U.S. Markets open in 9 hrs 24 mins

Edited Transcript of HYH earnings conference call or presentation 27-Feb-17 2:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Halyard Health Inc Earnings Call

Atlanta Feb 27, 2017 (Thomson StreetEvents) -- Edited Transcript of Halyard Health Inc earnings conference call or presentation Monday, February 27, 2017 at 2:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Dave Crawford

Halyard Health, Inc. - VP of Treasurer & IR

* Robert Abernathy

Halyard Health, Inc. - Chairman & CEO

* Steve Voskuil

Halyard Health, Inc. - SVP & CFO

================================================================================

Conference Call Participants

================================================================================

* Rick Wise

Stifel Nicolaus - Analyst

* Larry Keusch

Raymond James & Associates, Inc. - Analyst

* Jonathan Demchick

Morgan Stanley - Analyst

* Matthew Mishan

KeyBanc Capital Markets - Analyst

* Kristen Stewart

Deutsche Bank - Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

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

(Operator Instructions)

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

--------------------------------------------------------------------------------

Dave Crawford, Halyard Health, Inc. - VP of Treasurer & IR [2]

--------------------------------------------------------------------------------

Thank you, and good morning, everyone. It is my pleasure to welcome you to the Halyard Health fourth-quarter earnings conference call. With me this morning are Robert Abernathy, Chairman and CEO, and Steve Voskuil, Senior Vice President and CFO. Robert will begin with an assessment of our fourth-quarter and full-year performance against our 2016 priorities and provide an overview of our 2017 priorities and outlook.

Then Steve will review our results and provide additional detail on our planning assumptions for the year. We will finish with Q&A. A presentation for today's call is available on the investor section of our website, halyardhealth.com. As a reminder, our comments today contain forward-looking statements related to the Company, our expected performance, economic conditions and our industry.

No assurance can be given as to the future financial results. Actual results could differ materially from those in 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'll turn the call over to Robert.

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [3]

--------------------------------------------------------------------------------

Thanks, Dave, and good morning, everyone. I appreciate your interest in Halyard Health. Let me start by saying 2016 was a strong year for Halyard. We delivered results ahead of our financial plan, successfully integrated our first acquisition, increased our research and development investment and generated $160 million of free cash flow. My management team and I are pleased with our accomplishments and the progress we made advancing Halyard's transformation into a leading medical devices company.

At this time last year we laid out two main priorities: deliver our plan and fuel our growth pipeline. We delivered on both counts. Fourth-quarter adjusted diluted earnings per share was $0.50 and full-year adjusted diluted earnings per share was $1.97, which came in at the high end of our guidance. Our fourth-quarter net sales of $410 million puts us at $1.6 billion for the year.

Both medical devices and S&IP produced sales in line with or above our expectations. Medical devices net sales increased 15% for the second consecutive quarter and 11% for the year, strengthened by our CORPAK acquisition and solid demand across all categories. S&IP sales were down 2% for the year and declined 4% for the fourth quarter due to lower selling prices.

Looking at our growth pipeline, we successfully executed our first acquisition to augment our medical devices portfolio. We are ahead of plan with our integration and have realized synergies earlier than we expected. We will continue to pursue M&A to fuel growth. We also laid the foundation for growth by increasing our research and development spending last year to $41 million.

In 2016, we launched 11 products, exceeding our expectations and up from 6 the prior year. Finally, we generated free cash flow above our plan. Our strong cash position allows us to invest for more growth in 2017. Now turning to our 2017 priorities. They remain consistent.

We're going to deliver our plan and we're going to fuel our growth pipeline. We will maintain our momentum in medical devices and expect the segment to grow 7% to 9% next year. We will continue to focus on delivering our pain management portfolio by increasing investment and market development and the global expansion of non-opioid pain therapies. In S&IP we expect 2017 sales to be flat to down 2%.

We expect total net sales on a constant currency basis to be flat to up 2% compared to last year. We will continue to increase our investment in innovation and plan to launch more than a dozen new products in 2017. We expect these product introductions to accelerate medical devices growth and maintain our leading market positions in S&IP.

Finally, we will look to execute M&A to help round out our medical devices portfolio and enhance our performance through operational synergies. Overall, we plan to deliver adjusted diluted earnings per share of $1.70 to $2, which reflects our updated commodity planning assumptions.

Now let me update you on our vision to transform Halyard into a leading medical devices company. As a reminder, our transformation centers on three areas: portfolio, Company and culture. Shifting our portfolio to higher margin, faster growing medical devices has always been the cornerstone of our strategy.

Let me give you two examples of our progress to date. First, sales of medical devices represented 38% of our portfolio in the fourth quarter, up from 30% at the time of our separation. We have also experienced a meaningful shift in operating profit during the same period as medical devices generated 64% of our operating profit, up from 37%. We will advance our portfolio shift through continued research and development investment, increased market adoption of non-opioid pain therapies and M&A.

