Avanos Medical Inc (AVNS) 2016 Q3 法說會逐字稿

Welcome to the Halyard Health third-quarter earnings conference call.

(Operator Instructions)

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

Thank you and good morning, everyone. It is my pleasure to welcome you to the Halyard Health third-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 third-quarter performance and discuss the progress we are making on our 2016 objectives. Then Steve will review our third-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's 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. Yesterday marked our second anniversary of establishing Halyard and introducing our long-term strategy of transforming into a leading medical devices company. I'm happy to report that we've made meaningful advances against our goals. Let me briefly illustrate four examples.

Today medical devices represent 37% of our sales, up from 30% 2 years ago. Adjusted gross margin was 36% in the third quarter, compared to 34% in the first quarter of 2015. Research and development spending on medical devices is up almost 50% over the past 2 years, and we are well on our way to doubling our total R&D investment.

And the last point is about cash. As of the third quarter of this year, free cash flow already totaled $122 million, up from $27 million for all of last year. While we have more work to do, we are pleased with our accomplishments over the last two years.

Now shifting to our results. As you will recall, we outlined two priorities for the year, delivering our 2016 plan and fueling our growth pipeline. Today I'll begin by talking about our efforts to drive growth and the strategic investments we have made, beginning with an update on our CORPAK acquisition.

As you know, we closed CORPAK in May and the results to date are better than expected. Largely as a result of accelerated synergies in our headquarters and sales teams and effective integration, we now expect full-year adjusted diluted earnings to range between $1.87 and $1.97 per share. As the integration continues, we are leveraging our digestive health portfolio to deepen our relationships with existing customers to create new sales opportunities and to drive growth in new geographies.

CORPAK is just one of the investments that is helping fuel our growth. We continue to differentiate our portfolio through innovation, and are on track to deliver on our new product launches for the year.

In medical devices we recently launched ON-Q Trac, a mobile app that enables healthcare providers to access real-time patient generated data during recovery to improve patient engagement and collect outcome information. ON-Q Trac enables physicians to provide value-based care that emphasizes the total patient experience, addresses patient outcomes, and improves quality of care.

Halyard's growth investments were possible because of our strong balance sheet and our ability to generate cash. As a result of our strong cash position, we anticipate repaying our CORPAK related borrowing by the end of the year and building capacity to fund additional strategic investments.

Now let me talk about our progress on our 2016 plan. I'm pleased to report we delivered another solid quarter, with adjusted diluted earnings per share of $0.48 and net sales of $398 million, a 2% increase over the prior year. From a segment perspective, medical devices grew 15%, bolstered by our CORPAK acquisition and organic growth, which was at the midpoint of our guidance.

As expected, S&IP markets remain challenging, as sales declined 4% on a constant currency basis. Net selling prices declined 3%, in line with our projections. Despite these challenges, our recently launched exam gloves and AERO CHROME performance surgical gown have resonated well with healthcare workers, demonstrating our commitment to deliver value-added products.

In closing, I'm encouraged by our progress to date, especially our team's ability to identify strategic acquisition targets and to execute integration plans. While we still have work to do, we've made great progress in advancing Halyard's transformation into a leading medical devices company. And with three solid quarters behind us, we are poised to achieve our 2016 objectives.

With that, I'll 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. Let me start by saying that I am pleased that we have exceeded our adjusted diluted earnings-per-share expectations and that we are on track to meet our planning assumptions for the year. For the quarter sales increased 2% to $398 million, including our CORPAK acquisition that contributed 3% of the growth.

Favorable currency exchange rates benefited sales by 1%. Excluding CORPAK and the expected $3 million declining corporate sales, volume was flat and selling prices were lower by 2%. Adjusted gross margin was 36% for the quarter compared to 35% a year ago.

Margin expansion was due to our portfolio shift to medical devices bolstered by our CORPAK acquisition and favorable currency exchange rates. These benefits were partially offset by lower selling prices in S&IP.

