Avanos Medical Inc (AVNS) 2016 Q1 法說會逐字稿

Good morning, and welcome to the Halyard Health First Quarter 2016 Earnings 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 of Investor Relations. Please go ahead, sir.

Thank you, and good morning, everyone. It is my pleasure to welcome you to the Halyard Health First Quarter 2016 Earnings Conference Call. With me this morning are Robert Abernathy, Chairman and CEO; Steve Voskuil, Senior Vice President and CFO; and Chris Lowery, Senior Vice President and Chief Operating Officer. Robert will begin with an assessment of our first quarter performance and discuss our progress on our 2016 objectives; then Steve will review our first quarter results and provide additional detail around our outlook for the balance of the year. We will finish with Q&A with Robert, Steve and Chris. A presentation for today's call is available on the Investors 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 excludes 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. Last quarter, we said 2016 would mark the beginning of Halyard's transformation into a leading medical device company as we enhance our portfolio, our Company and our culture. To advance our transformation, we are committed to achieving two objectives for the year. One, fuel our growth pipeline; and two, deliver our 2016 plan. I'm pleased to say that we've made solid progress on both fronts, starting with the purchase of CORPAK MedSystems. The CORPAK acquisition is Halyard's first as an independent company, and I'm happy to announce that the deal closed Monday.

CORPAK is a leader in the enteral feeding market with a diversified portfolio. The company generated approximately $54 million of sales in 2015. CORPAK improves how patient care is delivered through innovative products such as CORTRAK, which uses visualization technology for safe and accurate feeding tube placement.

CORPAK is the type of company we consider to be a compelling strategic fit for Halyard for two reasons, its product portfolio and its financial profile. CORPAK's portfolio of unique and segment-leading products sold worldwide complements our Digestive Health portfolio. Its call points and manufacturing process fit nicely into our business. In addition, the acquisition creates value for our Company and our shareholders. CORPAK's financial profile aligns with our existing medical devices business with slightly higher sales growth and similar gross margins.

On an adjusted basis, we anticipate that this transaction will be $0.05 accretive this year and approximately $0.15 accretive in 2017. The CORPAK deal is just the beginning of Halyard's transformation, and we intend to execute more acquisitions over time to further shift our portfolio to higher-margin, faster growing medical devices. We are also fueling our growth pipeline through other strategic investments, such as our commitment to increasing our research and development spend in order to introduce new products, differentiate our portfolio and maintain our market-leading positions. As planned, we are on track to introduce 10 new products across S&IP and Medical Devices this year. We're also committed to building on our momentum in interventional pain through increased investment in sales and marketing support and clinical studies.

Now let me turn to our first quarter results. I'm pleased to report that we delivered adjusted diluted earnings per share of $0.53 and net sales of $385 million. Our results benefited from the measured approach we took with discretionary spending, along with incremental improvements in exchange rates and commodities. With one quarter behind us, we remain focused on delivering our 2016 plan. We maintain our full year 2016 adjusted diluted earnings per share to be in the range of $1.50 to $1.70. This includes the $0.05 of accretion related to our CORPAK acquisition that I previously mentioned.

In summary, we are executing well against our two objectives of fueling our growth pipeline and delivering our 2016 plan. We generated solid results and took our first big step in shifting our portfolio to faster growing, higher-margin medical devices with the acquisition of CORPAK. Now before I turn the call over to Steve, I want to address the recent 60 Minutes story about the litigation claims made against our MICROCOOL gowns. First, the story did not contain any new information. It rehashed the same points we've been litigating for the past 18 months. That said, it did present Halyard in an unfavorable light, and that portrayal runs contrary to the reputation of quality and integrity that we've earned during our decades in the healthcare industry. The truth is that our MICROCOOL gowns have an excellent safety record. We have sold over 58 million gowns and have not received a single complaint of injury due to barrier protection.

MICROCOOL's overall quality record is also exceptional with less than one complaint of strikethrough per million gowns sold. Our product quality, as measured by feedback from doctors and nurses is outstanding. They use thousands of our gowns every day and have overwhelmingly endorsed the product. You can be certain that we stand firmly behind the safety and efficacy of all of our products, and we will work hard every day to maintain the trust and confidence of all of our stakeholders, including customers, employees and investors.

