Avanos Medical Inc (AVNS) 2016 Q2 法說會逐字稿

Good morning and welcome to the Halyard Health second-quarter 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, Investor Relations. Please go ahead.

Thank you and good morning everyone. It is my pleasure to welcome you to the Halyard Health second-quarter 2016 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 second-quarter performance and discuss the progress we're making on our 2016 objectives. Then Steve will review our second quarter results and provide additional detail on our outlook for the balance of the year. We'll 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 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 will turn the call over to Robert.

Thanks Dave, and good morning everyone. I appreciate your interest in Halyard Health. We're midway through 2016 make a solid progress on our transformation towards becoming a leading medical device Company. We'd previously talked about achieving two objectives this year. Delivering our 2016 plan and fueling our growth pipeline. Today I'll provide an update on both.

Let me talk first about delivering our 2016 plan. I'm pleased to report we delivered another good quarter. With adjusted diluted earnings-per-share of $0.45 and net sales of $400 million, a 3% increase over the prior year. Given our strong start to the year with two solid quarters of performance behind us, we are raising guidance for our full-year adjusted diluted earnings per share by $0.20 to a range of $1.70 to $1.90.

From a segment perspective, Medical Devices grew 12%, in part due to our CORPAK acquisition. But also thanks to our organic performance, which was in line with our expectations. I'm also pleased that in S&IP, in spite of the challenging environment, we were able to repeat our performance from last quarter. Sales grew overall by 1% despite a price loss of 3%.

We are also excited about the progress we've made against our second objective, fueling our growth pipeline through strategic acquisitions and innovation. Let's begin with our recent acquisition of CORPAK, a leader in the enteral feeding market, with diverse products with complement our digestive health portfolio. We are three months into the CORPAK integration and I am pleased with the progress so far. As I mentioned, CORPAK is accelerating the results of our medical devices business and the integration is proceeding on plan. I'm confident that we are well positioned to deliver or exceed our expected commitments as we progress through the year.

We are also fueling our growth pipeline through other strategic investments. Including increased research and development spending to develop new products, differentiate our portfolio, and introduce innovation to maintain Halyard's market-leading positions. To date we have launched 6 new products and we remain on track to launch 10 this year.

In Medical Devices we recently launched a new initial placement kit for enteral access. This product establishes Halyard is a leader in adopting new industry standards for our digestive health category. Additionally we have submitted two 510(k)'s for innovation in our surgical pain category and to launch new medical device products this year.

Turning to S&IP, we launched new exam gloves that enhance our portfolio in the non-acute care market segment and in our Europe, Middle East, and Africa region. Our Black-Fire dual protection glove features breach protection technology, which is designed to protect first responders in a variety of situations. This glove features a black side and a high visibility orange side, enabling EMS professionals to quickly identify breaches in protection caused by cuts and tears.

Also our Flexaprene glove designed for dental professionals is made from chloroprene and is a alternative to latex gloves. These gloves feature a powerful grip and tactile sensitivity comparable to latex, without the risk of allergic reactions. In our surgical category we launched Aero Chrome Performance a AAMI Level 4 surgical gown that combines a full range of protection for high fluid procedures with an unprecedented level of comfort. These are great examples of Halyard bringing innovation to the market and demonstrate our commitment to improving outcomes in safety and reducing the cost of care.

Another key aspect of our transformation into a leading medical devices Company is our ability to generate cash, which we will use to fund our strategic investments. I'm used to say that our free cash flow for the quarter was higher than expected and we anticipate positive cash generation to continue through the balance of the year.

Overall we have built some momentum that we'll take into the back half of the year thanks to our solid earnings, ongoing CORPAK integration, and new product launches. Our transformation into a leading medical device Company is progressing well and our job is to continue to deliver in the second half of the year and beyond. Was that I will turn it over to Steve for a more detailed look at the quarter and our outlook for the balance of the year.