The second part of our transportation is Company, which focuses on our cost structure, supply chain efficiencies and tax rate. These are key areas for us to increase cash flow and enhance our bottom line. While we have made incremental progress in reducing our IT spend as a percent of sales, we have more work ahead of us. In 2017 we will begin to implement steps to consolidate our IT systems.

In 2016 we saw the benefit from our enhanced supply chain capabilities which helped us deliver an improvement in primary working capital. We will seek further opportunities to drive efficiencies. Our tax team remains focused on long-range planning. Their efforts to date have resulted in a 2016 adjusted effective tax rate of 31.9%, better than our expectations.

The final area Halyard's transformation is culture. As a standalone medical devices company, we are driving our teams to be thought leaders across the healthcare landscape, emphasizing value-based innovation and empowering them to make bold decisions in a customer-centric environment. This is our continuing vision for Halyard.

In summary, I am pleased with our 2016 accomplishments. We are carrying momentum into 2017 and are well positioned to continue our transformation into a leading medical devices company. Now, I will turn the call over to Steve who will provide more details on our 2016 performance and 2017 outlook.

--------------------------------------------------------------------------------

Steve Voskuil, Halyard Health, Inc. - SVP & CFO [4]

--------------------------------------------------------------------------------

Thank you, Robert. Let me start by saying that I am pleased that we achieved our 2016 priorities, delivered another solid quarter of earnings and generated strong cash flow. For the quarter, sales increased 2% to $410 million, including CORPAK which contributed 3% of the growth. Favorable currency exchange rates benefited sales by 1%.

Excluding CORPAK, volume increased 2% which was offset by 4% lower price. Adjusted gross margin was 37% for the quarter compared to 34% a year ago. Our portfolio shift to medical devices, bolstered by CORPAK, manufacturing savings and favorable currency exchange rates, drove our margin expansion which more than offset lower selling prices in S&IP.

Adjusted operating profit and operating margin for the quarter were $40 million and 10%, respectively, compared to $41 million and 10% in the prior year. During the quarter, we incurred $10 million of post-spin related charges, $3 million for acquisition-related charges, $5 million for litigation matters and $6 million for intangible amortization expense. Adjusted EBITDA was $51 million for the quarter, which was even compared to the prior year.

As Robert mentioned, we reported $0.50 adjusted diluted earnings per share for the quarter. Several factors contributed to our performance. First, our adjusted effective tax rate for the quarter was 25.7%, which helped drive our full-year tax rate to 31.9%, 110 basis points below the low end of our planning assumptions. While a portion of the decrease was the result of our team's continued tax planning work, we also received a one-time benefit that drove the improvement.

Second, we continue to see a favorable benefit from currency exchange rates, with the Mexican peso driving most of the favorability this quarter. Finally, we saw higher volume in our S&IP business as increased demand for exam gloves continued. Higher than expected price loss in S&IP partially offset these benefits. Additionally, research and development and SG&A spending were higher than expected due to the timing of projects.

Now turning to our segment results, medical devices delivered another solid quarter of growth. Net sales increased 15% to $154 million, driven by 4% organic growth and 10% growth from CORPAK. Medical devices operating profit was $33 million, a 57% increase from $21 million a year ago. Performance was driven by higher sales volumes, which were partially offset by planned higher selling expenses, as well as research and development investment to support our growth opportunities.

S&IP markets remained challenging. On a constant currency basis, net sales decreased by 5% during the quarter to $252 million. Overall, S&IP sales volumes were flat compared to the prior year. Volume growth in exam gloves was partially offset by anticipated lower volume in surgical drapes and gowns. As we have previously discussed, a significant customer is beginning to transition to a GPO where Halyard is not currently on contract.

Lower selling prices, primarily in our exam gloves and sterilization categories, led to a 5% price loss for the quarter. This was above our expectations, as we cycled a tough comparison to last year, due to the timing of distributor fees and rebates. Finally, favorable currency exchange rates added 1% of growth. For the quarter, S&IP operating profit was $19 million compared to $27 million in the prior year. Lower selling prices offset manufacturing cost savings and favorable currency exchange rates compared to the prior year.

Now for a brief recap of our full-year 2016 results. Sales increased 1% to $1.6 billion, including CORPAK which contributed 2% of the growth. Excluding CORPAK and the expected $22 million decline in corporate sales, volumes increased 3% but were offset by 3% lower prices compared to the prior year. Adjusted gross margin was 36% compared to 35% a year ago.

