Avanos Medical Inc (AVNS) 2015 Q4 法說會逐字稿

Good morning and welcome to the Halyard Health fourth-quarter earnings results conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Dave Crawford, Vice President, Investor Relations. Please go ahead.

Thank you and good morning, everyone. It is my pleasure to welcome you to the Halyard Health fourth-quarter 2015 earnings conference call. With me this morning are Robert Abernathy, Chairman and CEO; and Steve Voskuil, Senior Vice President and CFO.

Robert will begin with an assessment of our fourth-quarter and full-year performance and discuss our priorities and guidance for 2016. Then Steve will review our results and provide additional detail around our planning assumptions for the year. We will finish with Q&A. A presentation for today's call is available on the Investor section of our website, 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 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, and good morning, everyone. I appreciate your interest in Halyard Health. Those of you who have been following us for a while know that we have charted a course to execute our long-term strategy of transforming Halyard into a global medical devices Company. Our goal for 2015 was to lay the groundwork for that transformation by completing our separation and building our capabilities as an independent Organization.

My Management team and I are proud to say that we accomplished those goals, including exiting transition services agreements, establishing IT capabilities, and progressing with our rebranding and repackaging. Additionally, our Medical Devices segment performed in line with our expectations and we will initiate the first steps in the transformation of Halyard in 2016.

With respect to our Surgical and Infection Prevention business, we faced a difficult environment in 2015. While we expect these challenging market conditions to continue, we are committed to defending our leading share positions, bringing innovation to these categories, and maximizing cash flow.

Against that backdrop, I'm pleased to report that we ended both fourth quarter and full year 2015 in line with our revised expectations. Fourth-quarter adjusted diluted earnings per share was $0.57 and full-year adjusted diluted earnings per share was $2.11. Our fourth-quarter sales of $401 million put us at $1.6 billion of sales for the year.

Let me provide a quick overview of our performance and then Steve will go deeper into the numbers. Our segment performance was consistent with the trends that we've seen throughout most of the year. Medical Devices had a solid quarter, with 6% growth on a constant currency basis. This marked the third consecutive quarter Devices grew 5% or more in constant currency.

For the year, Medical Devices grew 3% in constant currency, which was in line with our expectations. Medical Devices growth was driven by Interventional Pain, where we continue to see robust performance from COOLIEF. In Surgical Pain, ON-Q volume returned to growth in the back half of the year as planned. Also, our Respiratory and Digestive Health categories delivered growth in line with expectations.

Turning to S&IP, sales declined 9% in the fourth quarter on a constant currency basis as we cycled against a strong quarter a year ago, which was driven by pandemic preparedness sales. For the year, sales declined 7% on a constant currency basis. Last year, the S&IP markets became more challenging as input costs declined and selling prices contracted, resulting in aggressive competition for market share. We expect these dynamics to continue in 2016.

We ended the year with a solid balance sheet, including $130 million of cash on hand, while also reducing our debt by $50 million. Our cash generation was balanced between S&IP and Medical Devices. In 2016, we expect to generate free cash flow in excess of $100 million, driven by lower capital spending and lower separation expenses.

I began by talking about how 2016 will be the start of Halyard's transformation that will take place over the next few years. This consists of three parts: portfolio, Company, and culture. The portfolio transformation has been the foundation of our strategy since day one. Through increased investment in research and development, and strategic acquisitions, we will enhance our Medical Devices segment, roughly one-third of our business, and realize our vision of becoming a leading medical devices Company.

The second part is transforming our Company. This includes rationalizing our corporate costs through reducing our IT spend and gaining operational efficiencies that will also optimize our tax structure. The third and final part is a cultural transformation. We are no longer a small segment of a large consumer goods company being run for cash. We're a health care Company and we must be bold and agile.

Our cultural transformation that began last year will accelerate as we produce innovations that will impact the future of health care. That is our vision for the future of Halyard Health.

We're going to accomplish this by delivering our 2016 plan and fueling our growth pipeline. Our 2016 plan calls for delivering full-year adjusted diluted earnings of $1.45 to $1.65 per share and we expect total net sales to decline 2% to 5% on a constant currency basis.