Thank you, Robert. Second quarter sales increased 3% to $400 million, including our CORPAK acquisition that contributed 2% of the growth. Excluding the expected $5 million decline in corporate sales, volumes increased 4%, partially offset by 2% lower selling prices.

Adjusted gross margin was 36% for the quarter compared to 35% a year ago. The increase was driven by the shift in our product portfolio with the addition of CORPAK, favorable currency exchange rates and lower distribution costs, as we cycled against a quarter impacted by the West Coast port disruption. This favorability was partially offset by lower selling prices in S&IP.

Adjusted operating profit and operating margin were $41 million and 10%, respectively, compared to $48 million and 12% a year ago. Improved gross margin was offset by planned higher SG&A investment in R&D spending to support future growth. During the quarter we incurred $2 million of post spin related charges, $9 million in acquisition related charges, $6 million for litigation matters, and $6 million in intangible amortization expense. Adjusted EBITDA was $52 million for the quarter compared to $58 million in the prior year.

As Robert mentioned, we reported $0.45 adjusted diluted earnings per share for the quarter. Our performance was impacted by three factors. First anticipated lower S&IP selling prices were partially offset by increased sales volumes largely in our higher-margin facial protection category. Second favorable currency exchange rates benefited our results. And finally commodity prices were more favorable than expected.

Now turning to our segment results. Medical devices delivered another solid quarter of growth increasing 12% to $142 million driven by 5% organic volume growth and 7% growth attributed to CORPAK. Higher volumes were partially offset by 1% unfavorable selling prices. In digestive health, sales volumes benefited from the timing of orders in our international regions and continued growth in North America. Additionally, COOLIEF contributed another quarter of strong growth in interventional pain in North America. Finally ON-Q growth continued giving us a full year of growth supported by the increasing awareness and acceptance of non-narcotic pain therapies.

Medical devices operating profit for the quarter was $29 million a decrease from $33 million a year ago. Higher sales volumes and favorable currency exchange rates were offset by planned increases in SG&A and R&D spending to fund growth.

Turning to S&IP, net sales increased 1% to $257 million. Sales volumes for the quarter increased 4%. Volume growth continues to come from our focus on exam gloves and an increased demand in facial protection due to the late cold and flu season. Globally our sales volumes in surgical drapes and gowns for the quarter were even compared to the prior year. We are encouraged to see minimal sales loss due to the adverse media exposure related to MICROCOOL gowns. With that said we anticipate sales headwinds in the second half of the year due to a recent transition of a significant customer to a GPO, where we are not currently on contract.

S&IP sales volume gains were partially offset by 3% lower selling prices, concentrated in exam gloves and sterilization. While the S&IP market remains challenging, our price loss was at the midpoint of our expectation. For the quarter S&IP operating profit was $25 million compared to $26 million in the prior year. The impact of lower selling prices was partially mitigated by increased sales volumes, improved cost savings, lower distribution costs, and favorable currency exchange rates compared to last year.

Turning to our balance sheets and cash generation. We ended the quarter with $79 million of cash on hand. Cash from operating activities, less capital expenditures, or free cash flow, totaled $45 million for the quarter. With our strong financial profile and the expectation to repay our CORPAK borrowings by year-end, we have acquisition capacity of up to $400 million to execute additional transactions furthering our Company transformation. 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 raising our full-year adjusted diluted earnings-per-share guidance to a range of $1.70 to $1.90. Based on current trends and our visibility into factors that could affect our performance, we're also updating the following key planning assumptions. Total net sales on a constant currency basis including corporate sales of $5 million to $15 million but excluding CORPAK, are expected to improve from a decline of 2% to 5% to a decline of 2% to 4% compared to 2015. We now expect S&IP net sales, on a constant currency basis and excluding net sales to Kimberly-Clark, to improve from a 3% to 5% decline to a 2% to 4% decline compared to 2015.

We anticipate the foreign currency translation impact to net sales will be flat, which is an improvement from our previous guidance of a negative impact of 0.5% to 1.5% compared to prior year. Based on our commodity outlook, we now anticipate inflation from key inputs to be unchanged from the prior year. A change from our previous guidance of $5 million to $10 million of inflation. The balance of our 2016 key planning assumptions, which we provided on our year-end 2015 conference call on February 29, remain unchanged.