Adjusted operating profit and operating margin were $43 million and 11% respectively, compared to $46 million and 12% a year ago. During the quarter, we incurred $7 million of post spin related charges, $4 million for acquisition related charges, $5 million for litigation matters, and $6 million for intangible amortization expense.

Adjusted EBITDA was $53 million for the quarter compared to $56 million in the prior year. As Robert mentioned, we reported $0.48 adjusted diluted earnings per share for the quarter. Two factors strengthened our performance relative to plan.

First, accelerated CORPAK synergies leave us poised to exceed our accretion expectations for the year. Therefore, we anticipate a slightly smaller year-over-year increase in earnings related to CORPAK in 2017. Second, we will have some SG&A expenses hit in the fourth quarter rather than the third as originally planned.

Now turning to our segment results. Medical devices delivered another solid quarter of growth, increasing net sales 15% to $145 million driven by 4% organic volume growth across all categories and 11% growth from CORPAK. Medical devices operating profit was $32 million, a 12% increase from $29 million a year ago. Performance was driven by higher sales volumes, which were partially offset by planned higher selling expense as well as research and development spending to support growth opportunities.

Moving on to S&IP, the markets remain challenging. On a constant currency basis, net sales decreased by 4% to $249 million. Our focus on exam gloves continues to pay off, with another strong quarter of volume growth. Additionally, exam glove growth was aided by higher than expected sales to Kimberly-Clark.

However, this volume growth was offset by anticipated lower sales in surgical drapes and gowns. As we discussed last quarter, a significant customer transition to a GPO where Halyard is not currently on contract. We also saw the impact of previously communicated account losses.

In total sales volumes for the quarter decreased 1%. Lower selling prices, primarily in our exam gloves and sterilization categories, led to a 3% price loss, which was at the midpoint of our expectations. Finally, favorable currency exchange rates added 1% of growth.

For the quarter, S&IP operating profit was $22 million, compared to $26 million in the prior year. The impact of lower selling prices was partially offset by favorable currency exchange rates and manufacturing cost saving compared to last year.

Turning to our balance sheet and cash generation, we ended the quarter with $87 million of cash on hand. Cash from operating activities less capital expenditures, or free cash flow, totaled $42 million for the quarter and $122 million year to date. I'm pleased that we exceeded our cash flow expectations and are rebuilding our acquisition capacity faster than anticipated. For the balance of the year, we expect to continue to generate strong cash flow, which we will use to fund future growth opportunities.

Finally turning to our outlook for the year, we are raising our full-year adjusted diluted earnings-per-share guidance to $1.87 to $1 97, up from $1.70 to $1.90. Based on current trends and our visibility into factors that could affect our performance, we are also updating the following key planning assumption.

We now expect S&IP sales to Kimberly-Clark to be $50 million to $55 million, up from $40 million to $45 million. The balance of our 2016 key planning assumptions, which we provided on our second-quarter conference call on August 3, remain unchanged. In summary, while we have more work to do, we have made progress against our transformation objectives, and our strong balance sheet leaves us well positioned to advance our strategic plan.

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

(Operator Instructions)

Kristen Stewart, Deutsche Bank.

Good morning. This is Brittany Henderson in for Kristen. Congratulations on a nice quarter.

I know it's early yet, but just given the momentum that we saw here in 3Q 2016 and expectations for the remainder of the year, how should we think about some of the puts and takes as we look forward to 2017, just given you're updated thoughts on CORPAK that you highlighted in the prepared remarks as well as any pricing expectations within the S&IP business for 2017? And then I have a follow up.

As we always do we will give guidance in the first quarter of next year. But there are some things that we have communicated about next year, specifically about S&IP pricing, what we think will happen next year and I can update you now on what we think will happen with CORPAK for next year.

On S&IP pricing we've communicated that we expect another year similar to this year, with price loss probably in that 2% to 4% range. We'll be completing our third year of renegotiating contracts. These are typically three-year contracts.

