Q1 2023 Avanos Medical Inc Earnings Call
Participants
Joseph F. Woody; CEO & Director; Avanos Medical, Inc.
Michael C. Greiner; Senior VP, CFO & Chief Transformation Officer; Avanos Medical, Inc.
Scott Galovan; VP of Strategy & Corporate Development; Avanos Medical, Inc.
Andrew Christopher Ranieri; Equity Analyst; Morgan Stanley, Research Division
Brett Adam Fishbin; Senior Equity Research Associate; KeyBanc Capital Markets Inc., Research Division
Frederick Allen Wise; MD & Senior Equity Research Analyst; Stifel, Nicolaus & Company, Incorporated, Research Division
Unidentified Analyst
Presentation
Operator
Good morning, and welcome to the Avanos Q1 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.
I would now like to turn the conference over to Scott Galovan. Please go ahead.
Scott Galovan
Good morning, everyone, and thanks for joining us. It's my pleasure to welcome you to Avanos 2023 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 and expectations for 2023 as well as provide an update on the current business environment. Then Michael will discuss additional details regarding our first quarter and 2023 planning assumptions.
We will finish the call with Q&A. A 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. 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 will 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 F. Woody
Thanks, Scott. Good morning, everyone, and thank you for joining us to review our operational and financial results for the first quarter of 2023.
Our first quarter results were generally in line with our expectations. As we noted in our year-end earnings call, our quarterly results for 2023 would likely be uneven given the timing uncertainties associated with our transformation plan including the pace at which we rationalized our product portfolio, eliminate SKUs or accelerate cost savings.
The demand for our products remain strong, and although supply chain disruptions have improved with our backlog coming down $1 million during the quarter, we continue to have a sticky backlog that has limited our ability to fulfill our demand levels. Coming into the year, we anticipated that 2023 would continue to present supply chain headwinds and pockets of product availability challenges, but that as we got to the back half of the year, many of these headwinds would ease and we believe that's still to be the case.
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, we achieved sales of $192 million or a negative 2.9% compared to last year. Excluding both the negative impact of foreign exchange and the $5 million impact related to our previously announced decision to walk away from revenue that was not meeting our returns criteria, organic growth was unfavorable 0.7% for the quarter.
Separately, for the quarter, we generated $0.27 of adjusted diluted earnings per share and greater than $26 million of adjusted EBITDA. While our adjusted gross margin was 56.4% and our SG&A as a percentage of revenue, 41.6% (sic) 48.4%. These results support the transformation priorities we laid out at the JPMorgan conference in January, and which we will expand upon at our Investor Day on June 20.
Now I'll spend the next few minutes discussing our results at the product category level. On a constant currency basis, our adjusted health portfolio grew over 10%, bolstered by our NeoMed business, which posted another strong quarter with over 36% growth versus the prior year as we continue to take advantage of the strong demand for ENfit conversions in North America.
Our legacy enteral feeding product line maintained its global mid-single-digit growth behind the continued expansion of our U.S. CORTRAK standard of care offering.
Our respiratory business declined by a little over 6% with both our closed suction catheters and oral care solutions facing tough comps due to the Omicron spike in early 2022. We anticipate that the respiratory health business will grow 2% for the full year 2023, with normal seasonal ordering patterns returning during the second half of the year.
In total, our Chronic Care business grew greater than 5% in the first quarter. Excluding the negative impact of foreign exchange and low growth, low-margin product care categories, we are no longer selling.
Turning to the Pain portfolio. Sales were down 10% for the quarter with soft results across our Surgical Pain, Game Ready and 5 shot HA product categories, each of which were down at least 10% versus the prior year.
Our interventional pain products categories grew by 1%. As noted on the year-end earnings call, we continue to experience supply headwinds within our surgical pain category. We expect these headwinds to remain a factor throughout the first part of 2023. Alleviating the supply chain challenges is critical as macro dynamic factors impacting the use of our surgical pain products during the past 2 years like hospital staff shortages and overall reduction of electric procedures have subsided, and we are working diligently to take advantage of this improved landscape.