In order to fuel our growth pipeline and deliver on our commitment to transform Halyard we have three key areas of focus. The first is to accelerate investment in our Pain platforms. These categories are leading our growth in the case of Interventional Pain and returning to growth in the case of Surgical Pain.

We plan to build on this momentum, as well as our leading market positions in non-narcotic pain therapies. We are increasing our sales and marketing resources in Interventional Pain to help continue to meet growing demand. In addition, we will increase our investment in physician education events and clinical evidence to help grow our categories.

The second area of focus is innovation. We expect to successfully launch 10 product line extensions across S&IP and Medical Devices this year. We remain committed to doubling our investment in research and development, enabling us to introduce new innovations, differentiate our portfolio, and maintain our market-leading positions.

The third area of focus is acquisitions. We expect to complete our first acquisition to accelerate growth in our Medical Devices business and enhance our performance through operational synergies. In closing, while we appreciate the challenges ahead of us, we have built a solid foundation and are ready to lead Halyard through its next stage.

We feel as confident about our strategy now as we did on day one. With that, I will turn it over to Steve.

Thank you, Robert. I'd like to remind everyone that our results for the fourth quarter of 2014 partially reflect the business as it existed when it was part of Kimberly-Clark. Included in our 2014 results are pre-spin costs associated with executing the spin-off.

Fourth-quarter sales totaled $401 million, down 7% on a constant currency basis compared to a year ago, as we cycled against a strong quarter that included an estimated $13 million of pandemic preparedness sales. Exchange rates negatively affected net sales by 2% or approximately $10 million. For the quarter, volumes were down 2% while lower selling prices also impacted sales by 2%.

Lower volume in Exam Gloves and [Roll] goods sales to Kimberly-Clark contributed the remaining 3%. Adjusted gross margin was 34% this quarter compared to 37% a year ago. The previous year's gross margin benefited from higher production volumes related to pandemic preparedness sales, while during this quarter, we reduced production volume to manage inventory levels, resulting in lower fixed cost absorption.

Overall, we reduced inventory by $20 million, compared to the end of the third quarter of 2015. Adjusted operating profit was $41 million, down from $77 million a year ago. The decrease was driven by lower S&IP sales volume and pricing, production curtailment, increased investment in research and development, and planned stand-alone costs due to our spin-off.

During the quarter, we incurred $8 million of post-spin-related charges, $7 million in intangible amortization expense, and $8 million for litigation matters that were partially offset by a $2 million downward adjustment of our previously announced goodwill impairment estimate. These items were excluded from adjusted operating profit margin of 10% for the quarter. Adjusted EBITDA was $51 million for the quarter, compared to $87 million in the fourth quarter a year ago.

As Robert discussed earlier, part of our Company transformation is optimizing our tax structure. Our adjusted effective tax rate for the quarter was 20%, and 33% for the year. Our tax rate benefited from the passage of the Research and Development tax credit at the end of 2015, which was not included in our original guidance.

Our tax team, working with different areas of the business, was able to identify qualified spending that increased our R&D tax credit substantially over the prior year, that will allow us to reinvest in our Business. We identified efficiencies that enabled us to take the initial steps in our tax planning.

Going forward, there could be increased variability in our tax rate as we implement operational changes to our business structure and processes. Some of these changes could cause an upfront increase in our effective tax rate followed by a reduction in future years.

Looking at our performance on a segment basis, S&IP net sales declined 9% on a constant currency basis for the quarter, with an additional 3% decline coming from exchange rates. Sales volumes were down 5%, as we cycled against a strong prior-year quarter. Volumes were also impacted by share loss in Surgical Drapes and Gowns, and protective apparel, as well as reduced Exam Glove sales to Kimberly-Clark.

Lower selling prices, concentrated in Exam Gloves and Sterilization, negatively affected sales by 2%. S&IP operating profit for the quarter was $27 million, compared to $48 million in the prior year, as a result of lower sales volume and selling price, higher manufacturing costs due to the production curtailment, and planned stand-alone costs.