In summary I am pleased with the progress we've made on our objectives of delivering our plan and fueling our growth. We're at the midpoint of the year and we have increased our guidance, the CORPAK integration is on plan, and we have a strong balance sheet. We are well-positioned to continue advancing our transformation into a leading medical devices Company.

With that operator we are ready to take questions.

(Operator Instructions)

Rick Wise, Stifel.

Good morning Robert. Hello everybody. Robert congratulations on the good quarter. Really encouraging. And just to start off, maybe you could force focus on S&IP a little more.

Obviously this is the second quarter of more stability, better performance from S&IP. How confident are you in a broad sense that we are now sort of sustainably on a more solid predictable historically normal ground despite the variables, pluses and minuses? And maybe if you could just as part of that Robert talk a little bit more about are we past the worst of the concerns about MICROCOOL and the potential headwinds there?

Thanks for the question Rick. Let me first say how pleased I am with our S&IP business in the first half of the year. It has really delivered stronger volumes than we anticipated. And as a result of those stronger volumes we have some momentum going into the second half of the year. So we feel good about that.

With that said, price loss continues to be exactly where we thought it would be midpoint of the range at 3% price loss and we still anticipate that level of price loss going into 2017. So there is still the sort of dark clouds around the price loss part of S&IP.

The volume gains have been encouraging, particularly in our glove business. That is one where we added increased focus ever since the spin and we're clearly gaining some market share in the glove category so we feel confident about that. Now in the back half of the year there are going to be some headwinds that we will have to face with S&IP in terms of volume. Steve mentioned a significant customer that shifted to a GPO, where we are not on contract.

We did have some businesses that we lost at the end of last year. And while we've transitioned some of those during the first half of this year will see more impact of some of those lost accounts later this year. We will continue to see price loss as I mentioned. And we will also be cycling against some tougher quarters particularly in exam gloves where we were ramping up late last year with some increased sales in the second half of last year. So this business, S&IP it will continue to be competitive but we are encouraged by a more balanced sort of equilibrium that we have been able to achieve thus far this year.

The second part of your question is relative to MICROCOOL. That has really gone very quiet following the 60 Minutes report. I think our crisis plan focusing on customers, employees and investors has been very effective.

Our S&IP team and our sales organization did an outstanding job of getting to customers literally customer by customer by customer. To reassure in terms of the key talking points that our products are now and have been safe and effective. That was clearly heard. We do anticipate losing about $2 million worth of our surgical sales in North America and that is out of an over $200 million category.

So we do anticipate that, but we are pleased that the loss is not at the level that we had once feared. Encouraged by S&IP. Great first half of the year. Some headwinds coming in the second half. And a big issue that is still on the plate is price loss and we are hoping to see price loss start to drop off certainly in 2018.

One quick follow-up and another question. The account that switched to another GPO, can you quantify that for us? And last Robert, M&A and clearly it seems like CORPAK initially is going well.

But can you talk about the activity around what is next? Clearly the balance sheet is in good shape, cash flow is great. What should we expect and when should we expect it? Strong possibility of something else this year. Thank you so much.

Sure. Let me first talk about the account that shifted from one GPO to the next. And it's Tenet. Tenet switched from MedAssets to HPG and we're not on the contract with HPG. And we were a dual on the contract with MedAssets.

And Tenet is a big customer they have 100 facilities, almost all of which are acute care hospitals. We will see some loss of sales across the Tenet hospital customer base. Obviously will work hard to hold on to as much of that business as we can, but we are anticipating the back half of the year to see some S&IP losses as Tenet switches to HPG.

CORPAK clearly has gone very well. We are pleased with how we started off with the CORPAK acquisition. I would say all of the planning assumptions that we had in place in terms of maintaining the growth of the business in that sort of mid single-digit range is happening. The integration process is exactly on schedule as we thought about.