Separately, our HA portfolio experienced a weaker-than-expected first quarter. However, this softness was primarily concentrated in our 5 shot or GenVisc product. 5-Shot market has specific pricing and competitive challenges that are not as prevalent within the 3-shot market.
TriVisc, our 3-shot offering remains in line with our long-term orthopedic [call point] strategy and is performing as anticipated.
Volatility will continue to be a factor throughout the year as we face strong comparables from last year and continue to experience the related swings from entering the ASP reporting environment in Q3 2022. Despite the volatility, we believe we have the right strategies in place to capitalize on the opportunities present in the HA market, including continuing to provide best-in-class service and support, expanding market access through both our direct-to-patient and our specialty pharmacy business and targeting long-term stability and reliability and pricing for our customers, porting characteristics for the orthopedic market, in particular.
Now moving to an update on our 2023 priorities and transformation efforts. We have four key priorities for the next 3 years that will optimize our go-to-market opportunities and meaningfully enhance our financial profile. These priorities include 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.
In the first quarter, we executed well against these priorities as Kerr Holbrook announced his new sales and marketing organization, among other strategic initiatives. Our margin profile was enhanced versus prior year first quarter. We executed against our portfolio optimization strategy and remained on track to deliver at least $10 million in current year operating expense savings.
Additionally, we continue to review our capital allocation priorities, including strategic M&A, and opportunistic share repurchases. We look forward to presenting additional detail regarding this transformation program and the related 3-year financial targets at our Investor Day on June 20 to be held at the Convene 101 Park Avenue location in New York City.
Now I'll turn the call over to Michael, who will continue to lead these efforts and his expanded role as Chief Transformation Officer and will further discuss our first quarter financial results.
Michael C. Greiner
Thanks, Joe. Before diving deeper into these transformation efforts, I'll provide additional color to our first quarter results. Total reported sales for the first quarter was $191.7 million, a decrease of 2.9% compared to last year. Adjusted EBITDA for the quarter was greater than $26 million compared to $23 million a year ago, with EBITDA margin improving 200 basis points versus last year.
Adjusted net income for the quarter totaled almost $13 million compared to $12 million a year ago, translating to $0.27 of adjusted diluted earnings per share versus $0.25 a year ago. We ended the quarter with $96 million of cash on hand and a leverage ratio of 0.8. As Joe already noted, we delivered on both our gross margin and SG&A as a percentage of revenue targets.
Our gross margin for the quarter was 56.4%, a 50 basis point improvement versus the prior year, primarily driven by the positive impact of our manufacturing efficiency programs. We anticipate second quarter gross margin to be slightly improved versus the first quarter.
Separately, SG&A as a percentage of revenue improved by 140 basis points versus the prior year, primarily related to our cost savings efforts to streamline the organization and reduce our external spend profile.
As with gross margin, we anticipate our SG&A levels will be largely similar during the second quarter versus the first quarter with material improvement expected in the second half of the year as our cost management transformation efforts begin to accelerate.
As we previously shared, 2023 will be a transition year, given our product portfolio rationalization and cost management initiatives. And the first quarter was an example of this unevenness with slightly lower revenue than anticipated across some of our product categories while profitability measures were either in line or exceeded our expectations.
In summary, we are pleased with our first quarter execution in total and remain confident in our ability to meet our previously announced guidance for the year of earning between $1.60 and $1.80 of adjusted diluted earnings per share while delivering at least $60 million of free cash flow, excluding the onetime cash costs associated with the restructuring efforts expected to total approximately $25 million.
Finally, including the current year impact of the approximately $35 million annualized impact of product portfolio rationalization, the company anticipates organic revenue growth to be low single digits.