Steve, Chris and I will be glad to address your questions during Q&A. In addition, for a more detailed response, visit our website, halyardhealth.com.

With that, I will turn it over to Steve.

Thank you, Robert. First quarter sales totaled $385 million, down 1% on a constant currency basis compared to a year ago. Excluding the expected $13 million decline in corporate sales, volumes increased 4%, partially offset by 2% lower selling prices. Adjusted gross margin was 36% this quarter compared to 34% a year ago. The increase was driven by favorable commodity costs and currency exchange rates with an offset coming from lower selling price in S&IP. Additionally, we incurred lower distribution expense as we cycled against higher prior year costs related to the West Coast port strike.

Adjusted operating profit was $45 million, or 12%, down from $46 million a year ago. Improved gross margin was offset by planned higher research and development spending to support product innovation and SG&A investment for interventional pain to drive organic growth. During the quarter, we incurred $2 million of post-spin-related charges, $1 million in acquisition charges, $4 million for litigation matters, $5 million in intangible amortization expense and $4 million related to the re-measurement of a prior year deferred tax asset due to a statutory tax rate change in Thailand.

Adjusted EBITDA was $55 million for the quarter, which was even with the first quarter a year ago. As Robert mentioned, we reported $0.53 adjusted diluted earnings per share for the quarter. Our performance was impacted by the following three factors. First, our results have benefited from the timing of certain project expenses, primarily marketing related. These are ongoing planned projects, and we anticipate incurring these expenses later in the year to support our marketing and sales efforts behind new product launches.

Second, it had taken us longer than anticipated to fill a number of open roles that we carried into 2016. We anticipate filling these positions this year. Finally, favorable currency exchange rates and commodity cost deflation improved our results.

Now, turning to our segment results. In S&IP, net sales increased 1% on a constant currency basis. Volumes increased 4% as we cycled against the quarter where customers and distributors drew down inventory built up at the end of 2014. We also saw slight volume benefit this year due to distributors building their inventory above their average levels.

Volume growth for the quarter was also bolstered by robust demand in exam gloves in North America, where we have seen our renewed focus drive year-over-year improvements. Volume gains were partially offset by 3% lower selling prices, concentrated in sterilization and exam gloves. While the S&IP markets remain challenging, our price loss was in line with our expectations of a 2% to 4% decline.

For the quarter, S&IP operating profit was $25 million, up from $20 million in the prior year. Commodity cost deflation and favorable currency exchange rates benefited the quarter. The impact of lower selling price was partially mitigated by increased volumes, as well as improved cost savings and lower distribution expense compared to last year.

Turning to medical devices, our business delivered another solid quarter of growth, increasing 4% on a constant currency basis to $127 million. Performance was driven by 5% higher volumes, which was partially offset by 1% unfavorable selling prices. COOLIEF fueled another quarter of double-digit growth in interventional pain in North America.

In respiratory health, despite this year's light cold and flu season, sales volumes benefited from the timing of distributor orders. Also, ON-Q grew year-over-year for the third consecutive quarter supported by the increasing awareness and acceptance of non-narcotic pain therapies.

Medical devices operating profit for the quarter increased to $30 million from $25 million a year ago. Higher volumes and favorable currency exchange rates were partially offset by our planned increase in research and development spending.

Turning to our balance sheet and cash generation, we ended the quarter with $165 million of cash on hand. As a result of lower one-time separation costs and capital expenditures, we achieved our highest quarterly cash generation of free cash flow of $35 million. For the balance of the year, we expect to continue to generate strong cash flow, which we will use to fuel future growth.

Shifting to our guidance for the year as Robert mentioned, we are maintaining our adjusted diluted earnings per share to be in the range of $1.50 to $1.70. This includes the $0.05 of accretion related to our CORPAK acquisition. Also, our 2016 key planning assumptions, which we provided on our year-end 2015 conference call on February 29, remain unchanged.

As the year unfolds, and we gain additional visibility into factors that could affect our performance, such as continued currency and commodity volatility, we will provide an update on our outlook and key planning assumptions as appropriate.