So we have a high confidence level that we will be able to deliver the $0.05 of earnings accretion this year and the $0.15 of earnings accretion next year. And we're feeling good about our capacity to do another acquisition. So relative to your last question, is there a strong possibility? I wouldn't say strong possibility.

The business development group is in active discussions with bankers and with companies. We have been actively in the process even this last quarter. But clearly we feel good about our ability both from a cash standpoint and from a capacity human resources capacity standpoint to do an acquisition. But most likely it would fall into early next year or mid next year.

Thanks again.

Thank you.

Lawrence Keusch, Raymond James

Good morning gentleman, this is John Hsu in for Larry.

Good morning, John. How are you?

Doing well thanks. Robert if we could start and maybe going back to S&IP, the volumes obviously came in stronger than you had been talking about. You did call out a benefit for late flu.

I think you also mentioned inventory destocking in the 2Q of last year. So again, could you kind of help us parse out some of the pieces and kind of what helped drive that volume versus the kind of 1% range that you've talked about historically?

The biggest benefit that we got in Q2 of this year relative to last year would be the late cold-and-flu season and sales of our facial-protection category. That one swung the number more than any other item. But we are continuing to see a ramp-up of glove sales. That would be the second big one.

We really started seeing a ramp-up of the glove sales about midyear last year. Built some momentum through the third and fourth quarter of last year and now both first and second quarter of this year we have seen a ramp-up in volume with the glove business. So those are the two that kind of stand out in terms of the overall category growth.

Okay. Great. And then just one more on S&IP and then a quick one on med devices. Just your latest thoughts obviously I got your thoughts on that large contract, but how is the second half teeing up and what are you expecting regarding the GPO agreements?

I believe you have roughly 50% of your revenues tied up for GPO agreements that kind of tee up in the back half and renew and then kind of again if you could just walk us through your latest thoughts on the risk of price loss related to those.

We obviously do expect price loss in S&IP on virtually any GPO contract that is negotiated. This is the second year of three years of renegotiating those contracts after commodity prices, particularly polymer and nitrile prices dropped sharply in the fourth quarter of 2014. We do expect price loss on any contracts that get negotiated this year and next year, with GPOs.

This happens to be a busy year for GPO negotiating contracts because we are renegotiating our largest contract, which is now the Vizient surgical contract. It will go into effect April 1 of next year but it is being negotiated this year. We are about halfway through the negotiation process. It is going exactly as you would expect.

There is a technical part of the contract negotiation and there is a pricing part of the contract negotiation. So we are well along in that process now. And we have had a contract with Novation and MedAssets now as they combine we have had contracts with Novation for three decades. We have high confidence and certainly expect that we will be on that contract when it is awarded later this year.

The only thing that I would add John is as we look at this year, our current S&IP price guidance anticipates the renewals. Most of the renewals we will be looking at in the back half will have more impact as we look at 2017.

Okay. Great. And actually maybe if I could switch gears to free cash flow. Obviously you've put up some pretty nice numbers in the first half I believe you've generated just over $80 million in free cash flow.

Yet you kind of kept this guidance the same at $100 million plus so could you kind of just walk us through is that conservative? What is driving, keeping that guidance constant despite the out-performance in the first half? Thank you.

The $100 million is conservative. We have $80 million of free cash flow already, we continue to generate strong cash. We had our strongest cash generation quarter since the spin off was this second-quarter cash generation. So we feel good about the cash generation.

There will be some things that hits in the second half that will cause the cash generation to be lower than the first half. We have bigger tax payments that we make in the second half because we got a tax rebate in the first half that allowed us to have lower tax payments in the first half.

We have slightly increased capital spending in the second half, not dramatically. We've also got some additional spending that's planned across some of the businesses themselves. So we will have some slightly higher, but I think the $100 million is clearly conservative with already $80 million in the bank.

Great. Thank you.

David Lewis, Morgan Stanley.

Good morning, this is actually the Jon Demchick in for David.

