Q1 2024 Avanos Medical Inc Earnings Call

Participants

Scott Galovan; Senior Vice President, Strategy and M&A; Avanos Medical Inc

Joseph Woody; Chief Executive Officer, Director; Avanos Medical Inc

Michael Greiner; Chief Financial Officer, Senior Vice President, Chief Transformation Officer; Avanos Medical Inc

Kristen Stewart; Analyst; C.L. King & Associates

Daniel Stauder; Analyst; JMP Securities

Presentation

Operator

Good morning, ladies and gentlemen, and welcome to the Avanos First Quarter 2024 earnings conference call. (Operator Instructions) This call is being recorded on Thursday, May 2, 2024.
I would now like to turn the conference over to Scott Galvan. Please go ahead.

Scott Galovan

Good morning, everyone, and thanks for joining us. It's my pleasure to welcome you to Autodesk's 2024 first quarter Earnings Conference Call. Presenting today will be Joe Woody, CEO; and Michael Greiner, Senior Vice President, CFO, and Chief Transformation Officer.
Joe will review our first quarter results, the current business environment, as well as provide an update on our transformation efforts. Michael will share additional detail regarding these topics and affirm our 2024 planning assumptions, we will finish the call with Q&A.
The presentation for today's call is available on the Investors section of our website, avanos.com. As a reminder, our comments today contain forward-looking statements related to the company. Our expected performance, current economic conditions and our industry no assurance can be given as to future financial results and 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 risk factors described in our filings with the SEC. Additionally, we'll be referring to adjusted results and outlook. The press release has information on these adjustments and reconciliations to comparable GAAP financial measures.
Now I'll turn the call over to Joe.