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

(Operator Instruction) Larry Keusch, Raymond James.

Robert, could you, in the S&IP segment, talk a little bit about the competitive environment? Obviously, you referenced that you're seeing some progress with gloves given your renewed focus there, but I'm sort of just curious as to how you're thinking about the competitive dynamics out there. And I think, in the past you talked about -- you felt like the competitors were getting close to a point where it would be more difficult to lean on price, but just wanted to hear your thoughts?

We haven't seen a significant shift in the competitive environment. It continues to remain very competitive. Our planning assumptions around price loss in S&IP continue to be price loss in that 2% to 4% range, and that's exactly what we saw in the first quarter here. We do believe because we've seen an increase in polymer price this last quarter that would have gone across the entire industry that that will start the buffer a little bit, some of the deeper discounting on some of the contract bids, but really no significant change in the overall competitive landscape at this point. As you know, we are a year-and-a-half into renegotiating contracts following the real reduction in commodity price in polymer, and we've got another sort of year-and-a-half to go before all of the big contracts with the GPOs will have been renegotiated. And we expect to continue to see price loss through the remainder of this year and into next year.

Okay, terrific. And then just two quick ones perhaps for Steve. So free cash flow, as you mentioned, was $35 million, obviously a strong number. I think your guidance for the year had sort of indicated $100 million plus, and I recognize the plus side of that. But obviously, you're annualizing now closer to $140 million, so just wanted to get your thoughts around how we should think about the ramp in cash generation for the remainder of the year? And the other quick one was on the post-spin transition costs, I think if I saw this correctly, you're now looking at $0.20 to $0.22 and I believe at the time of the fourth quarter, it was $0.13 to $0.20, so just curious about the change there?

Yes, I'll start with the first one. On cash generation, it was very strong in the first quarter. Obviously, you saw very light CapEx in the first quarter. And I think the kind of counterbalance that we're going to see in the next couple of quarters is the ramp up in the SG&A spending. So, as we talked about on the call, as we spend more on long-term incentives, we spend more on some of the organizational (inaudible), that will be a little bit of a draw on cash as we go into the future. But we still would, obviously, call it over $100 million. I don't think we're going to put a too fine a point on that number, but we're certainly more optimistic coming out of a strong cash quarter.

And Larry, I'll take the second one on post-spin transition cost. Our planning assumption was that it would be in a range from $10 million to $15 million for this year, and we still believe that range is appropriate.

David Lewis, Morgan Stanley.

This is actually Jon Demchick in for David. So Robert, I wanted to start off on the guidance update on the quarter. The results were very strong, especially in S&IP and across gross margins, and from listening to the commentary, it sounds like there's not much that would be one-time in nature. So, I was a bit surprised that guidance didn't move higher. So, as I kind of think about the balance of the year, with FX a little better, commodities cost getting a little better, tax looks a little better, S&IP looks a little better and the beat on the quarter was pretty strong, so why would we not expect to see these results to kind of carry forward throughout the balance of the year?

Yes, Jon, we certainly had that conversation and talked about whether we should maintain current guidance. And ultimately, I just decided it's just too early. We've only got one quarter behind us now. We then went through every one of the planning assumptions on S&IP volume, S&IP price, device volume and price, our cost inflation, commodity cost, all of those, and said each of those planning assumptions still seems appropriate. So, just too early -- planning assumptions still seem right.

There were some items, as we looked at the first quarter we said there are some phasing items particularly around spending and marketing, that we did get some benefits from commodity while we're expecting our commodity cost inflation to impact us by $5 million to $10 million this year. We actually had a positive benefit from currency and from commodities this first quarter that we don't anticipate would continue for the remainder of the year. So, there are a few things that did hit positively in the first quarter, but ultimately, we looked at it and said we think the planning assumptions for the year are still appropriate.

Were there anything one-time in nature kind of in this quarter? Or is it, just business kind of as usual?

No, it was a fairly clean quarter overall, other than the sort of phasing things that we talked about.

We talked a little bit about hirings. So, we're a little behind on hiring. And so that was something we probably had planned to be a little further along on that front that will carry a little bit forward if we fill those roles. It's not unusual, just -- we look to fill those roles in the next couple of quarters.