As we discussed before, in the last few years, our S&IP markets have seen a decline in commodity prices, which has quickly translated into lower selling prices and increased market share competition. In steadier commodity environments, we have historically averaged 1 point of volume growth offset by 1 point of pricing contraction. However, in this current environment of low commodity costs, competitors have become more aggressive in passing that commodity benefit on to gain share.

This dynamic resulted in 2% price loss in 2015. We expect this dynamic to continue in 2016 and to result in a 2% to 4% annual price loss. In this environment, success in S&IP will be defined by defending our leading market share positions and bringing innovation to our categories, while maximizing cash flow. In Surgical Drapes and Gowns, we will defend our leading position by launching new products that meet our customers' evolving needs while differentiating our portfolio.

In Sterilization, we will aggressively leverage the growing body of clinical evidence demonstrating that our sterilization products are significantly more effective in preventing infections than rigid containers. We believe this is a major area of concern for the health care industry and an example of where we can win in a challenging market. Over the long term, we expect commodity prices and market pricing will stabilize and our results will align more closely to historic norms.

Turning to Medical Devices, our business delivered another solid quarter of growth. Compared to the prior year, sales increased 5% to $134 million, or 6% on a constant currency basis. This marks the third consecutive quarter of growth at or above 5%.

Results were driven by 6% higher volume, which was partially offset by 1% of unfavorable currency exchange rates. Interventional Pain delivered another strong quarter of double-digit growth, fueled by continued momentum of COOLIEF in North America. Surgical Pain sales increased 3%, driven by increased demand for ON-Q.

This marks the third consecutive quarter of sequential growth for ON-Q and the second consecutive quarter of year-over-year growth. Medical Devices' operating profit for the quarter declined to $21 million from $28 million a year ago. Higher volumes were more than offset by higher strategic research and development spending and increased selling expenses.

Now for a brief recap of our full-year 2015 results. Sales totaled $1.6 billion, a 3% decline on a constant currency basis, with currency negatively impacting sales by 3%. Volume and price each declined 1%. The remaining 1% decline resulted from lower sales to Kimberly-Clark.

Compared to the prior year, adjusted gross margin was 35%, compared to 37%, and adjusted operating profit margin decreased to 11%, compared to 17%. The decrease was due primarily to a decline in selling prices, higher distribution expense and the addition of stand-alone costs. Adjusted EBITDA declined from $326 million in 2014 to $220 million in 2015.

Shifting to our segments. First, S&IP sales were down 10%, a 7% decline on a constant currency basis. Higher Exam Glove volume in Latin America and Asia-Pacific was offset by lower volume in Surgical Drapes and Gowns in North America and EMEA, Facial Protection in North America, and Exam Glove sales to Kimberly-Clark.

Overall, net selling price declined, primarily in our Sterilization and Exam Glove categories. Operating profit was $98 million, compared to $166 million a year ago. Declining sales volumes and selling price, higher distribution, and stand-alone costs impacted our 2015 performance.

Turning to Medical Devices, sales increased 2% to $510 million, up from $502 million. On a constant currency basis, sales increased 3%, meeting our expectations. Volume increased 3%, driven by strong demand in Interventional Pain in North America, as well as solid growth in Digestive Health.

Operating profit increased 3% to $108 million, up from $105 million a year ago. The increase was driven by higher sales volume that was partially offset by higher selling and research and development expenses. As we enter 2016, with a focus on delivering our plan and fueling our growth, let me walk you through our key planning assumptions, which support the earnings and sales guidance Robert discussed earlier.

Medical Device sales are expected to increase 3% to 5% compared to 2015 on a constant currency basis. Excluding sales to Kimberly-Clark, we expect S&IP top-line sales to decrease 3% to 5% compared to the prior year on a constant currency basis. Our outlook for S&IP contemplates 2% to 4% lower selling prices.

S&IP sales to Kimberly-Clark, which were $50 million in 2015, are expected to range between $40 million and $45 million in 2016. Corporate sales, which were $35 million in 2015, are expected to be between $5 million and $15 million in 2016. Foreign currency exchange rates are expected to negatively affect our sales by 0.5% to 1.5%.