Our mix shift to medical devices, cost savings and favorable currency exchange rates more than offset lower S&IP selling prices. Adjusted operating profit was 11% which was even with the prior year. Higher gross margin was offset by higher planned research and development investment to support growth opportunities in medical devices. Adjusted EBITDA totaled $211 million in 2016 compared to $220 million in the prior year.

Turning to our segments, medical devices sales increased 11% to $567 million, up from $510 million in the prior year driven by 4% organic growth across all categories and 7% growth from CORPAK. Operating profit increased 15% to $124 million from $108 million a year ago. We achieved positive operating leverage as higher sales volumes more than offset higher selling expenses and research and development investments to support growth opportunities.

Moving to S&IP, the volumes increased 2% driven by continued robust demand for exam gloves. For the year, volume growth was offset by 3.5% lower selling prices. Price loss continued to be concentrated in exam gloves and sterilization. Operating profit was $91 million compared to $98 million a year ago. Results were impacted by lower selling prices which were partially offset by favorable currency exchange rates and manufacturing cost savings.

Shifting to our balance sheet and cash generation, we ended the year in a strong financial position with $114 million of cash on hand. Cash from operating activities, less capital expenditures or free cash flow, totaled $38 million for the quarter and $160 million for the year.

I am pleased that we continue to generate strong free cash flow. The improvement this quarter was driven by a significant decrease in our inventories. As a result of our strong cash flow, we repaid the remaining debt used to acquire CORPAK.

Let me turn now to our 2017 outlook and our key planning assumptions for the year. Building on our momentum in 2016, we expect sales of medical devices on a constant currency basis to increase 7% to 9% compared to 2016. This includes approximately 3% growth attributed to CORPAK and an increase in our lower-margin respiratory health category as we recently won a new GPO contract.

Based on the current market conditions, and excluding sales to Kimberly-Clark, we expect S&IP sales on a constant currency basis to be flat to down 2% compared to the prior year. Our outlook for S&IP contemplates lower selling prices of 2% to 4%.

S&IP sales to Kimberly-Clark, which were $52 million in 2016, are expected to range between $40 million and $45 million. Corporate sales, which were $11 million in 2016, are expected to range between $10 million and $15 million. We expect a foreign currency translation impact to net sales of 0% to negative 2% compared to the prior year.

In the past month, the cost of nitrile, a key commodity in our exam glove business, has increased significantly due to supply availability. Therefore, we anticipate commodity inflation for the year to range between $10 million and $20 million. While there is market movement, we believe the underlying factors impacting cost will not continue long term.

As Robert mentioned, we are well on our way to doubling our research and development investment. As a result, we are increasing our 2017 investment to be between $40 million and $45 million. Our adjusted effective tax rate is expected to be in the range of 32% to 34%.

In summary, for the quarter and for the year, we delivered adjusted diluted earnings per share ahead of our guidance. We have a strong balance sheet and remain committed to investing in growth opportunities that advance our transformation into a leading medical devices company. With that, Operator, we are ready to take questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions)

Rick Wise, Stifel.

--------------------------------------------------------------------------------

Rick Wise, Stifel Nicolaus - Analyst [2]

--------------------------------------------------------------------------------

Robert, maybe let's start off with a question about the M&A pipeline outlook for 2017. Obviously you have done a great job with CORPAK. It sounds like there is more to come. As you look ahead to 2017, maybe if you would kindly reflect on your priorities, reflect on what's in the pipeline and do you feel more optimistic, less optimistic today than you did three to six months ago about getting something additional done in 2017?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [3]

--------------------------------------------------------------------------------

Thanks for the question, Rick. Clearly CORPAK has been a tremendous acquisition for us. It just fell right in line in terms of the strategic direction that we want with medical devices so that we can continue to grow medical devices. We were able to deliver synergies earlier than we expected and it's, quite frankly, delivering accretion to our EPS line at a nice strong level.

So that's exactly what we want to duplicate again. To be on strategy, we need to do an acquisition every year. Our radar screen is still quite healthy in terms of the number of potential acquisition targets that are there. We continue to see probably smaller acquisition targets than we had originally hoped for we were completing the spin.

We had hoped for targets that were more $100 million in revenue, up to $200 million in revenue. We're tending to see acquisition targets that are more $30 million up to about $70 million.

We were concerned coming into the year that maybe a lot of companies would wait until they saw tax proposals before they were ready to bring them to market. But we actually haven't seen that. We have seen pretty healthy conversations about bringing companies to market and we are optimistic that we will be able to get an acquisition done this year.

--------------------------------------------------------------------------------

Rick Wise, Stifel Nicolaus - Analyst [4]

--------------------------------------------------------------------------------

That's great. On the R&D front, you called out -- you had spent $40 million in 2016. Now you're contemplating $40 million to $50 million. You launched 11 products.

That's a significant increase. I assume 90% of that is medical devices. Please correct me if that's not the right way to think about it.

