go ahead.

Hi guys. This is [John] on for Dave. Can you hear me okay?

Yes, we can John.

Okay. So first thing I want to ask about is you mentioned the IT migration, now you're on externally hosted servers and I was just wondering if you could walk us through that aspect of what you're doing in your separation plans, and what else needs to happen before you'd be positioned to be able to integrate an acquisition.

Yes, this was by far the biggest element in terms of risk for the year of all the transition services [aggreements] with this -- transition away from the Kimberly-Clark-hosted servers to an externally hosted servers. It was a migration of several days down over the last weekend and it was very successful, very smooth and efficient so we're pleased by that.

That then frees up the IT organization. Obviously there's additional follow-up to be done but that frees up the IT organization to focus on two things.

First, to get our IT costs down as we start to look to simplify and reduce our IT costs as a percent of sales.

Second, it frees up that group to be able to do an acquisition in the future where we have those resources available to make sure that we got a new company embedded within Halyard and that we could put all the financials and other operating systems in place for an efficient integration of the company.

We said all along that we had to get past this date before we even consider an acquisition of any source. So we're very pleased that we have successfully had the migration of the IT system and it does position us to be more capable now to do an acquisition from this point forward.

Okay. Then the next one kind of in a similar vein. I was wondering if you could talk to us a little bit about the resources that you have in place, the business development team, the kind of people you've hired, how active they are currently? Just any color you can give us around that would be helpful. Thank you.

Yes, will do. We do have a strong business development team that we put in place. Part of that team was part of Kimberly-Clark. And then others on the team have joined us. The team is predominantly folks who have extensive health care experience as well as members who have experience in investment banking.

The team has a broad range of skills in finance and analytics. We have the ability to analyze opportunities to work closer with bankers to be able to look at whether we can deliver synergies quickly and get an acquisition accretive over an acceptable period of time and return higher than our costs of capital so we feel good about our organization.

The individual leading that group has been with the health care business here at Halyard. Prior to that, Kimberly-Clark for most of his career, he was responsible for doing the acquisitions back in the late 90s/early 2000 when we did [Technol] and Ballard and Safe Skin, so he has a lot of experience with health care acquisitions.

All right. That's helpful. That's it from us this morning. Thanks, guys.

Thank you, John.

The next question comes from David Lewis from Morgan Stanley. Please go ahead.

Hello, this is actually Jon Demchick in for David.

Hi, Jon.

Hey, Jon.

So I wanted to start off on upguided guidance. I think heading into the quarter, did we expected a reduction in the guidance but the magnitude was probably a bit large than we would have expected. Obviously the two main adjustments coming from the S&IP and then also on the EPS side.

So just starting off focusing on the S&IP segments, so volume fell quite a bit sequentially, especially after you back out the larger headwind from pandemic spending that have impacted the first quarter. And I think the pricing headwind is a pretty one to understand. But I was wondering if you could give us little more color behind the market share loss. And more importantly I was wondering if you could provide us with some reasons behind your confidence that there's going to be some sequential improvement in the back half of the year.

Yes. Let's start with the market share loss. We have seen some market share loss. We would estimate that market share loss is about $10 million in the second quarter. About half of the shortfall to plan in S&IP would be market share loss.

The share loss comes in sort of three categories -- surgical, sterilization, and in the apparel category. And what we've seen is some very aggressive pricing.

But let me back up and talk about the share loss because some folks say -- well, did you lose contracts? The answer is no. We've maintained all of our GPO contracts, new contracts that have been negotiated, we've been able to renew those contracts.

Most of the contracts as you know are either single-sourced contracts, dual contracts or multi-contracts, meaning that you'd have three or more on there.

Where we've seen some share losses in those duals and multi-contracts where you're in then trying to negotiate with individual hospitals, or hospitals networks, and so we have seen some share loss in those three categories -- surgical, sterilization, and apparel.

We are seeing some price loss as well where competitors are prepared to go in with pretty low pricing due to the low commodity pricing that we're experiencing now. So that's the share loss portion.