We anticipate commodity inflation of key inputs to range between $5 million and $10 million. As Robert mentioned, one of our strategic priorities in 2016 is to invest in growth initiatives. As a result, we are increasing our research and development investment to be between $35 million and $40 million.

We anticipate, for the year, spin-related transitional costs will be between $10 million and $15 million. We forecast total transition costs for 2014, 2015, and 2016 to be in the range of $67 million to $72 million. Our adjusted effective tax rate is expected to be in the range of 33% to 35%.

In summary, for the quarter and for the year, we delivered adjusted diluted earnings per share ahead of our revised guidance, as well as Medical Device growth in line with our plan. While S&IP remains challenging, we are committed to defending our leading market share positions and innovating in our categories, while maximizing cash flow. We are also committed to investing for growth to shift our portfolio to faster-growing, higher-margin medical devices.

With that, operator, we are ready to take questions.

(Operator Instructions)

Our first question comes from Larry Keusch of Raymond James. Please go ahead.

Thank you. Good morning, everyone.

Good morning, Larry.

Robert, I was hoping that we might start with M&A. Obviously, you have been articulating the strategy quite clearly since you spun the Company back in 2014. I'm just wondering if you can, again, at a high level, give us any update as it might relate to timing, and again, how you're thinking about the criteria around deploying your capital?

Yes, we're very excited about M&A this year. In fact, we've identified completing our first acquisition this year as one of the key priorities for the Company. We're optimistic that we'll be able to have an acquisition in the first half of this year that will fit very nicely within our current portfolio of products. We've talked all along about the acquisitions that we're looking at.

Now, it would be in the Medical Devices area, in areas like digestive health, respiratory care, and pain management. We see the first acquisition, and probably acquisitions to follow in the next year or so, to be more of the tuck-in acquisitions to really give us the ability to deliver synergies, both manufacturing synergies, as well as selling synergies, and to get some synergies around our headquarter operations. We're in active discussions now, and I'm very optimistic about being able to announce our first acquisition sometime soon.

Okay. That's really helpful. Then just a quick follow-on to that and one for Steve. Just again, you've talked about having firepower of roughly $500 million. Is there any way that we should calibrate our expectations size range for that first deal? I suspect you're very focused on that first one being strategically obvious and I'm just wondering about size?

And then the second question, for Steve, is it looks like you're now including some commodity or cost inflation for the outlook for 2016. I'm just curious what's driving that, and again, any sensitivity to if oil prices start to rise, how quickly does that translate into cost increases for your business?

Great. Let me start with the firepower and potential size of the acquisitions. We've said all along, with now $130 million of cash on hand on the balance sheet and a $250 million undrawn revolver, that we do have capacity to go up and use roughly $500 million or so, and we're at the low end of our debt covenants now.

If you think about the multiples of sales that people are paying, that would allow us to buy a company that would be $50 million up to $150 million in sales, and that's the target zone that we're looking at now. In terms of the commodity pricing, there has been some movement there. As you know, we've talked about increase in our polymer price this year that happened at the first of the year.

I do think that will start to maybe cause people to pause a little bit in terms of the very aggressive nature of some of the contracts, as we get into this next round of contract negotiations, but certainly we've seen that pass along to us, and we'll certainly take that into account as we look at future contract negotiations. Steve, I'll let you jump in on that one, as well.

All I would add, Larry, is the increase is primarily related to the polymer side, and in particular, the spread that our suppliers add to the base cost of the monomer. With a constrained polymer supply in North America, we saw it over the course of 2015.

We've had a first announced price increase as of January 1, this year, all related to that spread. We still think there is some risk in that spread, as there's some profit taking by suppliers. So that's the driver of the year-over-year increase.

Okay. Terrific. Thanks, guys.

Thanks, Larry.

Our next question comes from John Gillings of JMP Securities. Please go ahead.

Hi, guys, thanks for taking the question. Can you hear me okay?

Yes, we hear you, John. Thanks.