But how do we think about the contribution to sales and margins and growth? Is that all, if you will, upside from I assume better price, better mix, better share? Is that all dialed into your forecast or could we imagine that as you build momentum here that could be upside? How do we think about that?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [5]

--------------------------------------------------------------------------------

This is part of our strategy to continue investing in R&D to double our research and development spending over a four year period. We have now completed two years of that ramping up and we have increased our medical device spending by 50% from the time of the spin. And you are right, the majority of this extra spending is in medical devices -- the vast majority of it. We formed a new research area which we call the pain center of excellence.

But with that said, we are also spending slightly higher on our S&IP business to make sure that we're refreshing the product lines. We have been having more and more product launches. That's an indication that the increase spending is paying dividends.

We went from two product launches to six product launches to 11 product launches and now we are signalling next year it will be even higher. I have been warned to stop counting but it will be even more product launches -- more than 12 we said in the script this morning. So far the product launches have been more line extensions or replacements of current products.

So as I'd say, on the revenue line they have predominantly cannibalized some of our own products which is still important to us that we refresh the portfolio, gives us better leverage in terms of price negotiations. It also gives news in the marketplace in terms of improved products. But long term, Rick, what we would like to see is more new to the industry product launches and that's why we are investing in things like our pain center of excellence.

Over time we do expect there would be more revenue generated from the new product launches. And we have built-in revenue generation into the guidance that we are giving today relative to the 11 new products that we launched last year. Some of those new products are getting us into some new categories.

A line of gloves that we call Black-Fire gets us into the first responder category. Another line of gloves gets us into the dental market. So there's optimism about us getting some higher revenue from some of the product launches that happened in 2016.

--------------------------------------------------------------------------------

Rick Wise, Stifel Nicolaus - Analyst [6]

--------------------------------------------------------------------------------

Okay. And just last for me on the EPS guidance. In 2016 you guided to $1.50, $1.70 to $1.97. Let's say half of that was M&A. And I guess the organic upside came from maybe a little faster CORPAK, some ongoing cost-cutting, et cetera.

Help us think through -- obviously your guidance for 2017 doesn't include M&A but it sounds like you are reasonably hopeful you can get something done this year. Help us think through, Robert, some of the puts and takes in maybe getting to the upper end of the range. What's the most critical?

Is it less headwind than expected from S&IP? Is it something with currency? A lot of factors are at work here. Help us think through that if you would.

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [7]

--------------------------------------------------------------------------------

First, let me reflect a little bit on 2016. We did beat our initial guidance by $0.42 and $0.12 of that was CORPAK. And the rest really came from over-delivery and volumes from S&IP versus our original guidance as well as benefits from currency and commodity during the year.

So it was a combination of some things that were just pleasant surprises in terms of tailwinds and other things were a lot of hard work like CORPAK and like the volume growth in S&IP. This year looking forward -- what would get us to the top end of the range? I think there's two things to point out.

Number one is if the commodity impact from Nitrile doesn't hit as hard as we've currently built into the forecast, that would certainly allow us to get to the top end. So we have built in the negative impact from Nitrile pricing that just came through in January. We expect that pricing to hit predominantly in the first half of the year.

So we will be able to see just in the next few months whether that comes in about where we planned or maybe not quite as impactful as we had built into the plan. So that's one way we could get into the top end of the range. You mentioned S&IP price, that's obviously the second big element.

If we came in at that low end of that pricing range, more of a 2% price loss rather than that midpoint of 3%, that would allow us to get to the top end of the range as well. So those are the two factors that moved it a lot. But we're going to work on some other things.

We over-delivered cost savings this year and we've got a strong plan going into the year to generate even higher cost savings to help offset some of the commodity input costs that are there. We talked a lot during this last year about potentially 2016 being the trough year for us in terms of EPS. And we're certainly going to do everything we can to get to the high end of this range that we have given you so that 2016 will end up being the trough year for us.

--------------------------------------------------------------------------------

Rick Wise, Stifel Nicolaus - Analyst [8]

--------------------------------------------------------------------------------

Thank you very much.

--------------------------------------------------------------------------------

Operator [9]

--------------------------------------------------------------------------------

Larry Keusch, Raymond James.

--------------------------------------------------------------------------------

Larry Keusch, Raymond James & Associates, Inc. - Analyst [10]

--------------------------------------------------------------------------------

Thanks for taking my question. I guess, Robert, just big picture on S&IP -- I just want to make sure I understand how you are seeking to optimize that portfolio. And I guess I'm thinking in the context of you saw a negative 5% price headwind in the fourth quarter. You're looking for minus 2% to minus 4% for next year.