Why do we think sequentially that we'll get better for the rest of the year? We have a number of new accounts that we see coming online for the rest of the year. We're focused on growing our glove business so that we can get glove contracts coming on for the rest of the year, or pick up glove business for the rest of the year. So that part gives us confidence that we're going to start to see some sequential improvements.

Thank you. Very, very helpful. On the EPS side, I guess the reduction there was a little larger than we would have expected. Kind of running the math it sounds like half of the reduction is probably associated with lower S&IP sales. And then maybe there's another $0.10 associated with the distribution costs as well as the lower commodity benefits. I was just wondering if there's anything else kind of going into the reduction here. Are those really the main points? And then kind of also running the math it seems like margins are expected to kind of stay at the current level. Do you see them improving into the back half of the year or do you think kind of where we're exiting 2Q is where we should really be expecting it through the balance? Thank you.

Yes. Let me start with the last question first. The margins we expect -- assuming commodities don't move dramatically, we expect margins to be similar to where they are now.

We're on plan. We'd always talked about once we fill out all the capabilities to be an independent publicly traded company that we'd see gross margins come down about 200 basis points and operating margins come down about 500 basis points. And that's exactly what's happened so far. So we think the margins are in the range. I mean they could be up or down 50 basis points at any given time. But they're in the right ballpark.

Moving to the guidance movement, you had each part almost exactly right, Jon. The way we profiled it, of the $0.40 decline in our guidance, we said about half of that is the volume and price loss in S&IP. We would then say distribution is a full $0.10 by itself. We've then got currency and commodities as kind of one big bucket at another $0.10. And then there's a hit of cost to sales at about $0.10 which is offset by some OpEx savings that we've seen. So that nets you out at about that 40% drop that we have. But by far the biggest impact over -- half of it is the volume decline and price loss in S&IP.

Thank you. That was very clear. And then just one follow-up on M&A plans, kind of following up on John's question from earlier. Do you have a specific focus on size? And I think earlier you guys talked about maybe the max size that you go up to is about $500 million. Then last quarter, I think it maybe inched up a little bit. Do you guys have a preference to go more of a larger deal versus more of the tuck-in variety? And does recent performance in the S&IP segment maybe change the urgency in getting a deal done or is it still status quo?

Well, let me start by saying a key part of our strategy is to dramatically shift the portfolio towards more of the high-margin medical devices and we're going to do that through growing organically our current medical devices and through acquisition of medical device products or companies.

We have always had an urgency to get the acquisitions started early in 2016 and we haven't changed that opinion. We feel very good about our balance sheet giving us the flexibility to do that. We feel very good about the fact that we're efficiently getting the transition services agreements exited, and that's setting us up to be able to move to a phase where we could start thinking specifically about companies and product lines to acquire.

We've also been taking our Board of Directors through a very rigorous process, a strategy development process to get them aligned on the sort of companies and the product lines that we would be interested in buying. So that's how far we've progressed so far.

Size of the acquisitions, we haven't limited ourselves saying they have to be small tuck-ins and we haven't said they need to be above a certain size. We're really looking more at whether they strategically fit our business. Do they offer higher growth in our current medical devices? Do they offer better margins than our current medical devices? Do they fit in in terms of product portfolios such that we can get synergies in year one, both sales synergies and manufacturing synergies. So that's really how we have thought about it.

Understood. Thank you very much.

(Operator Instructions) The next question comes from [Larry Keusch] from remained James. Please go ahead, sir.

Hi. Good morning. I was wondering, Robert, if we could start off thinking about the M&A strategy in a slightly different way. Which is given the S&IP business and the margin profile of it, just trying to think about over the next couple of years how we should be thinking about the move towards higher margin products? Because obviously if they're smaller acquisitions it's going to take a lot longer to influence the overall profile of the business. So maybe just help us calibrate a little bit as to how we should be thinking about this over the next several years.