Okay. First one, I just want to follow up on Larry's question about M&A. Obviously, we've come into an environment that's a little bit more challenging for raising capital, that sort of activity. Can you just give us some color on how the environment may have affected or changed the kinds of negotiations that you're having or how people are reacting to that in your discussions?

We haven't seen a lot of change in terms of the environment. There are people that are prepared to be in the process, to bid just as we are. The properties that we're looking at, they're good companies with growth rates, margins at or above our current growth rate and margins for our Medical Devices category. So these are the sort of product lines or companies that are going to be desirable, but we've seen a pretty active marketplace right now.

Okay. That's helpful. And then just looking at the tax side, you mentioned that there might be some increased variability, maybe some upfront costs with savings coming later on. Can you just help walk us through some of the -- just broadly, some of the types of things you're looking at doing on the tax side and where you think that could go over the next several years? So that we can get a sense, if you get the 500 basis points of operating margin you've been talking about getting over five years, what juice could be added by what you could do on the tax side?

Let me start and then I'll kick it over to Steve. I am really pleased with what we're seeing in our tax rate progress so far. Obviously, some of it has come from the research and development tax credit, but others have just come from the start of us proceeding down our road map of improving our overall tax.

So there's a good sound bite there in terms of we are starting to make some progress, and clearly the tax line is below that 500 basis points of improvement that we need to get from things like IT and other areas, but we're clearly pleased with the fourth-quarter progress that we saw in the tax area. Steve, let me let you jump in.

Yes, sure. John, we're very aware that our tax rate is still well ahead of our peers. As Robert said, that was and remains a key part of our go-forward strategy, is getting more efficient there. We're not going to share a lot of details on the strategies themselves.

But relative to the volatility or potential variability in the tax rate, we recognize we've got deferred assets and tax liabilities around the world, and any time you begin to look at structures, all of those are have potential for revaluation. That's really just what we're calling out there.

All right. That's helpful. Thanks, guys.

Thank you.

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

Good morning.

Good morning.

Robert, just a couple things I wanted to focus on. Maybe we start with Steve on oil. One of the things we get from investors is oil was supposed to be a tailwind. It's obviously turned into a headwind. I wonder if you could parse that out?

Is the primary issue that while oil costs are going down and your input costs should go lower, on top of that you had this issue of losing scale and input power, post the Kimberly-Clark days? Is that really the principal issue? Investors just really want to understand how oil has become an incremental headwind. Is it the purchasing power?

That could be a portion of it. The fact that there's constraint in capacity right now, in North America, has allowed the biggest producers to pass along pretty severe margin increases. Just to give you a sound bite on that, over a year ago, about 80% of what we paid was for the monomer itself and about 20% was for the spread, the profit for the producers like Exxon.

Now, that's 50%/50%, so the monomer is 50% of our total cost, and their margin, their spread is 50%. So they have more than offset the decline in the monomer price by just passing along price increases in the spread.

Okay.

That's a very different phenomenon than what we've seen in the past, so it's really almost as if the monomer cost has decoupled itself from the actual pricing.

Okay. Very helpful. Maybe just one more strategic for you and then a quick one for Steve. Robert, the two things that have changed since the IPO, as it relates to S&IP, it feels like one, obviously, is this oil dynamic, which I think you've eloquently explained. The second is this notion of new competition, distributor competition, entering your business. What do you think is the new structural growth rate for S&IP?

Well, as Steve said in his section earlier, we do expect it to return to that more normal level of volume up 1% and price down 1%. We think that happens after we've completed the full three years of renegotiating prices at the lower commodity prices. The one exception to that could be gloves, just based on the nature of the glove market, but across all of the medical non-wovens businesses, like drapes and gowns and face mask, apparel, we do expect it returns to that 1% up, 1% down level over time.

Okay.

The 1% you would expect if you maintain your leading market share positions, which is clearly a strategy that we've articulated, that we would grow with the market. These are fully penetrated categories. But if you expect hospital utilization, particularly in acute care hospitals, is going to grow in that 1% a year, that ought to give you that volume growth. And then it's a matter of making sure that you don't eat it up with price loss, as we did in 2015, and as we're going to experience again in 2016.