I think you indicated you saw some soft demand in surgical drapes and gowns. You're saying good volume in gloves yet it sounds like you are taking price there. So just help us think big picture how we should be think about how you're optimizing that overall portfolio.

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [11]

--------------------------------------------------------------------------------

Let me start by talking about price loss in S&IP. We didn't really see any fundamental differences in the fourth quarter in terms of price dynamics in the marketplace than we had in the quarters before that. What we did see though was some timing on distributor fees on rebates that caused the number to be slightly higher compared to prior year.

And as we analyze that and then take that away, we are quite comfortable with the price range that we are guiding you to for this year of a 2% to 4% price loss in S&IP. In terms of how we think about it, we have had strong growth -- volume growth in gloves.

We will continue to leverage that to be able to make sure that we are growing the top line, getting some volume growth in the business. We will continue to use the lever to hold down price loss. Just a reminder -- I think we have updated many times that about half of the price loss is coming in our glove business.

And potentially with slightly higher Nitrile prices, which is the key raw material that goes into gloves, maybe there won't be as much price pressure in this year as we built into the plan. The other way we think about the S&IP business is maintaining our market-leading position.

So doing everything we can to hold margins, drive volume and get cost savings that will help offset some of the price loss. So that's really how we're managing the business, very strong cost savings programs to help offset some price loss, to help hold margins while we maintain our market-leading positions.

--------------------------------------------------------------------------------

Larry Keusch, Raymond James & Associates, Inc. - Analyst [12]

--------------------------------------------------------------------------------

Okay. Terrific. And then two other ones -- I guess just thinking broadly about your tax structure. How should we think about -- I am assuming obviously the guidance is based on the current tax codes, but how are you guys thinking about the fact that you do a lot of manufacturing of the blue non-woven materials here and then move that down to Mexico for cutting and sewing and then bring that back into the US?

Does that make you a net importer, net exporter? What's the right way to think about it? And, Steve, also, just relative to free cash flow and the outlook for 2017, can you help us think about -- obviously 2016 was a very strong year -- but help us think about cash flow from ops for 2017 as well as CapEx spending.

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [13]

--------------------------------------------------------------------------------

Sure. Let me start with tax. It's a good news story. At the time of the spinoff we had a tax rate of 38% and we just completed this year with a tax rate right at 32%. So a lot of hard work by the tax team to get that tax rate down to 32%.

Now we did get a benefit in the that was a one-time benefit that was worth about maybe $0.02, two pennies. So that won't happen again. But it was a nice little benefit for the fourth quarter to get that $0.02 of extra tax.

Going forward, we are a net importer, specific to your question. Yes, we manufacture the blue fabric in North America, then send it across the border either to Honduras or Mexico where those products are then converted into the finished product that's then brought back. We have about anywhere, depending on how you look at it, anywhere from 20% to 40% of our COGS are produced outside the US.

So we are a net importer. Also as a reminder though, the way our tax structure is set up in Mexico we are a full US taxpayer for our manufactured products in Mexico. So that makes us slightly different than others that might be importing from Mexico. And if there's any legislation that would look at duties importing from Mexico, we would certainly remind and lobby specific to the fact that we are already a full US taxpayer on those manufactured products.

--------------------------------------------------------------------------------

Steve Voskuil, Halyard Health, Inc. - SVP & CFO [14]

--------------------------------------------------------------------------------

All I would add -- I'll switch to the cash flow question -- is until the legislation settles down and we get more visibility, it's just tough to call what the impacts are going to be. We've got more room here with the model build to -- whether it's a border adjustment scheme or something else to react to and give more clarity. But today, as Robert said, how [maquilas] are treated and what is considered a cost end-market is still not fully defined.

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [15]

--------------------------------------------------------------------------------

But the good news story is a corporate tax rate adjustment would be great benefit for Halyard. If that was to come through without any offsetting adjustments across border imports, then we certainly would have a nice upside benefit to us on the tax line.

--------------------------------------------------------------------------------

Steve Voskuil, Halyard Health, Inc. - SVP & CFO [16]

--------------------------------------------------------------------------------

That's right. On the cash flow question, yes, a fantastic year in 2016. It certainly exceeded our expectations. As we've talked about all year and especially the back half of the year, we got a lot of help by working capital improvement and, in particular, inventory. We had talked in the past that once we got past the bolus of the TC branded inventory and the complexities of the spin that we'd have some opportunity to reduce inventory.

And so we were able to take advantage of that as well as some new planning tools to help manage inventory more thoughtfully. So as we go to 2017 we would love to see some or improvement from a working capital standpoint but I doubt we're going to drop $40 million, $50 million like we did this year through cash flow. So from a guidance standpoint, I would like to see free cash flow again be over $100 million for the year.