Now turning to our transformation priorities, which are designed to shift their product portfolio over time into a higher growth portfolio, leveraging our cornerstone product families in digested health as well as our orthopedic pain and recovery-focused products. In addition, these priorities will rightsize our cost structure and enhance our operating profitability allowing us to generate significantly greater annual free cash flow over the next 3 years while meaningfully improving ROIC over this transformation horizon.
As already shared, we expect to realize approximately $10 million of savings in 2023, while anticipating $45 million to $55 million of gross cost savings by 2025, most of which will be achieved in 2024.
I will end with reiterating what I shared at the end of my prepared remarks for the year-end earnings call. We are excited to embark on our transformation journey and are confident we will improve on each of our financial metrics as 2023 progresses. With a slow start for the first quarter, followed by acceleration in the back half of the year, similar pacing to what we experienced in 2022. Operator, please open the line for questions.
Question and Answer Session
Operator
(Operator Instructions). The first question comes from David Turkaly from JMP Securities.
Unidentified Analyst
Yes. This is actually [Danny] on for Dave. So just a quick one on gross margin. It was a nice increase during the quarter, and you noted some of that benefited from manufacturing efficiencies and improvement in supply chain, but I guess our question really is more around looking ahead, how should we think about benefits to gross margin for the full year? More specifically, how much of the improvement should we expect from the exiting of lower-margin product lines and other portfolio rationalization efforts versus continued improvement in the supply chain that you've seen?
Michael C. Greiner
Yes. Thanks Dan, for the question. We still anticipate, as we said previously, we will have 100 basis point improvement on our operating margin for the full year. And we've given the uncertainties of the moving pieces, we weren't sure if that was going to come from gross margin. or from our SG&A as a percentage of revenue, our total OpEx spend. But I do think as we move through the year, the 56.4% that we started with in the first quarter, which we were very pleased with the overall execution that you pointed out should land higher for the full year.
Unidentified Analyst
Great. And then just one follow-up. Just on free cash flow. -- an outflow of about $11 million this quarter, and you had called it out as a focus for 2023. So just cadence throughout the year on how -- what we should expect going forward and any other considerations there would be great.
Michael C. Greiner
Yes. So the first quarter for free cash flow is definitely going to be the lowest. It was going to be what we ended up with for the quarter was going to be dependent upon how much execution we had on the transformation and cost savings plan. So we spent as you'll see in the onetime cost in a non-GAAP reconciliation. We spent about $7.5 million in cash in the first quarter for those activities and of course, revenue was a little bit softer than we anticipated.
So the combination of those two had free cash flow a little bit lower than we anticipated in the first quarter. That will be our lowest free cash flow quarter for the year, putting aside some tax payments that we may have. So we should see an improvement in free cash flow through the rest of the year.
Operator
The next question comes from Rick Wise from Stifel.
Frederick Allen Wise
Joe, just to start this off. So far this earnings season, we've heard a lot from much larger companies, obviously, talking about just in general, the macro environment so challenging, but less of a headwind, supply chain stabilizing -- stabilized, et cetera, et cetera. It would be really interesting to hear your perspective on how that -- is that really happening in the world of Avanos? How did they trend in the quarter? How -- what are you seeing so far in second quarter? And sort of how does this all wrap into your outlook for the year?
Joseph F. Woody
Yes, Rick, I mean, a couple of things, and I noted the other earnings calls as well and a lot of the larger companies have the broader portfolio to your point. But they did inside of that inside those comments say that they still made it clear that there were some issues. So for us, specifically, ON-Q and some catheter availability is hurting us there generally. We really had it across the board, though, even in our COOLIEF product line, our ambIT product line, somewhat into Digestive Health, although we did move a lot of that through in the quarter. It's definitely going to improve, but still be with us. We do agree that the second half is likely going to be much, much better, given that these things are going to disappear us. But again, for us, we probably had $4 million to $5 million more that we could have pushed through if we were all the way clear on our backlog.