Joseph Woody

Thanks, Scott. Good morning, everyone, and thank you for joining us to review our operational and financial results for the first quarter 2024. First quarter results were in line with our expectations as digestive health continued its consistent performance, and we experienced additional positive shifts in our pain management and recovery business.
As we noted in our 2023 year end earnings call our quarterly performance for 2024 will improve as the year progresses. Following a similar cadence to past years, the demand for our products remains strong and our supply chain organization is executing effectively to support our commercial strategy with our backlog at about $1 million at quarter end. This is a significant improvement over last year's first quarter backorder levels of over $8 million.
We are continuing to make steady progress against each of our transformation priorities, of which both Michael and I will talk further about And as always, our primary focus is on getting patients back to the things that matter as we meet the needs of our customers.
For the quarter, our sales from continuing operations were approximately $166 million adjusted for the effects of foreign exchange and the impact of our strategic decision to discontinue revenue streams that did not meet return criteria specified by our portfolio transformation priority organic sales were up 4.7% compared to a year ago. We generated $0.22 of adjusted diluted earnings per share and above $21 million of adjusted EBITDA from continuing operations.
Our three year transformation priorities continue to drive our execution, and our first quarter results provide confidence in our ability to be within the ranges of the 2025 financial targets we established last year during our Investor Day.
Now I'll spend the next few minutes discussing our results at the product category level our digestive health portfolio continues to deliver excellent results with over 9% organic growth versus prior year. This performance was bolstered by our new unit product line, which posted another terrific quarter, growing double digits versus the prior year.
As we continue to take advantage of the strong demand for infant conversions in North America, while we are currently experiencing solid double-digit growth we anticipate slower growth over the next few quarters as we enter the late stages of the in-pit adoption.
Our legacy enteral feeding business also posted a strong quarter, growing mid-single digits compared to the previous year. As noted during our last call, we anticipate mid to high single digit growth organically for our digestive health portfolio this year and our ability to deliver above-market growth will be supported by innovations. We plan to launch during the back half of the year, expansion into additional global markets with attractive growth prospects, low growth, product rationalization and actionable M&A opportunities.
Now turning to our pain management and recovery portfolio. Sales for this quarter were down approximately 1% excluding the benefit of Darice related sales. The impact of foreign exchange and our previously announced strategic decision to discontinue certain low growth, low margin products.
While our overall surgical pain portfolio was down year over year, our combined ON-Q and IT portfolio was flat for the same period in line with our expectations. Past quarter. Performance are indicators that our new go-to-market strategy and structure for this part of our portfolio support our low single-digit growth expectations for 2024.
The slight year-over-year decline in our IBP business, excluding the positive impact of Durus revenue, was primarily due to strategic rationalization within the low growth low margin product category. The performance of our combined radio frequency ablation portfolio grew by mid-single digits.
We're encouraged by the continued momentum seen in our IBP generator sales, driven by our renewed ASC. strategy and the increasing productivity of our fully deployed new sales structure, further supporting our ASC strategy, our new Trident product line acquired in the deal. This transaction continues to exceed our expectations.
We were able to capture upside opportunities in the first quarter and continue to scale up manufacturing capacity in our Toronto facility to support our growth objectives. Including capitalizing on our promising US market launch.
Our Game Ready portfolio put together another solid quarter coming off our fourth quarter results with double-digit growth this quarter compared to prior year. Finally, our ag portfolio was flat year over year and consistent with our fourth quarter results.
This leveling off of revenue in our ag portfolio as anticipated and aligns with our forecast of a 20% decrease in ag revenue for the full year. We remain confident in our strategies and ability to maintain this level of performance while leveraging long term opportunities for our first quarter performance in our pain management recovery portfolio is not yet where we want it to be.
We're encouraged by the progress we're seeing across each of the pain businesses and I believe these are solid indicators of our ability to deliver mid-single digit growth for 2024, excluding the 20% decline in ag revenue I just noted.
Now moving to our 2023 to 2025 transformation priorities and efforts. As a reminder, we have four key priorities for the next two years that will improve our go to market opportunities and meaningfully enhance our financial profile.
These priorities are strategically and commercially optimizing our organization, transforming our portfolio to focus on categories where we have attractive margin profiles and the right to win, taking additional cost management measures to enhance operating profitability and continuing our path of efficient capital allocation to meaningfully improve our ROIC.
We've made substantial progress against our transformation priorities with accelerating momentum against these priorities. Some of our first quarter highlights include meaningful stability and progress across our patent portfolio.
Strong early execution with our new Trident product line, continued separation efforts associated with the divestiture of our Respiratory Health business, finalizing our commercial sales and marketing organizations to support our second half growth expectations, exceeding 5% adjusted gross margin delivery approaching 60% and completing our latest share repurchase program.
While we're pleased with our first quarter results and the continued progress against each of our transformation priorities, we are focused on delivering consistent results over the coming quarters in order to meet our 2025 financial targets.
Now I'll turn the call over to Michael, who will provide further insight on our financial results and transformation platform.