I think that's where we'd start out. And then we will get after things like working capital and cost savings and other things that contribute to that as well. And I think we're going to see in 2017 CapEx return to a little more normal level at 2% to 3% of sales where as we were fairly light on CapEx in 2016.

--------------------------------------------------------------------------------

Larry Keusch, Raymond James & Associates, Inc. - Analyst [17]

--------------------------------------------------------------------------------

Okay. Terrific. Thanks, guys.

--------------------------------------------------------------------------------

Operator [18]

--------------------------------------------------------------------------------

Jonathan Demchick, Morgan Stanley.

--------------------------------------------------------------------------------

Jonathan Demchick, Morgan Stanley - Analyst [19]

--------------------------------------------------------------------------------

Thanks for taking the questions. Robert, I wanted to start off with a question on guidance and I guess specifically on margins. You mentioned, and we talked about it a little earlier on the call, but 2016 there was a lot of upside to the original earnings guidance number even adjusted for the CORPAK deal. This year it looks basically similar levels of upside are going to be a little more challenging with pricing and commodity headwinds.

And as I run the math, this could be roughly a 2 point headwind to margins. So two questions, first does the math on headwinds from pricing commodity sound about right? And second, are there enough offsets to hold margins flat year-over-year even as you continue to invest in the device business?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [20]

--------------------------------------------------------------------------------

On the margin front we're very pleased with what we were able to accomplish in 2016 -- gross margins up 190 basis points. And that came from a number of areas, cost savings a big part of that CORPAK of course. We got some benefits from currency as well as some volume gains with mixed shift to medical devices. So as we go into 2017, I would say our challenge is to hold that margin level where we are and not allow it to go down.

And in order to do that, we have got to offset the higher commodity input cost so it's going to be back to a similar theme to what we had in 2016 -- strong cost savings to help offset part of that, continuing to see that mix shift getting the full year of CORPAK benefit. So those things are the levers that we will have available to us to offset any of the commodity headwind that we have to be able to roughly hold those margins flat year-on-year.

--------------------------------------------------------------------------------

Jonathan Demchick, Morgan Stanley - Analyst [21]

--------------------------------------------------------------------------------

Thanks. And I had a quick follow-up on the device franchise. I guess organically it looks like you are expecting about 4% to 6% which is encouraging and looks to expect basically stability from this past year to even acceleration. And as I think about the acceleration, obviously part of that seems to be related to the new GPO contract in respiratory that you mentioned.

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [22]

--------------------------------------------------------------------------------

Yes.

--------------------------------------------------------------------------------

Jonathan Demchick, Morgan Stanley - Analyst [23]

--------------------------------------------------------------------------------

So can you help us quantify how large of an impact that is? And then what you are assuming for your broader pain franchises and how they're going to contribute relative to last year?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [24]

--------------------------------------------------------------------------------

We typically don't give a size of an individual contract but think of it more in the $10 million to $15 million in sales range for that particular contract. So that's what's delivering about over a two year period -- sorry, Dave just told me over a two-year period that's what the sales would be delivered. So it accounts for most of that 1% extra growth in the category. So instead of 3% to 5%, think of it just as you said Jonathan 4% to 6%.

That is slightly lower margins so factor that into your models as well. But underlying that we are really pleased that our surgical pain business, ON-Q business, it returned to growth this last year. We are expecting good growth next year. We're expecting continued strong double-digit growth in our COOLIEF interventional pain business.

And we are expecting nice continued growth from CORPAK and our digestive health business. And then just strong continued growth, a low single-digit growth in our respiratory care. So the fundamentals of the business are still right on plan, right on strategy and then layering on that new contract is certainly a benefit for us.

--------------------------------------------------------------------------------

Jonathan Demchick, Morgan Stanley - Analyst [25]

--------------------------------------------------------------------------------

Understood. Thank you very much.

--------------------------------------------------------------------------------

Operator [26]

--------------------------------------------------------------------------------

(Operator Instructions)

Matthew Mishan, KeyBanc.

--------------------------------------------------------------------------------

Matthew Mishan, KeyBanc Capital Markets - Analyst [27]

--------------------------------------------------------------------------------

Could you guys give us a little bit more color on the commodity inflation? I think you mentioned there is a shortage. What's causing the shortage?

When is it expected to alleviate? And then also I think the last couple of quarters you mentioned the FX benefit of the peso was an offset to commodities. Is that going to be the case in 2017 as well?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [28]

--------------------------------------------------------------------------------

Let me start with the commodity increase. The base materials for the gloves, the Nitrile gloves is butadiene and acrylonitrile. And those have gone up predominantly because those same materials are used in automobile parts manufacturing, specifically tires in China. So some of the base material has swung away from natural rubber latex and has swung into making automobile tires for China.