Okay. So it sounds like you get back to something like flattish growth, maybe 2018 beyond, after the 2015 through 2017 renegotiation years, just let me know if that's close enough for government work. Then, Steve, just a quick one is free cash flow outlook for 2016, and I'll jump back in queue? Thank you.

Free cash flow for 2016, as Robert and I said even at the JPMorgan conference, it's somewhere north of $100 million. That's a pretty big increase year over year, but we have lower capital spending as we come off 2015, which was unusually high with some of the spin-related capital, and also for absence of as many spin-related costs, so somewhere north of $100 million.

All right. Our next question comes from Kristen Stewart of Deutsche Bank. Please go ahead.

Hi, thanks everyone for taking the question. I was just wondering if you can go back to some of the new products that you were talking about and what gives you the confidence that some of the new products can really turn around the S&IP business and the terms there?

Great question, Kristen. It's always fun to talk about innovation. We do have 10 product launches scheduled this year. They're predominantly line extensions, if you will, but it's significantly higher than what we've seen in past years. So as we've been ramping up the R&D spend, particularly in some of the Medical Devices areas, but also in S&IP, we are able to bring more innovation to the marketplace.

The 10 line extensions, some of those are in S&IP, and some are in Devices. We don't detail that this early in the year because we like to hold that as a big announcement as our sales conferences, which are happening this next month, and then to be able to launch those at the appropriate times during the year. But we're excited about the innovation we're bringing to the marketplace.

Okay. And then how should we just think about the gross margin balancing out all of the price reductions in some of these new products, as well as some of the input costs?

I'll talk about S&IP first and then I'll talk about Medical Devices second. S&IP, we're certainly going to continue to see margin pressure as the price loss continues this year and into next year. We've always got strong cost-savings programs to help offset some of that, and we'll continue to focus on making sure that we get the right mix to be able to drive holding margins or at least minimizing the loss of margins in our S&IP business.

In Medical Devices, we expect margins to stay strong. They were a bit choppy this year, as we had some timing of R&D expenses and some write-offs, due to some manufacturing issues. But we still expect our margins in our Devices business to hold in that low-20% range and be very strong going forward.

Okay. And then just on [in precedent] on operating margin level, but just from a gross margin level, do you think that -- where should we see those go on a consolidated basis for Halyard?

The gross margins will be most impacted in S&IP due to the price loss, and then a lot of the clawback that we'll get will actually be below gross margin with our cost savings. So I would expect to see some lower gross margins in S&IP, but not so in our Medical Device area.

Okay. And the -- sorry, go ahead, Steve.

I'll let Steve jump in there.

I was going to add, as Robert summarized, you have the two dynamics, you have the accretive uplift of the Medical Device business growing and then the price flow through on S&IP, and part of that price flow-through offset by cost savings. So we see there's going to be some, I'll say, flat to downward pressure on gross margin for 2016, as that price for 2016 on S&IP dominates the accretive benefit of the growth in Devices.

And the Medical Device tax, was that in your SG&A? I don't think it was that significant, but just wanted to check on that?

Yes, it was in G&A. That's right, Kristen.

Okay. Perfect. Thanks very much.

Thanks, Kristen.

Our next question comes from Matthew Mishan of KeyBanc. Please go ahead.

Great. Thanks for taking my questions.

Hi, Matthew.

Hey. First on S&IP, above and beyond the pricing impact, it looks as if you're expecting volume declines of about 1% before the Kimberly-Clark business. Can you give us a little bit of color on what's driving that in 2016? I believe in 2015 a lot that was really very tough comp coming off of the pandemic preparedness?

As we look at that -- you're exactly right, how you categorize it. We see a 2% to 4% decline in price, and 3% to 5% that we're guiding for the total sales of the S&IP business, which would give you a 1% loss in volume. We'll continue to see a decline in our sales to Kimberly-Clark, our S&IP sales. That's going to make up a portion of that, but we're also continuing to see very competitive environment.