So expect another 2% to 4% price loss in S&IP for next year. On CORPAK obviously we are over-delivering versus what we had previously communicated. We had communicated to expect about $0.05 of accretion this year and $0.15 of accretion next year.

With the run rate that we are experiencing now and getting synergies faster than we had anticipated, we are expecting to get more like $0.12 this year and maybe as much as $0.20 next year. So that gap of say $0.10 incremental year on year might be slightly lower because we'd gotten synergies faster this year. But clearly it's a good news story on CORPAK with up to maybe $0.12 of earnings accretion happening this year and maybe as much as $0.20 is next year.

Okay. That's great news. My second question here, you mentioned the increase in free cash flow thus far this year and your commitment to evaluating further M&A opportunities. Has anything changed in terms of your broader outlook and thoughts on M&A?

I think last quarter you talked about looking for deals that were about the size of CORPAK. With your free cash flow that you're generating now, could you and would you be willing to do something bigger at this point? How are you thinking about that now?

Yes. Most of the deals that are on our radar screen now, the ones that we are in active conversations on, are more CORPAK in size. Sales anywhere from $30 million up to $70 million or so.

But we would absolutely entertain if it was the right strategic fit, met our financial hurdles in terms of expectations of accretion and return the cost of capital that we would expect, that we would certainly entertain deals that would be larger. We believe we've got the financial capability, or we will at the end of this year and into next year, to be able to spend $350 million in cash or so, which would allow us if you are paying 3 to 3.5 times sales as a rough indicator, we could certainly do a deal of $100 million or $150 million in sales.

So I'd love for a deal like that to be available to us. It would meet all our strategic objectives.

Okay. Perfect. Thank you. I'll hop back in the queue. And congratulations on a great quarter.

Thank you.

Larry Keusch, Raymond James.

Thanks very much. Starting with the SG&A comment, I think you mentioned that it was a bit lower in the third quarter than you had anticipated, and it sounds like it will pick up in the fourth. Maybe if you could help expand upon on the SG&A spending?

We have had some phasing of SG&A during the year. We've talked about that over the last couple of quarters. We always knew it was ramping up, so we do expect SG&A to be higher in the fourth quarter than the third quarter.

We've got some spending that we are going to take on in the fourth quarter specific to getting at our high IT cost and looking at ways to get our tax situation into a better position and that spending is more about putting together the roadmap for the future. So there will be some consulting spending that will happen in the fourth quarter related to both tax and IT.

In addition to that we've still got three more product launches that are coming, so there's going to be higher marketing spending related to those product launches. And we're continuing to build out some of the capabilities in terms of filling some vacancies within teams as well as adding some more folks to support some of our growth areas in medical devices. So expect higher SG&A spending in the fourth quarter.

Okay. Just on that, can you just to help us understand how you're thinking about the fourth quarter give us some sense of either what you expect the sequential increase to look like in the fourth quarter, or perhaps in another way what do you think you may have pushed out from the third quarter into the fourth quarter to help us get some sense there?

And then the other question was if you could potentially help us understand the bridge between the prior EPS guidance for the year and the increased guidance for the year. What's specifically getting you to that higher rate outside of the obviously to beat the quarter?

Let me talk about the bridge first and then I will toss it to Steve to talk about the SG&A. In terms of the bridge itself, we are up $0.12 on increasing guidance, over half of that is due to the CORPAK over-delivery, both what's already been delivered in the third quarter and what we see coming in the fourth quarter. So that's over half of the step up to that $0.12 of increase in guidance.

The other bits that are in there, we got a bit of currency that has helped us, and we built that into the remaining forecast. And then SG&A is the other part where we know what we spent through three quarters now, we know what we are ramping up in the fourth quarter, but it's still going to be a lower SG&A spend than we had anticipated in the plan when we gave guidance the last time.