There has also been some manufacturing downs for their yearly maintenance that have occurred. So the spike that we are seeing is really going to be in the first quarter of this year and then maybe into the second quarter. So that's why I say I think the entire hit will happen in the first half of the year.

The forecast coming out in the second half of the year really pulled the prices down to what we've been experiencing over the last couple of years. So that's why in our text we talked about it returning to more normal levels.

In terms of long-term prospect, there's really nothing that's out of balance in terms of the supply demand ratio in this business. We think it's a couple of month spike in the particular cost of butadiene and the input cost for the Nitrile for the glove business.

--------------------------------------------------------------------------------

Steve Voskuil, Halyard Health, Inc. - SVP & CFO [29]

--------------------------------------------------------------------------------

And with respect to the peso, I think as we started the year and had the plan, I think we expected that currency benefits to help offset most of the commodity impact, as Robert said. This most recent update on the Nitrile front will make that more challenging now.

--------------------------------------------------------------------------------

Matthew Mishan, KeyBanc Capital Markets - Analyst [30]

--------------------------------------------------------------------------------

Okay. Perfect. And then if I am not mistaken, the consolidation of IT is a big piece of the dissynergies you had talked about when you post spin. Could you kind of quantify the savings or what you said in the past on what could potentially be the benefit of bringing that up to scale?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [31]

--------------------------------------------------------------------------------

We have talked in the past about potentially a couple of hundred basis points of margin improvement coming from the consolidation of IT. When we first spun off we were at 6% of sales was our IT cost. After getting -- becoming independent from Kimberly-Clark, we got that down a bit but we still have got a ways to go to get down to 3% of sales.

So there's a couple of hundred basis points of cost savings left to be delivered in the IT area. And it really does come from consolidation of systems. And then all the benefits that can come from that -- just better utilization of the systems across our businesses.

--------------------------------------------------------------------------------

Steve Voskuil, Halyard Health, Inc. - SVP & CFO [32]

--------------------------------------------------------------------------------

And a lot of focus in that area -- we talked, I think, on the last earnings call of doing some consulting pre-work -- the last -- typically the fourth quarter getting ready for the next steps. And as you can imagine, it's something you want to manage the disruption and the transition very carefully. And so we've got some data harmonization and other pre-work that we will need to complete before we go full speed ahead with the actual system transition. But as Robert said, that remains a very high priority because of the leverage it can bring to the P&L.

--------------------------------------------------------------------------------

Matthew Mishan, KeyBanc Capital Markets - Analyst [33]

--------------------------------------------------------------------------------

Perfect. And [Tessera] seems to be moving closer to a nerve block indication. How confident are you that versus 2014 when they did -- when they were able to impact your sales, how confident are you that if they did get the nerve block indication that it wouldn't impact overall med device gross?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [34]

--------------------------------------------------------------------------------

Certainly if they got the indication that, that would be a competitive issue that we would have to overcome. We have got a strong position there. We have been following closely their comments about getting the indication. But we feel strongly that our product categories, particularly surgical pain categories with the elastomeric pump business, ON-Q business, its return to growth.

We think it's more about penetration of the category and our key businesses and ON-Q that we're still in less than 10% of the surgeries that we believe should be using our product. So it's really less about market share gain versus competition. It's more about growing the total category against opioids, narcotic pain medications.

--------------------------------------------------------------------------------

Matthew Mishan, KeyBanc Capital Markets - Analyst [35]

--------------------------------------------------------------------------------

Okay. And then last question, just on the percentage of GPO contracts that you have now renegotiated at a lower price. How many more -- what percentage do you still have that's left to go there?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [36]

--------------------------------------------------------------------------------

We have completed over 80% now because the largest contract, the Vizient contract, we talked about -- that's now been negotiated. It goes into effect on April 1. We were pleased with the outcome of that contract as we have signaled a number of times. So with that one complete, we are at over 80% of the contracts have now been renegotiated at the lower input cost.

So we have got the tail that's left to complete for the rest of this year. And then as a reminder, glove contracts come up all the time. So that still represents 50% of our price loss but the main GPO contracts -- we're into the last stretch here.

--------------------------------------------------------------------------------

Matthew Mishan, KeyBanc Capital Markets - Analyst [37]

--------------------------------------------------------------------------------

All right. Thank you very much.

--------------------------------------------------------------------------------

Operator [38]

--------------------------------------------------------------------------------

Kristen Stewart, Deutsche Bank.

--------------------------------------------------------------------------------

Kristen Stewart, Deutsche Bank - Analyst [39]

--------------------------------------------------------------------------------

I was just curious if you could go through the spread in terms of the guidance. If I look at the guidance for this year, it's $1.70 to $2 and last year was at least beginning with $1.45 to $1.65. So clearly you guys have surpassed that. But I was wondering what's the reason behind the $0.30 spread? Is it just a lack in confidence of where price is or is it just leaving yourself a little bit more room in terms of the commodity cost? I guess why just a little more wide spread this year relative to last year?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [40]

--------------------------------------------------------------------------------

It's a good question because we did spread it out this year. For the last two years we've had a $0.20 spread and we like that $0.20 spread. But we got the higher Nitrile price right at the time where we were putting this guidance together.