We lost some market share last year. While we're focused on defending our leading share positions, bringing innovation to the categories, and maximizing cash flow, we do expect that competitive environment to continue, particularly in a couple of key areas like sterilization wrap, where we had a major patent that expired two years ago now. So we'll continue to see some volume pressure in that category.

Could you help me differentiate between the non-woven sales that were in corporate last year, and then you're starting to call out the -- and I don't believe you called it out specifically last year in your guidance -- the sales to Kimberly-Clark, which is in their industrial business? Is the reason why you're calling it out now, is that because you expect that to decline as you go into 2017?

We do. It declined last year. We expect it to decline again this year, and it might likely decline the next year. So as we look at it, it's a low-margin business. It's the sales of gloves to Kimberly-Clark, used predominantly in industrial areas, as you mentioned. But breaking that out allows us to focus more on the core businesses, where we're selling into acute care hospitals and the health care business, as opposed to what we're selling to Kimberly-Clark.

So we are just factoring that number out so you can see it. We just want to give more visibility to that number. The corporate sales, those are roll goods of materials, non-woven materials, used in Huggies Diapers. We did some machine conversions this last year to allow us to transition our machines to make the Medical Devices blue fabric that we make and, therefore, Kimberly-Clark will need less of the materials from us going forward.

Matthew, for 2016, those two combined contribute negative 2 points of growth. So that's part of the reason for calling it out. It's fairly significant for the consolidated number.

Okay. Great. Just last question from me. Was there any change in surgical pain management, in January and February, after -- because Sierra had their warning letter resolved mid-December or so. That wouldn't have had any impact on the fourth quarter, but did you see any change in that business, in January and February, after that was resolved?

We hadn't talked a lot about first quarter, of course, but through all of last year, as they had changes in terms of what was approved and not approved and the lawsuits withdrawn, we haven't seen a big change. The key message there is people do understand that the narcotic pain issue is real.

More and more physicians, more and more hospitals are hearing the concerns and high costs related to addictions and re-admissions and discomfort, nausea, and the like. The key messages are being heard, and we're now starting to see the growth of our business, so we feel good that the business has returned to growth.

All right. Thank you very much.

Thank you.

Our next question comes from Rick Wise of Stifel. Please go ahead.

Good morning, Robert. Good morning, everybody.

Good morning, Rick.

Robert, I wanted to come back to Med Device operating margins. Obviously, down sequentially for some of the factors you talked about. But help us better understand -- I understand that some of the pressures maybe, but help us better understand the incremental investment spending.

Did you add two new salespeople? 50 new salespeople? The R&D -- help us understand what happened uniquely in the fourth quarter, and how we think about the potential positive impact that, that could have of that investment in 2016 and beyond?

Let me talk about fourth quarter and macro first, and then I'll get more specific to people that we've added, extra spending, particularly in our interventional pain area. That's the rapid growth of the COOLIEF. There's a couple of big factors that happened in the fourth quarter in Medical Devices. One of those is phasing of R&D spending. Another was phasing of our sales incentives, the timing of that.

But the biggest portion was a write-off in our respiratory care area. We had a manufacturing mistake, and we contained the problem within our distribution area, but it was a pretty substantial write-off that will not recur. So once you back that out, now let's talk about the positives coming from the R&D spending and the additional sales ramp-up of capabilities.

We have added over a dozen people to our interventional pain business. We feel good about that. Some of those are in research. Some are in selling. As the business grows, we're building stronger and stronger capabilities in that area, and the leading indicators in that area of physicians trained and generators placed would certainly say we're going to continue to see strong growth in our COOLIEF and interventional pain businesses.

Okay. Maybe for Steve. Just thinking about your free cash flow, if I'm looking at the numbers right, you had something like $27 million in free cash flow in 2015. You're talking about $100 million in 2016. I understand some of the components, but can you just walk us through, help us understand the bridge that gets you to that -- to those numbers?

There's two big parts, and then I'll pass it over to Steve. The two big parts was the one-time costs associated from separating from Kimberly-Clark and the capital spending, We had a very high capital spending because we had to convert a major piece of manufacturing equipment to be able to make the Medical Devices grade of blue fabric.