Hi, Jon.

I wanted to start off by following up on some of the earlier questions on S&IP. You listed some headwinds but guidance does imply that the positive 1% growth that we have seen in the first half kind of shifts down to maybe a 5% decline into the back half.

It sounds like pricing, the expectations that stays relatively constant. So the main variable that looks to take a stepdown is volumes. And you walked through some of the headwinds but just given the extent of the change is it possible to kind of think about these in buckets of how much they really impact that?

For example obviously Tenet is probably the main difference here. Is that accounting for half of that expected change from the first half to the back half? How should we be thinking about that from a quantity perspective?

I don't think it would represent is much as half. I think price loss is still the biggest component that will hit S&IP in the second half. But in terms of volume itself we're cycling against some tougher quarters. Particularly in exam gloves I think that is going to have a big effect.

You'll probably remember Jon that in the first quarter of this year where we posted a 4% improvement in volume, I said really kind of think of that as being flat to prior year. Because we have that loading for pandemic preparedness in the fourth quarter of 2014. We then had the destocking in one year by distributors and the restocking the following year.

So I said really think about that first quarter of this year as being more like last. And then the second quarter is a legitimate 4% up because really more of the facial-protection volume that came from cold and flu. So I think there are some things as you really look at the volume that the second half we're not going to be having some of those favorable events that occur. But the things that really do hit us you mentioned clearly the Tenet move to HPG will impact us.

I think that is going to have a material effect on volumes for the remainder of the year. And then the lost businesses. We lost a couple of big accounts end of last year that we held onto some of that business through the first part of this year but we'll see more of that loss coming as the year goes on.

Okay. Very helpful. And just to kind of clarify it sounds like with some of the one-off things happening in the first half it sounds like the basic growth of the S&IP on a volume perspective is still in the 1% to 2% area is that the way that you're looking at it?

Yes, that is how we would look at it. We still think that this is a category that is growing about 1% or so based on hospital and surgical utilization rates. And we are constantly focused at maintaining our growing our market shares. So over time we would be focused on making sure that we have a bit of a portfolio play.

We are doing some things on the price side to make sure that we hold market share and doing some other things in some categories to make sure we are able to grow some volume. So it is something that we're constantly looking at to balance that price versus volume equation.

Very helpful. And I just had a quick follow-up for Steve on gross profits. First half of the year has definitely come in a lot stronger than I think we would've expected it to on a gross profit side. Especially given the strength in S&IP. As you head back into the back half of the year and into the next, is there a reason why you can't maintain these gross margin levels where they currently have been?

Obviously, you've had the benefit of less of a headwind from both commodities as well as FX. And then you're going to have device mix I guess building even more with CORPAK into the back half and into the next year. So is this sort of 36% level the right baseline to be looking at now?

Yes, Jon that is exactly right I think we are feeling more optimistic on the gross margin side. Obviously as you said we're getting some tailwind on the manufacturing currencies right now. And we're not seeing the commodity inflation. So those two pieces.

And we are starting to see the device impact in the mix. And with the CORPAK coming in a bit in the second quarter and more as we go forward that is going to ramp-up from a gross-margin standpoint. So yes you are exactly right we probably would call it flat versus closer to 35% maybe we had in our last conversation.

I am pretty encouraged Jon about gross margin moving from 35% to 36%. The real encouraging thing is the proof point around improving our margins as we shift the mix through acquisitions.

The CORPAK acquisition added about 60 basis points of gross margin for us. And as we talk about growing this business into being a leading medical devices Company and improving margins through strategic acquisitions that accelerate our growth and improve our margins, CORPAK is a really good proof point on that.

Thank you very much.

Dave Turkaly, JMP Securities.

Thanks I was wondering just to start off if you could you give us a little more color on the five 10-Ks in the surgical pain area that you filed?

We are not ready to give details on that. We filed those. They will be two of the product launches in our surgical pain business that will be happening later this year. I'm going to save the details for our Marketing Team who likes to make a big splash with some of these launches.