And Larry, just picking up on the OpEx side. I think as a rough guideline think $5 million to $10 million incremental sequentially for the fourth quarter. As Robert said, it's a mixture of some capability investment and as I think we've talked about all year, we've been catching up from a vacancy standpoint as we've gone quarter to quarter. So there will be some incremental expense there as well.

Okay, and that $5 million to $10 million is you said operating expense, but is that just SG&A?

Correct.

Perfect. Thanks, appreciate it.

David Lewis, Morgan Stanley.

Good morning. Just a couple of quick questions here, maybe starting with Steve. Looking at some of the segment detail, your operating profit for S&IP this quarter decline 15%, which we didn't see that trend in the second quarter. I know we've been dealing with these pricing issues all year.

Just interested in why your operating profit fell so sharply in the third quarter versus the second? And I'm assuming CORPAK helped make up the difference for the broader business.

Maybe just talk about that, and then also in light of that, Rob, at our conference you talked very broadly about 2017 margins, and I think you talked about a flattish margin commentary for 2017. I wondered if you could update those comments right now, and I had a quick follow up

On S&IP I think we've benefited in the first half by the volume size. We've been ahead of plan for the first two quarters of course off some weak comps versus prior year. But the price increase -- or price decrease side has been pretty much right on plan, it was the same in the third quarter. We saw the price drop through. We didn't have the benefit of -- on the volume side and saw that piece correct a bit more. So that's where you're seeing some of the gross margin impact in the quarter, from a S&IP standpoint.

And you're right on devices. Devices you get the benefit of CORPAK adding in, and then on the overall also the benefit of devices in our mix as well which covers up some of the S&IP side.

As we think about 2017, not that we're going to give a lot of guidance yet, but I think from our standpoint where we are today we'd see it looking like it does today, but subject to thing like currency and commodities which we still have to get better forecasts and inputs on the uncontrollables for 2017.

Let me talk a little bit about the margins, because I did mention that at the conference. We are really pleased with gross margins, so far we are up 130 basis points year to date. So feel good about our longer-term goal of driving improvements in gross margin.

Clearly some of the gross margin improvement is coming from mix as the CORPAK acquisition has added 90 basis points of gross margin to the overall Halyard business. But with that, with mix, with CORPAK we always have to start by talking about price loss in S&IP. We're expecting another 2% to 4% price loss next year. So if you balance price loss in S&IP along with the CORPAK benefit and improved shifting the mix toward higher margin medical devices, I do think it is going to be relatively flat year on year next year compared to this year.

Okay. Thanks, Robert. Steve, one quick question, your fourth-quarter implied guidance is actually pretty stable frankly with the third quarter. It's just on a dramatically easier comp because the fourth quarter was a pretty soft year for you. You've been conservative all year frankly in your sequential quarterly performance.

Is there some fourth-quarter conservatism priced into that implied guidance? I'm just thinking you could do a little better frankly in light of the easier comp and fourth quarter 2015. Thanks, I'll jump back in queue.

Certainly we'd hope to do better. I think on the other side we still have some variables. We talked all year about the impact of some of the account losses accumulating giving us some of that in the third quarter. Still expecting some more of that the fourth quarter. But certainly we'd hope to be on the higher side of the guidance range from a volume standpoint in S&IP certainly.

As I look at the guidance I'd say we had to hit the midpoint of the guidance that we just issued we'd need a $0.45 fourth quarter. The second quarter of this year we had a $0.45, we just had a $0.48 now.

We've got some additional SG&A spending that I just talked about that's coming in the fourth quarter. So I think that $0.45 as a midpoint of the range feels about right.

Robert and Steve just on a revenue growth perspective, same kind of question, Robert as you think specifically on revenue growth versus earnings in the fourth quarter?

Revenue growth is -- we typically have slightly higher sales in the fourth quarter. Not dramatically higher, but fourth quarter is usually our highest growth for the year. I think the real unknown is S&IP, because we communicated last quarter that we had a major customer hospital group, Tenet, who had shifted from one GPO to the next and the GPO that they shifted to we are not on contract there. We are continuing to see losses of those Tenet hospitals as they shift out away from Halyard products to their new supply.