Michael Greiner

Thanks, Joe. As you shared, we are pleased with our first quarter results, results that show continued progress against our transformation and support our full year targets since 2021, we have been delivering mid to high single-digit growth in our digestive health portfolio and again, delivered that level of performance in the first quarter.
Our Game Ready portfolio grew double digits this quarter compared to prior year. And our newly acquired Trident product line has produced results above our expectations, capitalizing on our US market launch, which kicked off in November of last year and continued momentum in international markets.
As expected, we continue to see price volatility in our HA business. However, we believe we have set the right strategies in place to largely mitigate unfavorable price impact. This quarter our HA sales are in line with our fourth quarter and prior year through higher sales volumes from continuing operations standpoint, net sales were $166.1 million. We generated $21.6 million of adjusted EBITDA and $0.22 of adjusted diluted earnings per share during the quarter.
Adjusted for the effects of foreign exchange and the impact of our strategic decision to discontinue revenue streams that did not meet return criteria specified by our portfolio transformation efforts organic sales were up 4.7% compared to a year ago.
Our adjusted EBITDA grew by 34% compared to a year ago, with adjusted EBITDA margin expansion of 290 basis points. Our adjusted diluted earnings per share grew by 69% compared to a year ago. This margin expansion was positively impacted by top line growth manufacturing and operations execution and continued SG&A optimization efforts.
For the quarter, our adjusted gross margin was 59.8%, which is sequentially favorable to our fourth quarter 2023 results and versus the first quarter of last year. We were able to offset inflation and HA price volatility through our transformation initiatives at the plants and operations level.
We expect adjusted gross margin to be approximately 60% next quarter as well. SG&A as a percentage of revenue stood at 45.8%, reflecting an improvement of 220 basis points compared to the first quarter of last year, primarily related to our cost savings efforts to streamline the organization and reduce our external spend profile.
As you know, this is part of our ongoing journey to further enhance our financial profile with continued improvements throughout 2024, ultimately leading to our 2025 goal of between 38% to 39%. Our performance in the first quarter is tracking with our expectations for the year, reflecting the success of our transformation strategy, which remains our organization's primary focus.
As such, we are reaffirming our 2024 full year guidance with revenue in the range of $685 million to $705 million, representing mid-single digit organic growth, adjusted gross margin to range between 59.5% and 60.5% and SG&A as a percentage of revenue to be between 41% and 42%.
These financial metrics support and adjusted diluted earnings per share of between $1.30 and $1.45 for the year, as well as adjusted EBITDA margin improvement of at least 200 basis points.
Now turning to our financial position and liquidity. Our balance sheet remains strong and continues to provide us with strategic flexibility with $76 million of cash on hand and $177 million of debt outstanding as of March 31, we have maintained bank debt leverage levels meaningfully below one turn over the past nine quarters and will continue to be good stewards of our balance sheet.
While we intend to maintain conservative leverage levels, we will actively pursue strategic M&A opportunities that align with our returns criteria as well as opportunistic share repurchases.
Finally, free cash flow was negative $12 million in the first quarter, roughly as anticipated, driven by year end, variable compensation payouts and onetime cash costs associated with accelerating certain transformation efforts. We anticipate marked improvement in our free cash flow profile in the second quarter and remain confident in our ability to generate approximately $75 million of free cash flow for 2024.
Now turning to some additional highlights specific to our transformation journey that began in 2023. In addition to product portfolio rationalization, the divestiture of our Respiratory Health business, the acquisition of zero share repurchases, organizational changes and meaningful cost management initiatives.
We remain focused on our digestive health and pain management and recovery business strategies, implementing further business process efficiency and cost management initiatives and actively seeking capital allocation opportunities that optimize our return on invested capital.
For the second year of this transformation journey is crucial for achieving the 2025 financial objectives we outlined on Investor Day, which include consistent mid-single digit growth that would drive our organic revenue to approximately $730 million in 2025.
Gross margins surpassing 60% SG&A as a percentage of revenue being between 38% to 39% and free cash flow generation of approximately $100 million in 2025, supported by these operational financial metrics as well as consistent CapEx spend and meaningful improvement in working capital.
Operator, please open the line for questions.

Question and Answer Session

Operator

(Operator Instructions)
Kristin Stewart, CLK.

Kristen Stewart

Thanks for taking the question. Tom and I was just wondering if you could further expand upon your commentary around the pain management business and what kind of gives you the confidence that you're going to see improved results for the balance of the year.

Joseph Woody

Hey, Christine, thanks for the question. Good morning. So a couple of things. I mean, inside of that, we saw Game Ready at double digit growth. We talked about the RF business in that portfolio of RF at sort of mid-single digit growth that got hurt by some exits that we purposely did in that group.
But we also sold 80 generators during the quarter, which sort of shows us that we're trending in the right direction. We're seeing a good adoption of the Trident technology from DuerOS. We see some positive things also in the international business, albeit it's a smaller part of the business.
And the other thing I would say is that on between Amit non Q that leveling off, we see no real potential for low single digit growth for surgical pain this year, which is the first time in a long time. So everything's pointing in the right direction.
We feel like we'll be able to point to some further evidence in Q2. And we're standing by the perspective that outside of HA, which kind of runs through by Q4, we've got a mid-single-digit grower now in that in that pain business for the for the full year.

Kristen Stewart

Perfect. And then I was wondering if we could switch gears and just talk a little bit about your appetite for M&A. You mentioned the low leverage ratio and plenty of firepower to kind of do deals be thinking about potential transactions as we look out over the next 12 to 18 months.