Okay. That's fair. And then ON-Q just color I think you said it grew, but could you put us in the ballpark of what it grew year over year?

It continues to grow in that kind of mid single-digit range as we predicted. This is our fourth quarter of growth. We had predicted it would return to growth following the understanding about how effective our product is relative to competitors' products in terms of giving up to five days of pain relief based on the size of the elastomeric pump. And others not been able to deliver that level of pain relief for that time period.

In addition to that there's just so much that is in the press now about the overuse of narcotic pain medications. Even the federal government getting involved now to start to set some legislative parameters around usage. So we think those two things, the effectiveness of our product and all of the increased publicity that is out there about opioids, is really going to keep this business in growth mode.

Last one from me just looking at the increase to your EPS guidance for the year and sort of where the world is sitting next year. We kind of had always figured 2016 would be a trough from the EPS standpoint. And I know there is a lot of moving parts for you guys, but certainly on the pricing side and S&IP, but some good things happening on devices. Good things with margins.

Do you think it is still prudent to consider 2016 as a trough year in EPS? And given where your range is now for the year what consensus is next year that people actually would assume there would be more of an increase?

I think there is going to be a number of moving parts but I like that idea of this being a trough year. Clearly we're making some major investments this year. We have had a lot of price loss in S&IP this year. But it is too early for us to give any guidance or even estimates for 2017, but we do know price loss in S&IP will continue next year. Probably at a similar rate to what we are seeing of this year.

So we will have to overcome that. But I'm very encouraged by CORPAK adding $0.15 of earnings accretion from the CORPAK acquisition clearly gives us a head start on next year. I am clearly encouraged by our medical device business growing exactly on the estimate that we have given. So I feel good about that one and the momentum it will have going into next year.

And the other thing I'm encouraged by is our innovation. Two years ago we launched 3 new products, last year 6 new products, this year 10 new products. And I am not signaling that line keeps going up year after year, but 10 new product launches this year we will see a bigger impact next year from volume lift from those products. So there are some encouraging things as we look out to 2017 that could help us overcome that price loss.

The other big swing as you always know Dave is commodities and currencies. Those can swing our business pretty dramatically, we've seen that over a series of years. Right now I have no reason to think that commodity and currency will move dramatically for the rest of this year or next year but those always have the possibility of moving us positively or negatively.

Thanks for all of the color.

Thank you.

Matthew Mishan, KeyBanc

Good morning I think you for taking my questions.

Good morning, Matthew.

I guess first question is can you get on HPG and when do you get to bid on that?

We are always, in fact I was there just recently. We have a very gifted Leader that is literally is located, calls on HealthTrust located in Nashville, calling on HealthTrust. So we're always bidding as contracts come up, whether it is a surgical contract or face-mask contract or apparel contract.

We are always in there bidding. But it is just one of those GPOs that we have been less successful than we have been with say Novation or MedAssets or some of the others. But absolutely, we're in there bidding and we have got our best talent on that account.

Can you talk a little bit about the competitive landscape around COOLIEF and RF ablation. I think Boston Scientific just bought a competitive product to that and I [give] Boston Scientific in Saint Jude with a broader portfolio with neuromodulation around the interventional pain. Can you talk about the landscape there?

It is not a surprise to see smaller companies being bought up by bigger companies. This is a growth category as you know. It is the fastest growing business in all of Halyard Health. It's a double-digit grower so when you have the ability to add companies like NeuroTherm being bought by Saint Jude and now Cosman being bought by Boston Scientific that is not a surprise.

Those are businesses that we also would be very happy to add into our portfolio. Those are the sort of businesses that fit our growth profile in terms of fast growing, high margin with a lot of runway left for growth.

The number of competitors haven't shifted. We have been the competing against NeuroTherm and against Cosman. Particularly Cosman has strong positions in Europe so we'll be watching that to see if there's any change in the competitive landscape as a result of being owned by Boston Scientific. But they continue to be a good competitor and we'll now compete against them as part of Boston Sci

On the cost-inflation side and the margin side, even if inflation is kind of flat this year you still have a significant pricing headwind that is flowing straight through the P&L. Can you talk about or quantify at least how much of that pricing headwind you think you are able to offset with productivity initiatives, restructuring and so forth?