Okay. Just a couple of quick ones on the 60 Minute report. It is understandable that you guys are 100% behind the products and I'm sure you have the testing to support that as well. But as I watched the report as customers may watch the report, it certainly was not the most positive look of MICROCOOL. So, how do we think about the exposure here? And how have your conversations with customers gone following this report as they think about MICROCOOL versus competitors?

Yes, thank you for bringing it up. We're going to have a lot of conversations about this 60 Minutes report this week and the weeks to follow. And we're particularly focused on our customers, our employees as well as our investors. Specific to your question on customers, many of our customers have expressed support for us, and they understand that we have a strong track record of quality and performance. You heard in my prepared remarks earlier, we've sold 58 million gowns, never had a single issue in terms of injury or harm. We have this extraordinarily low complaint rate and the customers do understand that. We have decades of kind of positive relationships established with the customers. But you categorized it right, this was a -- this reflected very poorly on Halyard, the report did. We take exception with how we were portrayed by 60 Minutes. Once again, it's rehashing information that's been out there all along. In terms of the exposure, it's 3% of sales with the MICROCOOL. So, it is significant. That's a big portion of sales and these are important sales for us. So, I wouldn't want to downplay that much. We will certainly be vigorously communicating the product quality, and we will stay very close to customers through the next couple of weeks; and then particularly into the next round of negotiations with hospitals and group purchasing organizations in our gown business.

How many of -- is MICROCOOL generally a sole-source product with GPO contracts? Or is it multisource or dual source?

Not necessarily sole-sourced. There are some competitive products that make a protection claim similar to MICROCOOL. So, it is a competitive product in the marketplace in terms of our competitors having a similar product with the AAMI 4 claim.

Again just one quick final one for Steve probably. We've seen movement in your bond pricing following that 60 Minutes report, probably around how the uncertainty of MICROCOOL impacts. So, do you think that perhaps could impact your ability to do deals near term or is that less of a concern?

I think as the kind of sensational aspects of this die down, I would expect to see the bond pricing level out. Clearly, a reaction to the story and if we were going to the capital markets today, it would have an impact on our pricing to be sure. But as we look forward, and again we've got a multiyear M&A agenda. I don't see it long term or even as we get past this stage and get to later parts of the year, I don't see it being a big overhang on our ability to access the capital market. And again, as Robert said the underlying facts in the case have not changed. There has really been no evolution. So there's -- we will continue to evaluate that in terms of what if any future cash claims might arise from it. But at this stage, we don't see it impacting the capital markets.

Rick Wise, Stifel.

Let me start off, Robert, maybe -- actually it might be a question for Steve. Steve, could you just flesh out your comment. Several times you talked about -- if I heard you and understood you correctly, distributor inventory build in the quarter. If I understood that correctly, can you give us a little flavor of what that contributed? And does that suggest that second quarter or third quarter sales are less because of that? Is this typical seasonal pattern? Just help us understand a little bit that dynamic?

Sure, sure. So, we see and we try to track movements in distributor inventories. Obviously, it was a big factor in 2015, particularly in the first quarter. This year, we saw just out of the gates about a 1% impact in the first quarter relative to what we say to be our normal run rate for the year. And to your question, could we see that come back in future quarters? We could. Expectation might be we see some of that in the second quarter, but it gets harder to call. Obviously, the distributor inventories are moving all the time. Our data is not perfectly precise, but if you look at the first quarter, we see about 1% impact.

Robert, turning to your ongoing M&A focus, with CORPAK closed, what are your thoughts now about where you go next? Are there other possible deals in the pipeline that we could see this year? And maybe talk a little bit about CORPAK integration. What needs to be done to move that solidly into the portfolio of your selling teams?

Yes, let me start with CORPAK. We were able to close the deal this Monday, very pleased by that. It's the exact strategic fit that we had hoped for, for our first acquisition. We're continuing to look at other acquisitions. We have an active radar screen with acquisitions. And at this point, we said we could be prepared to do another acquisition this year if it was in an area that was not digestive health. It would be difficult for us to do two acquisitions in the digestive health business and properly integrate CORPAK into Halyard Health.