Michael C. Greiner
I think the other thing too, Rick to add to that is our confidence in reiterating our previously announced guidance is high because we do think the storm clouds are clearing. And some of the things that we missed this quarter were very specific to us our raw materials, our input costs, but we think those -- we think we have visibility to those things clear and giving us confidence to being able to still achieve our full year guidance outcomes.
Joseph F. Woody
And if you do think -- you've been following us for quite some time, and we do have a portfolio that unfortunately starts, as Michael has outlined, slow with Q1 being the weakest. And even if you think about last year, we sort of progressed as each quarter went and then a very large third and fourth quarter.
Frederick Allen Wise
Yes. No, that makes sense. And Michael, maybe this is a question for you. On the interventional pain side, if I'm doing the back of the envelope math correctly, I may not be, please, don't hesitate to correct me. It looks like what I would call the base ex OrthogenRx Pain Management business. It was down sequentially 25% versus the fourth quarter. I know that seasonal sequential good figure, whatever, down 5% to 10%, is that the backlog? Is that component? Is there something else going on? And just maybe I missed your language, is Pain more uniquely affected here? Or you're seeing less of a recovery? Any extra color would be great.
Michael C. Greiner
Yes. No, that's helpful. So it's a couple of things. It's one will you just hit on, which is there is some component and access to material issues there, but in particular, Game Ready had a very strong fourth quarter and a less than optimal first quarter. So a big part of the math that you're doing is Game Ready attributed. In addition, standard RF was also down. That was more attributable to the availability of product.
COOLIEF was by and large a push 4Q to 1Q. So primarily our RF and our Game Ready are the pain points, no pun intended for the weak 4Q to 1Q transition and Interventional Pain.
Frederick Allen Wise
Got you. And just last for me. Joe, I hate to keep being one, but what can I do? asking the M&A question. But I know that you had hoped to have at least one transaction announced before the upcoming June Investor Day, if I remember your words correctly, we're a month or so away from it. Any additional color on M&A front and just help us -- bring us up-to-date.
Joseph F. Woody
Yes, we do feel like we're going to be able to talk about an additional bolt-on for the orthopedic pain business, something that would help us in the Ambulatory Surgical Center strategic area. It's also possible that we'll be able to say some things more explicitly about the portfolio that would be a significant change for us. So we feel pretty good about that. And you know a lot of times we hit it, and it's hard to predict these things, but we're working very hard to make that happen because I think that will be very key for the Investor Day.
Operator
(Operator Instructions)
Michael C. Greiner
I don't think there's anybody else queued up, operator.
Operator
Yes, Sir. There are no more.
Michael C. Greiner
Yes, [Brett] just got in, let's let Brett ask you this question.
Brett Adam Fishbin
Just wanted to ask on guidance. I am thinking about the cadence sequentially. I think you guys kind of have hinted that a little bit of a softer first quarter relative to the low single-digit organic guide. Just wanted to think about the rest of the year, how it plays out? I know you said that the second half would likely be stronger but also just maybe breaking out Pain Management versus Chronic Care and what you'd expect to see as a base case for the rest of the year.
Michael C. Greiner
Yes. So great question. So Q2 is going to look largely similar, give or take, to Q1. There'll be some pushes and takes there, but largely similar to Q1, as we said, I think gross margin will be improved given that we've got some programs there that are picking up momentum. And the back half of the year will be very strong both on the gross margin and the OpEx side. What we'll do an Investor Day in 45 days is give a little more specific layout. We'll kind of pre talk about Q2 given that it will be June 20, and then we'll lay out the back half of the year with more detail, inclusive of some of these transactions, we think we'll be able to get over the finish line to talk about on June 20.
Brett Adam Fishbin
All right. Great. And then just a quick follow-up. I'm not sure if you said in the prepared remarks, if there was any change around the Orthogen expectations for the rest of the year? Does guidance still contemplate relatively flat full year sales versus last year? Or has there been any type of change?