Yes, I think the way I think about it, Larry, is number one, S&IP, we've got to protect that business. We've got to make sure that it continues to generate the cash flow that it has historically generated. So the focus on S&IP is going to be to shore that business up, stabilize it, get it back into a stronger position in terms of volume growth and minimize price loss. But historically that business, we had seen volume up 1%, price down 1%. And obviously in the first six months of this year, it has not performed to that profile. So we need to focus on that.

But the entire M&A activity is going to be on medical devices. So we're not thinking about any M&A within the S&IP categories.

Then it's all about how fast can you go? How much financial flexibility do we have? How close do we want to buff up against our banking covenant ceilings? How much do we want to go outside the range of our current credit ratings? And we've said all along we're prepared to stretch that, but we'd like to be able to get back to our current credit ratings over time and work with the rating agencies to allow that to happen.

We'd profile that and say that over about a five-year time period we believe we can get to where we are 50% medical devices and 50% S&IP by effectively using cash available to us while maintaining our current credit rating.

Now, that doesn't rule out a transformative acquisition where we would say we're prepared to go outside of those planning assumptions but that's the planning assumptions we've talked most frequently with, investors as well as our Board of Directors.

Okay. That's really helpful. And then you partially answered this but I just want to dive back in, if I could. So obviously the S&IP business remains very important from a cash flow perspective. And so you're talking about again needing to execute in that business.

But again, over the -- given what we've seen in the first six months, maybe just specifically, or to the extent that you can, just help us understand what the strategy really is to kind of shore that business up and make sure that it's generate the cash flows that are necessary. And I guess as part of the question -- do you think the S&IP business, given where we are today, is capable of generate the historic cash flows that it has?

)) Yes, the answer is yes. I think it is capable of generating the historic cash flows that it has. It's a strong business, a stable business. These are product categories that are critically important in hospitals for preventing infection. And as hospital utilization grows, we expect these categories to grow.

I am expecting higher price loss. That's the one thing that -- with low oil prices leading to low monomer prices, we are expecting higher price loss than we've experienced in the past, particularly in categories where folks now look and say -- boy, it's possible that prices could stay down for a number of quarters or even a number of years. So as a result of that, competitors are far more likely to come in with slightly lower prices, realizing there's less risk that the commodity goes up dramatically and you get saddled with a very low cost, unprofitable contract.

So I think that dynamic has shifted. But over time our strategy is to continue to aggressively reduce our cost, our manufacturing cost, our distribution costs and to dramatically change our product designs with design for value products. You'll see more and more products where just like our arrow blue gown where we have got a more protective front panel on the surgical gown but then a less expensive lighter weight and more breathable back material to allow us to have higher margins with lower cost materials. So it's a matter of continually transitioning the products to lower costs so that we can maintain margins in the business while we also work on improving the volume.

Okay, great. Then just lastly, the R&D which you've indicated I believe will be in that $30 million, $35 million for the year. I think if I did the math, right? You're kind of in the $12 million-ish range for the first half. I know you indicated that that would pick up in the second half of the year. But are those kind of firm numbers where the projects are there and will be kicking off, or is it possible that that number does come in lower?

No, those are firm numbers and we're confident we're on track to double our research spending over a four-year time period. We're ramping up this year. We've got a new leadership team in our research and development area.

We have specific projects that are now being funded. We had a fun exercise across all of the technology teams and marketing teams within Halyard where we did what we call a shark tank.

We then selected a number of key projects to begin investment in. These are new to Halyard, new to these category opportunities. We've started funding those now. A lot of that funding comes in the second half of the year. And we're confident that we're going to be in that $30 million to $35 million research spend rate by year-end.

Okay. Terrific. Thanks for all the color.

Thank you, Larry.

Again, if you have any questions, please press star then 1 on your touchtone phone.

This concludes our question answer and session. I'd now like to turn the conference back over to Mr. Robert Abernathy for any closing remarks.

Well, thank you for your interest today in Halyard Health. Information about how to access today's presentation can be found on the Investor Relations section of our website, Halyardhealth.com. Thank you, everyone.

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