But if there was an acquisition that was attractive, value creating for shareholders, a good strategic fit for Halyard in an area like pain management, we would certainly be a part of that conversation with the company. In terms of CORPAK itself, we have an integration team in place. We were there at CORPAK following the announcement roughly a month ago. The integration process is underway. Our initial focus is to make sure that we maintain the growth momentum and the business momentum that the Company now has. Then the second step in that integration would be to determine how to begin pulling the two companies together, the sales organizations, manufacturing, Headquarters operation. Clearly, we need the talent that is in the CORPAK organization, particularly talent in research, quality, across their selling organization. So, we look forward to that talent joining us. We've communicated to the CORPAK teams that we come back in about 60 days with a very detailed integration plan and be able to share that with them.

And just one last one for me. Coming back to the guidance question again, obviously, you had really nice outsized first quarter performance. You've added this accretive deal, it's closed. It sounds like it's going to integrate smoothly. Obviously, folks like us would think that it could suggest commentary about upper-end of the range or potential -- set the stage for potential move up a bit. To what extent, if any, is the 60 Minutes fallout or concern or maybe incremental caution on MICROCOOL part of your thinking there? I understand it's early in the year, but is that part of the thinking or no, it's just really that -- it's just appropriate giving a wide range to stay here for now?

Yes. Actually, the 60 Minutes was not even considered when we decided to maintain the guidance range. We had a Board meeting here last week before we knew that the 60 Minutes program was airing. We had the conversation with our Board about what we should do with guidance, and we decided and recommended to the Board that we would maintain the guidance.

Then, after our Board meeting was over, Directors had all returned home, that's when we found out on Thursday that there would be a 60 Minutes report airing. So, it didn't factor into our thinking. It really was more about it's just too early and the fact that we thought that the planning assumptions that we were given were still appropriate and that idea that there were some phasing things that are going to come later in the year and that we had some positive things that happened in the first quarter, like currency and commodities.

Thanks for the strong start to the year.

(Operator Instructions) Matthew Mishan, KeyBanc.

So Bob, I think under Kimberly-Clark, I think you've previously said that R&D and sales and marketing was an area of underinvestment for the company. I just wanted to get your sense of confidence that the appropriate investment was made in the overall quality and compliance systems while you were under Kimberly-Clark as well?

Yes, we have a strong quality compliance organization with very well-structured processes for quality compliance. The quality process is the same process that's used by many, if not all medical device companies. It's the process that's audited by and approved by the FDA. So, we've had a strong quality compliance process in place, as part of Kimberly-Clark and it continues as part of Halyard.

In addition to that, we have a strong culture of compliance within the Company. And that culture of compliance goes across areas like safety and quality. So, there is not a concern there. So, the issue now is for us to better communicate that to our customers, to our investors, so that we can restore confidence that's been damaged as a result of this 60 Minutes program.

Okay, great. And then I just wanted to understand a little bit more around the 4% volume gain in S&IP. Could you talk a little bit maybe about the easy comparison you had coming off of the pandemic preparedness and the pull down in inventories? And then put that in context with your overall guidance for the full year for volumes to be down, I think 1% on the full year?

Yes, there were so many moving parts, it's important to kind of remember back. First quarter of last year, we had all the inventory that had been purchased in the fourth quarter of 2014, the pandemic preparedness product that was all pulled down. In addition to that we had some distributor destocking in the first and second quarters of last year and then you compare that to some inventory stocking this year. So, we netted all those out and said, really, if you did an apples-to-apples comparison that our volume would have been roughly flat to very slightly down as opposed to the 4% up.

Okay, I think that makes sense then. And just the last one, you called out cost deflation in the quarter. I think the full year guidance still in place, cost deflation, has something changed in the commodity environment, which may give you a little more confidence that the cost side won't be up as aggressively?

We did get some benefit in the first quarter as we talked about, but polymer price has increased, so that was a negative to our P&L this last quarter. But the benefit came in our nitrile. Nitrile is the key commodity material used in our glove business. So, we got a benefit in nitrile that helped offset the negative in polymer and roughly the benefit was about $1 million in Q1. But looking out, we still expect the full year cost inflation to be in that range of $5 million to $10 million based predominantly on the fact that polymer price is higher now than it was in prior years.