Joseph F. Woody
No. There's been some change there. We talked about really a combination, if you will, of 10% decline in Orthogen in the HA product primarily in the 5-shot area as well as the Game Ready and even the acute pain sector ON_Q Pain. ON-Q being tied to supply chain. So there is that potential that's kind of pulled into our, but we're still lining up to our full year guidance. And one thing we've talked about a lot in this HA environment that we're in is that there's ebbs and flows quarter-to-quarter. -- or customers go away for a bit. They're chasing the best reimbursement and they come back, but it's really going to all kind of even itself out by the end of the year.
Brett Adam Fishbin
So just to clarify quickly, are you still contemplating like flat Orthogen sales relative to last year?
Joseph F. Woody
No, we're not contemplating flat. No.
Michael C. Greiner
TriVisc will be flat to better versus last year or meaningfully better to last year, 5-shot will be down versus last year. We just -- we aren't confident yet we have a sense of exactly what that mix will look like. But in total, it will be down versus last year.
Brett Adam Fishbin
Okay. I guess like lastly for me, would you point to any product areas as a potential offset to guidance like given low single-digit organic was unchanged. And it seems like Orthogen, it might be a little bit lower.
Michael C. Greiner
Yes. Digestive in particular, we also believe there is upside in acute pain as we get visibility to the supply chain issues. And then international as well, we think we have some pockets of strength internationally that have not been fully accounted for.
Operator
The next question comes from Drew Ranieri from Morgan Stanley.
Andrew Christopher Ranieri
Just another on Orthogen for a moment, but I hear you on the 5-injection and 3-injection market, but just curious maybe on the 5-injection, is the decline at all more of just a mix shift into the 3-injection? Can you give a little bit more color there? And then I have a follow-up.
Joseph F. Woody
Yes, yes. I think there's really two things. I mean one is some customers clearly with the reduced reimbursement in that segment, which is -- a lot of it is non-orthopedic segments. It's more of a pain center segment are leaving the business.
The other component of that is that we had a competitor that has a special code in the first quarter. I believe that's going away in Q2 as they start reporting too. So you have a number of customers that kind of moved over for a bit to take advantage. We benefited from that, obviously, in Q4, but we didn't in Q1 that all settles out and our intention is to maintain the base that we'll have of 5, but we're growing and stabilizing in the 3, and we've actually have another focus that is inclusive of additional to (inaudible) new structure, a new VP of sales coming in to focus on the orthopedic space, not only in HA, but in the Ambulatory Surgical Center with some of our other products. And then the bolt-on that we alluded to in the earlier comments.
Andrew Christopher Ranieri
Got it. And then just another follow-up to one of Rick's questions on M&A. But kind of in response to this question, you mentioned there could be more of a portfolio move. It sounds like more of a divestiture than anything. So are we kind of hearing you right into Analyst Day that, that could be something that's still on the table? And should we think about that as a multiple of what you're doing already in kind of the product rationalization for 2023?
Michael C. Greiner
If though we were to do a divestiture, it would be a multiple of the product rationalization. So that's a fair assessment.
Operator
Gentlemen, there are no more questions at this time.
Joseph F. Woody
Again, I want to thank everybody for their continued interest in Avanos. We feel the demand and fundamentals of our products remain strong. We are committed to obviously creating meaningful shareholder value through thoughtful strategic capital allocation. We believe the '22 results have built the necessary foundation to deliver the commitment that we have and are confident in the priorities that we've detailed in the transformation program, combined with our market-leading portfolio in attractive markets. This all positions us for growth, margin expansion and cash flow, as we've outlined and as Michael has talked about in the transformation process. We do look forward to seeing everybody at the June 20 Investor Day to be held at the Convene 101 Park Avenue location in New York City. Have a great rest of your week. Thank you for your interest. Bye.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