Joseph Woody

I mean, we've been primarily focused in digestive as we lay that out. And again, the types of bolt-ons that we've been doing, we've actually passed on a couple of transactions that we thought were two things really on multiples were a bit high, but also when we looked internally and through third parties at some of the growth perspectives of the businesses that didn't really seem to be there.
And we feel like in this stage of our execution, that's not really where we want to be. But the pipeline itself is robust around digestive. That's probably where you'd likely see something on first coming from us.

Kristen Stewart

Thanks.

Operator

(Operator Instructions)
Daniel Stauder, JMP.

Daniel Stauder

Yes, great, thanks. So first question and just on the gross margin, can Nice to see the improvement. Then you also gave some 2Q commentary that points to another good quarter. But how should we think about Chris Martin, for the rest of the year, you noted that you have been able to offset some of the impacts from HA, but what is baked in or what is assumed as far as A.J. stabilization, the back half of the year and what gets you to the higher end of your guidance range? Thanks.

Joseph Woody

So the gross margin for the year quarter over quarter will be fairly stable, give or take 100 basis points. And to your point, Dennie in the back half of the year, we do anticipate gross margin trends to be above 60%, as you know, our back half of the years are heavier revenue part of the year and the mix in the back half of the year is a little bit more favorable.
And third, it gives us another few months for continuation of the cost savings and other initiatives we're doing at the plant. So very pleased with the first quarter print confidence as we announced on the call today around where we should be in 2Q somewhere around 60%. And then we should be heading north of 60% as we get into the back half of the year based on the few things I just mentioned.
So where we're doing all the right things in the plants, mix is obviously helpful from a Jay, to your point is going to be very stable through the year, we'll be doing somewhere between $9 million and $12 million per quarter each quarter. And that lines up with the negative 20% decline in AEJ that we had indicated on the year-end earnings call.

Daniel Stauder

Great. And then this is a follow-up focusing on that Game Ready double digit growth in the quarter, another strong quarter, but could you just give us any more color on what's driving this and yes, you'll have it above your growth expectations? And then just given the quarter and what you're seeing as far as trends do you still think that mid-single digit growth is what it could be this year or and any color there would be great, sir?

Joseph Woody

No Game Ready, obviously driven by sports medicine and orthopedic procedures. I think you're seeing some of the relationships with distributors and some of the work we've been doing on our direct force starting to pay off. But on top of that, we're on making some strides in the international markets as well as being ready or he had been a little bit more passive before we definitely see Game Ready as a mid-single digit grower.
And then ISM, I was saying earlier, if you take ag out of the equation until we settle out on the pricing element of that, probably in the Q4 ish range. We're more and more confident on the mid-single digit growth of the pain management and recovery business and mid-single digit growth for the full year.

Michael Greiner

One thing I'd just add that it's on the funding that Danny, on the pain business primarily hurt us in the first quarter and pain where our IV infusion and needles kits and trays product families on those are less focused on your obviously, historically, we do have some things throughout the year that we will refocus some energies there and strategies there.
Those are the two categories IV infusion which is in our surgical pain, our grooming and needles kits and trays, which is in our Interventional Pain grouping that really hurt us in the first quarter from a total growth standpoint, but we don't anticipate that to be the case as we enter the back half of the year, which is further supportive tie that Kristen Stewart earlier questions, further supportive of what we will be able to do in the back half of the year in pain in total.

Daniel Stauder

Thank you.

Operator

Thank you. There are no further questions. You may proceed with closing comments, but our focus has been on execution.

Joseph Woody

Good. We've done a lot of things successfully executing on the product exits, divesting our age, making the DRS. acquisition and increasing our share holdings through our repurchase program. I think we're established now that the foundation to meet our midterm financial commitments, our transformation priorities and shaping our portfolio, which we think are in attractive markets.
So we're confident that we're well positioned as we outlined in the script for sales growth, margin expansion and meaningful free cash flow generation through '24 and accelerating that in '25. So I appreciate everyone's attendance on the call. Thank you, and you continued to following of Avanos.

Operator

Ladies and gentlemen, this concludes your conference for today. We thank you for participating, and we ask that you please disconnect your lines.