So that will buffer fourth quarter a little bit. Earlier in the year in S&IP we had said I think about roughly a 1% volume loss. We are now saying think more like that being flat year-on-year in terms of the volume loss. The Tenet, the shift away from the Tenet hospitals is the big unknown there, David.

Okay. Thank you very much.

Matthew Mishan, KeyBanc.

Good morning and thank you for taking my questions. Can you walk us through the commodity environment? I think sequentially you saw several of your base raw material prices moving higher through the third quarter and into the fourth quarter as far as expectations go, but you were able to keep your commodity inflation guidance unchanged.

Yes. Sometimes we get lucky. We had one go up and one go down. So polymer has been the one that has been going negatively for us. But it's been almost equally offset by nitrile, which is used in exam gloves going in the other direction.

So they offset each other this last quarter, and we had very little impact on earnings as a result of commodities. So we are expecting that to stay the same in the fourth quarter as well, with very little impact on our earnings based on commodities. So sometimes you get lucky and one goes one way and one goes the other, sometimes you get unlucky and they both go in the wrong direction.

Fair enough. I don't know if I missed it or not, but can you give us an update on the negotiations around the Novation MedAssets contract? If it's sourced all three players versus being dual sourced previously, what kind of impact would that have on you?

That's a good question. We've been talking about that for the last couple of quarters. Those on the line, this is our largest GPO contract. It's our surgical contract with what was Novation and MedAssets now the combined entity Vizient. That contract is being negotiated now.

Nothing new to report. We are in the final stages of negotiating that contract. We've been on a dual contract with Novation, a dual contract with MedAssets. There will be some pressure for that to be multi, meaning all three suppliers would be on the contract.

If that is the outcome, I actually don't think it will have any significant impact on our business. We're already positioned in hospitals. Hospitals prefer typically to stay with the trusted supplier that they are using. So we're not expecting any big shifts in terms of market share swings resulting from going from -- the potential of going from a dual contract to a multi.

Okay. Great. And then you talked a little bit about ON-Q Trac, but can you talk a little bit also about some of the clinical work you are doing around the interventional pain portfolio?

Yes, we've had some nice clinical work that was completed this last quarter in osteoarthritis, and the clinical work is just now being published. But very strong clinical results showing significant pain reduction scores. That clinical work will be used to further reinforce reimbursements so that we can have a stronger position on getting reimbursements from the payers and so we are excited about that outcome and you will hear more about it over the next quarter.

Okay. Great. Thank you very much. It was a nice quarter.

Chris Cooley, Stephens.

Thank you. Good morning and congratulations as well on a very nice continued progression there in the business.

Two remainders for me here this morning. Can you give us a little bit more of an overview on the general business trends you are seeing in the medical device portfolio across the various pillars there? 4% organic growth, very solid as you mentioned at the midpoint of the guide, but off modestly sequentially.

Just maybe help frame up for us what we should expect to see just from a volume standpoint here through the back half of the year, and if anything in particular is standing out in the 3Q? And then I have one quick follow up.

Yes. This is a reminder for folks that are listening we have four pillars, as Chris just refer to, in our medical device area.

Two of those, our respiratory care and digestive health, are fully penetrated categories, mature categories. They are low single digit growers, tend to grow with hospital utilization and surgical procedure utilization. Then we have two areas that are growing faster, that's our pain management areas so our pain businesses, ON-Q in particular is a mid-single digit grower. And then our chronic pain business, the key part of that is our COOLIEF, and COOLIEF is a double-digit grower.

So when you net all those together sort of low single digit for respiratory and digestive; mid-single digit for ON-Q, the biggest part of our surgical pain business and COOLIEF, the biggest part of our interventional pain business, that's how you net out in that 3% to 5% range where we're hitting roughly a 4% now.