And the numbers were pretty --the range of numbers was big and we said lets take into account the full range. If it goes in our favor we could hit that top end of the range and then 2016 would be the trough year and we would be able to grow earnings year-on-year.

If it swung, as I said the first half of the year, most of the impact of the higher Nitrile prices there -- if that was to continue longer in the year then we built in the lower end of the range. It would be -- if it stayed higher for more of the full-year rather than just part of the year. But you are right. We went to a wider range entirely because of the Nitrile price -- no other reason.

--------------------------------------------------------------------------------

Kristen Stewart, Deutsche Bank - Analyst [41]

--------------------------------------------------------------------------------

Okay. And then just thinking about the GPO contract that has gone off, has the amount of business that you have been able to retain been in line with your expectations on the S&IP side?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [42]

--------------------------------------------------------------------------------

Yes, it has. We don't see a lot of change in business, particularly in surgical drapes and gowns. We see more churn in another businesses like gloves.

But, yes, we have been able to retain the business, are quite pleased with our overall maintaining market leadership positions and haven't seen specific loss other than what we accounted for from the post 60 Minutes report. Lost about $2 million there and then from the change of a GPO contract that we signaled last year that happened through the fourth-quarter and is now under way. But we are right on target of what we had modeled to lose in those areas.

--------------------------------------------------------------------------------

Kristen Stewart, Deutsche Bank - Analyst [43]

--------------------------------------------------------------------------------

Okay. And then last question, just in terms of having all these -- and by I guess 80% of the contracts renegotiated at the lower input costs -- is Nitrile the main input that we should be looking to in terms of input costs going up as a main concern in terms of margin compression for you guys? Or are there other things that we should watch now that all these contracts are renegotiated at lower prices?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [44]

--------------------------------------------------------------------------------

So the two big input costs that we have are polymer, which is polyethylene, polypropylene as well as Nitrile. We are actually getting a slight improvement in price on the polymer for the year. And then Nitrile is the only one that's moving negatively.

--------------------------------------------------------------------------------

Steve Voskuil, Halyard Health, Inc. - SVP & CFO [45]

--------------------------------------------------------------------------------

The only thing I would add is in the last two forecast, although polymers have benefit, we've seen it move up in the forecast a little bit. And probably -- as you've seen oil tick up a little bit as well. But for us right now, as Robert said, Nitrile is the big mover.

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [46]

--------------------------------------------------------------------------------

Right. But we will get a benefit on polymer year-on-year -- a slight benefit so that's good news.

--------------------------------------------------------------------------------

Kristen Stewart, Deutsche Bank - Analyst [47]

--------------------------------------------------------------------------------

Okay. Great. Thanks, guys.

--------------------------------------------------------------------------------

Operator [48]

--------------------------------------------------------------------------------

(Operator Instructions)

Kristen Stewart, Deutsche Bank.

--------------------------------------------------------------------------------

Kristen Stewart, Deutsche Bank - Analyst [49]

--------------------------------------------------------------------------------

I am back. (laughter) Just one last one. How much is CORPAK accretion in 2017? Because I know you guys over achieved in 2016 and I was just wondering if that number has changed for 2017.

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [50]

--------------------------------------------------------------------------------

No. It's a good news story. We had originally said that we would expect $0.05 of earnings in 2016. We ended up delivering $0.12 and now we are modeling $0.20 for the full year 2017.

--------------------------------------------------------------------------------

Kristen Stewart, Deutsche Bank - Analyst [51]

--------------------------------------------------------------------------------

Okay. And that's incremental over 2016?

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [52]

--------------------------------------------------------------------------------

No, it would be $0.08 incremental. So we delivered $0.12 and now this year, full year we'll deliver $0.20.

--------------------------------------------------------------------------------

Kristen Stewart, Deutsche Bank - Analyst [53]

--------------------------------------------------------------------------------

Okay. Perfect. All right. Thanks very much. That's it for me. I promise.

--------------------------------------------------------------------------------

Operator [54]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Robert Abernathy, Halyard Health, Inc. - Chairman & CEO [55]

--------------------------------------------------------------------------------

Well thank you, again, for your interest in Halyard Health. As you can probably tell, we're optimistic about 2017. Thanks, everyone.

--------------------------------------------------------------------------------

Operator [56]

--------------------------------------------------------------------------------

And thank you, sir. Today's conference has now concluded and we thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.