This year, we see reducing capital spending back to our more normal levels and much lower one-time expenses. We signaled that one-time expenses being in that $10 million to $15 million rate this year. So Steve?

That's a pretty good breakdown. If we take the 2015 free cash flow of, I'll just round it to $30 million, and then add back that CapEx for 2016, should be more on that 2% to 3%, so call it roughly half of the number that we saw in 2015, and then that difference between transitional costs being over $40 million for 2015 and then down to that guidance range of $10 million to $15 million for 2016. That pretty much gets you to that $100 million plus.

But it's pretty encouraging. Clearly, we're generating strong cash. The cash is allowing us to execute our strategy. The cash on the balance sheet, now at more than $130 million, allows us to get that first acquisition done this year. So we're very pleased with that cash flow.

Robert, obviously 2015 turned out to be a more challenging year than you would have hoped, I'm sure. You've given us -- it seems like things are on balance stabilized. A couple of questions related to the outlook for 2016. On the one hand, you've got this reinvestment process and cross-rationalization, operating-efficient initiatives, the new investments, more salespeople, et cetera. How confident are you in the guidance you've given us, this range, relative to the experience you had in 2015? I'm sure you want to get it right this year?

That's the right way to categorize it, Rick. We did stumble out of the gate last year. We over-promised and under-delivered. We don't want to do that again, but we have rolled up a plan that is within the guidance we've given. We feel good about the plan and our ability to deliver on that plan, but there were clearly lessons learned last year.

Thank you.

(Operator Instructions)

Our next question is a follow-up from Kristen Stewart of Deutsche Bank. Please go ahead.

Hi, again. Just going back to M&A. I know you had talked about having things lined up sounds like in the queue, but how should we think about M&A contribution? Should we think about it as acquisitions that should add accretive to growth? Should we think about acquisitions that may be accretive over the next two to three years? How should we just think about these products coming in from a tuck-in perspective, from an accretion point of view?

Thanks, Kristen. The way we think about it is, certainly it should be accretive by the end of year two, both cash accretive and EPS accretive. And to do that and return higher than our cost of capital, which would be 8% to 9%, we clearly see the need to get synergies quickly, both manufacturing synergies and synergies around product line selling. So that's how we think about it. Think about certainly accretion by the end of year two.

Okay. And is that for the larger sized deals or is that for even the small deals, and are you talking about accretion from a cash basis or --?

We think about it for all deals.

ROIC?

Yes, we would think about that for smaller deals, as well as larger deals. At this point, most of the deals we're looking at, as I mentioned earlier, are more of a tuck-in size, $50 million, up to $150 million of sales, and across that full range, certainly we would expect them to be accretive by the end of year two.

Okay. Thank you.

Thank you, Kristen.

Our next question is from Dave Turkaly of JMP Securities. Please go ahead.

Thanks. I just had one really quick follow-up. Obviously ON-Q has had a couple good quarters here. I was wondering if you could just maybe share your outlook for that franchise in your guidance, and then what you expect over the next couple years? Do you think we continue to see a year-over-year growth in that low- to mid-single-digit range? Thanks a lot.

Thanks, Dave. Yes, that's the right way to think about it. We think of ON-Q having -- it was in decline and then it started to return to growth. We'll start to get some numbers that are a little tougher comparisons. We had some pretty low numbers, there, to compare against in the back half of this last year.

But the fact is that it is growing sequentially, and we've had two really good quarters. The key messages are being heard by physicians and by hospital administrators. People understand the options, now, of how to deliver non-narcotic pain relief. So we're optimistic about the growth and profiling, much as you described.

Thank you very much.

And this concludes our question-and-answer session. I would now like to turn the conference back over to Robert Abernathy for any closing remarks.

Thank you. Thank you for your interest today in Halyard Health. I'd also like to point out that Steve and Dave will be presenting next Monday afternoon, March 7, at the Raymond James International Investors Conference in Orlando, Florida. Information about how to access the presentation can be found on the Investor Relations section of our website, halyardhealth.com. Thanks, everyone. Appreciate it.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your line. Have a great day.