Typically we been able to -- and you are exactly right the pricing headwind is predominantly in our S&IP business and the midpoint of our price-loss range would be 3%. So we have to overcome that. Traditionally we find about 1% cost savings in manufacturing and other areas to offset that. We are delivering that again this year so we find about 1% that can overcome that.

We've clearly have objectives to deliver even higher than that amount of cost savings over time to begin to reclaim part of the 200 basis points of margin that we lost from dissynergies and 500 basis points of operating margin that we lost following the spinoff from Kimberly-Clark. So cost savings continues to be a key part of our overall strategy and delivering at least 1% and potentially higher is always in our plan.

Last one [on the] model, as we think about 3Q and the full impact of CORPAK, how much SG&A is related just to CORPAK specifically? And then how much of the SG&A increase is related to the investments?

I don't have a hard number on those to share, but we do have investments that are coming particularly in our interventional pain business as we have added sales people and we've added clinical-affairs people and some researchers to start ramping up that business.

So we will continue to see SG&A ramp-up as associated with that. As well as we will continue to -- we picked up the SG&A that came with the CORPAK business also. So we do expect in the third quarter and fourth quarter to have SG&A go up slightly, but not dramatically.

Thank you very much.

From Q2.

Thanks, Matt.

Kristen Stewart, Deutsche Bank.

Hey guys.

Good morning, Kristen.

Good morning just going back to the Tenet contract. How much of it will we see really impact 2016 versus how much will it fall into 2017? How should we think about that?

We think we'll get a good big of bit of the impact in the second half of 2016 and then of course the full impact next year. HPG seems to be a highly compliant group of hospitals they are much more compliant than you might see from some of the other GPO organizations.

So we expect that the hospitals, they will clearly run out inventory levels that we have with them. We'll work hard to hold onto some. Those that are inclined to not be as compliant on the contract. But I think we'll see a big impact and that is why we built that into some of the volume loss for S&IP in the second half of the year.

Okay. Half of this year, half next I guess.

I think that is a good way to think about it.

Okay. So I guess there was probably some haircutting of that contract probably coming in prior or when you gave guidance I guess originally.

There was, we knew that contract so we had build some of that into the guidance already. But clearly it is more comparing first half of this year to back half of the year. I think that is where you will see the bigger swing in terms of first half. Why didn't we have volume loss and why are we going to happen S&IP volume loss in the second half.

I guess given that the guidance didn't really change all that much or you just kind of tightened the range, what is it that is offsetting the loss of this contract? Just better underlying performance or just increased gloves, gloves doing a little bit better?

In terms of the guidance, clearly we moved it up $0.20. So moving the guidance up $0.20 there is a number of positives. CORPAK is one element of that. But that $0.05 was built into guidance previously.

Continued strong results in our devices business, continues to feel very good. But the biggest difference really in the guidance is: first commodity price where we had signaled $5 million to $10 million of headwinds for the year. We are now saying that is flat, so that is the biggest impact.

And then currency is the next biggest impact where we said that we're not going to see any impact on the sales line from currency and we're going to see some operating profit benefits on currency. The other one that is different that caused us to raise our overall estimate would be S&IP volume in gloves predominantly.

The only piece to add, Kristen, we have been able to offset a little bit of that in the first half because as Robert said earlier we have some known losses in S&IP that the sales team has done a great job of retaining and slowing some of those losses. But as they think about the second half we see some of those beginning to bite.

Okay. The Tenet loss was just in S&IP on the S&IP side?

Yes.

Okay and so it is just basically the better performance in S&IP that you've seen so far this year that you are able to offset whatever your risk-adjusted number had been previously coming into this year?

The majority of the contracts are S&IP. And obviously there's many, many different contracts across all of our categories. But S&IP is the one that we signal that we will expect some volume loss in the second half of the year compared to the first half.