Dave Turkaly, JMP Securities.

Moving over to the device side for a sec, I was wondering if you would mention the ON-Q growth number. And then as we're looking at 5% volume in the quarter and a deal coming on, do you think that volume number alone accelerates throughout 2015 or maybe to something slightly higher than that?

No, we're pleased with ON-Q. This is our third consecutive quarter of growth. We had said early last year that we expected ON-Q to return to growth, and it has. While we don't give the specific numbers, I'll tell you ON-Q was in that sort of mid-single-digit growth range, which we're pleased with. And then the surgical pain category in general, there was an offset a little bit with our IV business, which was down. But, specifically to ON-Q, very pleased by its return to growth.

Great. And then just one or two on the gown side. I was wondering if you would be willing to share, if you looked back trailing 12 months, just that business as a component of S&IP, what do the volumes look like there. Has that business been growing over that period from a volume standpoint?

The gown business over -- and I'll back up for several years, the gown business has been relatively flat. In 2014, we gained some share. In 2015, we lost a little share, but if you go back over several years, plus or minus 0.5% or 1%, we would be either up or down. So, it's a very stable business in terms of its overall volume.

And just a quick follow-up there. How many of these AAMI 4 gowns are there in your portfolio? And have you guys launched any other new ones since 2010?

This is -- there are two AAMI 4 gowns in our portfolio, MICROCOOL is one of those two and we have not (multiple speakers) lost any other AAMI 4 gowns.

Larry Keusch, Raymond James.

Yes, just one quick one. Obviously, you don't provide quarterly guidance and there were a bunch of moving pieces in this quarter. So, I was wondering if you could give us some sense of that $0.53. I'm assuming it was ahead of your expectations and if it was, just help us bridge again on a per share basis kind of what the benefits were there?

Yes, certainly the benefits -- are you talking about Q1 this year versus Q2 last year? Or would you like to bridge more toward expectations going out for the remainder of the year, Larry?

No, I was really just trying to wrap my arms around the $0.53, what you were actually anticipating for the quarter. And again, I'm assuming it did better and what kind of got you there was really, what I was trying to understand?

Yes exactly. So, there are a couple of things that clearly moved in our favor. The volume benefits in S&IP were favorable to our expectation. Gross margin, both commodities and currency was a nice benefit. And then the one that really kind of stood out was some hiring delays. We're filling positions and we are behind in filling the positions. We do intend to fill those for the rest of the year. So, we got a pretty big benefit in SG&A from just having vacant positions that will be filled later in the year..

Yes, the only thing I would add is we've also kept marketing and advertising fees more towards the back of the year. Absolutely, we've got 9 of the 10 innovations yet to hit the market. And so we expect to see that profile harder as we go forward in the next three quarters.

So, would that be -- is that $0.10, $0.15 on that $0.53? I'm just again trying to get my arms around that.

In order of magnitude, Larry, on the SG&A side, you're probably talking somewhere $0.08, $0.09, something like that. And if you go on to gross margin side and in there is the commodity piece, the currency piece, the absence of as much spending on distribution recalling last year that we had port strike, that by itself is probably another $0.08 or $0.09. Those were the big pieces and then you've got a little bit of tax, a little bit of volume.

(Operator Instructions) Rick Wise, Stifel.

Just one last quick one for me. I don't think anybody asked. Were there any extra selling days in the period?

We're all staring at each other. We'd have to look that up. Not that we're aware of.

Just checking, but thank you. I'm going to take that as a no, if you are not thinking about it.

It wasn't a factor.

And ladies and gentleman, this will conclude our question-and-answer session. I would like to hand the conference back over to Robert Abernathy for his closing thoughts.

Well, thank you today for your interest in Halyard Health. I'll be presenting tomorrow morning at the Deutsche Bank Health Conference in Boston. Information about how to access that presentation can be found on the Investor Relations section of our website, halyardhealth.com. Thank you everyone.

And ladies and gentlemen, this concludes today's presentation. Thank you for attending. You may now disconnect your lines.