You layer on top of that the acquisition of CORPAK and then you get accelerated growth. So 4% for the base business feels right, and that's what you should expect in the fourth quarter and then ongoing we are continuing to look for those right acquisitions to more rapidly shift the mix of our portfolio to higher margin medical devices.

Super. And then just as a follow on maybe for Steve, you mentioned you have some planned spend in the fourth quarter, really investing now for future growth when you think about the investments to consolidate on the IT side as well as to lower the effective tax rate over time from a planning perspective. Could you just remind us again what the potential savings that you think you could realize over the next 3 to 4 years would be on the IT side, and help us think about how we gate that going forward?

And then similarly as you've looked at the S&IP portfolio now, 2 years has just anniversaried that. Time flies when you're having fun, I guess. Any thoughts on that portfolio? I realize the acquisition focuses on med device, but is the S&IP portfolio right sized as it stands today? I will get back in queue. Thank you.

I will throw the second one over to Robert in a second, but just on the tax rate and IT, and you didn't ask about tax rate but just to mention we are still targeting our guidance for this year, 33% of 35% as we've talked about in past calls. Some of the investment we are making now and assessment is to help drive that lower, certainly down towards the lower 30%. That is something I hope we'll be able to talk about when we do start talking about guidance for next year.

On the IT side, we've talked in the past about needing to recapture the lost basis points that came with the spin and to build out of the standalone infrastructure. Clearly making progress on this portfolio shift part of that basis point recapture through the growth of the device business and now with the addition and growth of the CORPAK business.

The IT piece is part of getting at that remainder and certainly over the next few years it's still our anticipation, our goal to drive some of efficiency in IT, as we've talked about before our spend both in direct IT but also the ancillary costs of running three instances of SAP are pretty heavy. We look at this investment to start setting the table for a progression that can get after a good portion of those remaining basis points.

So we're not ready to profile that out over the next couple of years. The work we're actually doing right now is to help establish with that profile as well as the investment, because we know there's going to be some investment required in order to execute that part of the transformation. I'll say more to come on that one as we better define what the next few years will look like.

Chris, I'll take the one on whether S&IP is right size. I'll answer two ways.

One is that is it the right size in terms of us meeting the needs of the business? It's a $1 billion business for us. We're in the categories where we want to compete, those are the surgical supplies categories as well as exam gloves. We have leading market share, number one or number two market share, across each of those categories. So yes, we think the business is a good size, right size, gives us a lot of scale and brand recognition within hospitals.

In terms of right sized from a spending standpoint, we believe it's right sized there as well. We've taken a couple of opportunities over the last five years to really take the headcount to the right level as we've seen margin erosion occur. In addition to that we've looked at the spending levels across things like marketing, research and development, clinical affairs, and we believe that we'd gotten those right sized as well.

If I had to say what would I tweak a little bit, we are spending a bit more on research and development than we have in the past. That's an area that was underinvested as part of Kimberly-Clark.

So as part of our goal of doubling our research investment we are increasing our research spending in S&IP. But it's still a low research spend relative to the industry. We'll only spend about 1% of sales on S&IP research. That's an appropriate amount for us to be able to refresh the products and bring innovation to the marketplace.

Understood. Thanks again.

(Operator Instructions)

Rick Wise, Stifel.

It's Jamie Fritz on for Rick. Congrats on the good quarter.

Maybe just focusing on ON-Q for a minute. I know you've had some easier comps to date, and now you're comping against a little bit tougher growth profile there.

Maybe just talk about the outlook for ON-Q, what your expectations are there? What is driving that in terms of market dynamics and your competitor on that front? And you mentioned you continue to see this as a mid-single digit grower. Just maybe talk about your confidence in the sustainability of that over time?

Good question. We are facing some tougher comps. Back when we were really declining in sales we lapped all those. So now we're into quarters where we had return to growth this time last year and we do have tougher comps.

But we have got some real tailwinds in the industry as more and more people are aware of the issues related to narcotic pain medications and there's just more pressure on physicians and hospitals to get away from using narcotic pain medications. We're continuing to very strongly market the fact that ours can give you three to five days of non-narcotic -- of surgical pain relief.