Okay. Despite that you are still tightening the range so it is not as if you are lowering it because you've just lost it but it seems like your just tightening the range for S&IP.

Correct.

All right. And then just kind of looking at you said on SG&A you're just expecting a slight increase because it seems that is also a bit different relative to what you had been talking about kind of coming into the year. Is that also correct? Just trying to understand that commentary as well.

Yes. So compared to Q2, in Q2 we ended SG&A at 23.8% and I would say we will go up slightly from that 23.8%. So think about some increases as there is some phasing of spending later in the year.

We will get -- we only had two months of CORPAK SG&A built-in into this quarter. Each quarter going forward we will have the full impact of CORPAK SG&A added in. So I would take it up a bit from that 23.8%.

Okay. Perfect. And I'll let Steve go work on the taxes since he is clearly still has room to go.

(Laughter) Absolutely. That has not gone unnoticed.

Don't let him off the hook on that one Kristen.

I'm not letting him slide on that. All right. Thanks guys. Have a good one.

(Operator Instructions)

Chris Cooley, Stephens.

Good morning and thanks for taking the questions. Just quickly maybe here at the end could you maybe just give us a little bit more color on the M&A environment? Obviously CORPAK looks to be a very strong acquisition and you alluded to $400 million in capacity at year end.

Just talk to us a little bit about: one, what you are seeing in terms of how close both buyers and sellers are on valuation? And similarly maybe with the change in FX your bias between domestic versus maybe OUS acquisitions? And I have just one other quick follow-up.

Okay. We continue to see a fairly active M&A environment. We're getting a lot of suggestions from bankers of companies that are coming to market or are currently in the market. We have been active in terms of those discussions as I said earlier.

Valuations look to be similar to what they have been over the last year or so. I think the valuations peaked about maybe a year ago and have dropped maybe a slight bit, but not dramatically. And in terms of how far sellers and buyers are apart, can't give you a lot of indication on that. It just depends on business by business. But we obviously were able to come to an agreement on CORPAK and we feel very good about that one.

In terms of how we're thinking about M& A we're still focused on acquisitions that meet our strategic plan. In other words medical devices that are growing at or above the current rate of our medical device growth with margins at or above the margin profile of our medical device business.

So that's really how we're thinking about M& A. I think if we had to give a very general comment, I would say we are seeing more small companies or parts of companies. We are seeing more CORPAK size, more $30 million to $70 million as opposed to $100 million to $500 million acquisition opportunities. Clearly with CORPAK we've been able to take that $50 million-plus acquisition and the integration is underway, so we feel good about that.

Domestic versus foreign, most of the acquisition opportunities we see are still domestic. We do look at acquisition potential that are in Europe or Asia but most of those that come across our desk are domestic.

Thank you and then maybe just two quick housekeeping-type questions for Steve. Steve if I look back through my notes, I think distributor-inventory builds contributed about 1% versus the normal run rate if we go back to the 1Q. Just curious kind of how that trended during the second quarter?

And then lastly for me and I'll get back in queue could you just give us an update on where you are in transitioning some of the product I believe primarily outside of the US it's still Kimberly-Clark signage if you will to Halyard?

Sure. On distributor inventory you're exactly right, Chris, we've built some in the first quarter. Second quarter was a flat, so we didn't feel that distributor inventories increased but nor did they come back down to more normal level. That is one of the factors that impacts the S&IP volume if you look first half, second half. So we have built in a little bit of a drag in the second half assuming those distributor inventories normalize.

And on the second question, yes we continue to be right on track in terms of the rebranding efforts. Right in the throes of it. But I say the light is visible at the end of the tunnel and the teams are continuing to transition. We are working through the long tail of some of those transitions yet. But everything is on track from a budget-and-timing standpoint.

Thank you and congratulations on the great quarter.

Thank you.

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

Just again thank you for your interest in today in Halyard Health. I appreciate you dialing into the call. Thank you.

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