We continue to be encouraged by the fact that there is a lot of upside potential in this business as we look at surgical procedures, large incision surgeries like trauma surgeries, hip and knee replacement surgeries that we're -- our ON-Q product is only used in less than 10% of the surgeries, where we believe it would be appropriate to be used. So we still see a lot of growth potential in there and expectation of mid-single digit growth for ON-Q going forward is certainly supported by the trends and issues within the industry.

Okay. Great. And then maybe focusing again on the uptick in R&D spending, and you've talked about your 10 products that you plan to launch this year and on track with that. Should we think about the cadence of new products accelerating from here? And what does that do to the business?

So on R&D spending in our medical device area as part of Kimberly-Clark we were spending less than 3% of sales, we are now spending closer to 5% of sales with an idea to move that up closer to 6% of sales over time. So we're exactly on track where we wanted to be to significantly increase the spending across the full business, but particularly in medical devices.

In terms of what to expect, most of the product launches this year have been adjacencies or line extensions, if you will. And over time what you would expect is that with the research spending that we're going to have more new to the industry, new to Halyard products that are being developed.

We're putting a lot of focus on medical devices, particularly in the pain management area. We formed a new group and hired some outstanding talent and formed a group that we call the pain center of excellence to really focus on opportunities to dramatically expand our pain management technology area. So the research spending should lead to not just more product launches but more meaningful product launches.

Great. Thanks so much. Congrats again on the quarter.

Thanks.

Dave Turkaly, JMP Securities.

Thanks. I know that you mentioned manufacturing cost savings in your operating margin profile for both businesses. I'm just curious if you might be willing to give us a little more color on that.

I know you mentioned some of the input costs on the S&IP side from IT initiatives. Maybe some efficiencies post the spin, but I'm just trying to understand if you have opportunities to improve margins ahead looking at that cost profile?

Dave, I do believe we have opportunities to improve even further, but this year hasn't been a good year if you look at year-over-year comparisons. We typically deliver about 1% cost savings in our S&IP business to offset some of the price loss.

This year in particular it's running at that level or slightly higher because we had some added costs last year from the West Coast dock workers' strike and some other things that were disruptive in the business. We haven't had those external factors like the dock workers' strike this year, so we have seen some nice comparisons to prior year in terms of our cost savings in manufacturing and supply chain.

Long term we'll continue to focus on better utilization at our plants, better labor utilization, reduced waste, higher manufacturing output. We're also focusing on more efficient distribution of our products, that's the good bit of where the cost savings are coming as well. But going forward I would say continue to count on that 1% cost savings in S&IP that's coming from our supply chain.

Great. And then on the ON-Q Trac, I'm curious were customers asking for that? If you could give us any comments on specifically how you think maybe that could impact your position in the market or your growth rate ahead from that product?

Yes. If you said are they asking for it, what they've been asking for, for the longest period of time is a better way to measure pain scores. When you think of the sophistication of hospitals and medical devices, in terms of your pain scores you are still given a little chart with a frowny face on one end and a smiley face on the other end and you're asked to -- asked what your pain score is.

More and more physicians once you're out of the hospital they don't know your pain score because there's not someone there that's recording that. So they wanted more sophistication. They want more feedback on whether their procedure that they're using is better in terms of pain management than other procedures.

So this is a way to get real-time data. It's got patient/customer engagement and it gives feedback to the physician so that they can know real time how those pain scores are progressing in that first week following discharge from the hospital. So it's been really well received.

The physicians are very interested in these numbers. And so as we are trialing it out now, we believe it's not going to be about making a lot of money selling an app, this is all about us being able to better demonstrate clinical outcomes because of the pain scores and showing that our ON-Q really is the most effective clinical treatment.

Thanks a lot.

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

Well thank you again for your interest in Halyard Health. I appreciate you joining us on the call today. Thanks, everyone.

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